Limitations of Dunnings OLI Model and other Alternative Specific Models - Case Study Example

Limitations of Dunning’s OLI Model and other Alternative Specific Models and Thesis ment In determining foreign direct investment, the Dunning’s OLI model gives a general paradigm used to explain the immediate drivers of external direct investment. Organization use Dunning’s OLI model to design an international strategy for corporate purposes. However, the definition given by the head limits the scope through which the Dunning OLI model can work. This calls for application of additional models that can help to do the same task as those performed by Dunning OLI model. In addition, the application of these new specific models is a great challenge to companies due to their scarcity and complexity. This paper seeks to discuss the limitation posed by the Dunning OLI model in ascertaining the foreign direct investment of corporate organization. In doing this, the paper will analyze the limitation of Dunning OLU model in creating an international strategy for a cooperate body. Moreover, the paper will analyze the specific models required as a result of this limitation. Introduction Dunning’s OLI model serves the purpose of providing a framework for making decision on the kind of direct investment to undertake in a foreign country but does to explain the dynamism in the factors affecting such decision. This has led to complexity and limitation of its application in formulating in international strategy for a corporate entity. However, there exist a number of specific models tailored to solve any dynamic scenario surrounding an investment decision in a foreign country Dunning’s OLI model’s General Paradigm for Explaining the Determinants of Foreign Direct Investment The Dunning’s OLI approach is a model for a company to follow when making the decision of whether it’s worthwhile to pursue foreign direct investment. It also provides a very helpful framework for multinational enterprises (MNES). It has also contributed a lot of applied work in economics and international business. Even though it’s not a formal theory that is backed up scientifically by use of data, it’s helpful in the categorization of recent empirical and analytical research on Future direct investment.(Foreign Direct Investment). “OLI” stands for Ownership, Location, and Internalization. These indicate areas that can be manipulated by MNEs to their advantage when they make the decision to go multinational. The framework basically explains the incentives for MNEs to go overseas, location choices, organizational forms that can be partaken by the MNEs and the choice between FOREIGN DIRECT INVESTMENT and its alternatives such as licensing and outsourcing (Brainard, 1997). Ownership Additional costs of running an MNE in a foreign country are to be expected and accounted for. Cultural, legal and language barriers can be cited as possible reasons for the additional costs. A MNE has to therefore have an advantage in the foreign market that helps it overcome the additional cost. Earning higher revenues for the same costs is a sure way of overcoming the additional costs, the MNE may also ensure it reduces its cost for the same revenues. These advantages may also be referred to as core competences or firm specific advantages (FSAs) as they tend to be internal to a certain firm. In explaining the existence of MNEs, a higher than average asset potential has the character of internal public goods that when applied in different locations can be able to provide the same end results as before. Helpman (1984) encompasses some of these assets to one broad term “headquarter services” which include product development, patents and marketing skills. The motive for Foreign Direct Investment can be determined by assessing the firms’ productivity which can be divided into three; low, medium and high productivity firms. Sunken cost have to be considered when calculating a firm’s productivity. Low and medium productivity firms are only able to produce for the home market so only high productivity firms are able to have motive for Foreign Direct Investment. Consequently, use of the model deduces that greater heterogeneity among firms in industries will lead to more firms being engaged in Foreign Direct Investment. Location factor (country specific advantages) In order to earn full rents on its FSAs, use of foreign factors is imperative for a firm attempting to engage in Foreign Direct Investment. In determining the host country for a MNE to carry out Foreign Direct Investment, location advantages are a key consideration. The location advantages can also be referred to as country specific advantages. They can be further subdivided into social, economic and political advantages. Two forms of Foreign Direct Investment; horizontal and vertical have also to be distinguished by the MNE with Foreign Direct Investment motives. While horizontal Foreign Direct Investment majorly concentrates on relocation of a firm abroad to gain more market access, vertical Foreign Direct Investment seeks to reduce production costs in the new location while keeping the firm’s headquarters in the original country. Horizontal Foreign Direct Investment as applied in OLI framework is encouraged by lower trade costs but discouraged by higher fixed costs. Vertical Foreign Direct Investment concentrates on the ability of a firm to serve in its