Dunning’s OLI and Porter’s diamond, Global Sourcing and Production Networks

(1) With reference to real-world examples, critically discuss the idea of MNE’s “ownership
advantage” (first developed by Hymer, then integrated by Dunning).
Professor John Dunning proposed the eclectic/general paradigm as a framework for determining the
extent and pattern of the value-chain operations that companies own abroad.
•       Three conditions determine whether or not a company will enter a given foreign country via
FDI:
Ownership-specific advantages: Knowledge, skills, capabilities, relationships, or physical assets that
the firm owns and that are the basis of its competitive advantages
Location-specific advantages: Similar to comparative advantages; specific advantages that exist in
the country that the MNE has entered, or is seeking to enter, such as natural resources, low-cost
labor, or skilled labor
Internalization advantages: Control derived from internalizing foreign-based manufacturing,
distribution, or other value-chain activities
Example of the Eclectic Paradigm: Sony in China
•       Ownership-Specific Advantages.  Sony possesses a huge stock of knowledge and patents in the
consumer electronics industry, as represented by products like the Playstation and Vaio laptop.
•       Location-Specific Advantages. Sony desires to manufacture in China in order to take advantage
of China’s low-cost, highly knowledgeable labor force.
•       Internalization Advantages. Sony wants to maintain control over its knowledge, patents,
manufacturing processes, and quality of its products.

(2) With reference to the concept of “transaction costs” (Coase 1937), the work of Williamson
(1975) and the publications of Buckley and Casson (1976), critically discuss the category
“Internalisation”.

Coase. “The Nature of the Firm” (1937) offered an economic explanation of why individuals choose
to form partnerships, companies and other business entities rather than trading bilaterally
through contracts on a market. (Elena’s note: temporary short-term contracts workers are cheaper
but produce additional transaction cost. That is why it is better to hire people into the company for
long-term. But the size of the company also matters in increasing transaction cost. This is limitation
of hiring people within one firm and location. That is why firms tend to either be in different
geographic locations or to perform different functions -> “Internalisation”).

There are a great variety of arrangements in producing goods. In agriculture often most of the labor
force works on a day-to-day basis. In other industries the labor force may be permanent, tied to the
firm with long-term contracts. Repair services in some firms may be supplied by an internal
organization; in others it is provided by specialized firms from outside. A firm is a system of long-
term contracts that emerge when short-term contracts are unsatisfactory.

The traditional economic theory of the time suggested that, because the market is "efficient" (that
is, those who are best at providing each good or service most cheaply are already doing so), it should
always be cheaper to contract out than to hire.

The unsuitability of short term contracts arise from the costs collecting information and the costs of
negotiating contracts. This leads to long term contracts in which the remuneration is specified for
the contractee in return for obeying, within limits, the direction of the entrepreneur.
Coase notes that the economic theory of the production level of a plant in the short run and long run
are well worked out, but the theory of the size of the firm is not well developed. This is clear in the
matter of acquisition of companies by other companies.

There is a natural limit to what can be produced internally, however. Coase notices "decreasing
returns to the entrepreneur function", including increasing overhead costs and increasing propensity
for an overwhelmed manager to make mistakes in resource allocation. This is a countervailing cost
to the use of the firm.
Coase argues that the size of a firm (as measured by how many contractual relations are "internal"
to the firm and how many "external") is a result of finding an optimal balance between the
competing tendencies of the costs outlined above. In general, making the firm larger will initially be
advantageous, but the decreasing returns indicated above will eventually kick in, preventing the firm
from growing indefinitely.
Other things being equal (ceteris paribus), a firm will tend to be larger:
 the less the costs of organizing and the slower these costs rise with an increase in the
transactions organized.
 the less likely the entrepreneur is to make mistakes and the smaller the increase in mistakes
with an increase in the transactions organized.
 the greater the lowering (or the less the rise) in the supply price of factors of production to
firms of larger size.
The first two costs will increase with the spatial distribution of the transactions organized and the
dissimilarity of the transactions. This explains why firms tend to either be in different geographic
locations or to perform different functions. Additionally, technology changes that mitigate the cost
of organizing transactions across space will cause firms to be larger—the advent of the telephone
and cheap air travel, for example, would be expected to increase the size of firms. On a related note
the use of the internet and related modern information and communication technologies seem to
lead to the existence of so-called virtual organizations.
Coase does not consider non-contractual relationships, as between friends or family

