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Theories of International Management - summary articles 2016
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Theme 1: Theoretical foundationBuckley, P. J., & Casson, M. C. (2009). The internalization theory of the multinational
enterprise: A review of the progress of a research agenda after 30 years.
The future of the MNE
Buckley and Casson (1976) analysed the MNE within a broad-based intellectual framework based on
the pioneering work of Ronald Coase (1937). The 1976 book explained why MNE activity was
concentrated mainly in knowledge-intensive industries characterised by high levels of R&D
expenditure and advertising expenditure, and by the employment of skilled labour. An MNE was
defined as a firm that owns and controls activities in two or more different countries.
The analysis was based on 3 principles: 1) the boundaries of a firm are set at the margin where the
benefits of further internalisation of markets are offset by the costs. 2) firms sought out the least-cost
location for each activity, taking its linkages with other activities into account. 3) the firm’s
profitability & dynamics of its growth, were based upon a continuous process of innovation (R&D).
The book provided a simple but radical analysis of the MNE by examining both location and
internalization strategies.
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.
This was a radical departure from the neoclassical economic view of the firm as a unitary
‘‘black box’’ devoted entirely to production, whose inputs and outputs were related by a
simple production function. The new vision of the firm emphasized the internal division of
labour, involving specialized functions comprising not only production but also marketing and
R&D.
This view had an immediate impact. Previously the market entry decision had been analysed
as a simple choice between exporting and foreign investment, whereas afterwards it was
analysed as a three-way decision between exporting, foreign investment and licensing.
When applied using a global systems view, internalisation theory illustrates how the activities
of different MNEs interact with each other. As a result, an MNE’s decisions on how to enter a
particular national market are embedded within its wider global business strategy.
The concept of internalization
Internalisation is a general principle that explains the boundaries of organisations; its application to the
MNE is just one of its many implications. It can be combined with trade theory to explain the location
of the firm’s operations, with organisation theory to explain international joint ventures (IJVs), and
with theories of innovation to explain the kinds of industry in which a firm will operate.
Most organisations purchase inputs from independent suppliers, and so the question naturally
arises as to whether they should produce these inputs for themselves (“make or buy decision”,
“backward integration”). Many organisations use independent agents to distribute their product, or to
add further value to it before it is passed to the final user (“forward integration). In the context of
international trade, the question arises as to whether producers should establish overseas sales
subsidiaries to monitor and control distribution operations in foreign markets.
In general, most organisations 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
internalised.
Internalisation theory assumes rational action. Rational agents will internalise markets when
the expected benefits exceed the expected costs. Firms derive an economic rent from their exploitation
of the internalization option, equal to the excess of the benefit over the cost.
Rational action modelling
, Internalisation theory analyses the choices that are made by the owners, managers or trustees
of organisations. The theory assumes that these choices are rational. Rationality signifies that the
decision-maker can identify a set of options, and has an objective by which these options can be
ranked, and an ability to identify the top-ranked option and select it. Rationality concerns the process
by which the best option is identified, irrespective of the nature of the objective.
Rational action models distinguish between endogenous and exogenous variables. Where
decision-making is concerned, the factors that influence the decision are exogenous, whereas the
outcomes of the decision are endogenous. The outcomes include both the decisions themselves, and
their consequences for the organization concerned.
The exogenous variables in the Buckley and Casson model (1976) can be characterised as
either firm-specific, 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; and location-specific
factors by production costs in different regions.
Rational action modelling can be applied to a wide range of international business issues,
including: (1) extending the theory of the firm; (2) dynamic market entry; (3) IJVs; (4) international
entrepreneurship (Casson, 2000), dynamics, and innovation; (5) business culture (Casson, 1991), and
strategic complexity in international business.
The Coasian heritage: Internalisation as a general theory of the firm
Internalisation holds the key to the formation of any firm, whether multinational or not. Typically, an
entrepreneur recognises a product market opportunity, hires a team of workers to exploit it (knowledge
internalisation), coordinates the work of the team, possibly through a manager (operational
internalisation), and makes a profit if his judgement is correct. A team can be configured in all sorts of
ways. It does not have to be concentrated in a single plant, or even a single country. The most
appropriate configuration depends upon the entrepreneur’s idea and the best means of exploiting it.
