Why do multinationals divest overseas operations?

Introduction

Multinational corporations divest overseas operations for a number of reasons. For example, over the years, a number of multinational corporations from the UK have divested their operations in the US. These have included Tesco and Sainsbury’s in food retailing. Other industries such as fashion retailing have also seen companies make a hasty and dramatic retreat from overseas markets they had previously expanded into, such as Marks and Spencer also in the USA. The reasons for divestment are many and variable. They include lower cost production and new market opportunities elsewhere (Berry 2009), poor performance (Hoskisson et al 1994), exchange rate volatility and geographic market growth differentials (Berry 2013; Shaver et al 1997) as well as a refocus on a multinational’s core activities (Chang and Singh 1999). Often, a divestment decision can come to a trade-off between markets. Some of these reasons are examined in more detail in the next section.

Why multinational firms divest overseas operations?

Divestment and the reasons why firms do it have been studied by a number of scholars. In their study of 59 divestments carried out by US MNCs between 1975 and 1980, Duhaime and Grant (1984) found that three factors seemed to play a major role in the decision to divest. These were; low return on equity, poor performance and detraction away from the parent’s core strength and competency. Poor performance has also been supported by other scholars (Hoskisson et al 1994; Berry 2009; Hitt and Ireland 1986).

According to Berry (2009), many firms still have to make trade-offs regarding which markets represent the best use of their resources and capabilities. This can simply be a question of divesting in poorly performing markets or poorly performing operations (Hoskisson et al 1994) and investing in other products or geographic markets. So a multinational firm can decide to divest an existing and inefficient operation so that it can invest in cheaper production that will enable it make the best use of existing resources. Foreign investment often necessitates MNC’s to reconfigure their home operations as they seek lower cost production in such places. This can be as simple as offshoring the entire production to a foreign subsidiary. The end result may be a need to divest current home country operations in pursuit of lower cost production overseas (Berry 2009).

Other than lower cost production, a second reason why MNC’s may divest their operations in one (market home market for example) is because of new market opportunities elsewhere. According to Berry (2009), MNCs especially those that are diversified across different product categories and geographic markets, find the need to divest some operations, critical in order to avoid resource cannibalisation as well as optimise performance across the different markets competed in. This also entails choosing what markets to participate in depending on a number of factors such as market growth, or the state of regulatory stability (Belderbos and Zou 2009).

As Belderbos and Zou (2009) and Berry (2013) noted, markets that experience low market growth or where regulatory stability is not certain have been known to influence divestment decisions, thus demonstrating the importance of market factors in the divestment decisions of firms. Berry (2013) for example noted that poor firm performance can also lead to divesture. As Hoskisson et al (1994) argue, MNCs are likely to divest poor performing or struggling operations especially if such divestments are likely to provide an opportunity for the divesting multinational to convert what it deems an unattractive asset into a liquid resource. In their study of divestments in New Zealand, Hamilton and Chow (1993) noted that most of the large firms in the country divested in order to concert unattractive assets into more a more liquid that is then used to either reinforce the core strength of the divesting firm, satisfy liquidity needs or move into new lucrative areas.

Nevertheless, Berry (2013) argues that market growth is often the mediating factor between poor subsidiary performance and divestment. Hoskisson et al (1994) for example noted that poor performance leads to divesture because it signals to the parent firm that the current approach is not working. But this is decision is influenced by market factors especially country market growth. Berry (2013) for example argues that MNC’s are unlikely to divest a poorly performing subsidiary in a high growth market because of the greater potential to improve performance benefit from the new demand in the high growth market.

Chang and Singh (1999) also argue that some firms can divest a business unit from their portfolio if it detracts away from the parent’s core strength and competency or even a lack of experience in that market. This is more so when that particular business unit requires particular technologies or operating resources that are not a core strength or competency of the parent firm. Research by Hoskisson and Hitt (1990) for example found that business units of a parent firm whose product lines were directly related to the parent’s core product lines benefited from the knowledge, resources and synergy derived from sharing resources as well as cooperating with other sub units. They found that parent firms were more willing to divest a business unit in which they were less familiar with either the product lines, or the host country environment. Under such circumstances, even a high growth context may not be enough to stop a parent firm from divesting a business unit especially if it is performing poorly.

Conclusion

The logic to divest an overseas business unit is thus likely to be influenced by a number of factors.

Firstly, when the parent company realises that the business unit is performing poorly, it can choose to divest. This decision nevertheless will be mediated by other factors such as the multinationals parent experience in that host market, the market growth, the product relatedness of the overseas business unit to the core competencies of the parent company. A divesture in this case will be driven by the motivation to refocus on a multinational’s core activities.

Secondly, divestment of an overseas business unit may be a response of the parent company to better opportunities for firm resources in other markets. Such market opportunities can simply be lower cost production or new market opportunities elsewhere due to geographic market growth differentials. Often, a divestment decision can come to a trade-off between external market factors or internal firm factors.

References

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