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Classical country-based trade theories and Modern Firm-based trade theories

This paper presents an analysis of classical country-based theories and modern firm-based theories. Subsequently, further critical analysis is presented based on Mercantilism, being the least favorable theory and The National Competitive – Porter’s Diamond theory being the most appealing theory. This paper concludes with a case study of Toyota Motor Corporation’s global strategy in the international trade.

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Classical country-based trade theories and Modern Firm-based trade theories

  1. 1. 1. Table of Contents Abstract.........................................................................................................2 1. Introduction............................................................................................2 1.1 Overview of Trade Theory............................................................................................... 3 2. Analysis of Classical country-based and Modern firm-based Trade Theories ........................................................................................................4 2.1 Mercantilism..................................................................................................................... 4 2.2 Absolute Advantage (Adam Smith, 1776) ....................................................................... 5 2.3 Comparative Advantage (David Ricardo, 1817).............................................................. 6 2.4 Heckscher-Ohlin Theory (Eli Heckscher (1919) and Beril Ohlin (1933))....................... 6 2.5 The Product Life Cycle Theory (Vernon, mid-1960s)..................................................... 7 2.6 New Trade Theory: Economies of Scale & First Mover Advantage (Paul Krugman) .... 8 2.7 National Competitive Advantage..................................................................................... 8 2.7.1 Factor endowments (factors of production).............................................................. 9 2.7.2 Demand conditions ................................................................................................. 10 2.7.3 Relating and supporting industries.......................................................................... 10 2.7.4 Firm strategy, structure, and rivalry........................................................................ 10 3. Critiques – Mercantilism vs National Competitiveness........................10 3.1 Mercantilism and Neo-Mercantilism ............................................................................. 11 3.1.1 Currency manipulation............................................................................................ 11 3.1.2 Increase conflict between nations ........................................................................... 12 3.1.3 Unemployment........................................................................................................ 12 3.2 National competitive advantage – Porter’s Diamond Model......................................... 12 3.2.1 Government interventions and Policies .................................................................. 13 3.2.2 Competitive strategy............................................................................................... 13 4. Global Strategy - Manufacturing industry ...........................................14 4.1 Product quality and innovation “Kaizen”....................................................................... 15 4.2 Mode of Entering Foreign Markets and Government Policies ...................................... 16 4.2.1 Penetrating the US Market through JV................................................................... 16 4.2.2 Penetrating the Asian Market through FDI – Economies of Scale and “TPS”....... 17 5. Conclusion............................................................................................18 References...................................................................................................20
  2. 2. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 2 Abstract This paper presents an analysis of classical country-based theories and modern firm-based theories. Subsequently, further critical analysis is presented based on Mercantilism, being the least favorable theory and The National Competitive – Porter’s Diamond theory being the most appealing theory. This paper concludes with a case study of Toyota Motor Corporation’s global strategy in the international trade. 1. Introduction It is quite a normal experience to see labels like “Made in Vietnam” on a pair of Adidas running shoes, a German multinational company, a Hard Rock Café T-shirt collector getting “Made in Bangladesh” Hard Rock Café Tokyo city-tee, or thinking of buying a famous Japanese electrical appliance, chances are that the item has been manufactured in Thailand or assembled in Malaysia instead of its home country. It is also quite often seen “Made in China” label or toys imported from China when we walk into a toy shop. These experiences depict the effects of international trade. In a nutshell, international trade is defined as an exchange of goods and services across international borders (Barot, 2015). International trade exposes consumers and countries to the international market that enables exchange of goods and services between countries. Product that is bought from the global market is called an import and product that is sold to the global market is called an export. Simply put, it allows countries to trade globally as well as enable consumers to choose and shop goods and services that suits their own preferences in terms of quality and price which are not available in their own countries. This notion is supported by Wood (1993) where he mentioned “… the greatest part of international trade is when some goods can be produced better or cheaper in one country rather in another”. Many researchers, analysts and academia, including Barot (2015); Hill et al (2015) discuss and highlight the importance of a country to engage in international trade. Their arguments are mainly based on popular international trade theories. International trade theory refers to patterns of international trade between countries and the volume of trade among goods (Barot, 2015). For decades, these theories have shaped the economic development and government policies of many