Oliver E. Williamson defines transaction costs as the costs of running an economic system of

companies, and unlike production costs, decision-makers determine strategies of companies by
measuring transaction costs and production costs. Transaction costs are the total costs of making a
transaction, including the cost of planning, deciding, changing plans, resolving disputes, and after-
sales. Therefore, the transaction cost is one of the most significant factors in business operation and
management.
Transaction cost theory predicts when the governance forms of hierarchies, markets, or hybrids
(e.g., alliances) will be used. Williamson theorized that whether activities would be internalized
within a firm depended on their transaction costs. He saw transactions broadly as transfers of goods
or services across interfaces, and argued that when transaction costs were high, internalizing the
transaction within a hierarchy was the appropriate decision. Conversely, when transaction costs
were low, buying the good or service on the market was the preferred option. Three dimensions
were developed for characterizing transactions: uncertainty, frequency, and asset specificity, or the
degree to which transaction-specific expenses were incurred. Transaction cost theory is built on
assumptions of bounded rationality and opportunism, defined as self-interest with guile.

Buckley and Casson. An MNE is a firm that internalises imperfect markets across national frontiers in
the services of intangible assets owned or controlled by the firm. The scope of the firm is
determined as firms grow by internalising markets until the cost of further internalisation outweighs
the benefits.
These simple ideas:“internalise or buy” and “least cost location” lead to two simple, but powerful,
decision rules:
1. Where should an activity be located?
2. How should each activity be controlled?

The advantages of internalising a market:

1. Coordination of multistage process in which time lags exist but futures markets are lacking. 2.
Discriminatory pricing in internal markets allows efficient exploitation of market power. 3. Bilateral
concentration of market power – internalisation eliminates instability. 4. Inequalities of knowledge
between buyer and seller (“Buyer uncertainty”) removed. 5. Internal transfer pricing reduces tax
liability on international transactions.

The costs of internalising a market:

1. Higher resource costs when a single external market becomes several internal markets (can be
reduced by partial internalisation). 2. Communication costs in internal markets rise (vary with
psychic distance). 3. Political problems of foreignness. 4. Management costs in running complex
multiplant multicurrency operations.

(3) With reference to the business model of the company NIKE, critically discuss the “I”-
component of the theory. Do firms need to invest (internalise) in order to achieve management
control? Besides NIKE: are there other examples for cross-border management control in the
absence of FDI?
Moreover, discuss to which extent FDI is still a good descriptor for MNEs.

If Internalization advantages outweigh the benefits of using the market the firm will use some FDI
method over contracting. The greater the company’s ownership assets, the more important it is to
protect these assets by maintaining control over company secrets.
Nike uses the internationalization process through Uppsala model, as firm progressively increased
their activities in foreign markets. Firm gains experienced from the domestic market before they
headed towards the foreign markets. The firm started from their manufacturing country covering
the cultures and geographic elements then gaining enough progress they moved towards the foreign
market.
Apple. Facing recent challenges of intellectual property rights with ‘Apple Fake Stores’ in Kunmin,
the capital of the Chinese province Yunnan, the company decided, at last, to solve the iPhone trade
mark problem in China. By finally acquiring the trademark from Hanwang Technology, Apple made
what was the quickest and cleanest strategic move instead of engaging in open-ended licensing.

The key feature of FDI is that it establishes either effective control of or at least substantial influence
over the decision-making of a foreign business. The level of ownership determines whether a direct
investor is assumed to have a significant degree of influence or complete control. Investors that hold
10% or more and up to 50% of the capital or voting rights are deemed to have a significant degree of
influence. Investors that hold over 50% of capital or voting rights control the enterprise; the direct
investment enterprise is deemed to be dependent.

International investment or capital flows fall into four principal categories: commercial loans, official
flows, foreign direct investment (FDI), and foreign portfolio investment (FPI).

