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OCR for page 9
Causes of internationalization
Although U.S. manufacturing has been international in scope for most
of this century, the past 10 to 15 years have witnessed the evolution of a
new global manufacturing environment. Previously, the international mar-
ket was the preserve of large multinational corporations and generally was
ignored by domestic firms. Today it is essential that virtually all manufac-
turers be aware of and participate in international markets. Reasons for
the increased importance of internationalization include the following:
Foreign competition in the U.S. market has grown incessantly.
Rapid increases in foreign demand for manufactured products have
created highly attractive markets abroad.
· The pace of technological development has accelerated as sources
of new technology have diffused worldwide.
· Changes in global political and economic conditions have created
a variety of new opportunities and challenges for manufacturers.
These factors have created not only a new global market for manu-
facturing inputs and products but also a need for international awareness
unknown in previous eras. They have also opened an array of options for
participating in international markets that were unavailable in the past.
Each of these factors affects different industries, even different products,
in varying degrees; generalizations are impossible in a sector as diverse as
manufacturing. Closer examination will reveal some of the differences and
provide a better understanding of the internationalization process.
9
OCR for page 10
10
CHAR GES IN GLOBAL MARKETS
The nature of global markets and the role of the United States in
the world marketplace have shifted fundamentally since the mid-1970s.
Relevant changes range from broad economic trends that have altered the
relative importance of various national and regional markets to technolog-
ical developments that have changed the criteria for competitive success in
those markets.
Foreign Competition in the United States
One of the most important developments Is the increasing openness
of the U.S. economy. Import penetration in consumer goods grew from
about 7 percent of domestic consumption in the early 1980s to more
than 11 percent in 1988 (see Figure 2~. In capital goods, penetration
rose from about 14 percent to almost 40 percent in the same period (see
Figure 3~.i The rapid increase in foreign-owned production capacity in
the United States further expands foreign competition in the domestic
market. Assets of foreign manufacturing affiliates as a percentage of total
assets of U.S. manufacturing corporations rose from 5.2 percent in 1977
to 12.2 percent in 1987; similarly, the number of employees working for
foreign manufacturing affiliates as a percentage of total U.S. employment
more than doubled from 3.5 percent in 1977 to 7.9 percent in 1987 (see
Figure 4~.2 Foreign competition has become so extensive in virtually every
industry that all companies, even small- and medium-sized firms that have
not historically produced or marketed products abroad, must contend with
foreign firms that are either direct competitors in the United States or have
the potential to be.
The pervasiveness of foreign competition is forcing domestic manufac-
turers to upgrade their manufacturing operations or face serious competitive
difficulties. Achieving a combination of cost, quality, delivery, and perfor-
mance that maximizes value to the customer has become the determinant of
global manufacturing success. Just-in-time and total quality control systems
have become the minimum ante for world-class manufacturing operations.
Other measures, such as improving productivity by enhancing workers'
skills and encouraging their participation in decision making, strengthening
customer-supplier relations to instill a sense of partnership, and effectively
implementing advanced manufacturing technologies to enhance flexibility
and spur innovation, are becoming essential to competitive manufacturing
~ Rudiger Dornbusch, James Poterba, and Lawrence Summers, The Case for Manufacturing in
America's Future, Rochester, N.Y., Eastman Kodak, 198S, and Federal Reserve Board, unpub-
lished data, 1989.
2 Graham and Krugman, Foreign Direct Investment in the United States, p. 13.
OCR for page 11
11
Percent of Domestic Absorption
40 -
38 -
36 -
34 -
32 -
30 -
28 -
26 -
24 -
22 -
20 -
18 -
16 -
12 - ,
1 980 '81
~
/
/
/
~~'
r
'82 '83 '84
FIGURE 2 Import penetration~onsumer goods.
1 1 -
10 -
9
8 -
6
1980 '8 1 '82 '83 '84 '85 '86 '87 '88
FIGURE 3 Import penetration~apital goods.
'85 '86 '87 '88
Percent of Domestic Absorption
12 -
l
,%i
t
l
, . . . .
/V
OCR for page 12
12
14
12
10
8
6
4
2
O I I i
1977 1978
Percent
1 1 1 , 1 1 1
1979 1980 1981
Share US Mfg
1982 1983 1984 1986 4986 1987
Year
i Share Mfg employment
FIGURE 4 Foreign role in U.S. manufacturing, 1977-1987 (percentages). Source: Graham
& Krugman.
in the domestic market. The need to stay abreast of product and process in-
novations worldwide and to build genuinely world-class operations is being
forced on companies of all sizes, even those with no historical international
presence.3
Growth in Foreign Demand
The second major development in the global market is the shift in
the relative size of markets in the United States and abroad. In 1965 the
United States accounted for 40 percent of world gross domestic product; by
1987 the U.S. share percentage had fallen to about 30 percent (see Figure
5~. Over the same period, growth in private consumption abroad exceeded
the rate in the United States.4 In particular, rapid economic growth in
developing countries has greatly expanded the number, sophistication, and
wealth of markets around the world. In the past, U.S. manufacturers
could be satisfied with the domestic market or at least confident that the
United States was their leading market, but many are now finding that
an increasing proportion of their current sales and a large proportion of
3A number of authom have addressed the need to upgrade manufacturing capabilities to be
globally competitive. See, for example, Kim Clark, Robert Hayes, and Steven Wheelwright,
Dynamic Manufacturing, New York, The Free Press, 1988.
