Institutions and the OLI Paradigm of the Multinational Enterprise - Term Paper Example

Dunnings OLI Model Introduction Foreign direct investments (FDI) are considered to play an important role in economic development as well as the prosperity of a nation by itself. Empirical studies conducted in the realm of FDI indicate that most nations are affected either on the micro or the macro level due to such foreign investments. The developing and the under developed nations are seen to be most benefitted due to such FDI1. The present study is aimed towards analysing the Dunnings OLI model and judges its usefulness. Also, the paper incorporates discussions relating to other FDI models, based upon the short comings of the Dunnings model. The main objective of the paper is to understand whether the Dunnings theory is sufficient for designing international corporate strategies. Most evaluations conducted in respect to the Dunnings model reveal that although the model discusses few of the factors which impacts FDI, it overlooks certain crucial aspects such as competition, exchange rates and resource factors. Without such factors, framing a corporate strategy would be deemed ineffective. FDI decisions are extremely crucial as they have long term impacts. Hence, firms are required to consider a number of factors before taking such crucial decisions and investing in a foreign firm. Critique Analysis Dunnings OLI model  The Dunnings OLI model also known as the electrical model was developed by professor Dunning. The theory is essentially a mix of three elements, namely ownership, location and internationalization. The three elements of the theory were explained as advantages by Dunnings. The model was developed by him with the object of identifying the main factors which motivate a firm to expand internationally. Dunnings was of the opinion that existing theories of international expansion are partial and tries to develop a concrete theory by bringing in the various aspect of existing theories together2. Ownership The ownership advantage as explained by Dunnings are key aspects behind the existence of MNE’s. The ownership advantages are firm specific. When large organizations invest in a foreign nation, they are bound to have certain costs. These costs may be related to increase in production expenses, setting up of manufacturing units, procurement of resources and other factors. In order to overcome such costs, the firm is required to get compensated in some other form. This can be by gaining increased revenue or procuring enhanced retained earnings and so on. The ownership costs play an important role for MNE’s to invest in foreign nation for productions. If the cost of ownership is low, FDI can be easily made. However, the market and industry feasibility must be well analysed before making such an investment. Alternatively, if the ownership costs are high, firms should forecast and determine if making such an investment would be profitable for the long run or not. The ownership costs under such a case need to be compensated with adequate levels of returns3. Usually, ownership benefits in a foreign country arise out of aspects such as property or other firm specific advantages. Ownership advantages are seen to develop out of monopoly as well, such as privileged or singular access to certain resources or patents. Most MNE’s which seek to invest in a new foreign market prefer to initially understand and assess the different forms of ownership advantages which can be procured. Many at times, such ownership benefits gained from a foreign nation facilitates the firm’s aids in improving operations at the firm’s parent base in a different nation. For instance, a number of firms invest in China so as to procure ownership advantages of low cost superior technology. Such technological benefits may also be transferred to the firms other operational units located in diverse nations. The ownership advantages may also occur in a reverse form, such as different strengths of a firm which can be exploited abroad. Such as a firm which possess patent rights regarding the production of a certain product may find more demand in a foreign market than its own parent nation. Hence, already existing firm advantages may facilitate a company to function more successfully in a foreign market4. Location Such advantages can also be termed as the country specific advantages. The location advantages are a key factor for determining in which country a firm must invest. While investing in a foreign nation, it is essential for a company to assess the conditions which exists in the new nation. These are essentially political, economical and social factors. If there is much political unrest, commercial activities would be impacted in a negative manner. Due to political issues, the flow of FDI into such nations would be marginally low effecting a nation’s economic growth. Economic feasibility would include factors such as rate of exchange, cost of production, supply of resources and general level of income distribution. Economic factors determine the spending capability of factors which ultimately determines the extent of revenue generation. Foreign firms would find it difficult to establish themselves and develop commercial relations if the economic conditions are not suitable. Social conditions on the other hand include factors such as demand for various products and services and the quality of human resource. In case a firm is willing to expand into a foreign nation with the motive of selling products and services, the demand and income conditions should be well analysed. Similarly, if the motive is to manufacture goods or services, the cost of factors production should be analysed. Social factors would also include the acceptability of foreign firms in the market. In many nations, consumers prefer purchasing products that are produced domestically rather than those through foreign firms. Local factor studies play a very important role in setting up and maintaining continuity of organizations5. Internationalisation A firm may expand into another nation using techniques such as franchising, exporting, licensing, acquisitions or joint ventures. The technique which a firm would use for entering into a foreign market would essentially depend upon the market conditions, capital procurement and the level of industry competition. Firms are seen to indulge in internationalisation mainly for enhancing market opportunities and diversification of risks. Sometimes it is observed that manufacturing in a different nation provides MNE’s with cost and resource advantages. This is considered to be one of the main reasons behind internationalisation. Without distinctive advantages, a firm would not consider to expand internationally. International expansion requires the investments of much capital and takes many efforts6. Hence, the decision to expend internationally would only be feasible if it generates adequate returns. International expansion aids firms to have an international recognition, ultimately, leading to