Mini-Case: The US Tire Industry

The U.S. tire industry illustrates the troubles faced by multinational ?rms that have lost their source of differential advantage. Although Europe once was a pro?table market for the Big Four U.S. tire makers—Goodyear, Firestone, Goodrich, and Uniroyal—each of these ?rms has, by now, partially or completely eliminated its European manufacturing operations. The reason is the extraordinary price competition resulting from a lack of unique products or production processes and the consequent ease of entry into the market by new ?rms.

Moreover, these ?rms then faced well-?nanced challenges in the U.S. market by, among others, the French tire maker Michelin, the developer of the radial tire and its related production technology. Uniroyal responded by selling off its European tire-manufacturing operation and reinvesting its money in businesses that were less competitive there (and, hence, more pro?table) than the tire industry. This reinvestment includes its chemical, plastics, and industrial-products businesses in Europe.

Similarly, Goodrich stopped producing tires for new cars and expanded its operations in polyvinyl chloride resin and specialty chemicals. In 1986, Uniroyal and Goodrich merged their tire units to become Uniroyal Goodrich Tire, selling only in North America. Late in 1989, its future in doubt, Uniroyal Goodrich sold out to Michelin. The previous year, in early 1988, Firestone sold out to the Japanese tire maker Bridgestone. Goodyear is now the only one of the Big Four tire makers that is still a U.S. company.

Goodyear, the world’s number one tire producer before Michelin’s acquisition of Uniroyal Goodrich, has maintained its leadership by investing more than $1 billion to build the most automated tire-making facilities in the world and is aggressively expanding its chain of wholly owned tire stores to maintain its position as the largest retailer of tires in the United States. It has also invested heavily in research and development to produce tires that are recognized as being at the cutting edge of world-class performance.

Based on product innovation and high advertising expenditures, Goodyear dominates the high-performance segment of the tire market; it has captured nearly 90% of the market for high-performance tires sold as original equipment on American cars and is well represented on sporty imports. Geography has given Goodyear and other American tire manufacturers a giant assist in the U.S. market. Heavy and bulky, tires are expensive to ship overseas.

Textbook Notes (Hints):

Foreign Direct Investment and Survival: Thus far, we have seen how firms are capable of becoming and remaining multinationals. However, for many of these firms, becoming multinational is not a matter of choice but, rather, one of survival.

Cost Reduction: It is apparent that if competitors gain access to lower-cost sources of production abroad, following them overseas may be a prerequisite for domestic survival. One strategy that is often followed by firms for which cost is the key consideration is to develop a global-scanning capability to seek out lower-cost production sites or production technologies worldwide. In fact, firms in competitive industries have to seize new, nonproprietary, cost-reduction opportunities continually, not to earn excess returns but to make normal profits and survive.

Economies of Scale: A somewhat less obvious factor motivating foreign investment is the effect of economies of scale. In a competitive market, prices will be forced close to marginal costs of production. Hence, firms in industries characterized by high fixed costs relative to variable costs must engage in volume selling just to break even. A new term describes the size that is required in certain industries to compete effectively in the global marketplace: world-scale. These large volumes may be forthcoming only if the firms expand overseas. For example, companies manufacturing products such as computers that require huge R&D expenditures often need a larger customer base than that provided by even a market as large as the United States in order to recapture their investment in knowledge. Similarly, firms in capital-intensive industries with enormous production economies of scale may also be forced to sell overseas in order to spread their overhead over a larger quantity of sales.

L.M. Ericsson, the Swedish manufacturer of telecommunications equipment, is an extreme case. The manufacturer is forced to think internationally when designing new products because its domestic market is too small to absorb the enormous R&D expenditures involved and to reap the full benefit of production scale economies. Thus, when Ericsson developed its revolutionary AXE digital switching system, it geared its design to achieve global market penetration.

These firms may find a foreign market presence necessary in order to continue selling overseas. Local production can expand sales by providing customers with tangible evidence of the company's commitment to service the market. It also increases sales by improving a company's ability to service its local customers. For example, an executive from Whirlpool, explaining why the company decided to set up operations in Japan after exporting to it for 25 years, said, “You can only do so much with an imported product. We decided we needed a design, manufacturing, and corporate presence in Japan to underscore our commitment to the Japanese market and to drive our global strategy in Asia. You can't do that long distance.” Thus, domestic retrenchment can involve not only the loss of foreign profits but also an inability to price competitively in the home market because it no longer can take advantage of economies of scale.

Questions **Please EXPLAIN/QUANTIFY Your Answers**

1. What barriers to entry has Goodyear created or taken advantage of? Why?

2. Goodyear has production facilities throughout the world. What competitive advantages might global production provide Goodyear? Why?

3. How do tire manufacturing facilities in Japan ?t in with Goodyear’s strategy to create shareholder value?

4. How will Bridgestone’s acquisition of Firestone affect Goodyear? How might Goodyear respond to this move by Bridgestone?