Page 42 - DMGT545_INTERNATIONAL_BUSINESS

Unit 2: Theories of International Trade

process innovations. Vernon further argued that most new products were initially produced in notes
America. Apparently, the pioneering firms believed it was better to keep production facilities
close to the market and to the firm’s centre of decision-making, given the uncertainty and risks
inherent in introducing new products. Also the demand for most new products to be raised on
non-price factors. Consequently, firms can charge relatively high prices for new products, which
obviate the need to look for low-cost production sites in other countries.

Vernon went on to argue that early in the life cycle of a typical new product, while demand is
starting to grow rapidly in the United States, demand in other advanced countries is limited to
high-income groups. The limited initial demand in other advanced countries does not make it
worthwhile for firms in those countries to start producing the new product, but it does necessitate
some exports from the United States to those countries.

Overtime demand for the new product starts to grow in other advanced countries (e.g. Great
Britain, France, Germany and Japan). It becomes profitable for foreign producers to begin
producing for their home markets. In addition, US firms might set up production facilities in
those advanced countries where demand is growing.
If cost pressures become intense, the process might not stop there. The cycle by which the United
States lost its advantage to other advanced countries might be repeated once mare, as developing
countries (e.g. Thailand) begin to acquire a production advantage over advanced countries. Thus
the focus of global production initially switches from the United States to other advanced nations
and then from those nations to developing countries.
The consequence of these trends is that over the time the United States switches from being
exporter of the producer to an importer of the product as production becomes concentrated in
lower-cost foreign locations and then developing countries.

2.6.1 stages of Product life cycle

There are three stages of the product cycle.

stage 1: the new Product

Innovation requires highly skilled labour and large quantities of capital for research and
development. The product will normally be most effectively designed and initially manufactured
near the parent firm and therefore in a highly industrialized market due to the need for proximity,
information and communication other than the many different skilled-labour components
required.
In the development stage, the product is non-standardized. The production process requires a
high degree of flexibility (meaning continued use of highly skilled labour). Costs of production
are therefore quite high. The innovator at this stage is a monopo list and therefore enjoys all of
the benefits of monopoly power, including the high profit margins required to repay the high
development costs and expensive produc tion process. Price elasticity of demand at this stage is
low; high-income consumers buy it regardless of cost.

stage 2: the maturing Product

As production expands, its process becomes increasingly standardized. The need for flexibility
in design and manufacturing decline, and therefore, the demand for highly skilled labour also
decline. The innovating country increases its sales to other countries. Competitors with slight
variations develop, putting downward pressure on prices and profit margins. Production costs
are an increasing concern.

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