4The World Bank, World Development Report 1989, New Yorl:, Oxford University Press, 1989,
pp. 169, 179.
OCR for page 13
13
United States
40.1 West Germany
Un i ted K ~ngdom~,~
West Germany
6.6
United Kin l
5.1
~ f =~>
France ~
\
Ot her
37.4
World Bank World Development Report 1989
/
FIGURE 5 Share of world GDP 1965, 1987.
United States
. 29.7
Japan
15.7
France
5.8
Ot he r
37.6
potential future demand are abroad. Those firms that have aggressively
pursued foreign markets have also discovered the benefits of a global
presence in smoothing demand fluctuations, creating significant advantages
over competitors concentrated in one market.
In its discussions with manufacturing executives, the committee found
a growing realization that simply exporting to foreign markets may not
provide the broad access, interaction with customers, and learning opportu-
nities needed for long-term growth in global market share. Manufacturing
managers often cite this realization as the primary motivation for siting
production facilities abroad.
There are a number of reasons. One is the advantages of bringing
global assets and capabilities to bear on local markets. For instance, a U.S.
medical products firm with a global manufacturing and marketing capability
has used integrated global production and R&D to compete successfully
with a host of small competitors in protected local markets. Another reason
is the advantages of encountering a range of strategies used by multiple
competitors. The lessons learned help to identify the critical success factors
that apply in any market. Finally, a global presence helps guard against
complacency and gives the ability to retaliate against competitors in their
home markets. By facing challenges in foreign markets, U.S. firms can
preempt competitors' ability to use a strong foreign market position as
a lever for aggressive marketing in the United States. For instance, the
strength of the Kellogg Company in global markets for ready-to-eat cereals
has been a major reason why large foreign competitors such as Nestle have
a limited presence in the U.S. cereal market. A company that is unable to
retaliate against foreign competitors that enter its domestic market is at a
serious disadvantage.
OCR for page 14
14
Shorter Product Lives, More Customization, Faster Response
Advanced design and manufacturing technology and management prac-
tices have given companies in many industries the ability to introduce new
products more rapidly and to customize products to define and attack a
range of market niches. The result is shorter product life cycles. In mi-
croelectronics, for example, the number of functions on a dynamic random
access memory (DRAM) chip has doubled every 2 years, creating a new,
denser commercial chip every 3 to 4 years;5 the resulting improvements
In memory then drive next-generation products in computers, consumer
electronics, and a number of other industries as well as demanding rapid
improvements in processing equipment. In automobiles the Japanese have
compressed vehicle development lead times to less than 4 years, allowing
more frequent model changes and better response to customer demand;
U.S. and European firms are striving to catch up. The trend Is also appar-
ent in industrial goods markets. For instance, Allen-Bradley uses advanced
manufacturing technologies to produce customized contactors and relays
in batches as small as one; General Electric does the same with circuit
breakers. As the technology advances and permeates more companies,
rapid response time and customization will become competitive necessities.
The implications of this change for corporate and government strategy
are becoming apparent. Only a few industries remain in which the tra-
ditional product cycle approach to international production still applies.6
Strong intellectual property rights have become more important as com-
panies are forced to recoup investments on new products and production
facilities over shorter periods. Manufacturers cannot afford the revenue
losses associated with misappropriation of intellectual property. The Inter-
national Made Commission estimates that inadequate protection of ~ntel-
lectual property cost U.S. firms $24 billion in lost sales in 1986.7 Finally
possession of the resources, expertise, and production capabilities needed
to participate in multiplying market segments with rapid product turnover
is becoming a key element in corporate and national competitive success.
1b meet international competition, manufacturers must be able to organize
frequent product launches on a global basis, which increasingly requires
multinational manufacturing and engineering capabilities. For example,
5Thomas Howell, William Noellert, Janet MacLaughlin, and Alan Wm. Wolff, The Microelec-
tronics Race: The Impact of Government Policy on International Competition, Boulder, Colo.,
Westview Press, 1988, p. 38.
6 For a fuller description of many of the issues related to trade and technology, see Raymond
Vernon, "Coping with Technological Change: U.S. Problems and Prospects," in Harvey Brooks
and Bruce Guile, eds., Technology and Global Indusay, Washington, D.C., National Academy
Press, 1987.
7"The Sun Also Rises over Japan's Technology," The Economist, April 1, 1989, p. 57.
OCR for page 15
15
Apple Computer has built an international manufacturing and engineering
infrastructure with facilities in California, Ireland, and Singapore, to allow
broad, simultaneous product introduction in all of its major markets.
