Dunnings Eclectic Paradigm - Essay Example

Executive Summary Dunning’s eclectic paradigm comprising of OLI advantages for firms wanting to enter foreign markets has been evaluated. Various new strategies have been found and new set of circumstances which force the companies to look towards other criteria or entry. Trade liberalization and the consequent competition combined with reduced costs have made the companies turn towards other strategies like alliances. Dunning’s model completely ignored the investing firm’s capability when deciding the mode of entry. It also did not take into account the motives of the firm in investing abroad. Market uncertainties and product characteristics are equally important. Firms enter through the research and development process and then get a foothold in the country. In the face of competition firms even ignore the short-term losses when they find tremendous potential in investing. Hence, several variables need to be added to the existing model as resources have become readily available. Table of Contents 1. Introduction 1 2. Findings 2 3. Conclusion 8 References 10 Introduction Dunning sees an interrelationship between I and O type advantages in that internalisation helps a firm to acquire or increase those assets which give it an O type advantage. The essence of the eclectic approach is to consider the OLI type advantages together and in applying them to both international trade and production. This means that it is more of a synthesis of other approaches. Dunning calls his theory systemic because it relates to the way in which the firm coordinates its activities. Dunnings model attempts to integrate elements of micro and macro theory and to explain international trade and production within the same conceptual framework. It is centered on the notion that FDI is the most effective vehicle for serving foreign markets when the firm possesses the advantages under conditions of imperfect competition (Holsapple, Ozawa & Olienyk, 2006). Dunning’s framework according to Brouthers and Hennart (2007) can be conceptualized as a tool that combines insights from resource-based (firm-specific), institutional (location) and transaction cost (internalization) theories. The approach is dynamic since the OLI advantages interact with one another. L advantages may create incentives to internalise and I advantages create further O advantages. The main doubt about Dunnings model is whether it is more than a mere taxonomy. The model is a helpful classification - but does it explain anything? Findings Dunning’s framework has not been found to be sufficient to arrive at a decision concerning the mode of entry in international markets. Additional sets of variables have been employed to arrive at a conclusion. For instance, in the case of Taiwanese investments in the United States, the additional influence of strategic variables like the motive for entry was studied (Brouthers & Hennart, 2007). It has also been found that OLI may affect the manufacturing and service firms differently. Some authors have found that ownership advantages may be location-specific. This implies that when the advantage is context-specific, it would differently influence the mode choice in developed and undeveloped countries. In the case of the IT industry, Dunning’s model is ineffective as various other parameters have to be taken into account. Level of control is the most critical factor in the case of IT as technology transfer is required. The level of control determines the risk and return that the foreign firm may encounter. In technology transfer high level of control is required and the contracts have to be specific. Before the contract is signed, the buyer is not aware of the exact characteristics of the technology and hence he is likely to undervalue it. The seller on his part has to be careful in divulging too much information on the technology before the agreement is sealed as the benefit would be lost (Blomstermo, Sharma & Sallis, 2006). Hence in the case of IT firms, Dunning’s model is ineffective and Porter’s theory of competitive advantage or Porter’s Diamond Model is more effective. The four determinants in this model include the factor conditions, the demand conditions, related and supporting industries and firm strategy, structure and rivalry (Abbot, 2004). This takes into account the bargaining power of the buyers as well as the supporting role of the government. There is no provision to evaluate these factors in Dunning’s model. A study by Rajan and Pangarkar (2000) found that Singapore MNCs choice of entry mode depends upon the costs of setting up a particular venture, be it transactional due to firm specific assets or agency cost due to country risk. If the firm specific assets are threatened by potential opportunistic behavior by their local partner, then these Singapore MNCs would prefer higher equity stakes. This means the L disadvantages influence the O factors. In countries like China where the internalization costs are high due to underdeveloped legal system, they go in for two-tier equity stake pattern. Hence, apart from OLI, the Singapore MNCs have to take into account the costs in their overseas ventures. Van Der Putten (2004) contends that Dunning’s model can only show why it is advantageous for a certain company to engage in FDI in a certain place. This approach is too superficial for a company at an individual level. All the relevant data may not be available to assess the advantages and besides the investor may have motives other than efficiency. Even what constitutes economic efficiency differs across managers and investors. This implies that a company would interpret its own advantages. This can be done by applying the corporate governance approach based on the stakeholder theory. This approach becomes essential for companies because the internal balance-of-powers system of a company affects the way a company responds to changes in its environment. Merely studying the advantages may not be sufficient for a company to take a decision. When Philips wanted to enter Taiwan in 1960s, they understood the locational advantages as per Dunning’s model but this alone did not persuade them to invest. How the company responded to these factors requires an analysis of corporate governance. It was the role of the CEO who urged the stakeholders including the board members to make the largest possible investment in shortest possible time that made the move to Taiwan possible. Hence, assessment of the advantages is not sufficient. There is no single theory of international trade that can explain the trade flows. General Motors (GM) gained sustainable competitive advantage by investing in R&D. They took advantage of the time and opportunity when other automobile companies were reluctant to drain technology and quality control (Hara & Nakanishi, 2004). Most confined themselves to assembly of finished cars and at this juncture GM tied up with the government for R&D functions. They entered China through this method but today have local production, established R&D function and also developed its own sales channel. First-mover advantages refer to the economic and strategic advantages that accrue to early entrants into an industry. Because of economies of scale, early entrants get lock on the world market that discourages subsequent entry. Countries may export certain products simply because they have a firm that was an early entrant. New trade theorists stress the role of luck, entrepreneurship and innovation in