THE STRATEGY OF INTERNATIONAL BUSINESS

According to Johnson & Scholes (2005, p. 9), strategy refers to a definition of the long-term direction
and scope of an organization, which seeks to attain sustainable competitive advantage by matching its
resources and competences to its changing environment and in particular its markets, customers or
clients so as to meet stakeholder expectations. Strategy links a firm and its environment (Grant, 2008),
and hence, a strategy is effective only if it is in harmony with the firm’s internal environment (such as
goals, values, resources, capabilities and systems), and the external (political, ecological, social,
technological, economic and legal) environment in which it operates.

Strategy reflects the actions that managers must take to attain the goals of the firm. As a matter of fact,
the preeminent goal of most firms is to maximize the value of the firm for its owners. 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. Profitability can be defined 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. Profit growth is measured by the percentage increase in net profits over time. 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. Managers can increase the profitability of the firm by pursuing strategies that lower costs or
those that add value to the firm’s products, thus enabling 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.

Michael Porter maintains that positioning determines the profitability of a firm in the industry. A firm
that positions well in the industry may earn high rates of returns, even though the industry structure is
unfavourable (Porter, 2004 p. 11). Porter proposes two basic or generic competitive strategies for
creating value and attaining a competitive advantage in an industry: (1) Low-cost strategy suggests that
a firm has high profits when it creates more value for its customers and does so at a lower cost, and (2)
Differentiation strategy focuses primarily on increasing the attractiveness of a product. These
competitive advantages, combined with scope of activities, for which the firm seeks to achieve them,
lead to three generic strategies: Cost leadership, Differentiation and Focus. Cost leadership and product
differentiation strategies seek a broad mass market, while focus strategies aim at a niche (narrow)
market. Cost leadership and product differentiation strategies seek competitive advantage in a broad
range of industry segments while focus strategies aim at cost advantage in the narrow segment.
The focus has two variants, cost focus and differentiation focus.

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 () 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. In general, the
higher the firm’s profit per unit sold, the greater its profitability will be, all else being equal.

It is important for a firm to be explicit about its choice of strategic emphasis with regard to value
creation. Management must decide where the company wants to be positioned with regard to value
and cost. A central tenet of the basic strategy paradigm is: To maximize its profitability, a firm must do
three things—(i) Pick a position on the efficiency frontier that is viable in the sense that there is enough
demand to support that choice; (ii) Configure internal operations so that they support that position; and
(iii) 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. The term “Operations” refers to the different
value creation activities a firm undertakes.
The convex curve in the Figure above 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 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.

The concept of value chain, too, was developed by Michael Porter in 1980, in terms of the popular value
chain analysis. A value chain helps in analysing specific activities through which a firm can create value
and competitive advantage. It may be viewed as a chain of activities that link together to increase value
of the business for a firm operating in a particular industry. The competitive advantage in value chain is
obtained from two sources: (i) differentiation advantage, i.e., a customer perceives more value from the
firm's product, and (ii) low cost advantage, i.e., a firm provides the product or service at a lower cost
than the average market cost. According to Porter, the operations of a firm can be arranged as a value
chain, revealing a series of distinct, yet linked value creation activities, categorized as primary activities
and support activities.
(A) Primary or Core activities include:
- Research & development
- Production
- Marketing & sales
- Service
(B) Support or Non-core Activities include:
- Materials management or logistics
- Human resource
- Information systems
- Company infrastructure
If a firm is to implement its strategy efficiently, and position itself on the efficiency frontier, it must
manage these activities effectively and in a manner that is consistent with its strategy.
Managers of a domestic firm decide to engage in international business when pursuing a growth-
oriented corporate strategy of expanding geographically, across the national borders of the home-
country, with a view to boost the firm’s profitability and increase the rate of profit growth over time.
Expanding globally allows firms to increase their profitability and rate of profit growth in ways not
available to purely domestic enterprises. In particular, firms that operate internationally are able to: (1)
expand the market for their domestic products, (2) realize location economies by dispersing individual
value creation activities, (3) realize greater cost economies, and (4) earn a greater return by leveraging
any valuable skills developed in foreign operations.

A company can increase its growth rate by taking goods or services developed at home and selling them
internationally. Returns from such a strategy are likely to be greater if indigenous competitors in the
nations a company enters lack comparable products. Success of multinational companies also rest upon
the core competencies that underlie the development, production, and marketing of goods or services.
Core competencies are skills within the firm that are valuable, rare, cannot easily be imitated by
competitors, and organizationally exploitable. Core competencies are the bedrock of a firm’s
competitive advantage and enable them to reduce the costs of value creation.

Location economies are the economies that arise from performing a value creation activity in the
optimal location for that activity can have one of two effects: (i) It can lower the costs of value creation
and help the firm to achieve a low-cost position and/or (ii) It can enable a firm to differentiate its
product offering from those of competitors. One result of this kind of thinking is the creation of a global
web of value creation activities, with different 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.

