Learning value:
On going through the chapter, reader will
THE CONCEPT
If we ask any employee of a multinational company in a developing country,
he is proud of his status, sense of achievement and affluence as compared to
his peers. The system, style, technology and working style elevate his
position little higher than others.
There are multinationals that have a total turnover exceeding the GDP
of many small or less developed nations. The Minnesota Mining and
Manufacturing Company, called for short, 3M, have more than a thousand
product lines. The top three multinationals in the world today could combine
to purchase a small nation. Few multinationals in the total employee force
that is larger than the population of a country and my even have the power to
bring down governments. Therefore, multinationals have money power,
muscle power, managerial power, technology power and political power
through which they influence many economies in the world.
All the three roles are played by the head quarters after completing major
five pre-requisites:
S1 S2 S3 S4
In most cases the power rests with the main company at its head
quarters. However, a few multinationals do give considerable powers to their
subsidiaries. Currently, multinationals are motivated solely by revenue
wherein profits are the main criteria.
CLASSIFICATION OF MULTINATIONALS
Depending upon the relationship between the headquarters and
subsidiaries, multinationals can be classified into three broad categories:
1. Pyramidal Model Multinationals
HQ
(STRONG)
S1 S2 S3 S4 S5
e) They do not bring sentiments and emotions for the local population
into their dealings.
Sympathy, compassion and human approach are generally far off in their
approach. Lower is the prime motive in their style. Age old colonialism and
imperialism got percolated to follow such style.
HQ
S1 S2 S3 S4
e) High respect for the sovereignty of the county where they operate.
3. Inter-conglomerate Multinationals
Conglomerate indicates grouping of business activities aiming at high profits
and revenue generations, whether it is related to existing core business or
not. Inter –conglomerate multinationals are aggressive in expansion and
achieving a high turnover. Such multinationals enter into any business where
the profits are exponentially high. They generally do not consider any other
aspect, except high profits, as a performance indicator.
INV ESTM ENT
PRO FITS
HUG E
REV ENUE
EXP ANS IO N
HIGH R AT E
AN D
O F R ET UR N
A GGR ESSION
The investments are high and are made with expectations of high returns,
which will be used for aggressive expansion, diversification and takeovers?
STRUCTURE OF MULTI-NATIONAL
CORPORATIONS
Top
Top
Management
Management
Financial
Financial Asian
Asian American
American
Division/
Division/ Subsidiary
Subsidiary Subsidiary
Subsidiary
Planning
Planning Division
Division Division
Division
Division
Division
International
FINANCE MARKETING HR
Division
FINANCE MARKETING HR
Top
Management
Marketing Finance HR
CMD
CMD
PRODUCTION MARKETING
CMD
Timing Flexibility
By shifting profits from high-tax to low-tax nations, MNCs can reduce their
global tax payments. In additions, they can transfer funds among their
various units, which allow them to circumvent currency control and other
regulations. Cyprus, Panama and Malta are safe destinations for such
operations.
Some companies such as Coca Cola and Proctor & Gamble take
advantage of the fact that potential entrants are wary of the high costs
involved in advertising and marketing a new product. Such firms are able
to exploit the premium associated with their strong brand names. MNCs
can use single campaign and visual aspects in all the countries
simultaneously with different languages like Nestlé’s Nescafe.
It is often possible for an MNC to sell its knowledge in the form of patent
rights and to license a foreign producer. This relieves the MNC the need to
make foreign direct investment. However, sometimes an MNC that has a
production process or product patent can make a larger profit by carrying out
the production in a foreign country itself. The reason for this is that some
kinds of knowledge cannot be sold and which are the result of years of
experience.
2. Protecting Reputations
3. Building Reputations
Sometimes, MNCs invest to build their image and reputation rather than
protect their reputation. This motive is of particular importance in the case of
foreign direct investment by banks, because in the banking business an
international reputation can attract deposits. If the goodwill is established the
bank can expand and build a strong customer base. Quality service to a large
number of customers is bound to ensure success. This probably explains the
tremendous growth of foreign banks such as Citibank, Grind lays and
Standard Chartered in India and other developing countries.
4. Protecting Secrecy
It has been argued that opportunities for further gains at home eventually dry
up. To maintain the growth of profits, a corporation must venture abroad
where markets are not so well penetrated and where there is perhaps less
competition. This hypothesis perfectly explains the growth of American
MNCs in other countries where they can fully exploit all the stages of the
life cycle of a product. A prime example would be Gillette, which has
revolutionized the shaving systems industry. HP laptop, Sony Walkman and
Xerox face various stages of their life-cycle in their home country.
6. Availability of Capital
The fact that MNCs have access to capital markets has been advocated as
another reason why firms themselves move abroad. A firm operating in only
one country does not have the same access to cheaper funds as a larger firm.
However, this argument, which has been put forward for the growth of
MNCs, has been rejected by many critics.
The strategic motive for making investments has been advocated as another
reason for the growth of MNCs. MNCs enter foreign markets to protect their
market share when this is being threatened by the potential entry of
indigenous firms or multinationals from other countries. Fast growing
countries like India and China give a great boost to MNCs originated in U.S,
Japan and Europe.
9. Symbiotic Relationships
Some firms have followed clients who have made foreign direct investment.
This is especially true in the case of accountancy and consulting firms. Large
US accounting firms, which know the parent companies’ special needs and
practices, have opened offices in countries where their clients have opened
subsidiaries. These US accounting firms have an advantage over local firms
because of their knowledge of the company and because the client may
prefer to engage only one firm in order to reduce the number of people with
access to sensitive information. Templeton, Goldman Sachs and Ernst and
Young are moving with their clients even to small countries like Panama,
Mauritius, Malta and Sri Lanka.
