Provide a definition of Liability of Foreignness (LoF)
Answer: The disadvantage that foreign firms vs. local firms (\'not being local\'), the cost of doing business abroad. Impact of various forms of distance on MNE operations in foreign countries
2.
Name two types of LoF
Answer: Discriminatory LoF and Incidental LoF (also unfamiliarity LoF)
3.
What does discriminatory LoF entail?
Answer: Preferential treatment of host country government for local firms (nationalism), this remains relatively stable over time according to governmental regulations (cost of not being local)
4.
What does incidental LoF entail?
Answer: The cost of being unfamiliar in the market, firm does not know anything yet, they might have to find a partner to learn and adapt (these costs are incidental LoF related). Incidental LoF is high in the beginning but decreases over time.
5.
What are four sources of LoF? (Zaheer, 1995)
Answer: Coordination cost, adaption and learning cost, cost from host location and cost from home country
6.
Explain Coordination cost (LoF) (Zaheer, 1995)
Answer: Spatial distance cost (transport etc)
7.
Explain Adaption and Learning cost (LoF) (Zaheer, 1995)
Answer: Related to unfamiliarity in host country (cost of finding a partner etc)
8.
Explain Host location cost (LoF) (Zaheer, 1995)
Answer: Discrimination from host government through for example preferential treatment for national firms
9.
Explain Cost from home government (LoF) (Zaheer, 1995)
Answer: These are cost that an MNE is imposed to by its home government, e.g. trade restrictions with certain countries -> for example EU countries cannot trade with Iran.
10.
Name a way to overcome LoF (Hymer)
Answer: Possess monopolistic advantages to sufficiently outweigh LoF (e.g. superior marketing skills, product differentiation).
Content preview
Week 1: Theoretical foundations of studying IB and the MNE.
1.1 Fifty years of international business theory and beyond (Rugman,
Verbeke, Nguyen, 2012) Shift from analysis on country level->MNE level->
subsidiary level, focus on firm specific advantages.
Liability of foreignness; the impact of various forms of distance (cultural,
economic, institutional & geographical), on MNE operations in foreign countries.
Only few firms are able to operate truly globally, there are almost always barriers
that do not allow for balanced global sales. To own and control value-adding
activities, a firm must possess some kind of monopolistic advantages sufficient to
outweigh the LOF.
Examples: product differentiation ability, superior marketing & distribution skills,
trade marks or brand names, access to raw materials, economies of scale, access to
capital, intangible assets (patents, technologies, management skills, ability to do
horizontal and vertical integration).
Uppsala model of international expansion
Internationalization has stages in which potential benefits of exploiting FSAs abroad
must be weighted against the risks & costs of operating in a foreign environment.
Hence firms are likely to first:
• Expand to nearby countries with similar CSA
• Learn to overcome LOF
• Expand to more distant markets
• Then the unfamiliar environment will be offset against a firm’s ability to recombine
its FSAs with host country CSAs.
Ways to enter a foreign country
• Exporting
• FDI with fully owned subsidiaries
• Licensing
• International joint ventures
Hymer: existence of FDI is based on two conditions
1. Foreign firms must possess a countervailing advantage over local firms to
make the investment viable.
2. The market for selling this advantage must be imperfect.
FDI is a firm-level strategic decision not a capital market financial decision and will
occur mainly in imperfect markets.
Internalization theory-> general MNE theory
Firms aim at maximizing profits by internalizing their intermediate business across
borders in face of various market imperfections. (Check p.6,6): here, the MNE’s
existence is not caused by monopolistic advantages leading to entry barriers and
consumer exploitation, but by it’s efficiency properties, in other words, its capacity
to reduce transaction costs when replacing an inefficient or non-feasible arm’s
length transaction in the market by an internal transaction, inside the firm,
especially in the context of transferring intermediate (mostly knowledge-based)
outputs across borders.
Brigitte Stilma - Page 1 of 44
,The essential argument of internalization theory is that firms aim at maximizing
profit by internalizing their intermediate markets (typically the markets for
intangible assets such as technology, production, know how, brands, etc.) across
national borders, in the face of various market imperfections (such as the public
goods externality associated with pricing an intermediate product like knowledge,
the lack of future markets, information asymmetries between buyers and sellers,
government intervention in the form of trade barriers or the ineffective application
of the national patent system).
Three conditions should be satisfied for MNEs to organize inter-dependencies
between economic actors located in different countries more efficiently than
markets (Hennart, 2009)
- Interdependent actors must be located in different countries
- MNE must be most efficient governance system to organize
interdependencies
- Cost incurred by MNEs to organize interdependencies in the market must be
higher than those of organizing them within MNEs
Bridge gap between internalization theory and strategic thinking by concepts of
- LB: location bound
- NLB: non-location bound
- FSA: firm specific advantages
Coasian transaction cost economics theory:
When markets for intermediate products are imperfect, there are incentives to
bypass them by creating internal markets.