  3. 3. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 3 nations and firms globally. The formation of World Trade Organization, the European Union and the North American Free Trade Agreement (NAFTA) were resulted from the development of these international trade theories. The development was then expanded to ASEAN countries when ASEAN Free Trade Area (AFTA) was formed and agreed at the 1992 Singapore ASEAN summit. The objective is to leverage the potentials and strengthen intra-ASEAN market (MITI, 2015). In the 1990s, the influence of these international trade theories has resulted in significant changes in the global free trade (Hill et al, 2015). The theories are 1) Mercantilism, 2) Absolute Advantage (by Adam Smith, 1776), 3) Comparative Advantage (by Ricardo, 1817), 4) Heckscher- Ohlin Theory (by Eli Heckscher and Beril Ohlin), 5) The Product Life Cycle Theory (by Vernon, mid-1960s), 6) New Trade Theory: Economies of Scale & First mover Advantage (by Paul Krugman), and 7) National Competitive Advantage (by Michael Porter). 1.1 Overview of Trade Theory Mercantilism is the first classical country-based theory propagated in the sixteenth and seventeenth centuries. The theory is about three hundred years old, but it has been one of the most debated theories until today. Mercantilist suggested countries to encourage exports and discourage imports. The next classical theory which was proposed by Adam Smith in 1776 is known as Absolute Advantage theory. The theory explains the benefits of unrestricted free trade. Adam Smith highlights that in order to raise richness is to embrace free trade between states. In the 1817, David Ricardo refined the theory and suggested Comparative Advantage theory where he indicates that countries can gain from trade even if one of them is less productive (Barot, 2015). In the 1920s and 1930s, two Swedish economists, Eli Heckscher and Bertil Ohlin set a framework known as Heckshcer-Ohlin theory. This theory is the extension of the previous theories of Adam Smith and David Ricardo. Hill et al (2015) highlight that Smith, Ricardo and Heckscher-Ohlin theories suggest if local citizens buy products from other countries, it will improve the economy of the country although the products could be produced locally. In other words, international trade allows countries to specialize in one particular or many industries and export the products. At the same time they import products from other countries of which they are specialized in.
  4. 4. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 4 In 1960s, Raymond Vernon developed the first modern firm-based theory called Product Life Cycle theory. The theory suggests that a country exports products that they have developed in other countries, and as the products mature and well accepted globally, other countries which have greater factor endowments will start producing locally and export back to other countries including the original country of the products. In the 1980s, more economists such as Paul Krugman developed a New Trade Theory – Economies of Scales and First mover Advantage. As the name of the theory explains a country or firm that has a specialty in the production of products and pre-dominate the market (first-mover) and able to spread the fixed costs over a large volume (economies of scale) will have the competitive advantage over its competitors (Hill et al, 2015). In another research related to new trade theory, Michael Porter developed a theory called as National Competitive Advantage. The theory explains the attributes of competitive advantages for countries and firms to be successful in the international trade. According to Porter (1990), there are four attributes which formed a diamond, hence the name Porter’s Diamond model. 2. Analysis of Classical country-based and Modern firm-based Trade Theories As briefly discussed, classical country-based theories refer to Mercantilism, Absolute Advantage, Comparative Advantage and Heckscher-Ohlin theories, while the modern firm-based theories refer to The Product Life Cycle, New Trade Theory – Economies of scale and first mover advantage and lastly National Competitive Advantage. The following will discuss in details the differences between classical country-based and modern firm-based theories. 2.1 Mercantilism This theory emerged in England in the mid-sixteenth century as the first theory of international trade. It suggests that the quantity of metals (Barot, 2015) which refers to gold and silver (Hill et al, 2015) owned by countries represent the country’s richness. Gold and silver were used as a currency of trade between countries and countries could earn more gold and silver by exporting more and restrict imports transactions. In other words, a country must promote export transactions than its import transactions to improve the country’s balance of payments (BOP) or economy’s