Foreign portfolio investment (FPI) instead refers to investments made in securities and other
financial assets issued in another country. Although FDI and FPI are similar in that they both
involve foreign investment, there are some very fundamental differences between the two.
The first difference arises in the degree of control exercised by the foreign investor. FDI investors
typically take controlling positions in domestic firms or joint ventures and are actively involved in
their management. FPI investors, on the other hand, are generally passive investors who are not
actively involved in the day-to-day operations and strategic plans of domestic companies, even if
they have a controlling interest in them.

(4) Critically discuss how the “L”-advantage in Dunning’s eclectic theory is related to Ricardo’s CCA
and to the HOT.
Location-specific advantages: Similar to comparative advantages; specific advantages that exist in
the country that the MNE has entered, or is seeking to enter, such as natural resources, low-cost
labor, or skilled labor
Ricardo’s Comparative Advantage theory argues that countries can benefit from international trade
by specializing in the production of goods for which they have a relatively lower opportunity cost in
production even if they do not have an absolute advantage in the production of any particular good. 

The 'hot hand' is the notion where people believe that after a string of successes (or failures), an
individual or entity is more likely to have continued success (or failure).

(5) Explain Porter’s diamond and show that Porter’s revolutionary contribution to the theory of
the international firm is the application of the value chain to international trade and investment
theory. How does this change the theory of intra-industry-trade? In addition, explain Porter’s
expressions “global” and “multi-domestic”.

Michael Porter’s Diamond Model is a diamond-shaped framework that focuses on explaining why

certain industries within a particular nation are competitive internationally, whereas others might
not. Porter argues that any company’s ability to compete in the international arena is based mainly
on an interrelated set of location advantages that certain industries in different nations posses,
namely: Firm Strategy, Structure and Rivalry; Factor Conditions; Demand Conditions; and Related
and Supporting Industries. If these conditions are favorable, it forces domestic companies to
continiously innovate and upgrade. The competitiveness that will result from this, is helpful and
even necessary when going internationally and battling the world’s largest competitors. This article
will explain the four main components and include two components that are often included in this
model: the role of the Government and Chance. Together they form the national environment in
which companies are born and learn how to compete.

Porter’s Diamond Model of National Advantage explains why some industries in some countries are
so much more developed and competitive compared to industries elsewhere on the planet. It
basically sums up the location advantages that Dunning is referring to in his Eclectic paradigm (also
known as OLI framework). The Diamond Model could therefore be used when analyzing foreign
markets for potential entry or when making Foreign Direct Investment decisions. It is adviced to also
conduct a macro-environment analysis and an industry analysis by using PESTEL
Analysis and Porter’s Five Forces respectively.

Professor Michael Porter argued that industries are either multi-domestic or global. In global
industries, competitors compete in all markets and offer homogeneos products. In multi-domestic
industries, firms compete in each national/separable market independently of other markets.

More specifically a global industry can be defined as:

1) An industry in which firms must compete in all world markets of that product in order to survive
2) An industry in which firm’s gain economies of scale or economies of scope across markets
Companies such as GE, Apple, Sony and Gillette pursue a global strategy by competing in all markets,
providing the same product for each market, strong centralised control, identifying customer needs
and wants across international borders, and locating value adding activities where they can achieve
the the lowest cost.
A global strategy is effective when differences between customers in countries are small and
competition is global.

A multi-domestic strategy involves producing products/services tailored to individual countries.

Following this strategy innovation comes from local R&D; managers decentralise decision making;
and encourage local sourcing. This strategy may result in higher production costs because of tailored
products and duplication of effort across countries.

Four drivers determine which strategy is best for a specific company.

1) Market drivers like degree of homogeneity of customer needs, global distribution networks,
opportunities for shared marketing.
2) Cost drivers like potential for economies of scale, transportation cost, and product development
costs.
3) Government/political drivers like trade policies, compatible technical standards and common
marketing regulations, ownership rules.
4) Competitive drivers. The more that competitors and customers are following a global market
strategy the greater the tendency for a ll firms in industry to follow a differentiated globalization
strategy.

Why are some industries multidomestic?

