Why Would a Firm Want to Become a Multinational?

Tuesday, April 14, 2015

Each issue of The Regional Economist, published by the Federal Reserve Bank of St. Louis, features the section “Ask an Economist,” in which one of the bank’s economists answers a question. The answer below was provided by Economist Silvio Contessi.

Let's be clear about what we mean by a multinational. This is a firm that extends beyond the borders of an individual nation and operates with affiliates and branches in at least two countries. A multinational organizes phases for producing goods and services to sell in different countries. For example, many car companies have mastered the so-called international segmentation of production, which works like this: A Toyota vehicle assembled in San Antonio may have been designed at the Toyota design center in Australia; the vehicle's aluminum-wheel components may have been produced in Delta, British Columbia; and its other components may have been produced in yet another location.

Other multinationals replicate entire production processes in different countries. Consider Coca-Cola. If you are visiting Poland, the Coke you drink probably was produced in a plant in Lodz, Poland, not in the United States, although the brand and the company hail from the U.S.

International business scholars and economists have observed that firms become multinationals to exploit three broadly defined sets of advantages.

Ownership Advantage

Multinational firms usually develop and own proprietary technology (the Coca-Cola formula is patented and kept extremely secret) or widely recognized brands (such as Ferrari) that other competitors cannot use. Multinationals often are technological leaders and invest heavily in developing new products, processes and brands, while usually keeping them confidential and protected by intellectual property rights. Maintaining stronger protection of these elements helps firms enjoy greater profits from innovation.

Localization Advantage

Multinationals usually try to build facilities that produce and sell their products in locations near the consumer (the Polish consumers of Coke in our example). This helps reduce transportation costs or helps the company fit in better with local tastes and needs. Proximity to demand also helps firms adapt their products and services to different markets. At the same time, they also may take advantage of lower production costs (for example, labor costs, energy, sometimes even lower environmental standards) or more abundant production factors, such as expert engineering or greater raw materials). For example, the Polish affiliate of Coca-Cola also owns bottling plants in the Beskidy Mountains region of Poland, which is rich in mineral water for making other beverages.

Internalizing Benefits

Finally, multinationals want to internalize the benefits from owning a particular technology, brand, expertise or patents that they find too risky or unprofitable to rent or license to other firms. Enforcing international contracts can be costly or ineffective in countries in which the rule of law is weak and court procedures are long and inefficient. In these cases, the company also may risk losing its ownership advantage, which it has created at a substantial cost.

Additional Resources

Posted In Output  |  Tagged silvio contessimultinational
Commenting Policy: We encourage comments and discussions on our posts, even those that disagree with conclusions, if they are done in a respectful and courteous manner. All comments posted to our blog go through a moderator, so they won't appear immediately after being submitted. We reserve the right to remove or not publish inappropriate comments. This includes, but is not limited to, comments that are:
  • Vulgar, obscene, profane or otherwise disrespectful or discourteous
  • For commercial use, including spam
  • Threatening, harassing or constituting personal attacks
  • Violating copyright or otherwise infringing on third-party rights
  • Off-topic or significantly political
The St. Louis Fed will only respond to comments if we are clarifying a point. Comments are limited to 1,500 characters, so please edit your thinking before posting. While you will retain all of your ownership rights in any comment you submit, posting comments means you grant the St. Louis Fed the royalty-free right, in perpetuity, to use, reproduce, distribute, alter and/or display them, and the St. Louis Fed will be free to use any ideas, concepts, artwork, inventions, developments, suggestions or techniques embodied in your comments for any purpose whatsoever, with or without attribution, and without compensation to you. You will also waive all moral rights you may have in any comment you submit.
comments powered by Disqus

The St. Louis Fed uses Disqus software for the comment functionality on this blog. You can read the Disqus privacy policy. Disqus uses cookies and third party cookies. To learn more about these cookies and how to disable them, please see this article.

Subscribe to
On the Economy

Get notified when new content is available on our On the Economy blog.

Email Alerts  |  RSS

About the Blog

The St. Louis Fed On the Economy blog features relevant commentary, analysis, research and data from our economists and other St. Louis Fed experts.

Views expressed are not necessarily those of the Federal Reserve Bank of St. Louis or of the Federal Reserve System.

Contact Us

For media-related questions, email mediainquiries@stls.frb.org. For all other blog-related questions or comments, email on-the-economy@stls.frb.org.