Increasing Capital Intensity
A number of high-technology industries have experienced escalations
in the capital intensity of production facilities that forced them to adopt
a global marketing strategy combined with a concentrated manufacturing
base. For example, in microelectronics, greater capital intensity, expensive
product and process R&D, and escalating costs of capital equipment have
made the ability to sell products globally essential to achieving the requisite
scale economies for amortizing investments. In 1986 facilities' charges
for state-of-the-art semiconductor plants ranged between $50 million and
$100 million; recent estimates have priced new plants at $250 million to
$400 million. When R&D costs are included, estimates for 16-megabit
DRAM facilities exceed $1 billion. This level of capital intensity has two
major effects on corporate strategy. First, it forces manufacturers to share
the costs and the risks. For example, Texas Instruments and Hitachi,
Motorola and Toshiba, and IBM and Siemens have reached agreements
for joint work in developing 16-megabit DRAMs and the requisite process
technology. High capital requirements also demand that costs be amortized
by maximizing capacity utilization, moving rapidly along the learning curve
to boost production yields, and attacking markets on a global scale. This
demand implies a strategy of concentrating production in a few locations
and exporting. These forces help to explain the importance of open markets
in semiconductors, as demonstrated by the U.S. demand for greater access
to the Japanese semiconductor market.
Market Sophistication
In a variety of industries a presence in specific markets abroad has
become essential to maintaining a technological edge. For historical and
other reasons, certain markets have developed an industry mix that demands
state-of-the-art products in certain areas. In these state-of-the-art markets,
constant improvement in product and process technologies is driven by
customer demand; therefore, successful innovation becomes a key determi-
nant of competitive success. Participating in these markets is essential both
to keep pace with technological advances in a given product class and to
provide ready access to a customer base for innovations that can ease the
risks and build a basis for global sales. Japan, for instance, has become the
state-of-the-art market for semiconductor process equipment and consumer
electronics. Germany and Japan probably share this distinction in machine
OCR for page 16
16
tools. The United States can still claim to be the leading market in, for
example, aerospace, computers, and software technologies, but in many
technologies crucial to manufacturing (process equipment) or to capturing
large markets for manufactured products (consumer electronics), the United
States is not the state-of-the-art market.
Firms competing on the basis of the technological sophistication of
their products have no choice but to build a strong presence in these state-
of-the-art markets. Effective participation through exports alone, though
not impossible, is very difficult. Production capabilities in the market,
along with significant engineering resources, are essential to identifying
and responding to rapidly changing consumer demand or competitors'
challenges. The lessons learned can then be transferred to the firm's other
production facilities worldwide and used to gain a competitive edge in
world markets.
These examples illustrate the kinds of issues that the globalization
of markets has introduced to manufacturing strategies. Operational im-
plementation takes a range of forms, depending on the industry, product
sophistication and maturity, size and resources of specific companies, polit-
ical constraints, and other factors. Conditions might dictate a wholly owned
investment strategy or, increasingly, some form of collaboration with a firm
that already has a market presence. Managers at one auto parts company
explained that joint ventures are now its favored approach to building inter-
national market share in mature product markets, but the firm still depends
on direct investment to build a presence in new businesses. In particular,
many U.S. manufacturers view joint ventures as the most effective way to
penetrate the Japanese market; such alliances can help overcome close
manufacturer-supplier relations and language barriers.
GLOBAL DISSEMINATION OF TECHNOLOGY
Another major factor in the globalization process is the development
of technological strengths in many foreign firms and economies that are
overtaking the United States in a number of critical areas. Various in-
dicators support this contention. Japan, Germany, and France devote a
greater percentage of gross national product (GNP) to nondefense R&D
than the United States. By 1988 the number of U.S. patents granted to
foreign inventors, primarily from Japan, Germany, France, and Britain,
virtually matched those to U.S. inventors (see Figure 6~. Finally, the share
of the U.S. market for high-technology goods supplied by imports climbed
from a negligible 5 percent in 1970 to 18.2 percent in 1986; over that
period the sources of such imports expanded beyond Europe to include
OCR for page 17
17
Japan (the dominant supplier) and the Asian newly industrialized countries
(NICs Hong Kong, Singapore, South Korea, and lbiwan).8
A key ramification of this diffusion of technological capability is the
need for U.S. manufacturers to improve their ability to tap multiple sources
of technology and to absorb new technologies into their products and
processes. Despite many exceptions, certain evidence shows that U.S.
manufacturers are handicapped in global competition by their poor ability
to absorb new technologies, particularly from external sources, that form
the basis for building new competitive advantages and commercializing
new products rapidly. A recent study of the time and funds needed by
Japanese and U.S. firms to commercialize new technology showed U.S.
manufacturers to be at a clear disadvantage in commercializing external
technology, though for internally developed technology the two countries
were about even. Although this disadvantage may be due to differences
in the way resources are allocated in the innovation process, it is also an
indication of the costs of a pervasive "not-invented-here" attitude in U.S.
industry that must be overcome.9 The global dissemination of technology,
both hardware and "soft" management systems, has made this shortcoming
of U.S. manufacturers a major detriment to their global competitiveness.
