Dunnings OLI Model Is Incapable of Fully Designing an International Corporate Strategy - Essay Example

DUNNING’S OLI MODEL IS INCAPABLE OF FULLY DESIGNING AN INTERNATIONAL CORPORATE STRATEGY Introduction OLI stands for Ownership, Location and Internalization; they are the three core sources of advantages, which underlie a companys decision to be multinational. Eclectic or OLI is an approach to studying a foreign direct investment (FDI). John Dunning developed the model (Faeth, 2009). It has to some extent proved useful in explaining the multinational enterprises (MNEs); it has also inspired some great work in international businesses and economics. In itself has no formal theory that can be served in the scientific way of analyzing data (Beugelsdijk, 2012). The above approach neglects critical issues, which are critical in defining a multinational firm. The model has three areas where its main advantages are based, that is; Ownership It has its advantages in explaining the MNEs existence. Ownership has its advantages in the sense that it addresses the question of why that some firms will go abroad and not others, it postulates that there are some benefits that allow it to overpower the cost of operating abroad. Since firms are the collection of different assets and MNEs candidate has a higher-than-average asset level to have an internal public goods character. The assets can be used in the production in various areas without reduction of their effectiveness. The assets include product dimensional factor, common to model in terms of a single index of the production of the firm. The highest sophisticated treatment in these lines is found in immediate work on non-homogeneous firms that combines the horizontal simplest version motive for FDI, with an assumption of their productivity differences (Faeth, 2009). The OLI model has an aspect to pay a sunk cost in productivity determination. Low-production can be produced only for the purposes of the home market; while medium productivity ones are chosen to pay for export fixed costs, but the most productive ones chosen to pay for higher costs for FDI engagements. The above predictions are in accordance with the evidence. On a further contribution, the model provides that industries with greater heterogeneities have more firms engaged in the FDI. Locations Location advantages address the question of where the firm chooses to locate. Though the theory of international trade has taken ownership advantages just for granted, to make them in more obvious ways, this model has emphasized more on exploration of alternative motives to be located by MNEs abroad. The major factor that has created much attention is the clear distinction between vertical and horizontal FDI. Horizontal FDI happens when company locates a plant abroad for it to improve its foreign customers’ market access. In simple terms, this replicates facilities of domestic production at the foreign location (Gong, 2013). Vertical FDI is not primarily aimed at the sale of production in a foreign market but seeks to avail low production cost. In all the cases, the mother firm maintains its headquarters in home country, and the ownership or firm-specific advantages ensure flow of headquarter services to plant’s host country, this is in accordance with firms’ vertical FDI, though the distinction between cost motives and market-access for FDI is crucial. The horizontal FDI motive reflects to the proximity concentration trade-off; which entails local plant building, which saves the trade costs and has an advantage of proximity, but loses the benefits of production concentration in home plant firm. The vertical FDI motive has a different view of determinants together with implications of FDI. The firm focuses on how to it can adequately serve the home market, by either vertically integrating or producing at home and moving its facilities of production to areas of lower foreign cost. For simplicity, each output unit operates at a state with a single unit of labor. In the above element, the aspect of determining fully and explain satisfactorily determinants of foreign direct investment in designing an international corporate strategy is not realized. Internationalization Finally, internalization addresses the question, how the firm chooses to operate abroad. The firm’s propensity depends on the OLI advantages, which may vary from time to time. The market collaboration and failure, competitive advantages and dynamic environments should be incorporated in the model making decisions on international production. Internationalization reflects a balance between the organizational costs and transaction costs of running a firm. In recent past economists who were in the information economics tried to endogenize the two sources of cost, by emphasizing on the agents’ inability to write contracts that are complete. The research production model carried out in 1986, gives the results, which can either be demonstrated within a firm integrated vertically or sold to users downstream. However, the final user of the research should agree to purchase it before the outcome is known. The model demonstrates a greater degree of uncertainty