Vernon (1979)

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Vernon (1979) - The Product Cycle Hypothesis in a new international environment

According to product cycle hypothesis, firms set us plants in foreign countries in order to gain a monopolistic advantage. Pg255
If this benefit is not perceived, firms will not take the risks and absorb the costs of moving abroad.
“One such special strength is an innovational lead” Pg256

The first stages of the PCM begin in the industrialised countries.
The first stage begins at home, where scientists can interact with customers and speedy innovation can occur.
The innovation team needs to be in a centralised location.
A firm strategy can gain direction at home, as HQ is more in touch with its customers.

Firms in the US reflect the needs of its customers, resulting in labour-saving, capital-intensive goods. (This is a reflection of a strong capitalist economy and other countries were not at this stage just after the war, being that most of their resources were drained between 1939-45)

PCM is all about reducing uncertainty. The first stage is to keep at home, even though there may be low-cost production places abroad. Pg258

Firms which specialise in innovation move abroad sooner than other industries. These include pharmaceuticals, electronics, machinery.

Firms begin spreading to countries to which they feel most similar. For example, the US firms spread to Canada and the UK. Pg258

The number of foreign subsidiaries went from 138 in “fewer than 6 countries” to 9 in fewer than 6 countries in 1975, and from 0 to 44 in “more than 20 countries” and from 43 to 128 in 6-20 countries.

Vernon notices that moves to “traditional areas” has declined from 1946 to 1975, perhaps due to increased knowledge of foreign markets and technologies such as telephone and commercial air travel. For example, before 1946 23% subsidiaries were located in Canada, and by 1975, that proportion had dropped to 13%, with “the offsetting gains being recorded principally in Asia, Africa and the Middle East” Pg259

Environmental changes
Vernon noticed that the other countries were catching up, economically, meaning that firms could sell their products at an earlier stage.

He observes that the economic post-war gap was large (less than one third), but by the latter 1970s, the economies of the US, Germany and France was about equal. Pg260

This “weakened a critical assumption of the product cycle hypothesis”, as entrepreneurs in the US faced very different markets.
In addition, the US was relying more and more on imported raw materials, the factor costs of the various markets declined further still.

Europe has caught up partly because of the EEC (EU today).

Now US firms cannot claim that they do not know other markets and cannot claim that they are very different to them. Pg261

Global network in operation
3 types of firms to assess innovation in operations of MNEs in different industrialised countries.
1. Purely hypothetical firm, which has perfect, now costless, global scanning capabilities. It develops innovation in response to opportunity or threat from markets in which it is operating. It would be in an advantageous position to those firms without scanning capability, as it would be able to spot trends first.

PCM here would only play a small role. The strength of location of production would be tenuous, as the nature of the global scanner would be to continuously look for better places.

This firm can only be hypothetical, as such information is not costless and digestion of such information is not costless (in terms of time or money)

2. A firm which makes standardised products for what it sees as a homogenous world market, and is unwilling to respond to distinctive local needs. Pg262
Many industries do this, such as oil and petrochemicals, metals and even automobiles. The advantages of this approach are that a firm can benefit from economies of scale and reduces costs (time and money) of searching for and digesting local information. The hope is that the advantages of standardisation outweigh the disadvantages of not responding to local tastes.

These firms work well with the PCM, but they face heavy risks with their innovations.
Processes of the standardised product can be outsourced to low-wage countries, but integration at a centralised point is still needed. Pg263

Some firms apparently have plants in both distant and local countries in order to maintain a global strategy and adapt to local requirements.

3. A firm which has a multi-domestic, or poly-centric strategy (from EPRG), in which it makes all its innovations at home and leaves analysis of foreign markets to its subsidiaries (no real co-ordination and lots of autonomy for subsidiaries). The home firm creates a range of products and the subsidiaries pick and choose which ones they think are best. They have no say on what HQ should make.
The view is that interpreting all that foreign information centrally outweighs any benefits, or does not know how to absorb the information. Pg264

The PCM exists here, but only for a bit, as the period in which “the parent is responsible for serving foreign markets is foreshortened and the oligopolistic strength of the innovating firm will be relatively weak”, as other firms in other countries will compete.

Due to the lack of co-ordination and control over subsidiaries, the firm will find it difficult to expand, as they will not know where to, having little or no knowledge of unknown markets.

PCM is based on assumptions of costly knowledge, meaning that firm 1 does not fit.

The PCM was useful for the first two or three decades after the war. Things are different now, as MNEs have developed global networks of subsidiaries and the US is not unique “among national markets in either size or factor cost configuration”. Pg265
Thus the PCM is less useful in comparing US firms with firms from other industrialised countries and explaining the relationship between developed and underdeveloped countries. “But strong traces of the sequence are likely to remain” (See psychic distance - Uppsala model, GSM lecture 2).

The sequence will continue in SMEs, which do not have the global scanning capabilities of the larger firms.
Vernon also argues that even large firms will stick to the sequence at least at the early stages. When developing a product, the production processes will be less stable and so they are more likely to want to keep facilities at home until the final product and production processes are stable and easily imitable. Pg265

The cycle can also be used to predict the subsidiaries in less developed economies, as their economic status often prevents them from having all the attributes of the parent firm. Pg266
Thus many developing countries are still absorbing innovations already established on the markets of industrialised countries (Flying Geese model, for example)

Those emerging economies are following the product cycle by building up firms which respond to their unique conditions and then begin exporting their products and following the PCM as once followed by the industrialised countries.

In the 1970s, there were reports of firms HQd in developing countries and creating products designed for those markets, which was leading to the establishment of subsidiaries on those countries. Pg267

“The product cycle continues to explain and predict a certain category of foreign direct investments”. It is no longer useful for US firms, but can be applied elsewhere in the world.