Eclectic Theory of International Production

 Dunning (1977, 1980) proposed an eclectic theory or paradigm of FDI.

 Dunning (2000) substantially updated the eclectic theory in a paper titled "The Eclectic
Paradigm as an Envelope for Economic and Business Theories of MNE Activity".
 Geography and Industrial composition of FDI undertaken by MNEs depends on the
configuration of three sets of advantages:
 The (net) competitive advantages, which firms of one nationality possess vis-a-
vis firms of other nationalities for serving that particular market.
 Locational advantage
 Internalisation advantage
 Net Competitive Advantages: Based on the developments in the FDI and
related literature, Dunning (2000) categorizes the net competitive
advantages into three groups:
 The first one relates to the possession and exploitation of
monopolistic advantages which arise from (or create) barriers to
entry to final product markets for firms not possessing them.
 The second one stems from the ownership of a bundle of scarce,
unique and sustainable resources and capabilities as identified by
the RBV.
 These advantages stem from (or create) barriers to factors (or
intermediate goods) market for firms not possessing them.
 The third one comes from the organization theory of MNEs and
includes "the competencies of the firms to identify, evaluate and
harness resources and capabilities from throughout the world and
to coordinate these with the existing resources and capabilities
under their jurisdiction in a way which best advances the long
term interest of the firms”.
 The long term interest of the firm may include "minimizing
transaction costs and maximizing the benefits of innovations,
learning and accumulated knowledge".
 The multinationality (i.e. the extent to which a firm undertakes
value-adding activities in many different foreign countries) per se
has also become an important intangible asset.
 The advantages of multinationality due to operation in many
diverse countries may include: i) economies of scale arising from
spreading of fixed costs over a larger market; ii) lowering of risk
stemming from the change in a country's interest rates, wage
 rates, and commodity and raw material prices; iii) accessing to
cheaper and idiosyncratic resources available in various countries
such as the cheaper labour, better technology, or any country-
specific resources; iv) global opportunities for organizational
learning or experience and for scanning rivals, markets and
profitable ventures.
 Locational advantages:
 The eclectic paradigm recognizes the locational advantages or the
attractiveness of the countries as the key determinants of foreign
production by MNEs.
 The location-specific advantages of a country may include cheaper
availability of factor endowments like natural resources, labour,
raw material; large domestic market, lower transport and
communication cost; better physical infrastructure (e.g. power
telecommunications, roads, seaports and airports); commercial,
legal and financial infrastructure; favourable, transparent and
nondiscriminatory policy environment towards FDI; fiscal
incentives, low tax rates, political stability and less government
interventions and institutional set up.
 Provided that a firm has unique ownership or competitive
advantages, it must be profitable for the firm to utilise these
advantages in combination with location specific advantages
existing in a foreign country, otherwise, the foreign markets
would be served by exports.
 The greater the net ownership advantage of the firms (net of any
disadvantages of operating in a foreign location), the more the
incentive they have to utilize these advantages among
themselves.
 Thus, a firm's propensity to engage in foreign production is jointly
determined by the country's locational advantages of immobile
natural resources or created assets and its own ownership or
competitive advantages.
 Internalization Advantage:
 A firm has a set of competitive or ownership-specific advantages
and the immobile locational advantages of a foreign country are
such as to warrant locating value adding or asset augmenting
activities.
  The firms not only try to maximize profits by optimizing the use of
existing assets internally through their foreign affiliates but they
also undertake FDI, as in many cases of cross-border mergers and
acquisitions, to acquire new resources and capabilities, or to
acquire new markets, or to achieve lower unit costs of production,
or to gain market power, or to forestall or thwart the
competitions.
 The eclectic paradigm further avers that the significance of each of these three
advantages (i.e. the net competitive advantages, locational advantages and
internalization advantages), the precise configuration of these advantages applicable to
a firm and the response of the firm to that configuration are likely to be the context
specific.
 The context specific factors may include the following:
 a) The economic and political features of the country (or the regions) of the
investing firms and the countries (or the regions) hosting FDI.
 b) The nature of industry and the types of value-added activities in which the
firms are engaged.
 c) The characteristics of the individual investing firms, including their objectives
and strategies in pursuing these objectives.
 d) The four motives of the FDI, namely, natural resources seeking, market
seeking, efficiency seeking and strategic asset seeking.
 e) The extent of market failure influencing whether or not the market for
technology is internalized across different industries.
 f) Differences in the perceptions of different corporations about the comparative
locational advantages of different countries as a manufacturing base.

Resource-based View of Firm:

 With the rise of Resource-based View in the 1990s, the focus regarding
sources of sustainable competitive advantage and firm level performance
(efficiency/profitability) has shifted from industry structure and firms'
conducts to the quantity and nature of resources possessed of the firms
within an industry.
 The researchers subscribing RBV look for possible causes of sustainable
competitive advantage mostly within the resources and capabilities of a
firm, holding constant all external environmental factors.
 The RBV divides resources into two major heads, namely tangible resources
and intangible resources or assets.
o The tangible resources include financial, physical and human capital.
These resources possess fixed long-run capacity and properties of
ownership and are relatively easy to be measured, traded and
duplicated.
o Intangible resources (or assets) consist of intellectual property rights
(e.g. trademarks, patents, copyrights, registered designs, and
brands), contracts (viz. agency agreements, license agreements,
property lease), organizational and marketing expertise, trade
secrets, reputation or goodwill and networks with customers,
suppliers, government organizations, research institutes.
 In comparison to tangible resources, intangible assets do not diminish by
extra use; they are relatively resistant to duplication and difficult to be
measured, valued and traded.
 Thus, the intangible resources are more important source of heterogeneity
and divergence in competitive advantage and performance across firms.
 RBV is based on two major assumptions:
o First, firms are fundamentally heterogeneous in terms of their bundle
of resources and capabilities within an industry.
o Second, resource heterogeneity may persist over time because the
resources used for acquiring competitive advantages are rare,
valuable, imperfectly imitable, imperfectly substitutable and
imperfectly mobile in strategic factor markets.
 The RBV provides an efficiency based explanation of performance.
 Peteraf and Barney (2003) suggest that a firm builds competitive advantage
only through efficiency or effectiveness in use of it resources, i.e., by
producing more economically from the set of resources it holds and by
 delivering greater benefits to its customers at a given cost (or the same
benefits at a lower cost).
 The identification and evaluation of resources and capabilities has been the
major contributions of the RBV.

FDI based on monopolistic power:

 Kindleberger (1969), by extending the work of Hymer, put forward his

theory of FDI on the basis of monopolistic power.
 Kindleberger argued that advantages enjoyed by MNCs could be useful only
in the case of market imperfection.
 The advantages described by him might be in the form of superior
technology, managerial expertise, patents etc.
 These advantages generally encourage a firm to invest in a foreign country
in order to fully exploit them instead of sharing them with potential
competitors in the foreign market.
 The greater the chances of earning monopoly profits, the higher will be the
encouragement among firms to invest directly.
 Kindleberger described various forms of advantages generally enjoyed by a
firm over the host country firm; he failed to describe which advantage a
firm should focus on.
 A firm can exploit its monopolistic advantages abroad only if the host
country’s policy allows it to do so. Generally, in the name of national
interest, the host Government would be unwilling to permit free entry of
foreign firms into the country.