in this aspect, and there is a likely outcome of the efforts of research that makes it expensive downstream and upstream firms, in writing a contract, where due to the complexity of the process must be outcome independent. The more the uncertainty, the higher the chances of production being vertically integrated via MNEs, this reduces its reliability. The emergence of MNEs did not require an international difference in aspects of price, as other vertical FDI models (Kalamova and Konrad, 2010). A different approach of endogenizing internalization decision that relied on incomplete contracts was also done. When the property rights approach was done to simplify the problem of bargaining in the potential employee/supplier and the firm owner, it was found that the post efficiency was greater when the residual rights ownership is allocated to the a party which accounts for more in the final output. In the model there is the product differentiation and trade, this shows that more and more efficient firms which are relying much on the headquarter services should exhibit internalization, that is; supplier is contracted by the owner who for that case is the employee. The fewer efficient companies present arms-length trade, that is; the supplier is always an isolated legal entity. The model has an assumption that the final-goods producers only located in one nation. For such a case, producers are postulated to possess a two-fold choice, that is; they have in one hand to choose the vertical integration that will solve the hold-up problems but at the expense of reducing the incentives to the input provider and in an arms-length basis. On the other hand, they should choose the production in their native country, by trading-off wages, which are high to the north against the lower contract protection on the lower side. The OLI framework and FDI academic work, which is the bulk, has been primarily concentrating on the Greenfield FDI mode where the mother firm establishes another firm on the host nation (Song, 2014). Though in truth the bulk of the FDI in the developed countries takes a cross-border (M&As) mergers and acquisitions, where parent firm will acquire a controlling interest in a host country firm that has been existing over time. The distinction factors from the research show that the implications and the determinants of the cross-border (M&As) are very different as compared to those of the Greenfield FDI. There are two primary motives associated with the domestic M&As, that is; the synergy motive that arises from the market in which the assets firm has acquired are complimentary to the ones of the acquirer. The other motive is referred to as the strategic that arises from an oligopolistic market, that is; the competitors’ number is small, since the firm gains a lot from absorbing its rival and thus increasing its market power. The after-merger synergies can occur from many sources, which include cost savings through internal transfer of technology, overhead reductions and the other fixed costs and integrating the marketing and the pricing decisions on products differentiation. In a context of the open economy, a particular plausible type of synergy occurs of ‘O and ‘L advantages of various firms. The international networks and the superior productivity of acquiring an MNE to the hand, which is combined with the distribution and the local knowledge system of the potentially targeted firm. A better model should be developed which captures the synergy where the competitive international market in corporate assets permits the company to rhyme with the affiliates that are suitable. The model should be able to predict the efficient matching to occur where more efficient mother companies acquire targets, which are more effective. They should be able to show how the most efficient companies engage in Greenfield FDI and not in the M&As cross-borders, due to their consistent in evidence (Beugelsdijk, 2012). Mergers are driven by synergies that can be expected to hype world welfare since they can be practically realized. In contrast, mergers that are executed by strategic considerations can be expected to lower the welfare as they are bound to increase in concentration. This approach is incomplete for two primary reasons. First, without synergies, mergers that will surface at equilibrium are those which acquirer can afford to purchase but out the targeted firm. Secondly, at a general equilibrium, the increase of more effective acquiring firms and the reduction of less efficient targeted firms pull pressure downward on the wages, which encourages the rise in output, and reduce the prices in all other sectors. Mergers are possibly likely to increase the overall welfare of the firm though the distribution shifts in income favor the profits at the cost of wages. This model, though it makes a definite prediction in the sense that they assume same direction with trade, thus they should be encouraged more than being discouraged to some extent. As in the empirical evidence mergers serve as comparative advantage instruments promoting more commerce and specialization along the lines of comparative advantages (Lemi, 2013). The