Multinational Business: the Dunnings Eclectic Paradigm - Term Paper Example

?Dunning’s Eclectic Paradigm Introduction 2 Academic Literature 2 Ownership-Specific Advantages 3 Internalization Advantages 4 Location Specific Advantages 5 Critical evaluation 6 Comparison with other theories 8 Conclusion 9 References 10 Bibliography 12 Table of Contents Introduction 3 Academic Literature 3 Ownership-Specific Advantages 4 Internalization Advantages 5 Location Specific Advantages 6 Critical evaluation 7 Comparison with other theories 9 Conclusion 10 References 11 Bibliography 12 Introduction Investment in foreign land by the multinational firms has been a major issue of discussion over the past decades. Over the years researchers have tried to identify various crucial aspects of ‘international production’ by developing various models. The main objective of such models or theories was to explain the activities of the organizations that are already operative or want to be operative in multiple numbers of nations. At the present economic environment such theories and models are considered to be very important as the importance of multinational organizations to the global economy has increased significantly. Dunning’s eclectic paradigm theory is one of the most widely discussed theories in the world of international production. This paper attempts to present a clear description of this theory and several of its dimensions. The paper also includes a proper analysis of the criticisms that the Dunning’s model has faced over the years. There are several other theories on the similar subject and Dunning’s theory can be compared with those to analysis the effectiveness of it. This paper includes such a comparative analysis that is likely to help an individual to have a clear conception regarding the entire picture of such theories. Academic Literature John H Dunning is famous in the international business arena for his ‘Eclectic Paradigm’ theory. It is actually the integration of several theories on internationalization. It covers many mainstream theories such as Ohlin and Heckscher’s ‘factor endowment theory’, Coase’s ‘trasaction cost theory’, Hymer’s ‘monopolistic advantage theory’ and ‘internalization theory’ of Casson and Buckley. In 1976, Dunning presented the core concept of eclectic paradigm at Nobel Symposium which is located in Stockholm. The theory explains precisely why a firm should go global. Dunning attempted to provide a clear and complete explanation regarding international production. He has consistently supplemented and improved his theory in accordance to various developments in the global economic environment and also in accordance to several constructive criticisms. Dunning opined that there are three conditions that have significant influence over the firm’s decision regarding transnational production. In other words, a firm will involve in ‘international production’ if these three conditions are met. The three conditions are 1) ‘ownership-specific advantages’, 2) ‘internalization advantages’ and 3) ‘location specific advantages’ (Dicken, 2007). Each of them is properly described below. Ownership-Specific Advantages According to Dunning, an organization must have some ownership specific advantages which are not possessed by the rival organizations of other countries. The basis of this theory of Dunning lies in the ‘Monopolistic Advantage Theory’ that was developed by Hymer. According to Dunning, ownership specific advantages “must be sufficient to compensate for the costs of setting up and operating a foreign value-adding operation in addition to those faced by indigenous producers or potential producers” (Dunning, 1981). These advantages are like ‘internal assets’ of a firm which is the sole owner of them. Ownership specific advantages can be gained from the factors like technology, knowledge, internal brands, human resources etc. (Dicken, 2007). In the words of Dunning, ownership specific advantages “need not arise from multinationality” (Perry, 1992). These advantages must be exploited in the most suitable way by the firm for the betterment of its own rather than leasing or even selling them to other organizations. In his early paper regarding eclectic paradigm, Dunning explained about three different types of ownership specific advantages. The first type of advantage is the result of the privileged possession of some income generating assets. The second type of advantage arise from the comparison of the firm with a new one and the last type of advantage is enjoyed due to geographical diversification (Dunning, 1988). Later Dunning has broken the concept of ownership specific advantages into two new concepts which are ownership transaction advantage and ownership asset advantage. Ownership asset advantage comes from the proprietary ownership of some specific assets like property rights, trademark, goodwill, management expertise and innovative technologies. It is important to notice that each of these is intangible asset. The ownership transaction advantage, on the other side arises from the capability of a firm of capturing transactional benefits by reducing the transactional costs at the time of international production. A useful example of ownership specific advantages can be presented in the context of Huawei Technologies Corporation which is a renowned Chinese company. The ownership advantages in case of Huawei are comprised of two components – inborn advantages and acquired advantages. High efficiency, low cost and differentiation are the three major inborn advantages that Huawei has been enjoying over the years. The low cost related advantage is derived from the effective research and development programs. Technology has been a key generator for acquired advantages and it is also a consequence of significant emphasis on R&D. In fact it is observed that almost 48% of the company’s total employee strength is allocated in the R&D (Zhu, 2008). Internalization Advantages Dunning’s theory of ‘internalization advantages’ is developed on the basis of the internalization theory that was proposed by Casson and Buckley. Some experts believe that it is the most abstract part of the eclectic paradigm theory (Zhu, 2008). ‘Internalization advantages’ is referred to the ability of a firm to internalize its ownership specific advantages efficiently for lowering the transaction cost at the time of international production. The degree of internalization of ownership specific advantages depends on the degree of uncertainty in the environment where the firm is operating. ‘Knowledge’ is one area where internalization happens significantly. Huge volume of investment is made by the firms in areas like knowledge and technology. In order to gain maximum out of these investments, firms develop effective incentive policies so that the technology and knowledge base are used within the organizational boundaries only. Instead of leasing or selling the new technology to a foreign firm, they establish their own production facilities where newly innovated technologies can be exploited (Dicken, 2007). Again, the internalization advantages can be further explained in the context of Huawei Technology Corporation. When the company stepped in the markets of emerging economies of Africa, Asia and Latin America, they already had the ‘ownership specific advantages’. In order to internalize the knowledge and technology in these new markets, the company developed training centres and technology support centres. For instance, Huawei has developed a training and technology support centre in Abuja (capital of Nigeria). It is known to be the largest of its kind in the African continent and the company has invested almost 10 million USD for it. The main purpose behind such a huge development was to internalize the local knowledge and technologies (Huawei News, 2006). Thousands of local technical workers are employed by the company not just to enjoy the low cost advantage but to keep away from uncertainty and loss which are likely to arise from the transactions that involve external markets. Location Specific Advantages Being a multinational organization, every firm has to decide on the country where it would set up its production facility. The ‘location specific advantages’ of eclectic theory indicate that a firm will involve in production in foreign land when it realizes that it will be able to combine the intermediate goods that are ‘spatially transferable’ from the domestic nation with the other intermediate goods or immobile factor endowments in another nation (Dunning, 1988). Location specific advantages are referred to those factors which are “specific in origin to particular locations and have to be used in those locations” (Dicken, 2007). Major location specific factors include markets, production costs, cultural and political conditions. In fact location specific advantages are divided into four categories – 1) natural resources advantages, 2) economic environmental advantages, 3) social and cultural advantages and 4) legal and political environment (Dunning, 1988). Example of natural resources advantages includes the spatial distribution of various resources like energy and raw materials. Whereas, example of economic environmental advantages include the availability, productivity and skill of human resources, price of inputs, availability of semi finished goods and accessibility of required infrastructure. Recently British Petroleum (BP) has made a joint venture with the India based Reliance Industries Limited to capture into the natural gas market in India. Now, BP has to make the best out of the facilities that are solely available in India and these facilities cannot be changed by BP. It has to use local man power, inputs and infrastructures. It has to take advantage of skilled labour of India and natural has blocks which are available in India. Critical evaluation Like other theories, Dunning’s eclectic theory has also been criticized over the year by several experts. First of all it is argued that the variables that are recognized in the eclectic paradigm theory are ‘too numerous’ and hence the predictive value of paradigm is next to zero (Pitelis and Sugden 2002). While denying this criticism, Dunning has said that every single variable of the paradigm is established on the basis of economic theory. In order to support his views, Dunning has also explained that the main objective of developing the paradigm theory is not offering a detailed explanation of every aspect of international production rather it is aimed to develop a methodology and a general set of variables that include the ingredients which are required to explain any specific kind of value-added activity in the foreign land (Pitelis and Sugden 2002). An expert like Perlitz, however, has argued that it is very difficult to bring several variables like OLI together. According to him, Dunning has tried to merge the ‘management decision data’ with the ‘macro-economic data’. He believes that without establishing any specific link such merger is not feasible. There are experts like Casson who has questioned the necessity of ‘ownership specific advantages’ in the paradigm theory. Casson has opined that the combination of two variables which are ‘location specific advantages’ and ‘internalization’ is sufficient enough for explaining the activities of the multinational organizations. He has further argued that Dunning has given too much importance on the supposition that multinational enterprises incur extra costs while doing business in foreign nations. Casson believes that all such costs have to be considered as a “simple one component of the overall cost of integrating activities in different countries, and it is only the overall cost that is crucial to the theory” (Jones, 1996, pp 13) Casson also believes that the type of ownership advantages that are gained from the control over various intangible assets are less required in the overall theory. Like Casson, Itaki also believes that the aspect of ownership specific advantages is less important as compared to the other two variables (Margardt, 2009). Kiyoshi Kojima has criticized the Dunning’s eclectic paradigm by saying that it is a micro-economic phenomenon. However, Dunning believes that eclectic paradigms and internalization are the similar phenomenon to Kojima. Furthermore, Dunning has admitted that Kojima’s macro-economic