2.1 Multinational Location Options and Frictions

bring intermediates to the assembly location and final product to the consumer market location. The trade costs include transportation costs and border clearance costs such as tariffs and nontariff measures.

The ownership decision, sometimes called the “internalization” or “make-or-buy” decision, entails determining which chain activities to conduct within the boundaries of the firm and which should be done through contracting with outsiders (at home or abroad). High transaction costs tend to gear a firm toward ownership and include situations in which there are difficulties in establishing complete contracts that cover all contingencies and where customized (relation-specific) investments are needed.2 In the face of incomplete contracts, ownership provides a source of bargaining power when unforeseen contingencies are encountered. The ultimate sourcing, assembly, market, and ownership decisions are the outcomes of a profit-maximization and strategic-goaloptimization strategy.

Business relationships along the value chain have become increasingly important, and relational contracting has been growing. Production along value chains has created complex arrangements across international partners, which have been a challenge for contracting. It has expanded the extent of the “incompleteness”—the inability to incorporate everything that can ever happen—of the standard transactional contract. Thus, firms have opted for relational contracts—informal agreements sustained by the value of the future relationship—which overcome the inefficiencies associated with incomplete transactional contracts. GVCs may involve sharing proprietary knowledge on the part of the lead firm and customized (relation-specific) investments on the part of the partner firm. Thus, relationships and trust have become very important, albeit with some variation by industry (see Gould 2018; Kukharskyy 2016; Malcomson 2012).

FIGURE 2.1 Multinational Location Options and Frictions

Headquarters (HQ) location (i) Activities: • Research • Design • Branding • Network coordination

τij HQ input transfer costs Marketing costs

λiq HQ input transfer costs τik

Input supplier locations (j) Activities: • Intermediates production Intermediates trade costs

ŋjk

Source: Adapted from Head and Mayer 2019. Markets (q) Activities: • Distribution and sales

tkq Trade costs

Assembly locations (k) Activities: • Assembly