model of OLI approach, though has some advantages over some other models, it has some shortcomings in the sense that it cannot sufficiently determine or predict the outcome of a foreign corporate strategy. The model is based on prediction of the outcome of the emergence of MNEs in regard to the internalization advantage. The aforementioned might not be the case since the prevailing market forces, cultural beliefs; political influence of the foreign country may interfere with the outcome (Wamser, 2011). The uncertainty associated with this model will not make it the best in researching or predicting for the foreign corporate strategy. The model also is skewed to the aspect of internalization where it relies on the equilibrium of the manufacturing and labor market. The manufacturing equilibrium has three-stage production, involving; research, which is quite unpredictable. It also has an upstream production and the downstream production, primarily depending on the factors prevailing in the both countries. The labor market equilibrium may also vary from one place to another; this aspect makes the OLI model to be a bit sufficient way of predicting the probable outcome of the corporate strategy in a foreign country. The OLI model has a theory, which is based on, the theory postulates that the firm’s incentives should go to multinational. There is another conflicting factor in this theory called arm’s length transaction; this assumes a contract will exist between two firms, which are independent. The two firms can either be one from the foreign country and the other in the mother country, where one can be research upstream and the other research down-stream. The multinational is the operating from the foreign country while the arms length is the one operating from the home country. The two effectively works together; they depend on the initial specialization in each sector determined by relative factor intensities (Lundan, 2014). When instance, the relative factors are not agreeing with the prevailing demands, then the predicted outcome will not be accurate to the actual results. The factor above will make the OLI model the best and finest in designing the foreign-based corporate strategy. Again, the same factor will also depend on other external forces from the respective locations since different people inhabit the two geographical areas. There are high chances of poor compatibility of the taste from the two areas; this challenge will pose a great obstacle before the new customers develop the taste of the product. The model does not also give the predictions of the probable alternative if the corporate fails for the first trial, there is a lot of uncertainties when using this model. Again, the OLI model postulates the use of the multinational operations in two places where there are existence of the similar relative factors, this implies that for two places with no such similar parameters the model will be limited and will not be able to give the probable outcome. The above is also rare case to be found in an ordinary world where two different countries are exhibiting similar relative factors; this aspect primarily limits this model in the designing of a corporate strategy in a foreign country. The factors such as land, labor or capital are very hard to have them being relatively similar in two different countries due to many other factors, which affect them. The factors such as land, capital or land are affected by other factors like population, nation’s economic status and probably the birth rate. For the aforementioned factors to be relatively similar in two different nations the chances are very slim, this will make the model to insufficient to be used to design a corporate strategy for the foreign country due to considerable uncertainty posed by this model (Wang, 2012). The model requires a lot the skilled workmanship and a lot of the know-how from the given field. The inequality in this aspect in both countries will make the working of the firms be complicated in that there is uneven capital requirement. The other factor making the model to be less reliable is the fact that the knowledge capital is most concentrated in the developed countries, this aspect will prove difficult for a multinational corporate being established in two nations where one is in the developing category and the in the developed one (Wamser, 2011). The OLI model failed to grasp the fact that the some direct investments comes due to the aspect of the dissimilarities posed by factor intensities. The other factor limiting this model is that there is one wage rate for all sectors of the firm; this inhibits the aspect of working hard by the employees, since the ultimate remuneration are the same and this may indirectly bring out the tendency of the poor knowledge management in the firm. The aspect of one wage rate across different sector may also demoralize employees who may feel that some areas should be considered for special treatment, like areas where hardships allowance should be offered as compared the other fields where employees are more satisfied. In such cases the employees in the place where they feel uncomfortable, they