Lecture 4Theories of International Business

Dr Alex Newman

MGX9660: International Business Theory & Practice

OPENING CASE:

How did Spanish bank Santander become a common sight on British high streets?

FDI Vocabulary

• There are 2 kinds of international investment:

Foreign Portfolio Investment (FPI)> An investment in a portfolio of foreign securities

such as stocks and bonds that do not entail the active management of foreign assets. FPI is ‘foreign indirect investment’

Foreign Direct Investment (FDI)> Defined by the United Nations as involving

an equity stake of 10% or more in a foreign-based enterprise.

Horizontal FDI duplicates its home country-based activities at the same value chain stage in a host country through FDI

If a firm through FDI moves upstream or downstream in different value chain stages in a host country, we label this vertical FDI

MNE versus non-MNE• An MNE, by definition, is a firm that engages in FDI. Note

that non-MNE firms can also do business abroad by (1) exporting and importing, (2) licensing and franchising, (3) outsourcing, (4) engaging in FPI or other means.

• What sets MNEs apart from non-MNEs is FDI.

• In 1990, there were 37,000 MNEs, with 170,000 foreign affiliates.

• By 2009, more than 82 000 MNEs (more than double the 1990 number) managed about 810 000 foreign affiliates (almost five times the 1990 number). Clearly, there has been a proliferation of MNEs lately.

Top 10 economies for FDI outflows

Why do Firms Go International?• Resource seeking• Market seeking• Reconfiguring business portfolios• What are the new economic and trade

related issues that determine internationalisation process

Theory of Foreign Direct Investment• Firms expand across borders seeking

specific opportunities to earn profit• Opportunities:

Natural resourcesFactor advantages including cheap labourKnowledgeSecurity and risk minimisationMarkets

FDI Investment• John Batman bought 600,000 acres of land from

Aborigines in return for blankets, knives, looking glasses and scissors and flour.

• Promise of a rent by Batman gave him the right to select a site for the City of Melbourne

• FDI forms:– Purchase of assets in a foreign country– New investment in property, plant and equipment– Participation of a joint venture with a local partner

Internationalisation Theory• Firms internationalise for gradual and

increased involvement and commitment in international operations

• To integrate processes and efficiently use knowledge of foreign markets.

• A study of four Swedish firms

(Johanson & Vahlne, 1977)

Internationalisation Theory• Local market imperfections• Attractiveness of foreign markets

(Caves, 1971, Chen 2010)

• Firms internal capability• Economics of foreign markets

Welch & Loustarinen, 1988, 1993)

Dunning’s Eclectic Paradigm• Offers a unifying framework for determining the extent and

pattern of foreign owned activities.• It posits that multinational activities are driven by three sets of

advantages– Ownership– Location – Internalization

• This has later been termed as (OLI) model• It is the configuration of these sets of advantages that either

encourages or discourages a firm from undertaking foreign activities and becoming an MNE.

OLI Model

• O = Ownership Advantageso Firm Specific Advantages

• L = Location Advantageso Country Specific Advantages

• I = Internalization Advantageso Transaction costs advantages

O = Ownership Advantages

• Are related to firm Specific Advantages

• O - addresses the WHY question.– why does a Firm need to go abroad?

• This suggests that an MNE has one or more "firm specific advantages" (e.g. core competency) which allows a firm to overcome the costs and other impediments of operating in a foreign country.

Location Advantages• L = Location Advantages (Country Specific

Advantages) focus on the WHERE question [locate where?].

• The motive to move offshore is to use the firm's competitive advantage (core competency) in conjunction with factor advantages in a foreign country.

• Through these factors (e.g. labor, land), the MNE makes profits (earns rents) on its firm specific advantages

Internalization Advantages

• I=Internalization Advantages refer to the HOW or organizational question [how to go abroad?].

• A MNE has various choices of entry mode, ranging from the market (arm's length) transactions to the hierarchy (wholly owned subsidiary).

• If there is no potential market or if the market functions poorly, transaction costs can make the business unviable.

• Transaction costs can be kept in check through internalization.

OLI• When Dunning wrote his original work, manufacturing and trade

was the main focus of MNE activity.– (providing most of the basis for the ‘O’ and ‘L’ aspects).

• The ‘make-or-buy’ decision was the main focus of MNE strategy.– (the main basis of the ‘I’ aspect).

• Three decades later, most MNEs value creation is related, directly or indirectly, to knowledge management.

• A major source of MNE competitive advantage resides in the value-creating potential of relationships, i.e., critical resources that span its boundaries and are embedded in inter-firm routines and procedures.

OLI• O= Ownership issues will increasingly revolve around

issues of intangible assets and intellectual property rights (IPR).