Despite the evidence that U.S. companies do not integrate new tech-
nologies into their operations as well as many foreign competitors, an
increasing number of firms are recognizing the importance of tracking and
gaining access to technological developments worldwide. As with the other
drivers of the internationalization process, the steps needed to do so can-
not be generalized. They depend on the firm's own technological assets,
whether competitiveness is based on product or process technology or both,
whether the firm strives to be a technological leader or a quick follower,
and the relative availability of foreign technology. Techniques used to gain
access include creating wholly owned R&D facilities in key foreign mar-
kets, contracting with independent research institutions, strengthening ties
to local universities, establishing local production facilities in areas with
relevant technological concentrations, entering joint ventures with foreign
firms in the United States or abroad, buying key technologies (embodied
in products or processes) from foreign suppliers, licensing foreign patents,
reviewing local technical publications, and informal cooperative research
with foreign companies. A few examples will help to illustrate the kinds of
steps that manufacturers are taking to ensure global access to technology.
These and other statistics on R&D, technology trade, and production are available in National
Science Board, Science and EngineeringIndicators 1989, Washington, D.C., U.S. Government
Printing Office, 1989.
9 Edwin Mansfield, "Industrial Innovation in Japan and the United States," Science, September
30, 1988, p. 1769.
OCR for page 18
18
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OCR for page 19
19
Access to Critical Components
Perhaps the most common way to gain access to technology is to
purchase components from outside suppliers. Sourcing decisions usually
involve a sophisticated analysis of which products and components should
be manufactured in-house and what can be bought from suppliers. The op-
timum balance between make and buy depends on a variety of factors, not
just access to technology; they include cost, supply flexibility, necessary pro-
cess capabilities, and the role of specific components or products In overall
corporate strategy. In some product segments, however, buying components
from foreign manufacturers has become the only way to participate in final
product markets.~° For instance, Canon dominates global production of
engines for facsimile machines and laser printers, with 84 percent of the
world market. Similarly, Fanuc holds more than 70 percent of the global
market for machine tool controllers. These market shares imply not only
monopolistic power over price and deliveries but also virtual control of the
pace of innovation in the affected product markets. The customers' need
to guarantee access to such critical components can be the determining
factor in corporate decisions ranging from plant location to frequency of
model changes. In many cases, heavy dependence on single suppliers for
critical components can be reversed with appropriate investments IBM,
for instance, manufactures its own laser printer engines but the ability
to build the necessary production capabilities with the requisite skill and
knowledge becomes more difficult with each new generation of component
technology.
Access to Process Equipment
Competitive product technologies often depend on the most advanced
process technologies, which in some industries requires that process equip-
ment be obtained from foreign suppliers. For example, U.S. semiconductor
manufacturers depend on Japanese suppliers for certain advanced mate-
rials (glass, ceramics, and some specialized chemicals) and increasingly
for leading-edge lithographic equipment. U.S. auto companies now must
import state-of-the-art machine tools in some applications to achieve world-
class parts quality. The rising level of import penetration in the U.S. capital
equipment market in the 1980s is a clear indication of the overall strength
of foreign suppliers (see Figure 3~.
moor a discussion of U.S. dependence on Japanese suppliers ofmicroelectronic components,
see Robert B. Reich, "The Rise of Techno-Nationalism," The Atianac Monthly, May 1987, pp.
63-69.
~ ~ "Canon," Financial Times Supplement, April 27, 1988, p. 16B.
i2 Gene Bylinsky, "]apan's Robot King Wins Again," Fortune, May 25, 1987, p. 53.
OCR for page 23
23
(the costs of quality), and the importance of a support infrastructure in
achieving production goals.l6
In the 1960s and l970s much of the offshore movement of U.S.
manufacturing was driven by a strategy based on low labor costs. U.S.
managers reasoned that the low prices of many imported products, from
automobiles to consumer electronics, were attributable to cheap labor; the
only way to compete was to move production offshore to match or beat
those labor costs. Over time, however, the importance of labor costs in
international investment and production decisions has been diminished by
a number of factors:
· Advances in technology and a long history of squeezing labor out
of production have reduced direct labor content in most manufacturing
industries to 15 percent or less of production costs; in high-technology in-
dustries it seldom exceeds 10 percent and increasingly is under 5 percent.~7
Even wide variations in direct labor costs have relatively insignificant effects
on total costs.
Many companies have discovered that a strategy based on low
labor costs is difficult to implement in the long term. Low-wage locations
are equally open to competitors' investments, relative wage levels between
locations can change abruptly with changes in exchange rates and shifts
in demand, and the extra capital and logistical costs of shifting operations
to alternative sites to maintain low wages (so-called "island hoDDin~"N can
1 ~ O.
easily consume the resulting wage savings.
· In most manufacturing industries, labor costs have been outweighed
by market access, quality control, timely delivery, and responsiveness to
customers as determinants of global competitiveness. Competitive manu-
facturers, adopting manufacturing systems for total quality control, have
found that siting plants in areas with the skills and capabilities needed
to control total costs and quality is more important than siting them
to minimize labor costs. These considerations explain the predominance
of developed economies in U.S. manufacturing investment abroad (see
Figure 7~.
