Dunning's Electric Paradigm - Case Study Example

DUNNING’S ECLECTIC PARADIGM (ON MODE OF ENTRY) ON ITS WAY OUT? TABLE OF CONTENTS TABLE OF CONTENTS 2 EXECUTIVE SUMMARY 3 Mode of entry: 4 EXECUTIVE SUMMARY Growing levels of globalization have resulted in many companies expanding into international markets. This practice is also compounded by the increasing level of competition within the domestic market. There are many methods by which a company can expand internationally and they include joint ventures, Greenfield acquisition, and direct entry. Many theories on how companies choose a particular mode of entry. Prominent among them is the Dunning’s eclectic paradigm. This paper reviews the Dunning’s paradigm in relation of mode of entry of companies. It also reviews other theories and factors that determine the mode of entry. Prominent among them is the Porter’s diamond model. Dunning’s paradigm became popular because it took into account three important factors that determine mode of entry, namely ownership, location, and internalization. But in the current scenario, this paradigm is not taking into account many factors like changes in technological capability and governmental policies of the host nation. It would be better not to depend on one theory or model when considering a mode of entry DUNNING’S ECLECTIC PARADIGM (ON MODE OF ENTRY) ON ITS WAY OUT? Introduction: The multinational enterprise of today has got the options to expand even more in the international market as a result of increasing globalization. These companies which are operating in different countries are able to generate profit through their unique policies and strategies and sometimes their profit margins overcome the nation state. They are able to find new business destination and succeeding to sustain in the particular market. This report will focus critical issue of entry into foreign markets of critically examining Dunning’s eclectic paradigm. It will also review to what extent the theory provides a basis for understanding why firms choose one entry mode over another and consider any alternative theories with relation to mod of entry. Mode of entry: According to Xuemin Zhao and Reinhold Decker, “Being such an important issue market entry mode choice became the object of numerous theories and models developed to understand and explain associated phenomena.” (Zhao and Decker, p.3). The authors have provided several theories that have been developed over the years in relation to the mode of entry by corporations they include the Dunning’s eclectic paradigm, Transactional Cost Analysis Model, the Stage of Development Model, the Organizational Capacity Model, and the Decision Making Process Model. Dunning’s eclectic paradigm (OLI factors): Ownership advantages: The advantage that exists with regard to ownership is specific to individual firms. “These ownership advantages are created through a firms international experience, size, their ability to differentiate their product or service, the adaptability of the product or service, the service intensity and the technology intensity of their offerings.” (Brouthers, Broutherst and Werner, p.379). Location advantages: Where as ownership advantages are company specific, location advantages are market or country specific. In other words, every foreign company that operates in a specific market faces the same environment that includes factors like laws and statutes, social and work culture, talent and availability of qualified personnel, cost of production, technology available etc. Here the advantage derives from individual company’s ability to adapt or adjust to the location factors “The perceived distance between the home and host country in terms of culture, economic systems, and business practices determines location familiarity; the shorter the perceived distance, the greater the location familiarity.” (Hill, Hwang and Kim 1990, p. 117-128). Internalization: Internalization advantages are those “arising from transferring ownership advantages across national boundaries within own the organization.” (Zhao and Decker, p.8). According to Dunning, his earlier paradigm had only the two factors location and ownership. He writes that “In explaining the activity of firms outside their national boundaries, I extended the O and L advantages identified in my earlier research to include another set of choices available to firms, which related to the way the firms organized the generation and use of the resources and capabilities within their jurisdiction and those they could access in different locations.” (Dunning 2001, p.173-190). Dunning adds that it is the balance between these factors (OLI) that will ultimately determine the mode of entry. Dunning also admits that the paradigm does not take into other factors that motivate companies to choose a particular mode of entry. These factors may include the need for cost reduction, enchaining technological capabilities, and need to expand the market due to factors like competition. (Brouthers, Broutherst and Werner 1996, p.379). According to the authors referred to above, one of the reasons why theories (like Dunning’s paradigm) fail or become outdated partially or fully is that they usually do not take into account rapid changes in the economy and also other factors like development of nations and advancement in technology. Effect of company size, market potential, and product differentiation in Dunning’s paradigm: A study that included managerial perceptions with regard to Dunning’s eclectic paradigm was done by Sanjeev Agarwal and Sridhar Ramaswami. The researchers had developed five hypothesizes which are given here. The first one is that larger firms who had previous experience of operating in international markets prefer to enter the market directly (FDI) than opt for a joint venture. The second is that smaller firms with little or no international experience will prefer a joint venture with a company in the host country as a mode of entry. The third hypothesis is that in case of high risk markets (with regard to investments) firms having highly differentiated products prefer a direct entry (no joint venture) while even larger firms (with multinational experience) have a less probability of entering the market even through a joint venture. The fourth one is that in markets with high contractual risks, firms with differentiated products prefer direct entry while larger multinationals prefer not to do so. The last one is that in countries with high market potential coupled with high contractual risks, firms prefer either exporting or joint ventures. According to the researchers, “The main effect results confirm, with one exception, previous empirical findings in the entry mode literature.” (Agarwal and Ramaswami 1992, p.15). With regard to the first hypothesis, the study shows that larger firms prefer both sole and joint venture entries, but are averse to enter markets with low potential. In case they decide to enter a market, strategy takes precedence of cost benefits and