Due to these and other imperfections, firms locate their production and
other operations internally. As these market imperfections disappear, the
importance of MNCs may diminish. The days for this may not be far off due
to the international apex body, WTO and its regulatory norms are strictly
implemented in near future.
TRANSFER PRICING
Transfer prices are the charges made when a company supplies goods,
services or finance to another company to which it is related. It is an
internationally accepted principle that transactions between related parties
should be based upon the same terms as those between unrelated parties.
Thus both tax treaties entered into between countries and domestic tax
legislation of various countries have adopted the arm’s length principle.
The important sections relating to transfer pricing in the Income Tax Act
1961 are Section 40A (2), Section 80 1A (9) and Section 1A (10). The first
enables tax authorities to disallow any expenditure made to a related party,
which they feel is excessive. Certain tax benefits are available under Section
80 1A such as a tax holiday for a certain number of years. If transfer pricing
is suspected then the tax authorities can deny such tax holidays.
The most important provision in the tax laws is in Section 92. This
allows the Indian tax authorities to adjust the taxable income of the Indian
party, if they feel that the prices charged in a transaction are not at an arm’s
length due to close connection between the Indian entity and a foreign party.
COUNTRY RISK
When making overseas direct investments it is necessary to allow for risk
due to the investment being in a foreign country. Country risk is one of the
special issues faced by MNCs when investing abroad. It involves the
possibility of losses due to country-specific economic, political and social
events.
Among the country risks that are faced by MNCs are those related to
the local economy, those due to the possibility of confiscation i.e.
government takeover without any compensation, and those due to
expropriation i.e. government takeover without any compensation, and those
due to expropriation i.e government takeover with compensation which at
times can be generous. In addition there are the political/social risks of wars,
revolutions and insurrections. Even though none of these latter events are
specifically directed towards an MNC by the foreign government, they can
damage or destroy an investment. There are also risks of currency non-
convertibility and restrictions on the repatriation of income. International
magazines like Euro Money and The Economist regularly conduct country
risk evaluations in order to facilitate MNCs.
3. Joint ventures
Concern has been expressed, especially within the US, that their
MNCs can defy the foreign policy objectives of the government through
their foreign branches and subsidiaries. MNCs might break a blockade and
avoid sanctions by operating through overseas subsidiaries. This has led to
greater concern in some host countries, as they feel that companies operating
within their boundaries may follow orders of the US or any other foreign
government, and even within international trade unions. For example, in
1981 Chrysler Corporation was given loan guarantee to continue its
operation. The US government insisted on wage and salary roll backs as a
condition. Chrysler workers in Canada did not appreciate the instructions
from the US Congress to accept a reduced wage.
The examples below illustrate some of the controversies faced by
MNCs.
Parke-Davis
Pfizer
SmithKline Beecham
This case gives us an insight into the royalty issues. In 1997, SmithKline
Beecham India announced its plan to pay 5% of net revenues earned from
the sale of Horlicks to its parent company for using the brand name. At that
point Horlicks accounted for 80% of the company’s Rs. 430 crore net sales.
Although it paid about Rs.5 crore in 1996, the estimated annual outgoings
worked out to about Rs.20 crore, against a net profit of Rs.45.6 crore in the
same year.
Here, the main issue for investors was whether royalty payment
needed to be paid to the parent company at all. Although the Indian
company does not own the brand and is only its licensed user, it has
nevertheless spent a huge amount on brand promotion and advertisement
expenses for Horlicks, over the last four decades, and approximately Rs, 175
crores over the past 10 years. Critics feel that the company could have used
this money to promote a brand of its own, with considerable success.
Philips
When the offer opened, three financial institutional – GIC, LIC and
UTI – together held 22% of the shares, while another 27% were held by the
minority shareholders. Within days of the announcement, most minority
shareholders started worrying about what would happen to anyone who did
not sell their entire stake, Philips would need to pick up only another 17% of
the shares to reach a level of 90%. So, if Philips managed to pick up only
90% of the shares, all those who held out would be trapped. They would
agree to buy them after the deadline was over, provided it already had the
90% it needed.
For a majority of the shareholders, the offer price was not the critical
factor in their decision to sell. In fact, many of them thought the price was
too low and that Philips had timed its offer cleverly. Royal Philips had
strictly followed SEBI guidelines which state that the offer price should not
be less than the average price of the past six months, Philips made sure that
most shareholders would sell out even if it was not the most attractive
option.
2. While many Indian companies, such as the Tatas and Birlas allocate
funds for charitable works like hospitals, temples and scholarships for
higher studies, not many MNCs do so, though they generate huge
revenue.
3. They generate profits when the situation is favourable, but will close
their business if any risk is anticipated. E.g., many multinationals pulled
out of South East Asia during the currency crisis, especially in Thailand
and Indonesia.
7. One Union Carbide could cost the life of thousand of living beings in
Bhopal due to sheer negligence and disrespect for the pollution control
norms. It shows that just for earning money such a multinational never
had a concern for valuable human lives.
FOREIGN COMPANIES
A foreign company is one that has been incorporated outside India
and conducts business in India. These companies are required to comply
with the provisions of the Indian Companies Act, 1956 as far as the Indian
operations are concerned. Foreign companies can set up their operations in
India by opening liaison offices, project offices and branch offices. Such
companies have to register themselves with the Registrar of Companies
(ROC), New Delhi within 30 days of setting up a place of business in India.
As an Indian Company