3.2  Is There a Hurdle to Ongoing Export Growth?

Much of the information for this section has come from the Infometrics Manufacturing Export Survey. Over the decade that the Infometrics survey has been running, it has accumulated information on the issues facing a selection of New Zealand non-resource based[12] manufacturing exporters. Around thirty firms have been interviewed in this survey every two years since 1991. The sample group has changed over the decade of the surveys, and in the latest survey 16 firms were interviewed for the fifth or sixth time. The survey is not a random sample of New Zealand exporters. Firms chosen depend on the willingness of management to discuss issues surrounding their business, as well as changes in the industry composition over the decade.

Despite these limitations, the survey covers a considerable proportion of New Zealand’s non-resource based exports by volume. The thirty firms studied in the 2002 study accounted for a third of the increase in exports in non-resource based manufacturing sectors between 1998 and 2001. The firms surveyed are certainly not a random sample, but make up a considerable proportion of New Zealand’s non-resource manufacturing export growth.

The firms in the Infometrics Manufacturing Export Survey are all established exporters looking to grow their exports, and therefore their experiences are relevant to the issue of an ongoing hurdle to export growth. Many experience similar problems, while others provide useful exceptions. However due to reasons of commercial confidentiality, case studies in this section are limited to publicly available knowledge. Often the full extent of examples behind each concept cannot be disclosed.

A great deal of attention has been drawn to the seeming inability of New Zealand firms to continue growing once they reach international SME status (Yeabsley 2001). The emerging question from the case study literature is whether there are ongoing hurdles to internationalisation. Once established as an international SME, only resource-based New Zealand firms seem to be able to continue growing indefinitely, eventually reaching Multinational Enterprise (MNE) status.

Not all firms want to achieve MNE status, and MNEs are not appropriate in all industries. The lack of non-resourced based MNEs is a symptom of a potential issue, rather than an issue unto itself. This section does not cast any normative judgement on whether New Zealand needs more MNEs. The issue under investigation is whether there are any unique difficulties facing New Zealand firms from ongoing export growth.

According to Cartwright (1998), the defining factor of the MNE is that it “manages value-producing activities in several countries”. Using this definition, Cartwright (1998) claims that all New Zealand MNEs are resource based[13]. These include Fonterra, Fletcher Challenge (no longer in existence, but the forest and building arms are still operating under New Zealand ownership), firms in the meat industry and orchard fruit (Zespri and ENZA). Lion Nathan was also emerging as another MNE prior to its sale to Japanese interests.

In actuality, there are several other examples of New Zealand companies that meet Cartwright’s criteria (i.e. managing foreign value adding activities such as manufacturing) but are not included in Cartwright’s list. None of these excluded firms is very large in comparison to the resource firms, suggesting that they have been omitted because of lack of materiality. If we introduce materiality as another criteria Cartwright’s characterisation holds. The New Zealand Stock Exchange confirms that most big New Zealand firms operating internationally are resource based. As shown by Table 3, only one of the top 20 firms by market capitalisation is a non-resource based exporter. Also, Figure 5 shows that the majority of exports are resource based (mainly in the form of food manufactures).

Figure 5: Composition of New Zealand's exports[14]

Source: Statistics New Zealand 2001

The key to the success of the resource-based exporters appears to be based partly on the exploitation of New Zealand’s comparative advantage. More importantly however these companies had the scale to invest and create a market presence overseas, leverage linkages with consumers and suppliers and customise/ differentiate their products accordingly. Some of these resource industries have done well at diversifying markets and altering products to match[15].

It appears that by beginning with bulk products (which originally require little differentiation, distribution or marketing effort) these firms amassed the scale and cashflow necessary to continue their expansion and become truly global. Links to the United Kingdom also provided useful cashflow for some of our resource industries. New Zealand’s comparative cost advantage in agriculture gave these firms an immediate entry into a mass market. This allowed a smoother growth path by providing the accumulation of cashflow and scale. Once a firm has built up some scale this can be used to finance moves into increasingly differentiated markets that require higher investment in distribution and marketing.

Many non-resource based firms put down difficulties in ongoing expansion to a lack of scale. Campbell-Hunt and CANZ (2001) state “firms with a small domestic market have less chance of achieving economies of scale in research and development, manufacturing and marketing.” As will be shown in the following sections, marketing and distribution seems to be particularly important.

Source; Frame (2000)

3.2.1  Production Economies

Internal economies of scale relate to the firms production process. A stylised representation of these economies of scale is shown on Figure 6 below. The average cost line on Figure 6 demonstrates that for a given fixed capital investment a firm’s average costs will generally fall as production increases to the optimal capacity of the capital employed. This is because the fixed costs of the capital investment are being spread over a greater output. The least cost capacity is shown by Point B on Figure 6. In New Zealand’s case the small domestic market may not offer firms enough opportunity to expand production to the optimal capacity of the firm – even with minimal capital employed. As such, New Zealand firms serving the domestic market may be stuck in the high cost position of Point A in Figure 6. This may make it relatively unprofitable to set up business in certain industries, unless immediate overseas expansion is possible.

