Why Would a Firm Want to Become a Multinational?

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

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