How multinational enterprises create value through intangible capital

Intangible capital plays a key role in value capture in global value chains (GVCs). High value-added activities at the beginning and at the end of the value chain often rely on intangible assets, such as research and development (R&D) upstream, or brands and data on consumers downstream. By contrast, core manufacturing activities in the middle of the value chain tend to generate less value added per unit of output. This is the reason why lead firms specialize in the most knowledge-intensive activities in GVCs.

Multinational enterprises (MNEs) produce not only in their country of origin but also abroad. They establish foreign affiliates through foreign direct investment (FDI) and build their value chains across different countries. Intangible assets play a specific role in MNEs strategies. MNEs tend to possess superior technology or brands, giving them an advantage over local firms. They try to retain the knowledge that underpins these advantages within the firm and only transfer it to entities they control. Moreover, FDI allows MNEs to acquire knowledge and to expand their portfolio of intangible assets when they buy foreign companies and enter into mergers and acquisitions (M&A). 

Intangible assets allow MNEs to capture higher shares of income in the value chain

Take the example of Adidas, a German manufacturer of sport shoes, clothing and accessories. Nearly 100 per cent of the company’s production is outsourced to contract manufacturers in countries such as Viet Nam, Indonesia, Cambodia and China. Adidas focuses on R&D activities –which are concentrated in its headquarters in Germany and in the United States- and on marketing and distribution through a network of foreign affiliates and retail stores all over the world. The company’s intangible assets are its brand, the design of shoes, patents on innovative materials, partnerships with athletes and its expertise in working with manufacturers to deliver products consumers want to buy. As the owner of these assets, Adidas captures most of the value in the supply chain when it sells its final products to consumers in the distribution stage. Industry-level data constructed by the OECD illustrate this pattern of value capture: nearly 70 per cent of income generated by sales of German textile products and footwear is captured  in the distribution stage, with 11 per cent of this income generated by returns to intangible capital.

Foreign-owned firms generate more returns through intangible capital

To keep valuable knowledge within the confines of the firm, MNEs serve markets or source inputs through foreign affiliates. These affiliates benefit from the intangible capital accumulated by their parent company and we  therefore expect foreign-owned firms to derive a higher share of value added from intangible capital. We empirically observe this result when we compare the average factor income shares of foreign-owned and domestic-owned firms in all GVCs. While returns to intangible capital account, ­­on average, for 23 per cent of the value added generated by domestic-owned firms across industries and countries, the corresponding share for foreign-owned firms is 28 per cent.1

Compared to domestic-owned firms, foreign affiliates generate a larger share of income at the distribution and the intermediate production stages. This reflects the fact that many foreign affiliates are not engaged in final production activities. Exploiting economies of scale, MNEs tend to concentrate final production in a limited number of locations but have multiple foreign affiliates that are involved in the provision of intermediate inputs and distribution. As illustrated by the Adidas example, MNEs can also fully outsource manufacturing tasks and focus primarily on the most intangible-intensive activities. The value added of foreign-owned firms is thus less concentrated in the final production stage.

The contribution of foreign affiliates to returns to intangible capital varies across GVCs

There is considerable heterogeneity when we look at returns to intangible capital across GVCs for specific industries. As the figure below illustrates, world returns to intangible capital are concentrated in a set of manufacturing and commercial services GVCs. Three manufacturing GVCs stand out: chemicals, food products and information and communication technologies (ICT) & electronics. Chemicals (including pharmaceuticals) is the manufacturing GVC with the highest returns to intangible capital in absolute terms. It is also the GVC where the contribution of foreign affiliates is highest. Foreign-owned firms generate one-third of total returns to intangible capital in this GVC. AstraZeneca is an example of a large pharmaceutical MNE that heavily relies on R&D and strategically uses M&A to gain access to intangible assets. In 2007, it acquired a U.S. biotech company to boost its knowledge base in vaccine development. More recently, it acquired Alexion (2020) to reinforce its capacities in immunology and the development of treatments for rare diseases.

Food products and ICT & electronics are further examples of GVCs with high returns to intangible capital, but foreign-owned firms account for a lower share than in motor vehicles or other manufacturing (including furniture and toys). The fact that food products are among the three GVCs that generate the highest returns underscores the importance of brands as intangible assets. While the food sector is relatively less technology-intensive, investments in marketing and digital technologies in the distribution stage explain the high returns generated by intangible assets.

In the commercial services sector, four GVCs account for the bulk of returns to intangible capital: finance & insurance, wholesale & retail, other business services and telecoms. Not surprisingly, finance & insurance is the GVC with the highest returns to intangible capital in absolute terms. It is not only one of the largest sectors of any economy, it also creates value along the entire value chain through intangible assets, such as financial research and innovation or data on markets, companies and consumers. Wholesale & retail trade is another GVC that generates over USD 1 trillion of returns to intangible capital. Compared to finance & insurance, the distribution sector relies less on foreign affiliates. Foreign-owned firms account for only 7 per cent of returns to intangible capital in this sector.

Other business services (encompassing professional services, technical testing, consulting and management services) and telecoms are GVCs where foreign affiliates account for a large share of intangible income (15 per cent). Tata Consultancy Services (TCS) is an information technology (IT) company that exemplifies the relevance of intangible assets for the strategies of MNEs in this sector. Headquartered in Mumbai, India, its business model relies on the fine-slicing of business functions and the shift towards outsourcing of IT-related tasks. It operates through a global delivery model that allows the company to combine the benefits of geographical proximity to customers with location-specific advantages regarding expertise and labour costs across a large portfolio of subsidiaries.

Conclusion

Foreign affiliates of MNEs generate more income through intangible assets than domestic-owned firms. As intangible assets represent an increasing share of income derived from global production and are key drivers of productivity and growth, there is a need to identify trade, investment, innovation and industrial policies that can attract and retain intangible capital. These policies can be grouped into three categories that jointly constitute the “ABCs of GVC-oriented policies”2: attractiveness policies aimed at strengthening the appeal of a location for intangible-intensive activities; place-based buzz policies that intend to internally strengthen the local production and innovation ecosystem; and international connectedness policies that strengthen the local ecosystem’s links to other locations.

Countries can benefit from the accumulation of intangible capital in foreign affiliates – either when foreign-owned firms are established in their domestic economy or when foreign-owned firms are part of their international supply chains. Therefore, attractiveness policies should target foreign firms and address regulatory barriers that can discourage them from operating in the domestic economy.

Spillovers from intangible-intensive foreign affiliates to domestic firms are not automatic, however, and buzz policies can help domestic firms to increase their “absorptive capacity” and to benefit from participation in GVCs. While buzz policies can strengthen the innovation capacity of domestic as well as foreign-owned firms, connectedness policies are complementary to allow knowledge spillovers through the international value chain and through interactions with global firms.