Manufacturing and Assembling Subsidiaries
Where subsidiaries are engaged in manufacturing or assembly and constitute market outlets, there is an equal desire for full control over operations. In this connection the following comments by the former Minister of Revenue of Quebec are interesting:
“The purpose of investment in subsidiaries is not simply to earn a profit. In the parent-affiliate relationship, a profit on inter-company transactions may be taken at either end, but be normally taken by the parent. Thus, a subsidiary could lose money and still make a net contribution to the parent company’s income by the profit on purchases of raw materials and component parts from the parent, by patents royalties and fees for management, advertising and research services. In fact, the primary purpose of investment in overseas markets is to earn a profit for the parent by the control of markets for the export of parts. components and row material concentrates. It is not essential that the affiliate show a profit.”
Here too, the low profitability of subsidiaries was frequently offered as a reason why it would not be feasible for multi-national corporations to sell minority stock of subsidiaries. Insofar as the costs of these subsidiaries include management fees, and charges for similar services supplied by the parent company as well as expenditures on commodity inputs, it is difficult to know whether the profit margins of the subsidiaries ore really as low as they are reported to be. 11,cse subsidiaries are integrated units of a manufacturing complex, and there is an obvious conceptual difficulty in establishing pro6l rates for them.
Low profit margins of subsidiaries however become important when we consider the difficulties experienced by independent Arms in competing with branch plants. The former cannot charge back losses against pro6tablc parent companies. The parent company can offset losses against profits earned on exports to subsidiaries, royalties and fees received, and so justify the continuance of the branch plant, even where the accounting profit of the. Individual subsidiary is small or negative. If the independent firm. however, can make only a small profit or if it makes a loss it cannot long survive.
In these conditions of branch plant industrialization there is a tendency to over-expansion of capacity. The manufacturing sector becomes both inefficient and highly competitive in the sense that too mom competing but slightly different products are produced. This has been named the “miniature replica” effect. It is most dramatically illustrated in Canada, where the variety of products produced and assembled can only be explained in terms of the economics of the international manufacturing corporation. Because there exists a market for each of these products created by the spill over of the taste pattern of tl1e American consumer, it pays the multi-national corporation to produce a great variety of products in Canadian” subsidiaries. Inefficiency which is usually laid at the door of protective tariffs is in fact the result of a combination of two circumstances, the tariff and the entry of numerous branch plants.
In the decade 1950 to 1960 direct investment in manufacturing subsidiaries in Canada was very heavy. The total number of companies engaged in manufacturing in Canada rose from 10,000 to 17,000. The percentage of manufacturing output controlled by foreigners rose f:om 50 per cent to 60 percent over the decade. The percentage of loss companies rose from 26 per cent to 31 per cent. The rate of profit after tax fell from 9.5 per cent to 4 per cent.
The following reply from on American manufacturing corporation with wholly-owned subsidiaries in Canada illustrates the point:
“We have found that because of economic and competitive conditions. our Canadian operations tend to be marginal and capable of staving alive only because the benefit from the United States operation., in numerous ways. Our profit margins at present, in Canada, even so, are’ not likely to be attractive to an investor.”
While low profitability is the reason corporations advance for refusing to issue equity stock in subsidiaries, the truth is probably that their financial strength permits them to expand to the margin and beyond the margin of profitability. We must, however, draw attention to the fact. already mentioned, that the profits shown in statements of subsidiaries must be added to the contributions the make to the profits of the parent by their purchases of goods and services.
An important effect of the tendency to take the profit at the metropolitan end of the parent-affiliate relationship is the assured and substantial increase in the earnings of the parent company.
Shareholders in the parent company can be shown highly satisfactory and secure earnings, in good, hard, familiar currency. This enables management to set limits to the rate of dividend pay-out in the parent concern. The shareholders know that they can, if they wish, realize capital gains by selling their stock which appreciates to the extent that investment is financed from internal savings. Management stresses the advantages of holding shares in the parent company and discourages shareholding in subsidiaries. To the extent that it succeeds it is faced by only one set of shareholders, who themselves are, in a way, “‘insiders”. insofar as the corporation goes to the market only for marginal financing.
A number of countries have legislated to force corporations to entertain local participation. But this the companies regard as a concession to be made in particular circumstances and to be opposed as a matter of general policy. We cite two examples: ·
“To move from the general to the particular, we have very flexible policies with regard to local equity situations. In a Latin American Company where we have recently applied for a license to … we with considerable local participations. Have decided that the best course is to create a joint venture company”
In our Canadian situation it is our view that the operation’s size and fluctuating fortunes do not warrant changing our present equity situation.
“A number of large American corporations in the recent t have expressed the view that the long range solution to internationalizing one shareholder base and broadening the foundation of the private enterprise system lies not so much in the sale of local equities – with its many potential conflict of interests – but rather with making it easier and more attractive for the local investor to purchase common shares of the parent U.S. corporation and thus, of course, share in the world wide profits.”
“We have characterized our … operations as a “Free World Enterprise, based in the United States.” We have manufacturing plants in 18 foreign countries and our product, are available in more than 80 countries of the free world. We consider each of our branches and subsidiaries as part of a unified whole, with a large degree of interdependence. We believe that less than full ownership usually presents problems and complications that tend to limit the activities of subsidiary to a particular product or group of products. Nevertheless in some cases we have taken in local partners.”
In deciding initially, or giving consideration to a change in organizational structure, some of the key points we consider are:
“The contribution that local participation can make, including financial, marketing, and general operating know how, and public, government and employee relations”