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Updated: January 5, 2010 13:37 IST

Handbook on maximising profits

K. SUBRAMANIAN
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Classical economics of the Adam Smith variety and its latter day variants had no theory of foreign direct investment (FDI) or the growth of multi-national corporations (MNCs).

In the post-Second World War years, economists like Raymond Vernon posited “product cycle” theories which were U.S.-centric.

A radical breakthrough was made in the 1960s when Stephen Hymer explained FDI as the defining feature of the MNC and related its advantages vis-À-vis the other forms of foreign operations such as licensing.

Coasian concept

While Hymer hinted at the idea of ‘internalisation’ of knowledge as the driver of MNC growth, it was Ronald Coase who provided a theoretical framework known as “internalisation.” Since then, a rich body of theoretical literature has been built around the Coasian concept of “transaction cost.” No wonder, he received the Nobel Prize for his unique contribution.

Transaction cost is not the cost of a transaction but the cost inherent in the transaction itself. Contracts fail and cannot be enforced with all available legal resources. The issue turns critical when a corporation has to trade in assets that are proprietary — brand names, secrecy of process and products, managerial skills, and so on. To avoid costs such as misappropriation and to maximise gains, the MNCs internalise the assets within their structure.

The field was taken over by Dunning and a number of economists in the Manchester School. They developed what is called the ‘OLI Paradigm’ (also known as eclectic) which combines the advantages of Ownership, Location, and Internationalisation.

Oliver Williamson who received the Nobel Prize this year advanced our understanding richly. He applies “transaction cost” ideas in different settings to figure out governance structures in different circumstances.

MNC theories

The endeavour in current work is to establish that the MNCs create internal markets and take steps to handle situations where the external market does not exist or fails. There is no longer reliance on vertically integrated formations. It takes an array of alliances or networks as long as there is broader control over the formation as a whole. They provide for cultural variety across the borders and for the problems inherent in control from long distances.

The ideas of Mia de Kuijper, author of this book, have to be tested against these trends in MNC theories. de Kuijper has her feet firmly in both academia and giant corporations; she was associated with companies such as Royal Dutch Shell and PepsiCo.

Critical to her exposition is the notion of “profit power,” which is derived from “power nodes.” She has identified 12 such nodes. In defining them, there is confusion or mix-up between assets and strategies. For instance, nodes like brand, secret ingredients, and focussed and proprietary processes are assets. The others such as “regulatory protection”, “financial resources”, and “customer base”, are strategies.

By describing ‘profit power’ as “economic clout — the ability of a company to hold on to the value it itself has created, as well as to extract a share of profits from competitors, to create incremental value for itself and its partners in business relationships, and to shape the risks it and others will take on” — she engages in tautology. Profit power flows from holding on to proprietary assets and internalising them. Indeed, strategies may, and will, change from time to time.

Transparency

There is vagueness or a mystique attached to her idea of “value addition” along the chain. It is difficult to envision how, without the controlling influence or the “invisible hand” from headquarters, it can be added or sustained.

Another key theme running across the book is the role of “transparency” and the impact of information technology. There can be no disagreement that access to information has increased exponentially and the cost of collection has come down precipitously. Informatics and outsourcing are indeed integral parts of current corporate management and strategies. However, it will be naïve to conclude, as de Kuijper does, that all information is in the public domain and accessible. Supply of information will continue to be limited and guarded and those vital for corporate growth will be held back.

Mia de Kuijper says “the contribution of this book to economic theory is to demonstrate why markets do not work perfectly even when, or rather especially when, information becomes perfect, and to show how we can make practical use of this insight.” At another place, she says how it can be a source of “extraordinary profitability.”

From a theoretical level, the book lowers its bars and turns into a guide for corporate executives on developing ‘nodes”, adopting rules to maximise profits, and drawing up action plans to achieve that goal. The book attempts to ride two horses — economic theory and management guide. While it fails in the former, it is more successful as a practitioner’s handbook.

PROFIT POWER ECONOMICS — A New Competitive Strategy for Creating Sustainable Wealth: Mia de Kuijper, Oxford University Press, 198 Madison Avenue, New York. $ 34.95.

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