  5. 5. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 5 transactions between countries (Barot, 2015). As a result, the country accumulates more gold and silver, which subsequently increase the country’s richness, power and reputation. According to Hill et al (2015), mercantilists are supported by the government through the implementation of protectionism policies. These policies include imposing import tariffs, restrictive quotas, other government regulations, and at the same time promoting export subsidy. Mercantilist policy, however, has been argued by many economists (Barot, 2015; Hill et al, 2015). The theory has been argued for being unjust to others or known as a zero-sum game. It is only beneficial to one party (country) while the other is at a loss. This theory is then refined by Adam Smith and David Ricardo and demonstrate that trade should be a positive-sum game or a win-win situation. In a modern business world today, many economists and academia (Kowalski, 2011; Barot, 2015; Hill et al, 2015), believe that some countries are adapting mercantilist policy or known as neo-mercantilism. China and Germany, for example, have been argued as a supporter of neo- mercantilism policy. This allegation will be further discussed in the later part of this paper. 2.2 Absolute Advantage (Adam Smith, 1776) As mercantilist policies give a bad impact to a country’s economic growth (Barot, 2015), Adam Smith in 1776 challenges the zero-sum game by arguing that the policy is only beneficial to the mercantilist country and does not give a positive advantage to consumers (Hill et al, 2015). He suggests the notion of a positive-sum game where it is more profitable export transactions if a country imports goods that will also benefit others, including the consumers. During that period, England is known for its specialty in textile manufacturing while France is known for its world’s best wine production. How these specializations of England and France illustrate this theory is when both countries exchange its product with each other. England in this case, has an absolute advantage by producing textile products efficiently than France, whereby France has an absolute advantage of producing the wine. By exchanging products via international trade, both England and France can have both clothing and wine at the same time. England does not need to produce wine, where they are not good at producing it and vice versa. Essentially, Smith’s theory indicates that a country should
  6. 6. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 6 never produce a product locally when there is another country that can produce it efficiently and cheaper as compared to producing the same product locally. By engaging in trade, both countries will enjoy the benefits thus explains the positive-sum game concept. 2.3 Comparative Advantage (David Ricardo, 1817) Adam Smith’s absolute advantage theory, however, does not explain situations where countries which do not have absolute advantage in any of the product or have the absolute advantages in all of the products. Based on that argument, David Ricardo in 1817 develops a comparative advantage theory. According to Hill et al (2015), Ricardo suggests that countries should specialize in the production of those goods they produce most efficiently and buy good that they produce less efficiently from other countries, or, at the same time buying goods from other countries that they could produce more efficiently at home. This notion can be illustrated by an example where Ghana is more efficient in the production of both cocoa and rice. In Ghana, it takes 10 resources to produce one ton of cocoa and 131/3 resources to produce one ton of rice. Given its 200 units of resources, Ghana could produce 20 tons of cocoa and no rice. 15 tons of rice and no cocoa, or some combination of the two based on 200 units of resources. While in South Korea, it takes 40 resources to produce one ton of cocoa and 20 resources to produce one ton of rice. With the same units of resources, South Korea could produce 5 tons of cocoa and no rice, 10 tons of rice and no cocoa, or some combination of the two. Based on the above scenario, Ghana is more efficient in producing cocoa as compared to South Korea or comparatively more efficient at producing cocoa than it is at producing rice. If both countries engaging in trade, they can increase their combined production of rice and cocoa, thus benefiting consumers in both countries as they can consume more of both goods. 2.4 Heckscher-Ohlin Theory (Eli Heckscher (1919) and Beril Ohlin (1933)) Kowalski (2011) and Hill et al (2015), discuss the different explanation of comparative advantage developed by Swedish economists Eli Heckscher in 1919 and Bertil Ohlin in 1933. According to Heckscher and Ohlin, the comparative advantages arise from differences based on national factor endowments which are land, labor cost and capital. These differences in factor endowments