Direct labor still receives more attention than it deserves because of
accounting systems that continue to allocate overhead costs on the basis
of labor load. Still, realizations of the true significance of labor costs are
beginning to have important effects on management decisions. Particularly
for firms pursuing total quality, international differences in the costs of
assuring quality in production are the critical factor in investment decisions.
i6The Manufacturing Studies Board is currently engaged in a major study of international dif-
ferences in the cost factors driving manufacturers' global production and investment decisions.
i7Clark, Hayes, and Wheelwright, 1?ynamic Manufactunng, p. 137.
OCR for page 24
24
EEC
116
At r i ca
Asia
33
Canada
35
Lati n Amer ice
10
Eastern Europe
/
9
Other Western Europe
~3
FIGURE 7 U.S. manufacturing investment abroad, 1989: acquisitions, joint ventures, new
plants.
The pursuit of total quality in different manufacturing processes reveals a
wealth of information about where costs are created and the resources and
capabilities needed to control them. The ability to minimize inventory, to
eliminate scrap and rework, to integrate functions, and to shorten time to
market depends on trained personnel, a strong supplier base, a streamlined
organization, and flexibility. Therefore, international site selections might
hinge on the cooperation, flexibility, and trainability of the labor force
rather than on its cost. For firms using just-in-time systems, the availability
of a responsive supplier base or the ability to create one quickly is another
important consideration.
The lessons learned about a labor cost strategy and a total system
approach to cost control have created different considerations in production
location decisions, but direct labor remains important to production costs
in some product lines. Managers from several industries told the committee
that, as a general rule, if direct labor costs exceed 10 percent of total costs,
production can be cheaper in low-wage locations. Assembly of electronic
devices is one example. Many of the large companies in this industry
use sophisticated models to determine the relative advantages of using
automated assembly technologies (when available) or low-cost labor at
various wage rates; proximity to customers and suppliers is also considered
OCR for page 25
25
as well as various scenarios for overhead costs. The results vary by product.
For instance, low-cost labor may be preferred to automation for products
with very short model lives to minimize fixed asset exposure. When low-
cost labor offers a clear advantage, sites in Thailand, Malaysia, and the
Philippines are attracting more U.S. and Japanese investment because
labor costs in Korea, Taiwan, and Singapore have increased rapidly in
recent years.
One land of labor whose costs have begun to receive more attention,
at least in knowledge-based industries, is highly skilled technical labor for
support services. For instance, Texas Instruments has joined AT&T and
other U.S. firms in establishing software engineering facilities in India to
take advantage of well-trained, low-cost computer programmers. Other
firms are finding that the engineering labor force in Korea, Singapore, and
other NICs compares favorably to U.S. engineers but at a fraction of the
cost. However, managing high-value offshore activities effectively remains a
challenge, particularly product and process engineering activities that often
are critical to competitive success. On one hand, the short-term cost ad-
vantages of moving product/process design and engineering responsibilities
to low-cost locations, where firms often have factories, are evident. On
the other hand, the broad infrastructure necessary to maximize engineer-
ing's value added may not exist in low-wage locations, and the ability to
integrate offshore engineering into the firm's total manufacturing system
may be constrained by distance and cultural differences. Consequently, the
long-term effects remain unclear.
In some capital-intensive industries, such as semiconductors and chem-
icals, the cost of capital is the major cost consideration in investment de-
cisions.~8 Because labor needs are minimal, supplies are shipped globally,
and transportation costs are low, the key factors in site selection are avail-
abili~ of low-cost capital and the presence of the appropriate technical and
logistical infrastructure. In such capital-intensive industries, government
incentives to reduce capital costs using mechanisms such as interest rate
subsidies, tax holidays, and cost sharing on plant and equipment can be
particularly effective in swaying corporate location decisions. Though the
advantages of such incentives to individual companies are undisputed, it
18A number of recent studies have addressed international differences in the cost of capital
as a source of U.S. disadvantage in manufacturing competitiveness. For instance, see Robert
McCauley and Steven Zimmer, 'Explaining International Differences in the Cost of Capital,"
Federal Reserve Bank of New York Quarterly Renew, vol. 14, no. 2, Summer 1989, pp. 7-28. The
committee's intent in this brief discussion is not to resolve the complex issue of whether U.S.
capital costs are higher than those of other nations but to note the importance of access to low-
cost capital as a driver in the internationalization process.
OCR for page 26
26
remains an open question whether these government programs represent
an efficient use of public resources.~9
POLITICAL AND ECONOMIC FACTORS
In addition to changes in markets, technology sources, and cost struc-
tures, a varieW of political and economic factors have changed the global
manufacturing environment. The range of factors extends from exchange
rate volatility to specific government-to-government agreements both to
open markets and to manage trade. This aspect of the internationalization
process Is far too extensive to permit an exhaustive review here, but a few
examples will illustrate the importance of such factors to manufacturers'
international decisions.
Exchange Rate Fluctuations
The 1971 breakdown of the Bretton Woods system of fixed exchange
rates introduced a new source of risk to international trade and investment.
