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International Business Book

International Business Book

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Published by Waqas Abrar

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Published by: Waqas Abrar on Jan 11, 2012
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06/28/2013

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Market imperfections provide a major explanation of
why firms may prefer FDI to either exporting or
licensing. Market imperfections are factors that inhibit
markets from working perfectly. The market
imperfections explanation of FDI is the one favored by
most economists.8

In the international business literature,
the marketing imperfection approach to FDI is typically
referred to as internalization theory.

With regard to horizontal FDI, market imperfections
arise in two circumstances: when there are impediments
to the free flow of products between nations, and when
there are impediments to the sale of know-how

Impediments to Exporting

Governments are the main source of impediments to the
free flow of products between nations. By placing tariffs
on imported goods, governments can increase the cost of
exporting relative to FDI and licensing. Similarly, by
limiting imports through the imposition of quotas,
governments increase the attractiveness of FDI and
licensing.

Impediments to the Sale of Know-How.

99

The competitive advantage that many firms enjoy comes
from their technological, marketing, or management
know-how. Technological know-how can enable a
company to build a better product; for example, Xerox's
technological know-how enabled it to build the first
photocopier, and Motorola's technological know-how has
given it a strong competitive position in the global
market for cellular telephone equipment. Alternatively,
technological know-how can improve a company's
production process vis-á-vis competitors. If we view
know-how (expertise) as a competitive asset, it follows
that the larger the market in which that asset is applied,
the greater the profits that can be earned from the asset.

According to economic theory, there are three reasons
the market does not always work well as a mechanism
for selling know-how, or why licensing is not as
attractive as it initially appears. First, licensing may
result in a firm's giving away its know-how to a potential
foreign competitor. Second, licensing does not give a
firm the tight control over manufacturing, marketing, and
strategy in a foreign country that may be required to
profitably exploit its advantage in know-how. With
licensing, control over production, marketing, and
strategy is granted to a licensee in return for a royalty
fee. However, for both strategic and operational reasons,
a firm may want to retain control over these functions.

Third, a firm's know-how may not be amenable to
licensing. This is particularly true of management and
marketing know-how. It is one thing to license a foreign
firm to manufacture a particular product, but quite
another to license the way a firm does business--how it
manages its process and markets its products.

100

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