MARKET-EXPANSION INVESTMENTS
MARKET-EXPANSION INVESTMENTS
Transportation
Early trade theorists usually ignored the cost of transporting goods from one place to another. More recently, location theorists have considered total landed cost (cost of production plus shipping) to be a more meaningful way of comparing where production should be situated. When transportation is added to production costs, some products become impractical to ship over a great distance. In the opening case, we showed that one of the factors influencing Bridgestone's decision to invest in the United States was the high cost of transporting tires relative to the production price of tires. Numerous other products that are impractical to ship great distances without a very large
escalation in the price quickly come to mind: A few of these products and their investing companies include newspapers (Thompson Newspapers, Canadian), margarine (Unilever, British-Dutch), dynamite (Nobel, Swedish), and soft drinks (PepsiCo, U.S.). For these firms, it is necessary to produce abroad if they are to sell abroad. When firms move abroad to produce basically the same products that they produce at home, their direct investments are known as horizontal expansions.
Lack Of Domestic Capacity
As long as a company has excess capacity at its home-country plant, it may be able to compete effectively in limited export markets in spite of the high transport costs. This could be because the fixed
operating expenses are covered through domestic sales, thus enabling foreign
prices to be set on the basis of variable rather than full cost. Such a pricing
strategy may erode as foreign sales become more important or as output
nears full plant capacity utilization. This helps to explain why firms, even
those with products for which transport charges are a high portion of total
landed costs, typically export before producing abroad. Another major fac-
tor is that companies wan^jo_gej_a_better indication that they can sell
a sufficient amount "in the foreign country before committing resources for
foreign productiomjinally, they may want to learn more about the foreign operating environment by exporting to it before investing in production facilities within it. Once they have experience in foreign production, they are more apt to shorten the export-experience time before they produce abroad.
This reluctance to expand total capacity while there is still substantial excess capacity is not unlike a domestic expansion decision. Internationally as well as domestically, growth is incremental. To understand this process, it is useful to draw a parallel of how growth may take place domestically. The simplest example is the firm that makes only one product. Most likely, this firm will begin operations near the city where its founders are already residing and will begin selling in only the local or regional area. Eventually, sales may be expanded to a larger geographic market. As capacity is reached, the firm may build a second plant in another part of the country to serve that region and save on transportation costs. Warehouses and sales offices may be located in various cities in order to assure closer contact with customers. Purchasing offices may be located close to suppliers in order to improve the probability of delivery at low prices. In fact, the company may even acquire some of its customers or suppliers in order to reduce inventories and gain economies in distribution. Certain functions may be further decentralized geographically, such as by locating financial offices near a financial center. As the product line evolves and expands, operations continue to disperse. In the pursuit of foreign business it is not surprising that growing firms eventually find it necessary to acquire assets abroad.
Scale Economies
Transportation costs must be examined in relation to the type 0f technology used to produce a good. The manufacture of some prod-
ucts necessitates plant and equipment that use a high fixed-capital input. In
such a situation, especially if the product is highly standardized or undifferentiated from competitors, the cost per unit is apt to drop significantly as output increases. Products such as ball bearings, alumina, and semiconductor wafers fall into this category. Such products are exported substantially be-cause the cost savings from scale economies overcome the added transport expenses to get goods to foreign markets.
The needed scale of production must be considered in relation to the size
of the foreign market being served. For example, many European firms have
production facilities in both the United States and Canada. They are more apt
to sell the U.S. output only in the United States because of the large market,
whereas much of the Canadian output is sold in their home countries to gain large-scale production.10
Products that are more differentiated and labor intensive, such as pharmaceuticals and certain prepared foods, are not as sensitive to scale economies. For these types of products, transportation costs may dictate smaller plants to serve national rather than international markets." David's Cookies, for example, first entered the Japanese market with ingredients mixed in the United States. However, because there was little cost reduction obtained by mixing bigger batches of batter, David's switched to Japanese ingredient preparation to overcome the transport cost incurred when exporting.