will lack incentive of working hard, this may adversely affect the firm’s production. The above limitations will hinder a smooth running and will pose some challenge in designing an international corporate strategy. Apart from OLI model, there are other models, which are also limited in a way in addressing satisfactorily how to design an international corporate strategy as compared to the OLI model. The model only addresses some aspects while neglecting others. These models include; The OC Model The OC is an abbreviation of organization capacity; it is based on the theory of organization. It refers largely on knowledge and capabilities where personal skills, technology and organization are woven together. The model postulates that the issues relating to the firm’s boundary, entry mode decision are related to the capability and is based on calculus governed by development and deployment related considerations. The organization or firm’s capability is considered for entry mode in choice of decision-making (Lundan, 2014). The only limitations on this model are that the traditional assumptions that individual capacity of the firm is limited to the level of ownership, which is invalid when decisions of firm’s efficiency do. The limitation shows that a strategy depends on the organizations capability as well as organization efficiency. The model neglects the decision-maker impacts as well as political and social factors. The DMP model DMP is an abbreviation of the decision-making process. It suggests that one should treat the entry mode choice as a multistage process of making a decision. In the decision-making process diverse factors, like aims of the given market entry, associated costs and risks and existing environment. Focusing on optimization of decision-making and not on the exploring the factors that might affect their entry mode choice impact, this model is more practical on this aspect (Lundan, 2013). The model ignores the role played by the organization and the one of the decision maker in a decision-making process. The SD model SD or stage of development model is also referred to as U model. It was developed when studying strategies of internalization of Small and Medium Enterprises (SMEs). The model argues that SME internalization is slow, long and incremental procedure with two dimensions; cultural or geographical expansion and commitment. The approach was used to explain entry mode decisions of the market. It is argued that the entry mode depends on firm’s development stage. The only shortcoming of this model provides feasible entry modes not the right ones, since it does not satisfactorily explain why firms that are newly established starts entry with owned venture and not export (Sauvant and Pradhan, 2010). The TCA model TCA means Transaction Cost Analysis; it is based on economies of transaction cost as a tool to explain problems of economics where an asset plays a key role. Under this hypothesis, the structure of organization and design is found by minimizing costs of the transaction. MNEs rely on the specific market mode entry that maximizes efficiency of a long-term transaction that is risk-adjusted. This model choice depends on the four constructs determining the optimal control degree. The four constructs include; transaction-specific asset, free riding potential, internal uncertainty and internal uncertainty (Spero and Hart, 2010). The entry modes are evaluated by control level. Conclusion When the OLI model is thoroughly studied, it has some shortcoming or limitations that are not adequately addressed, this gives a chance for another model to be devised to address the satisfactorily all the shortcomings. Thus, OLI being considered as the best paradigm of determining the foreign direct investment, it does not fully address every factor, thus limiting it, which can affect designing of an international corporate strategy. References Beugelsdijk, S. (2012). Firms in the international economy. Faeth, I. (2009). DIRECT INVESTMENT DETERMINANTS - A TALE OF NINE THEORETICAL MODELS. Journal of Economic Surveys, 23(1), pp.165-196. Gong, Y. (2013). Global operations strategy. Berlin: Springer. Kalamova, M. and Konrad, K. (2010). Nation Brands and Foreign Direct Investment*. Kyklos, 63(3), pp.400-431. Lemi, A. (2013). Foreign Aid, Foreign Direct Investment and Governance in Africa. SSRN Journal. Lundan, S. (2014). Transnational Corporations and Transnational Governance. Palgrave Macmillan. Lundan, S. (2013.). Transnational corporations and transnational governance. Sauvant, K. and Pradhan, J. (2010). The rise of Indian multinationals. New York: Palgrave Macmillan. Song, J. (2014). A Comparative Study on Competitiveness of Major International and Korean Contractors in International using OLI+S model. jkpa, 49(4). Spero, J. and Hart, J. (2010). The politics of international economic relations. Boston, MA: Wadsworth Cengage Learning. Wamser, G. (2011). Foreign (in)direct investment and corporate taxation. Canadian Journal of Economics/Revue canadienne conomique, 44(4), pp.1497-1524. Wang, X. (2012). Foreign Portfolio Investment and Informativeness of Foreign Direct Investment. SSRN Journal. Read More