Product life-cycle theory Essay

The product life-cycle theory is an economic theory that was developed by Raymond Vernon in response to the failure of theHeckscher-Ohlin model to explain the observed pattern of international trade. The theory suggests that early in a product’s life-cycle all the parts and labor associated with that product come from the area in which it was invented. After the product becomes adopted and used in the world markets, production gradually moves away from the point of origin. In some situations, the product becomes an item that is imported by its original country of invention.[1] A commonly used example of this is the invention, growth and production of thepersonal computer with respect to the United States. The model applies to labor-saving and capital-using products that (at least at first) cater to high-income groups. In the new product stage, the product is produced and consumed in the US; no export trade occurs. In the maturing product stage, mass-production techniques are developed and foreign demand (in developed countries) expands; the US now exports the product to other developed countries. In the standardized product stage, production moves to developing countries, which then export the product to developed countries. The model demonstrates dynamic comparative advantage. The country that has the comparative advantage in the production of the product changes from the innovating (developed) country to the developing countries. Product life-cycle There are five stages in a product’s life cycle: Introduction Growths Maturity Saturation Decline The location of production depends on the stage of the cycle. Introduction New products are introduced to meet local (i.e., national) needs, and new products are first exported to similar countries, countries with similar needs, preferences, and incomes. If we also presume similar evolutionary patterns for all countries, then products are introduced in the most advanced nations. (E.g., the IBM PCs were produced in the US and spread quickly throughout the industrialized countries.) A copy product is produced elsewhere and introduced in the home country (and elsewhere) to capture growth in the home market. This moves production to other countries, usually on the basis of cost of production. (E.g., the clones of the early IBM PCs were not produced in the US.) The Period till the Maturity Stage is known as the Saturation Period. The industry contracts and concentrates—the lowest cost producer wins here. (E.g., the many clones of the PC are made almost entirely in lowest cost locations.) This is a period of stability. The sales of the product reach the peak and there is no further possibility to increase it. this stage is characterised by: Saturation of sales (at the early part of this stage sales remain stable then it starts falling). It continues till substitutes enter into the market. Marketer must try to develop new and alternative uses of product. Poor countries constitute the only markets for the product. Therefore almost all declining products are produced in developing countries. (E.g., PCs are a very poor example here, mainly because there is weak demand for computers in developing countries. A better example is textiles.) Note that a particular firm or industry (in a country) stays in a market by adapting what they make and sell, i.e., by riding the waves. For example, approximately 80% of the revenues of H-P are from products they did not sell five years ago. the profits go back to the host old country. Product Life Cycle Theory Raymond Vernon developed the international product life cycle theory in the 1960s. The international product life cycle theory stresses that a company will begin to export its product and later take on foreign direct investment as the product moves through its life cycle. Eventually a country’s export becomes its import. Although the model is developed around the U.S, it can be generalised and applied to any of the developed and innovative markets of the world. The product life cycle theory was developed during the 1960s and focused on the U.S since most innovations came from that market. This was an applicable theory at that time since the U.S dominated the world trade. Today, the U.S is no longer the only innovator of products in the world. Today companies design new products and modify them much quicker than before. Companies are forced to introduce the products in many different markets at the same time to gain cost benefits before its sales declines. The theory does not e xplain trade patterns of today. New trade theory New trade theory (NTT) is a collection of economic models in international trade which focuses on the role of increasing returns to scale and network effects, which were developed in the late 1970s and early 1980s. New trade theorists relaxed the assumption of constant returns to scale, and some argue that using protectionist measures to build up a huge industrial base in certain industries will then allow those sectors to dominate the world market. Less quantitative forms of a similar â€Å"infant industry† argument against totally free trade have been advanced by trade theorists since at least 1848 (see: History of free trade). Contents †¢1 The theory’s impact †¢2 Econometric