The International product life cycle theory given by Vernon, explains the various stages in the life of a new product and the resultant international trade. The two important principles of this theory are:
Technological changes and innovations: According to this theory, innovations are generally concentrated in the richer and developed countries. This is because innovations require huge capital investment and developed countries being capital rich countries are in a better position to fund them. Further, they also have effective patent regulations along with a favourable tax structure and availability of skilled labour. Also, the consumers in these countries have high income with high per capita consumption and generally do not hesitate to try new products.
The innovations in the automobile industry and product and process developments taking place in pharmaceutical industry clearly highlight the fact that developed countries provide conducive environment to manufacture and market the innovated products.
Market structure: Initially these goods are produced for local consumption on account of proximity to factors of production and consumption market. Owing to price inelasticity, producers enjoy high profits, which also covers their high manufacturing costs. These high profits encourage production that leads to oversupply and the country starts exporting. As the product enters the maturity stage or factors of production change, the production shifts to other developed countries with more suitable patterns of factor prices.
The factor of production changes on account of standardization of products or expiry of the patent granted or on account of development of substitutes. This leads to decline in exports of the country that first came up with the innovation and eventually may end up becoming an importer. However, one must also note that a product may be at different stages of life cycle at the same time. Hence a country may be exporting gas well as importing the same product, albeit different versions.
Consider the automobile industry. The history of automobile industry begins with the steam era. The first self-driven steam based vehicle or carriage was developed until Henry Ford set the assembly lines for mass production. This development set the path for automobile industry expansion and growth. Savings that happened during depression and world war later fuelled consumption as World War II ended and employment increased. With supply falling short of demand, many technologically advanced foreign players from Japan and European nations marked entry into the US markets leading to stiff competition. The oil crises also led to fall of a market share of US carmakers as Japanese manufacturers were technologically advanced to manufacture more fuel-efficient cars. Further, such cars were priced at affordable rates. All this led to stiff competition in US markets and increased imports from Japan. Also the factors of production started becoming expensive with shifts in factor of production across industries (manufacturing to service oriented). Apart form scaling cost of production, market reached a saturation point that necessitated moving out of homeland and foraying into developing or emerging economies, whose per capita consumption was increasing and where automobile sales have been propelling.
With the increase in cost of manufacturing domestically, US and European nations, even before foraying into emerging economies and setting up a manufacturing base in collaboration with domestic players, had already started outsourcing auto components products from low cost producers in developing countries to minimize cost of production. India is a preferred destination of auto manufacturers owing to its strong engineering skills and relatively low cost highly skilled human resource.
Thus, international product life cycle highlights that US started losing dominance as other developed technology oriented economies like Japan and Europe came out with more efficient products or process of manufacturing the same product leading to a competitive environment. In such cases consumers turn out to be beneficiaries of increasing competition as prices are scaled downwards. With saturation and increase in cost of production, developing economies gain. With increased employment, disposable income increases, this leads to increase in consumption. Increased spending in turn increases demand for products. This facilitates competition that leads to emergence of strong companies domestically and also entry of foreign players if policies and laws favour so, also collaborations and joint ventures activities are witnessed that leads to a win-win situation (foreign players get a new market, domestic players get access to technology).
Same is the case with other booming industries like retail and pharmaceutical industry (patents expiring, changing regulations and policies facilitating globalization of industry, high cost of research and development necessitating collaborations and growth of generics market). The IT industry in India developed owing to increased outsourcing by developed economies like US. Though the industry lost sheen with fluctuation in currency rates and slowdown in global economies, the IT giants are diversifying their revenues across geographies including other developing economies.
Thus, the current attention gathered by the developing economies is owing to the international product life cycle.
Read our view on the product life cycle in context of the retail sector.