Dunning's Model - Literature review Example

School: Topic: DUNNING’S OLI MODEL Lecturer: Introduction Due to expanding international market opportunities that have come about as a result of globalisation, the need for firms of appreciable size to seek international business expansion continues to emerge and become prominent for sustainable business development. However, when the quest for internationalisation arises, there are several factors that firms have to consider. In the opinion of Byrne and Popoff (2008), some of the most important considerations to make include the choice of destination, choice of governance forms and levels of activities to be engaged in. meanwhile, Douma and Schreuder (2012) noted that as far foreign direct investment (FDI) is the approach to internationalisation a company seeks, the eclectic paradigm, also known as the OLI (ownership, location, internalisation) model developed by John Dunning is one important framework that provides general paradigm for knowing the determinants of the FDI. In this paper, the strengths of the OLI model to the study of FDI are appreciated whiles examining the limitations of the model in designing an international corporate strategy for firms. By extension, the paper takes a stance that it is one thing to be engaged in internationalisation and another to have an international corporate strategy. This is because the latter is wider and covers several aspects of corporate growth and expansion management than the former (Li, Ferreira & Serra, 2009). Strengths of OLI model to the study of FDI There are several ways that the OLI model helps in influencing the study of FDI. On the whole, the model helps firms to make decision on becoming multinational by understanding the potential sources of advantages they have that could make them successful. The model is important in providing firms with an understanding of their ownership advantages, where the question of firm-specific qualities of the firm is addressed (Antras & Elhanan, 2004). Because the firm-specific advantages are tied around the company’s unique approach to doing business, it helps firms to identify their competitive advantage which allows them to overcome the cost of operating in international markets (Peng, 2001). Without applying the OLI model and for that matter ownership advantage therefore, it becomes difficult for firms to identify their competitive advantage with which they will become preferred options for consumers instead of their competitors. Secondly, the OLI model is relevant in helping firms identify location advantages, where the firms answer questions on the best places to choose for internationalisation (Neary, 2007). In doing this, there are several factors that are put into consideration to ensure that the selection of one location over the other will be seen as the best possible option. Some of the factors that are considered include availability of raw materials, cost of labour, and availability of special taxes and tariffs (Zaheer & Mosakowski, 1997). In effect, the OLI model has the strength of ensuring that multinational firms are able to avoid most forms of country risks by using the model as a framework or guide in making the most profitable selection by way of location. According to Dunning (1997), the location attractions of different countries vary and so it important for decisions on location to be made in ways that guarantee value adding activities for firms. What is more, the OLI model helps firms to have a detailed and critical study of FDI by understanding the internalisation advantages they are presented with whiles going international. By internalisation advantage, reference is made to the approach by which the firm chooses to operate in the foreign market (Markusen, 2002). Here, there are several forms of entry modes that Dunning (1997) considers. These include trading off savings in transactions, exports, licensing, and joint venture. However, greater focus of the OLI model has for long being on the use of Greenfield mode of FDI. The internalisation advantages therefore guides firms in weighing the benefits of making their production rather than producing through a partnership that is arranged through either licensing or joint venture (Li, Ferreira & Serra, 2009). In effect, the OLI model is useful for creating and exploiting core competencies associated with internalising cross-border markets (Huggins, Demirbag & Ratcheva, 2007). Limitations with the use of OLI model in designing international corporate strategy As stated in the introduction, it is one thing to engage in FDI and another to design an international corporate strategy. This is because even though international corporate strategy may involve components of internationalisation and for that matter FDI, it is a wider scope of business growth and expansion management that may require more options, approaches and innovative steps to international growth than merely going international (Burdon, Chelliah & Bhalla, 2009). For example even if a company chooses to go international or be engaged in FDI, it would have to ask a core question of how it can strategically position itself grow and expand. It is from this perspective that the OLI model can be found to have a number of limitations as it seems to be more focused and detailed with the study of FDI than international corporate strategy as a whole. Yeaple (2003) argued that one of the major limitations with using the OLI model in designing international corporate strategy is that