Impact of Channel Co-opetition and Tax on a Multinational Firm's Local Production Decision

In recent years, emerging markets such as India and Indonesia have encouraged / required multinational firms (MNFs) to produce and sell goods locally. This might change MNFs' previous supply chain structure of "overseas-production-local-sale" (OPLS) to "ocal-production-local-sale" (LPLS). Tax burden comprising of tariff and corporate income tax plays a critical role in MNFs' strategic production decisions. In this paper, we formulate a MNF operating a retailing division in an emerging market, which competes with a local retailer. It is optional for the MNF to set up local factories for production to enjoy the preferential tax policies and avoid tariff, but the MNF has to undertake enormous factory establishment cost. It is also optional for the MNF to produce overseas and take advantage of tax planning, but the benefit is constrained by the widely adopted Arm's Length Principle (ALP). This makes the MNF loses pricing flexibility when its manufacturing division sells goods to its retailing division and the local retailer. We find that, when the factory establishment cost is in a moderate range, the MNF's preference over production strategies switches twice from local production to overseas production and then back to local production, as the competition intensity increases. Interestingly, when the factory establishment cost is high, the MNF's preference heavily depends on the tax disparity, exhibiting a threshold policy based on the competition intensity. We further investigate the impact of tariff and local production inefficiency to examine the robustness of our main findings.