A critical comparison of Internationalisation theories: Eclectic Paradigm of Dunning vs. Uppsala School

Term Paper 2007 42 Pages

Business economics - Miscellaneous


I. Table of Content

II. List of Figures

III. List of Acronyms

1 Introduction

2 Definitions
2.1 Multinational enterprise
2.2 Export
2.3 Foreign direct investment
2.4 International contracts

3 The eclectic paradigm of international production
3.1 OLI advantages
3.1.1 Ownership advantages
3.1.2 Location advantages
3.1.3 Internationalisation advantages
3.2 Market Entry Strategies
3.3 Endowment/Market Failure Paradigm
3.4 Criticism

4 Uppsala-model of Internationalisation
4.1 Patterns of Internationalisation
4.1.1 Establishment Chain
4.1.2 Psychic Distance Chain
4.2 Model of Internationalisation
4.2.1 State Aspects
4.2.2 Change Aspects
4.3 Criticism

5 Critical Comparison
5.1 Comparison Eclectic Paradigm & Uppsala-model
5.1.1 Dynamic vs. static
5.1.2 Negligence of demand
5.1.3 Validation
5.1.4 At home and abroad
5.1.5 Mode & point of time
5.1.6 Individuals decide
5.1.7 Disregard industries and companies particularities
5.2 Eclectic Paradigm in favour of Uppsala-model
5.2.1 A simple vs. a complex approach
5.2.2 Uncertainty avoidance vs. rationality.
5.3 Uppsala-model in favour of Eclectic Paradigm
5.3.1 Fast vs. slow Internationalisation process
5.3.2 Explanation of market entry strategies vs. gradual process

6 Conclusion

7 Outlook
7.1 Eclectic Paradigm
7.2 Uppsala-Model of Internationalisation

IV. Bibliography

V. Declaration

II. List of Figures

Fig. 1: Eclectic theory of international production

Fig. 2: Psychic distance as a concept of geographical distance

Fig. 3: Establishment Chain

Fig.4: The Internationalisation Process of the Firm

III. List of Acronyms

illustration not visible in this excerpt

1 Introduction

Centuries ago it was out of question for companies to operate worldwide. The costs to act global had been too high as well as the existent lack of knowledge about other countries, cultures, languages, foreign demands etc. But a few decades ago, companies started to run for globalisation which is seen as a process of internationalisation. Globalisation can be defined as a global network of economic processes. Today companies face less risk when engaging in international activities than ever before. Nowadays markets are easy accessible and the society faces a similar development concerning living standards all over the world. Companies notice the existing possibilities when passing national borders. Today internationalisation is an option for big companies as well as for SME´s. Internationalisation can be defined more exactly as the name “international” predicts as an international network between companies of different nations which means in most cases industrialised nations. Today almost all products and services are internationalised and available on the world market. It is indispensable that enterprises conduct business in host countries to remain competitive. Most companies are aware of internationalisation processes. Multinational companies are enterprises which operate in two or more countries. Bundeszentrale für politische Bildung (1) states that in 1980, approximately 17.000 MNE´s existed. Further Bundeszentrale für politische Bildung (1) explains that already in the year 2000, 63.000 MNE´s existed and in 2004 existed even 70.000 MNE´s. According to Bundeszentrale für politische Bildung (1) belong MNE companies to the countries where their headquarter is based in. Further Bundeszentrale für politische Bildung (1) estimates that approximately 9.000 MNE´s belong to Germany and approximately 2.500 international firms belong to the United States. As it can be observed, the trend in businesses is to become a multinational company. To become a company which engages in international activities is a long time process consisting of various steps. Therefore firms having international intentions began to question under which circumstances they should internationalise its activities and which market entry form they should choose.


Various theories exist which cover that topic for example: the product life cycle of Vernon, Porters diamond model, the Eclectic Paradigm of international production and the Uppsala-School Internationalisation approach; only to name a few. This paper focuses on two approaches which explain firms intention to establish activities outside their national borders: the Eclectic Paradigm of international production and the Uppsala-model of internationalisation and thus their comparison examining similarities and differences. The basis of that paper is information from books, professional journals and the Internet. Some information appear rather old but in fact the important basic information of the theories comes from the seventies and eighties. As a matter of course the most used literature is actual one. In first place, some definitions are made to provide a common understanding of fundamental terms used within this paper. Second the Eclectic Paradigm of international production is described as a general framework to explain multinational enterprise activities. Further the Uppsala-model of internationalisation is examined which is one of the most popular approaches in international management. Afterwards a critical comparison of the Eclectic Paradigm of international production and the Uppsala School Internationalisation-model is made. That critical juxtaposition is made in the end; after the basics of the Eclectic Paradigm and the Uppsala School internationalisation approach had been explained. Finally that paper will end by the conclusion which focuses on the most important points. The end of that seminar paper is the outlook which puts forward ideas of improvement as well as possible changes of the theories.

