International Business

Multi National Corporations Prof. C.K.Sreedharan

MNCs and Investment

Uninational company: An uninational company or a domestic company has all its operating assets and organizational sub-units in its home country. It may on occasion engage in exporting or importing by transacting with foreign firms, but its own capacity to function is limited to the domestic market.

 The multinational is a business unit which operates simultaneously in different parts of the world either by manufacturing or marketing or both. In some cases, the manufacturing unit may be in one country, while the marketing and R & D may be in other countries. In other cases, all the business operations are carried out in different countries, with a strategic head quarters in any part of the world.

 For a MNC, the strategic nerve center is the companys headquarters (HQ), where major decisions are taken and policies formulated. At its HQ the main roles of a typical MNC are: 1. Strategy formulation for worldwide operations. 2. Execution of policies and decisions and 3. Maintaining control over global strategies and operations.

 Every MNC has to operate through its satellite units, called subsidiaries. Hence, MNCs have HQs and a number of subsidiaries scattered throughout the world. A typical MNC operates as per the following model:
Headquarters
S1 S2 S4 S3 (S- Subsidiaries)

 Example: The Manhattan based company, Colgate Palmolive Inc. which manufacturers and markets dental care, health care, hair care and skin care products, in more than 120 countries. Example: Procter & Gamble, based in Cincinnati also has similar product lines and operates in more than 150 countries.

 At one time American based multinationals ruled the world. To day many Japanese, Korean, European and Indian multi-nationals have spread their wings in many parts of the world. There are about 35,000 MNCs around the world to day, controlling over 170,000 foreign affiliations.

 The main feature of MNC is the power center. The power center is at the Head Quarters and all major policy / strategic decisions are taken at the HQ.

Some Indian MNCs.

Ranbaxy: It is the first Indian MNC in the pharma industry and the ninth largest generic company in the world.It exports to over 70 countries. US market is the biggest for Ranbaxy and contributes about 40 % of its sales. It has manufacturing facility in seven countries.

 Tata Motors: Largest automobile in the country. Has tie up with Rover of UK and sell small cars in Europe. Has acquired Daewoo commercial vehicle company.

 Bharat Forge: Auto components manufacturing company. In 03-04 it acquired a German forging company, making it second largest forging company in the world.

 Sundaram Fasteners: Manufacturer of fasteners. It has a manufacturing facility at China. It has also acquired a fastener company- Dana Spicer- a UK based company. It has a manufacturing facility at Kualampur also.

 ONGC: It has crude oil exploration activities in Iraq, Iran, Sudan, Vietnam, Myammar, Russia etc. Sterilite Industries Ltd. Metals and mining bussiness. It also deals with aluminium. Owns copper mines in Tasmania.

 Essel Propack: Largest manufacturer of lami tubes in the world. It has 17 plants located across 11 countries. It commands 30 % of market share. It has manufacturing facilities at Egypt, China, Germany, US etc. It has acquired Switzerlands Propack A.G.

 Asian Paints: Glocal- is the right word to describe the global strategy of Asian Paints for it explains the setting up of manufacturing facilities overseas that produces paints according to local requirements.

 Asian Paint acquired Berger International Ltd. Which gave access to 12 markets across China, South East Asia, West Asia. It has also acquired SCIB Chemicals an Egyptian company. It has a JV in Bangladesh and has acquired a largest paint company in Srilanka.

 Moser Baer: Manufacturers DVD for media storage. It was a JV between Moser Bayer India and Swiss firm Moser Bayer to make time keeping machines. The JV failed but the name was retained by the Indian company and diversified in to floppy disc production.

 Subsequently the firm started producing CDs and now Moser Bayer is the worlds third largest manufacturer of CDs. The company presence in 82 countries and almost 85 % of output is exported to Europe and US.

 Infosys Technologies Ltd. It has 26 global software development centers in US, Canada, Australia, UK and Japan. Wipro Ltd. : Software exporter. I- Flex Solutions Ltd.: Banking software.

 Hindalco Ltd: Aditya Birla Group. Main bussiness is aluminium. Took over Novelis a UK based company. Dr. Reddys Laboratories, Aurobindo Pharmaceuticals etc.

