MGT 3220International Operations

Management

Week 3 Economic Theories of Internationalization

Economic Theories of Internationalization

• Raymond Vernon’s Product Life Cycle • John Dunning’s Eclectic Paradigm • Michael Porter’s Competitive Advantage of

Nations

Dunning’s Eclectic Paradigm

Three types of advantage needed to explain FDI:

Dunning’s Eclectic Paradigm• Ownership Advantage: creates a monopolistic advantage

which can be used to prevail in markets abroad

How does a firm overcome disadvantage of operating abroad?

- something unique to the firm – COMPETITIVE ADVANTAGE

- e.g., brand, superior technology, economies of scale, management know-how

Workshop Exercise 1

• Select a company and • Discuss their ownership advantage

Dunning’s Eclectic Paradigm• Internalization Advantage: transaction costs of an

arms-length relationship – licensing, exports – higher than managing the activity within the MNE’s boundaries

Why not exploit ownership advantage via the market?

e.g., license technology to local firm- get paid for the technology- let someone else take the risks.

Why not license technology to local firm?

Imperfections in the market for knowledge:• Problems of intangible assets• Knowledge as a public good – hard to exclude

others from its benefits• Property rights problems

- knowledge tends to be leaky.• Buyer uncertainty – how do you agree a price?

Dunning’s Eclectic Paradigm• Location Advantage: the FDI destination local market must

offer factors that it is advantageous for the firm to locate its investment there.

Why are production facilities established by MNEs in particular countries?

Need to use factor inputs in other countries because of: - transport costs - labour costs - raw material costs - import controls etc.

Workshop Exercise Continued

• Please explain the location advantage of a country that you believe is the best suitable place to internationalize

• Please think about how to internalize

Advantages of the Eclectic Paradigm

• Draws on several modern developments in theory of FDI

• Permits simple analysis of FDI (just 3 factors)

• Explains all 3 main methods of exploiting foreign markets:– FDI– Trade– Licensing

Decision framework

How high are transportation costs

and tariffs?

Is know-how amenable to licensing?

Is tight control over foreign operation required?

Can know-how be protected by licensing contract?

Then license

Export

No

Yes

Yes

Low

No

Yes

No

FDI

FDI

FDI

High

1. Modes of International OperationDunning’s Eclectic Paradigm

  Ownership Internalization Location

FDI Yes Yes Yes

Export Yes Yes No

License Yes No No

Weaknesses of Eclectic Paradigm

• A shopping list – listing of variables with limited predictive power

• Are OLI variables really independent?

• Static, not dynamic

• Cannot explain conglomerate MNEs

Exporting Exporting - producing goods at home and then shipping them

to the receiving country for sale

• Advantages:– Avoids cost of establishing manufacturing operations– May help achieve experience curve and location economies

• Disadvantages:– May compete with low-cost location manufacturers– Possible high transportation costs– Tariff barriers– Possible lack of control over marketing reps

Licensing

• Firm with some proprietary know-how allows another firm exclusive rights to its use in return for payment.

In other words;

• Agreement where licensor grants rights to intangible property to another entity for a specified period of time in return for royalties.

Licensing versus FDI• Advantages:

– Profit from know-how while licensee takes the risk of selling in foreign markets.

– Lowers initial costs of entering market– May be only way to enter some markets

• Disadvantages:– Reduces control over all stages of production harder to achieve

location economies– Problems of knowledge seen in week 2

Impediments to the sale of know-how

Impediments to the sale of know

how

Risk giving away know-

how to competitors

Licensing implies low control over

foreign entityKnow-how not amenable to

licensing

Licensing versus FDINecessary conditions:• Clear protection of property rights (e.g. patent)

(bundle of legal rights over using and earning income from a resource or asset)

• Markets can be segmentedi.e. prevent licensees competing with each other

IF ONE OR BOTH NOT SATISFIED, FDI PREFERABLE TO LICENSING

Workshop Exercise

• Please define a method of entry for the company and location you have chosen as a group.

• Please explain the reasons based on the slides above.

2. Strategies of International Business

Two key forms of competitive pressure:• Reduce costs• Be responsible to local needs/tastes

Pressures for cost reductions force the firm to lower unit costs, but pressure for local responsiveness require the firm to adapt its product to meet local demands in each market—a strategy that raises costs

Reduce (Unit) Costs• Economies of scale

(lower unit costs as output increases) – shows costs at a point in time.

• Learning curve (lower unit costs as cumulative output increases) – shows costs through time

Pressure to be locally responsive

• Cultural issues• Variations in consumer tastes• Variations in infrastructure• Distribution channels• Government pressure

Workshop Exercise Contd…

• Please explain whether the company you have chosen should follow a cost reduction strategy or a locally responsive strategy.