Discuss the usefulness of Dunning’s eclectic paradigm in helping us understand how firms internationalise
Introduction: Dunning Eclectic paradigm was appeared in by J. H Dunning. After this journal published, dunning eclectic paradigm becomes the most influential theory in research of foreign direct investment (FDI) and multinational (MNE). It is used comprehensively to analysis the motivation and advantages of MNE in term of FDI. In the following essay, I am going to talk about the importance of MNE and the development of eclectic paradigm in order to have a brief background for the reader. After that, I will begin to discuss the usefulness of Dunning’s eclectic paradigm in helping us understanding how firms internationalise.
The importance of MNE MNE is acting a more and more important role in advancing globalization. According to world investment report, there are more than 60 thousands MNE in 1999. These MNE own around 500 thousands of branches which covered more than 160 countries. They have an extremely powerful influence for the global economic due to their super-large scale and capital. Lots of local company are trying to become one of the MNE but eventually more of them failed. The companies which fail to access the global market have not enough preparation and understanding of the global environment.
To deal with such problem, Dunning’s eclectic paradigm provides a clear and comprehensive analysis of MNE. These analysis helps the company understand what they needed if they want to become MNE. Development of eclectic paradigm In 1960, Stephan Hymer proposed Monopolistic Advantage Theory in his dissertation. He thinks market failure is the main reason of MNE carrying FDI. A foreign company own monopolistic advantage that other local company haven’t so the foreign company can run their business overseas and earn much more profit. C. P. Kindleberger, H.G Johnson, R. E. Caves and F. T. Knickerbocker keep completing and modifying this theory. However, it still can’t explain why some companies in developing country invest to developed country even they don’t have monopolistic advantage. In 1996, America economist R. Vernon in challenge Monopolistic Advantage Theory that can’t explain why the company must go through FDI but not licencing or exporting. He suggested that monopolistic advantage, product life cycle and location should be combined in order to look at a MNE. In 1976, P. J. Buckley and M.
Casson provide a new theory “Internalization” It stressed companies’ monopolistic advantages are not caused by market failure, but market failure assist the company to keep monopolistic advantages in their company. In 1981, J. H Dunning summarized all the theory above and created a new theory called dunning’s eclectic paradigm. The usefulness of Dunning’s eclectic paradigm Dunning’s eclectic paradigm concluded the previous academic’s theory and provide a detailed, comprehensive and clear analysis for people to understand how firm internationalise.
It clearly pointed out that a MNE must own ownership specific advantages, internalization advantage and location advantage. I will explain both of them in detail in the following essay. Also, the case of Lenovo will be used as an example to show how to understand firm’s internationalisation through Dunning’s eclectic paradigm. Ownership Advantage: This idea first brought up by Hymer in 1960. It becomes one of the basic contexts in Dunning’s eclectic paradigm. Ownership advantage can be called as monopolistic advantage or competitive advantage.
It means that a firm own some advantages over other company in the markets in which it is located or in which it is considering locating. It helps a foreign company gain a better power which the local company don’t have. These ownership advantages can be classified as two aspects. One is the advantages caused by a company occupying the intangible assets, such as patents, proprietary technology, trademark rights, copyright, land user and franchises. Another is caused by the economics of scale the company owned, which included technology and general innovative capacities, information, and managerial and entrepreneurial skills.
The ownership advantage can help people understand why a firm is going to have foreign direct investment. The reason why MNE willing to have FDI is because they got the ownership advantage but their local competitor doesn’t have which makes sure MNE can access the market and earn the profit they want. However, if a company only got the ownership advantage but not own location and internalization advantages as well, then they can only through licencing but not FDI. Here is the example of Lenovo. Lenovo is a Chinese brand, which internationalised since 2000. First of all, let’s take a look of the ownership advantage Lenovo owned..
As a high-tech product producer, Lenovo owned more than 1000 inventions with patent and it is keep investing in their R&D department. Besides that, Lenovo has modern production base in Beijing, Shanghai and Guangdong, which produce more than 5 million high-tech product each year. Also, the vice chairman and president of Lenovo Liu innovated the structure of company and combined with western managerial theory. The excellent product, well service and honest culture built up Lenovo’s wonderful brand image and it assisted Lenovo get the advantage in financing and crediting.
Therefore, we can analysis through dunning’s eclectic paradigm to conclude that Lenovo got the advantage in technology and general innovative capabilities advantage, managerial and entrepreneurial skills advantage and scale advantage. Lenovo owned the ownership advantages while other company lack of so they can access the foreign market and began to build up overseas R&D centre and recruit the talent overseas. As we saw, dunning’s eclectic paradigm help us to point out what kind of advantages Lenovo have and what are they rely on in order to access foreign market.
Internalization Advantage: Internalization advantage is another factors explained in dunning’s eclectic paradigm. It explains how the company use their ownership advantages. Most likely company will utilize their ownership advantages in two ways. One is selling their ownership advantages to other company which we can call it externalization. For example, Eastman Kodak Co sold their patent of digital imaging technology and earned $525 million in 2013. After they sold this patent, they are not longer to use it anymore, that what we called externalization.
However, what is internalization? Internalization means that the company use the ownership advantages themselves but not selling to others. Then, how will the company make decision between externalization and internalization? It depends on the profit they can earn and some other factors. In most of case, firm will prefer internalization when market failure or imperfection existing. Here are some reasons why company will internalize: (1). to prevent the outflow of technology advantages (2). to form the economics of scale (3). to escape foreign exchange control, traffic and tax .