trade-offs. Smaller firms tend to prefer joint ventures when planning international expansion, confirming their second hypothesis. The third hypothesis fails in the study because the results show that firms having highly differentiated products do not have any preference for a particular mode of entry. It indicates that choice is determined by other considerations. With regard to the fourth hypothesis, firms with highly differentiated products prefer a sole entry even in markets with high contractual risks. Their fifth hypothesis is also validated partially because the study shows that firms prefer exporting rather than entry into markets with high investment risks. Reasons for choosing Dunning’s model: This is one of the earliest models with regard to mode of entry. This is also one model on which many studies have been made with regard to its efficacy. For example, a study on Greek investment pattern in other countries uses this paradigm for analysis. The researchers of this study say that “this is a holistic, yet context specific framework of analysing foreign direct investment (FDI) determinants.” (Stoain and Filippaios 2007, p.349-367). One such study (not the above one) will be reviewed later in this paper. A few other theories of market entry are given here below. Stage of Development (SD) model or the U-Model of entry: The U model states that internationalization of firms is a slow and step-by-step process. This model “is based on the assumption that one cycle, or stage, of events constitutes the “input” of the next, in terms of accumulated knowledge and extended network activities.” (Gustaf and Christofer, 2006, p.6). There exists two dimensions which affect the development of the firm in the host market, namely geographic/cultural factors and commitment level of the firm. Commitment is based on the level of investment that the firm has in the host market. The theory also implies that lack of knowledge (about the market) and resources pull back firms from expanding internationally. The U Model is considered to be inadequate and hence “the SD model does not dominate the existing literature.” (Zhao 2005, p.18). Transaction cost model: This approach is the view that firms tend to minimize transactions costs. The book ‘Internationalization of firms’, states that firms believes in the premise “a low level of ownership is preferable until proven otherwise.” (Buckley and Ghauri 1999, p.190.). The drawback of this approach is that it only takes into consideration transaction costs, and not any other factors that may influence mode of entry. The organization capacity model: Aulakh and Kotabe who developed this view states that mode of entry is organization specific and is dependent on the capability of the organization taking into consideration factors like skill, technology, and knowledge that exits within the firm. Porter’s diamond model and concept of first mover advantage: Porter’s diamond model is based upon his theories from the book ‘The Competitive Advantage of Nations’ and are based on 4 factors. Factor conditions include all the natural and human resource advantage that a nation can offer. China’s low cost labor is an example. The next factor is home demand conditions where local products are preferred to international ones. The third factor is the availability of supporting industries and infrastructure. The fourth set of factors which are Firm Strategy, Structure, and Rivalry relates the work culture, management practices and strategies that are followed in a particular country.(Porter’s Diamond – Determining Factors of National Advantage. 2001). “The idea of first mover advantage is that the initial occupant of a strategic position or niche gains access to resources and capabilities that a follower cannot match.” (Grant 2002, p. 240). But in times of high levels of globalization, this first mover market may be difficult to identify. Even if it were found, the ‘advantage’ in first mover advantage will not be there unless a nation has other resources conducive to development. (Timmons, Zacharakis and Spinelli 2004, p. 9). Free trade and globalization: Many economies have opened up their markets in the hope of reaping the benefits of globalization and free trade. A study titled ‘What effects choice of entry mode?’ “indicate that government ownership restrictions most likely affect the choice of entry mode.” (Oztali and Abrami 2008, p.33). This could be an indication that government policies are the most important factors affecting choice. Some real life examples: Wal-Mart is a famous multinational retailer who uses different modes of entry into different markets. In Canada the company entered the market through acquisitions since it was considered to be a mature market with regard to retailing. (Govindarajan and Gupta 2009). In Mexico, the company chose a joint venture mainly due to the cultural differences that exists between the two countries. Managerial expertise also plays a hand in decision with regard to the mode of entry. This is in accordance with what has been said in Dunning’s model of ownership advantages. With regard to this area, IBM, Philips, and “P&G prefer Wholly Owned Subsidiaries.” (Going Global). Conclusion: From this study it is clear that there is no perfect and comprehensive theory of mode of entry. Due to the rapidly changing environment, increasing globalization, investment regulations of host countries and other related factors have made this situation complex. Government regulations in most cases give no choice to companies with regard to mode of entry. The statutes of the host country will specifically state that only a particular way can be followed. This could be the reason why no one single theory can satisfactorily provide an answer to how firms select the preferred choice of entry. The first mover advantage is also not a stand alone factor in deciding mode of entry. But it can be seen a deep analysis of Porter’s diamond model will give a clear picture about the market and companies can use this to decide on the mode of entry. But too many new factors have come up that have diminished the relevance of theories on the subject. For example a company might prefer a direct entry into an international market, but government regulation may only allow a joint venture. Hence no individual theory holds well with regard to choice of mode of entry if government regulation specifies a particular way. The best way is to have a combination of the many theories and studies, as well as a study of cultural and work practices, along with statutory regulations while determining a mode of entry. Bibliography AGARWAL, Sanjeev., and RAMASWAMI, Sridhar. N. (1992). Choice of Foreign Market Entry Mode: Impact of Ownership Location and Internalization Factors. [online]. Journal of International Business studies, 15. Last accessed 11 March2009 at: http://aib.msu.edu/awards/23_1_92_1.pdf BROUTHERS, Keith D., BROUTHERST, Lance Eliot., and WERNER, Steve. Ownership advantages. 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