  7. 7. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 7 translate to differences in factor costs, it means more favorable a factor lead to a lower cost. As such, Heckscher-Ohlin predict that countries will export goods that make intensive use of locally abundant factors, and import goods that make intensive use of factors which are locally scarce. Hill et al (2015) highlight the notion of this theory that every nation have a varying factor of endowments which explains differences in factor costs, while Kowalski (2011) stresses the greater impact of this theory is the possibility of accommodating various combinations of factors of production such as land, capital, technology, skilled, and unskilled labor. The theory suggests that countries will export goods that intensive use of factors that are locally strong and importing goods that make intensive use of factors that are locally weak. The key point in this theory emphasizes the interaction between product and country characteristics that together form the basis of comparative advantage. 2.5 The Product Life Cycle Theory (Vernon, mid-1960s) The Produce Life Cycle theory is the first modern firm-based theories. This theory was developed by Raymond Vernon in the mid-1960s. According to Barot (2015), the theory emphasizes on creativity, markets extension, comparative advantages and strategic answer of the global rivals in decisions related to the production, trade and international investments. The Product Life Cycle theory consists of three phases, 1) a new product, 2) mature product, and 3) standardized product. Hill et al (2015) cited that Vernon argues in the early stage of a new product, the market is limited to the home country and the demand from other countries is limited to a certain group of people. The limited demand in those countries does not make it worthwhile for firm in those countries to start producing the new product, but it does encourage exports from the original producer of the product. Over time, as the demand starts to grow in other countries, it becomes mature and worthwhile for foreign producers to begin producing for their home markets. The firm starts globalizing by setting up production facilities abroad, thus limiting export from the country of origin. As the product becomes standardized, pricing (Hill et al, 2015) becomes the key marketing strategy. Cost considerations play an important role in firm to stay competitive in the market. The
  8. 8. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 8 firm is forced to reduce their cost (Barot, 2015) and the country of the original producer begin to import the goods which they initially export to other countries. In this case, from countries with having lower labor costs. The imports, eventually, replace the internal production of the home country. 2.6 New Trade Theory: Economies of Scale & First Mover Advantage (Paul Krugman) In the 1980s, economists such as Paul Krugman and Kevin Lancaster (Barot, 2015), develop a theory which is called the New Trade Theory – Economies of Scale and First Mover Advantage. The theory stresses out that any firm that able to achieve better economies of scale (unit cost reductions associated with a large scale of output) would give a positive impact to international trade (Hill et al, 2015) by increasing the variety of goods available to consumers and decrease the average cost of those goods (economies of scale). First mover advantages (the economic and strategic advantages that accrue to many entrants into an industry) will promote economies of scale and introduce barriers to entry for other firms (Hill, 2009). The key elements of being a first mover advantage is the ability for firms to achieve economies of scale (lower cost structure) before of later entrants. Hill (2009) argues that when products where economies of scale are significant and represent a substantial proportion of world demand, the first movers in an industry can gain a scale-based cost advantage which later entrants find it difficult to compete. In sum, countries may dominate in the export of certain goods when they are able to achieve economies of scale in their production, and at the same time located in countries which offer lower production cost that will give them the first mover advantage. 2.7 National Competitive Advantage In 1990, Michael Porter revealed the results of his research in his book The CompetitiveAdvantage of Nations, why some nations achieve international success and some failed to survive (Hill, 2009; Hill et al, 2015 and Barot 2015). He emphasizes on company strategy and competition. Competition differ significantly from country to country and from one industry to another. For example, the reason why Japan is doing so well in automobile industry, and Germany and the United States are best in the chemical industry. These questions can’t be answered by previous theories, but Porter’s theory tries to provide some explanations to these questions.
  9. 9. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 9 In this theory, Porter identified four attributes of which he calls the diamond that promote the creation of a competitive advantage. These attributes are 1) Factor endowments (factors of production), 2) Demand conditions, 3) Related and supporting industries, and 4) Firm strategy, structure, and rivalry. Porter (1990) suggests that the presence of all four components of the diamond will boost up competitive performance. At the same time, he suggested that government interventions such as policies, subsidies and regulations can influence each of the four components of the diamond. Figure 1.1 – Porter’s Diamond framework 2.7.1 Factor endowments (factors of production) These factors can be either basic natural resources, climate, location, or advanced factors such as skilled labor, communication infrastructure, research facilities and technological know-how. Factor endowments are based on Heckscher-Ohlin theory which Porter did not propose anything new. These factors can provide an initial advantage that is then reinforced and extended by investment in advanced factors. According to Porter, advanced factors are the most significant for competitive advantage (Hill et al, 2015).