These reasons support why company will choose internalization but not externalization because they can gain a greater profit through internalization. Let’s look at the case of Lenovo and see how they internalize. Lenovo wanted to access a country with high tariff and barrier. In order to overcome such market failure, Lenovo has to set up a company and branch in that country. It can actually escape the traffic and barrier when Lenovo sell their product. If Lenovo just export their product, the exporting cost will much more higher than they internalize.
Also, licence is a very dangerous way for the high-tech company like Lenovo. It is extremely easy to divulge their technology advantage and damage the profit of company. As we saw, dunning’s electric paradigm help us understand how a company use their ownership advantage and keep them in their own company. Location Advantage: Dunning’s eclectic paradigm help us understand where will a company going to invest. In order to internationalise, company have to choice which country they are going to invest. The country they are going to invest must own some advantages which their original country hasn’t.
When a company have ownership and internalization advantage, then they need to make a choice between domestic investment and FDI. It depends on which one can bring more profit to the company. Location advantages are specific to a particular country but are available to all firms, which can include natural resources, labour, society, domestic economics, geography, technology, culture, education, politics and transport. If these factors can benefit for a company and help them earn as much as they want, they will choice that country to invest. Location advantages can be classified as two types.
The first one is direct location advantages which the advantage owned by the targeting country, such as wider market, labour intensive and preferential investment policy. The second one is indirect location advantages which are caused by some unfavourable factors in the investing country and targeting country, such as high transportation cost or insurmountable trade barriers. For example, whenever Lenovo want to invest in a new country, they will analysis the environment of that country and look whether they can benefit through the environment or not.
This is a very important issue for the company to consider the environment of country. If they can utilize the benefit from the environment, most like they will success in that country. However, if a company ignore the importance of environment, it is a disaster and they will fail no matter how powerful they are. To conclude, location advantages determine whether the company is going to invest overseas or not and where they are going to invest. Four conditions: Dunning’s eclectic paradigm help us understand an MNE’s degree of foreign value-added activities depends on the satisfaction of the following four condition.
1. The degree to which a firm possess ownership advantages over other firms in a particular market. If a firm can own advantages greater than others, they will have more value-added activities. 2. The degree to which an MNE believes it is in its best interests to exploit its ownership advantages rather than sell them to another firm, perhaps in the form of technology licensing or franchising (the internalization factor). It means that if the firm believe that they can earn more profit through FDI than licensing, they will increase their value-added activities. 3.
The degree to which there are location-specific advantages of a particular country which raise the value of ownership advantages relative to elsewhere. A place can provide a greater benefit for the company’s ownership advantages, and then the company will invest more in that particular country. 4. The degree to which foreign production is consistent with the long-term strategy of the firm. If the firm is tracing for a long-term strategy, they will more care and stress about the foreign value-added activities. Diagram of dunning’s eclectic paradigm Ownership advantages Internalization advantages Location advantages FDI Yes Yes
Yes Export Yes Yes No Licence Yes No Yes In dunning’s eclectic paradigm, it stressed that a company must have both of three advantages in order to have FDI. A company rely on ownership advantages against the local company. Also, they choose a right environment which can benefit their business. Then they internalize their business into that country and expand their business. Therefore, only the company with ownership, internalization and location advantage can be called as MNE. When a company possess ownership and internalization advantages but lack of location advantage, they can only sell their product through exporting.
It means that they can only utilize their advantage domestically because they can’t find a suitable investment country. Also, if a company have ownership and location advantage but no internalization advantage, they will licence other company. Lacking of internalization advantage means that the company’s ownership advantage can’t be utilized within their own company and they have to sell or translate those advantages to others in order to earn profit. Meanwhile, a company with internalization and location advantages means that they lack of the most basic criterion to have FDI because ownership advantage is the precondition of FDI.
Limitation: Although dunning’s eclectic paradigm help us a lot in understanding how firm internationalize, some limitations still exist in this theory. Some academics criticize that eclectic paradigm is not dynamic enough to explain the changes in strategy by MNEs. Also, it has not a deep study in the connection between internal management and FDI. Besides that, dunning’s eclectic paradigm mainly concern the MNEs in developed country but not the company in developing country. These companies also have FDI but eclectic paradigm can’t have a detailed, scientific and comprehensive explanation for these firms.
Conclusion: Dunning’s eclectic paradigm summarize previous theory about firm’s internationalization and created a new way to analysis MNEs. It captured the essence of former and overcame the insufficient part of their theory, which dunning modified them into a comprehensive and understandable theory. The core concept of eclectic paradigm is ownership advantage, internalization advantage and location advantage. These three advantages help us to understand the ‘why’, the ‘where’ and the ‘how’ of the internationalization of production respectively.
Ownership advantage explained why company is going to have FDI and what they rely on in order to battle with other firm. Internalization advantage explained how the company keep their ownership advantage within own company. Location advantage explained which country can benefit for the business of company. However, dunning’s eclectic paradigm is a static and microscopic theory which limited the usefulness of this concept. Although dunning’s eclectic paradigm had such limitation, it doesn’t affect this theory become the most influential way in analysing company’s activity in FDI.