Economies of Scale

12ch ap

ter

opening case

W alk into an IKEA store anywhere in the world, and you would recognize it instantly. The warehouse-type stores all sell the same broad range of affordable home furnishings, kitchens, and accessories. Most of the products are instantly recognizable as IKEA merchandise, with their clean yet tasteful lines and functional design. The outside of the store will be wrapped in the blue and yellow colors of the Swedish flag. The store itself will be laid out as a maze that requires customers to walk through every department before they reach the checkout stations. Immediately before the checkout, there is an in-store warehouse where customers can pick up the items they purchased. The furniture is all flat, packed for ease of transportation, and requires assembly by the customer. If you look at the customers in the store, you will see that many of them are in there 20s and 30s. IKEA sells to the same basic customer set the world over: young upwardly mobile people who are looking for tasteful yet inexpensive “disposable” furniture.

A global network of more than 1,050 suppliers based in 53 countries manufactures most of the 9,500 or so products that IKEA sells. IKEA itself focuses on the design of products and works closely with suppliers to bring down manufacturing costs. Developing a new product line can be a painstaking process that takes years. IKEA’s designers will develop a prototype design—a small couch, for example—look at the price that rivals charge for a similar piece, and then work with suppliers to figure out a way to cut prices by 40 percent without compromising on quality. IKEA also manufactures about 10 percent of what it sells in- house and uses the knowledge gained to help its suppliers improve their productivity, thereby lowering costs across the entire supply chain.

It’s a formula that has worked remarkably well. From its roots in Scandinavia, IKEA has grown to become the largest furniture retailer in the world with almost 300 stores in 26 countries and revenues of more than 27 billion euros. IKEA is particularly strong in Europe, where it has 227 stores, but it also has around 50 stores in North America. Its strongest growth recently has been in China, where it had 17 stores in 2013, and Russia, where it had 14 stores.

IKEA

The Strategy of International Business

–continued

338 Part Five The Strategy of International Business

Look a little closer, however, and you will see subtle differences between the IKEA offerings in North America, Europe, and China. In North America, sizes are different to reflect the American demand for bigger beds, furnishings, and kitchenware. This adaptation to local tastes and preferences was the result of a painful learning experience for IKEA. When the company first entered the United States in the late 1980s, it thought that consumers would flock to their stores the same way that they had in western Europe. At first they did, but they didn’t buy as much, and sales fell short of expectations. IKEA discovered that its European-style sofas were not big enough, wardrobe drawers were not deep enough, glasses were too small, and kitchens didn’t fit U.S. appliances. So the company set about redesigning its offerings to better match American tastes and was rewarded with accelerating sales growth.

Lesson learned, when IKEA entered China in the 2000s, it made adaptations to the local market. The store layout reflects the layout of many Chinese apartments, where most people live, and because many Chinese apartments have balconies, IKEA’s Chinese stores include a balcony section. IKEA has also had to shift its locations in China, where car ownership lags behind that in Europe and North America. In the West, IKEA stores are located in suburban areas and have lots of parking space. In China, stores are located near public transportation, and IKEA offers a delivery service so that Chinese customers can get their purchases home. •

Sources: J. Leland, “How the Disposable Sofa Conquered America,” The New York Times Magazine, October 5, 2005, p. 45; “The Secret of IKEA’s Success,” The Economist, February 24, 2011; B. Torekull, Leading by Design: The IKEA Story (New York: Harper Collins, 1998); and P. M. Miller, “IKEA with Chinese Characteristics,” Chinese Business Review, July–August 2004, pp. 36–69.

Introduction The primary concern thus far in this book has been with aspects of the larger environment in which international businesses compete. As described in the preceding chapters, this environment has included the different political, economic, and cultural institutions found in nations; the international trade and investment framework; and the international mon- etary system. Now, our focus shifts from the environment to the firm itself and, in particu- lar, to the actions managers can take to compete more effectively as an international business. This chapter looks at how firms can increase their profitability by expanding their operations in foreign markets. We discuss the different strategies that firms pursue when competing internationally, consider the pros and cons of these strategies, and study the various factors that affect a firm’s choice of strategy. We also look at why firms often enter into strategic alliances with their global competitors, and we discuss the benefits, costs, and risks of strategic alliances.

The strategy of furniture retailer IKEA, which was discussed in the opening case, gives us a preview of some of the key issues discussed in this chapter. IKEA’s business-level strategy is to target young, upwardly mobile people and offer them affordable, tastefully designed, furniture and accessories. IKEA differentiates its offering by design. At the same time, the company does everything it can to lower the costs of the products it sells, thereby enabling it to underprice its rivals and still make good profits. IKEA developed its basic formula for competing in Scandinavia in the 1950s and 1960s. This formula, or business model, includes self-service warehouse-type stores, a maze-like store layout that funnels customers through every department and maximizes impulse purchases, the design of furniture so that it can be flat-packed, an in-store warehouse, and so on. IKEA initially expanded into other countries by using exactly the same segmentation strategy and retailing formula and selling the same set of products. We refer to such a standardized approach as a global strategy. One of its great

Chapter Twelve The Strategy of International Business 339

virtues is that it can help a company attain a low-cost position through the realization of economies of scale. However, as the opening case makes clear, while this worked in the west- ern European region, it did not work in North America where IKEA had to adapt its prod- uct design to the tastes and preferences of North American consumers. In other words, IKEA found that it needed to localize some of its offerings. As we shall see in this chapter, there is often a tension between the desire to standardize a product offering in order to attain low costs and the need to localize the offering to better match the tastes and prefer- ences of local consumers, which can make it more difficult to attain scale economies and raise costs.

Strategy and the Firm Before we discuss the strategies that managers in the multinational enterprise can pursue, we need to review some basic principles of strategy. A firm’s strategy can be defined as the actions that managers take to attain the goals of the firm. For most firms, the preeminent goal is to maximize the value of the firm for its owners, its shareholders (subject to the con- straint that this is done in a legal, ethical, and socially responsible manner—see Chapter 5 for details). To maximize the value of a firm, managers must pursue strategies that increase the profitability of the enterprise and its rate of profit growth over time (see Figure 12.1). Profitability can be measured in a number of ways, but for consistency, we shall define it as the rate of return that the firm makes on its invested capital (ROIC), which is calculated by dividing the net profits of the firm by total invested capital.1 Profit growth is measured by the percentage increase in net profits over time. In general, higher profitability and a higher rate of profit growth will increase the value of an enterprise and thus the returns garnered by its owners, the shareholders.2

Managers can increase the profitability of the firm by pursuing strategies that lower costs or by pursuing strategies that add value to the firm’s products, which enables the firm to raise prices. Managers can increase the rate at which the firm’s profits grow over time by pursuing strategies to sell more products in existing markets or by pursuing strategies to enter new markets. As we shall see, expanding internationally can help managers boost the firm’s profitability and increase the rate of profit growth over time.

VALUE CREATION The way to increase the profitability of a firm is to create more value. The amount of value a firm creates is measured by the difference between its

LO 12-1 Explain the concept of strategy.

Strategy Actions managers take to attain the firm’s goals.

Profitability A ratio or rate of return concept.

Profit Growth The percentage increase in net profits over time.

12.1 FIGURE Determinants of Enterprise Value

Sell more in existing markets

Add value and raise prices

Pro!tability

Pro!t growth

Enterprise valuation

Reduce costs

Enter new markets

340 Part Five The Strategy of International Business

costs of production and the value that consumers perceive in its products. In general, the more value customers place on a firm’s products, the higher the price the firm can charge for those products. However, the price a firm charges for a good or service is typically less than the value placed on that good or service by the customer. This is because the customer captures some of that value in the form of what economists call a consumer surplus.3 The customer is able to do this because the firm is competing with other firms for the cus- tomer’s business, so the firm must charge a lower price than it could were it a monopoly supplier. Also, it is normally impossible to segment the market to such a degree that the firm can charge each customer a price that reflects that individual’s assessment of the value of a product, which economists refer to as a customer’s reservation price. For these reasons, the price that gets charged tends to be less than the value placed on the product by many customers.

Figure 12.2 illustrates these concepts. The value of a product to an average consumer is V, the average price that the firm can charge a consumer for that product given competitive pressures and its ability to segment the market is P, and the average unit cost of producing that product is C (C comprises all relevant costs, including the firm’s cost of capital). The firm’s profit per unit sold (p) is equal to P 2 C, while the consumer surplus per unit is equal to V 2 P (another way of thinking of the consumer surplus is as “value for the money”; the greater the consumer surplus, the greater the value for the money the consumer gets). The firm makes a profit so long as P is greater than C, and its profit will be greater the lower C is relative to P. The difference between V and P is in part determined by the intensity of com- petitive pressure in the marketplace; the lower the intensity of competitive pressure, the higher the price charged relative to V.4 In general, the higher the firm’s profit per unit sold is, the greater its profitability will be, all else being equal.

The firm’s value creation is measured by the difference between V and C (V 2 C); a company creates value by converting inputs that cost C into a product on which consumers place a value of V. A company can create more value (V 2 C) either by lowering production costs, C, or by making the product more attractive through superior design, styling, func- tionality, features, reliability, after-sales service, and the like, so that consumers place a greater value on it (V increases) and, consequently, are willing to pay a higher price (P in- creases). This discussion suggests that a firm has high profits when it creates more value for its customers and does so at a lower cost. We refer to a strategy that focuses primarily on lowering production costs as a low-cost strategy. We refer to a strategy that focuses primarily on in- creasing the attractiveness of a product as a differentiation strategy.5 IKEA’s strategy is primar- ily about lowering costs, although you will note from the opening case that the company also tries to differentiate itself by design.

Michael Porter has argued that low cost and differentiation are two basic strategies for cre- ating value and attaining a competitive advantage in an industry.6 According to Porter, supe- rior profitability goes to those firms that can create superior value, and the way to create superior value is to drive down the cost structure of the business and/or differentiate the

Value Creation Performing activities that increase the value of goods or services to consumers.

12.2 FIGURE Value Creation

V P C

V – C

V – P

P – C

C

V = Value of product to an average customer P = Price per unit C = Cost of production per unit

V – P = Consumer surplus per unit P – C = Pro!t per unit sold V – C = Value created per unit

Chapter Twelve The Strategy of International Business 341

product in some way so that consumers value it more and are prepared to pay a premium price. Superior value creation relative to rivals does not necessarily require a firm to have the lowest cost structure in an industry, or to create the most valuable product in the eyes of consumers. However, it does require that the gap between value (V) and cost of production (C) be greater than the gap attained by competitors.

STRATEGIC POSITIONING Porter notes that it is important for a firm to be explicit about its choice of strategic emphasis with regard to value creation (differentiation) and low cost, and to configure its internal operations to support that strategic emphasis.7 Figure 12.3 illustrates his point. The convex curve in Figure 12.3 is what economists refer to as an efficiency frontier. The efficiency frontier shows all of the different positions that a firm can adopt with regard to adding value to the product (V) and low cost (C) assuming that its internal operations are configured efficiently to support a particular position (note that the horizontal axis in Figure 12.3 is reverse scaled—moving along the axis to the right im- plies lower costs). The efficiency frontier has a convex shape because of diminishing returns. Diminishing returns imply that when a firm already has significant value built into its prod- uct offering, increasing value by a relatively small amount requires significant additional costs. The converse also holds, when a firm already has a low-cost structure, it has to give up a lot of value in its product offering to get additional cost reductions.

Figure 12.3 plots three hotel firms with a global presence that cater to international travelers: Four Seasons, Marriott International, and Starwood (Starwood owns the Sheraton and Westin chains). Four Seasons positions itself as a luxury chain and emphasizes the value of its product offering, which drives up its costs of operations. Marriott and Starwood are positioned more in the middle of the market. Both emphasize sufficient value to attract international business travelers, but are not luxury chains like Four Seasons. In Figure 12.3, Four Seasons and Marriott are shown to be on the efficiency frontier, indicating that their internal operations are well configured to their strategy and run efficiently. Starwood is inside the frontier, indicating that its operations are not running as efficiently as they might be and that its costs are too high. This implies that Starwood is less profitable than Four Seasons and Marriott and that its managers must take steps to improve the company’s performance.

Porter emphasizes that it is very important for management to decide where the company wants to be positioned with regard to value (V) and cost (C), to configure operations accord- ingly, and to manage them efficiently to make sure the firm is operating on the efficiency

12.3 FIGURE Strategic Choice in the International Hotel Industry

Marriott

Strategic choices in this area not viable in international hotel industry

Low cost (C)High cost

In cr

ea se

d va

lu e/

di ffe

re nt

ia tio

n (V

)

Efficiency frontier Four Seasons

Starwood

342 Part Five The Strategy of International Business

frontier. However, not all positions on the efficiency frontier are viable. In the international hotel industry, for example, there might not be enough demand to support a chain that em- phasizes very low cost and strips all the value out of its product offering (see Figure 12.3). International travelers are relatively affluent and expect a degree of comfort (value) when they travel away from home.

A central tenet of the basic strategy paradigm is that to maximize its profitability, a firm must do three things: (1) pick a position on the efficiency frontier that is viable in the sense that there is enough demand to support that choice; (2) configure its internal operations, such as manufacturing, marketing, logistics, information systems, human resources, and so on, so that they support that position; and (3) make sure that the firm has the right organiza- tion structure in place to execute its strategy. The strategy, operations, and organization of the firm must all be consistent with each other if it is to attain a competitive advantage and garner supe- rior profitability. By operations we mean the different value creation activities a firm under- takes, which we shall review next.

OPERATIONS: THE FIRM AS A VALUE CHAIN The operations of a firm can be thought of as a value chain composed of a series of distinct value creation activi- ties, including production, marketing and sales, materials management, R&D, human re- sources, information systems, and the firm infrastructure. We can categorize these value creation activities, or operations, as primary activities and support activities (see Figure 12.4).8 As noted earlier, if a firm is to implement its strategy efficiently, and position itself on the efficiency frontier shown in Figure 12.3, it must manage these activities effectively and in a manner that is consistent with its strategy.