2 Definitions

In this chapter significant definitions are made to establish a common understanding for basic terms used within this paper. The following terms are playing a significant role in every chapter of the paper. The start definition is the explaination of the term multinational enterprise, further a definition of export is given, afterwards foreign direct investment is explained and finally a definition of International contracts is provided.

2.1 Multinational enterprise

In the following section the term multinational enterprise is exclusively explained. A broad definition of a MNE is the circumscription as a corporation which acts in more than two countries by establishing its own subsidiaries in production and sales. One widely spread criteria of a MNE is its quantitative internationalisation degree that means that MNE´s activities in a home country are compared to the activities abroad. Some measurement categories could be the annual turnover, employees, incoming orders and fullfilled orders. Dunning (1993, p. 3) defines more closely “A multinational or transnational enterprise is an enterprise that engages in foreign direct investment (FDI) and owns or controls value-adding activities in more than one country.” This definition of a MNE is the one which is mostly accepted by scientists. Dunning (1993) speaks from six equal important criteria to measure a companies multinationality:

1. the size and number of subsidiaries abroad,
2. the quantity of countries in which the enterprise operates on value-adding activities,
3. the allotment of foreign branches to ratios of the total enterprise. Foreign to total operations ratio (employees, revenues, income); f.ex. FTO employees: describes the proportion of employees abroad in comparison to the totality of employees,
4. the extent of internationalisation of management and share property; f.ex. local employees know better about local markets,
5. the degree of internationalisation of higher value activities as R&D
6. the extent of advantages of the company through operating in various countries.

An important point is where the headquarters of the parent company is domiciled when allocate to countries. Bpd (http://www.bpb.de/wissen/K61B0G, 2006) says that a parent company is a corporation with a majority of rights to vote of a subsidiary or with the right to displace the majority of a subsidiary employees. Further Bpd (http://www.bpb.de/wissen/K61B0G, 2006) differentiate a multinational company as a corporation with indepent acting subsidiaries or branches These subsiadiaries operate independent concerning supply, production, distribution but conform to the parent company policies. The most important questions of decisions are decentralized, which means the subsidiaries have decision autonomy to reach optimal solutions. Dunning (1993) states also that the MNE´s activities influence trade on the home market as well as on the host market. Especially MNE´s pursue the strategy of global sourcing by using the tool of foreign direct investment.

2.2 Export

Export and import too are basic forms of foreign trade, especially when some products and services aren´t available in a certain country but are demanded. Today export is one of the most important market entry strategies. Kutschker, Schmid (2006) define export as the activity of a company to distribute goods and services in a foreign country. Wheelen, Hunger (2004) say that export business is less risky than other forms of market entry. Export is differentiated in direct or indirect export. Welge, Holtbrügge (2003) state that direct export business happens without including trade agents. Further Welge, Holtbrügge (2003) state that it exists a direct relation between domestic and foreign business partners. Another export form is the indirect export. Trade agents or middlemen are part of the indirect export process. Wheelen, Hunger (2004) say that an exporting company can transfer functions also to a professional export management company. Welge, Holtbrügge (2003) conclude that export business is possible almost without any international experience and input coming from the exporting company.

2.3 Foreign direct investment

There are different strategies how a company can enter a country and overcome market entry barriers. Foreign direct investment is one option among others as strategic alliance, export, subcontracting, licensing or joint venture. There exist no general definition of foreign direct investment. But there exist various definitions witch share common opinions what a FDI specifies. FDI is an important driver of globalisation and the number of FDI is increasing constantly.

Dunning (1993) states that foreign direct investment (FDI) is a long-term investment process of a company in a foreign county. The investment is made to the outside, but from inside the investing enterprise. Dunning (1993, p. 5) says that FDI “…consists of a ´package´ of assets and intermediate products, such as capital, technology, management skills, access to markets and entrepreneurship.” The investing firms remains owner of the transferred resources and therefore controls them. FDI is the financial investment in a company abroad to exert a long-term influence on its business policy. Corresponding to international standards, the long-term influence can be guaranteed at 10% of the direct investment, means capital or voting rights. In this context influence and control are important terms by which FDI are differentiated from Portfolio investments. Portfolio investments are normally short-term oriented and smaller amounts which mark the ownership. FDI are important indicators for globalization and build connections between countries and companies.