Classification of MNCs
Depending upon the relationship between the HQ and subsidiaries, MNCs can be classified into three broad categories: 1. Pyramidal model MNCs 2. Umbrella model MNCs and 3. Inter-conglomerate MNCs

Pyramidal Model of MNC

Headquarters (Strong)

S1

S2

S3

S4

S5

 Features:
A pyramid indicates a broad bottom and a narrow top. They have strong HQS and weak subsidiaries All major decisions like new product development, plant location etc are made at the HQ and imposed on the subsidiaries. No concern for sentiments and emotions of the local people. Quite autocratic and run their business through power.

Umbrella Model MNCs

Headquarters (Flexible)

 Here the HQ is flexible and acts as a facilitator. Constantly motivate their subsidiaries. Maintains harmony between employees at different levels High respect for the sovereignty of the country in which they operate. Concerned about their image, goodwill and reputation. Consult their subsidiaries in strategic decision making process.

Inter-conglomerate MNCs
Investment

Huge profits High rate of return Aggressive expansion

 Features:
A conglomerate refers to the grouping of business activities aimed at high profits and revenue generation, whether or not they are related to the existing core business. Inter-conglomerate MNCs are aggressive in their expansion and achieve a high turnover rate. Such MNCs enter into any business where profits are high. They generally do not consider any aspect other than high profits as a performance indicator. No social considerations in the country of their operation.

 Although MNCs can be classified in one of the above categories, the MNCs are becoming more and more flexible. As the social forces in the developing countries are becoming more stronger, the pure pyramidal model will no longer work. Pure umbrella models can not generate sufficient revenues and may be difficult for them to face stiff competition. Inter-conglomerate models cant solely focus on profit but should be sensitive towards host countrys social concerns.

Classification based on equity

MNCs can be classified in to two types depending on the extent of control: 1. Equity based and 2. Non equity based.

Equity based MNCs

Many older MNCs obtained their multinational status through direct foreign investments. They either built from ground up or bought the equity of the desired capital assets. Equity ownership provides the basis for managerial control over the foreign company which is integrated with the HQ.

Non-Equity based MNCs

Management contracts Production sharing arrangements Industrial lease agreements and Technology transfer agreements.

 Management of contracts: A new generation of MNCs has started to emerge in which the source of managerial control is technology and management expertise, instead of ownership of the operating assets. Long term contracts with the owners of the operating facilities are entered in to often formally, informally sanctioned by the host government.

 Under such a contract the owners will let the MNC to take over possession and management of the bussiness and the MNC will obligate itself to share profits with the owners by some agreed formula. Example: Hotel, mining, etc.

 Production sharing : In mining, crude oil production and other Resource Based bussinesses, profit sharing may be replaced by output sharing. The arrangements provide that the MNC not only produce in an extractive sector (iron ore, coal, crude oil etc.) but also must meet specific obligations for the development of indigenous supplier industries, training engineers and managers for keeping pace with developments.

 This formula involves sharing of output of the ventures. For instance the contract may provide 40:60 output sharing of a mining output, the MNC retaining 40 % of output, and market on behalf of the owner the remaining 60 %.

 Industrial lease agreements: These are contracts under which an owner, leases a complete industrial facility to an MNC. The rent consists of normally of a fixed annual sum plus a payment based on the output of the plant.

 Technology transfer agreements: In the high technology industries electronics, aircraft, computers, biochemical etc. - the host governments places the highest priority on indigenous production capability.

 In technology transfer agreements, MNC enters in to JV with the host country company, often with the assistance of the govt. The responsibility of the MNC is to transfer technology, assistance in efficient adoption of the product to suit the host country, effective long term cooperation after the plant starts production and marketing of output outside the host country.

Classification based on orientation

MNCs can be classified as below based on their orientations: 1. Ethnocentric orientation 2. Polycentric orientation 3. Regiocentric orientation and 4. Geocentric orientation

Strategies of MNCs
Three broad categories of strategies adopted by MNCs are explained below:1. Innovation based multinationals 2. Cost advantage based multinationals and 3. Expansion to low cost areas.

 Innovation based MNCs: These MNCs create barriers to entry for others by continually introducing new products and differentiating existing ones, both domestically and internationally. Firms in this category spend large amounts of money on R & D.

 Their products are typically designed to fill a need perceived locally or abroad. Example: Nokia E-Merck.