CSA/FSA Matrix
1. Mainstream international economics
explains how comparative advantage will
lead to home country export of goods &
services which build upon its abundant
factor inputs: labor, capital and natural
resources. Example: Saudi Arabia exports
oil and China attracts manufacturing
assembly through its abundant cheap
labor. This element also captures cultural
stereotypes.
2. The Firm being studied is an MNE
operating across multiple countries trying
to coordinate various resource
dependencies across borders.
3. Both CSA & FSA are important -> recombining resources across borders
should be done (Rugman & Verbeke).
4. Country factors do not matter much, competitive advantage solely results
from FSAs unaffected by geography (RBV). Solely FSA based competitive
advantage, non-location bound. Example: location independent brand equity
of a firm, managerial resources/capabilities of management.
Brigitte Stilma - Page 2 of 44
,1.2 Internationalisation theory of the multinational enterprise (Buckley,
Casson, 2009)
Based on coasian transaction cost economics theory
3 principles for MNE
• Boundaries of a firm are set at a margin where the benefits of further
internationalization of markets are offset by the cost
• Firms sought out the least cost location of each activity
• The firms profitability and the dynamics of its growth were based upon a
continuous process of innovation from R&D
- Internalization; in general, most organizations use a range of intermediate inputs
and generate a range of intermediate outputs. It is the markets for these
intermediate inputs and outputs that may be internalized. Internalization theory
assumes rational action. Rational agents will internalize markets when expected
benefits exceed expected costs. Two distinct forms of internalization were identified:
1. Operational internalization: involving intermediate products flowing through
successive stages of production and the distribution channel.
2. Knowledge internalization: the internalization of the flow of knowledge emanating
from R&D.
1.3 the electric paradigm as an envelope for economic and business
theories of MNE activity (Dunning, 2000)
Eclectic paradigm or OLI (Ownership, Locational, International); ‘The extent,
geography and industrial composition of foreign production undertaken by MNEs is
determined by the interaction of three sets of independent variables, with each sub
variables’ -> Dominant analytical framework that can be used to test economic
theories of FDI & the foreign activities of MNEs
Ownership specific advantages
The greater the competitive advantages of the investing firm (vs. other firms) the
more likely they are able to engage in/increase foreign production (assuming ceteris
paribus). Example; Unilever has a shampoo brand, which is an intangible FSA, which
attracts local consumers because it is known for its quality and luxury.
Three main ownership advantages:
• Monopolistic
• Scarce, unique, sustainable resources and capabilities
• Competencies of managers of the firm
Resource based theory
Reexamine the content and significance of existing resources and capabilities of the
firm in terms of
1. Their ability to sustain and or upgrade these advantages
2. Their ability to harness and influence the quality and price of complementary
assets, and to efficiently coordinate these with their own innovating
competencies
Brigitte Stilma - Page 3 of 44
, 3. Their ability to locate their value added activities in countries and regions,
which offer the optimum portfolio of immobile assets, both for creating or
acquiring new O specific advantages, and for exploiting their existing
advantages. Inter alia, such immobile assets may reflect the bargaining and
negating skills of MNEs in their dealings with foreign governments (Rugman &
Verbeke).
Evolutionary theory
Pays attention to the process of path by which the specific ownership advantages of
firms evolve and are accumulated over time. It tends to be in contrast with the
internationalization theory as it regards the firm as an innovator of created assets
rather than a ‘nexus of treaties’. It focuses on the firm’s long-term strategy towards
asset accumulation and learning capabilities, and its implications both for
established routines and the development of new ones.
Locational attractions of alternative countries or regions
For undertaking value-adding activities with MNE when companies need to combine
local resources with their ownership advantages they are more likely to engage in
FDI vs. subsidiaries.
Example; for Unilever to be market seeking FDI in combination with local production
FSAs to allow adaption to understand local market needs.
Internationalization advantage
The greater the benefits from internalizing cross border immediate product markets,
the more likely a firm will engage in foreign production markets, the more likely a
firm will engage in foreign production themselves vs. licensing an external party to
do so: franchise agreement.
Example; Unilever wants to sell Shampoo in India, however when exporting and
using local distributors there is not enough control over marketing etc., hence
transaction costs are high, therefore they might decide to set up a Greenfield Wholly
Owned Subsidiary.
Four main types of MNE activity (foreign based)
1. Market seeking: demand oriented satisfy one/multiple foreign market(s)
2. Resource seeking: designed to gain access to natural resources, labor etc.
3. Rationalized efficiency seeking: promote more efficient division of labor.
4. Strategic asset seeking FDI: protect or augment specific Ownership advantage
or reduce those of the competition
Conclusions:
• Variety of explanations of MNE & FDI are complementary
• Theory should be adapted to changing economy
1.4 the resource-based view and international business (Peng, 2001)
The resource-based view (RBV) of a firm has become an influential theoretical
perspective in recent international business research (IB).
RBV is a management device used to assess the available amount of a business’s
strategic assets. It is based on the idea that the effective and efficient application of
all useful resources in a company can help its competitive advantage.
Brigitte Stilma - Page 4 of 44
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