enhancing their goodwill in the international front. Operating in the international market also enhances a firm’s possibility to operate in a number of stock exchanges. Internationalisation is mainly coupled with the motive of enlargement ones market stand. Firms are required to constantly procure market advantages so that their competitive position in terms of size and revenue in the industry can be maintained. For such reasons, organizations are seen to constantly expand their market reach either for increasing sales or to enhance resource potential7. Other Specific Models Although the OLI model suggested by Dunnings facilitates in bringing together a few important aspects which motivate firms to expand internationally, it is seen to have a few disadvantages. The model does not critically analyse such impact of foreign exchange, trade policies and production cycle. A firm generally goes through the important stages of “innovation, growth, maturity and decline”. Usually, international expansion is undertaken when a firm is in the stage of growth or maturity. In the initial stage of business, a firm should generally focus upon increasing their market strength and develop a strong base. International expansion at this stage might not be suitable as it may lead the firm to get distracted from its main objectives. International expansion is best suited when the firms has set up a good base in its home nation. The stage at which a firm must expand had not been discussed well in the Dunnings theory. The same, however, has been explicitly discussed in the Production Cycle Theory of Vernon8. While expanding to an international market, firms are required to increase their production capabilities massively. This is seen to be difficult in the initial stage of business development. As firms expand, their resource capabilities also increase which facilitate them to increase their scale of production. The increased revenue and strength gained from strong initial growth leads to their subsequent expansion internationally. Also, when the production has increased, firms are able to meet both the needs of the domestic and the international markets. In case a firm has expanded to a foreign nation for setting up their manufacturing location, gaining superior financial strength is of much importance. Only when a firm has gained a certain degree of strength can it compete with the foreign firms. While expanding into a foreign nation a firm, it is required to assess the degree of competition and other industry condition. The risks which a foreign nation provides can only be faced and overcome if the expanding firm has sufficient strength. For ensuring that the foreign entry is successful, most firms prefer to adopt internationalisation when they have reached a comparatively large size. The Dunnings model was seen to completely neglect the association of foreign investment and the stage of growth of a firm9. Another important factor which the firms consider while expanding into foreign nations, is the exchange rates. If firms expand into a nation with which its currency rates are weaker, the profits earned would be higher when converted. This is one reason why developing nations try to expand their business into developed nations. The exchange rate theory incorporates the elements of risks as well. If the economy falls, the rate of exchange might get devalued leading to lower profits. Hence, while expanding into a foreign nation, the economic conditions must be well verified. When firms which belong to well developed nation expand their business into a developing nation, the revenue generated must be adequately high, so that when converted into their home nation currency, sufficient profits can be earned. Although the Dunnings model does incorporate exchange rate risks as under the location advantages, the same have not been discussed widely. The factor has however been covered under other theories established in the context of foreign direct investments10. Foreign expansion may also be triggered by the saturation of internal markets. When the markets of the domestic nations are saturated with a number of players, firms try to expand to foreign nations. The aspect of home nation’s market conditions had not been incorporated in the Dunnings model. When the competition existing in the domestic markets leads to loss of revenues and competitive advantages, firms try to expand to other nations. The foreign nations are required to be selected in a manner such that their existing competencies are seen as useful competitive advantages in foreign firms. Another compelling factor which drives organizations to adopt internationalisation is the loss of resources. The exhaustion of resources or its lower availability due to prolonged usage may drive firms to expand into foreign nation where the same can be procured in abundance. Studies conducted in respect to foreign direct investments models have facilitated in developing the understanding that resources are one of the most important decisions criteria based upon which nations take decisions in respect to whether or not they should expand into a foreign nation. The OLI framework alone can be stated to be less useful while studying foreign relations. The framework is seen to neglect aspects such as resource advantages, competition, exchange rate factors and the life stage of organizations11. Conclusion Foreign direct investments can be stated to be one of the most important products of globalization. FDI facilitates a number of nations to enhance their economic strengths by way of technological growth, generation of more revenue, employment generation and increasing the quality of lifestyle through products and services. However, before undertaking an FDI plan, firms are required to carefully evaluate a number of factors. The OLI model developed by Dunnings is considered to be useful in this respect. It is seen to overlook a number of factors which other models have incorporated such as the product cycle theory and the exchange rate theory. Although, the Dunnings model tries to bring together some of the vital factors which impact FDI decision making, using only this model might not be useful for organizations. Hence, organizations must combine the Dunnings model with other models so as to frame a more impactful FDI plan and taking decisions in respect to it more effectively. Reference List Dunning, J. H. "The eclectic paradigm as an envelope for economic and business theories of MNE activity", International business review, vol 9, no. 2, 2000, pp. 163-190. Dunning, J. H. and Sarianna, M. L., "Institutions and the OLI paradigm of the multinational enterprise", Asia Pacific Journal of Management, vol 25, no. 4, 2008, pp. 573-593. Dunning, J. H. “Explaining International Production”, London, Routledge, 2014. Dunning, J. H., "The eclectic (OLI) paradigm of international production: past, present and future", International journal of the economics of business, vol 8, no. 2, 2001, pp. 173-190. 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