Coase, 1937: concluded that, given the existence of alternative coordination mechanisms,
economic principles suggested that the cheapest form of coordination would be selected in any given
circumstances. He assumed that the economy was basically market driven, and that firms would arise
only when managerial coordination proved itself superior to the market.
Coase’s line of argument: Conclusions:
Firms do not have to internationalise incrementally; they can be born globally. Firms are
created when entrepreneurs identify profit opportunities and set up firms to exploit them.
Economies of internalisation are not specific to licensing decisions nor to the
internationalization of the firm. They provide the basic logic for the formation of the firm,
and remain of strategic importance throughout its life.
The advantages exploited by multinationals are created, not endowed. They begin with the
initial inspiration of the founder entrepreneur, and are refined through continuous knowledge
development. This process of knowledge development involves continuous feedback effected
through the circulation of information between production, marketing and R&D. In this
context R&D represents any organised activity that converts ideas and experience into
incremental innovations in the design, production, or marketing of the product range.
Historical Context to the Emergence of the Theory
When economists first began to look at the MNE in the 1960s, the dominant theory in
international economics at the time was Heckscher–Ohlin trade theory. According to this theory, each
country had a fixed endowment of labour and capital, and specialised in producing a mix of products
that made the best possible use of its endowments. Each country had access to the same technologies,
and all markets worked perfectly. Each country exported the products in which it specialised. There
was no room in this theory for the MNE; it was purely and simply a theory of trade. The natural way
to introduce MNEs appeared to be to relax the assumption that each country had a fixed endowment of
capital. But having ruled out capital as the explanatory factor, economists turned to technology.
, Conventional industrial economists took the national market as their basic unit of analysis, and
it was therefore a significant breakthrough when Hymer (1976) began to analyse monopoly as a
global phenomenon. Hymer argued that the wave of US investment in postwar Europe was a
consequence of US technological supremacy, as revealed by the technology-based monopolies of its
leading industrial firms.
Kindleberger postulated the existence of some advantage possessed by the foreign investor
that more than outweighed the penalty of being foreign. In addition to Hymer’s monopolistic
advantage, he described other advantages, such as superior access to capital. While Hymer’s advantage
was specific to the firm, some of these other advantages were not; they were shared by all firms
headquartered in a given country – in particular the US.
Caves (1971) suggested another source of monopolistic advantage – brands – while Aliber
(1970, 1971) suggested another non-monopolistic advantage in the form of a currency premium. The
difficulty with the advantage approach, however, was that it failed to explain why firms did not license
their advantage to local firms abroad, thereby generating economic rents through license fees while
avoiding the costs of doing business abroad. The answer, as Buckley and Casson (1976) pointed out,
was that the costs of licensing were usually even greater than the costs of doing business abroad.
There were therefore three contending theories of the MNE in the mid-1970s: a trade theory
with international capital movements, a monopoly theory based on industrial economics, and
internalization theory. There were two main questions to be resolved: 1) What explains the existence
of the firm? 2) What explains the existence of the MNE? Internalisation theorists regarded the first
question as fundamental and the second question as derivative. By answering the first question they
were able to answer the second question too. There was no need to assume special costs of doing
business abroad – a significant advantage when analysing the modern globalised economy. Knowledge
internalisation explained why firms were set up and how they acquired a degree of monopoly power,
while operational internalisation explained why it was natural for successful firms to evolve a network
of foreign subsidiaries.
Internalisation reveals the theory of the MNE as a special case of a general theory of the firm
that embraces both domestic and multinational firms. In this theory, profit opportunities are identified
by founder entrepreneurs who then build sustainable global markets supported by global production
systems and a commitment to continuous R&D.
The international division of labour in a global economy: A global systems view
In the 1980s evidence began to suggest that some MNEs were evolving systematically into
global firms. Many mature MNEs had begun to restructure their operations. They acquired new
facilities, often through mergers and acquisitions, and divested themselves of other activities. Buckley
and Casson therefore developed a ‘‘systems view’’ of international business that was designed to
provide greater clarity on these issues.
