1. Advantage Categories
1.1. Ownership-Specific Advantages
The more ownership-specific advantages are possessed by an enterprise, the greater the inducement to internationalize them; and the wider the attractions of a foreign rather than a home country production base, the greater the likelihood that an enterprise will engage in international production. Such ownership-specific advantages may take the form of legally protected rights, patents, brand names, trademarks, or even a commercial monopoly in the market. Furthermore, if access to resources such as knowledge becomes essential for the making of a product or service, exclusive control over particular purchasing and/or distribution channels seems desirable. Ownership-specific advantages may arise from the size or technical characteristics of firms, the economies of scale in production, and qualified entrepreneurial capacity.
The eclectic approach of international production in an enterprise can be described like this: a national firm supplying its own market has various avenues for growth. It can diversify horizontally or laterally into new product lines, or vertically into new value chain activities. Alternatively, the firm can acquire other enterprises; or it can enter and exploit foreign markets. When it makes economic sense to choose the last route, the firm becomes an international enterprise (defined as a firm that services foreign markets). However, in order to be able to produce alongside indigenous firms domiciled in these foreign target markets, the firm possesses additional ownership advantages sufficient enough to outweigh the costs of servicing an unfamiliar or distant environment. The function of an enterprise is to transform, by the process of value generation, through valuable inputs into more valuable outputs (Dunning 1980a). Ownership advantages secure multinational enterprises’ competitive superiority (Rasmussen et al. 2008).
1.2. Internalization Advantages
Market imperfections arise wherever information about the product or service being marketed is not readily available or is costly to acquire and, as a result, wherever transaction costs are high. The risk of market failure causes enterprises to internalize market transactions in intangible assets (e.g., knowledge) or tangible assets (e.g., manufacturing facilities) (Dunning 1979,1995a). In-house value chain activities help the enterprise reduce the cost of information search in the market, expenses for negotiating and contracting with outside suppliers, and protection of intellectual property rights. Internalization advantages develop certain enterprise-specific capabilities concerning experience curves, operational scale effects and organizational skills. The issue of ‘internalization’ deals with the question as to why firms choose to engage in foreign direct investment rather than buy or sell intermediate products, in other words, performing market transactions (Dunning 2000).
Besides the phenomena of market imperfections, local governments’ intervention in the allocation of resources may also encourage firms to internalize their ownership advantages. This arises particularly with respect to government legislation toward production and, where there are differential tax and exchange rate policies, multinational enterprises may wish either to avoid or exploit them (Dunning 1980a).
1.3. Location-Specific Advantages
The ability of an MNE to acquire ownership-specific advantages is clearly related to the endowments that are specific to the countries in which they operate and particularly those endowments that are specific to their country of origin. Location-specific advantages answer the questions of where firms choose to locate their value-adding activities, as well as why firms produce in one country rather than another (Dunning 2002). Location advantages evaluate the alternative that it is more profitable for the MNE to use its ownership advantages together with factor inputs outside the home country (Rasmussen et al. 2008). Examples of location- specific advantages are government policy (with respect to tariff and non-tariff import barriers, infrastructure, etc.), access and costs of raw material and labor, market volume and market attractiveness, and transportation and communication infrastructure (Dunning 1980).
2. Market Entry Strategy According to Advantage Categories
Dunning derives the following recommendations for international business engagements from the ownership-location-internalization (OLI) advantage categories. The OLI paradigm suggests that MNEs that have merely ownership-specific advantages, and neither internalization nor location-specific advantages, should deal with their foreign business in the form of international contracts (e.g., licenses). However, the greater the ownership and internalization advantages possessed by firms and the more the location advantages of creating, acquiring (or augmenting), and exploiting these advantages from a location outside its home country, the higher the probability that foreign direct investment activities will be undertaken (Dunning 1994: 23-25). Where firms possess substantial ownership and internalization advantages but location advantages favor the home country, then domestic investment will be preferred to foreign direct investment; and foreign markets will be supplied by exports (Dunning & Dilyard 1999:13). The advantage category connections and corresponding market entry strategies are illustrated in Figure 2.3.