2.4 International Contracts

The last point within the chapter of definitions is the point international contracts which means the transfer of resources, for example licensing or franchising. Licensing means that one enterprises grants rights to another enterprise. Then the licensee can produce or sell or even change slightly the product in a foreign country. Welge, Holtbrügge (2003) state that even knowledge can be transferred to another company. An example are patents which a company is allowed to use after receiving the rights to use them. Normally a licensing contract is limited for a certain time. The licensee has to pay for the use of patents of the licensing firm. Wheelen, Hunger (2004) favour the market entry strategy of licensing especially when a brand or product is already well known in a foreign country. Another form of transfer of resources is franchising. According to Wheelen, Hunger (2004) means the term franchising that one firm grants rights to another firm. The franchisee is allowed to open a store and distribute products of the franchising firm. Additional the franchisee is allowed to use the brand name and the organizational system of the franchising firm. Welge, Holtbrügge (2004) declare that the franchisee is educated, as well as constantly informed and controlled by the franchising company. Further Welge, Holtbrügge (2004) state that the franchise charge is 1-10% of franchisees turnover depending on the industry. Wheelen, Hunger (2004) state that franchising is a good market entry strategy in countries where investments are difficult.

3 Eclectic paradigm of international production

The eclectic paradigm of Dunning is celebrated as one of the most beneficial approaches to explain the process of internationalisation as well as international production. Dunning (2001) tells that he launched the paradigm in 1976 by himself. John H. Dunning which is Professor of International Business, presented its approach at a Nobel Symposium on the International Location of Economic Activity in Stockholm. Dunning (2001) purports that he worked since the mid-fifties on its eclectic paradigm. During the next years, the paradigm had been adopted by Dunning according to the changing companies behavior and the changing environmental circumstances (Dunning, 1977, 1979, 1980, 1988, 1995, 1999, 2000 in Perlitz, 2004; Kutschker, Schmid 2006). Kutschker, Schmid (2006, p.452) stated that the name eclectic paradigm comes from the fact that Dunning sees its approach rather as a “conglomeration” of various factors (eclectic) which are “melt into a paradigm” than a proper theory. This is seen in the fact that Dunning called its approach ´systemic theory´ in past and afterwards, since 1988, eclectic paradigm (Dunning (2001),Dunning (1977) in Kutschker, Schmid, 2006, p. 452). Dunning´s paradigm assume that international activities undertaken by a company are depending on several factors. The eclectic paradigm is often cited as a three- tiered framework because of the importance of three factors: ownership-specific advantages, locational advantages and internationalization incentive advantages, called “the OLI characteristics” by Dunning (2001). Perlitz (2004) states that Dunning examines the impact of these “OLI” advantages for firms and their building up of production sites abroad. Dunning states that MNE´s choose their market entry strategy dependent on its OLI advantages. In fact the Eclectic Paradigm shares some ideas with the transaction cost theory.

3.1 OLI advantages

3.1.1 Ownership advantages

Dunning (1993, p.82) describes the ownership advantages as “the `why` of MNE activities”. The question for companies is: Why to go abroad? Kutschker, Schmid (2006) state that Dunning refers to approaches of the monopolistic advantage by the ownership advantages. According to Kutschker, Schmid (2006), John H. Dunning sees three classes of O advantages. Kutschker, Schmid (2006) say in the first place, there are O advantages which follow from a companies long subsistence compared to market participants. These advantages are access to markets, organizational and marketing systems, R&D activities, innovatory capacity, brand loyality and economies of scale etc. according to Dunning (1993). Kutschker, Schmid (2006) state in second place, there are advantages which are connected by a companies internationality, especially a better access to resources. For example capital, information or raw materials. In third place, it is referred to O advantages which exist independent from a companies long existence and internationality such as technology, patents or management skills. When a company has specific ownership advantages, the firm can overcome costs when engaging abroad. Additional having ownership advantages is seen as a precondition for companies engaging in a foreign country.