Primary Activities Primary activities have to do with the design, creation, and de- livery of the product; its marketing; and its support and after-sale service. Following nor- mal practice, in the value chain illustrated in Figure 12.4, the primary activities are divided into four functions: research and development, production, marketing and sales, and cus- tomer service.

Research and development (R&D) is concerned with the design of products and pro- duction processes. Although we think of R&D as being associated with the design of phys- ical products and production processes in manufacturing enterprises, many service companies also undertake R&D. For example, banks compete with each other by develop- ing new financial products and new ways of delivering those products to customers. Online banking and smart debit cards are two examples of product development in the banking industry. Earlier examples of innovation in the banking industry included automated teller machines, credit cards, and debit cards. Through superior product design, R&D can

Operations The various value creation activities a firm undertakes.

12.4 FIGURE The Value Chain

Primary activities

R&D

Company infrastructure

Support activities

Information systems Logistics Human resources

Production Marketing

and sales

Customer service

Chapter Twelve The Strategy of International Business 343

increase the functionality of products, which makes them more attractive to consumers (raising V). Alternatively, R&D may result in more efficient production processes, thereby cutting production costs (lowering C). Either way, the R&D function can create value.

Production is concerned with the creation of a good or service. For physical products, when we talk about production, we generally mean manufacturing. Thus, we can talk about the production of an automobile. For services such as banking or health care, “produc- tion” typically occurs when the service is delivered to the customer (e.g., when a bank originates a loan for a customer it is engaged in “production” of the loan). For a retailer such as Walmart, “produc- tion” is concerned with selecting the merchandise, stocking the store, and ringing up the sale at the cash register. For MTV, production is concerned with the creation, programming, and broadcasting of content, such as music videos and thematic shows. The production activity of a firm creates value by performing its activities efficiently so lower costs result (lower C) and/or by performing them in such a way that a higher- quality product is produced (which results in higher V).

The marketing and sales functions of a firm can help to create value in several ways. Through brand positioning and advertising, the marketing function can increase the value (V) that consumers perceive to be contained in a firm’s product. If these create a favorable impression of the firm’s product in the minds of consumers, they increase the price that can be charged for the firm’s product. For example, Ford produced a high-value version of its Ford Expedition SUV. Sold as the Lincoln Navigator and priced around $10,000 higher, the Navigator has the same body, engine, chassis, and design as the Expedition, but through skilled advertising and marketing, supported by some fairly minor features changes (e.g., more accessories and the addition of a Lincoln-style engine grille and nameplate), Ford has fostered the perception that the Navigator is a “luxury SUV.” This marketing strategy has increased the perceived value (V) of the Navigator relative to the Expedition and enables Ford to charge a higher price for the car (P).

Marketing and sales can also create value by discovering consumer needs and commu- nicating them back to the R&D function of the company, which can then design products that better match those needs. For example, the allocation of research budgets at Pfizer, the world’s largest pharmaceutical company, is determined by the marketing function’s assessment of the potential market size associated with solving unmet medical needs. Thus, Pfizer is currently directing significant monies to R&D efforts aimed at finding treatments for Alzheimer’s disease, principally because marketing has identified the treat- ment of Alzheimer’s as a major unmet medical need in nations around the world where the population is aging.

The role of the enterprise’s service activity is to provide after-sale service and support. This function can create a perception of superior value (V) in the minds of consumers by solving customer problems and supporting customers after they have purchased the prod- uct. Caterpillar, the U.S.-based manufacturer of heavy earthmoving equipment, can get spare parts to any point in the world within 24 hours, thereby minimizing the amount of downtime its customers have to suffer if their Caterpillar equipment malfunctions. This is an extremely valuable capability in an industry where downtime is very expensive. It has helped to increase the value that customers associate with Caterpillar products and thus the price that Caterpillar can charge.

Support Activities The support activities of the value chain provide inputs that allow the primary activities to occur (see Figure 12.4). In terms of attaining a competitive advan- tage, support activities can be as important as, if not more important than, the primary ac- tivities of the firm. Consider information systems; these systems refer to the electronic systems for managing inventory, tracking sales, pricing products, selling products, dealing with customer service inquiries, and so on. Information systems, when coupled with the communications features of the Internet, can alter the efficiency and effectiveness with

A Caterpillar motor factory in Germany helps to ensure product after-sales and service outside the U.S.

344 Part Five The Strategy of International Business

which a firm manages its other value creation activities. Dell, for example, has used its infor- mation systems to attain a competitive advantage over rivals. When customers place an or- der for a Dell product over the firm’s website, that information is immediately transmitted, via the Internet, to suppliers, who then configure their production schedules to produce and ship that product so that it arrives at the right assembly plant at the right time. These sys- tems have reduced the amount of inventory that Dell holds at assembly plants to under two days, which is a major source of cost savings.

The logistics function controls the transmission of physical materials through the value chain, from procurement through production and into distribution. The efficiency with which this is carried out can significantly reduce cost (lower C), thereby creating more value. The combination of logistics systems and information systems is a particularly potent source of cost savings in many enterprises, such as Dell, where information systems tell Dell on a real-time basis where in its global logistics network parts are, when they will arrive at an as- sembly plant, and thus how production should be scheduled.

The human resource function can help create more value in a number of ways. It ensures that the company has the right mix of skilled people to perform its value creation activities

effectively. The human resource function also ensures that people are adequately trained, motivated, and compen- sated to perform their value creation tasks. In a multina- tional enterprise, one of the things human resources can do to boost the competitive position of the firm is to take advantage of its transnational reach to identify, recruit, and develop a cadre of skilled managers, regardless of their nationality, who can be groomed to take on senior management positions. They can find the very best, wher- ever they are in the world. Indeed, the senior management ranks of many multinationals are becoming increasingly diverse, as managers from a variety of national back- grounds have ascended to senior leadership positions.

The final support activity is the company infrastruc- ture, or the context within which all the other value cre- ation activities occur. The infrastructure includes the organizational structure, control systems, and culture of the firm. Because top management can exert considerable influence in shaping these aspects of a firm, top manage- ment should also be viewed as part of the firm’s infrastruc- ture. Through strong leadership, top management can consciously shape the infrastructure of a firm and through that the performance of all its value creation activities.

globalEDGE Business Review

In Chapter 12, we are bringing you closer to running a globally oriented company based on the issues we have covered on country differences, global trade and investment environment, and the global money sys- tem. This is where many of you will “make your money” as strategic decision makers in corporations. This also means you need to know what is current, important, and strategic in the global marketplace; your company’s products or services; and your company’s uniqueness in satisfying the needs and wants of customers. The globalEDGE Business Review (gBR) is a leading source for cutting-edge global busi- ness knowledge with a main target audience of business executives

(globaledge.msu.edu/gbr). Note that gBR complements the overall glo- balEDGE site content by publishing cutting-edge articles dealing with a variety of international business issues facing managers in different world areas, industries, and management functions. With millions of visitors to the site and some 30,000 subscribers, gBR reaches farther and has more impact and visibility than any business journal in interna- tional business. One gBR article is titled “From Domestic to Interna- tional to Global Sourcing.” Based on this article, how much should a company engage in “international/global purchasing activities” versus “domestic purchasing only” to best operate a global strategy?

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, physi- cal 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 difference between the costs (e.g., tuition, time, lost income) and what you receive in the form of education (e.g., knowledge, tools, networks), how does your choice of major area of focus in your education fit into your personal develop- ment strategy? How do your choices of how you spend your time fit into your value chain? Do you 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?

Chapter Twelve The Strategy of International Business 345

Organization: The Implementation of Strategy The strategy of a firm is implemented through its organization. For a firm to have superior ROIC, its organization must support its strategy and operations. The term organization architecture can be used to refer to the totality of a firm’s organization, including formal organizational structure, control systems and incentives, organizational culture, processes, and people.9 Figure 12.5 illustrates these different elements. By organizational structure, we mean three things: first, the formal division of the organization into subunits such as product divisions, national operations, and functions (most organizational charts display this aspect of struc- ture); second, the location of decision-making responsibilities within that structure (e.g., centralized or decentralized); and third, the establishment of integrating mechanisms to coordinate the activities of subunits including cross functional teams and or pan-regional committees.

Controls are the metrics used to measure the performance of subunits and make judg- ments about how well managers are running those subunits. Incentives are the devices used to reward appropriate managerial behavior. Incentives are very closely tied to performance metrics. For example, the incentives of a manager in charge of a national operating subsid- iary might be linked to the performance of that company. Specifically, she might receive a bonus if her subsidiary exceeds its performance targets.

Processes are the manner in which decisions are made and work is performed within the organization. Examples are the processes for formulating strategy, for deciding how to allocate resources within a firm, or for evaluating the performance of managers and giving feedback. Processes are conceptually distinct from the location of decision-making responsibilities within an organization, although both involve decisions. While the CEO might have ultimate responsibility for deciding what the strategy of the firm should be (i.e., the decision-making responsibility is centralized), the process he or she uses to make that decision might include the solicitation of ideas and criticism from lower-level managers.

Organizational culture is the norms and value systems that are shared among the em- ployees of an organization. Just as societies have cultures (see Chapter 4 for details), so do organizations. Organizations are societies of individuals who come together to perform col- lective tasks. They have their own distinctive patterns of culture and subculture.10 As we shall see, organizational culture can have a profound impact on how a firm performs. Finally, by people we mean not just the employees of the organization, but also the strategy used to recruit, compensate, and retain those individuals and the type of people that they are in terms of their skills, values, and orientation (discussed in depth in Chapter 17).

As illustrated by the arrows in Figure 12.5, the various components of an organization’s architecture are not independent of each other: Each component shapes, and is shaped by,

Organization Architecture The totality of a firm’s organization, including formal organizational structure, control systems and incentives, organizational culture, processes, and people.

Organizational Structure The three-part structure of an organization, including its formal division into subunits such as product divisions, its location of decision-making responsibilities within that structure, and the establishment of integrating mechanisms to coordinate the activities of all subunits.

Controls The metrics used to measure the performance of subunits and make judgments about how well managers are running those subunits.

Incentives The devices used to reward appropriate managerial behavior.

Processes The manner in which decisions are made and work is performed within any organization.

Organizational Culture The values and norms shared among an organization’s employees.

People The employees of the organization, the strategy used to recruit, compensate, and retain those individuals and the type of people that they are in terms of their skills, values, and orientation.

12.5 FIGURE Organization Architecture

Processes Incentives and controls

Culture

People

Structure

346 Part Five The Strategy of International Business

other components of architecture. An obvious example is the strategy regarding people. This can be used proactively to hire individuals whose internal values are consistent with those that the firm wishes to emphasize in its organization culture. Thus, the people compo- nent of architecture can be used to reinforce (or not) the prevailing culture of the organiza- tion. If a firm is going to maximize its profitability, it must pay close attention to achieving internal consistency among the various components of its architecture, and the architecture must support the strategy and operations of the firm.

In Sum: Strategic Fit In sum, as we have repeatedly stressed, for a firm to attain superior performance and earn a high return on capital, its strategy (as captured by its de- sired strategic position on the efficiency frontier) must make sense given market conditions (there must be sufficient demand to support that strategic choice). The operations of the firm must be configured in a way that supports the strategy of the firm, and the organiza- tion architecture of the firm must match the operations and strategy of the firm. In other words, as illustrated in Figure 12.6, market conditions, strategy, operations, and organiza- tion must all be consistent with each other, or fit each other, for superior performance to be attained.

Of course, the issue is more complex than illustrated in Figure 12.6. For example, the firm can influence market conditions through its choice of strategy—it can create demand by leveraging core skills to create new market opportunities. In addition, shifts in market conditions caused by new technologies, government action such as deregulation, demo- graphics, or social trends can mean that the strategy of the firm no longer fits the market. In such circumstances, the firm must change its strategy, operations, and organization to fit the new reality—which can be an extraordinarily difficult challenge. And last but by no means least, international expansion adds another layer of complexity to the strategic challenges facing the firm. We shall now consider this.

Global Expansion, Profitability, and Profit Growth Expanding globally allows firms to increase their profitability and rate of profit growth in ways not available to purely domestic enterprises.11 Firms that operate internationally are able to:

1. Expand the market for their domestic product offerings by selling those products in international markets.

LO 12-2 Recognize how firms can profit by expanding globally.

12.6 FIGURE Strategic Fit

Strategy

Operations strategy

Organization architecture

Su pp

or ts

Supports

Supports

Fits Market conditions

test PREP Use LearnSmart to help retain what you have learned. Access your instructor’s Connect course to check out LearnSmart or go to learnsmartadvantage.com for help.

Chapter Twelve The Strategy of International Business 347

2. Realize location economies by dispersing individual value creation activities to those locations around the globe where they can be performed most efficiently and effectively.

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 valuable skills developed in foreign operations and transferring them to other entities within the firm’s global network of operations.

As we will see, however, a firm’s ability to increase its profitability and profit growth by pursuing these strategies is constrained by the need to customize its product offering, mar- keting strategy, and business strategy to differing national or regional conditions—that is, by the imperative of localization.

EXPANDING THE MARKET: LEVERAGING PRODUCTS AND COMPETENCIES A company can increase its growth rate by taking goods or ser- vices developed at home and selling them internationally. Almost all multinationals started out doing just this. For example, Procter & Gamble developed most of its best-selling prod- ucts (such as Pampers disposable diapers and Ivory soap) in the United States and subse- quently sold them around the world. Likewise, although Microsoft developed its software in the United States, from its earliest days the company has always focused on selling that software in international markets. Automobile companies such as Volkswagen and Toyota also grew by developing products at home and then selling them in international markets. The returns from such a strategy are likely to be greater if indigenous competitors in the nations that a company enters lack comparable products. Thus, Toyota increased its profits by entering the large automobile markets of North America and Europe, offering products that were different from those offered by local rivals (Ford and GM) by their superior qual- ity and reliability.