The experience curve refers to systematic reductions in production costs that have been observed to
occur over the life of a product. There are two explanations for the experience effect: (i) Learning effects
refer to cost savings that come from learning by doing; and (ii) Economies of scale refer to the
reductions in unit cost achieved by producing a large volume of a product. The strategic significance of
the experience curve is clear; moving down the experience curve allows a firm to reduce its cost of
creating value and increase its profitability.

Leveraging the skills created within subsidiaries and applying them to other operations within the
firm’s global network may create value. Learning how to leverage the skills of subsidiaries presents a
challenge for managers of multinational organizations, and depends upon the following conditions: (i)
They must have the humility to recognize that valuable skills leading to competencies can arise
anywhere within the firm’s global network; (ii) They must establish an incentive system that encourages
local employees to acquire new skills; (iii) They must have a process for identifying when valuable new
skills have been created in a subsidiary; (iv) They need to act as facilitators, helping to transfer valuable
skills within the firm.

Firms that compete in the global marketplace typically face two types of competitive pressure: (1)
Pressures for cost reductions, and (2) Pressures to be locally responsive.

International businesses often face pressures for cost reductions because of the competitive global
market. Pressures for cost reduction can be particularly intense in industries producing commodity-type
products. Universal needs exist when the tastes and preferences of consumers in different nations are
similar if not identical. 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.

Pressures for local responsiveness can arise due to (i) national differences in consumer tastes &
preferences (e.g., North American families like pickup trucks while in Europe they are viewed as a utility
vehicle for firms); (ii) national differences in infrastructure & traditional practices (e.g., Consumer
electrical system in North America is based on 110 volts; in Europe on 240 volts); (iii) national
differences in distribution channels (e.g., Germany has few retailers dominating the food market, while
in Italy it is fragmented); and (iv) host-country government demands (e.g., health care system
differences between countries require pharmaceutical firms to change operating procedures).

How do differences in the strength of pressures for cost reductions versus those for local responsiveness
affect the firm’s choice of strategy? According to Bartlett and Ghoshal (1993), firms typically choose
among four main strategic postures when competing internationally. These can be characterized as four
different internationalization strategies, namely, (1) international exporter strategy (2) multidomestic
localization strategy, (3) global standardization strategy, and (4) transnational network strategy. As
shown above, the appropriateness of each strategy varies given the extent of pressures for cost
reductions and local responsiveness.
The Achilles heel of internationalization strategies is that over time competitors inevitably evolve. An
international strategy may not be viable in the long-term, so firms need to shift toward a global
standardization strategy or a transnational strategy in advance of competitors. As competition
intensifies, international and localization strategies tend to become less viable. Managers need to orient
their companies toward either a global standardization strategy or a transnational strategy.

International Strategy involves (i) creation of value by transferring valuable core competencies to
foreign markets that indigenous competitors lack; (ii) centralization of product development functions at
home; (iii) establishment of manufacturing and marketing functions in local country, with head office
exercising tight control over it; and (iv) limiting customization of product offering and market strategy.
This strategy effective if firm faces weak pressures for local responsive and cost reductions.

Multidomestic Strategy aims at (i) maximum local responsiveness through (ii) customization of product
offering, market strategy, as well as production and R&D, according to national conditions. This strategy
is generally unable to realize value from experience curve effects and location economies. It possesses
high cost structure due to multiplication of value creation activities in various locations.

Global Strategy focuses on achieving a low-cost strategy by reaping cost reductions that come from
experience curve effects and location economies. Accordingly, production, marketing, and R&D are
concentrated in few favorable low-cost locations. It helps market standardized products in order to keep
costs low. It is effective where strong pressures for cost reductions and low demand for local
responsiveness exist, e.g., the semiconductor industry.

Transnational strategy is a concept originated by Bartlett and Ghoshal (1989, 1993). It serves as a
solution to meet competition in situations where firms aim to reduce costs, transfer core competencies,
and simultaneously pay attention to pressures for local responsiveness. It emphasizes global learning to
facilitate the development of valuable skills in any of the firm’s worldwide operations, and the transfer
of knowledge from foreign subsidiary to home country, as well as to other foreign subsidiaries. The
transnational strategic solution seeks to overcome weaknesses of earlier strategic options focused on
global integration or local responsiveness only. It envisages a truly global enterprise with loose network
characteristics, although ownership is retained with the same firm, unlike a strategic alliance. It is not
controlled from unified corporate HQ. Transnational strategy is difficult to implement because of the
contradictory demands placed on the organization. It requires a borderless mind-set (Ohmae, 2000), and
integration of 3 flows: internal flow of resources, ideas and intelligence —intra-unit, inter-unit flows and
across the entire network. The critical challenge is one of managing diversity, complexity and change.