3.1.2 Location advantages

Dunning (1993, p.82) defines the location advantages as “the ´where´ of production”. The question is: Where to start production abroad?Kutschker, Schmid (2006) state that Dunning refers to the location theories by the location advantages. In general parlance location advantages mean that some locations are more favorable to exert particular activities than others. Dunning (1993, p.82) refers to “ the possession of natural resources and communication infrastructure” as well as “tax and other incentives”. There are additional factors as “material and labor costs; market size and characteristics ...” and “... government policy...” The gist is that an enterprise should establish in a foreign country itself when that would bring further benefit to the company. Welge, Holtbrügge (2003) see L advantages as the precondition for foreign direct investments.

3.1.3 Internationalisation advantages

The internationalisation advantages are seen by Dunning (1993, p. 82) as “the ´way` of involvement”. The question is: How will a company go abroad? Kutschker, Schmid (2006) state that Dunning refers to the internationalisation theories by the internationalisation advantages. Dunning (1993) state that internationalisation advantages lead to export. In Dunnings view (1993, p.82) exist I-advantages “to ensure stability of supplies at right price; control markets. Wish to reduce transaction or information costs, buyer ignorance, or uncertainty, etc.; to protect property rights.” The most important fact to pay attention to is that the OLI advantages can´t be regarded separately. They are linked. Enterprises decisions to internationalize are influenced by three other factors: County or region, industry or activity and firm (Dunning, 1993, p. 84).

3.2 Definition of Market Entry Strategies

The variables of the eclectic paradigm of international production have to be seen in relation to define market entry strategies for MNE´s. As it can be observed a company with ownership advantages has various possibilities depending on the environment. In Macharzina (2005), Dunning assumes that a company will start foreign direct investments when a company met the three OLI advantages. Foreign direct investments are interesting for the investing firm to influence the other companies business behaviour and its strategies. FDI is the biggest form to enter a market. Following the theory of Dunning in Macharzina (2005), a company which meets both ownership specific advantages and internationalisation specific advantages but not location specific advantages, will engage in export activities. Export activities by a MNE are seen as a rather simple form to start their international activities. Thus, Macharzina (2005) states that a company that only met ownership advantages, will engage in international contracts. The scheme is presented in figure 1.

Fig.1: ”Eclectic theory of international production”

illustration not visible in this excerpt

Source: On basis of Macharzina (2005, p. 932) : Unternehmensführung

3.3 Endowment/Market Failure Paradigm

During the following years, a lot of scientists criticized the eclectic paradigm. Therefore, Dunning extended its theory during the eighties. Reasons to extend the paradigm had been changing environmental circumstances and the constant changes of companies behaviour. The extension of the paradigm of international production is often seen as limited important by various scientists. The main variables of the Paradigm remain and therefore also the important conclusions about MNE´s international approaches. Perlitz (2004, p. 110,111) describes the extension of Dunnings approach by four components:

“(1)reasons concerning the decision about international production sites had been included,
(2)country factor equipment which are the basic point for location specific advantages, had been enlarged by intermediate products and by the exchange mobility of products,
(3)structure variables concerning strategy decisions had been included in the theory,
(4)the fields of application of its theory had been enlarged through the attempt to explain the establishment of international production sites as well as the attempt to explain the business between groups or disinvestments.”

Macharzina (2005) stated that after Dunning added the four components, he called its approach factor endowment/ market failure paradigm. The eclectic paradigm faced a lot of criticism over the years. By the extension of the approach through the four components, Dunning tried to compensate the criticism. But some critical points remain.

3.4 Criticism

Despite Dunnings attempt to modify and adopt its theory over years, some facts remain critical but Welge, Holtbrügge (2003) state that Dunnings approach is actually the most cited one.

Following Perlitz (2004), it is critical to bring together factors from different approaches. Perlitz (2004) states that Dunning merges for example macroeconomic data as well as management decision data. Perlitz (2004) says that it is not possible to bring these data together without connecting links. Following Perlitz (2004), Dunning shows how difficult it is to develop an internationalisation theory. Various factors are important but difficult to bring together. Already Dunning itself (Dunning, 2001) recognizes the difficulty to bring various facts together. Dunning (2001) speaks about “A shopping list of variables”. This fact had been also criticised by several scientists. Dunning (2001) claims that scientists seen the numerous variables as too much, so that their value is critical. Dunning (2001) justifies the existence of such a big number of variables by their importance for the paradigm. John H. Dunning (2001) contends that the OLI variables are reasoned by economic and organisational theory. Nevertheless Dunning can´t eliminate the frequent criticism of the missing linkage between the variables.



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Internationalisation Eclectic Paradigm Dunning Uppsala School




Title: A critical comparison of Internationalisation theories: Eclectic Paradigm of Dunning vs. Uppsala School