In 1901, U.S. Steel became the world’s first corporation with a stock market value greater than $1 billion. In October 2021, Tesla joined Alphabet (Google’s corporate parent), Amazon, Apple, and Microsoft as the only U.S. corporations whose stock market value exceeds $1 trillion. (The Saudi Arabian Oil Company is the only non-U.S. firm with a market value above $1 trillion.)
As large U.S. corporations developed in the late nineteenth and early twentieth centuries, a key problem facing them was how to allocate the firms’ scarce financial capital across competing uses. (A thorough—and lengthy!—discussion of the development of the modern U.S. corporation is Alfred Chandler’s book, The Visible Hand: The Managerial Revolution in American Business.) By 1940, many large corporations had formed executive committees comprised of the chief executive officer (CEO), the chief operating officer (COO), and other so-called C-suite executives.
Executive committees typically don’t become involved in the day-to-day operations of the firms, leaving those responsibilities to lower level managers. Instead, executive committees devote most of their time to strategic issues such as whether to introduce new products, where to locate sales and production facilities, and how much of the firm’s resources to devote to research and development and to marketing. The decisions that an executive committee concentrates on involve how best to allocate the firm’s financial capital, funds that come from investors who buy the firm’s stocks and bonds and from the firm’s retained earnings—the firm’s profits that aren’t distributed as dividends to the firm’s shareholders. In allocating these funds, executive committees face trade-offs of the type we discuss in Chapter 2. For instance, if a U.S.-based firm uses funds to build a factory in another country, it may not have the funds to expand its domestic factories.
Allocating the firm’s financial capital will not have much effect on the firm’s profits in the short run but can be the main determinant of the firm’s profitability—and even its survival—in the long run. For instance, the failure of Blockbuster Video to expand into offering rentals of DVDs by mail or to offering a movie streaming service, resulted in the company shrinking from having 4,000 stores in the early 2000s to a single store today. In contrast, the decision in 2018 by U.S. pharmaceutical firm Pfizer to partner with BioNTech, a small German firm, to develop vaccines using messenger RNA (or mRNA) biotechnology proved very profitable for Pfizer (and saved many lives) when the Covid-19 virus led to a worldwide epidemic.
At Tesla, CEO Elon Musk has final say on strategic decisions, a situation typical of many large firms where a single executive, through stock ownership, has control of the company. One of his key decisions has been where to locate his production facilities. In making this decision, Musk faces trade-offs in how to use the scarce funds the firm has available for expanding production capacity. Building a facility in one place means not being able to fund building a facility in another place. In addition, funds used to build new factories is not available to increase research and development on autonomous cars or on other improvements to car design or technology.
Initially, Tesla operated a single factory in Fremont, California. Built in 1962, the factory had been owned by General Motors and then jointly by GM and Toyota before being sold to Tesla in 2010. In 2019, Tesla began construction of a second factory in Shanghai, China and in 2021 was awaiting final governmental approval to build a factory in Grünheide, Germany.
Why would Tesla, or another U.S. firm, decide to build factories in other countries? The simplest answer is that firms expand their operations outside the United States when they expect to increase their profitability by doing so. Today, most large U.S. corporations are multinational firms with factories and other facilities overseas. Firms might expect to increase their profits through overseas operations for five main reasons:
- To avoid tariffs or the threat of tariffs. Tariffs are taxes imposed by countries on imports from other countries. Sometimes firms establish factories in other countries to avoid having to pay tariffs.
2. To gain access to raw materials. Some U.S. firms have expanded abroad to secure supplies of raw materials. U.S. oil firms—beginning with Standard Oil in the late nineteenth century—have had extensive overseas operations aimed at discovering, recovering, and refining crude oil.
3. To gain access to low-cost labor. In recent decades, some U.S. firms have located factories or other facilities in countries such as China, India, Malaysia, and El Salvador to take advantage of the lower wages paid to workers in those countries.
4. To reduce exchange-rate risk. The exchange rate tells us how many units of foreign currency are received in exchange for a unit of domestic currency. Fluctuations in exchange rates can reduce the profits of a firm that exports goods to other countries. (We discuss this point in more detail in Economics, Chapter 28, Section 28.3 and in Macroeconomics, Chapter 18, Section 18.3.)
5. To respond to industry competition. In some instances, companies expand overseas as a competitive response to an industry rival. The worldwide competition for markets between Pepsi and Coke is an example of this kind of expansion.
All of these reasons, apart from 2., likely played a role in Tesla’s decision to build factories in China and Germany.
In 2021, Tesla was building a factory in Austin, Texas. It was also moving its corporate headquarters from California to Texas. With these actions, the firm may have been responding to lower taxes in Texas and lower housing costs for its workers.
In October 2021, Tesla’s $1 trillion stock market value seemed very high relative to the profits it was currently earning and also because it made Tesla’s value greater than the values of the next nine largest car makers combined. The price of its stock reflected the expectation among investors that Tesla’s profits would increase in future years. Tesla’s decisions about locating its new factories would play a key role in determining whether that expectation turns out to be correct.
Sources: Rebecca Elliott and Dave Sebastian, “Tesla Surpasses $1 Trillion in Market Value as Hertz Orders 100,000 Vehicles,” wsj.com, October 25, 2021; Al Root, “How Tesla Gained $175 Billion in Value From Hertz’s $4 Billion Order. It Makes Perfect Sense,” barrons.com, October 26, 2021; Bojan Pancevski and Jared S. Hopkins, “How Pfizer Partner BioNTech Became a Leader in Coronavirus Vaccine Race,” wsj.com, October 22, 2020; William Boston, “Tesla Awaits Green Light for Production in Germany,” wsj.com, October 12, 2021; Niraj Chokshi, “Tesla Will Move Its Headquarters to Austin, Texas, in Blow to California,” nytimes.com, October 13, 2021; and Alfred D. Chandler, Jr., The Visible Hand: The Managerial Revolution in American Business, Cambridge: Harvard University Press, 1977; and Tesla.com.