Initially addressed as a static model, Dunning further developed the eclectic paradigm several times over a period of more than twenty years, paying more attention over time to dynamic competitiveness and the strategic aspects of the firm (compare: Dunning, 1973,1983,1993,2001). Changes in the global markets witnessed since the 1990s, the deepening integration of global capital and logistics, the liberalization of cross-border markets, and the emergence of several new countries as important players in the global economic arena caused Dunning to modify and enlarge each of the OLI categories with dynamic components (Dunning 2001).
Resources and capabilities, such as the ability to internally produce and organize proprietary assets that match existing market needs at any given moment in time (static ownership advantages) were enlarged by context-specific issues to increase income-generating assets over time (dynamic ownership advantages). ‘Dynamic’ means, for example, that the trade-off of resources that can be internally developed with those externally acquired (e.g., through bilateral relationships with other market actors) becomes more crucial than the resources themselves (Dunning 1995b; 2001).
Location-specific advantages have been traditionally expressed by the availability of a country’s unique immobile natural resources, which the MNE may make use of. This category was enlarged by distinctive and non-imitable, location-bound created assets, such as the presence of firms that have specific local market knowledge (e.g., access to local customers because of suitable and efficient marketing communications). MNEs might form relationships to complement their own core competencies (e.g., advanced production technology) with the specific knowledge (e.g., marketing) of local firms in the foreign target markets, for example, through international joint ventures (Dunning 2001). Geographic locations that used to be regarded as targets for the supply of raw materials (e.g., static location advantages) are also becoming recognized as possible sources of learning and innovative capabilities (e.g., dynamic location advantages). The need for the firm’s efficiency improvement through rationalization highlights the importance of management’s strategic capabilities through developing dynamic capabilities (Dunning, Pak, & Beldona 2007).
3. Review of the Eclectic Paradigm
The achievement of Dunning’s paradigm is that multiple reasons are considered that influence an MNE’s choice of international market entry strategy. The appearance and combination of advantage categories serves as the basis for management decision making as to whether to proceed with exports, contractual entry modes such as licensing or franchising, or foreign direct investments.
The creation of the eclectic paradigm is based on different models, such as internalization theory which is built on transaction cost theory (internalization advantages), the resource-based view (ownership advantages), and location theory (location-specific advantages). In a parallel manner, criticism of the paradigm is related to its grounding in other theories. Hohenthal (2001) criticizes the paradigm for mixing three different and sometimes overlapping sets of explanations such as location concepts, resource-based theory, and transaction cost theory. This conglomerate of theories makes the eclectic paradigm very complex, limits validity testing of the model, and makes it difficult to use. The three advantage categories are formulated too generally, which makes it impossible to develop a concrete recommendation for an MNE’s internationalization strategy.
The eclectic paradigm presupposes that different firms have broadly similar objectives and respond to economic signals both consistently and following the same strategic direction. The model ignores the fact that a firm can also utilize different market entry modes (e.g., export and license) depending on its diversified businesses in the same foreign target country (Robock and Simmonds 1989).
The eclectic paradigm rather is suitable when considering circumstances in manufacturing industries instead of in internet-based service businesses. Due to the influence of the transaction cost theory, the eclectic paradigm assumes a rationally thinking actor who makes decisions mainly based on cost calculations. On the one hand, transaction costs are difficult to specify and quantify. On the other hand, the assumption of rational thinking is hard to accept when it comes to behavioral aspects, such as preferences or aversions of the entrepreneur and/or management, which also influence market entry decisions. The strategic concept concerning foreign market entry is not mandatory based on the pure rational trade-off of logical circumstances, but usually is influenced by the founding entrepreneur and/or the operating management and often driven by their individual experience related to foreign target markets.
Source: Glowik Mario (2020), Market entry strategies: Internationalization theories, concepts and cases, De Gruyter Oldenbourg; 3rd edition.