1) Customized products are needed in some countries
2) National competitors are common
3) Countries have unique distribution channels
4) There are no or few economies of scale
5) Local/national firms have some inherent advantages in the host country over global competitors
Why are some industries global?
1) Homogenized product needs across markets
2) Customers are global firms
3) High R&D expenditures require more than one market to recover development costs
4) There are many economies of scale in production, international logistics, or marketing
5) The firm has global product differentiation, proprietary product technology, and production
mobility.

Example Global. The following are examples of industries where many competitors have a global
market strategy and are considered global industries: Aircraft, Energy, Entertainment, Media, and
Communications, Financial Services, Information Technology, Clothing/shoes, Ship building and Fast
Food.

Example Multidomestic industries include cutlery and hand tools, railroads, structural metal
products, personal care, bedding and furniture. According to Makhija, Kim, and Williamson in a
multidomestic industry virtually all company value-added activities are located in a single country.
Until recently, a perfect example of this was the funeral industry which operated within nations.

(6) Please explain the expressions “offshoring”, “outsourcing”, and “international outsourcing” in
the context of the theories.

What Is Outsourcing?
Outsourcing is a process where a company contracts work to a third-party entity.
Instead of performing the work themselves, they ask this third-party to do it for them.
Most people view outsourcing as contracting work to a provider in another (usually cheaper) country
– however, that’s not entirely true.
Many companies outsource work like PR and legal work to firms within their home country.
Therefore, outsourcing may be local and international. Moreover, outsourcing isn’t always about
saving costs.

WhatsApp. To keep operation costs down, they outsourced development to developers in Russia,
and for a fraction of the costs it would have taken to keep business at home.

What Is Offshoring?
Offshoring refers to a shift in business operations to another country – usually to leverage cost
benefits.
Unlike outsourcing, where you’re contracting work to a different company, offshoring might keep
work processes in-house.
In this case, you’re simply moving work processes to a different country, but they are still your own
employees.
However, if you contract your work to an external company with operations in a different country,
that’s offshoring too. This specific instance is also known as ‘Offshore Outsourcing.’
For example, many companies offshore their software development to less expensive offshore
locations to benefit from lower wages and fewer taxes.

Offshoring is most common in Information Technology because of the shortage of professionals to

meet the industry demand. In fact, large tech corporations such as Apple, IBM and Microsoft
offshore part of their departments to other countries.

(7) Please discuss the “standard” design of production networks in the car and in the textile
industry (you may use the descriptions in Dicken).

Global Production Networks (GPN) is a concept in developmental literature which refers to "the

nexus of interconnected functions, operations and transactions through which a
specific product or service is produced, distributed and consumed."
Conceptual dimensions constitute the frameworks through which value is created, power exercised
or institutional embeddedness etc. given concrete effect in terms of particular initiatives and
policies: firms, sectors, networks, institutions.

From the dimension of sectors:

While GPNs have characteristics that are firm-specific, firms that operate in the same sector are
likely to create GPNs that have some degree of similarity. The reasons for this are that similar
technologies, products and market constraints are likely to lead to similar ways of creating
competitive advantage and thus broadly similar GPN architectures. Thus, for our purposes, a sector
need to be defined by criteria other than mere statistical classification. Besides being a unique
structure of competition and technology, firms in the same economic sector usually share a common
‘language’ and a particular communication structure specific to that sector (Hess, 1998). A sector not
only includes a range of companies, from the sector’s leading producers to suppliers of different
elements, including service functions, but its governance structure is often complemented by
purpose-built organizations, such as industrial pressure groups (for instance, employer and labour
associations), vocational training institutions or others. These sectoral particularities create
sectorspecific regulational environments, were particular issues are addressed by government
policies at different scales. Examples of these include the supra-national multi-fibre-agreement for
the textiles and clothing sector and national ‘sector’ policies to foster innovation and
competitiveness (as is the case of some Asian countries’ automobile and electronics
industry policies).
(8) Please compare the Anglo-Saxon type of forward and backward integration with the so-called
Japanese “Keiretsu” and the South Korean “Chaebol”.