The success of many multinational companies that expand in this manner is based not just upon the goods or services that they sell in foreign nations, but also upon the core competencies that underlie the development, production, and marketing of those goods or services. The term core competence refers to skills within the firm that competitors cannot easily match or imitate.12 These skills may exist in any of the firm’s value creation activities—production, marketing, R&D, human resources, logistics, general manage- ment, and so on. Such skills are typically expressed in product offerings that other firms find difficult to match or imitate. Core competencies are the bedrock of a firm’s competi- tive advantage. They enable a firm to reduce the costs of value creation and/or to create perceived value in such a way that premium pricing is possible. For example, Toyota has a core competence in the production of cars. It is able to produce high-quality, well-designed cars at a lower delivered cost than any other firm in the world. The competencies that enable Toyota to do this seem to reside primarily in the firm’s production and logistics functions.13 Similarly, IKEA has a core competence in the design of stylish and affordable furniture that can be manufactured at a low cost and flat-packed, McDonald’s has a core competence in managing fast-food opera- tions (it seems to be one of the most skilled firms in the world in this industry), and Procter & Gamble has a core competence in de- veloping and marketing name-brand consumer products (it is one of the most skilled firms in the world in this business.

Because core competencies are, by definition, the source of a firm’s competitive advantage, the successful global expansion by manufacturing companies such as Toyota and P&G was based not just on leveraging products and selling them in foreign markets, but also on the transfer of core competencies to foreign markets where indigenous competitors lacked them. The same can be said of com- panies engaged in the service sectors of an economy, such as financial institutions, retailers like IKEA, restaurant chains, and hotels. Expanding the market for their services often means replicating their business model in foreign nations (albeit with some changes to

Core Competence Firm skills that competitors cannot easily match or imitate.

P&G’s core competency in marketing is evidenced in this photo of Olay men’s skin care products for sale in a Shanghai, China supermarket.

348 Part Five The Strategy of International Business

account for local differences, which we will discuss in more detail shortly). Firms like Star- bucks and IKEA, for example, expanded rapidly outside of their home markets the United States by taking the basic business model that they developed at home and using that as a blueprint for establishing international operations.

LOCATION ECONOMIES Earlier chapters revealed that countries differ along a range of dimensions—including the economic, political, legal, and cultural—and that these differences can either raise or lower the costs of doing business in a country. The theory of international trade also teaches that due to differences in factor costs, certain countries have a comparative advantage in the production of certain products. Japan might excel in the production of automobiles and consumer electronics; the United States in the production of computer software, pharmaceuticals, biotechnology products, and financial services; Swit- zerland in the production of precision instruments and pharmaceuticals; South Korea in the production of semiconductors; and Vietnam in the production of apparel.14

For a firm that is trying to survive in a competitive global market, this implies that trade barriers and transportation costs permitting, the firm will benefit by basing each value creation activity it performs at that location where economic, political, and cultural conditions— including relative factor costs—are most conducive to the performance of that activity. Thus, if the best designers for a product live in France, a firm should base its design opera- tions in France. If the most productive labor force for assembly operations is in Mexico, assembly operations should be based in Mexico. If the best marketers are in the United States, the marketing strategy should be formulated in the United States. And so on.

Firms that pursue such a strategy can realize what we refer to as location economies, which are the economies that arise from performing a value creation activity in the optimal location for that activity, wherever in the world that might be (transportation costs and trade barriers permitting). Locating a value creation activity in the optimal location for that activ- ity can have one of two effects. It can lower the costs of value creation and help the firm to achieve a low-cost position, and/or it can enable a firm to differentiate its product offering from those of competitors. In terms of Figure 12.2, it can lower C and/or increase V (which, in general, sup- ports higher pricing), both of which boost the profitability of the enterprise.

For an example of how this works in an international business, consider Clear Vision, a manufacturer and distributor of eyewear. Started by David Glassman, the firm now gener- ates annual gross revenues of more than $100 million. Not exactly small, but no corporate giant either, Clear Vision is a multinational firm with production facilities on three conti- nents and customers around the world. Clear Vision began its move toward becoming a multinational when its sales were still less than $20 million. At the time, the U.S. dollar was very strong, and this made U.S.-based manufacturing expensive. Low-priced imports were taking an ever-larger share of the U.S. eyewear market, and Clear Vision realized it could not survive unless it also began to import. Initially, the firm bought from independent over- seas manufacturers, primarily in Hong Kong. However, the firm became dissatisfied with these suppliers’ product quality and delivery. As Clear Vision’s volume of imports increased, Glassman decided the best way to guarantee quality and delivery was to set up Clear Vision’s own manufacturing operation overseas. Accordingly, Clear Vision found a Chinese partner, and together they opened a manufacturing facility in Hong Kong, with Clear Vision being the majority shareholder.

The choice of the Hong Kong location was influenced by its combination of low labor costs, a skilled workforce, and tax breaks given by the Hong Kong government. The firm’s objective at this point was to lower production costs by locating value creation activities at an appropriate location. After a few years, however, the increasing industrialization of Hong Kong and a growing labor shortage had pushed up wage rates to the extent that it was no longer a low-cost location. In response, Glassman and his Chinese partner moved part of their manufacturing to a plant in mainland China to take advantage of the lower wage rates there. Again, the goal was to lower production costs. The parts for eyewear frames manufac- tured at this plant are shipped to the Hong Kong factory for final assembly and then distrib- uted to markets in North and South America. The Hong Kong factory employs 80 people and the China plant between 300 and 400.

Location Economies Cost advantages from performing a value creation activity at the optimal location for that activity.

Chapter Twelve The Strategy of International Business 349

At the same time, Clear Vision was looking for opportunities to invest in foreign eyewear firms with reputations for fashionable design and high quality. Its objective was not to re- duce production costs but to launch a line of high-quality, differentiated, “designer” eye- wear. Clear Vision did not have the design capability in-house to support such a line, but Glassman knew that certain foreign manufacturers did. As a result, Clear Vision invested in factories in Japan, France, and Italy, holding a minority shareholding in each case. These factories now supply eyewear for Clear Vision’s Status Eye division, which markets high- priced designer eyewear.15

Thus, to deal with a threat from foreign competition, Clear Vision adopted a strategy intended to lower its cost structure (lower C): shifting its production from a high-cost loca- tion, the United States, to a low-cost location, first Hong Kong and later China. Then Clear Vision adopted a strategy intended to increase the perceived value of its product (increase V) so it could charge a premium price (P). Reasoning that premium pricing in eyewear depended on superior design, its strategy involved investing capital in French, Italian, and Japanese factories that had reputations for superior design. In sum, Clear Vi- sion’s strategies included some actions intended to reduce its costs of creating value and other actions intended to add perceived value to its product through differentiation. The overall goal was to increase the value created by Clear Vision and thus the profitability of the enterprise. To the extent that these strategies were successful, the firm should have at- tained a higher profit margin and greater profitability than if it had remained a U.S.-based manufacturer of eyewear.

Creating a Global Web Generalizing from the Clear Vision example, one result of this kind of thinking is the creation of a global web of value creation activities, with differ- ent stages of the value chain being dispersed to those locations around the globe where perceived value is maximized or where the costs of value creation are minimized.16 Consider Lenovo’s ThinkPad laptop computers (Lenovo is the Chinese computer company that pur- chased IBM’s personal computer operations in 2005).17 This product is designed in the United States by engineers because Lenovo believes that the United States is the best loca- tion in the world to do the basic design work. The case, keyboard, and hard drive are made in Thailand; the display screen and memory in South Korea; the built-in wireless card in Malaysia; and the microprocessor in the United States. In each case, these components are manufactured and sourced from the optimal location given current factor costs. These com- ponents are then shipped to an assembly operation in China, where the product is assembled before being shipped to the United States for final sale. Lenovo assembles the ThinkPad in Mexico because managers have calculated that due to low labor costs, the costs of assembly can be minimized there. The marketing and sales strategy for North America is developed by Lenovo personnel in the United States, primarily because managers believe that due to their knowledge of the local marketplace, U.S. personnel add more value to the product through their marketing efforts than personnel based elsewhere.

In theory, a firm that realizes location economies by dispersing each of its value creation activities to its optimal location should have a competitive advantage vis-à-vis a firm that bases all of its value creation activities at a single location. It should be able to better differ- entiate its product offering (thereby raising perceived value, V) and lower its cost structure (C) than its single-location competitor. In a world where competitive pressures are increas- ing, such a strategy may become an imperative for survival.

Some Caveats Introducing transportation costs and trade barriers complicates this picture. Due to favorable factor endowments, New Zealand may have a comparative advan- tage for automobile assembly operations, but high transportation costs would make it an uneconomical location from which to serve global markets. Another caveat concerns the importance of assessing political and economic risks when making location decisions. Even if a country looks very attractive as a production location when measured against all the standard criteria, if its government is unstable or totalitarian, the firm might be advised not to base production there. (Political risk is discussed in Chapter 3.) Similarly, if the govern- ment appears to be pursuing inappropriate economic policies that could lead to foreign

Global Web When different stages of value chain are dispersed to those locations around the globe where value added is maximized or where costs of value creation are minimized.

350 Part Five The Strategy of International Business

exchange risk, that might be another reason for not basing production in that location, even if other factors look favorable.

EXPERIENCE EFFECTS The experience curve refers to systematic reductions in production costs that have been observed to occur over the life of a product.18 A num- ber of studies have observed that a product’s production costs decline by some quantity about each time cumulative output doubles. The relationship was first observed in the aircraft industry, where each time cumulative output of airframes was doubled, unit costs typically declined to 80 percent of their previous level.19 Thus, production cost for the fourth airframe would be 80 percent of production cost for the second airframe, the eighth airframe’s production costs 80 percent of the fourth’s, the sixteenth’s 80 percent of the eighth’s, and so on. Figure 12.7 illustrates this experience curve relationship between unit production costs and cumulative output (the relationship is for cumulative output over time, and not output in any one period, such as a year). Two things explain this: learning effects and economies of scale.

Learning Effects Learning effects refer to cost savings that come from learning by doing. Labor, for example, learns by repetition how to carry out a task, such as assembling airframes, most efficiently. Labor productivity increases over time as individuals learn the most efficient ways to perform particular tasks. Equally important in new production facili- ties, management typically learns how to manage the new operation more efficiently over time. Hence, production costs decline due to increasing labor productivity and management efficiency, which increases the firm’s profitability.

Learning effects tend to be more significant when a technologically complex task is re- peated because there is more that can be learned about the task. Thus, learning effects will be more significant in an assembly process involving 1,000 complex steps than in one of only 100 simple steps. No matter how complex the task, however, learning effects typically disappear after a while. It has been suggested that they are important only during the start- up period of a new process and that they cease after two or three years.20 Any decline in the experience curve after such a point is due to economies of scale.

Economies of Scale Economies of scale refer to the reductions in unit cost achieved by producing a large volume of a product. Attaining economies of scale lowers a firm’s unit costs and increases its profitability. Economies of scale have a number of sources. One is the ability to spread fixed costs over a large volume.21 Fixed costs are the costs re- quired to set up a production facility, develop a new product, and the like. They can be substantial. For example, the fixed cost of establishing a new production line to manufacture

Experience Curve Systematic production cost reductions that occur over the life of a product.

Learning Effects Cost savings from learning by doing.

Economies of Scale Cost advantages associated with large- scale production.

12.7 FIGURE The Experience Curve

Cumulative output Un

it co

st s B

A

Chapter Twelve The Strategy of International Business 351

semiconductor chips now exceeds $1 billion. Similarly, according to one estimate, develop- ing a new drug and bringing it to market costs about $800 million and takes about 12 years.22 The only way to recoup such high fixed costs may be to sell the product worldwide, which reduces average unit costs by spreading fixed costs over a larger volume. The more rapidly that cumulative sales volume is built up, the more rapidly fixed costs can be amortized over a large production volume, and the more rapidly unit costs will fall.

Second, a firm may not be able to attain an efficient scale of production unless it serves global markets. In the automobile industry, for example, an efficiently scaled factory is one designed to produce about 200,000 units a year. Automobile firms would prefer to produce a single model from each factory because this eliminates the costs associated with switching production from one model to another. If domestic demand for a particular model is only 100,000 units a year, the inability to attain a 200,000-unit output will drive up average unit costs. By serving international markets as well, however, the firm may be able to push pro- duction volume up to 200,000 units a year, thereby reaping greater scale economies, lower- ing unit costs, and boosting profitability. By serving domestic and international markets from its production facilities, a firm may be able to utilize those facilities more intensively. For example, if Intel sold microprocessors only in the United States, it might be able to keep its factories open for only one shift, five days a week. By serving international markets from the same factories, Intel can utilize its productive assets more intensively, which translates into higher capital productivity and greater profitability.

Finally, as global sales increase the size of the enterprise, its bargaining power with sup- pliers increases as well, which may allow it to attain economies of scale in purchasing, bar- gaining down the cost of key inputs and boosting profitability that way. For example, Walmart has used its enormous sales volume as a lever to bargain down the price it pays suppliers for merchandise sold through its stores.

Strategic Significance The strategic significance of the experience curve is clear. Moving down the experience curve allows a firm to reduce its cost of creating value (to lower C in Figure 12.2) and increase its profitability. The firm that moves down the experi- ence curve most rapidly will have a cost advantage vis-à-vis its competitors. Firm A in Figure 12.7, because it is farther down the experience curve, has a clear cost advantage over firm B.

Many of the underlying sources of experience-based cost economies are plant based. This is true for most learning effects as well as for the economies of scale derived by spreading the fixed costs of building productive capacity over a large output, attaining an efficient scale of output, and utilizing a plant more intensively. Thus, one key to pro- gressing downward on the experience curve as rapidly as possible is to increase the vol- ume produced by a single plant as rapidly as possible. Because global markets are larger than domestic markets, a firm that serves a global market from a single location is likely to build accumulated volume more quickly than a firm that serves only its home market or that serves multiple markets from multiple production locations. Thus, serving a global market from a single location is consistent with moving down the experience curve and establishing a low-cost position. In addition, to get down the experience curve rapidly, a firm may need to price and market aggressively so demand will expand rapidly. It will also need to build sufficient production capacity for serving a global market. Also, the cost advantages of serving the world market from a single location will be even more significant if that location is the optimal one for performing the particular value creation activity.

Once a firm has established a low-cost position, it can act as a barrier to new competition. Specifically, an established firm that is well down the experience curve, such as firm A in Figure 12.7, can price so that it is still making a profit while new entrants, which are farther up the curve, are suffering losses. Intel is one of the masters of this kind of strategy. The costs of building a state-of-the-art facility to manufacture microprocessors are so large (now around $5 billion) that to make this investment pay Intel must pursue experience curve effects, serving world markets from a limited number of plants to maximize the cost econo- mies that derive from scale and learning effects.