Variations In exchange rates under the current floating rate regime have
been large relative to typical profit margins; changes of 1 percent in a day
and 20 percent in a year are not uncommon. Many economists argue that
this volatility Is more attributable to the portfolio preferences of investors
than simply to adjustments needed to balance trade flows. Because shifts
in exchange rates are unpredictable, manufacturers are faced with high
uncertainty in the costs and returns of many international operations.
A wide array of financial mechanisms are available for hedging against
currency fluctuations, but they are most effective for short-term variations.
Manufacturers have responded to long-term currency shifts by diversifying
production geographically, making exchange rate variations an integral
factor in the internationalization process.20
For instance, the dramatic cost reductions achieved by major Japanese
exporters in recent years were necessitated by the tremendous rise in
the value of the yen after 1985-1986. Such cost reductions have not
19The question of the costs and benefits of government investment incentives typically is ad-
dressed in the context of local public finance debates. Incentives are typically provided by state,
regional, or local governments, both in the United States and abroad, though some national gov-
ernments, such as Ireland, have made incentives a matter of national policy. For a discussion of
many of the issues involved in the level and form of government investment subsidies, see, for ex-
ample, R. Scott Foster, "State Economic Policy An Assessment," Business in the Contemporary
World, Summer 1989, pp. 86-97.
20These arguments are made more extensively in Ronald I. McKinnon, "Monetary and Ex-
change Rate Policies for International Financial Stability A Proposal," Journal of Economic
Perspectives, vol. 2, no. 1, Winter 1988, pp. 8~103.
OCR for page 27
27
only been applied to domestic manufacturing operations but also have
led to more offshore production and purchasing by Japanese corporations.
The effect has been to accelerate the internationalization of the Japanese
manufacturing base.2i U.S. companies pursued similar responses to the
strong dollar of the early 1980s. Another response is for companies to
establish production facilities in local markets to minimize their dependency
on exports to that market and, therefore, to reduce the effects of currency
swings on product prices and market share. This reasoning has been an
important motivation for the recent increases in Japanese manufacturing
investment in the United States and Europe. Though reducing exposure
to currency swings may not be the primary driver in decisions to locate
production facilities or to buy components in specific countries, it can
speed such decisions and make an international production strategy both
unavoidable and competitively sound.
Europe 1992
The multigovernment initiative under way to create a unified European
market by 1992 is dramatically changing corporate plans and strategies in
Europe. The prospect of a single market of 320 million consumers is already
spurring new investments, plant rationalization, and strategic alliances that
would be unlikely otherwise. For many manufacturers in Europe, 1992
offers opportunities to consolidate small plants built to serge individual
national markets into European-scale facilities. For firms that have had
no production facilities in the European Community, the fear that 1992
may bring greater trade protection in Europe is prompting reevaluation
of the viability of export strategies and boosting investment plans. Europe
1992, more accurately described as a process than as a specific event,
Is stimulating changes in strategies among manufacturers worldwide and
will change the role of Europe in an increasingly interdependent global
economy.22
U.S.-Canada Free Trade Agreement
The U.S.-Canada Free Made Agreement of 1988 is sparking similar
changes in the North American market. Both U.S. and Canadian com-
panies have announced rationalizations In output and steps to determine
21Japan's offshore production is expected to be 8.7 percent of total Japanese output in 1990
compared to 3.5 percent in 1986. See "Remaking Japan," Business Week, July 13, 1987, p. 54, and
Eileen M. Doherty, Japan's Foreign Direct Investment in Developing Countries, Japan Economic
Institute, August 11, 1989.
22For an instructive sunrey of the 1992 process and its implications for business, see Nicholas
Colchester, "ASurvey of Europe's Internal Market," The Economist, July 8, 1989.
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which plants will serge what market. The resulting integration of the two
economies will further complicate the already difficult problem of account-
ing for trade between the two nations.
Trade Protection
The General Agreement on Tariff and Made (GATE) has been very
successful in achieving major multilateral reductions in tariffs since World
War II. In terms of tariffs alone, the level of trade protection has fallen
dramatically, resulting in the virtual elimination of tariff for most industrial
goods traded among developed countries.23 The predictable result has been
explosive growth in world trade. With GATE deterring tariff increases or
additions, however, nontariff barriers to trade have become a widely used
alternative for many national governments. Nontariff barriers take a varied
of forms, resulting in a range of responses by manufacturers.
Go forms of nontariff barriers voluntary export restraints and trigger
price mechanisms have been used by the U.S. government in recent years.
The use of voluntary export restraints (VER) on Japanese automakers ef-
fectively imposed a quota on U.S. imports of Japanese cars. The Japanese
response has been (a) to upgrade the mix of cars exported to this country
to maximize revenue per unit sold, and (b) to invest in U.S. production
capacity to build market share unconstrained by VER agreements. Presi-
dent Reagan initiated S-year VER agreements on machine tools with Japan
and Taiwan in May 1986. In this case the foreign response has been to
purchase existing domestic capacity, to build new manufacturing facilities in
this country, to license domestic builders, and to create joint ventures with
American machine tool builders.24 The government has used trigger price
mechanisms—establishing a minimum price for sales in the U.S. market
in both semiconductors and steel as a way to eliminate dumping by foreign
manufacturers. The result has been excess profits for low-cost foreign pro-
ducers, allowing greater investment to reduce production cost, to advance
the level of product and process technology, and to build manufacturing
capacity in the United States.
