Product cycle theory shows how specific products were first produced and exported from one country but through product and competitive evolution shifted their location of production and export to other countries over time. Figure 3.4 illustrates the trade patterns that Vernon visualized as resulting from the maturing stages of a specific product cycle. As the product and the market for the product mature and change, the countries of its production and export shift.
The product is initially designed and manufactured in the United States. In its early stages (from time t0 to t1), the United States is the only country producing and consuming the product. Production is highly capital-intensive and skilled-labor intensive at this time. At time t1, the United States begins exporting the product to other advanced countries, as Vernon classified them. These countries possess the income to purchase the product in its still new-product stage, in which it was relatively high priced. These other advanced countries also commerce their own production at time t1 but continue to be net importers. A few exports, however, do find their way to the less-developed countries at this time as well.
As the product moves into the second stage, the maturing product stage, production capability expands rapidly in the other advanced countries. Competitive variations begin to appear as the basic technology of the product becomes more widely known, and the need for skilled labor in its production declines. These countries eventually also become net exporters of the product near the end of the stage (time t3). At time t2 the less-developed countries begin their own production, although they continue to be net importers. Meanwhile, the lower cost of production from these growing competitors turns the United States into a net importer by time t4. The competitive advantage for production and export is clearly shifting across countries at this time.
The third and final stage, the standardized product stage, sees the comparative advantage of production and export now shifting to the less-developed countries. The product is now a relatively mass-produced product that can be made with increasingly less-skilled labor. The United States continues to reduce domestic production and increase imports. The other advanced countries continue to produce and export, although exports peak as the less-developed countries expand production and become net exporters themselves. The product has run its course or life cycle in reaching time t5.
A final point: Note that throughout this product cycle, the countries of production, consumption, export, and import are identified by their labor and capital levels, not firms. Vernon noted that it could very well be the same firms that are moving production from the United States to other advanced countries to less-developed countries. The shifting location of production was instrumental in the changing patterns of trade but not necessarily in the loss of market share, profitability, or competitiveness of the firms. The country of comparative advantage could change.
Although interesting in its own right for increasing emphasis on technology’s impact on product costs, product cycle theory was most important because it explained international investment. Not only did the theory recognize the mobility of capital across countries (breaking the traditional assumption of factor immobility), it shifted the focus from the country to the product. This made it important to match the product by its maturity stage with its production location to examine competitiveness.
Product cycle theory has many limitations. It is obviously most appropriate for technology-based products. These are the products that are most likely to experience the changes in production process as they grow and mature. Other products, either resource-based (such as minerals and other commodities) or services (which employ capital but mostly in the form of human capital), are not so easily characterized by stages of maturity. And product cycle theory is most relevant to products that eventually fall victim to mass production and therefore cheap labor forces, But, all things considered, product cycle theory served to breach a wide gap between the trade theories of old and the intellectual challenges of a new, more globally competitive market in which capital, technology, information, and firms themselves were more mobile.