352 Part Five The Strategy of International Business

LEVERAGING SUBSIDIARY SKILLS Implicit in our earlier discussion of core competencies is the idea that valuable skills are developed first at home and then trans- ferred to foreign operations. However, for more mature multinationals that have already established a network of subsidiary operations in foreign markets, the development of valu- able skills can just as well occur in foreign subsidiaries.23 Skills can be created anywhere within a multinational’s global network of operations, wherever people have the opportunity and incentive to try new ways of doing things. The creation of skills that help to lower the costs of production, or to enhance perceived value and support higher product pricing, is not the monopoly of the corporate center.

Leveraging the skills created within subsidiaries and applying them to other operations within the firm’s global network may create value. McDonald’s is increasingly finding that its foreign franchisees are a source of valuable new ideas. Faced with slow growth in France, its local franchisees began to experiment not only with the menu, but also with the layout and theme of restaurants. Gone are the ubiquitous golden arches; gone too are many of the utilitarian chairs and tables and other plastic features of the fast-food giant. Many McDonald’s restaurants in France now have hardwood floors, exposed brick walls, and even armchairs. The menu, too, has been changed to include premier sandwiches, such as chicken on focaccia bread, priced some 30 percent higher than the average hamburger. In France at least, the strategy seems to be working. Following the change, increases in same-store sales rose from 1 percent annually to 3.4 percent, and France is now the second largest national market for McDonald’s. Impressed with the impact, McDonald’s executives are considering similar changes at other McDonald’s restaurants in markets where same-store sales growth is slug- gish, including the United States.24

For the managers of the multinational enterprise, this phenomenon creates important new challenges. First, they must have the humility to recognize that valuable skills that lead to competencies can arise anywhere within the firm’s global network, not just at the corpo- rate center. Second, they must establish an incentive system that encourages local employees to acquire new skills. This is not as easy as it sounds. Creating new skills involves a degree of risk. Not all new skills add value. For every valuable idea created by a McDonald’s subsidiary in a foreign country, there may be several failures. The management of the multinational must install incentives that encourage employees to take the necessary risks. The company must reward people for successes and not sanction them unnecessarily for taking risks that did not pan out. Third, managers must have a process for identifying when valuable new skills have been created in a subsidiary. And finally, they need to act as facilitators, helping to transfer valuable skills within the firm.

PROFITABILITY AND PROFIT GROWTH SUMMARY We have seen how firms that expand globally can increase their profitability and profit growth by enter- ing new markets where indigenous competitors lack similar competencies, by lowering costs and adding value to their product offering through the attainment of location econ- omies, by exploiting experience curve effects, and by transferring valuable skills among their global network of subsidiaries. For completeness, it should be noted that strategies that increase profitability may also expand a firm’s business and thus enable it to attain a higher rate of profit growth. For example, by simultaneously realizing location economies and experience effects, a firm may be able to produce a more highly valued product at a lower unit cost, thereby boosting profitability. The increase in the perceived value of the product may also attract more customers, thereby growing revenues and profits as well. Furthermore, rather than raising prices to reflect the higher perceived value of the prod- uct, the firm’s managers may elect to hold prices low in order to increase global market share and attain greater scale economies (in other words, they may elect to offer consum- ers better “value for money”). Such a strategy could increase the firm’s rate of profit growth even further, because consumers will be attracted by prices that are low relative to value. The strategy might also increase profitability if the scale economies that result from market share gains are substantial. In sum, managers need to keep in mind the complex relationship between profitability and profit growth when making strategic decisions about pricing.

test PREP Use LearnSmart to help retain what you have learned. Access your instructor’s Connect course to check out LearnSmart or go to learnsmartadvantage.com for help.

Chapter Twelve The Strategy of International Business 353

Cost Pressures and Pressures for Local Responsiveness Firms that compete in the global marketplace typically face two types of competitive pres- sure that affect their ability to realize location economies and experience effects, and to le- verage products and transfer competencies and skills within the enterprise. They face pressures for cost reductions and pressures to be locally responsive (see Figure 12.8).25 These com- petitive pressures place conflicting demands on a firm. Responding to pressures for cost reductions requires that a firm try to minimize its unit costs. But responding to pressures to be locally responsive requires that a firm differentiate its product offering and marketing strategy from country to country (or in some cases region to region) in an effort to accom- modate the diverse demands arising from national (or regional) differences in consumer tastes and preferences, business practices, distribution channels, competitive conditions, and government policies. Because differentiation across countries can involve significant dupli- cation and a lack of product standardization, it may raise costs.

While some enterprises, such as firm A in Figure 12.8, face high pressures for cost reduc- tions and low pressures for local responsiveness, and others, such as firm B, face low pres- sures for cost reductions and high pressures for local responsiveness, many companies are in the position of firm C. They face high pressures for both cost reductions and local respon- siveness. Dealing with these conflicting and contradictory pressures is a difficult strategic challenge, primarily because being locally responsive tends to raise costs.

Pressures for Cost Reductions In competitive global markets, international businesses often face pressures for cost reduc- tions. Responding to pressures for cost reduction requires a firm to try to lower the costs of value creation. A manufacturer, for example, might mass-produce a standardized product at the optimal locations in the world, wherever that might be, to realize economies of scale, learning effects, and location economies. Alternatively, a firm might outsource certain func- tions to low-cost foreign suppliers in an attempt to reduce costs. Thus, many computer companies have outsourced their telephone-based customer service functions to India, where qualified technicians who speak English can be hired for a lower wage rate than in the United States. In the same manner, a retailer such as Walmart might push its suppliers (manufacturers) to do the same. (The pressure that Walmart has placed on its suppliers to

LO 12-3 Understand how pressures for cost reductions and pressures for local responsiveness influence strategic choice.

12.8 FIGURE Pressures for Cost Reductions and Local Responsiveness

Firm B

Firm A

Low

Lo w

Pressures for local responsiveness

Pr es

su re

s fo

r c os

t r ed

uc tio

ns

High

Hi gh Firm C

test PREP Use LearnSmart to help retain what you have learned. Access your instructor’s Connect course to check out LearnSmart or go to learnsmartadvantage.com for help.

354 Part Five The Strategy of International Business

reduce prices has been cited as a major cause of the trend among North American manufac- turers to shift production to China.26) A service business such as a bank might respond to cost pressures by moving some back-office functions, such as information processing, to developing nations where wage rates are lower.

Pressures for cost reduction can be particularly intense in industries producing commodity- type products where meaningful differentiation on nonprice factors is difficult and price is the main competitive weapon. This tends to be the case for products that serve universal needs. Universal needs exist when the tastes and preferences of consumers in different na- tions or regions are similar if not identical. This is the case for conventional commodity products such as bulk chemicals, petroleum, steel, sugar, and the like. It also tends to be the case for many industrial and consumer products—for example, smartphones, semiconductor chips, personal computers, and liquid crystal display screens. Pressures for cost reductions are also intense in industries where major competitors are based in low-cost locations, where there is persistent excess capacity, and where consumers are powerful and face low switching costs. The liberalization of the world trade and investment environment in recent decades, by facilitating greater international competition, has generally increased cost pressures.27

PRESSURES FOR LOCAL RESPONSIVENESS Pressures for local respon- siveness arise from national or regional differences in consumer tastes and preferences, infra- structure, accepted business practices, and distribution channels and from host-government demands. Responding to pressures to be locally responsive requires a firm to differentiate its products and marketing strategy from country to country, or region to region, to accommo- date these factors—all of which tends to raise the firm’s cost structure.

Differences in Customer Tastes and Preferences Strong pressures for local responsiveness emerge when customer tastes and preferences differ significantly among countries, as they often do for deeply embedded historic or cultural reasons. In such cases, a multinational’s products and marketing message have to be customized to appeal to the tastes and preferences of local customers. This typically creates pressure to delegate produc- tion and marketing responsibilities and functions to a firm’s overseas subsidiaries.

For example, the automobile industry in the 1990s moved toward the creation of “world cars.” The idea was that global companies such as General Motors, Ford, and Toyota would be able to sell the same basic vehicle the world over, sourcing it from centralized production locations. If successful, the strategy would have enabled automobile companies to reap sig- nificant gains from global scale economies. However, this strategy frequently ran aground upon the hard rocks of consumer reality. Consumers in different automobile markets seem to have different tastes and preferences, and they demand different types of vehicles. North American consumers show a strong demand for pickup trucks. This is particularly true in the South and West of the United States, where many families have a pickup truck as a sec- ond or third car. But in European countries, pickup trucks are seen purely as utility vehicles and are purchased primarily by firms rather than individuals. As a consequence, the product mix and marketing message needs to be tailored to consider the different nature of demand in North America and Europe.

Some have argued that customer demands for local customization are on the decline world- wide.28 According to this argument, modern communications and transport technologies have created the conditions for a convergence of the tastes and preferences of consumers from dif- ferent nations. The result is the emergence of enormous global markets for standardized con- sumer products. The worldwide acceptance of McDonald’s hamburgers, Coca-Cola, Gap clothes, Apple iPhones, and Microsoft’s Xbox—all of which are sold globally as standardized products—are often cited as evidence of the increasing homogeneity of the global marketplace.

However, this argument may not hold in many consumer goods markets. Significant dif- ferences in consumer tastes and preferences still exist across nations, regions, and cultures. Managers in international businesses do not yet have the luxury of being able to ignore these differences, and they may not for a long time to come. For an example of a company that has discovered how important pressures for local responsiveness can still be, read the accompanying Management Focus on MTV Networks.

Universal Needs Needs that are the same all over the world, such as steel, bulk chemicals, and industrial electronics.

Chapter Twelve The Strategy of International Business 355

Differences in Infrastructure and Traditional Practices Pressures for local responsiveness arise from differences in infrastructure or traditional practices among coun- tries, creating a need to customize products accordingly. Fulfilling this need may require the delegation of manufacturing and production functions to foreign subsidiaries. For example, in North America, consumer electrical systems are based on 110 volts, whereas in some European countries, 240-volt systems are standard. Thus, domestic electrical appliances have to be customized for this difference in infrastructure. Traditional practices also often vary across nations. For example, in Britain, people drive on the left-hand side of the road, creat- ing a demand for right-hand-drive cars, whereas in France (and the rest of Europe), people drive on the right-hand side of the road and therefore want left-hand-drive cars. Obviously, automobiles have to be customized to accommodate this difference in traditional practice.

Although many national and regional differences in infrastructure are rooted in history, some are quite recent. For example, in the wireless telecommunications industry, different tech- nical standards exist in different parts of the world. A technical standard known as GSM is com- mon in Europe, and an alternative standard, CDMA, is more common in the United States and parts of Asia. Equipment designed for GSM will not work on a CDMA network, and vice versa. Thus, companies in this industry—such as Apple, Nokia, Motorola, Samsung, and Ericsson— that manufacture smartphones or infrastructure such as switches need to customize their prod- uct offering according to the technical standard prevailing in a given country or region.

Differences in Distribution Channels A firm’s marketing strategies may have to be responsive to differences in distribution channels among countries, which may necessi- tate the delegation of marketing functions to national subsidiaries. In the pharmaceutical industry, for example, the British and Japanese distribution systems are radically different from the U.S. system. British and Japanese doctors will not accept or respond favorably to a U.S.-style high-pressure sales force. Thus, pharmaceutical companies have to adopt different marketing practices in Britain and Japan compared with the United States—soft sell versus hard sell. Similarly, Poland, Brazil, and Russia all have similar per capita income on a pur- chasing power parity basis, but there are big differences in distribution systems across the three countries. In Brazil, supermarkets account for 36 percent of food retailing, in Poland

Local Responsiveness at MTV Networks

MTV Networks has become a symbol of globalization. Established in 1981, the U.S.-based TV network has been expanding outside of its North American base since 1987 when it opened MTV Europe. Today, MTV Networks figures that every second of every day more than 2 million people are watching MTV around the world, the majority outside the United States. Despite its international success, MTV’s global expansion got off to a weak start. In the 1980s, when the main programming fare was still music videos, it piped a single feed across Europe almost entirely composed of American programming with English-speaking veejays. Naively, the network’s U.S. managers thought Europeans would flock to the American programming. But while viewers in Europe shared a common interest in a handful of global superstars, their tastes turned out to be surprisingly local. After losing share to local competitors, who focused more on local tastes, MTV changed its strategy in the 1990s. It broke its service into “feeds” aimed at national or regional markets. While MTV Net- works exercises creative control over these different feeds, and while all the channels have the same familiar frenetic look and feel of MTV

in the United States, a significant share of the programming and con- tent is now local.

Today, an increasing share of programming is local in conception. Although a lot of programming ideas still originate in the United States, with staples such as The Real World having equivalents in different countries, an increasing share of programming is local in conception. In Italy, MTV Kitchen combines cooking with a music countdown. Erotica airs in Brazil and features a panel of youngsters discussing sex. The Indian channel produces 21 homegrown shows hosted by local veejays who speak “Hinglish,” a city-bred version of Hindi and English. Many feeds still feature music videos by locally popular performers. This lo- calization push reaped big benefits for MTV, allowing the network to capture viewers back from local imitators.

Sources: M. Gunther, “MTV’s Passage to India,” Fortune, August 9, 2004, pp. 117–22; B. Pulley and A. Tanzer, “Sumner’s Gemstone,” Forbes, February 21, 2000, pp. 107–11; K. Hoffman, “Youth TV’s Old Hand Prepares for the Digital Challenge,” Financial Times, February 18, 2000, p. 8; presentation by Sumner M. Redstone, chairman and CEO, Viacom Inc., delivered to Salomon Smith Barney 11th Annual Global Entertainment Media, Telecommunications Conference, Scottsdale, AZ, January 8, 2001, archived at www. viacom.com; and Viacom 10K Statement, 2005.

management FOCUS

356 Part Five The Strategy of International Business

for 18 percent, and in Russia for less than 1 percent.29 These differences in channels require that companies adapt their own distribution and sales strategies.