  10. 10. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 10 2.7.2 Demand conditions It refers to the nature of home demand for an industry’s product or service. Demand conditions influence the development of capabilities. For example, sophisticated, knowledgeable and demanding customers pressure firm to be more competitive and to produce high quality and innovative products. 2.7.3 Relating and supporting industries This attribute refers to the presence supplier industries and related industries that are internationally competitive. According to Porter, investing in these industries can spill over and contribute to success in other industries. The most important findings are that successful industries within a country tend to be grouped into clusters of related industries which then prompt knowledge flow between firms. As a result, it benefits all firms within that cluster. 2.7.4 Firm strategy, structure, and rivalry The last attribute refers to the condition in the nation governing how companies are created, organized and managed, and the nature of rivalry within a nation. The two important points made by Porter highlight that different nations are characterized by different management ideologies which influence the ability of firms to build national competitive advantage. Porter’s second point is that there is a strong association between vigorous domestic rivalry and the creation and persistence of competitive advantage in an industry. Vigorous domestic rivalry induces firms to look for ways to improve efficiency, which makes them a better international competitor. They create pressures to innovate, to improve quality, to reduce costs and to invest in upgrading advanced factors. All these create intense competition in the market (Hill, 2009, Hill et al, 2015). 3. Critiques – Mercantilism vs National Competitiveness The world economy and economic policies of many nations today are the result of the international trade theories which have been developed and reviewed since mid-sixteenth century by many economists and researchers. Although these theories have not gone through detailed empirical
  11. 11. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 11 testing (Hill et al, 2015), the framework has been used as a guidance to shape the patterns of international trade. These theories continue to be debated and argued until today. 3.1 Mercantilism and Neo-Mercantilism Although Mercantilism theory existed since three hundred years ago, the doctrine is still being debated until today. Despite being argued and refined by many economists such as Adam Smith and Ricardo, the theory has several commonalities. According to Cwik (2011) and Hill et al, (2015), mercantilist believes that exports are beneficial to the nation while imports are detrimental. The trade surplus brings the nation's wealth and power. For example, Hill et al, (2015) highlight China’s outstanding economic performance has been led by this ideology. China has been using its cheap labor advantage to produce goods based on raw material imported from other countries and sell to developed nations such as the United States. Throughout 2005 to 2008, the exports have been growing faster than its import which economists have raised a concern over China pursuing a neo-mercantilist policy. The country has been deliberately discouraging imports and encouraging exports to grow its trade surplus and accumulate foreign exchange reserves which eventually develop its economic power. 3.1.1 Currency manipulation Hill et al (2015) highlight that the USA and the UK have been on trade deficit with China for over a decade. From a neo-mercantilist perspective, trade deficits are harmful. Cwik (2011) expresses the situation as “..if we import more than we export then ‘they’ are taking our ‘job’ and ‘our’ profits. Trade is reduced to a zero-sum game in which winning comes at the expense of the ‘losers’”. In relation to this strategy, the Chinese purposely keep its currency below the market rate to make their country’s exports cheaper on the foreign markets. Cwik (2011) in his journal highlights that this strategy led to another issue of protectionism through currency manipulation by the Chinese Central Bank. Technically, the Chinese government pegged the yuan to the dollar to keep the prices of China’s goods artificially low.
