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Chapter 1
Globalization
and the
Multinational
Enterprise

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1-2
The Multinational Enterprise (MNE)
• A multinational enterprise (MNE) is defined
as one that has operating subsidiaries,
branches or affiliates located in foreign
countries.
• The ownership of some MNEs is so
dispersed internationally that they are
known as transnational corporations.
• The transnationals are usually managed
from a global perspective rather than from
the perspective of any single country.

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1-3
Multinational Business Finance
• While multinational business finance emphasizes
MNEs, purely domestic firms also often have
significant international activities:
– Import & export of products, components and services
– Licensing of foreign firms to conduct their foreign
business
– Exposure to foreign competition in the domestic market
– Indirect exposure to international risks through
relationships with customers and suppliers

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1-4
Globalization and Creating Value in the
Multinational Enterprise
• Global business, like any business, is the social
science of managing people to organize, maintain
and grow the collective productivity toward
accomplishing productive goals, typically to
generate profit and value for its owners and
stakeholders.
• Reaching that goal requires combining three
critical elements:
– An open marketplace
– High quality strategic management
– Access to capital

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Exhibit 1.1 Creating Firm Value in Global
Markets

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1-6
The Theory
of Comparative Advantage
• The theory of comparative advantage provides a basis
for explaining and justifying international trade in a
model world assumed to enjoy:
– free trade;
– perfect competition;
– no uncertainty;
– costless information, and
– no government interference.

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The Theory
of Comparative Advantage
• The theory contains the following features:
– Exporters in Country A sell goods or services to unrelated
importers in Country B
– Firms in Country A specialize in making products that can
be produced relatively efficiently, given Country A’s
endowment of factors of production, that is, land, labor,
capital, and technology
– Firms in Country B do likewise, given the factors of
production found in Country B
– In this way the total combined output of A and B is
maximized

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1-8
The Theory
of Comparative Advantage
– Because the factors of production cannot be moved freely
from Country A to Country B, the benefits of
specialization are realized through international trade
– The way the benefits of the extra production are shared
depends on the terms of trade, the ratio at which
quantities of the physical goods are traded
– Each country’s share is determined by supply and
demand in perfectly competitive markets in the two
countries
– Neither Country A nor Country B is worse off than before
trade, and typically both are better off, albeit perhaps
unequally

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The Theory
of Comparative Advantage
• Although international trade might have
approached the comparative advantage model
during the nineteenth century, it certainly does
not today, for the following reasons:
– Countries do not appear to specialize only in those
products that could be most efficiently produced by that
country’s particular factors of production (as a result of
government interference and ulterior motivations)
– At least two factors of production – capital and
technology – now flow directly and easily between
countries

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1-10
The Theory
of Comparative Advantage
– Modern factors of production are more numerous than in
this simple model
– Although the terms of trade are ultimately determined by
supply and demand, the process by which the terms are
set is different from that visualized in traditional trade
theory
– Comparative advantage shifts over time, as less
developed countries become developed and realize their
latent opportunities
– The classical model of comparative advantage did not
really address certain other issues, such as the effect of
uncertainty and information costs, the role of
differentiated products in imperfectly competitive
markets, and economies of scale

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1-11
The Theory
of Comparative Advantage
• Comparative advantage is however still a relevant theory to
explain why particular countries are most suitable for
exports of goods and services that support the global supply
chain of both MNEs and domestic firms.
• The comparative advantage of the 21st
century, however, is
one based more on services, and their cross-border
facilitation by telecommunications and the Internet.
• The source of a nations comparative advantage is still
created from the mixture of its own labor skills, access to
capital, and technology.

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1-12
The Theory
of Comparative Advantage
• Many locations for supply chain outsourcing
exist today (see the following exhibit).
• It takes a relative advantage in costs, not
just an absolute advantage, to create
comparative advantage.
• Clearly, the extent of global outsourcing is
reaching out to every corner of the globe.

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Exhibit 1.2 Global Outsourcing of
Comparative Advantage

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Market Imperfections: A
Rationale for the Existence of the
Multinational Firm
• MNEs strive to take advantage of imperfections in
national markets for products, factors of
production, and financial assets.
• Imperfections in the market for products translate
into market opportunities for MNEs.
• Large international firms are better able to exploit
such competitive factors as economies of scale,
managerial and technological expertise, product
differentiation, and financial strength than are
their local competitors.

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Market Imperfections: A
Rationale for the Existence of the
Multinational Firm
• Strategic motives drive the decision to invest
abroad and become a MNE and can be
summarized under the following categories:
– Market seekers
– Raw material seekers
– Production efficiency seekers
– Knowledge seekers
– Political safety seekers
• These categories are not mutually exclusive.

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Sustaining and Transferring
Competitive Advantage
• In industries characterized by worldwide
oligopolistic competition, each of the above
strategic motives should be subdivided into
proactive and defensive investments.
• Proactive investments are designed to
enhance the growth and profitability of the
firm itself.
• Defensive investments are designed to
deny growth and profitability to the firm’s
competitors.

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Exhibit 1.4 Trident Corporation:
Initiation of the Globalization
Process

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Exhibit 1.5 Trident’s Foreign Direct
Investment Sequence

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Exhibit 1.6 Potential Limits on
Financial Globalization

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Mini-Case Questions: Porsche
Changes Tack
• What strategic decisions made by Porsche over
recent years had given rise to its extremely high
return on invested capital?
• Vesi wondered if her position on Porsche might
have to distinguish between the company’s ability
to generate results for stockholders versus its
willingness to do so. What do you think?
• Is pursuing the interest of Porsche’s controlling
families different from maximizing the returns to
its public share owners?

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Chapter 1
Additional
Chapter
Exhibits

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1-22
Exhibit 1.3 What Is Different about
International Financial
Management?

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1-23
Exhibit 1 Porsche’s Growth in Sales,
Income, and Margin

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Exhibit 2 Return on Invested
Capital (ROIC) for European
Automakers, 2004

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Exhibit 3 Porsche’s Velocity,
Margin, and ROIC