Host-Government Demands Economic and political demands imposed by host- country governments may require local responsiveness. For example, pharmaceutical com- panies are subject to local clinical testing, registration procedures, and pricing restrictions—all of which make it necessary that the manufacturing and marketing of a drug should meet local requirements. Because governments and government agencies control a significant proportion of the health care budget in most countries, they are in a powerful position to demand a high level of local responsiveness.

More generally, threats of protectionism, economic nationalism, and local content rules (which require that a certain percentage of a product should be manufactured locally) dictate that international businesses manufacture locally. For example, consider Bombardier, the Canadian-based manufacturer of railcars, aircraft, jet boats, and snowmobiles. Bombardier has 12 railcar factories across Europe. Critics of the company argue that the resulting dupli- cation of manufacturing facilities leads to high costs and helps explain why Bombardier makes lower profit margins on its railcar operations than on its other business lines. In reply, managers at Bombardier argue that in Europe, informal rules with regard to local content favor people who use local workers. To sell railcars in Germany, they claim, you must manu- facture in Germany. The same goes for Belgium, Austria, and France. To try to address its cost structure in Europe, Bombardier has centralized its engineering and purchasing func- tions, but it has no plans to centralize manufacturing.30

The Rise of Regionalism Traditionally, we have tended to think of pressures for local responsiveness as being derived from national differences in tastes and preferences, infra- structure, and the like. While this is still often the case, there is also a tendency toward the convergence of tastes, preferences, infrastructure, distribution channels, and host-government demands with a broader region that is composed of two or more nations.31 We tend to see this when there are strong pressures for convergence due to, for example, a shared history and culture or the establishment of a trading block where there are deliberate attempts to harmonize trade policies, infrastructure, regulations, and the like.

The most obvious example of a region is the European Union, and particularly the euro zone countries within that trade block, where there are institutional forces that are pushing towards convergence (see Chapter 9 for details). The creation of a single EU market—with a single currency, common business regulations, standard infrastructure, and so on—cannot help but result in the reduction of certain national differences among countries within the EU and the creation of one regional rather than several national markets. Indeed, at the economic level at least, that is the explicit intent of the EU.

Another example of regional convergence is North America, which includes the United States, Canada, and to some extent in some product markets, Mexico. Canada and the United States share history, language, and much of their culture, and both are members of NAFTA. Mexico is clearly different in many regards, but its proximity to the United States, along with its membership in NAFTA, implies that for some product markets (e.g., automo- biles), it might be reasonable to consider Mexico as part of a relatively homogenous regional market. We might also talk about the Latin America region, where shared Spanish history, cultural heritage, and language (with the exception of Brazil, which was colonized by the Portuguese) means that national differences are somewhat moderated. It can also be argued that Greater China, which includes the city-states of Honk Kong and Singapore along with Taiwan, is a coherent region, as is much of the Middle East, where a strong Arab culture and shared history may limit national differences. Similarly, Russia and some of the former states of the Soviet Union, such as Belarus and the Ukraine, might be considered part of a larger regional market, at least for some products.

Taking a regional perspective is important because it may suggest that localization at the regional rather than the national level is the appropriate strategic response. For example, rather than produce cars for each national market within the Europe or North America, it makes far more sense for car manufacturers to build cars for the European or North American

Chapter Twelve The Strategy of International Business 357

regions. The ability to standardize product offering within a region allows for the attainment of greater scale economies, and hence lower costs, than if each nation had to have its own of- fering. At the same time, this perspective should not be pushed too far. There are still deep and profound cultural differences among the United Kingdom, France, Germany, and Italy—all members of the EU—that may in turn require some degree of local customization at the national level. Managers must thus make a judgment call about the appropriate level of aggre- gation given (1) the product market they are looking at and (2) the nature of national differ- ences and trends for regional convergence. What might make sense for automobiles, for example, might not be appropriate for packaged food products.

Choosing a Strategy Pressures for local responsiveness imply that it may not be possible for a firm to realize the full benefits from economies of scale, learning effects, and location economies. It may not be pos- sible to serve the global marketplace from a single low-cost location, producing a globally standardized product, and marketing it worldwide to attain the cost reductions associated with experience effects. The need to customize the product offering to local conditions, whether national or regional, may work against the implementation of such a strategy. For example, as noted automobile firms have found that Japanese, American, and European consumers de- mand different kinds of cars, and this necessitates producing products that are customized for regional markets. In response, firms such as Honda, Ford, and Toyota are pursuing a strategy of establishing top-to-bottom design and production facilities in each of these regions so that they can better serve local demands. Although such customization brings benefits, it also limits the ability of a firm to realize significant scale economies and location economies.

In addition, pressures for local responsiveness imply that it may not be possible to lever- age skills and products associated with a firm’s core competencies wholesale from one nation or region to another. Concessions often have to be made to local conditions. Despite being depicted as “poster boy” for the proliferation of standard- ized global products, even McDonald’s has found that it has to customize its product offerings (i.e., its menu) to account for national differences in tastes and preferences.

How do differences in the strength of pressures for cost reductions versus those for local responsiveness affect a firm’s choice of strategy? Firms typically choose among four main strategic postures when competing internationally. These can be characterized as a global standardization strategy, a localization strategy, a transnational strategy, and an interna- tional strategy.32 The appropriateness of each strategy varies given the extent of pressures for cost reductions and local responsiveness. Figure 12.9 illustrates the conditions under which each of these strategies is most appropriate.

GLOBAL STANDARDIZATION STRATEGY Firms that pursue a global standardization strategy focus on increasing profitability and profit growth by reaping the cost reductions that come from economies of scale, learning effects, and location economies; that is, their strategic goal is to pursue a low-cost strategy on a global scale. The produc- tion, marketing, and R&D activities of firms pursuing a global standardization strategy are concentrated in a few fa- vorable locations. Firms pursuing a global standardization strategy try not to customize their product offering and marketing strategy to local conditions because customiza- tion involves shorter production runs and the duplication of functions, which tends to raise costs. Instead, they prefer to market a standardized product worldwide so that they can

LO 12-4 Identify the different strategies for competing globally and their pros and cons.

Global Standardization Strategy A firm focuses on increasing profitability and profit growth by reaping the cost reductions that come from economies of scale, learning effects, and location economies.

More Customized Products in the Global Marketplace? The Coca-Cola Company’s (TCCC) Minute Maid Pulpy became the cola giant’s 14th brand to reach US$1 billion in global retail sales (in 2011). As opposed to cola carbonates, which often rely on global brand recognition and cross-generational formulas for suc- cess, Minute Maid Pulpy has relied on product development and innovations inspired by local flavors and textures. Minute Maid released Minute Maid Pulpy toward the end of 2004, which con- tained less than 24 percent actual fruit juice, but TCCC was able to retail the product at a much lower price point. In China and throughout the Asia-Pacific region, consumer notions of freshness and health are connected much more to the consumption of actual fruit. Minute Maid Pulpy acknowledged this by including pieces of fruit in the drink, thereby creating a thicker texture that would not appeal to most North American consumers but has proven very popular in this region of the world. In customizing the product, Minute Maid Pulpy went from the 10th most popular fruit/ vegetable juice brand in China in 2004 to 1st by the time it had achieved $1 billion in total sales in 2011. But isn’t the world be- coming more globalized? Do we still need large multinational cor- porations customizing their products to local markets?

Source: http://blog.euromonitor.com/2012/05/fl avours-and-textures-how-local- consumer-taste-palates-aredefi ning-global-soft-drinks.html.

test PREP Use LearnSmart to help retain what you have learned. Access your instructor’s Connect course to check out LearnSmart or go to learnsmartadvantage.com for help.

358 Part Five The Strategy of International Business

reap the maximum benefits from economies of scale and learning effects. They also tend to use their cost advantage to support aggressive pricing in world markets.

This strategy makes most sense when there are strong pressures for cost reductions and demands for local responsiveness are minimal. Increasingly, these conditions prevail in many industrial goods industries, whose products often serve universal needs. In the semiconductor industry, for example, global standards have emerged, creating enormous demands for stan- dardized global products. Accordingly, companies such as Intel, Texas Instruments, and Motorola all pursue a global standardization strategy. However, these conditions are not al- ways found in many consumer goods markets, where demands for local responsiveness can re- main high. The strategy is inappropriate when demands for local responsiveness are high. The experience of Vodafone, which is discussed in the accompanying Management Focus, illustrates what can happen when a global standardization strategy does not match market realities.

12.9 FIGURE Four Basic Strategies

Low

Lo w

Pressures for local responsiveness Pr

es su

re s

fo r c

os t r

ed uc

tio ns

High

Hi gh

Global standardization

strategy

International strategy

Transnational strategy

Localization strategy

Vodafone in Japan

In 2002, Vodafone Group of the United Kingdom, the world’s largest provider of wireless telephone service, made a big splash by paying $14 billion to acquire J-Phone, the number-three player in Japan’s fast-growing market for wireless communications services. J-Phone was considered a hot property, having just launched Japan’s first cell phones that were embedded with digital cameras, winning over large numbers of young people who wanted to e-mail photos to their friends. Four years later, after losing market share to local competitors, Vodafone sold J-Phone and took an $8.6 billion charge against earn- ings related to the sale. What went wrong?

According to analysts, Vodafone’s mistake was to focus too much on building a global brand and not enough on local market conditions in Japan. In the early 2000s, Vodafone’s vision was to offer consumers in different countries the same technology so that they could take their phones with them when they traveled across international borders. The problem, however, was that Japan’s most active cell phone users— many of them young people who don’t regularly travel abroad—care

far less about this capability than about game playing and other fea- tures that are embedded in their cell phones.

Vodafone’s emphasis on global services meant that it delayed its launch in Japan of phones that use 3G technology, which allowed us- ers to do things such as watch video clips and teleconference on their cell phones. The company, in line with its global branding ambitions, had decided to launch 3G cell phones that worked both inside and outside Japan. The delay was costly. Its Japanese competitors launched 3G phones a year ahead of Vodafone. Although these phones only worked in Japan, they rapidly gained share as consumers adopted these leading-edge devices. When Vodafone did finally introduce a 3G phone, design problems associated with making a phone that worked globally meant that the supply of phones was limited, and the launch fizzled despite strong product reviews, simply because consumers could not get the phones.

Sources: C. Bryan-Low, “Vodafone’s Global Ambitions Got Hung Up in Japan,” The Wall Street Journal, March 18, 2006, p. A1; and G. Parket, “Going Global Can Hit Snags Vodafone Finds,” The Wall Street Journal, June 16, 2004, p. B1.

management FOCUS

Chapter Twelve The Strategy of International Business 359

LOCALIZATION STRATEGY A localization strategy focuses on increasing profitability by customizing the firm’s goods or services so that they provide a good match to tastes and preferences in different national or regional markets. Localization is most ap- propriate when there are substantial differences across nations or regions with regard to consumer tastes and preferences and where cost pressures are not too intense. By custom- izing the product offering to local demands, the firm increases the value of that product in the local market. On the downside, because it involves some duplication of functions and smaller production runs, customization limits the ability of the firm to capture the cost re- ductions associated with mass-producing a standardized product for global consumption. The strategy may make sense, however, if the added value associated with local customiza- tion supports higher pricing, which enables the firm to recoup its higher costs, or if it leads to substantially greater local demand, enabling the firm to reduce costs through the attain- ment of some scale economies in the local market.

At the same time, firms still have to keep an eye on costs. Firms pursuing a localization strategy still need to be efficient and, whenever possible, to capture some scale economies from their global reach. As noted earlier, many automobile companies have found that they have to customize some of their product offerings to local market demands—for example, producing large pickup trucks for North American consumers and small fuel-efficient cars for Europeans and Japanese. At the same time, these multinationals try to get some scale economies from their global volume by using common vehicle platforms and components across many different models and manufacturing those platforms and components at effi- ciently scaled factories that are optimally located. By designing their products in this way, these companies have been able to localize their product offering, yet simultaneously cap- ture some scale economies, learning effects, and location economies.

TRANSNATIONAL STRATEGY We have argued that a global standardization strategy makes most sense when cost pressures are intense and demands for local respon- siveness are limited. Conversely, a localization strategy makes most sense when demands for local responsiveness are high, but cost pressures are moderate or low. What happens, how- ever, when the firm simultaneously faces both strong cost pressures and strong pressures for local responsiveness? How can managers balance the competing and inconsistent demands such divergent pressures place on the firm? According to some researchers, the answer is to pursue what has been called a transnational strategy.

Two of these researchers, Christopher Bartlett and Sumantra Ghoshal, argue that in the modern global environment, competitive conditions are so intense that to survive, firms must do all they can to respond to pressures for cost reductions and local responsiveness.33 They must try to realize location economies and experience effects, to leverage products internationally, to transfer core competencies and skills within the company, and to simulta- neously pay attention to pressures for local responsiveness.34 Bartlett and Ghoshal note that in the modern multinational enterprise, core competencies and skills do not reside just in the home country but can develop in any of the firm’s worldwide operations. Thus, they maintain that the flow of skills and product offerings should not be all one way, from home country to foreign subsidiary. Rather, the flow should also be from foreign subsidiary to home country and from foreign subsidiary to foreign subsidiary. Transnational enterprises, in other words, must also focus on leveraging subsidiary skills.

In essence, firms that pursue a transnational strategy are trying to simultaneously achieve low costs through location economies, economies of scale, and learning effects; differentiate their product offering across geographic markets to account for local differences; and foster a multidirectional flow of skills between different subsidiaries in the firm’s global network of op- erations. As attractive as this may sound in theory, the strategy is not an easy one to pursue be- cause it places conflicting demands on the company. Differentiating the product to respond to local demands in different geographic markets raises costs, which runs counter to the goal of reducing costs. Companies such as 3M and ABB (one of the world’s largest engineering con- glomerates) have tried to embrace a transnational strategy and found it difficult to implement.

How best to implement a transnational strategy is one of the most complex questions that large multinationals are grappling with today. Few if any enterprises have perfected this

Localization Strategy Increasing profitability by customizing the firm’s goods and services so that they provide a good match to tastes and preferences in different national markets.