new foreign environment that is cheaper compared to its original environment with a sole purpose of serving its home market. Decision to invoke a Foreign Direct Investment depends mainly on the difference between the advantages or benefits of concentration and cost savings from relocation of the firm to a foreign country. In an expert comparison of the two motives illustrated, studies tend to favor horizontal over vertical. In a case where the foreign market is bigger the gain from Foreign Direct Investment will be increased by interaction between the two motives and an increase in the number of countries increases the potential to make more profit. Country specific advantages that influence the location for investment of a MNE in a new country can be divided into three; social, economic and political. All these factors affect the location of a firm in a foreign country. Economic advantages include factors of production, market, transport and communication. Social advantages encompass attitude towards foreigners, language and cultural. Political advantages include the general policies set up by the host country’s government Internalization OLI model predicts that a MNE can be able to stand on its own and replace its own internal market. It further predicts that motive investigation based on internal markets is so much better than the organizing of the market .this is especially true where external markets do not exist. Advantages will ensure that the MNE will focus mainly on fully owned over minority owned subsidiaries. This is aimed at the reduction of market failures .reduction of transaction cost is a vital method of eliminating unfavorable market conditions. Higher costs of transactions automatically reduce the volume of trade in the market set up. Market failures can also be tackled by looking at risk and uncertainty management. Policies and government levies imposed on a given market may also make or break trade. It should therefore be critically considered by the MNE as they may eat into the profit the firm intended to make. International production can however be tackled in various ways (Lundan & Sarianna M. 2015). Limitations in the Design of International Corporate Strategy A key limitation of use of Dunning’s OLI in the design of international corporate strategy is the fact that it does not explore the reason behind the disparities in productivity of the firms with Foreign Direct Investment motives. This limitation mean that an organization has to go an extra mile and to guess the disparity thus leading to biased decision. In addition, it does not consider prior investments both in product and process by these firms that may disproportionally account for the major variations in productivity of these firms. This is a critical aspect of foreign direct investment and overlooking it causes a lot of challenges when creating an international corporate strategy (Beugelsdijk & Sjoerd, 2013). The framework also fails in its ability to explain dynamic processes and thus assumes a state of static nature in any investment yet to be undertaken. This has made Dunning’s OLI not applicable foreign direct investments especially where the economics conditions are dynamic. Moreover, creating an international corporate strategy becomes a problem leaving corporate organizations with the option of applying dynamic investment. The framework has not also addressed the distinction between horizontal and vertical motives for locating production in foreign locations (countries). Consequently, it does not bring out the distinction between Greenfield and M&A modes of engaging in foreign direct investment. This has made Dunning’s OLI model a limitation in ascertaining the international strategy of a corporate entity for international relations (Gong &Yeming. 2013). The above limitations have led to corporate entities looking for alternative models that can provide design of corporate strategy without any limit of boundary or complexity. These models have been adopted by several companies and are being used to offer solutions especially where Dunning’s OLI model has failed to do. With the application of alternative models that are specific to the needs of an organization, proper direct investments in foreign entities have been taken and a lot of international corporate strategies have been adopted. These specific models were developed primarily for certain functions and thus cannot be altered in any way. Some of the specific models needed for the purposes of solving the limitations created by Dunning’s OLI model are discussed below. Specific Models Needed For the Task Foreign Investment Risk Matrix (FIRM) developed by Bhalla (1983) This specific model aims at using political and economic risk for Foreign Direct Investment decision making. A matrix is developed categorizing the countries based on whether the economic and political risks are acceptable, unacceptable or uncertain to encourage investment. Three measures of political risk and three measures of economic risk are used in determining acceptable countries for Foreign Direct Investment to be conducted. MNEs then can embark on carrying out further research on the identified potential locations for investment. This model specifically focuses on the viability of a Foreign Direct Investment on the grounds that political, and economic can either support or derail a foreign direct investment