Cost advantage based MNCs: The principle approach here is economies of scale. There are inherent cost advantages of being large. The more significant these economies of scale are, the greater will be the cost disadvantage faced by a new entrant in the same field in a given market. Example- Toshiba, Whirlpool.

 Reduction in promotional costs: Some companies like Coca Cola and Procter & Gamble take advantage of the fact that potential entrants are wary of the high costs involved in advertising and marketing a new product. Such firms are able to exploit the premium associated with their strong brand names.

 MNCs can use single campaign and visual aspects in all the countries simultaneously with different languages. Example: Nestle Pepsi

 Cost advantage through multiple activities: Other MNCs take advantage of economies of scope. Economies of scope exist whenever the same investment can support multi-profitable activities, which are less expensive.

 There are substantial cost advantages in producing and selling multiple products related to common technology, production facilities and distribution network. Example: Honda has increased its investment in small engine technology in the automobile, motor cycle, lawn mover, marine engine and generator bussiness.

 Expansion to low cost areas: There are some product lines where the competitive advantage erodes very fast. The strategy followed in such cases is to expand to lower cost areas. Example: Many electronics firms in USA shifted their production facilities to Taiwan and Hong Kong, to take advantage of lower labour costs.

Reasons for growth of MNCs..

Cutting edge technology: Continuous up gradation of the technology and ensuring the latest technology is adopted.

 Protecting reputation: Products develop a good or bad name, which transcends international barriers. It would be very difficult for an MNC to protect its reputation if a foreign licensee does an inferior job. MNCs prefer to invest in a country rather than licensing, to ensure maintenance of their good name.

 Building reputation: MNCs invest to build their reputation. If the goodwill is established, the firm can expand and build a strong customer base. Example: Excellent growth of foreign banks, such as Citibank, Grindlays, Standard Chartered and HSBC in India.

 Exploiting product life cycle theory: Even in an developed country opportunities for further growth eventually dry up. MNCs are always on the look out for markets which are not penetrated and where they can fully exploit all the stages of life cycle of the product. Example: Laptops, LCD TVs etc.

Financial Power: MNCs have huge financial capability. Transfer pricing: To quote low prices for inter-company transactions where taxes are high and enhance the price where tax rates are lower.

Criticism against MNCs

Interference with economic objectives: A MNC may wish to locate a plant in an area of prosperity where as the host country would prefer its location in an undeveloped region. MNCs demands of local infrastructure and other supports may add to the host countrys expenditure.

 Technology dependency: Since the MNCs typically do their research and development activities at home, host countries become technologically dependent on the MNCs for innovation.

 Inappropriate technology: MNCs technology is designed for world wide profit maximization, not to the development needs of poor countries. The technology brought by MNCs is hardly suitable to LDCs. The technology could be capital intensive but developing countries need a labour intensive one.

 In addition the technology brought in by MNC may be highly expensive. Also the MNCs charge exorbitantly in the form of fee and loyalty, which put a severe financial strain on the foreign exchange resources of a developing country.

 There are also instances of Technology being Dumped, which implies that MNCs use obsolete technology with the help of turnkey projects shipped down from other countries, where the technology has become obsolete.

 Destruction of competition: MNCs may destroy competition and acquire a monopoly status. Destruction of natural resources: MNCs may cause fast depletion of some of the non-renewable natural resources in the host country.

 No concern for society: MNCs do not give enough importance to the society in which they operate. An example is Union Carbide, which did not show much concern for the people of Bhopal.

 In South Africa, HIV medicines are sold at an expensive price irrespective of the cost. When people die out with these dreaded diseases in some region, MNCs consider that place as a huge potential for bussiness prosperity.

 No role in infrastructure development: In the developing countries active participation is needed in the development of infrastructure like roads, ports, power plants etc. MNCs enjoy all the benefits offered by the countries but do not actively contribute towards infrastructure development.

 Most MNCs in India deal in non-essential products such as soaps, toothpastes, shampoos and other consumer products. For example Unilever, Johnson & Johnson, Colgate Palmolive, Procter & Gamble etc- there is no contribution for infrastructure development. No MNC is actively involved in developing activities such as infrastructure.

 No real employment: There is a misconception that MNCs generate employment but on the contrary they retard growth. The top positions are occupied by home country professionals and lower operating level employment is given to locals.

 Environmental degradation: MNCs do not have any value for the environment and pollution control. The main motto is to earn money. No concern for valuable human lives. Example- Union Carbide tragedy at Bhopal.

