Internalization theory of multinational companies

The internalization theory of multinational companies describes the theory about the reasons for the integration of processes that were not previously in the company , across borders. In contrast to other forms of cooperation between companies, the main motives here are the minimization of transaction costs , the advantages of vertical integration and the easier technology transfer .

Definition of terms

Multinational companies

The multinational company represents a company which, in addition to its domestic assets, also has control over assets in another country. In terms of turnover, total assets or the number of employees, these are usually large companies. The intention of the multinationals for this step is initially the motive of all foreign trade - the imperfection of their own market, i.e. the lack of sales markets or raw material sources. Among the multitude of possibilities to compensate for this imperfection, the multinational company chooses the route through direct investments abroad. This can take the form of a business start-up. But also in the form of a purchase or participation in a foreign company are possible. The company is expanding its market power to another country because the competitive advantages that exist in its own market can be of an even better quality abroad.

Two main reasons why companies take this step are: internalization and the location motive . For the latter, factors such as the proximity to resources and sales markets, transport and factor costs as well as all other motives that are also relevant for trade play a role.

Internalization

Under Internalization refers to the incorporation of external effects in the revenue or cost accounting of a business entity.

The aim of internalization is to minimize the inefficiencies resulting from market failure and thus to achieve the optimum welfare.

Internalization is about integrating effects that were previously outside the company into the company. The advantage here is that certain transactions can be carried out more cheaply within a single company than between two or more companies. The cost of these transactions is interesting. These are decisive for whether a company creates services in-house or procures them from another company.

If a service is created in-house, additional costs arise from the organization of production (e.g. the salary of a responsible department head). But when another company takes over or sells products, there are additional sales or procurement costs (e.g. transport costs). The ratio of these costs to each other decides on make or buy . This decision is all the more important when the company expands vertically.

In contrast to the horizontal or lateral expansion , which is about influencing the same or non-company areas, the vertical expansion strives for the control of upstream or downstream production stages, i.e. the integration of the previous supplier of a material which is part of the Production is used (input). Or the inclusion of the previous buyer of the finished goods (output), e.g. B. a sales organization. Such control could be achieved through a vertical link, while the company remains legally independent. With vertical integration , on the other hand, these previously independent areas are merged under a single corporate management.

So if a company A integrates another company B, which provides input for A, then B is “upstream”, i.e. upstream from A, and A “downstream”, i.e. downstream from B.

For example, in the case of vertical integration, a furniture manufacturer could consider integrating his previous supplier of chipboard into his company (upstream) or the company that was previously responsible for selling the furniture (downstream). But it could also take on another furniture manufacturer (horizontal integration) or a bakery (lateral or diagonal integration).

Both the horizontal , lateral as well as vertical integration make molds represent an internalization.

Using different methods, one compares the respective costs of the alternative. These costs result from different production sizes, work organization, factor prices, etc.

Motives for internalization

overview

According to the work of RH Coase on the transaction cost approach from 1937, the transaction costs bear the decision on internalization. Transaction costs can be based on the phases of a transaction (according to Picot 1982):

the costs that arise from contract initiation - when looking for a potential business partner
Costs that arise in the following contract negotiations - for negotiations, contract drafting
Control costs - in the case of price or quality agreements
Costs for any adjustments - when enforcing z. B. Date and quantity changes

Picot also lists 5 factors for such transaction costs:

Ambiguity of the transaction situation - this is what we talk about when in certain situations a solution on the market is not possible for various reasons.

Thus (according to Williamson , 1971) the transaction costs increase the more specific the requirements are for a certain product that a company needs as input in its production process. The supplying company A may need special machines to carry out this order, while company B is highly dependent on the delivery of company A. This interdependence can translate into opportunistic behavior. So in a higher pricing or in a contract that is more advantageous for your own company. The uniqueness of the service also means that if there is no market or competitor for it, the value of the service can be assessed as being higher than it actually is. One draws the conclusion from this - the higher the uniqueness and the more complex the service, the higher the transaction costs.

In comparison, the transaction costs are lower if the service is offered by several companies. Such companies are not able to increase their price without risking a change of company negotiating with them.

if anything is unclear about the transactions, e.g. For example, with regard to quality issues, this means that contract negotiations could become more complicated.
the question of the frequency of transactions
what framework conditions the law specifies - e.g. B. when laws inhibit transactions
the technology used - e.g. B. to what extent are information technology and communication technology dignified.

The quintessence of these theories in favor of internalization are thus:

high investment costs and problems in assigning a value speak in favor of internalization
Uncertainties about the desired service are not the basis for long-term contracts - internalization is better
Frequencies of the transactions also mean an accumulation of the initiation costs - so speak in favor of internalization

In the search for the optimum depth of service, these transaction costs are decisive. Described in transaction cost theory .

Apart from the theoretical approaches, the internalization motives are less well researched. Above all, two main motives emerge: the easier transfer of technology and the possible advantages of vertical integration .

Technology transfer

Technology or any kind of economically usable knowledge can be traded just like a company's products. However, the conditions for such a transfer are very different. On the one hand, they can rarely be sold separately from the relevant specialists. On the other hand, a potential buyer can hardly estimate the value of this knowledge ( incomplete asymmetrical information ). If the buyer knew this, i. that is, if he knew exactly about it, he could determine the value more precisely, but would no longer have to acquire this knowledge either.

Added to this are the problems of property rights to knowledge and intellectual theft; Problems that can arise when a company licenses its technology away. The granting of licenses promotes the outflow of company-internal knowledge, since the learning curve of the licensee increases with the increasing use of license rights. This makes it easier to use the knowledge even without a corresponding license. Through internalization, the company retains control over its intellectual property as well as its use and implementation.

For example, especially in the area of information technology, in which every type of knowledge is available worldwide, the opportunities and risks of internalization are close together. The quick and uncomplicated sending of the knowledge to the recorded companies must be secured against unauthorized access by appropriate measures. The control aspect is also critical to the benefits of vertical integration.

Benefits of vertical integration

The advantage that results from the inclusion of the upstream or downstream production stages under a uniform company management is the expanded control options. The company receives control over the other production stages and thus over quality and delivery dates or sales prices and distribution channels. The coordination of the individual processes is thus made much easier. Vertical integration also enables prices to be kept essentially constant across national borders. Furthermore, according to these considerations, especially in the case of special services, a company can prevent the selfish or opportunistic behavior of the upstream or downstream company through vertical integration . The advantages also coincide with those of the transaction cost approach. Because the savings in information, negotiation, transfer and monitoring costs result in a not inconsiderable advantage.

Overall, the foreign contacts and information brought in represent an advantage for the company itself.

swell

RH Coase: The Nature of the Firm , Economica No. 4/1937, pp. 386-405
P. Krugman, M. Obstfeld: Internationale Wirtschaft , 7th Edition, Chapter 7, pp. 220-226, Pearson Studium, 2007
A. Picot: Transaction Cost Approach in Organizational Theory. Status of the discussion and informative value , Die Betriebswirtschaft 1982, pp. 267–284
A. Sell: Internationale Unternehmenskooperationen , 2nd updated and expanded edition, Chapter 2,3,7, pp. 18-22, pp. 30-45, pp. 102-110, Oldenbourg Verlag, 2002
OE Williamson: The Vertical Integration of Production: Market Failure Considerations , American Economic Review 1971, pp. 112-123