it fails to cover or cater for alternative modes of entry other than Greenfield mode of FDI. Indeed, it is not just the OLI model but most other academic works on FDI tend to focus on Greenfield where parent companies construct new plant in a preferred host country (Byrne & Popoff (2008). Meanwhile, there continues to increasing preference for such other modes of entry as cross-border mergers, which is not captured by the OLI model. Apart from cross-border mergers, Peng (2001) also asserts that the OLI model does not directly address the distinction between horizontal and vertical motives for setting production plants in foreign countries even though it has a whole component of location advantages that looks at location attractions. This means that the limitation with the OLI model is that whiles addressing location advantages, it only emphasises on what the location has to offer without studying the motives for deciding to select one location over the other. Other models required in designing international corporate strategy To address the limitation of the OLI model identified above, it is important to add other models which ensure that as many variables and parameters of international corporate strategy as possible are catered for. Two such models include the Transaction cost model and Ansoff matrix, which have been briefly discussed below. Transaction cost internationalisation model Like the OLI model, the Transaction cost internationalisation model also covers the use of Greenfield mode of entry. However, because the Transaction cost model is based on behavioural theory of the firm and theory of the growth of the firms, it advocates firms use processes that gradually increase their international involvement (Zaheer & Mosakowski, 1997). By interpretation, the Transaction cost model embraces cross-border mergers through the use of firm’s engagement in a specific country’s market where sales subsidiaries and independent representatives are engaged as a means of having a thorough understanding of the market (Antras & Elhanan, 2004). As part of the theory of the growth of the firm, the company does not undertake the firm’s engagement with goal of eventually manufacturing in the international market at all cost. Rather, decision to build a plant and those go the Greenfield way only comes as an option based on the outcome of broad categories of considerations made including search and information cost, bargaining cost, and policing and enforcement costs. In effect, through the use of transaction cost approach, the limitation with cross-border merger is catered for since cross-border merger could be an option after the overall outcome of studying the international market. Ansoff matrix The Ansoff matrix has for long being used to construct alternative corporate growth strategies, including international corporate strategies. The validity of the Ansoff matrix in catering for the international corporate strategies of firms is in the fact that the makes provisions for looking for new markets were both existing products and new products may be introduced to (Barba et al., 2004). Meanwhile, this new market could be an international market. As seen in the diagram below, when used in designing international corporate strategy, the Ansoff matrix helps firms to address the limitation of horizontal and vertical motives for setting production plants. Figure 1: Ansoff matrix Source: Quick MBA (2013) This is because it presents companies with several corporate growth strategies that could either satisfy a horizontal motive or a vertical motive. For example horizontal motives occur when the firm locates its plant abroad with the aim of improving market access to foreign consumers. In this, the Ansoff matrix presents the growth strategy of diversification where new products will be introduced to new international markets. But to achieve the horizontal motive in this instance, it will be important that the company already have brand equity in the international market so that the aim of improving market access can be done easily (Douma & Schreuder, 2012). Vertical motive have also been noted to involve the aim of seeking lower production cost. For this the market development where the firm can introduce its existing products in other markets to new international markets is preferred. This is because the use of existing products requires lesser cost for research and development in succeeding with the product introduction (Huggins, Demirbag & Ratcheva, 2007). Conclusion The OLI model is indeed useful in studying FDI but FDI can only be said to be a subset of the larger international corporate strategy responsibility that companies have. When thinking about internationalisation, it is not just about the question of making physical presence through Greenfield mode of entry. Rather, cross-border mergers are also becoming very relevant and useful. Even more, the motive for locating production facilities is relevant in selecting the right corporate international growth strategy. It is for this reason that the OLI model will be said to have limitations in designing a holistic international corporate strategy. In order to curb the limitation, it is important that multinational companies going international or considering international business expansion opportunities add other models such as the Transaction cost model or use other frameworks such as the Ansoff matrix in having a broader view of the international market. 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