Transnational Strategy Attempt to simultaneously achieve low costs through location economies, economies of scale, and learning effects while also differentiating product offerings across geographic markets to account for local differences and fostering multidirectional flows of skills between different subsidiaries in the firm’s global network of operations.

360 Part Five The Strategy of International Business

strategic posture. But some clues as to the right approach can be derived from a number of companies. For an ex- ample, consider the case of Caterpillar. The need to com- pete with low-cost competitors such as Komatsu of Japan forced Caterpillar to look for greater cost economies. However, variations in construction practices and gov- ernment regulations across countries and regions mean that Caterpillar also has to be responsive to local de- mands. Therefore, Caterpillar confronted significant pressures for cost reductions and for local responsiveness.

To deal with cost pressures, Caterpillar redesigned its products to use many identical components and invested in a few large-scale component manufacturing facilities, sited at favorable locations, to fill global demand and realize scale economies. At the same time, the company augments the centralized manufacturing of components with assem- bly plants in each of its major global markets. At these plants, Caterpillar adds local product features, tailoring the finished product to local needs. Thus, Caterpillar is able to realize many of the benefits of global manufacturing while reacting to pressures for local responsiveness by differenti- ating its product among national markets.35 Caterpillar started to pursue this strategy in the 1980s; by the 2000s, it had succeeded in doubling output per employee, signifi- cantly reducing its overall cost structure in the process. Meanwhile, Komatsu and Hitachi, which are still wedded to a Japan-centric global strategy, have seen their cost ad- vantages evaporate and have been steadily losing market share to Caterpillar.

Changing a firm’s strategic posture to build an organi- zation capable of supporting a transnational strategy is a

complex and challenging task. Some would say it is too complex because the strategy imple- mentation problems of creating a viable organizational structure and control systems to manage this strategy are immense.

INTERNATIONAL STRATEGY Sometimes it is possible to identify multina- tional firms that find themselves in the fortunate position of being confronted with low cost pressures and low pressures for local responsiveness. Many of these enterprises have pursued an international strategy, taking products first produced for their domestic market and sell- ing them internationally with only minimal local customization. The distinguishing feature of many such firms is that they are selling a product that serves universal needs, but they do not face significant competitors; thus, unlike firms pursuing a global standardization strategy, they are not confronted with pressures to reduce their cost structure. Xerox found itself in this position in the 1960s after its invention and commercialization of the photocopier. The tech- nology underlying the photocopier was protected by strong patents, so for several years Xerox did not face competitors—it had a monopoly. The product serves universal needs, and it was highly valued in most developed nations. Thus, Xerox was able to sell the same basic product the world over, charging a relatively high price for that product. Because Xerox did not face direct competitors, it did not have to deal with strong pressures to minimize its cost structure.

Enterprises pursuing an international strategy have followed a similar developmental pattern as they expanded into foreign markets. They tend to centralize product develop- ment functions such as R&D at home. However, they also tend to establish manufacturing and marketing functions in each major country or geographic region in which they do busi- ness. The resulting duplication can raise costs, but this is less of an issue if the firm does not face strong pressures for cost reductions. Although they may undertake some local custom- ization of product offering and marketing strategy, this tends to be rather limited in scope.

International Strategy Trying to create value by transferring core competencies to foreign markets where indigenous competitors lack those competencies.

Is Citigroup Now the Best in Financials? Recent earnings reports of the financials showed a separation between the more internationally focused business models of Bank of America and Citigroup, from the more domestic focused growth strategies of JP Morgan and Wells Fargo. The banking sector in the United States is heavily saturated, and the financials who rely primarily on the domestic economy for growth continue to struggle. Today, when you look at Citi’s business model, the company looks like an international bank headquartered in the United States because the company gets nearly 70 percent of its revenue overseas. The company is strongly positioned in almost every major emerging market economy, with bold plans for con- tinued future growth. In Latin America, for instance, Eduardo Cruz, one of the most respected executives in the banking indus- try, continues to successfully build out Citi’s retail and investment banking presence. Also, in Asia, where Citi has its largest interna- tional footprint, the company continues to be similarly successful in building out its core banking business across the region, with a particularly strong retail franchise in India. Based on the material in Chapter 12, do you think Citigroup is using a global stan- dardization strategy, localization strategy, transnational strat- egy, or international strategy? And, perhaps more interestingly, is Citigroup now the best in financials?

Source: http://seekingalpha.com/article/307549-is-citigroup-now-the-best-in- fi nancials.

Chapter Twelve The Strategy of International Business 361

Ultimately, in most firms that pursue an international strategy, the head office retains fairly tight control over marketing and product strategy.

Firms that have pursued this strategy include Procter & Gamble and Microsoft. Histori- cally, Procter & Gamble developed innovative new products in Cincinnati and then trans- ferred them wholesale to local markets (see the accompanying Management Focus). Similarly, the bulk of Microsoft’s product development work occurs in Redmond, Washington, where the company is headquartered. Although some localization work is undertaken elsewhere, this is limited to producing foreign-language versions of popular Microsoft programs.

THE EVOLUTION OF STRATEGY The Achilles’ heel of the international strategy is that over time, competitors inevitably emerge, and if managers do not take proac- tive steps to reduce their firm’s cost structure, it will be rapidly outflanked by efficient global competitors. This is what happened to Xerox. Japanese companies such as Canon ultimately invented their way around Xerox’s patents, produced their own photocopiers in very effi- cient manufacturing plants, priced them below Xerox’s products, and rapidly took global market share from Xerox. In the final analysis, Xerox’s demise was not due to the emergence of competitors—because, ultimately, that was bound to occur—but due to its failure to pro- actively reduce its cost structure in advance of the emergence of efficient global competi- tors. The message in this story is that an international strategy may not be viable in the long term, and to survive, firms need to shift toward a global standardization strategy or a trans- national strategy in advance of competitors (see Figure 12.10).

Evolution of Strategy at Procter & Gamble

Founded in 1837, Cincinnati-based Procter & Gamble has long been one of the world’s most international companies. Today, P&G is a global co- lossus in the consumer products business with annual sales in excess of $80 billion, some 54 percent of which are generated outside of the United States. P&G sells more than 300 brands—including Ivory soap, Tide, Pampers, IAMS pet food, Crisco, and Folgers—to consumers in 180 countries. Historically, the strategy at P&G was well established. The company developed new products in Cincinnati and then relied on semiautonomous foreign subsidiaries to manufacture, market, and dis- tribute those products in different nations. In many cases, foreign sub- sidiaries had their own production facilities and tailored the packaging, brand name, and marketing message to local tastes and preferences. For years, this strategy delivered a steady stream of new products and reliable growth in sales and profits. By the 1990s, however, profit growth at P&G was slowing.

The essence of the problem was simple; P&G’s costs were too high because of extensive duplication of manufacturing, marketing, and ad- ministrative facilities in different national subsidiaries. The duplication of assets made sense in the world of the 1960s, when national mar- kets were segmented from each other by barriers to cross-border trade. Products produced in Great Britain, for example, could not be sold economically in Germany due to high tariff duties levied on im- ports into Germany. By the 1980s, however, barriers to cross-border trade were falling rapidly worldwide and fragmented national markets were merging into larger regional or global markets. Also, the retailers through which P&G distributed its products were growing larger and more global, such as Walmart, Tesco from the United Kingdom, and Carrefour from France. These emerging global retailers were demand- ing price discounts from P&G.

In the 1990s, P&G embarked on a major reorganization in an attempt to control its cost structure and recognize the new reality of emerging global markets. The company shut down some 30 manufacturing plants around the globe, laid off 13,000 employees, and concentrated produc- tion in fewer plants that could better realize economies of scale and serve regional markets. It wasn’t enough! Profit growth remained slug- gish, so in 1999 P&G launched its second reorganization of the decade. Named “Organization 2005,” the goal was to transform P&G into a truly global company. The company tore up its old organization, which was based on countries and regions, and replaced it with one based on seven self-contained global business units, ranging from baby care to food products. Each business unit was given complete responsibility for gen- erating profits from its products and for manufacturing, marketing, and product development. Each business unit was told to rationalize produc- tion, concentrating it in fewer larger facilities; to try to build global brands wherever possible, thereby eliminating marketing differences among countries; and to accelerate the development and launch of new prod- ucts. P&G announced that as a result of this initiative, it would close an- other 10 factories and lay off 15,000 employees, mostly in Europe where there was still extensive duplication of assets. The annual cost savings were estimated to be about $800 million. P&G planned to use the savings to cut prices and increase marketing spending in an effort to gain market share, and thus further lower costs through the attainment of scale econ- omies. This time, the strategy seemed to be working. For most of the 2000s, P&G reported strong growth in both sales and profits. Signifi- cantly, P&G’s global competitors, such as Unilever, Kimberly-Clark, and Colgate-Palmolive, were struggling during the same time period.

Sources: J. Neff, “P&G Outpacing Unilever in Five-Year Battle,” Advertising Age, November 3, 2003, pp. 1–3; G. Strauss, “Firm Restructuring into Truly Global Company,” USA Today, September 10, 1999, p. B2; Procter & Gamble 10K Report, 2005; and M. Kolbasuk McGee, “P&G Jump-Starts Corporate Change,” Information Week, November 1, 1999, pp. 30–34.

management FOCUS

362 Part Five The Strategy of International Business

The same can be said about a localization strategy. Localization may give a firm a com- petitive edge, but if it is simultaneously facing aggressive competitors, the company will also have to reduce its cost structure, and the only way to do that may be to shift toward a trans- national strategy. This is what Procter & Gamble has been doing (see the accompanying Management Focus). Thus, as competition intensifies, international and localization strate- gies tend to become less viable, and managers need to orient their companies toward either a global standardization strategy or a transnational strategy.

Strategic Alliances Strategic alliances refer to cooperative agreements between potential or actual competitors. In this section, we are concerned specifically with strategic alliances between firms from dif- ferent countries. Strategic alliances run the range from formal joint ventures, in which two or more firms have equity stakes (e.g., Fuji Xerox), to short-term contractual agreements, in which two companies agree to cooperate on a particular task (such as developing a new

product). Collaboration between competitors is fashionable; recent decades have seen an explosion in the number of strategic alliances.

THE ADVANTAGES OF STRATEGIC ALLIANCES Firms ally themselves with actual or potential competitors for various strategic purposes.36 First, strategic alliances may facilitate entry into a foreign market. For example, many firms believe that if they are to successfully enter the Chinese market, they need a local partner who understands business conditions and who has good connections (or guanxi—see Chapter 4). Thus, Warner Brothers entered into a joint venture with two Chinese partners to produce and distribute films in China. As a foreign film company, Warner found that if it wanted to produce films on its own for the Chinese market, it had to go through a complex approval process for every film, and it had to farm out dis- tribution to a local company, which made doing business in China very difficult. Due to the participation of Chinese firms, however, the joint-venture films will go through a streamlined approval process,

LO 12-5 Explain the pros and cons of using strategic alliances to support global strategies.

12.10 FIGURE Changes in Strategy over Time

Low

Lo w

Pressures for local responsiveness Pr

es su

re s

fo r c

os t r

ed uc

tio ns

High

Hi gh

Global standardization

strategy

International strategy

Localization strategy

Transnational strategy

As competitors emerge, these strategies become

less viable

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

test PREP Use LearnSmart to help retain what you have learned. Access your instructor’s Connect course to check out LearnSmart or go to learnsmartadvantage.com for help.

Chapter Twelve The Strategy of International Business 363

and the venture will be able to distribute any films it pro- duces. Also, the joint venture will be able to produce films for Chinese TV, something that foreign firms are not allowed to do.37

Strategic alliances also allow firms to share the fixed costs (and associated risks) of developing new products or pro- cesses. An alliance between Boeing and a number of Japanese companies to build Boeing’s latest commercial jetliner, the 787, was motivated by Boeing’s desire to share the estimated $8 billion investment required to develop the aircraft.

Third, an alliance is a way to bring together complemen- tary skills and assets that neither company could easily de- velop on its own.38 In 2003, for example, Microsoft and Toshiba established an alliance aimed at developing embed- ded microprocessors (essentially tiny computers) that can perform a variety of entertainment functions in an automo- bile (e.g., run a backseat DVD player or a wireless Internet connection). The processors run a version of Microsoft’s Windows operating system. Microsoft brings its software engineering skills to the alliance and Toshiba its skills in de- veloping microprocessors.39

Fourth, it can make sense to form an alliance that will help the firm establish technological standards for the in- dustry that will benefit the firm. For example, in 2011 Nokia, one of the leading makers of smartphones, entered into an alliance with Microsoft under which Nokia agreed to license and use Microsoft’s Windows Mobile operating system in Nokia’s phones. The motivation for the alliance was in part to help establish Windows Mobile as the industry standard for smartphones as opposed to the rival operating systems such as Apple’s iPhone and Google’s Android. Unfortunately for Microsoft, the Nokia’s Windows phones failed to gain sufficient market share. In 2013, Microsoft decided to acquire Nokia’s mobile phone business and bring it in house so that it could ensure a continued aggressive push into the smartphone hardware business.

THE DISADVANTAGES OF STRATEGIC ALLIANCES The advan- tages we have discussed can be very significant. Despite this, some have criticized strategic alliances on the grounds that they give competitors a low-cost route to new technology and markets.40 For example, two decades ago, critics argued that many strategic alliances be- tween U.S. and Japanese firms were part of an implicit Japanese strategy to keep high-paying, high-value-added jobs in Japan while gaining the project engineering and production pro- cess skills that underlie the competitive success of many U.S. companies.41 They argued that Japanese success in the machine tool and semiconductor industries was built on U.S. tech- nology acquired through strategic alliances. And they argued that U.S. managers were aid- ing the Japanese by entering alliances that channel new inventions to Japan and provide a U.S. sales and distribution network for the resulting products. Although such deals may generate short-term profits, so the argument goes, in the long run the result is to “hollow out” U.S. firms, leaving them with no competitive advantage in the global marketplace. The same arguments are now made regarding alliances with Chinese firms.

