Establishing joint ventures

chapter 12 The Strategy of International Business

LEARNING OBJECTIVES

1 Explain the concept of strategy.

2 Recognize how firms can profit by expanding globally.

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

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

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

opening case Ford’s Global Strategy

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 could not use its European Focus plants to make cars for the United States, or vice versa. In a business where economies of scale are important, 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 on 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 platform 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 Depression, 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 low cost cars. The result was Mulullay’s One Ford strategy, which aims to create a handful of car platforms that Ford can use everywhere in the world.

One Ford

A strategy pursued by the Ford Motor Company that focuses on the development of global products.

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 5 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 significantly reduce its $50 billion annual budget for component parts. Moreover, because the different factories producing these cars are identical in all respects, 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 make good margins at lower price points in hypercompetitive developing nations, such as China, now the world’s largest car market, where Ford currently trails 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_id=13633.

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 monetary system. Now our focus shifts from the environment to the firm itself and, in particular, 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.

Ford Motor Company’s One Ford strategy, profiled in the opening case, gives a preview of some issues explored in this chapter. Historically, Ford pursued localization, selling cars in the different regions that were designed and produced locally (i.e., one design for Europe, another for North America). While this strategy did have the virtue of ensuring that the offering was tailored to the tastes and preferences of consumers in different regions, it also caused considerable duplication and high costs. By the late 2000s, Alan Mulally, Ford’s CEO, decided that the company could no longer afford the high costs associated with this approach, and he pushed the company to adopt his One Ford strategy. Under this global standardization strategy, Ford aims to design and sell the same models worldwide. The idea is to reap substantial cost reductions from sharing design costs, building on common platforms, sharing component parts across models, and building cars in identical factories around the world to share tooling costs. To the extent that Ford can do this, the company should be able to lower prices and still make good profits, which should help it not only to hold onto its share in developed markets, but also to gain share in rapidly growing emerging markets such as India and China. While there is a risk that the lack of local customization will lead to some loss of sales at the margin, Mulally clearly feels that the benefits in terms of lower costs and more competitive pricing clearly outweigh these risks. Only time will tell if he is correct.

Strategy and the Firm

LEARNING OBJECTIVE 1

Explain the concept of strategy.

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 constraint 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 (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

FIGURE 12.1 Determinants of Enterprise Value

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.

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 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 customer’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.

ANOTHER PERSPECTIVE Education as a Part of Your Value Chain

The concept of value chain can be used to examine the role your undergraduate education plays in your life plans. If you look closely at your personal development plans (education, internship, physical and emotional/spiritual fitness, extracurricular activities) and think about them in terms of primary and support activities, how does your choice of major fit into your personal development strategy? How do your choices of how you spend your time fit into your value chain? Do you ever spend time doing things that don’t support the strategic goals of your personal value chain?

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 (π) is equal to P − C, while the consumer surplus per unit is equal to V − 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 competitive 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.

FIGURE 12.2 Value Creation

The firm’s value creation is measured by the difference between V and C (V − 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 − C) either by lowering production costs, C, or by making the product more attractive through superior design, styling, functionality, 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 increases). 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 increasing the attractiveness of a product as a differentiation strategy. 5

Value Creation

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

Michael Porter has argued that low cost and differentiation are two basic strategies for creating value and attaining a competitive advantage in an industry.6 According to Porter, superior 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 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 implies 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 product 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 Strategic Choice in the International Hotel Industry

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 accordingly, and to manage them efficiently to make sure the firm is operating on the efficiency 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 emphasizes 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 organization 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 superior profitability. By operations we mean the different value creation activities a firm undertakes, which we shall review next.

Operations

The various value creation activities a firm undertakes.

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 activities, including production, marketing and sales, materials management, R&D, human resources, 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.

FIGURE 12.4 The Value Chain

Primary Activities

Primary activities have to do with the design, creation, and delivery of the product; its marketing; and its support and after-sale service. Following normal 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 customer service.

Research and development (R&D) is concerned with the design of products and production processes. Although we think of R&D as being associated with the design of physical products and production processes in manufacturing enterprises, many service companies also undertake R&D. For example, banks compete with each other by developing 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 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, “production” 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, “production” 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 communicating 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 treatment 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 product. 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.

Perception is everything! Even though the Ford Expedition (left) and the Lincoln Navigator (right) share many of the same attributes, such as the body and engine, customers are willing to pay about $10,000 more for the Navigator’s little extras.

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 advantage, support activities can be as important as, if not more important than, the “primary” activities 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 which a firm manages its other value creation activities. Dell, for example, has used its information systems to attain a competitive advantage over rivals. When customers place an order 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 systems have reduced the amount of inventory that Dell holds at its factories 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 assembly 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 compensated to perform their value creation tasks. In a multinational 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, wherever they are in the world. Indeed, the senior management ranks of many multinationals are becoming increasingly diverse, as managers from a variety of national backgrounds have ascended to senior leadership positions.

The final support activity is the company infrastructure, or the context within which all the other value creation 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 management should also be viewed as part of the firm’s infrastructure. Through strong leadership, top management can consciously shape the infrastructure of a firm and through that the performance of all its value creation activities.

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 structure); 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.

FIGURE 12.5 Organization Architecture

Organization Architecture

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

Organizational Culture

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

Controls are the metrics used to measure the performance of subunits and make judgments 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 subsidiary might be linked to the performance of that company. Specifically, she might receive a bonus if her subsidiary exceeds its performance targets.

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 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.

Processes

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

Organizational culture is the norms and value systems that are shared among the employees 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 collective 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).

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.

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, 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 component of architecture can be used to reinforce (or not) the prevailing culture of the organization. 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 capita, its strategy (as captured by its desired 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 organization 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 organization must all be consistent with each other, or fit each other, for superior performance to be attained.

FIGURE 12.6 Strategic Fit

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, demographics, 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.

• QUICK STUDY

1. How does a firm create value?

2. What is the difference between a low-cost strategy and a differentiation strategy?

3. What is the difference between the primary and support activities of a firm’s value chain?

4. Why is organization architecture so important for the attainment of high performance?

5. What do we mean by the concept of strategic fit? Why does this matter?

Global Expansion, Profitability, and Profit Growth

LEARNING OBJECTIVE 2

Recognize how firms can profit by expanding globally.

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.

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, marketing strategy, and business strategy to differing national 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 services 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 products (such as Pampers disposable diapers and Ivory soap) in the United States and subsequently 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 quality 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 management, 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 competitive 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 McDonald’s has a core competence in managing fast-food operations (it seems to be one of the most skilled firms in the world in this industry); Procter & Gamble has a core competence in developing and marketing name-brand consumer products (it is one of the most skilled firms in the world in this business); Starbucks has a core competence in the management of retail outlets selling high volumes of freshly brewed, coffee-based drinks.

Core Competence

Firm skills that competitors cannot easily match or imitate.

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 companies engaged in the service sectors of an economy, such as financial institutions, retailers, restaurant chains, and hotels. Expanding the market for their services often means replicating their business model in foreign nations (albeit with some changes to account for local differences, which we will discuss in more detail shortly). Starbucks, for example, expanded rapidly outside of the United States by taking the basic business model it developed at home and using that as a blueprint for establishing international operations. Similarly, McDonald’s is famous for its international expansion strategy, which has taken the company into more than 120 nations that collectively generate more than half of the company’s revenues.

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; Switzerland in the production of precision instruments and pharmaceuticals; South Korea in the production of semiconductors; and Vietnam in the production of apparel.14