• L= The governance of IPR will dominate location issues, just as property rights and the rule of law

dominated FDI flows over the previous half century.• I= Internalization issues are related to managing the risk

associated with ever-larger R&D budgets required by a higher technological frontier, as well as reconciling the conflict between the bureaucracy of large MNEs and the creative environment required for knowledge production and use.

Two Different Types of FDI

1. Resource seekingo Investments are made in order to establish access to

basic material like raw materials or other input factors2. Market seeking

o Investments are made to enter an existing market or establish a new market.

Table 6.3

The 15 Largest

Sovereign Wealth Funds

Transaction Costs?• The costs, other than price, incurred in the process

of exchanging goods and services.• These costs include the costs of negotiating and

enforcing contracts, and the costs of collecting charges for goods and services provided.

• The scale of economic and financial transactions costs can affect the market structure for a good.

Transaction cost theory, proposed by Ronald Coase, 1937, and Oliver Williamson, 1985

Transaction Costs

• People began to organise their production in firms when the transaction cost of coordinating production through the market exchange, given imperfect information, is greater than within the firm.

Ronald Coase, 1937

The Internationalisation Process • The stage model of internationalisation

1. The Uppsala internationalisation model (U-model)

1. Innovation-related internationalisation model (I- model)

Cavusgil, 1980 Johanson & Vahlne, 1977Welch & Luostarinen, 1988

Internationalisation Theory (Uppsala-Model –U model)

• International expansion is influenced strongly by managerial learning

• Internationalisation begins with low risk indirect exporting to psychically or culturally close or similar markets.

• Over time and through experience, a firm’s foreign market knowledge improves and, consequently, it increases its foreign market commitment and expands to more psychically distant markets.

Johanson & Vahlne, 1977

Stage Model U-Model

• Johanson and Wiedersheim-Paul (1975) distinguished four level of international market entry :

Stage 1: no export activities Stage 2: export via an independent representative or agent Stage 3: the establishment of an overseas sales subsidiary Stage 4: the installation of overseas production or

manufacturing units.

Core Assumption of the Model is that Increased Market Knowledgewill lead to increased market commitment

Enhances

knowledge,

improves

cultural understand

ing

I Model – Innovation-related Model• Domestic market stage- the firm has no initial

interest in overseas activities1. Pre-export stage- internal and external stimuli arouse

exporting interest2. Limited Experimental involvement stage- a move toward

an indirect export strategy that will only involve a small amount of the firm output,

3. Active involvement stage- move toward direct exports and expanding the volume of product exported, and

4. Committed involvement stage- the firm is a committed participant in international activity and allocates resources between domestic and foreign markets.

Cavusgil, 1980

I-Model• The firms in each of the four stages are defined in the

following way:• Stage 1: Non-exporting firms, not interested in gathering

export-related information• Stage 2: Non-exporting firms, interested in gathering export-

related information (roughly correspond to ”preinvolvement stage”)

• Stage 3: Exporting firms, export less than 10% of their output. (correspond to “limited experimental involvement stage), and

• Stage 4: Exporting firms, export more than 10% of their output. (correspond to “ active involvement stage”)

•  

Born Global• Internationalisation because of

technological advances in transportation, communication, and computers permit entrepreneurial actors to form new ventures that internationalize rapidly.

Knight & Cavusgil, 1996 McDougall, Shane, & Oviatt, 1994

1. International new ventures2. Global start ups3. Instant exporters

Types

Born Global Businesses

• Seek growth via market diversification.• Earn higher profits from lucrative foreign markets• Better serve existing customers who have located abroad• Gain economies of scale in production and marketing• Amortize the costs of product development and

marketing across many markets• Obtain new product ideas from foreign settings, and

confront competitors more effectively in competitors’ home market.

Characteristics of Born Global Firms

• Highly active in international markets from inception• Characterized by limited financial and tangible resources• Found Across most industries• Managers have strong international outlook and international

entrepreneurial orientation• Often emphasize differentiation strategy• Often emphasize superior product quality• Leverage advanced communications and information technologies• Typically use external, independent intermediaries for distribution in

foreign markets.

Cavusgil & Knight, 2009

Investment Development Path (IDP)

• A framework for looking at the relationships between inward foreign direct investment (FDI) by TNCs, outward FDI by domestic firms and economic development by the host country

• The central idea of the IDP that foreign TNCs might help indigenous firms to upgrade their capabilities is firmly grounded at the micro or firm-specific level (Dunning, 1981, 1988).

• Research on the IDP does not explore, in any detail, the mechanisms by which inward FDI prompts domestic host country firms to upgrade their own ownership (O) advantages and ultimately become outward investors themselves.

• How does IDP influence the process of upgrading of resources and capabilities at the level of the firm as a result of foreign affiliate and domestic firm interaction.

• A theoretical investigation of the types of non-equity resource transmission mechanisms (inter-firm linkages), and how these influence the ownership-location-internalization (OLI) configuration of a host economy and the subsequent progression through the stages of the IDP.