Chapter 04 - Theories of International Business

8/6/2019 Chapter 04 - Theories of International Business

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International Investment Theories



Investment theory

Ownership Advantage Theory:

� This theory states that a firm owning a

valuable asset that gives the firm a

monopolistic advantage in domestic

operation can also help that firm to use

that asset to penetrate in foreign marketthrough FDI.

� Does not explain why a firm does prefer

FDI to other alternatives . 6-2



� That asset could be a superior technology, a well-

known or powerful brand name (Coca-cola, DHL,

Nestle), or economies of scale (large scale production) etc.

� For example, Caterpillar built factories in Asia,

Europe, and South America in order to exploit

proprietary technology and its brand name.

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� It suggests ways of entering into foreign market

through FDI.

� It relies on transaction cost which means cost of entering into contract - those costs connected to

negotiating, monitoring and enforcing a contract.

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� Firm must consider whether it is better to own and

operate its own factory overseas or make agreement

with local firms through franchising, licensing.� Internalization theory refers that FDI will occur when

the cost of negotiating, monitoring and enforcing with

second firm are high.

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� For example Toyota's primary competitive

advantages are its reputation for high quality cars and

sophisticated manufacturing techniques. So Toyotahas chosen to maintain ownership of its overseas

automobile assembly plants. Local firm may

jeopardize its name and fame.

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� When transaction costs are low, firms are more likely

to contract with outsiders and internationalize by

licensing their brand name or franchise operation.� For example, KFC, McDonald¶s.

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Eclectic Theory:

� John Dunning in his eclectic theory combines

location advantage, ownership advantage andinternalization theory to form a unified theory of FDI.

This theory recognizes that FDI reflects both

international business activity and business activity

internal to the firm. According to Dunning FDI willoccur under following conditions:

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1. Location advantage

� In some cases, business operation in foreign location

are more profitable than domestic region. For example, Harvester textile runs their operation in

Bangladesh for lower cost labor.

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2. Ownership advantage

� The firm must own some unique competitive

advantages to compete with foreign firms in overseasmarkets. This advantage may be a brand name ,

ownership of proprietary technology, or benefits of

large scale production and so on.

� Nestle has all of these advantages over Bangladeshi

competitors.

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3. Internalization advantage

� When firms think that it is expensive to monitor, and

enforce the contractual performance (jeopardize

reputation, brand name and misuse of technology) bythe local company in that case firm can go for direct

operation.

�DHL in Bangladesh for the contractual limitations

runs its operation directly.

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Even when a firm internalizes its exclusive resources it

may be able to serve a foreign market without FDI

(for example by exporting). Therefore, for the production to take place in the foreign country there

should be some location-specific advantages.

So this theory answers why firm chooses specific

locations for FDI.



Other Theories

Factor Mobility Theory:There are pressures for the most abundant factors tomove to an area of scarcity where they cancommand a better return. Capital will move away fromcountries in which it is abundant to which it is scarce.

Mexico gets capital from US.

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Chapter 04 - Theories of International Business

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