Foreign governments have used similar nontariff barriers with similar
effects on the strategies of foreign manufacturers. Europe is a good exam-
ple. Japanese companies have dramatically increased their manufacturing
23A current GATE tariffstudy gives these average tariff levels (in percent of value of imports) for
selected countries: Canada~.9, United States 4.2, the European Economic Community 4,
Sweden 3.8, Japan 2.7, and Switzerland 2.2.
24For additional information on the internationalization of the U.S. machine tool industry, see
U.S. Department of Commerce, US. Industrial Outlook, recent years, and Nicholas S. Vonortas,
The Changing Economic Context: Strategic Alliances Among Multinationals, 'Troy, NY, Rensselaer
Polytechnic Institute, 1989.
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investments in Europe for example, in automobiles (Nissan, Toyota, and
Honda in Great Britain), semiconductors (Fujitsu in England), and con-
sumer electronics (Matsushita, Toshiba, Hitachi, Sony, and Canon, among
others, in Germany, France, Spain, and England). U.S. companies have
also established manufacturing facilities to breach trade barriers. For ex-
ample, both Texas Instruments and Intel plan to build new semiconductor
fabrication facilities in Europe (Italy and Ireland, respectively) in response
to increases in the amount of semiconductor processing that must be done
in Europe to avoid import restrictions.25
Local content requirements, as illustrated in the European semicon-
ductor example, are a particularly prevalent form of nontariff barrier. Such
requirements historically have been used to support local development of
key industries. Consequently, they have been an important factor in for-
eign direct investment decisions and a potent driver of internationalization.
In some cases, local content requirements may preclude penetration of a
specific market. The firm may deem the sales potential in the market too
small to justify a manufacturing investment or may view the local supplier
base as inadequate to fulfill quality specifications. In other cases, market
presence may be essential to tap sales potential or to gain access to specific
resources, but the local content rules force decisions on the amount and
form of manufacturing investment that are suboptimal from the firm's per-
spective. The rules introduce constraints on management flexibility, dictate
the type and scale of technology used in certain locations, and preclude
desired plant and product rationalizations. Finally, local content require-
ments may interact with other trade barriers to complicate the ability to
export from a given plant. Examples are the recent disputes in Europe
over the nationality of cars produced by Nissan in England and photo-
copiers produced by Canon in California. The value added locally to these
products is deemed insufficient to qualify them as English or American;
the final products therefore would be deemed Japanese and subject to ex-
isting trade barriers. Such disputes may proliferate as governments find it
increasingly difficult to define a local product unambiguously as companies
integrate production of components, subassemblies, and final goods into
global manufacturing systems.
Nontariff barriers take a range of forms in addition to those described
above. They include public sector policies such as government procure-
ment, subsidies, standards, regulations, and patent policy. They also include
private sector moves such as supplier qualification, distribution constraints,
collusion, and oligopoly. Each type of barrier tends to have characteristic
25"Intel Will Make Chips in Ireland," Semiconductor Industry and Business Survey, October 9,
1989, and Stuart Auerbach, "Europe 1992: Land of Opportunity Beckons," Washington Post,
March 20, 1989, p. A 1.
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effects on firms' international production and marketing strategies, partic-
ularly in high-technology industries.26 For instance, many foreign firms use
joint ventures with local firms to overcome nontariff barriers in Japan. As
these nontariff barriers affect manufacturers striving to compete on a global
basis, the emphasis on them in trade negotiations is likely to continue to
increase, resulting in further blurring of trade policy and domestic policy
and continued disputes about the proper role and mechanisms for each.
CONCLUSION
Markets, technology, costs, and politics have been the major forces for
change in the international manufacturing environment in the past 10 to
15 years. Market access has become the dominant driver of international
investment decisions, but other factors retain varying influence in specific
situations. Low-wage locations are still advantageous for manufacturing
products with high labor content. Companies that base their competi-
tiveness on technological leadership give priority to access to technology.
Other companies may focus on global proliferation of production capacity
to speed response to customers and to tailor products to local demand.
Firms with high capital requirements, in contrast, need to centralize pro-
duction. The relative weight given to each factor varies by company and
product and over time. No two companies face the same international
challenge.
Managers at several U.S. multinational corporations told the commit-
tee that their primary challenge in coming years is integrating their existing
global operations to perform as a single system rather than as islands of
manufacturing and technological capabilities. These firms have extensive
international networks of marketing and production facilities, based pri-
marily on a multidomestic model of international business. In this model,
foreign operations tend to duplicate those of the parent and are given sub-
stantial autonomy over production, distribution, product development, and
research. The resulting global production base, rather than U.S. exports,
has been the vehicle for U.S. penetration of global markets. Few companies
have progressed far in coordinating this extensive infrastructure on a global
basis, but the emergence of advanced communication and manufacturing
technologies has made global integration possible.
