How MNCs take advantage of small local firms

Anti-competitive practices may reduce consumer welfare, disrupt consumption patterns

ISLAMABAD: In Pakistan, there is a constant tussle between multinational companies (MNCs) and small-, medium-size enterprises (SMEs)

The main argument is that MNCs lock in SMEs as suppliers and vendors through one-sided contracts, which only provide a marginal benefit to SMEs in the long run, while the MNCs get most out of the profit.



The term “slave manufacturers” is often used for SMEs which points to their finished goods that provide very low cost to MNCs, which would then brand them and sell them at significantly high profit margins. On the positive side, it is also noted that MNCs do help in improving the quality of products, introduction of new technology and competition.

In this backdrop, at least two questions are pertinent: first, what should be the role of the government in ensuring a level playing field when it comes to mutual relationship between MNCs and SMEs? Second, how should SMEs themselves respond to the opportunities (and threats) when MNCs knock on their doors?

As I have been maintaining in these columns for the past six years, my basic premise will remain the same–an open economy produces welfare gains for most of the players though some players do lose out in the long run.

Let’s take an example.

The SME and MNC relation

Suppose a small, textile factory making bed sheets is contacted by a large MNC known for its household items worldwide to become its dedicated supplier or dedicate new facility for its own products. In return of assured supply, the MNC offers both bigger and longer business tenure.  This is a great opportunity for the SME, as the size of the order becomes manifold and because of branding, the life of the business is also longer and it gets steady revenue over time enabling the SME to expand and diversify its business. At the same time, it also poses a challenge, as maintaining new global standards for the SME would not be easy.



The MNC enjoys a substantial leverage now as it has effectively increased its production capacity without spending an additional penny. On the other hand, the SME faces one major risk – if anything goes wrong in the supply process, its expected revenue will fall suddenly and it faces the risk of losing capital dedicated for the MNC.

For an MNC, this discontinuation is also a problem but given its global operations, it is able to find an alternative source very soon. For the SME, the problem is bigger – not only will it have to lay off workers but finding a new buyer may be next to impossible due to differentiated specifications.

In the case of a legal conflict, in all likelihood, the location of conflict resolution is contractually defined as the city where the MNC is headquartered, and not where the SME is based. This simply implies that to file a case, the SME has to undertake substantial costs, whereas for the MNC, this might mean nothing more than deputation of an in-house junior lawyer.

In other words, there is an inherent power imbalance between MNC and SME, which gives advantage to the former despite the voluntary nature of contract.

What should be done?

Consequences of ill-conceived contracts

On part of the government, there is nothing much it can do in the case of a voluntary contract between two private parties, which had earlier agreed to settle disputes in a country where the MNC is based.

However, the educational and facilitative role of the government can be very important. In this educational role, the government, or for that matter any third party institute can establish standard guidelines by developing model contracts for SMEs to safeguard their interests. In its facilitative role, the government can ask its relevant foreign mission to help the SME in provision of legal help.

For the SME itself, it is a matter of choice, which carries significant risks. Not accepting the offer and opportunity extended by the MNC implies slow growth in terms of production and productivity.

The growth with the MNC will certainly be on a steep curve. However, on this path, the SME achieves more predictability in its revenue but at the same time losing the chance of developing its own brand.

In their study, “Multinational Corporations and Local Firms in Emerging Economies”, Eric Rugraff and Michael W. Hansen argue that MNCs may help in modernisation of economies and industries by technology transfer and exports market but they can also lock host economies in low value-added activities and crowd out local investments and jobs.



Furthermore, anti-competitive practices of MNCs may reduce consumer welfare and MNCs may help build consumption patterns that are unsuited for host countries.

The writer is founder of PRIME Institute; an independent think tank based in Islamabad and is now living in Kuala Lumpur, where he is CEO of Istanbul Network for Liberty and Director Research IDEAS.

 

Published in The Express Tribune, May 1^st, 2017.

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