 Manipulation of tax rules: MNCs indulge in transfer pricing which enables them to avoid taxes by manipulating prices on intra- company transactions.

Merits of MNCs .
Increase in domestic investment: MNCs help to increase domestic investment level thereby increasing the income level and employment in host country.

 Facilitates transfer of technology: MNCs have become vehicles for the transfer of technology, especially to the developing countries.

 Professional Management: MNcs brings in a managerial resolution in the host countries through professional management and by employing a highly sophisticated management techniques.

 Increase in foreign trade: MNCs enable the host countries to increase their exports and decrease import requirements.

 Break monopoly: MNCs help increase competition and break domestic monopoly. Availability of quality products: MNCs make available international quality products to the consumers.

MNCs and transfer pricing

This refers to the pricing of goods and services bought and sold by operating units or divisions of a single company. It is related to intra-corporate transactions that is the transactions buyers and sellers do within one corporate company.

 The basis for intra-company transfers depends on the nature of the subsidies, the market conditions, govt. policies and regulations. In most cases, fixing transfer prices remains the absolute prerogative of the parent company, regardless of the firms nationality

 The price charged by a company in country A to another company in country B is reflected in the profit and loss account of both the companies, either as income or expenditure. The above impacts the tax paid by the two related companies.

 By resorting to transfer pricing, the companies can reduce their total taxation by transferring higher income to low tax countries and greater expenditure to those countries where the tax rate is very high. Profit = Receipts (income) - Expenditure

 The current tax rate on domestic companies in India is say 33.3 %. If for example, the company A is located in India and company B is located in Singapore, and that both belong to the same group. Assume that tax rate at Singapore is 15 %.

 The company B will transfer raw material to company A at slightly higher prices. This will enable company A to show a higher expenditure and reduce its taxable profits. On the other hand, a slightly higher income will not harm company B much as the tax rate in that country is low.

 The company B will transfer raw material to company A at slightly higher prices. This will enable company A to show a higher expenditure and reduce its taxable profits. On the other hand, a slightly higher income will not harm company B much as the tax rate in that country is low.

 Thus the global group as a whole will benefit from tax savings. In this game, the first country is the major loser. Hence MNCs quote high price for intracompany transfers where taxes are high and quote lesser price for countries where the tax rates are low.

 When goods are shipped to high tariff countries, minimal transfer prices are quoted to reduce the effect of the duty. When dividend repatriation is curtailed by govt. policy, income may be taken out in the form of high prices for products or components shipped to units in that country

 Transfer prices can be used to strengthen the competitive position of a company or to neutralize the competitive advantage of others. MNC has the ability to cut prices to any level necessary to achieve either a foothold or to increase its market share.

 It is possible for a large MNC to absorb sizable per unit losses on its sales in a host country without sacrificing its overall profitability. MNCs thus tend to manipulate transfer prices to circumvent tax and dividend regulations to maximize their profits.

There are two widely used method for detecting transfer pricing: 1. Comparable Uncontrolled Price (CUP) method and 2. Cost Plus ( C + ) method.

 CUP method: Prices charged in similar business transactions between two independent parties is used as the yard stick for assessment.

 Cost Plus method (C + ) method: The arms length price is determined by applying an appropriate mark-up on the costs incurred.

Regulations
If transfer pricing is detected / suspected then the tax authorities can deny tax holidays granted. The most important provision in the tax laws is in section 92. This allows the Indian Tax Authorities to adjust the taxable income of the Indian firm, if they feel that the prices charged in a transaction are not at an arms length due to close connection between the Indian entity and a foreign entity.

Country risk
Country risk is one of the special issues faced by MNCs when investing abroad. It involves the possibility of loses due to country specific economic, political and social events.

 Various types of country risks faced by the MNCs are:

1. Expropriation 2. Confiscation 3. International war or civil strike: 4. Unilateral breach of contract: 5. Harmful action against employees: 6. Restrictions on repatriation of profits: 7. Discriminatory taxation policies 8. Political boycott * Already discussed PEST factors

 Managing political risk: 1. Avoiding investment 2. Joint Ventures 3. Threat by controlling critical inputs 4. Lobbying 5. Insurance (MIGA- Multilateral Investment Guarantee Agency ) ** Discussed under PEST