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Theories of International Management – Summary Week 3 Author: HuisinghIM Summary Article 1.1 Buckley & Casson (2009)
The internalization theory of the multinational enterprise: A review of the progress of a
research agenda after 30 years
Internationalization theory has retained its validity and its vitality over the past 30 years. Nowadays
it’s being extended into new fields of international business research. Buckley and Casson analysed
the multinational enterprise.
The multinational enterprise (MNE) = a firm that owns and controls activities in two or more
different countries.
Their book provided an analysis of the MNE by examining both location strategies and internalization
strategies.
Theory of location / location strategy used to be (orthodox): a firm chooses its optimal location
for production by evaluating regional production costs and chooses the location for which the costs
of production are minimized. This theory is complicated, because:
- There are increasing returns to scale in many activities.
- Modern businesses perform many other activities than routine production: non-production
activities (e.g. marketing, research & development (R&D).
- Firms operate largely in imperfectly competitive markets.
- Government intervention.
- Location decisions will be influenced by the extent to which internalization of markets in the
firm modifies the above considerations.
Where markets are internalized across national boundaries, MNEs are created.
Benefits of internalization arise from the avoidance (vermijding) of imperfections in the external
market. The optimum size of firm is set where the costs and benefits of further internalization are
equalized at the margin.
Combining both internalization and location effects allowed us to explain the division of particular
markets between domestic (binnenlandse) producers, local subsidiaries (dochterondernemingen) of
MNEs, exports from foreign-owned plants (fabrieken), and exports from MNEs (economics of
location vs economics of internalizing a market).
The question of servicing (onderhouden) a final market is bound up with the nature and ownership of
internal markets – which will be dictated (opgelegd) by the costs and benefits of internalization.
The result was a view of the firm as a complex of interdependent activities, linked by flows of
knowledge and intermediate products. These internal flows were coordinated by information flows
through the ‘‘internal markets’’ of the firm.
The new vision of the firm emphasized the internal division of labor, involving specialized functions
comprising not only production but also marketing and R&D.
Different plants could be located in different countries. When different countries were involved, a
multi-plant enterprise became an MNE.
1
,Internalization theory should be able to explain how the ownership of the system would be
parcelled out between different firms. It would identify the external markets through which the
boundaries of the firm were drawn, and also the internal markets that lay within the boundaries of
particular firms.
Finally, it would identify the long-term factors that explain why certain types of activity are best
carried out at certain types of location under the control of certain types of firm.
Internationalization theory illustrates how the activities of different MNEs interact with each other.
The concept of internalization
Internationalization = a general principle that explains the boundaries of organizations. It explains
where boundaries lie, and how they shift in response to changing circumstances.
(Not only geographical boundaries, also boundaries such as the boundary of a firm’s product range.)
Internationalization can be combined with:
- Trade theory to explain the firm’s operations.
- Organization theory to explain international joint ventures.
- Theories of innovation to explain the kinds of industry in which a firm will operate.
Most organizations purchase inputs form independent suppliers:
- Backward integration Should fims produce these inputs for themselves? “make or buy
decision”. By MNEs it’s exemplified by “resource-seeking investment”.
- Forward integration using independent agents to distribute your product, or to add
further value.
In the context of international trade, the question is: Should producers establish overseas sales
subsidiaries to monitor and control distribution operations in foreign markets?
Most organizations use a range of intermediate inputs and generate a range of intermediate outputs.
Internalization theory assumes rational action. Rational agents will internalize markets when the
expected benefits exceed the expected costs. The profit-seeking managers of a firm will internalize
intermediate product markets up to the margin where the benefits and costs of internationalization
are equalized.
The main focus of Buckley & Casson (1976) was on forward integration into production form R&D.
2 forms of internalization were identified:
- Operational internalization intermediate products flowing trough successive stages of
production and the distribution channel.
- Knowledge internalization internationalization of the flow of knowledge emanating from
R&D.
Licensing (pantenteren) would be an attractive option. A firm that employed a creative R&D
team could specialize in developing new knowledge and licensing it to independent
production firms that were better equipped to exploit the technology themselves.
(Unpatentable knowledge (low gains (winst/profijt)), patentable knowledge (high gains))
An MNE that monopolizes a new technology for the production of a good (readily tradable) has a
wide choice of production locations, and can therefore play off potential host countries against each
other to appropriate most of the gains for itself.
2
, Rational action modeling
Internalization theory analyses the choices that are made by the owners, managers or trustees of
organizations. The theory assumes that these choices are rational ones.
Rationality does not imply complete information, only sufficient information to make the risks
surrounding the decision acceptable, recognizing that mistakes are always possible.
In rational action models the number of options that decision-makers consider is often restricted, in
order to simplify the model.
Rational behavior is not necessarily selfish, as is sometimes suggested; the decision-maker’s
objective may, in fact, be an altruistic one. Normally the firm’s objective is to maximize profit.
Rational action modelling can generate parsimonious models that explain complex phenomena in
very simple terms. Rational action models distinguish sharply between endogenous and exogenous
variables:
- The factors that influence the decision are exogenous.
- The outcomes (decisions and consequences) of the decision are endogenous.
The exogenous variables in the Buckley and Casson model can be characterised as either
firmspecific, industry-specific, or location-specific:
- Firm-specific variables are exemplified by the costs of R&D, which reflect the skills of the
firm’s R&D team.
- Industry-specific factors by the costs of licensing, which reflect the nature of the knowledge
used in the industry.
- Location-specific factors by production costs in different regions.
The endogenous variables in Buckley and Casson (1976) included: the growth, profitability, and
degree of multinationality of the firm.
Rational action modelling can be applied to a wide range of international business issues, including:
- Extending the theory of the firm.
- Dynamic market entry.
- International Joint ventures (IJVs).
- International entrepreneurship (Casson, 2000), dynamics, and innovation.
- Business culture (Casson, 1991), and strategic complexity in international business.
When internalisation theory is combined with other theories, it is necessary to ensure that these
other theories are consistent with internalisation theory in their methodological approaches (e.g.
trade theory, neoclassical economic theories. Not: e.g. behavioural theories).
The Coasian Heritage: internationalization as a general theory of the firm
Why needed different activities located in different countries to be coordinated by a firm?
Employment with a firm provides an independent monitor – the employer – who ensures that the
workers do not impede each other. The monitoring need not be intrusive; loyalty to the
firm may encourage spontaneous hard work.
This is an example of operational integration in a small firm. Knowledge internalization may be
important too.
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