8.3 Dunning s eclectic paradigm of international production

8.3 Dunning ˜s eclectic paradigm of international production

Dunning s paradigm addresses the sources of competitive advantage for international operators. Compared with local competitors, a company operating abroad is faced with several disadvantages, such as lack of information, poor or no access to distribution channels and so on. In order to beat its competitors the company must be able to offset these disadvantages with competitive advantages by combining the various comparative advantage ^[3] identified during the first stage of the strategic planning process: the environmental and SWOT analyses. Dunning distinguishes between transactional, locational and firm-specific (ownership) advantages. The intensity and constellation of these determine both the choice of market entry strategy and the subsequent success of the MNE. The eclectic paradigm thus addresses all the interdependent factors in international operations in a systematic way.

The basic structure of the eclectic paradigm is depicted in Figure 8.3. A central assumption is that countries factor endowments and economic and political institutions differ . This leads to a situation of market failure in which opportunities emerge to convert these failures into competitive advantages. Market failures can have structural or transactional causes that influence the nature of the advantages enjoyed by MNCs. Structural market failures arise from factors that are external to the company while transactional market failures relate to the company s operations. For example, the shortages in the communist era were related to structural market failures, while a Western company s ability to produce quality goods and services economically shows its ability to overcome transactional market failures.

Figure 8.3: Dunning s eclectic paradigm. Source: Dunning (1988), p. 12.

A core use of the eclectic paradigm is to determine the most appropriate form of market entry. Various partial theories , for example those of macro resource allocation and organizational economics, are included in the analysis (hence the term ˜eclectic ), so Dunning s approach can explain more than partial theories are able to when applied alone (Dunning, 1993, p. 76). Furthermore the inclusion of trade theory, location theory and theories of competition enables conclusions to be drawn about the strength of certain categories of advantage for an MNE. ^[4] These categories, or ˜OLI configurations , are the ownership advantages of the analyzed company (O), the location advantages of the host country (L) and internalization advantages (I) (see Figure 8.3 for details of these).

Ownership advantages are competitive advantages that result from a company s special technological or managerial know-how. It is usually more difficult for foreign companies to enter a market than it is for domestic firms, and the larger the spatial, cultural and linguistic distance between the home and host country, the greater the difficulty. (This difficulty is easier to overcome for Westerners in Poland than, for example, in Russia and other countries further east due to the long tradition of Christian culture in Poland.) In order for a foreign company to succeed its ownership advantages must outweigh the obstacles of being foreign. Dunning divides ownership advantages into asset advantages (Oa) and transaction advantages (Ot). Oa advantages relate to specific assets that are not available to competitors, such as patents, while Ot advantages arise from the organization of transactions (Dunning, 1988, p. 2).

Table 8.3: Relationship between form of market entry and strategic advantages

	Direct investment	Export	Licensing
Ownership advantages	Yes	Yes	Yes
Internalization advantages	Yes	Yes	No
Locational advantages	Yes	No	No

Locational advantages are based on economic differences between nations. These country-specific advantages (such as lower labour costs in Poland) can be exploited by producing in the locations in question. Dunning outlines the importance of distinct factor endowments of different countries. In contrast to neoclassical approaches, he removes the restriction of immobile factors and allows intermediate products and know-how to be transferred across borders.

Internalization advantages can be achieved by coordinating international transactions. As a result of market failures, different forms of organization involve different transaction costs (Dunning, 1993, p. 66). Internalization advantages are therefore important when there is an incentive for a company to exploit a competitive advantage on its own (that is, by exporting or setting up a wholly owned subsidiary) rather than selling or leasing it to someone else (licensing).

The final combination of OLI advantages is determined by certain attributes of the company (for example firm size and strategy), the industry (for example intensity of technology) and the country (for example degree of industrialization). Depending on which of the three advantage categories exist in a particular case, Dunning recommends a particular form of market entry (Table 8.3). Foreign direct investment is recommended when all three advantage categories are positive. If there are no locational advantages an export strategy is preferable. If there is no incentive to profit from ownership advantages by producing inside the firm and there are no internalization advantages at all, licensing the production to a foreign company is the best solution. This leads us to the following hypothesis, which will be empirically tested in the next section: the economic competitiveness of the host country and particular firm-specific ownership and internalization advantages have a strong bearing on the appropriateness and likely profitability of the various forms of market entry, and thus on the actual market entry decision of a company.

^[3] Comparative advantages can easily be obtained by any company. However in order to gain competitive advantage firms must achieve uniqueness through an advantageous combination of activities. (This argument is consistent with Michael Porter s view of successful strategies; see Porter, 1996.)

^[4] Hymer s (1976) monopoly theory, for example, provides an appropriate basis for analyzing ownership advantages. Partial theories on the problem of location can be found in international trade theory (for example Ricardo, 1911; Ohlin, 1931; Heckscher, 1966) and location theory (as outlined in Tesch, 1980). Internalization advantages can be analyzed on the basis of transaction cost economics. See M ¼schen (1998) and M ¼schen and Meyer (1999) for further explanations .