The challenge of global integration is magnified by the still poorly de-
fined nature of prospective global organizational systems. In the computer
and information industry, for instance, rapid escalations In the costs of
26For a full discussion, see Michael F. Oppenheimer and Donna M. ILths, NontariffBarners: The
Effects on Corporate Strategy in lIigh-Technology Sectors, Boulder, Colo., Westview Press, 1987.
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R&D, capital equipment, software, and customer support are forcing com-
panies to strengthen their global market presence and to integrate global
operations to eliminate redundancy. At the same time, the global diffusion
of technological and scientific expertise in the industry calls for ready access
to sources of innovation around the world. This need tends to restrict the
ability to rationalize global operations to achieve efficiencies. Balancing
these two pressures appropriately has become a fundamental challenge to
the industry. Managers in most other industries face similar challenges in
creating integrated global manufacturing systems.
For emerging multinational companies, the challenge is not to integrate
but to expand global presence. Managers must consider the types of
marketing, distribution, and manufacturing presence necessary to build
foreign market share; the advantages of various locations; the possibilities
for partnerships with domestic companies (and in some cases the necessity
of partnerships); the source and level of control of foreign production; and
the likely impact on the existing production base. Careful attention to these
issues, with decisions based on accurate information, can avoid investments
that fail to perform as intended or alliances that give up more than they
gain.
Small and mid-sized U.S. companies also face the challenges of building
an international infrastructure. Often they are suppliers to large corpora-
tions striving to penetrate global markets, and in some cases, such as auto
parts, they are subject to direct competition from new foreign investment
in this country. The growth of international competition in the markets
served by small firms has set new standards for their production operations
and put a premium on staying abreast of technological developments world-
wide and attacking foreign markets. Most small firms lack the resources to
spread their production base to foreign markets, but options are available.
For instance, supplier firms can forge closer links with customers to take
advantage of larger firms' resources and international experience whenever
possible. Direct experience abroad can be gained by expanding exports.
Opportunities for foreign sales are often underestimated. A 1987
report from the American Business Conference demonstrated that small
to mid-sized firms the bulk of the U.S. manufacturing base can succeed
in building international sales, given management commitment.27 For the
firms studied in this report, the first step was to build foreign distribution
capabilities, leading to overseas production once sales reached a critical
mass. The required initial investments were fairly small, the first target
markets were often English-speaking ones to minimize cultural risks, and
success was quick the companies studied increased their foreign sales
nearly 20 percent annually in the 1980s, and most showed profits on foreign
27American Business Conference, In=, Wnningin the World Market, Washington, D.C., 1987.
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sales within the first year. The success of these companies clearly indicates
the potential for greater foreign sales by U.S. manufacturers, given the
required commitment. For firms without their own sales networks, export
trading companies have been formed to provide marketing and distribution
services. Learning what is necessary to serge foreign customers through
exports is probably the most important step for small firms wanting to
benefit from the internationalization process.
Japanese manufacturers tend to face a somewhat different challenge
than U.S. firms. With only a few exceptions, the Japanese have relied on an
export strategy to achieve broad penetration of world markets. Though their
marketing and distribution infrastructure is well established, they now face
the need to create a global manufacturing infrastructure. Changes in the
value of the yen, improving capabilities of other Asian nations, and fear of
increased protectionism in world markets are spurring a dramatic increase
in Japanese offshore production. By far the preferred mechanism has been
wholly-owned greenfield investment, with North America the favorite site,
but joint ventures with local producers have been common in industries
such as automobiles, steel, and machine tools. Many of these facilities
continue to be assembly operations that receive components from Japan
(standard practice for new plants by multinationals of all nationalities), but
several firms have said they intend to increase local value added in the
next few years. Honda, for example, plans to introduce to the U.S. market
a new automobile designed, engineered, and manufactured entirely in the
United States.
European manufacturers face the same kinds of issues. Major Euro-
pean multinationals, like similar U.S. firms, have extensive international
marketing and manufacturing capabilities; their main challenge is coor-
dinating these global operations. To a greater degree than their U.S.
counterparts, however, European multinationals have tended to retain
management control and strategic direction for global subsidiaries at their
European headquarters, creating a somewhat different basis for building a
globally-integrated manufacturing system. European firms that are multi-
national only within the European market face the challenge of expanding
their marketing and manufacturing presence in other world markets.
To an increasing extent, effective responses to the causes of inter-
nationalization will push manufacturers from each region toward similar
objectives. The need for a global marketing scope is well understood, but
the importance of a global manufacturing scope is only beginning to be
realized and the means of achieving it are still not well understood. The
differences in starting points among various companies and nationalities
will sometimes constrain the tools available and color the challenges to
be overcome. Because they have the most extensive global marketing and
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manufacturing infrastructure,28 U.S. companies are potentially in an ad-
vantageous position. Unfortunately, too few U.S. firms recognize the value
of their existing infrastructure or the steps needed to strengthen it.
28According to the Federal Reserve Board, all U.S. assets abroad currently continue to exceed
foreign assets in the United States by a wide margin if assessed at market value, $785 billion
versus $466 billion.
Representative terms from entire chapter:
labor costs