These critics have a point; alliances have risks. Unless a firm is careful, it can give away more than it receives. But there are so many examples of apparently successful alliances be- tween firms—including alliances between U.S. and Japanese firms—that the critics’ position seems extreme. It is difficult to see how the Microsoft–Toshiba alliance, the Boeing– Mitsubishi alliance for the 787, and the Fuji–Xerox alliance fit the critics’ thesis. In these cases, both partners seem to have gained from the alliance. Why do some alliances benefit both firms while others benefit one firm and hurt the other? The next section provides an answer to this question.

Was Nokia a Risky Purchase for Microsoft? Microsoft Corporation’s acquisition of Nokia Corporation’s devices and services business was seen as a bold but risky gamble in the software giant’s bid for a larger footprint in the fast-growing mobile market. Initially, it relied heavily on a strategic alliance with Nokia, which in 2011 announced that it was embracing Microsoft’s Windows Phone as its main operating system. This partnership produced Lumia, a Windows-based Nokia phone. It has won up- beat reviews but remains an insignificant player in a market domi- nated by Apple’s iPhone and other devices based on Google’s Android operating system. Nokia got caught in a tough transition from its phones based on its Symbian operating system to Windows-based devices, and this transition has been more painful than Nokia anticipated. Despite the somewhat rocky start to their alliance, in September 2013, Microsoft and Nokia announced that the two companies “have decided to enter into a transaction whereby Microsoft will purchase substantially all of Nokia’s Devices and Services business, license Nokia’s patents, and license and use Nokia’s mapping services.” Experts, the markets, and customers are skeptical. Was Nokia a risky purchase for Microsoft?

Source: “Microsoft to Acquire Nokia’s Devices and Services Business, License Nokia’s Patents and Mapping Services,” Microsoft News Center, September 3, 2013.

364 Part Five The Strategy of International Business

MAKING ALLIANCES WORK The failure rate for international strategic alli- ances seems to be high. One study of 49 international strategic alliances found that two- thirds run into serious managerial and financial troubles within two years of their formation, and that although many of these problems are solved, 33 percent are ultimately rated as fail- ures by the parties involved.42 The success of an alliance seems to be a function of three main factors: partner selection, alliance structure, and the manner in which the alliance is managed.

Partner Selection One key to making a strategic alliance work is to select the right ally. A good ally, or partner, has three characteristics. First, a good partner helps the firm achieve its strategic goals, whether they are market access, sharing the costs and risks of product development, or gaining access to critical core competencies. The partner must have capabilities that the firm lacks and that it values. Second, a good partner shares the firm’s vision for the purpose of the alliance. If two firms approach an alliance with radically different agendas, the chances are great that the relationship will not be harmonious, will not flourish, and will end in divorce. Third, a good partner is unlikely to try to opportunisti- cally exploit the alliance for its own ends, that is, to expropriate the firm’s technological know-how while giving away little in return. In this respect, firms with reputations for “fair play” to maintain probably make the best allies. For example, companies such as General Electric are involved in so many strategic alliances that it would not pay the company to trample over individual alliance partners.43 This would tarnish GE’s reputation of being a good ally and would make it more difficult for GE to attract alliance partners. Because IBM attaches great importance to its alliances, it is unlikely to engage in the kind of opportunistic behavior that critics highlight. Similarly, their reputations make it less likely (but by no means impossible) that such Japanese firms as Sony, Toshiba, and Fuji, which have histories of alliances with non-Japanese firms, would opportunistically exploit an alliance partner.

To select a partner with these three characteristics, a firm needs to conduct comprehen- sive research on potential alliance candidates. To increase the probability of selecting a good partner, the firm should:

1. Collect as much pertinent, publicly available information on potential allies as possible. 2. Gather data from informed third parties. These include firms that have had alliances

with the potential partners, investment bankers that have had dealings with them, and former employees.

3. Get to know the potential partner as well as possible before committing to an alliance. This should include face-to-face meetings between senior managers (and perhaps middle-level managers) to ensure that the chemistry is right.

Alliance Structure A partner having been selected, the alliance should be structured so that the firm’s risks of giving too much away to the partner are reduced to an acceptable level. First, alliances can be designed to make it difficult (if not impossible) to transfer technology not meant to be transferred. The design, development, manufacture, and service of a product manufactured by an alliance can be structured so as to wall off sensitive technologies to pre- vent their leakage to the other participant. In a long-standing alliance between General Elec- tric and Snecma to build commercial aircraft engines for single-aisle commercial jet aircraft, for example, GE reduced the risk of excess transfer by walling off certain sections of the pro- duction process. The modularization effectively cut off the transfer of what GE regarded as key competitive technology, while permitting Snecma access to final assembly. Formed in 1974, the alliance has been remarkably successful, and today it dominates the market for jet engines used on the Boeing 737 and Airbus 320.44 Similarly, in the alliance between Boeing and the Japanese to build the 767, Boeing walled off research, design, and marketing functions considered central to its competitive position, while allowing the Japanese to share in produc- tion technology. Boeing also walled off new technologies not required for 767 production.45

Second, contractual safeguards can be written into an alliance agreement to guard against the risk of opportunism by a partner. (Opportunism includes the theft of technology and/or markets.) For example, TRW Inc. entered into three strategic alliances with large Japanese auto component suppliers to produce seat belts, engine valves, and steering gears for sale to

Chapter Twelve The Strategy of International Business 365

Japanese-owned auto assembly plants in the United States. TRW put clauses in each of its alliance contracts that barred the Japanese firms from competing with TRW to supply U.S.- owned auto companies with component parts. By doing this, TRW protected itself against the possibility that the Japanese companies were entering into the alliances merely to gain access to the North American market to compete with TRW in its home market.

Third, both parties to an alliance can agree in advance to swap skills and technologies that the other covets, thereby ensuring a chance for equitable gain. Cross-licensing agree- ments are one way to achieve this goal. Fourth, the risk of opportunism by an alliance part- ner can be reduced if the firm extracts a significant credible commitment from its partner in advance. The long-term alliance between Xerox and Fuji to build photocopiers for the Asian market perhaps best illustrates this. Rather than enter into an informal agreement or a licensing arrangement (which Fuji Photo initially wanted), Xerox insisted that Fuji invest in a 50/50 joint venture to serve Japan and East Asia. This venture constituted such a signifi- cant investment in people, equipment, and facilities that Fuji Photo was committed from the outset to making the alliance work in order to earn a return on its investment. By agreeing to the joint venture, Fuji essentially made a credible commitment to the alliance. Given this, Xerox felt secure in transferring its photocopier technology to Fuji.46

Managing the Alliance Once a partner has been selected and an appropriate alli- ance structure has been agreed on, the task facing the firm is to maximize its benefits from the alliance. As in all international business deals, an important factor is sensitivity to cul- tural differences (see Chapter 4). Many differences in management style are attributable to cultural differences, and managers need to make allowances for these in dealing with their partner. Beyond this, maximizing the benefits from an alliance seems to involve building trust between partners and learning from partners.47

Managing an alliance successfully requires building interpersonal relationships between the firms’ managers, or what is sometimes referred to as relational capital.48 This is one lesson that can be drawn from a successful strategic alliance between Ford and Mazda. Ford and Mazda set up a framework of meetings within which their managers not only discuss mat- ters pertaining to the alliance but also have time to get to know each other better. The belief is that the resulting friendships help build trust and facilitate harmonious relations between the two firms. Personal relationships also foster an informal management network between the firms. This network can then be used to help solve problems arising in more formal contexts (such as in joint committee meetings between personnel from the two firms).

Academics have argued that a major determinant of how much acquiring knowledge a company gains from an alliance is its ability to learn from its alliance partner.49 For example, in a five-year study of 15 strategic alliances between major multinationals, Gary Hamel, Yves Doz, and C. K. Prahalad focused on a number of alliances between Japanese companies and Western (European or American) partners.50 In every case in which a Japanese company emerged from an alliance stronger than its Western partner, the Japanese company had made a greater effort to learn. Few Western companies studied seemed to want to learn from their Japanese partners. They tended to regard the alliance purely as a cost-sharing or risk-sharing device, rather than as an opportunity to learn how a potential competitor does business.

Consider the alliance between General Motors and Toyota constituted in 1985 to build the Chevrolet Nova. This alliance was structured as a formal joint venture, called New United Motor Manufacturing Inc., and each party had a 50 percent equity stake. The venture owned an auto plant in Fremont, California. According to one Japanese manager, Toyota quickly achieved most of its objectives from the alliance: “We learned about U.S. supply and transportation. And we got the confidence to manage U.S. workers.”51 All that knowledge was then transferred to Georgetown, Kentucky, where Toyota opened its own plant in 1988. Possibly all GM got was a new product, the Chevrolet Nova. Some GM managers complained that the knowledge they gained through the alliance with Toyota has never been put to good use inside GM. They be- lieve they should have been kept together as a team to educate GM’s engineers and workers about the Japanese system. Instead, they were dispersed to various GM subsidiaries.

To maximize the learning benefits of an alliance, a firm must try to learn from its partner and then apply the knowledge within its own organization. It has been suggested that all

366 Part Five The Strategy of International Business

operating employees should be well briefed on the partner’s strengths and weaknesses and should understand how acquiring particular skills will bolster their firm’s competitive posi- tion. Hamel, Doz, and Prahalad note that this is already standard practice among Japanese companies. They made this observation:

We accompanied a Japanese development engineer on a tour through a partner’s factory. This engineer dutifully took notes on plant layout, the number of produc- tion stages, the rate at which the line was running, and the number of employees. He recorded all this despite the fact that he had no manufacturing responsibility in his own company, and that the alliance did not encompass joint manufacturing. Such dedication greatly enhances learning.52

strategy, p. 339 profitability, p. 339 profit growth, p. 339 value creation, p. 340 operations, p. 342 organization architecture, p. 345 organizational structure, p. 345 controls, p. 345

incentives, p. 345 processes, p. 345 organizational culture, p. 345 people, p. 345 core competence, p. 347 location economies, p. 348 global web, p. 349 experience curve, p. 350

learning effects, p. 350 economies of scale, p. 350 universal needs, p. 354 global standardization strategy, p. 357 localization strategy, p. 359 transnational strategy, p. 359 international strategy, p. 360

Key Terms

Summary

This chapter reviewed basic principles of strategy and the various ways in which firms can profit from global expan- sion, and it looked at the strategies that firms that compete globally can adopt. The chapter made the following points:

1. A strategy can be defined as the actions that managers take to attain the goals of the firm. For most firms, the preeminent goal is to maximize shareholder value. Maximizing shareholder value requires firms to focus on increasing their profitability and the growth rate of profits over time.

2. International expansion may enable a firm to earn greater returns by transferring the product offerings derived from its core competencies to markets where indigenous competitors lack those product offerings and competencies.

3. It may pay a firm to base each value creation activity it performs at that location where factor conditions are most conducive to the performance of that activity. We refer to this strategy as focusing on the attainment of location economies.

4. By rapidly building sales volume for a standardized product, international expansion can assist a firm in moving down the experience curve by realizing learning effects and economies of scale.

5. A multinational firm can create additional value by identifying valuable skills created within its foreign subsidiaries and leveraging those skills within its global network of operations.

6. The best strategy for a firm to pursue often depends on a consideration of the pressures for cost reductions and for local responsiveness.

7. Firms pursuing an international strategy transfer the products derived from core competencies to foreign markets, while undertaking some limited local customization.

8. Firms pursuing a localization strategy customize their product offering, marketing strategy, and business strategy to national conditions.

9. Firms pursuing a global standardization strategy focus on reaping the cost reductions that come from experience curve effects and location economies.

10. Many industries are now so competitive that firms must adopt a transnational strategy. This involves a simultaneous focus on reducing costs, transferring skills and products, and boosting local responsiveness. Implementing such a strategy may not be easy.

11. Strategic alliances are cooperative agreements between actual or potential competitors.

12. The advantages of alliances are that they facilitate entry into foreign markets, enable partners to share the fixed costs and risks associated with new products and processes, facilitate the transfer of complementary skills between companies, and help firms establish technical standards.

test PREP Use LearnSmart to help retain what you have learned. Access your instructor’s Connect course to check out LearnSmart or go to learnsmartadvantage.com for help.

Critical Thinking and Discussion Questions

1. In a world of zero transportation costs, no trade barriers, and nontrivial differences between nations with regard to factor conditions, firms must expand internationally if they are to survive. Discuss.

2. Plot the position of the following firms on Figure 12.8: Procter & Gamble, IBM, Apple, Coca-Cola, Dow Chemical, U.S. Steel, McDonald’s. In each case, justify your answer.

3. In what kind of industries does a localization strategy make sense? When does a global standardization strategy make most sense?

4. Reread the Management Focus on Procter & Gamble and then answer the following questions: a. What strategy was Procter & Gamble pursuing when

it first entered foreign markets in the period up until the 1980s?

b. Why do you think this strategy became less viable in the 1990s?

c. What strategy does P&G appear to be moving toward? What are the benefits of this strategy? What are the potential risks associated with it?

5. What do you see as the main organizational problems that are likely to be associated with implementation of a transnational strategy?

13. A disadvantage of a strategic alliance is that the firm risks giving away technological know-how and market access to its alliance partner in return for very little.

14. The disadvantages associated with alliances can be reduced if the firm selects partners carefully, paying close attention to the firm’s reputation and the

structure of the alliance so as to avoid unintended transfers of know-how.

15. Keys to making alliances work seem to be building trust and informal communications networks between partners and taking proactive steps to learn from alliance partners.

Use the globalEDGE website (globaledge.msu.edu) to complete the following exercises:

1. Several classifications and rankings of the world’s largest companies are prepared by a variety of sources. Find one such composite ranking system and identify the criteria that are used to rank the top global companies. Extract the list of the top 20 ranked companies, paying particular attention to their home countries.

2. The top management of your company, a manufacturer and marketer of smartphones, has decided to pursue international expansion opportunities in eastern Europe. To ensure success, management’s goal is to enter into countries with a high level of global connectedness. Identify the top three eastern European countries in which your company can market its current product line. Prepare an executive summary to support your recommendations.

