International Business Environment - Example

Intеrnаtiоnаl Business Еnvirоnmеnt Name Institution Intеrnаtiоnаl Business Еnvirоnmеnt Foreign direct investment (FDI) entails an investment made by a person or company as a controlling ownership in a business in one nation by a unit based in another nation. This is made possible by either acquiring or establishing business operations in the foreign nation. It is a concept that is quite common with multinational enterprises. There are various methods of international investment, each having its benefits and drawbacks depending in the situation and factors involved. FDI can be categorized into three main forms; horizontal, vertical and conglomerate. Horizontal direct investment occurs when the investor establishes the same kind of business operation done in the local country in a foreign nation. A vertical investment involves carrying out different but related business operations in a foreign country. On the other hand, conglomerate kind of foreign direct investment involves an individual or a business organization undertaking business operations that are not in any way related to their business in the home country (Moran, 2012, p. 78). There have been different explanations of FDI as can be seen from various perspectives and theories. This piece of work will give a critical examination (in the form of compare and contrast) of the various explanations of FDI in view of various theories. The theories of concern are; Internalization theory, Vernon's product life cycle theory, Knickerbocker's theory of FDI and Eclectic Paradigm or OLI paradigm. In addition, based on the discussion of the above theories, the theory that provides the best explanation of the historical pattern of FDI will be highlighted. Internalization theory Internalization theory is one of the many theories that have been put forth to explain the concept of foreign direct investment. There are various modes of entry to foreign markets and different firms make a choice based on various factors such as the benefits and drawbacks that surround the different modes of entry. Foreign direct investment is one of the modes of entry and the internationalization theory aims at dictating the reason behind business companies choosing foreign direct investment as opposed to licensing or any other mode of entry into foreign markets. The internationalization theory states that the disadvantages that are linked with licensing as a strategy for entering foreign markets make it less popular compared to foreign direct investment. For instance, licensing has a limitation in that it does not allow a business organization to maintain adequate control over its business operations, an aspect that is quite undesirable for any business firm. Also, licensing process is likely to make a company end up in losing its proprietary technology to potential competitors. This is also a thing that is not attractive in any way. There is also the fact that in licensing, a company’s competitive advantage is based on its manufacturing, management and marketing capabilities rather than the products themselves (Rugman, 2010, p. 8). These and other drawbacks of licensing make it to come second after foreign direct investment modes of expansion with regard success. According to Rugman and Verbeke (2008, p. 163), the internationalization theory as it relates to foreign direct investment is assessed by comparing gains got from foreign direct investment alongside those from other modes of expansion. Those that support internationalization theory assert that modes of expansion that are related with FDI are better because of many reasons for instance less risk when it comes to dissemination of information monopoly. However, these modes are also linked with high agency costs of decentralization. An assessment of the gains indicate that that returns are considerably higher with use of non-FDI modes of entry compared to FDI modes of expansion. Vernon's product life cycle theory Vernon's product life cycle theory is another essential theory that helps in the understanding of the issue of foreign direct investment and various aspects that surround it. According to the theory, business enterprises carry out foreign direct investment at specific phases in the lifecycle of a product they have initiated in the market. Vernon states that a product passes through three common phases, which are all significant and have implications for the international location. It first starts as a new product through the process of product development, proceed to be a maturing product and finally reach the stage of becoming a standardized product. In the first stage, the product is invented by a nation, which is mostly developed with regard to high-tech benefit when it comes to responding to domestic demand (Tomes, 2008, p. 121). This is more so because the process of testing and adjusting the product requires more skilled labour and adequate resources. During the maturing stage, the product is steadily standardized and thus mass production commences. Here, capital becomes more significant and not much skilled labour is required. Global marketing is done for the product to get export markets and when exports increase, there is a high likelihood of the producers considering moving closer to the markets. The standardization stage involves looking at factors such as location and production cost in order to make decisions of establishing the new business. Mostly, the product is produced in other nations and imported to the original nation of production. At some point, production shifts to less developed nations (Potter & Watts, 2011, p. 422). The theory indicates that the location of products is a complex process that is influenced by many factors. Knickerbocker's theory of FDI Knickerbocker's theory of FDI suggests that business enterprises usually follow their domestic competitors in a foreign country. It is a theory that was based on oligopolistic industries whereby imitative behaviour is thought of being in a position to take various forms in an oligopoly and FDI is just one of them. According to this theory, FDI flows are largely an indication of the strategic rivalry that exists between firms in the international market place. FDI and oligopoly exhibit similar attributes. An oligopoly can be defined as an industry that has few companies that dominate a huge proportion of the market industry. In most cases, when a member of an oligopoly undertakes foreign direct investment, it affects other members involved, an aspect that is quite crucial when it comes to competition. This is more so as a result of the major players being interdependent. An action carried out by one firm impact the major competitors, making them to consider imitating the action. This translates to imitative behaviour as competitors imitate the firm’s initiative. According to Knickerbocker's, foreign direct investment is also characterized by imitative behaviour (Denisia, 2010, p. 56). Ietto-Gillies (2012, p. 112) argues that the Knickerbocker's theory also has the aspect of multipoint competition. This is where enterprises of different regions or even industries encounter each other. A rival is thought to be in a position to reinforce competitive attacks in other markets through profits gained in addition to occupying a commanding position in a market. The theory has a limitation of not illustrating