  12. 12. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 12 The immediate impact of China is they have a competitive advantage over other developed nations, especially the USA (Hill, 2009). This advantage is then translated into increased employment, development of new technologies and products, and positive cultural exchanges as the Chinese seek new markets and raw material sources (Cwik, 2011). 3.1.2 Increase conflict between nations Apart from currency manipulation as highlighted by Cwik (2011), neo-mercantilist policies have also increased conflict between nations. The earlier scenario between China and the USA on currency manipulation itself has created a conflict between these two nations. American economists have been accusing the Chinese for unfairly manipulating its currency against the dollar to promote its exports. The Americans put a pressure by imposing tariffs on Chinese imports into the US, but, China unlikely to back down (Will Hutton, 2010). The conflict has been going to the extent that the US will declare economic war against China. 3.1.3 Unemployment Neo-mercantilists policies increase employment opportunity in the local market, at the same time reduce employment opportunities in the other country. China in its efforts to increase production, it creates more domestic jobs to fulfill the export demands from the US. Conversely, an unemployment rate increase in the US, especially in the manufacturing sectors since the country is no longer producing its own textile products but import the products from China. The conflict creates domestic problems such as unemployment, social issues and poverty (Cwik, 2011). 3.2 National competitive advantage – Porter’s Diamond Model The most appealing theory centered on The National Competitive Advantage – Porter’s diamond model (1990). It represents a different paradigm to assess national sources of competitive advantages. In the early development of international trade theories, the focus for national competitiveness were on natural resources and factors of production – land, labor cost and capital (Porter, 1990). Over time, in the advent of technology and globalization, these theories are not able to justify country’s success primarily based on factors of production, and countries with or lack of
  13. 13. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 13 natural resources. Based on these elements, Porter developed The Diamond Model that consists of four attributes to the national competition. Porter (1990) suggests that all four components of the diamond will determine the competitiveness of a nation and this notion has been supported by many economists and researchers, including Grant, (1991) and Hill et al, (2015). Grant (1991) highlights that Porter has built “a bridge between strategic management and international economics” as economists usually study a country as whole based on factors such as GDP, interest rate, inflation rate, while strategists or academia study firms, managers and national cultures. Porter’s diamond model has influenced the international trade in many ways, such as government interventions, policy recommendation as well as a competitive strategy. 3.2.1 Government interventions and Policies According to Porter (1990), influences and support from the government is necessary for the diamond model to be effective. For example, government regulations, laws, subsidies, policies and educations (Hill et al, 2015), has greater effect on the factor endowments. Through Porter’s analysis in his theory has convinced the governments to provide support and develop a plan to for firms to be competitive in the marketplace. In a different perspective, Grant, (1991) and Hill et al, (2015) highlight that through demand conditions, the government can shape domestic demand through local product standards or with regulations that mandate or influence buyer needs. Through governance and policies such as tax policy and antitrust law can influence related and supporting industries. In relation to this, Porter’s notable findings is the “clusters” that has spillover benefits to all firms in the related and supporting industries. Firms and industries are being internalized within the industry cluster (Grant, 1991). 3.2.2 Competitive strategy In relation to the fourth attributes of the diamond – firm strategy, structure and rivalry, Porter (1991) argues the different management ideologies from different nations which affect the national competitive advantage. He compares top management team of Germans and Japanese firms with
  14. 14. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 14 the top management team of many US firms. The Germans and Japanese firms are occupied by experienced engineers whereby the top management of US firms is occupied by leaders with finance backgrounds. The findings indicate that the Germans and Japanese companies continue improving their manufacturing and product design, but the US firms are too focused on short-term financial returns. The consequence of the different management ideologies has shown why the US firms is not competitive in those engineering-based industries as compared to its rivals in Germany and Japan. As such, Porter’s findings on firm strategy and organization structure play an important role to ensure firms are relevant in the marketplace. At the same time, Porter (1990) emphasizes on innovation, creativeness as well as efficiency as sources of competitive advantages to compete in the market. The notion educates firms to be innovative, creative and efficient in its internal processes in order to be at a competitive advantage. In sum, The National Competitive Advantage theory has led to the development of the world economy. At the corporate level, it has transformed many firm’s processes, and educate firms to operate, manage and utilize all resources and sources of competitive advantage to compete with other competitors. At the industry level, the theory has accelerated technical change, compressed product life cycles and increased the geographical concentration of industries. Lastly, at the national level, the theory has reduced the gaps between nations in terms of their economic development (Grant, 1991). 