Research Task http://globalEDGE.msu.edu

When Ford CEO Alan Mulally arrived at the company in 2006 after a long career at Boeing, he was shocked to learn that the company produced one Ford Focus for Europe and a totally different one for the United States. “Can you imagine having one Boeing 737 for Europe and one 737 for the United States?” he said at the time. Due to this product strategy, Ford was unable to buy common parts for the vehicles, could not share development costs, and couldn’t use its European Focus plants to make cars for the United States, or vice versa. In a business where economies of scale are impor- tant, the result was high costs. Nor were these problems limited to the Ford Focus. The strategy of designing and building different cars for different regions was the standard approach at Ford.

Ford’s long-standing strategy of regional models was based upon the assumption that consumers in different regions had different tastes and preferences, which required considerable local customization. Americans,

it was argued, loved their trucks and SUVs, while Europeans preferred smaller, fuel-efficient cars. Notwithstanding such differences, Mulally still could not understand why small car models like the Focus, or the Escape SUV, which were sold in different regions, were not built on the same plat- form and did not share common parts. In truth, the strategy probably had more to do with the autonomy of different regions within Ford’s organization—a fact that was deeply embedded in Ford’s history as one of the oldest multinational corporations.

When the global financial crisis rocked the world’s automobile industry in 2008–2009 and precipitated the steepest drop in sales since the Great De- pression, Mulally decided that Ford had to change its long-standing practices in order to get its costs under control. Moreover, he felt that there was no way that Ford would be able to compete effectively in the large developing markets of China and India unless Ford leveraged its global scale to produce

Ford’s Global Strategy ccccccloooooooossssiinnnngggggggggg ccccccaaaassssssssssssssssssssssssseeeeeeeeeeeeeeeeeeeeeeee

Chapter Twelve The Strategy of International Business 367

368 Part Five The Strategy of International Business

Endnotes

1. More formally, ROIC 5 Net profit after tax/Capital, where capital includes the sum of the firm’s equity and debt. This way of calculating profitability is highly correlated with return on assets.

2. T. Copeland, T. Koller, and J. Murrin, Valuation: Measuring and Managing the Value of Companies (New York: John Wiley & Sons, 2000).

3. The concept of consumer surplus is an important one in eco- nomics. For a more detailed exposition, see D. Besanko, D. Dranove, and M. Shanley, Economics of Strategy (New York: John Wiley & Sons, 1996).

4. However, P 5 V only in the special case where the company has a perfect monopoly, and where it can charge each customer a unique price that reflects the value of the product to that cus- tomer (i.e., where perfect price discrimination is possible). More generally, except in the limiting case of perfect price discrimina- tion, even a monopolist will see most consumers capture some of the value of a product in the form of a consumer surplus.

5. This point is central to the work of Michael Porter, Competi- tive Advantage (New York: Free Press, 1985). See also chap. 4 in P. Ghemawat, Commitment: The Dynamic of Strategy (New York: Free Press, 1991).

6. M. E. Porter, Competitive Strategy (New York: Free Press, 1980). 7. M. E. Porter, “What Is Strategy?” Harvard Business Review,

On-point Enhanced Edition article, February 1, 2000. 8. Porter, Competitive Advantage. 9. D. Naidler, M. Gerstein, and R. Shaw, Organization Architecture

(San Francisco: Jossey-Bass, 1992). 10. G. Morgan, Images of Organization (Beverly Hills, CA: Sage

Publications, 1986). 11. Empirical evidence does seem to indicate that, on average,

international expansion is linked to greater firm profitability. For some recent examples, see M. A. Hitt, R. E. Hoskisson,

and H. Kim, “International Diversification, Effects on Inno- vation and Firm Performance,” Academy of Management Jour- nal 40, no. 4 (1997), pp. 767–98; and S. Tallman and J. Li, “Effects of International Diversity and Product Diversity on the Performance of Multinational Firms,” Academy of Man- agement Journal 39, no. 1 (1996), pp. 179–96.

12. This concept has been popularized by G. Hamel and C. K. Prahalad, Competing for the Future (Boston: Harvard Business School Press, 1994). The concept is grounded in the resource-based view of the firm; for a summary, see J. B. Barney, “Firm Resources and Sustained Competitive Advan- tage,” Journal of Management 17 (1991), pp. 99–120; and K. R. Conner, “A Historical Comparison of Resource-Based The- ory and Five Schools of Thought within Industrial Organiza- tion Economics: Do We Have a New Theory of the Firm?” Journal of Management 17 (1991), pp. 121–54.

13. J. P. Womack, D. T. Jones, and D. Roos, The Machine That Changed the World (New York: Rawson Associates, 1990).

14. M. E. Porter, The Competitive Advantage of Nations (New York: Free Press, 1990).

15. Example is based on C. S. Trager, “Enter the Mini-Multina- tional,” Northeast International Business, March 1989, pp. 13–14.

16. See R. B. Reich, The Work of Nations (New York: Alfred A. Knopf, 1991); and P. J. Buckley and N. Hashai, “A Global System View of Firm Boundaries,” Journal of International Business Studies, January 2004, pp. 33–50.

17. D. Barboza, “An Unknown Giant Flexes Its Muscles,” The New York Times, December 4, 2004, pp. B1, B3.

18. G. Hall and S. Howell, “The Experience Curve from an Economist’s Perspective,” Strategic Management Journal 6 (1985), pp. 197–212.

19. A. A. Alchain, “Reliability of Progress Curves in Airframe Production,” Econometrica 31 (1963), pp. 697–98.

low-cost cars. The result was Mulally’s One Ford strategy, which aims to cre- ate a handful of car platforms that Ford can use everywhere in the world.

Under this strategy, new models—such as the 2013 Fiesta, Focus, and Escape—share a common design, are built on a common platform, use the same parts, and will be built in identical factories around the world. Ultimately, Ford hopes to have only five platforms to deliver sales of more than 6 million vehicles by 2016. In 2006, Ford had 15 platforms that accounted for sales of 6.6 million vehicles. By pursuing this strategy, Ford can share the costs of design and tooling, and it can attain much greater scale economies in the production of component parts. Ford has stated that it will take about one- third out of the $1 billion cost of developing a new car model and should sig- nificantly reduce its $50 billion annual budget for component parts. Moreover, because the different factories producing these cars are identical in all re- spects, useful knowledge acquired through experience in one factory can quickly be transferred to other factories, resulting in systemwide cost savings.

What Ford hopes is that this strategy will bring down costs sufficiently to enable Ford to make greater profit margins in developed markets and be able to achieve good profit margins at lower price points in hypercompetitive developing nations, such as China (now the world’s largest car market),

where Ford currently trails its global rivals such as General Motors and Volkswagen. Indeed, the strategy is central to Mulally’s goal for growing Ford’s sales from 5.5 million in 2010 to 8 million by mid-decade.

Sources: M. Ramsey, “For SUV Marks New World Car Strategy,” The Wall Street Journal, November 16, 2011; B. Vlasic, “Ford Strategy Will Call for Stepping Up Expansion, Especially in Asia,” The New York Times, June 7, 2011; and “Global Manufacturing Strategy Gives Ford Competitive Advantage,” Ford Motor Company website, http://media.ford.com/article_display.cfm?article_id513633.

CASE DISCUSSION QUESTIONS 1. How would you characterize the strategy for competing internationally

that Ford was pursuing prior to the arrival of Alan Mulally in 2006? What were the benefits of this strategy? What were the costs? Why was Ford pursuing this strategy?

2. What strategy is Mulally trying to get Ford to pursue with his One Ford initiative? What are the benefits of this strategy? Can you see any drawbacks?

3. Does the One Ford initiative imply that Ford will now ignore national and regional differences in demand?

Chapter Twelve The Strategy of International Business 369

20. Hall and Howell, “The Experience Curve from an Econo- mist’s Perspective.”

21. For a full discussion of the source of scale economies, see D. Besanko, D. Dranove, and M. Shanley, Economics of Strategy (New York: John Wiley & Sons, 1996).

22. This estimate was provided by the Pharmaceutical Manufac- turers Association.

23. See J. Birkinshaw and N. Hood, “Multinational Subsidiary Evolution: Capability and Charter Change in Foreign Owned Subsidiary Companies,” Academy of Management Review 23 (October 1998), pp. 773–95; A. K. Gupta and V. J. Govindarajan, “Knowledge Flows within Multinational Corporations,” Strategic Management Journal 21 (2000), pp. 473–96; V. J. Govindarajan and A. K. Gupta, The Quest for Global Dominance (San Francisco: Jossey Bass, 2001); T. S. Frost, J. M. Birkinshaw, and P. C. Ensign, “Centers of Excel- lence in Multinational Corporations,” Strategic Management Journal 23 (2002), pp. 997–1018; and U. Andersson, M. Forsgren, and U. Holm, “The Strategic Impact of External Networks,” Strategic Management Journal 23 (2002), pp. 979–96.

24. S. Leung, “Armchairs, TVs and Espresso: Is It McDonald’s?” The Wall Street Journal, August 30, 2002, pp. A1, A6; and E. Beardsley, “Why McDonald’s in France Doesn’t Feel Like Fast Food,” NPR, January 24, 2012.

25. C. K. Prahalad and Yves L. Doz, The Multinational Mission: Balancing Local Demands and Global Vision (New York: Free Press, 1987). Also see J. Birkinshaw, A. Morrison, and J. Hulland, “Structural and Competitive Determinants of a Global Integration Strategy,” Strategic Management Journal 16 (1995), pp. 637–55; and P. Ghemawat, Redefining Global Strategy (Boston: Harvard Business School Press, 2007).

26. J. E. Garten, “Wal-Mart Gives Globalization a Bad Name,” BusinessWeek, March 8, 2004, p. 24.

27. Prahalad and Doz, The Multinational Mission. Prahalad and Doz actually talk about local responsiveness rather than local customization.

28. T. Levitt, “The Globalization of Markets,” Harvard Business Review, May–June 1983, pp. 92–102.

29. W. W. Lewis, The Power of Productivity (Chicago: University of Chicago Press, 2004).

30. C. J. Chipello, “Local Presence Is Key to European Deals,” The Wall Street Journal, June 30, 1998, p. A15.

31. For an extended discussion see: G. S. Yip and G. Tomas M. Hult, Total Global Strategy (Boston: Pearson, 2012), and A. M. Rugman and A. Verbeke, “A Perspective on Regional and Global Strategies of Multinational Enterprises,” Journal of International Business Studies 35, no. 1 (2004)), pp. 3–18.

32. C. A. Bartlett and S. Ghoshal, Managing Across Borders: The Trans- national Solution (Boston: Harvard Business School Press, 1998).

33. C. A. Bartlett and S. Ghoshal, Managing Across Borders: The Transnational Solution (Boston: Harvard Business School Press, 1998).

34. Pankaj Ghemawat makes a similar argument, although he does not use the term transnational. See Ghemawat, Redefin- ing Global Strategy.

35. T. Hout, M. E. Porter, and E. Rudden, “How Global Companies Win Out,” Harvard Business Review, September–October 1982, pp. 98–108.

36. See K. Ohmae, “The Global Logic of Strategic Alliances,” Harvard Business Review, March–April 1989, pp. 143–54; G. Hamel, Y. L. Doz, and C. K. Prahalad, “Collaborate with Your Competitors and Win!” Harvard Business Review, January– February 1989, pp. 133–39; W. Burgers, C. W. L. Hill, and W. C. Kim, “Alliances in the Global Auto Industry,” Strategic Management Journal 14 (1993), pp. 419–32; and P. Kale, H. Singh, and H. Perlmutter, “Learning and Protection of Proprietary Assets in Strategic Alliances: Building Relational Capital,” Strategic Management Journal 21 (2000), pp. 217–37.

37. L. T. Chang, “China Eases Foreign Film Rules,” The Wall Street Journal, October 15, 2004, p. B2.

38. B. L. Simonin, “Transfer of Marketing Know-How in Inter- national Strategic Alliances,” Journal of International Business Studies, 1999, pp. 463–91; and J. W. Spencer, “Firms’ Knowl- edge Sharing Strategies in the Global Innovation System,” Strategic Management Journal 24 (2003), pp. 217–33.

39. C. Souza, “Microsoft Teams with MIPS, Toshiba,” EBN, February 10, 2003, p. 4.

40. Kale, Singh, and Perlmutter, “Learning and Protection of Proprietary Assets.”

41. R. B. Reich and E. D. Mankin, “Joint Ventures with Japan Give Away Our Future,” Harvard Business Review, March–April 1986, pp. 78–90.

42. J. Bleeke and D. Ernst, “The Way to Win in Cross-Border Alliances,” Harvard Business Review, November–December 1991, pp. 127–35.

43. C. H. Deutsch, “The Venturesome Giant,” The New York Times, October 5, 2007, pp. C1, C8.

44. “Odd Couple: Jet Engines,” The Economist, May 5, 2007, pp. 79–80.

45. W. Roehl and J. F. Truitt, “Stormy Open Marriages Are Better,” Columbia Journal of World Business, Summer 1987, pp. 87–95.

46. B. Gomes-Casseres and K. McQuade, “Xerox and Fuji Xerox,” Cambridge, MA: Harvard Business School Case, February 15, 1991.

47. See T. Khanna, R. Gulati, and N. Nohria, “The Dynamics of Learning Alliances: Competition, Cooperation, and Relative Scope,” Strategic Management Journal 19 (1998), pp. 193–210; and Kale, Singh, and Perlmutter, “Learning and Protection of Proprietary Assets in Strategic Alliances.”

48. Kale, Singh, Perlmutter, “Learning and Protection of Propri- etary Assets in Strategic Alliances.”

49. Hamel, Doz, and Prahalad, “Collaborate with Competitors”; Khanna, Gulati, and Nohria, “The Dynamics of Learning Alliances: Competition, Cooperation, and Relative Scope”; and E. W. K. Tang, “Acquiring Knowledge by Foreign Part- ners from International Joint Ventures in a Transition Econ- omy: Learning by Doing and Learning Myopia,” Strategic Management Journal 23 (2002), pp. 835–54.

50. Hamel, Doz, and Prahalad, “Collaborate with Competitors.” 51. B. Wysocki, “Cross-Border Alliances Become Favorite Way

to Crack New Markets,” The Wall Street Journal, March 4, 1990, p. A1.

52. Hamel, Doz, and Prahalad, “Collaborate with Competitors,” p. 138.