the reason(s) as to why the first enterprise in oligopoly choose to undertake foreign direct investment as opposed to going through the path of license or even export and the advantages and challenges involved in either option. Eclectic Paradigm or OLI paradigm According to Dunning (2015, p. 108), an electric paradigm theory offers a frame work that can be followed by business enterprises in their pursuit to determine whether it is advantageous to undertake foreign direct investment. The theory is founded on the assumption that organizations are likely to keep away from transactions in the open market especially when the domestic transactions are associated with lower costs. Under normal circumstances, there ought to be a comparative advantage, an internalization advantage as well as an ownership advantage if a direct investment in a foreign country is to be beneficial. There is need to establish if there is comparative advantage to undertake some operations within a certain country. The considerations are mostly fixed and revolve around the availability and cost associated with resources when operating in one area as opposed to another. With regard to internalization advantage, a business enterprise should consider determining if it is viable for it to produce the specific product or involve a third party. In most cases, doing the production internally is usually considered and outsourcing only sought when the other company is in a position to perfectly meet the organization’s production needs at a lower cost. On the other hand, ownership advantages are linked with issues that surround the proprietary information and different rights that an organization may possess (Stoian & Filippaios, 2008, p. 361). These are mostly intangible and could include aspects such as trademark, copyright and essential skills. The fact that the electric paradigm is involved with the assessment of the entirety of the associations and interactions of the different elements involved makes it a holistic approach. To a great extent, the theory offers a means through which a firm’s strategy with respect to the expansion of its operations via foreign direct investments can be determined. The electric paradigm aims at establishing whether an approach offers more overall value compared to other national or global choices that could be available for the production of products and services. Businesses usually strive to identify the most cost-effective strategies while at the same time upholding a specific quality (Petersen, Pedersen and Lyles, 2008, p. 1106). For this reason, they make use of the electric paradigm to evaluate scenarios that seem promising in nature. Why Eclectic Paradigm theory Based on the above discussion of the theories associated with foreign direct investment, Eclectic Paradigm theory is the theory that offers the best explanation of the historical pattern of FDI. This is more so because it integrates the concepts of other previous theories that are linked with internationalization with an aim of offering a general analytical approach. It therefore tries to fill the gaps that have been left by other theories in one way or the other (Dunning, 2015, p. 128). Currently, the electric paradigm theory can be said to be the most complete theory when it comes to illustrating the internationalization process. As discussed earlier, the theory stipulates some steps of internalization process that business companies ought to comply with to be successful in foreign investment. The steps are significant and interrelated. According to the theory, a company has to possess competitive advantages in the national market in order to become a global firm. Core competencies of a firm make it rise above its competitors, an aspect that gives it a chance to survive in the national market and even think of strategies to internationalize its operations in foreign markets. Ownership specific advantages, location advantages as well as internalization advantages are all essential in allowing for success in foreign direct investment. For this reason, a firm should combine all these advantages in designing its system of operations and affiliates as a way of maximizing its growth and market share (Stoian & Filippaios, 2008, p. 354). All this will eventually lead to enhanced productivity and profitability. Although the other theories also offer some information on internalization and foreign direct investment in particular, the electric paradigm theory seem to be more comprehensive and hence its choice as the best theory for the sake of this assignment. Conclusion From the above discussion, it is clear that the concept of foreign investment is quite complicated and various factors have to be considered before a business organization makes the decision. Foreign direct investment is one of the major modes of entry and it has its own fair of benefits as well as challenges. Over time, there has been an evolution of theories that aim at explaining various aspects as they relate to foreign direct investment. Some of the theories that have been put forth in relation to foreign direct investment include the internationalization theory, Vernon's product life cycle theory, Knickerbocker's theory of FDI and Eclectic Paradigm or OLI paradigm as discussed above. The discussion of these theories does not only allow for an understanding of the issue of foreign direct investment but also provide a contrast and analysis among them. Each theory has some explanation with respect to foreign direct investment. They all have some certain level of emphasis and limitations and as such, some are considered more appropriate for certain perspectives such as the historical pattern of foreign direct investment. This paper finds Eclectic Paradigm theory as the best in terms of explaining the historical pattern of FDI. References Denisia, V., 2010. Foreign direct investment theories: An overview of the main FDI theories. European Journal of Interdisciplinary Studies, (3). Dunning, J.H., 2015. Reappraising the eclectic paradigm in an age of alliance capitalism. In The Eclectic Paradigm (pp. 111-142). London: Palgrave Macmillan UK. Ietto-Gillies, G., 2012. Transnational corporations and international production: concepts, theories and effects. Camberley: Edward Elgar Publishing. Moran, T.H., 2012. Foreign Direct Investment. New York: John Wiley & Sons, Ltd. Petersen, B., Pedersen, T. and Lyles, M.A., 2008. Closing knowledge gaps in foreign markets. Journal of international business studies, 39(7), pp.1097-1113. Potter, A. and Watts, H.D., 2011. Evolutionary agglomeration theory: increasing returns, diminishing returns, and the industry life cycle. Journal of Economic Geography, 11(3), pp.417-455. Rugman, A.M., 2010. Reconciling internalization theory and the eclectic paradigm. Multinational Business Review, 18(2), pp.1-12. Rugman, A.M. and Verbeke, A., 2008. Internalization theory and its impact on the field of international business. Research in Global Strategic Management, 14(1), pp.155-174. Stoian, C. and Filippaios, F., 2008. Dunning's eclectic paradigm: A holistic, yet context specific framework for analysing the determinants of outward FDI: Evidence from international Greek investments. International Business Review, 17(3), pp.349-367. Tomes, Z., 2008. Applying the life-cycle theory: The rise and fall of railways. The Journal of Transport History, 29(1), pp.120-124. Read More