The Product Life-Cycle Theory
Summarize the different theories explaining trade flows between nations.
Raymond Vernon initially proposed the product life-cycle theory in the mid-1960s.29 Vernon’s theory was based on the observation that for most of the twentieth century a very large proportion of the world’s new products had been developed by U.S. firms and sold first in the U.S. market (e.g., mass-produced automobiles, televisions, instant cameras, photocopiers, personal computers, and semiconductor chips). To explain this, Vernon argued that the wealth and size of the U.S. market gave U.S. firms a strong incentive to develop new consumer products. In addition, the high cost of U.S. labor gave U.S. firms an incentive to develop cost-saving process innovations.
Just because a new product is developed by a U.S. firm and first sold in the U.S. market, it does not follow that the product must be produced in the United States. It could be produced abroad at some low-cost location and then exported back into the United States. However, Vernon argued that most new products were initially produced in America. Apparently, the pioneering firms believed it was better to keep production facilities close to the market and to the firm’s center of decision making, given the uncertainty and risks inherent in introducing new products. Also, the demand for most new products tends to be based on nonprice factors. Consequently, firms can charge relatively high prices for new products, which obviates 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.
ANOTHER PERSPECTIVE Emerging Markets Drive Consumer Electronics
For the first time in history, emerging markets have zoomed past mature markets as the primary engine driving consumer electronics technology consumption, according to a research published in Accenture’s 2010 Consumer Products and Services Usage Survey. Some 16,000 respondents in four emerging markets were queried (China, India, Malaysia and Singapore) and their responses were compared to data from four mature markets (France, Germany, Japan and the United States). It was found that respondents in the emerging nations are twice as likely as their counterparts in the developed markets to purchase and use consumer technology over the next year. Furthermore, the emerging countries are more invested in mobile technologies—including applications on each device—than those in mature markets. The main factor in this paradigm shift is the rapid expansion of the middle class in emerging markets. More than half the world now earns at least a middle-class income. In emerging countries, that income is feeding a hunger for technology that far exceeds that of more gadget-saturated countries such as Japan and the United States. Further, because these countries are tapping into the market at a later stage of technological development, they are adapting newer, superior versions of smart phones, mobile gadgets, and social networking applications. The emerging market as consumer powerhouse is here to stay, and technology companies that wish to prosper in the future must service it well. Potentially billions of dollars in sales are at stake.
Over time, demand for the new product starts to grow in other advanced countries (e.g., Great Britain, France, Germany, and Japan). As it does, it becomes worthwhile for foreign producers to begin producing for their home markets. In addition, U.S. firms might set up production facilities in those advanced countries where demand is growing. Consequently, production within other advanced countries begins to limit the potential for exports from the United States.
As the market in the United States and other advanced nations matures, the product becomes more standardized, and price becomes the main competitive weapon. As this occurs, cost considerations start to play a greater role in the competitive process. Producers based in advanced countries where labor costs are lower than in the United States (e.g., Italy, Spain) might now be able to export to the United States. 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 more, as developing countries (e.g., Thailand) begin to acquire a production advantage over advanced countries. Thus, the locus 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 for the pattern of world trade is that over time the United States switches from being an exporter of the product to an importer of the product as production becomes concentrated in lower-cost foreign locations. Figure 6.5 shows the growth of production and consumption over time in the United States, other advanced countries, and developing countries.
FIGURE 6.5 The Product Life-Cycle Theory
Source: Adapted from Raymond Vernon and Louis T. Wells, The Economic Environment of International Business, 5th edition © 1991. Reproduced by permission of Pearson Education, Inc., Upper Saddle River, New Jersey.