Transportation
Early trade theorists usually ignored the cost of transporting goods from one place to another. More recently, location theorists have considered total landed cost (cost of production plus shipping) to be a more meaningful way of comparing where production should be situated. When transportation is added to production costs, some products become impractical to ship over a great distance. In the opening case, we showed that one of the factors influencing Bridgestone's decision to invest in the United States was the high cost of transporting tires relative to the production price of tires. Numerous other products that are impractical to ship great distances without a very large
escalation in the price quickly come to mind: A few of these products and their investing companies include newspapers (Thompson Newspapers, Canadian), margarine (Unilever, British-Dutch), dynamite (Nobel, Swedish), and soft drinks (PepsiCo, U.S.). For these firms, it is necessary to produce abroad if they are to sell abroad. When firms move abroad to produce basically the same products that they produce at home, their direct investments are known as horizontal expansions.
Lack Of Domestic Capacity
As long as a company has excess capacity at its home-country plant, it may be able to compete effectively in limited export markets in spite of the high transport costs. This could be because the fixed
operating expenses are covered through domestic sales, thus enabling foreign
prices to be set on the basis of variable rather than full cost. Such a pricing
strategy may erode as foreign sales become more important or as output
nears full plant capacity utilization. This helps to explain why firms, even
those with products for which transport charges are a high portion of total
landed costs, typically export before producing abroad. Another major fac-
tor is that companies wan^jo_gej_a_better indication that they can sell
a sufficient amount "in the foreign country before committing resources for
foreign productiomjinally, they may want to learn more about the foreign operating environment by exporting to it before investing in production facilities within it. Once they have experience in foreign production, they are more apt to shorten the export-experience time before they produce abroad.
This reluctance to expand total capacity while there is still substantial excess capacity is not unlike a domestic expansion decision. Internationally as well as domestically, growth is incremental. To understand this process, it is useful to draw a parallel of how growth may take place domestically. The simplest example is the firm that makes only one product. Most likely, this firm will begin operations near the city where its founders are already residing and will begin selling in only the local or regional area. Eventually, sales may be expanded to a larger geographic market. As capacity is reached, the firm may build a second plant in another part of the country to serve that region and save on transportation costs. Warehouses and sales offices may be located in various cities in order to assure closer contact with customers. Purchasing offices may be located close to suppliers in order to improve the probability of delivery at low prices. In fact, the company may even acquire some of its customers or suppliers in order to reduce inventories and gain economies in distribution. Certain functions may be further decentralized geographically, such as by locating financial offices near a financial center. As the product line evolves and expands, operations continue to disperse. In the pursuit of foreign business it is not surprising that growing firms eventually find it necessary to acquire assets abroad.
Scale Economies
Transportation costs must be examined in relation to the type 0f technology used to produce a good. The manufacture of some prod-
ucts necessitates plant and equipment that use a high fixed-capital input. In
such a situation, especially if the product is highly standardized or undifferentiated from competitors, the cost per unit is apt to drop significantly as output increases. Products such as ball bearings, alumina, and semiconductor wafers fall into this category. Such products are exported substantially be-cause the cost savings from scale economies overcome the added transport expenses to get goods to foreign markets.
The needed scale of production must be considered in relation to the size
of the foreign market being served. For example, many European firms have
production facilities in both the United States and Canada. They are more apt
to sell the U.S. output only in the United States because of the large market,
whereas much of the Canadian output is sold in their home countries to gain large-scale production.10
Products that are more differentiated and labor intensive, such as pharmaceuticals and certain prepared foods, are not as sensitive to scale economies. For these types of products, transportation costs may dictate smaller plants to serve national rather than international markets." David's Cookies, for example, first entered the Japanese market with ingredients mixed in the United States. However, because there was little cost reduction obtained by mixing bigger batches of batter, David's switched to Japanese ingredient preparation to overcome the transport cost incurred when exporting.
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