Reasons for a Company to Become a Multinational Corporation

May 7, 2010
Heino Døssing

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There are several good reasons for a company to invest abroad. Learn about these and the alternative approaches to international business.

In the 1980's, the economist John Dunning developed a theory that explains why companies would invest abroad and become multinational corporations (MNCs). This theory was named the eclectic theory. However, today it is more widely known as the OLI model, due to the three factors that are thought to spike foreign investments:

Organizational Advantages
Locational Advantages
Internalization Advantages

Coca-Cola is an example of a company with a significant organizational advantage. Its trademark is well-known and enough to sell soft-drinks in numerous countries across the world. According to James W. Harrington, a professor in geographical economics at the University of Washington, organizational advantages also cover company specific factors such as product quality, delivered price, marketing sophistication, distribution networks, low-cost inputs and superior production technology.

Natural resources in Greenland are becoming easier to access. Mining companies locating there, such as Nuukfjord Gold, have a locational advantage. Low wages, local tariffs and other trade barriers are also factors that would make it sensible to locate in a foreign country.

Internalization, i.e. owning foreign operations, is sensible when a company seeks to retain all expected profits or wishes to control the quality, marketing and local growth strategies. Being represented and taking responsibility abroad may also make it easier to sway local decision makers. Finally, according to the economists Jeff Madura and Roland Fox, having a presence in several countries can increase the knowledge of and access to new financing and investment opportunities.

Other Forms of International Business

Encyclopædia Britannica defines a MNC as a company “that is registered and operates in more than one country at a time. Generally the corporation has its headquarters in one country and operates wholly or partially owned subsidiaries in other countries.“ Thus, companies that have a joint venture abroad, established a foreign subsidiary or acquired an existing operation in a foreign country are considered MNCs.

In their book International Financial Management, Madura and Fox, describes three alternatives to becoming a MNC.

First, a company can simply choose international trade. Thereby, the company exports its goods and/or imports material or tools. The advantage of international trade is that it is relatively cheap to pull out, if it turns out not to be profitable. However, international trade can be risky, as earnings may decline due to protectionist reforms of tariffs and other trade barriers, exchange rate fluctuations or sudden logistical constraints. E.g. exporters of perishable goods were negatively affected when air freight was made impossible in large parts of Europe by the volcanic ash cloud from Iceland's Eyjafjallajokull, in April 2010.

The second alternative is licensing. Via licensing a company allows other firms to produce, sell and market its products in foreign markets. According to The Economist, it is reckoned that the NBA earns millions of dollars by licensing their merchandise to local firms in China. According to James W. Harrington, licensing has the advantage that it requires very little investment and provides an opportunity to harness the increase in return that the foreign partner may be able to create via superior technology, creativity and/or customer relations. On the other hand, the originating firm loses control of product quality.

Finally, a company can choose to become a franchisor. According to Madura and Fox a franchisor “provides a specialized sales or service strategy, support assistance and possibly an initial investment in the franchise in exchange for a periodic fee.” The advantages and disadvantages of franchising are quite similar to licensing. However, the specialized sales and service strategy offers some control over sales conditions.

The Multinational Corporation's Choice of Country

When a company looks abroad and seek to open a subsidiary, the attributes of the country should be thoroughly analyzed. Taking a look at the OLI model is not sufficient, e.g. a wider array of macroeconomic factors need to be taken into consideration. Both the current and future state of the local political, economic, social and technological environment should be thoroughly assessed. In economic theory this is called a PEST analysis.

This article has provided some insight on why companies may choose to open operations abroad. Moreover, alternative ways of conducting international business have been analyzed. However, a more thorough discussion on MNCs' choice of country is not within the scope of this article.