TRADE  THEORY  AND  LOCATION  THEORY

Our last two sessions focused on models of international trade.  These were, loosely, general-equilibrium models, concerned for the interaction of entire economies.  At the core of our analyses and frameworks was the understanding that each country has resources that need to be used as productively as possible:  our analytic question was how these resources should be used, for what products and potential exports.   Given a place, what should be produced there?

Our earlier treatment of  location decisions by particular companies was very different.  We were not concerned with the general-equilibrium impacts of industrial location on national (or regional) wages, employment levels, and  output.  Rather, we're concerned about maximizing the return to one company for its deployment of its limited resources -- which don't have to be deployed in any particular region or country.  Location theory typically doesn't concern itself with the effects of production location on economic aggregates;  it takes wage levels, resource locations, and markets as given and seeks to optimize microeconomic returns from a location decision.  Given a production process, where should it be produced?

In these notes, we turn our attention to large companies and their international investments.  Here, we emphasize their actions as individual companies.  Subsequently (see lecture notes), we emphasize the effects of those actions on national and international development.

CORPORATE  STRATEGY
A widely used framework for business planning is to identify the firm's unique (or relatively unique) advantages:  in more formal terms, to identify the assets on which the firm can earn economic rents.

In the complex, multi-divisional corporation, this analysis and the consequent actions can be pursued at different levels.  At the corporate level, the key question is "What lines of business would allow our assets to earn the maximum economic rents?"
 
 

A hotelier might ask whether its success at buying valuable real estate during market depressions makes it as much a real-estate investment company as a hotelier.  A positive answer might lead it into other forms of real estate investment and management, and perhaps out of direct management of the hotels.  Another hotelier might recognize that its worldwide name recognition and reservations system are its key assets, to be best exploited by owning few properties and managing many, and perhaps branching out into other forms of tourist or business travel arrangements.

A clothing company may recognize its strongest asset as its production capacity and skill, its trademark, its design, or its distribution network (company-owned warehouses, retail outlets, marketing lists, and information systems).  Greater profit per unit of investment may be had through directly "renting" its production capability to other firms, licensing its trademark to selected products made by others, designing for others, or including others' products in in its distribution system. Granted, it could maximize its size by doing it all.  But the usual goal is increasing return on investment, not total revenues.

Either of these cases suggests types of corporate choices:

• vertical integration or disintegration (taking on more or less of the production and marketing chain)
• horizontal integration or disintegration (taking on more or less of the total market)
• diversification (entering a very different line of business, not directly linked to a current line).

• acquisition or sale of existing operations, or by
• starting up new operations or shutting down old operations.

Often, diversification, vertical or horizontal integration or disintegration has international manifestations for the firm.  For most large firms, the fundamental question should be what strategic action needs to be taken to increase returns on corporate assets.  The particular action and the particular international manifestation should follow.
 

• Vertical integration to acquire certain production resources require entering a country where the natural resource, inexpensive labor, or specially trained technicians are available.
• Horizontal integration to enter certain markets requires a local presence:  sometimes for logistical reasons (think of our location model, where certain processes are best located at the market);  sometimes because of trade protection (a country may levy high tariffs on imports -- an MNC can avoid those tariffs by producing in the country rather than exporting to it).

LOCATION  STRATEGIES  FOR  MNCs

How does a company select a country for its vertical or horizontal integration, or diversification?

The first concern is which countries satisfy the reason for the international investment:

• For a market-oriented investment, which countries have an appropriate market?
• For a resource-oriented investment, which countries have that resource at reasonable costs?
• For an acquisition, which countries have attractive acquisition targets?

• logistical ease (with respect to home or other operations)
• linguistic and cultural similarity
• political stability
• market size and growth