4. Global Strategy - Manufacturing industry Based on the presented theories especially from modern firm-based theories, some key takeaways can be concluded into a few main areas such as; 1) product quality, 2) economies of scale, and 3) FDI, 4) government policies and regulations, and 5) sources of competitive advantages. In this section, a large Japanese based automobile manufacturer, Toyota Motor Corporation will be used to illustrate how a firm develops a global strategy using its resource-based capabilities to enter international market. Toyota Motor Corporation or “TMC” is one of the largest automobile manufacturers in the world. The firm was established back in 1937 and headquartered in Toyota City, Japan. The firm
  15. 15. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 15 has operations in Japan, North America, Europe and Asia and it has approximately 345, 000 employees around the globe. The firm is engaged in the design, manufacture and sales of many variants of cars. The company and its affiliates produce automobiles and related parts and components through more than 50 overseas manufacturing companies in 28 countries and regions besides its home country, Japan. The firm sells its products through approximately 170 distributors in more than 190 countries and regions. During the 2015’s financial year, the firm recorded revenues of JPY27, 234,521 million or USD248, 923.5 million and the net profit is JPY2, 173,338 million or USD19, 864.3 million (Toyota “Company Profile”, 2016). Based on the background of TMC, it shows how successful the firm in the global market. From an international trade perspective, there are a number of factors and strategies that contribute to the success of the firm in entering and competing in the international market. The following pages will analyze strategies adopted by TMC. 4.1 Product quality and innovation “Kaizen” One of the key success factors for TMC in both Japanese market and international market is primarily due to its capabilities in producing a high quality and reliable products. Additionally, the firm’s culture towards “continuous improvement” or known as “Kaizen” in Japanese has won the trust of consumers and named as the top brand name under the car industry category by BrandZ, the world’s largest brand equity database (BrandZ, 2016). These attributes have led to a strong market position specifically in domestic market, North America and Asia. This product development strategy has attracted many existing and new customers to experience its new innovations. The greatest product innovation of TMC is through Toyota Prius, the first full hybrid electric car (Toyota, 2016). The car has been the top-choice car for eco-friendly consumers around the world. As discussed by many economists and researchers such as Vernon and Porter, this strategy has significant impact on international trade, and at the same time considered as one of the resource-based capabilities that build firm’s competitive advantages. These capabilities and competitive advantages possessed by TMC have been the core elements that positioned the company in the global market today.
  16. 16. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 16 4.2 Mode of Entering Foreign Markets and Government Policies Today, TMC has local presence in 190 countries globally. The driver for this success is TMC’s vision to become the leading global player. Traditionally, there are three modes of entering foreign markets by 1) export, 2) joint venture, and 3) direct investments (FDI). In the 1950s, TMC began its foreign market penetration by exporting its products. 4.2.1 Penetrating the US Market through JV According to Toyota (2016), TMC entered the American market in 1957 under the name of Toyota Motor Sales, USA Inc. It began sales with Toyopet Crown Sedans and Land Cruiser. Although consumers agree on the quality of the car, it was not a good start as consumer complaint about the car being underpowered. In 1961, the sales stalled and the model was discontinued. Instead, the Land Cruiser began to gain a reputation as a durable vehicle. It was the flagship model until 1965 when then Toyota Corona arrived. The sales continued to soar as more Americans discovered the quality and reliability of the TMC’s vehicles. In 1975, TMC surpassed Volkswagen to become the No. 1 import brand in the United States. Meanwhile, domestic competition between TMC and local carmakers such as Nissan is getting more intense which leading to a great cost advantage (Das & Das, 2012) for TMC to pursue joint venture or “JV” strategy. In 1984, the US Federal Trade Commission approved a “JV” proposal between Generals Motors and Toyota Motor Corporation. The two automotive giants jointly manufacture compact cars in the US (Henne et al, 1985). According to Henne et al, (1985), the Japanese view “JV” as a less costly to enter the American market, while the American often view “JV” as an inexpensive way to enter a potentially lucrative market, (Robert and Eric, 1986). Additionally, “JV” allows US companies and consumers buy Japanese products at a lower price when producing it locally, at the same time it allows knowledge transfer and increase market reputation (Das & Das, 2012). 4.2.1.1 Roles of Government – Policy, Human and Infrastructure Investment On a relevant subject, part of a mitigation plan against government policies in protecting the local market is to pursue “JV”. Economists and researcher include Das & Das (2012) suggest that it is