They visualised a world production system, based on a configuration of facilities, including
R&D laboratories, production plants and distribution warehouses, spread across the world, and serving
a range of different industries. These facilities are owned instead by a range of different firms – mostly
private, but some owned by individual nation-states. Many of these firms are MNEs, because the
facilities they own are based in different countries.
Internalisation theory was then applied to explain why certain clusters of related facilities were
owned by the same firm. Different clusters, owned by different firms, would interface through external
markets, where different firms would trade with each other. A key insight of this systems view was that
the internalisation decisions are interdependent in two distinct ways:
First, firms are involved in multiple internalisation decisions. These decisions are
interdependent; the outcome of one decision cannot be fully understood without reference to
other decisions.
Second: related to the internalization decisions of different firms. From a systems perspective,
a facility that is wholly owned by one firm cannot be simultaneously wholly owned by another
firm, because the principle of private property does not permit this. Consequently, if one firm
internalises a linkage to a given facility, then other firms cannot internalize linkages to that
facility. They may have only external linkages to it. Thus the internalisation decisions of
, different firms are interdependent when they compete to internalize linkages to the same
facility.
How did the forces of globalisation shape the world production system? Buckley and Casson
argued that globalization arose from a combination of exogenous factors, the most important of which
were policy changes and technological improvements in international transport and communications.
Dunning, J (2000) The eclectic paradigm as an envelope for economic and business theories of
multinational enterprises activity
Introduction – the eclectic paradigm (later called OLI paradigm) has remained the dominant analytical
framework for accommodating a variety of operationally testable economic theories of the
determinants of foreign direct investment (FDI) and the activity of multinational enterprises (MNEs).
The eclectic paradigm is a simple, yet profound, construct. It avers that the extent, geographically and
industrial composition of foreign production undertaken by MNEs is determined by the interaction of
three sets of interdependent variables; competitive advantages, locational attractions and
internationalization advantages.
Competitive advantages are specific to the ownership of the investing enterprises. The greater the
competitive advantages of the investing firms, relative to those of other firms and particularly those
domiciled in the country in which they are seeking to make their investments, the more they are likely
to be able to engage in, or increase, their foreign production.
Locational attractions of alternative countries or regions are undertaking the value adding activities of
MNEs. The more the immobile, natural or created endowments, which firms need to use jointly with
their own competitive advantages, the more firms will choose to augment or exploit their ownership
specific advantages by engaging in FDI.
The third sub paradigm offers a framework for evaluating alternative ways in which firms may
organize the creation and exploitation of their core competencies, given the locational attractions of
different countries or regions.
The greater the net benefits of internalizing cross-border intermediate product markets, the more likely
a firm will prefer to engage in foreign production itself, rather than license the right to do so by
technical service or franchise agreement, to a foreign firm.
The precise configuration of the OLI parameters facing any particular firm, and the response of the
firm to that configuration, is strongly contextual. It will reflect the economic and political features of
the country or region of the investing firms and of the country or region in which they are seeking to
invest; the industry and the nature of the value added firms, including their objectives and strategies in
pursuing these objectives; and the reason for the FDI.
There are four types of foreign based MNE activity:
1. That designed to satisfy a particular foreign market, or set of foreign markets, market seeking
or demand oriented, FDI.
2. That designed to gain access to natural resources: minerals, agricultural products, unskilled
labor, supply oriented FDI.
3. That designed to promote a more efficient division of labor or specialization of an existing
portfolio of foreign and domestic assets by MNEs, which means rationalized of efficiency
seeking FDI. This type of FDI, though related to the first or second kind is usually sequential
to it.
4. That designed to protect or augment the existing ownership specific advantages of the
investing firms and/or to reduce those of their competitors i.e. strategic asset seeking FDI.
One of the first theories of FDI is the product life cycle theory by Vernon (1966), he was not only
concerned with explaining the process by which firms deepened and widened their markets, but
also how their locational needs might change as they moved from the innovatory to the
standardized stage of production.
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