concept is quite different from that of him (Dunning, 2000). Another important criticism that the eclectic paradigm theory has been facing over the years is in the form of ‘plagiarism’. In simple words, it is believed by some experts that Dunning has brought nothing new in the form of eclectic paradigm and its variables (Margardt, 2009). Perlitz has opined that the three variables were already presented in the Hymer’s theory of monopolistic advantage. However, according to Schmid and Kutschker, Hymer mainly emphasized on the ownership specific advantages; although they have also admitted that the aspects of location advantages and internationalization were mentioned indirectly by Hymer in his theory (Margardt, 2009). In addition to these, there are scientists who think that one cannot take into account the set of sub-paradigms or variables separately. In this regard, Holtbrugge and Welge have stated that after a certain period location advantages can transform into ownership advantages. In fact, Dunning has admitted this aspect and said that the interdependence among the three variables can be considered critical (Margardt, 2009). Comparison with other theories It is already discussed earlier that Dunning’s eclectic paradigm theory is influenced by several other theories that are associated with international production. In order to understand the entire scenario, some of the important theories can be compared with the eclectic paradigm theory. It is observed that up till 1960, economists used to follow the factor endowment theory that was presented by Ohlin and Heckscher in order to explain the global capital movement. The theory was based on traditional theorems where competition was considered to be perfect in nature. In 1960, this was challenged by Hymer in his theory of ‘monopolistic advantage’. In this theory it is assumed that competition is imperfect and multinational firms possess some ‘unique monopolistic advantages’ that are not possessed by the firms based on foreign countries. Different types of monopolistic advantages that these firms can enjoy are superiority in knowledge and management skills, accessibility to inputs, economies of scale, product differentiation and production efficiency. In addition to this theory there is another theory which is very crucial in regards to international production and this is the internalization theory of Buckley and Casson. This theory explains the reasons behind the internalization of intermediate product markets by a firm. It argues that the firm intends to retain the monopolistic advantages within it in order to deal with transaction cost and imperfect competition. According to Casson and Buckley, internationalization and internalization are closely related to each other as the first one can be seen as a by-product of the second one in an imperfect market. It is found that most of the experts have accepted this theory. However, it is still argued that lowering of transaction cost is not the only reason behind the internationalization of firms. Furthermore, it is assumed that the firms can involve in international transactions at any time, but in reality this may not be the situation (Klug, 2006). Dunning’s eclectic theory is the result of combination of these above mentioned theories. However, Dunning has modified this theories based on the criticisms that they have received. In fact, he had to modify the earlier version of his own theory so that it stays in alignment with the modern developments in the economic world as well as answers the criticisms properly. The eclectic theory includes significant aspects of both monopolistic advantage theory and internalization theory. Conclusion It is quite clear that Dunning’s theory of eclectic paradigm is an important theory that describes different aspects of international production. Over the years it has certainly caught the attention of various experts. If it is closely noticed, it will be found that the inclusion of three variables (OLI) have not got enough support from other researchers who have worked on the same subject over the years. However, Dunning has been significantly successful in integrating various aspects from other ‘international production’ related theories. References Dicken, P., (2007) Global Shift: Mapping the Changing Contours of the World Economy, 6th Edition, Sage. Dunning, J. (2000) The Eclectic Paradigm of International Production, Routledge Dunning, J (1981) “International Production and Multinational Enterprises”, London George Allen & Unwin, pp. 111. Dunning, J (1988) “The Eclectic Paradigm of International Production: A Restatement and Some Possible Extensions”, Journal of International Business Studies, Vol. 19, No. 1, pp. 1-31. Huawei News, (2006) “Huawei Enhances Western African Service Capabilities with US$10M Technology Supportand Training Centers”, [Online available at] http://www.huawei.com/news/view.do?id=645&cid=42 Jones, G. (1996) The evolution of international business: an introduction, Routledge Klug, M. (2006) Market Entry Strategies in Eastern Europe in the Context of the European Union: An Empirical Research Into German Firms Entering the Polish Market, DUV Margardt, D. (2009) A Critical Comparison of Internationalisation Theories: Eclectic Paradigm of Dunning Vs. Uppsala School, GRIN Verlag Perry, A. (1992) The evolution of U.S. trade intermediaries: the changing international environment, Greenwood Publishing Group Pitelis, C., and R. Sugden (eds) (2002) The Nature of the Transnational Firm, 2nd Edition, Routledge, London. Zhu, (2008) Internationalization of Chinese MNEs and Dunning’s Eclectic (OLI) Paradigm: A Case study of Huawei Technologies Corporation’s Internationalization Strategy, School of Economics and Management Department of Economics, Lund University, Bibliography Cavusgil, S. T., et al (2008) International Business: Strategy, Management, and the New Realities, Prentice Hall. Ietto-Giles, G. (2002) Transnational Corporations: Fragmentation Amidst Integration, Routledge, London. Morrison, J. (2002) The International Business Environment, Palgrave. Rugman, A. M., and S. Collinson (2006) International Business, 4th Edition, Prentice Hall. Read More