Sunday, 24 April 2011

In-house or market transaction?

For a multinational corporation one question relevant to the decision as to how to carry out production in a non-home market is whether to keep production inside the firm, by operating a wholly owned foreign subsidiary, or to outsource in some way, e.g. replying on a foreign supplier for components or to licence their know-how or brand image to a foreign party. Obviously there are advantages and disadvantages to both methods of production which in any given case have to be traded off. But will a company ever do both? Will it ever use both in-house production and at the same time use independent firms?

The answer is yes. An example is the Italian multinational Pirelli who manufactures both tyres and cables but its tyres are produced in wholly owned foreign plants and its cables are made by a foreign licensee. Why does one company use two different methods of production? After all if in-house (independent firms) is good for cables, why not tyres?

The answer seems to be to do with the dissipation of firm-specific assets, knowledge in this case. Pirelli developed a new method of manufacturing tyres, the Modular Integrated Robotised System (MIRS), which is a completely computer managed production process which requires no labour input. Foreign factories utilising this technology - in the UK, Germany and the US – are wholly owned subsidiaries. The reason for this is to protect proprietary knowledge in the MIRS technology. That is, Pirelli want to make it as difficult as possible for other firms to learn about their technology. In contrast when it comes to the production of their Afumex cables, which guarantee higher safety standard in case of fire than traditional cables, the technology is licensed to independent firms. In this case the basic technology is widely known and the innovative components of Afumex are protected by patents.

So when you have knowledge that you don't want other people to know you keep production in-house but where knowledge is already well known or can be protected in other ways, e.g. patent or copyright, then independent firms can be used.

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