Dunning Paradigm for Investment Evaluation - Case Study Example

Introduction Competitive advantage (Porter ME., 1980) is the heart of all strategies. Over a period of time since Dunning (1977) has driven home thepoint of why and how does a Multinational Enterprises (MNE) obtain this advantage away from their home bases. He developed the eclectic paradigm that explains the various factors that influence the MNE’s to decide on Internationalization through Foreign Direct Investment (FDI). Motives Motives for FDI may be summarized in a categorization formulated by Behrman (1972) and supported by Dunning (1993) who introduced a model of internationalization including four different categories of motives. These categories are market seeking, resource seeking, efficiency seeking and strategic resource seeking motives. Market and Resource seeking motives have been the two most recognized categories of motives (Dunning 2000). These two are the main reasons for most first time internationalization attempts by firms. Yet, efficiency seeking and strategic asset seeking motives increase in importance and are more common as motives for those companies who are already engaged in multinational activity. Dunning also confirms that closer relations with customers and durable relations with suppliers were equally important motives. Besides, he suggests that internationalization was driven by opportunities abroad rather than threats at home. Opportunity has been described in a different vein by Williamson (1975). He states that incomplete contracts and missing markets gave rise to opportunistic behaviour and to fill the void companies chose to face the challenge with replacing external contracts by direct ownership and internal hierarchy. Dunning’s eclectic paradigm is useful in analysing the complex decisions made by Firms to go international. The three OLI factors help to explain why production is based in a foreign land in place of home country. It explains the value additions available to a company in host countries on account of OLI. Each of these factors offers some advantage that enhances the competitiveness and performance of the firm. Basically the home advantage of Ownership is transferred to the host countries for competitiveness. These are then transferred to specific host country where the best the Locational factors exist through FDI. Finally the Internalization or the internal expertise, partly due to O factors accounts for the competitive advantage that was originally the objective of the exercise. This has been confirmed by the similar internalization theory of Rugman (1984). The main difference between the two has been described by Dunning himself stating that his eclectic paradigm is different from Rugman’s internalization theory in that it treats the competitive (so-called O-specific) advantages as endogenous or internal rather than as exogenous external variables (Dunning, 1995) The eclectic paradigm suggests that three conditions determine FDI. First, the firm must possess specific, ownership advantages not available to other firms. Ownership Advantages These advantages can be tangible. Or the advantages can be intangible, may even be embodied in a brand name, trademark or other indication of product quality, These are the specific abilities of the firm that have been developed at home as a strategy for competitive advantage and can be in the form of tangible assets like superior technology or natural resources at the command of the firm or the magnitude of its capital resources. It may even be a patent; or firm size that can generate transferable economies of scale and scope. They could be intangible like skills of its manpower resources, it brands, even its organizational culture or derived from the fact that the firm’s is having favored access to particular customers. . According to Dunning (1980) the O advantage are applicable to a country, an industry or the enterprise. He further states that such a firm has the ability to take the advantage of common governance to other countries (Dunning 1993). These advantages are the product of learning acquired through economies of scale and the vast scope developed by the firm in the home country (Tolentino 2001). An interesting side of the O advantage described by Dunning (2002) is that extension these could include relational assets. By this is meant the networking ability developed by the firm or its managers (Dimitratos & Plakoyiannaki 2003). This is becoming an important feature and can be called as the fifth motive in addition to resource, market, efficiency and strategy seeking resources. Nokia and Coke are prominent examples of MNE’s who have successfully transferred their O advantage to a number of host countries. Everywhere Nike operates it carries the weight of its brand image that it had created initially with Air Jordan sports footwear. Similarly with Coke the O advantage it carries is not only its brand image but its marketing tactics that have remained same or similar throughout its global markets. The difference between the two companies is however in their motive. Nike opted for resource seeking as it looked for cost effectiveness through what is known as sweatshop labour of the Asian countries. In marked contrast, Coke’s motive was market seeking as it was looking for global expansion of its universal product. Location Advantage Secondly, the foreign market should offer some locational or L advantage. It should be profitable to serve the overseas market by local production rather than by exporting. Important factors in this case are market size, tariff and non-tariff barriers or rigorous anti-dumping regulations that restrain the firm’s ability to price its exports and offers opportunity to locate itself within the market. Other major determinants of FDI are physical and political infrastructure, education