testing †¢3 History of the theory’s development o3.1 â€Å"New† new trade theory †¢4 Theoretical foundations o4.1 See also o4.2 References o4.3 External links The theory’s impact Although there was nothing particularly ‘new’ about the idea of protecting ‘infant industries’ (an idea offered in theory since the 18th century, and in trade policy since the 1880s) what was new in â€Å"new trade theory† was the rigour of the mathematical economics used to model the increasing returns to scale, and especially the use of the network effect to argue that the formation of important industries was path dependent in a way which industrial planning and judicious tariffs might control. The models developed were highly technical, and predicted the possibilities of national specialization-by-industry observed in the industrial world (movies in Hollywood, watches in Switzerland, etc.). The story of path-dependent industrial concentrations can sometime lead to monopolistic competition or even situations of oligopoly. Some economists, such as Ha-Joon Chang, had argued that free trade would have prevented the development of the Japanese auto industries in the 1950s, when quotas and regulations prevented import competition. Japanese companies were encouraged to import foreign production technology but were required to produce 90% of parts domestically within five years. It is said[who?] that the short-term hardship of Japanese consumers (who were unable to buy the superior vehicles produced by the world market) was more than compensated for by the long-term benefits to producers, who gained time to out-compete their international rivals.[1] Econometric testing The econometric evidence for NTT was mixed, and highly technical. Due to the timescales required, and the particular nature of production in each ‘monopolizable’ sector, statistical judgements were hard to make. In many ways, the available data have been too limited to produce a reliable test of the hypothesis, which doesn’t require arbitrary judgements from the researchers. Japan is cited as evidence of the benefits of â€Å"intelligent† protectionism, but critics[who?] of NTT have argued that the empirical support post-war Japan offers for beneficial protectionism is unusual, and that the NTT argument is based on a selective sample of historical cases. Although many examples (like Japanese cars) can be cited where a ‘protected’ industry subsequently grew to world status, regressions on the outcomes of such â€Å"industrial policies† (which include failures) have been less  conclusive; some findings suggest that sectors targeted by Ja panese industrial policy had decreasing returns to scale and did not experience productivity gains.[2] History of the theory’s development The theory was initially associated with Paul Krugman in the late 1970s; Krugman claims that he heard about monopolistic competition from Robert Solow. Looking back in 1996 Krugman wrote that International economics a generation earlier had completely ignored returns to scale. â€Å"The idea that trade might reflect an overlay of increasing-returns specialization on comparative advantage was not there at all: instead, the ruling idea was that increasing returns would simply alter the pattern of comparative advantage.† In 1976, however, MIT-trained economist Victor Norman had worked out the central elements of what came to be known as the Helpman-Krugman theory. He wrote it up and showed it to Avinash Dixit. However, they both agreed the results were not very significant. Indeed Norman never had the paper typed up, much less published. Norman’s formal stake in the race comes from the final chapters of the famous Dixit-Norman book.[3] James Brander, a PhD student at Stanford at the time, was undertaking similarly innovative work using models from industrial organisation theory—cross-hauling—to explain two-way trade in similar products.[citation needed] â€Å"New† new trade theory Marc Melitz and Pol Antrà  s stated a new trend in the study of international trade. While new trade theory put emphasis on the growing trend of intermediate goods, this new trend emphasizes firm level differences in the same industry of the same country and this new trend is frequently called ‘new’ new trade theory (NNTT).[4][5] NNTT stresses the importance of firms rather than sectors in understanding the challenges and the opportunities countries face in the age of globalization.[6] As international trade is increasingly liberalized, industries of comparative advantage are expected to expand, while those of comparative disadvantage are expected to shrink, leading to an uneven spatial distribution of the corresponding economic activities. Within the very same industry, some firms are not able to cope with international competition while others thrive. The resulting intra-industry reallocations of market shares and productive resources are  much more pronounced than inter-industry reallocations driven by comparative advantage. Theoretical foundations New trade theory and â€Å"new† new trade theory (NNTT) need their own trade theory. New trade theories are often based on assumptions such as monopolistic competition and increasing returns to scale. One of the typical explanation, given by P. Krugman, depends on the assumption that all firms are symmetrical, meaning that they all have the same production coefficients. This is too strict as an assumption and deprived general applicability of Krugman’s explanation. Shiozawa, based on much more general model, succeeded in giving a new explanation on why the traded volume increases for intermediates goods when the transport cost decreases.