Backward integration is a form of vertical integration in which a company expands its role to fulfill
tasks formerly completed by businesses up the supply chain. In other words, backward integration is
when a company buys another company that supplies the products or services needed for
production. For example, a company might buy their supplier of inventory or raw materials.
Companies often complete backward integration by acquiring or merging with these other
businesses, but they can also establish their own subsidiary to accomplish the task. Complete
vertical integration occurs when a company owns every stage of the production process, from raw
materials to finished goods/services.

Forward integration is also a type of vertical integration, which involves the purchase or control of a
company's distributors. An example of forward integration might be a clothing manufacturer that
typically sells its clothes to retail department stores; instead, opens its own retail locations.
Conversely, backward integration might involve the clothing manufacturer buying a textile company
that produces the material for their clothing.

In short, backward integration involves buying part of the supply chain that occurs prior to the
company's manufacturing process, while forward integration involves buying part of the process that
occurs after the company's manufacturing process.

Example. Netflix Inc., which started out as a DVD rental company supplying TV and film content, used
backward integration to expand its business model by creating original content.

Anglo-Saxon type of forward and backward integration. Mergers and acquisitions vary widely
between countries. In most European countries and the US there are government controls on
mergers and acquisitions where the combination of two or more companies can have an impact on
the overall level of competition within a particular market. This applies especially where the merger
or acquisition would give the new company the ability to alter or fix the price in a particular sector.

Keiretsu is a Japanese term referring to a business network made up of different companies,

including manufacturers, supply chain partners, distributors, and occasionally financers. They work
together, have close relationships and sometimes take small equity stakes in each other, all the
while remaining operationally independent. Translated literally, keiretsu means “headless combine."

(9) Please analyse how knowledge-based companies may be integrated into the global sourcing
chains. Are there successful examples from Central and Eastern Europe, Asia, and Latin America?

knowledge-based company is an institute with a minimum of 75% of its assets in intangible form.
Studies conducted by Business Week magazine concluded that companies in industrialized countries
consider creativity as their main strategy to take the lead among their competitors.

To understand why firms are more efficient than markets in the transfer and integration of
knowledge, we need to comprehend how knowledge integration occurs within the firm. It is
inefficient for one employee to learn the specialized knowledge of another. Efficient integration
must preserve the efficiencies of specialization in the acquisition and storage of knowledge. We
identify two primary mecharusms for knowledge integration: direction and routine. (1) Direction
involves the integration of knowledge through each specialist establishing rules, guidelines and
directives for other organizational members. Direction involves the codifying of tacit knowledge into
explicit knowledge (but in a very much reduced form). (2) Organizational routines achieve
integration of knowledge through patterns of interaction among different specialists. Thus, all teams
develop signals and responses which permit integration of knowledge without the need either for
extensive communication or for each organizational member to acquire the specialized knowledge
of the others.

IBM—Complete portfolio of enterprise content technologies and solutions.

Apple—Business and consumer software and hardware.

(10) Please research the Internet and literature and discuss to which extent the existence of
production networks is the result of genuine business models and to which extent foreign
investment was the result of government pressures. As examples, analyse the 1985-2015
investment of car manufacturers in Brazil, China, and Argentina. Why did car manufacturers invest
in these countries? To which extent did government policies
foster/hinder car manufacturers’ investment?

production networks. Every new product development effort should be coupled with the
development of a business model which defines its ‘go to market’ and ‘capturing value’ strategies.
Clearly technological innovation by itself does not automatically guarantee business or economic
success - far from it. This was a theme in the author’s earlier work on ‘Profiting from Innovation’,
which outlined a contingent approach with respect to how to organize the production system/value
chain, taking into account the ‘appropriability regime’ and the innovator’s prior asset positioning.

government pressures. The Brazilian government is leaving no stone unturned in giving a major
boost to its automobile industry. To attract more foreign investment in the sector, the government
has been taking initiative and has made several reforms at macroeconomic levels. With a view to
pull investment into the country, the government has completely restructured its investment
policies. The government has ensured revision of all the policy barriers obstructing the growth of the
industry, and has made special efforts to encourage healthy competition among many multinational
companies entering the automobile market.
 
