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International business product life cycle theory

International business product life cycle theory

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International Business

Product Life Cycle Theory

Raymond Vernon initially proposed the product life cycle theory in the mid-1960s.Vernon

argued that the wealth and size of the US market gave us firms a strong incentive to develop

cost-saving process innovations. Vernon further 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 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.

Stages of Product Life Cycle

There are three stages of the product cycle.

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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

monopolist and therefore enjoys all of the benefits of monopoly power, including the high profit

margins required to repay the high development costs and expensive production 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. As competitors increase their

pressures on price, the innovating firm faces critical decisions on how to maintain market share.

Vernon argues that the firm faces a critical decision at this stage, either to lose market share to

foreign-based manufacturers using cheaper labour or to maintain its market share by exploiting

the comparative advantages of factor costs by investing in other countries. This is one of the first

theoretical explanations of how trade and investment become increasingly intertwined.

Stage 3: The Standardized Product In this final stage, the product is completely standardized in

its manufacture. Thus, with access to capital in world capital markets, the country of production

is simply the one with the cheapest unskilled labour. Profit margins are thin and competition is

fierce. The product has largely run its course in terms of profitability for the innovating firm. The

country of comparative advantage therefore, shifts as the technology of the product’s

manufacture matures. The same product shifts in its production location. The country producing

the product during that stage enjoys the benefits of net trade surpluses. But such advantages are

fleeting, according to Vernon. As knowledge and technology continually change, so does the

comparative advantage of the producer country.

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International Business Product Life Cycle Theory Raymond Vernon initially proposed the product life cycle theory in the mid-1960s.Vernon argued that the wealth and size of the US market gave us firms a strong incentive to develop cost-saving process innovations. Vernon further 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 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 facilit ...
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