giving first-mover advantage to a firm. Firms like Philips and DHL enjoyed the first mover advantages in China. No doubt china offers L advantages but firms now believe that even if they do not gain in the short-term they still must have presence in China. Most foreign companies still operate unprofitably in the Chinese market but they see potential, which has prompted them to enter (Jagersma & Gorp, 2003). When one company is keen to exit, another MNCs is equally keen to enter the same emerging market. Dunning’s model would be unable to explain this concept. Vodafone of UK entered the Indian telecom market by making a deal with the Hong Kong-based Hutchison Telecommunication International Ltd. (HTIL). India had emerged as the fastest growing telecom market in the world but since it had low penetrating rate it promised the most lucrative market. HTIL exited because the urban markets were saturated and further growth would come through the rural areas which would mean lower average revenue per user (ARPU) and the return on investments would be low (ICMR, 2008). Many felt that Vodafone had overpaid for the deal but the company was convinced that the price would help them get a footprint in the most promising telecom market in the world. Here too, corporate governance has played a major role as the role of the then CEO was important in striking the deal. The OLI paradigm ignores the investing firm’s capability in taking risks in overseas ventures. A study was conducted by Forlani, Parthasarathy and Keaveney (2008) to assess the amount of risks the US business owners would be willing to take and the entry mode they would prefer in entering the Japanese market. They found that managers in lower capability firms would prefer non-ownership entry mode while the higher-capability firms see least risk in equal-partnership entry mode. For a new venture in foreign markets control over the R&D functions have to be retained. Again, FDI entries are not a one-time decision but a series of sequential decisions that determine the volume and direction of resources among countries. As firms learn more about the local market they would like to have greater control. This is the Uppsala stage model which maintains that MNCs with incremental experience and knowledge about the host country’s specific environment perceives fewer uncertainties (Zhang, Zhang & Liu, 2007). They thus gain the capability of correctly assessing the risks and returns, manage foreign operations effectively and then increase their foreign investment commitments. Uncertainties in the foreign markets can be culture-specific, country-specific or market specific. Operational difficulties arising from cultural distance are due to lack of understanding of the norms, values and institutions. For instance, McDonalds has faced criticism in India as well as in France and in Israel they had to lower their arches as they had not been respecting the sentiments of the local people (Prince-Gibson, 2002). Country-specific uncertainties include political hazards and government interference (Zhang, Zhang & Liu, 2007). Vodafone face such uncertainties in trying to enter India. Such uncertainties can outweigh the costs of unfamiliarity with the local market, culture and political system. Market specific uncertainties include the imperfect property rights protection, imperfect industry structure, relationship with suppliers and clients and a variance in consumer preferences. Ekeledo and Sivakumar (1988) point out that product classification can be a key determinant in entry mode choice. This has not been considered by previous eclectic models. Both macro and micro characteristics of the product are important for entry mode choice. While the macro characteristics help in identifying the right entry mode, the micro characteristics distinguish the firm’s products from similar products. In other words they reflect the proprietary content of the product. To protect the proprietary content a firm may decide on sole ownership in foreign markets. With trade liberalization and falling transport costs, the old FDI paradigm as suggested by Dunning’s has undergone a transformational change. Liberalization has reduced the role of trade policy and minimized the role of the host governments. The MNCs need no longer sell or license their technology or marketing assets to local firms. Communication has eased which allows the foreign firms to exercise greater control in foreign markets. Hence investors demand tighter intellectual property protection and better enforcement of the laws and regulations (Pigato, 2000). Today investors also look at competition policies and the local network of suppliers. Countries that have dynamic local firms are more attractive to investors as this would allow them to subcontract some of their processes to the local firms thereby saving costs and remaining competitive. It is no more about low-cost unskilled labor but firms seek qualified human capital. Hence the parameters that firms look for in entering a new market has undergone a phenomenal change, rendering Dunnings’ eclectic model inefficient. In the global car industry there is over-capacity which means too many manufacturers and too few buyers. Car manufacturers then have to adopt a strategy with a difference. Brand names and product reputations (ownership advantages) play an important part in consumer decision-making and hence companies like GM undertook expansion by investing overseas in smaller automobile firms through acquisition. They have been buying up small stakes in rivals’ businesses. They have a 20% stake in Japan’s Subaru, 20% stake in Fiat of Italy and 42% stake in Daewoo Motors of South Korea (Bized, 2009). Such strategic alliances give them economies of scale as their investment in developing new smaller models is reduced and it also helps them to come out faster with new models. GM has always tried to find a ‘fit’ between themselves and the smaller firm as it allows them to broaden their product range, this implies that they a car model for every pocket. This differentiation helps them compete in oligopoly markets. Conclusion It can thus be surmised that the old paradigm of OLI is no longer sufficient to decide on the mode of entry that a firm should employ. Trade liberalization, changes in transaction costs, changes in availability of resources, advanced communications technology have all contributed towards changes in the globalized market place. Today motive for entry is equally important and profit is no more the sole motive. Besides, economic efficiency can differ across managers. Investing firm capability also helps determine the level of control and risk that a firm would be prepared to undertake. Firms also enter a new market through R&D and after a certain period they start manufacturing. Sequential investments and control has also been found when firms want to increase their stakes as they getter a better understanding of the foreign market. Companies plan investments even when they know they would be losing in the short term but find great potential in the long run. Dunning’s model does not take into account these variables and in today’s changed environment can no longer serve the purpose. References: Abbott, PY 2004. Software export strategies for developing countries: A Caribbean perspective. Retrieved online 06 February 2009, from http://www.ejisdc.org/ojs2/index.php/ejisdc/article/viewFile/119/119 Agarwal, S & Ramaswami, SN 1992. 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