venture. Also, the model looks at the dynamism that exist in the various political and economic systems of various countries before settling on a Foreign Direct Investment or even formulating an international strategy for a corporate entity. The Internalization Theory It concentrates on trying to explain growth of MNEs and their motivations to achieving foreign direct investment. It was developed by Buckley and Casson (1976). The two key determinants of foreign direct investment as stated by Hymer (1976) were removal of competition and the specific advantages possessed by the MNEs. This meant that this model focuses specifically on the internal motive of a corporate in achieving its international corporate strategy and Foreign Direct Investment. Similarly, the models focuses on ascertaining the threats posed to an organization through competition and other opportunities posed by an organization such as competitive advantage. The Theory of Exchange Rates on Imperfect Capital Markets This theory is also used to explain foreign direct investment. The foreign exchange risks are analyzed from an international trade perspective. Uncertainty as an influence to foreign direct investment is analyzed by Itagaki (1981) and Cushman (1985). Cushman established that real exchange rate increase stimulates foreign direct investment made using US dollars while the converse also tends to be true.it however does not explain simultaneous foreign direct investment between countries with different currencies. In this theory, focus is made to the impact of foreign exchange rate on capital markets, thus the influence of investment decisions in foreign countries. The dynamism experienced in foreign exchange rates has led to easy decision making by the application of this specific model. Production Cycle Theory By Vernon (1966) The theory seeks to explain certain types of foreign direct investment made by U.S. companies in Western Europe post World War Two specifically in the manufacturing industry. Vernon believes that the four stages in the production cycle after the Second World War were affected as Europe increased its demand for manufactured goods with U.S. being a viable source of these products. Having an advantage of technological expertise made export a favorable option for the U.S. Between 1950 and 1970 a need arose for U.S. based manufacturers to set up base in European countries necessitated by the need to consolidate their previously acquired market base that was being depleted by the increasing imitating trends by companies in Europe. The production cycle is also dynamic and an organization may experience various cycles within its trading period. This model will help provide a specific decision based on the production cycle of each organization. Conclusion The Dunning OLI model has created a positive impact in various cooperate organizations in terms of ascertaining the external direct investment to be made by any corporate entity. Several decisions have been made that results into huge returns to the corporate entity concerned. In addition, the Dunning’s OLI model has successfully triggered direct investment and subsequent growth in the cooperate sector. Despite the fact that its application in creating an international corporate strategy is limited, it is still useful and cannot be ignored. However some alternative models are available in the market that can provide better solutions to direct external investment. These models are specific in function and are not affected by any aspect that may limit its scope. Thus, the specific alternatives provide a permanent solution to creation of international corporate strategy References Brainard, S. Lael. 1997. “An Empirical Assessment of The Proximity-Concentration Tradeoff Between Multinational Sales and Trade.” American Economic Review, 87(4): 520-44. A landmark paper in the empirical application of the horizontal model of foreign direct investment. Dunning, John H. 1977. “Trade, Location of Economic Activity and the MNE: A Search for an Eclectic Approach.” In Bertil Ohlin, Per-Ove Hesselborn, and Per Magnus Wijkman, eds., The International Allocation of Economic Activity. London: Macmillan. Ethier, Wilfred J. 1986. “The Multinational Firm.” Quarterly Journal of Economics 101(4): 805-34. Antras, Pol, and Elhanan Helpman. 2004. “Global Sourcing.” Journal of Political Economy 112(3): 552-80. A pioneering model that shows how firms with different productivities will choose between locating production at home or abroad and keeping it within the firm or outsourcing it to a sub-contractor Barba Navaretti, Giorgio, Anthony J. Venables, et al. 2004. Multinational Firms in the World Economy. Princeton: Princeton University Press. An invaluable overview of theoretical and empirical work on greenfield FOREIGN DIRECT INVESTMENT. K. Head, 2007. Elements of Multinational strategy: Chapter 7 - Multinational Formation Dunning, Multinational Enterprises and the global economy Lundan, Sarianna M. 2015. Transnational corporations and transnational governance: the cost of crossing borders in the global economy. http://www.palgraveconnect.com/doifinder/10.1057/9781137467690. Beugelsdijk, Sjoerd. 2013. Firms in the international economy: firm heterogeneity meets international business. Gong, Yeming. 2013. Global operations strategy fundamentals and practice. Berlin: Springer. http://dx.doi.org/10.1007/978-3-642-36708-3. Read More