[7] â€Å"New† new trade theory (NNTT) also needs new theorectical foundation. Melitz and his followers concentrate on empirical aspects and pay little interest on theoretical aspects of NNTT. Shiozawa’s new construction, or Ricardo-Sraffa trade theory, enables Ricardian trade theory to include choice of techniques. Thus the theory can treat a situation where there are many firms with different production processes. Based on this new theory, Fujimoto and Shiozawa[8] analyze how different production sites, either of competing firms or of the same firms locating in the different countries, compete. Porter’s Theory of Competitive Advantage of Nations of International Trade NIRAV S Micheal Porter’s Theory of Competitive Advantage of Nations against the Theory of Competitive advantage sought to examine the issue of why some nation’s business firms succeeded high in international/global competition. The theory of competitive advantage probes into three major aspects of trade phenomenon: i. Why does a nation succeed international in a particular industry? ii. What influence does a nation carry on competition in specific industries and their segments? iii. Why do a nation’s firms choose particular strategies of business? Porter’s analysis begins with following premises: 1. The nature of competition and the sources of competitive advantage differentials in the industries. 2. Successful global enterprises draw  competitive advantages through their value chain of worldwide network. 3. Innovation is the pillion of gaining/sustaining competitive advantage. 4. Pioneering and aggressive competitors in exploiting new market/technology are most successful. Porter undertook intensive research of 100 industries in ten countries. On the basis of empirical investigation, Porter identified for attributes of nation which determine (promote, impede) its competitive advantage referred to as Porter’s Diamond in. The Porter’s Diamond narrates for major attributes: Factor Conditions A country’s factor endowments or supply of factors of production such as human resources, physical resources, knowledge resources, location, capital resources and infrastructure play a significant role in determining its national competitive advantage. Besides basic factors (e.g., natural resources, climate, etc.,) advanced factors (e.g., skilled labour, communications infrastructure, technology) are the crucial determinants of the capabilities and competitiveness of a nation. Advanced factors are declined by the efforts of the individuals, firms, institution and government in a country. Japan’s success may largely be attributed to its advanced factors creation rather than basic factors arability. A nation can overcome its deficiency or comparative disadvantage of basic factors endowment by focusing on creation of advanced factors to improve its competitive advantage. Demand Conditions The demand conditions in home market is important in stimulating domestic firms to undertake innovation and improve quality of products. When domestic buyers are sophisticated, a pressure in the market is created for the domestic firms to meet high standards of quality demanded. For example, Japanese knowledge buyers have induced the Japanese camera manufacturers to produce innovative models first in the home market and then for the exports. Similarly, local customers in Sweden have stimulated Ericsson to invest in cellular phone equipment industry much before the rising global demand. A nations demand conditions, thus, refer to: i. The nature of home buyers needs – their sophistication and fastidiousness ii. The size and pattern of growth of home market iii. The timing of development of demands relative to buyer in foreign markets iv. The knowledge presence of domestic buyers in foreign markets and their preferences. v. The timing of market saturation and challenges at home market provide a strong reason to acquire global competitive position to a business firm. Suppliers and Related Industries National advantage in an industry is also conditioned by the preserve of vigorous home-based suppliers of cost-effective and quality inputs or related supporting industries. For example, the US success in several electronic goods including personal computers is attributed to the growth of semiconductor industry in the country. Same is the case with Malaysia to some extent. Likewise, Sweden steel industry has contributed much to the success of Sweden’s output in ball bearings and cutting tools. Successful industrial growth in the exporting country may emerge on quantum of the growing clusters of related/supervising industries. German textile and approach sector is a chronic case in this regard – (textile machinery, sewing machine needles, textile clothes forming the cluster of textile exporting industry of the country). Ongoing coordination and just-in-time strategy is easy when such cluster industrial growth occurs in a nation.