Multinational Corporations

Why do multinational enterprises (MNEs) exist? This seems to be a silly question. The answer seems to be simple – because they are profitable! But the issue is more complicated than it sounds.

There is some agreement that five different pieces together provide a good explanation of why multinational firms exist (and why they are as large as they are. The combination of these five pieces into a framework for understanding multinationals is often called the eclectic approach with credit for the synthesis going to John Dunning.

Inherent disadvantages

Our first step is to recognize that there are good reasons why MNEs should not exist. An MNE has inherent disadvantages in trying to compete with foreign rivals on their own turf. The MNE is at a disadvantage in this foreign environment because it does not initially have the native understanding of local laws, customs, procedures, practices, and relationships. In addition, the firm has the extra costs of maintaining management control. It is expensive to operate at a distance, expensive in travel and communications, and especially expensive in misunderstanding. Furthermore, the MNE may lack useful connections with political leaders in the foreign country, or it could feel actual or potential hostility from the foreign country's government.

Firm-Specific Advantages

To be successful, the MNE must have one or more firm-specific advantages – that is, one or more assets of the MNE that are not assets held by its local competitors in the host country (or, perhaps, by any other firm in the world). A firm's secret technology or its patents are a firm-specific advantage (IBM, Hitachi). Or the advantage may inhere in the MNE's access to very large amounts of capital, amounts larger than an ordinary national firm can command (General Motors). Or, as in the case of petroleum refining (Royal Dutch Shell) or metal processing (Alcoa), the firm may gain advantage by coordinating operations and capital investments at various stages in a vertical production process. Or the firm may have marketing advantages based on skillful use of advertising and other promotional methods that establish product differentiation for instance, through highly regarded brand names (Nestle, Proctor and Gamble). Or it may have truly superior management techniques (General Electric). The challenge to the firm is to maximize its returns on these assets.

We now have an enterprise that has firm-specific advantages such that it could operate profitably as a multinational. But should it? Even for the firm that has firm-specific advantages, it must also consider alternatives to FDI for earning profits from activities in a foreign market. It must be more profitable for an MNE to own and manage a foreign operation rather than adopting some other way of earning profits.

Here are two questions for