Chapter 4 Outline

The Product Life-Cycle Theory

Raymond Vernon initially proposed the product life-cycle theory in the mid-1960s.¹⁵ Vernon's theory was based on the observation that for most of the 20th century, a very large proportion of the world's new products had been developed by US firms and sold first in the United States (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 US market gave US firms a strong incentive to develop new consumer products. In addition, the high cost of US labor gave firms an incentive to develop cost-saving process innovations.

Just because a new product is developed by a US firm and first sold in the United States, 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, 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 new-product introduction. Because the demand for most new products tends to be based on nonprice factors, 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 produce the new product, but it does necessitate some exports from the United States to those countries.

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, US 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 play a greater role in the competitive process. One result is that 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 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.

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. These dynamics are illustrated in Figure 4.5, which shows the growth of production and consumption over time in the United States, other advanced countries, and developing countries.

Figure 4.5 see

The Product Life-Cycle Theory

Source: Adapted from R. Vernon and L. T. Wells, The Economic Environment of International Business, 4th ed. (Englewood Cliffs, NJ: Prentice-Hall, 1986).

Evaluating the Product Life-Cycle Theory

Historically, the product life-cycle theory is an accurate explanation of international trade patterns. Consider photocopiers; the product was first developed in the early 1960s by Xerox in the United States and sold initially to US users. Originally Xerox exported photocopiers from the United States, primarily to Japan and the advanced countries of Western Europe. As demand began to grow in those countries, Xerox entered into joint ventures to set up production in Japan (Fuji-Xerox) and Great Britain (Rank-Xerox). In addition, once Xerox's patents on the photocopier process expired, other foreign competitors began to enter the market (e.g., Canon in Japan, Olivetti in Italy). As a consequence, exports from the United States declined, and US users began to buy some of their photocopiers from lower-cost foreign sources, particularly from Japan. More recently, Japanese companies have found that manufacturing costs are too high in their own country, so they have begun to switch production to developing countries such as Singapore and Thailand. As a result, the United States and several other advanced countries (e.g., Japan and Great Britain) have switched from being exporters of photocopiers to being importers. This evolution in the pattern of international trade in photocopiers is consistent with the predictions of the product life-cycle theory. The product life-cycle theory clearly explains the migration of mature industries out of the United States and into low-cost assembly locations.

However, the product life-cycle theory is not without weaknesses. Viewed from an Asian or European perspective, Vernon's argument that most new products are developed and introduced in the United States seems ethnocentric. Although it may be true that most new products were introduced in the United States from 1945 to 1975, there have always been important exceptions. In recent years, these exceptions have become more common. Many new products are now introduced in Japan (e.g., high-definition television or digital audiotapes). With the increased globalization and integration of the world economy that we discussed in Chapter 1, a growing number of new products are now introduced simultaneously in the United States, Japan, and the advanced European nations (e.g., laptop computers, compact disks, and electronic cameras). This may be accompanied by globally dispersed production, with particular components of a new product being produced in those locations around the globe where the mix of factor costs and skills is most favorable (as predicted by the theory of comparative advantage).

Consider laptop computers, which were introduced simultaneously into a number of major national markets by Toshiba. Although various components for Toshiba laptop computers are manufactured in Japan (e.g., display screens, memory chips), other components are manufactured in Singapore and Taiwan, and still others (e.g., hard drives and microprocessors) are manufactured in the United States. All the components are shipped to Singapore for final assembly, and the completed product is then shipped to the major world markets (the United States, Western Europe, and Japan). The pattern of trade associated with this new product is both different from and more complex than the pattern predicted by Vernon's model. Trying to explain this pattern using the product life-cycle theory would be very difficult. The theory of comparative advantage might better explain why certain components are produced in certain locations and why the final product is assembled in Singapore. In short, although Vernon's theory may be useful for explaining the pattern of international trade during the brief period of American global dominance, its relevance in the modern world is limited.