The Brazilian government has formulated favorable trade and investment policies to encourage
private investments, and it has also made provisions to give the investors exemption from custom
duties and other taxes on purchase of certain capital goods and infrastructure. The government,
while laying great emphasis on attracting investment in the automobile sector of Brazil, has very
tactfully struck a balance to give a boost to the domestic industries.
 
The Brazilian government is making efforts to uplift the face of the auto industry in the country. The
government is pumping in a great investment of about $4 billion in the Brazilian auto industry.

(11) Then critically analyse the motivations for the car manufacturers’ investment in the Czech
Republic and into the new manufacturing “hub” Bratislava.

Boasting the highest per-capita car production in the world, Slovakia has become a magnet for
export-oriented manufacturing industries such as automotive and electronics, and a hotspot for
shared services centres (SSCs) and business process outsourcing centres (BPOs).
As a transit hub on the New Silk Road, Slovakia is actively developing and upgrading its infrastructure
to prepare for the expected increase in cargo traffic between Europe and Asia. It also benefits from
its favourable location between the seaports of southern and northern Europe.
The Slovakian government is also keen on adopting and promoting the use of new technology to
facilitate cross-border cargo movement. And it is continuing to stretch its wings to Asia, with
initiatives such as a plan to start a double tax treaty negotiation with Hong Kong. The private sector
is also keen to develop its services for clients who are looking for a reliable business accelerator to
tap the European market.

Automotive R&D in Slovakia has flourished hand in hand with the rise in car production, especially
for e-mobility products and initiatives such as wireless chargers for e-cars, electrical race cars and
testing for driverless cars. Other early fruits of successful auto-related R&D projects include seat
systems by American company Johnson Controls, lighting systems by Austria’s ZKW, brake calipers
by Continental Automotive  of Germany, transport automation by their compatriots Siemens, and
twinspin gearboxes and automatic logistics systems created by two domestic
businesses, Spinea and CEIT.

(12) Based on this analysis, critically discuss how the change from NAFTA to USMCA and the
imposition of higher tariffs the U.S. president announced several times, would/will change the
world’s production network of cars.

The United States is the most important export market for European cars, accounting for 29
percent of the value of all exported cars from the EU. By comparison, US-based companies are
delivering 19 percent of their car export value to Europe. European car manufacturers, such as
Volkswagen and BMW, contribute to this number by exporting more than 50 percent of the cars
they produce in the United States. Almost six percent of the EU’s working population is employed in
the car sector. On the other side of the Atlantic, the German car companies BMW, Mercedes, and
Volkswagen have created almost 120,000 jobs by building manufacturing plants across the southern
United States.

These German car plants rely on a downstream network of American and European suppliers as well
as retailers. Taken together, these US-based auto supply chains provide more than 400,000 jobs. In
2018, European auto manufacturers built 1.7 million cars in the United States, which amounted
to 15 percent of total US car production. When factoring in European-owned Fiat Chrysler, EU car
makers contributed 27 percent to total US auto output. Global Value Chains (GVCs) connect the US
domestic auto supply chains to Europe, Asia, and the rest of the world, and facilitate the exchange in
intermediate goods that is key to keeping the car plants humming.
A 25 percent US tariff on cars and car parts would deal a blow to the European auto industry.
Germany in particular would feel significant pain, given that it is responsible for 55 percent of all EU
auto exports. Would the US car industry benefit as a result of the tariffs? GVCs would channel some
of the tariff pain back to US-based car manufacturers right away by forcing these auto makers to pay
a premium on essential car parts from Europe and Asia. Despite higher input costs, some economists
expect expect the US auto sector to benefit from the tariffs because consumers might be more likely
to buy US-built cars and foreign car manufacturers might increase their production capacity in the
United States to avoid the tariffs. However, EU retaliatory tariffs against other sectors of the US
economy would likely negate any positive jolt the US car industry delivers to the overall American
economy. As usual, European and US consumers and workers would foot the bill for a transatlantic
car tariff tit-for-tat that increases prices for cars and other goods while eliminating jobs on both sides
of the Atlantic.