Figure 6: A Theoretical Example of Sub-Scale Production Economies

Evidence of firms trapped under minimum efficient scale is difficult to find. This may be because the concept has vastly different applications in each industry, or because it is simply untrue. Production technologies in each industry are constantly changing and shifting as production technologies and product differentiation evolves. This makes any practical application of the theoretical concept difficult, and has prevented qualitative or quantitative measurement in all but the largest standardised industries (such as Utilities).

Many New Zealand firms avoid the issue of minimum efficient scale by focussing on differentiation, customisation or targeting niche markets. This means that production economies may have little importance for New Zealand, except in encouraging firms to target certain niche industries over mass markets.

3.2.2  Distribution Economies

The proposition behind the existence of distribution economies is that large companies find it easier to set up distribution channels and market their products. Distribution economies have a broad definition that is expanded more fully in the following paragraphs, including an explanation of why scale is important in these areas.

The actual physical distribution system is important, and includes transportation, warehousing and either owning or having links with retail outlets. Scale improves time to market for products and can also reduce the unit costs of transport and warehousing. At the retailing end, scale can increase the prominence of goods in retail outlets.

The concept of distribution economies also includes the costs of marketing products to buyers and the creation of channels for feedback on customer preferences. Preparing a line of products for a new market usually involves an up-front and ongoing investment in products based on the preferences of locals, which large firms can afford more easily. Creating and maintaining a market presence also involves fixed costs, which are more easily borne by large firms.

In tandem with marketing is the issue of establishing brand and reputation. This is important to consumers and many large overseas customers who are seeking secure and trustworthy suppliers. Large-scale firms instantly have greater credibility and can afford to make the fixed cost investment in brand promotion.

In some markets providing a range of products is also important. Many MNEs offer a wide range of products. This gives three advantages - a complete solution to clients, greater exposure for the brand, and it also allows the distribution costs to be spread over a wider range of products. Scale also appears to aid ongoing investment in R&D to create new products.

All of these factors require investment, often before any return is achieved. Firms interviewed in the Infometrics survey report spending several years and millions of dollars dealing with these issues. Such investment requires significant retained earnings, debt, or outside equity. As will be shown in the next section, for many firms the easiest way of achieving all of these things is by becoming part of a foreign MNE.

As has been shown in the previous section, New Zealand firms entering exporting use different strategies to get around the fixed costs of moving into exporting (including producing niche products, using independent distributors, and focussing on one product). However, these approaches are of limited value in building an MNE. Focussing resources on one product prevents firms developing a broad product range to offer customers. Similarly, niche markets are quickly satisfied and firms must look for related applications of their technology (or completely new industries) to continue expansion. The use of distributors by New Zealand firms has two problems. Independent distributors do not focus on the firm’s product, and also have relatively high margins, making only the most profitable niche products are worth selling through these channels. Selling to one or a few large overseas firms can also be risky as the loss of one customer has a huge impact on the business. Large overseas companies also often use their own brand on the final product, preventing the New Zealand firm from developing a brand identity overseas. Brand development appears to be important for becoming an MNE.

To become continue growing New Zealand firms need to build brands and distribution systems so that they can effectively move into mass product markets. However, it is difficult to invest in such systems and brands without significant revenue. Capital markets can help this process, but they are likely to under-invest until the potential of a certain product or brand is proven. As a result, New Zealand firms find ongoing growth difficult. The next section will explore the ongoing growth strategies of non-resource based New Zealand firms. This will show how many firms form their strategy around overcoming the hurdle of achieving distribution economies.

3.2.3  Production or Distribution Economies?

Which has the strongest impact, production or distribution economies? In many ways, this is a chicken and egg question, and as production economies may prevent some products being made, counterfactuals are difficult to determine. However, the key observable issue is the ability to sell a product, rather than make it. Distribution economies seem to be more important.

Infometrics (1999) notes that some New Zealand firms are contracting out manufacturing entirely (usually overseas) so that they can concentrate on product development, distribution and marketing. The report argues that this is an issue of task specialisation (i.e. management wanting to focus on the most important part of the business), rather than simply cost cutting. The key exception to this is in low-skilled, labour-intensive industries where lower labour costs (again, rather than scale per se) probably are the key driver of manufacturing shifting overseas.

The ongoing hurdle facing New Zealand firms does not appear to be caused by traditional production economies.

“New Zealand manufacturing costs are relatively low and there is no reason why we cannot build production lines to world scale for particular products… Distribution is where real economies of scale exist, but our view is that few New Zealand companies have the sales volumes to capitalise on the true potential of distribution and marketing companies”.

Infometrics (1999)

New Zealand does in fact have world scale production facilities in certain industries. In looking at the case-study evidence (as in the next section) it seems that distribution economies are a hurdle to ongoing growth.