levels, and the per capita income. Contrary to mainstream thinking that FDI flows are towards the emerging or developing markets, the fact is that developing countries still attract major FDI due to their superior infrastructure, markets that have purchasing capacity, effective governance both at the political and firm level and a well educated work force. Whatever FDI that flows into the so called emergent markets of China, India, Russia and some Latin American countries is due to their liberalization policies and large middle income population that has got new purchasing power. It is rare to find that low labour cost is the sole factor for FDI inflows though it still has a role to play in highly labour intensive industries. This has led to another type of L advantage that firms are now actively pursuing in the shape of Mergers & Acquisitions (M&A). The new MNE has realized that putting up new production facilities or organizing fresh marketing efforts have a long gestation period. Hence they find buying out of rivals and competition a quicker and painless way of enhancing both efficiency and markets. Cross border M&A has become a common feature and an attraction of the L advantage type. In the recent race for M&A on a global scale two companies come readily to mind. Vodafone wanted to become the dominant player in the global mobile and fixed telephony market. It made many an acquisition, both friendly like that of AT&T to create Verizon, or hostile like Mannesmann GmbH of Germany, but the outstanding M&A was that of Hutchison (Hong Kong) 50% share of its Indian joint venture for a staggering sum of $ 11.1 billion. The motive here was clearly market seeking as with this acquisition Vodafone has become the world number one Mobile operator. Another remarkable takeover was of the European Arcelor group by Mittal Steel for a staggering $22 billion. This made Mittal group the largest steel producers in the world. This was a resource seeking alliance as well as strategy seeking as they can now control both production and prices and they have also acquired ore mines that have come along with this investment. Internalization Advantage Thirdly, there should be internalization or I advantage. Ownership advantages are best exploited internally rather than offered to other firms through some contractual arrangement such as licensing, a joint venture or management contracting. The problems of unenforceable and uncontrollable contracts with overseas partners can be overcome with direct ownership. The eclectic paradigm shares much in common with Rugman’s internalization theory in this respect. The ability to leverage its home market O advantages of the in the host market is evidenced where both the domestic and foreign operations are controlled by the common O advantages. The transaction cost economics highlight how such assets are transferred for this advantage. (Buckley and Casson, 1998, 2002, 2003).Strong links between the two ensures success as its rests on the internalization of the system of governance. Internal assets such as knowledge assets are transferred to avoid failures. This may or may not reduce transaction costs but certainly it manages risk better. However not all business can be done through subsidiaries and some joint ventures are necessitated by cultural differences. Although the I advantage is lost as there is more leaning on the local partners but here too the firms usually hold specific activities like R&D through their own I advantage controls (Gatignon and Anderson, 1988), but not every one agree with this contention (Kogut and Singh, 1988) Toyota Motors have a burning desire to become world number one in automobile sales and may likely reach this position this year itself as it is only marginally behind General Motors. It has successfully utilised it’s I advantage as it strongly controls its operations through its own Japanese managers. However in some places like Thailand it has given up some of its R&D controls and found this to its advantage when the Thai engineers designed and produced its now famous mini-van the Innova which has become the rage of the world. Here its motive was originally market seeking but became efficiency seeking casing on the brilliance of it overseas employees. Microsoft is another example. It also spread its wings globally and specially opened as many as three facilities in India. It had twin objectives. It is already in awe of the prowess of the Indian software engineers and employs some of the best brains in the business at its Redmond Headquarters. In India it made an exception and passed on the R&D activities to the Indians. Indeed Windows 98 and XP were largely developed in India. Microsoft’s motives were both resource seeking and efficiency seeking. References: 1. Behrman, J. N,. (1972) The Role of International Companies in Latin America: Autos and Petrochemicals. Lexington, MA: Lexington Books. 2. Buckley, P. J. and Casson, M., (1998). ‘Analyzing foreign market entry strategies: Extending the internalization approach’. Journal of International Business Studies, 29(3), 539–64. 3. Buckley, P. 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Kogut, B. and Singh, H., (1988). ‘The effect of national culture on the choice of entry mode’. Journal of International Business Studies, 19(3), 411–32. 15. Porter, M. E., Competitive Advantage. New York: Free Press: 1980 16. Rugman, Alan M., (1985) “Internalization is still a general theory of foreign 17. direct investment”, Weltwirtschaftsliches Archiv, 121, pp. 570-575. 18. Tolentino, P. E., (2001). ‘From a theory to a paradigm: Examining the eclectic paradigm as a framework in international economics’. International Journal of the Economics of Business, 8(2), 191–209. 19. Williamson, Oliver E.,(1975), Markets and Hierarchies: Analysis and Antitrust Implications. New York: Free Press. Read More