■ Three Theories : FDI is such an important entry strategy that three alternative theories are provided for explaining why firms choose it to gain and sustain competitive advantage: the Monopolistic Advantage Theory, Internalization Theory, and Dunning’s Eclectic Paradigm. Monopolistic Advantage Theory ■ This theory suggests that firms that use FDI as an internationalization strategy tend to control certain resources and capabilities that give them a degree of monopoly power relative to foreign competitors. ■ The advantages (specific to the MNE: e.g. proprietary technology, brand name) that arise from this monopoly power enable the MNE to operate foreign subsidiaries more profitably than local firms competing in the same markets. ■ Conditions: (for targeting foreign market rather than home market) ◘ Returns obtainable in the foreign market should be superior to those available in the home market. ◘ Returns obtainable in the foreign market should be superior to those earned by its domestic competitors in its industry in the foreign market. ■ Assumptions: Local firms do not possess these advantages, MNCs maintain ownership of these advantages by internalizing them, and Advantages should be firm- specific rather than location-specific. ■ The most important monopolistic advantage is superior knowledge , which includes intangible skills possessed by the MNE that provide a competitive advantage over local rivals. Internalization Theory The Internalization Theory explains the process by which firms acquire and retain one or more value-chain activities inside the firm , thus minimizing the disadvantages of dealing with external partners, reducing the risk of partners becoming competitors, and allowing for greater control over foreign operations and their proprietary knowledge.
■ Key reason to internalize: Proprietary knowledge: control and optimally use it in foreign markets ■ FDI should be compared in terms of a cost/benefit analysis (including risk/control issues) to other entry modes: exporting, licensing, etc. ■ By internalizing foreign-based value-chain activities, it is the firm, rather than its products, that crosses international borders. Dunning's Eclectic Paradigm ■ According to this paradigm, MNE activity leverages both the competitive advantages of firms and the comparative advantages of countries (using the pre-Porter terminology). ■ The Eclectic Paradigm specifies three conditions that determine whether or not a company will internationalize via FDI: ownership-specific advantages, location- specific advantages, and internalization advantages. Ownership-specific advantages ■ Refer to firm-specific competitive advantages that allow it to compete effectively in foreign markets, e.g. proprietary technology, knowledge, unique managerial skills, capabilities, key relationships, trademarks, brand names, economies of scale, and access to substantial financial resources.
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- Fall '07
- International Trade