  17. 17. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 17 a feasible strategy to reduce or even removing the trade barriers such as import tariffs, tax structure, quota restrictions, and other various laws and regulations. By removing the barriers, it will promote better free trade across the nations. In Asia, for example, the introduction of ASEAN Free Trade Area (AFTA) is to promote goods to flow freely among ASEAN countries without incurring taxes. The apparent result of this initiative is a significant reduction in car prices to the consumers. Apart from policies, Robert and Eric (1986), highlight the roles of government in terms of providing support of human resource development (technical training) as well as investing in technology infrastructure that will enhance factor endowments in line with Porter’s diamond model. In relation to TMC’s success in America, during the initial phase of “JV” with General Motors, it was opposed and heavily criticized by other local carmakers such as Chrysler and Ford. It was the US government roles and responsibilities via Federal Trade Commission that explains the objectives and the benefits of “JV” to US auto industry (Henne et al, 1985). 4.2.2 Penetrating the Asian Market through FDI – Economies of Scale and “TPS” Apart from North America, TMC has a large market share in Asia. The primary driver for the invasion to the Asian market is due to high demand of pickup trucks and Multipurpose Vehicle “MPV” especially in Thailand, Indonesia and Malaysia. In this space, TMC directly invests by forming a subsidiary of TMC and setting up major manufacturing facilities in these two countries including Malaysia. According to Porter (1990), there are three kinds of FDI motivations to enter foreign markets, resource-based sourcing, market access, and shifting the core decisions to the host country. In the case of Asia’s countries, resource-based is the main motivation factor and followed by market demand and support from the local government in promoting international trade and free trade. TMC is this situation, indulge in FDI as they can operate with much lower cost, which in a long-term will increase its overall bottom line. On the other hand, FDI improves economies of scale. In 2015, TMC globally produced 10.08 million units of cars around the world beating all other car manufacturers. Practically, Indonesia, Thailand and Malaysia provide a large pool of low-cost labor to support the production factories of TMC. TMC, in this case has been utilizing the factor endowments of low-cost labor in those countries (Toyota, 2016) to support the operation of its factories and to achieve economies
  18. 18. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 18 of scale.Additionally, by engaging FDI, technology transfer occurs from home country to the pool of resource in the host country (Das & Das, 2012). It’s strengthen the factor endowments in terms of skilled-labor, which eventually improve efficiency and productivity. As a result, it enables TMC to achieve bigger economies of scale, and deploy competitive pricing strategy in the marketplace. 4.2.2.1 Toyota Production System – “TPS” The success of the FDI strategy to global markets by TMC is also supported by their strong internal process known as Toyota Production System or “TPS” (Toyota, 2016). The system was established since 1970 covering about continuous improvement and lean manufacturing concept. The system acts as an integrator with all TMC business strategies and its business practices. The “Kaizen” culture which was discussed earlier is part of this process. According to Toyota (2016), this system has become one of its firm-based capabilities which has led to the success of the company and has given TMC a sustainable brand name and market leader position. In summary, TMC emphasis is on its product quality and reliability as their main source of competitiveness before confidently invading the global markets. With their strong capital and technologically advanced, together with strong organizational culture especially the “Kaizen” and “TPS”, TMC embraces foreign direct investment by forming affiliates, joint ventures and subsidiaries to strengthen their global market presence. 5. Conclusion In general, the international trade theories have developed different views between economists. In the early days, mercantilists argue the advantages of exports rather than import from other countries, while other economists argue that all forms of trade as equally advantageous. Over time, the modern firm-based theories advocate the notions of various factors that affect the performance of a country and firm competing with each other in the marketplace. The international trade theories also have some implications such as location implications, first-mover implications and policy implications. Location implications are quite obvious referring to the notion of many theories about different countries or locations have different advantages such as capabilities,
  19. 19. BMIB5103 - Assignment Nor Helmee Bin Abd Halim 19 human resource, natural resource and culture. While the notion of being the first-mover in the any particular industry will subsequently lead to dominating global trade in that particular product. Lastly, government intervention and policies have a paramount impact on the international trade as a policy maker to promote or become a barrier for businesses. [Word counter - 6215]
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