Table of Contents
2.The Importance of FDI for Host Country and Foreign Investor 2
3.The Theoritical Framework of the Eclectic Paradigm 3
4.Criticism of the Eclectic Paradigm 4
5.Case Study of Huawei: Background 5
5.1-Ownership Advantage 5
5.2-Location Advantage 6
5.3-Internalisation Advantage 7
Consider how multinational enterprises can assess the merits of Foreign Direct Investment (FDI) by applying Dunning’s Ownership-Location-Internalization framework to company examples of your choice.
Due to the increasing trend of globalisation, the role of Multinational enterprises (MNEs) in promoting and shaping the patterns of economic development at the global scale has become more and more important. This impact exerted by MNEs is largely realised by means of their FDI activities (Mccann and Mudambi, 2004). Since FDI has significant influences on the development of economy, growing efforts have been made to understand the determinants of MNEs’ FDI activities. Over the past few decades, numerous theories and frameworks have been developed to address the motives of MNEs for FDI (Lilova, 2009). One of the most influential frameworks among them was the eclectic paradigm introduced by Dunning (1977), which is also known as Ownership-Location-Internalisation framework. The eclectic paradigm has provided a valuable analytical framework for evaluating economic FDI and it is developed to explain why MNEs choose to engage in FDI to enter foreign markets rather than using other means of market entry (Holsapple, Ozawa, and Olienyk, 2006). Moreover, the eclectic paradigm suggests that FDI is the most effective way to serve foreign markets when the firm possesses a variety of advantages which arise as a result of imperfect market competition (Holsapple, Ozawa, and Olienyk, 2006).
In order to explain how MNEs can assess the merits of FDI by applying Dunning’s eclectic framework, this essay will firstly evaluate the importance of FDI for host country and foreign investor. Then, Dunning’s eclectic framework will be evaluated critically. After that, Huawei will be used as an example to illustrate how the eclectic framework can be applied to a MNE context. This will lead onto a discussion of the three aspects of advantages in the eclectic framework, including ownership advantage, location advantage, and internalisation advantage. The discussion of each aspect of the eclectic framework will be referred to the case of Huawei. Finally, a brief conclusion will be provided to summarise the main points which have been discussed in the essay.
The Importance of FDI for Host Country and Foreign Investor
In the contemporary globalised economy, FDI has been considered as one of the most important determinants of economic development in many countries (Stefanovic, 2008). The importance of FDI for both host country and foreign investor has been widely recognised. For host country, FDI is a significant source of capital which can help to stimulate the economic development, increase the business activities, and reduce the unemployment rate (Stefanovic, 2008). Besides, FDI can also in the form of investing advanced technology, bringing management expertise, and injecting technical know-how etc. These non-capital forms of FDI would have spill-over effect and bring a number of benefits to the local industry. Moreover, FDI is the most desirable mode of foreign capital inflow since it cannot be withdrawn easily (Stefanovic, 2008).On the other hand, for foreign investors, FDI can allow them to gain access to the raw materials, energy, labour, services, technology, and customers in the global markets and it can be used as a mode of market entry (Stefanovic, 2008). Since FDI is largely conducted by MNEs, growing efforts have been made to explain the determinants of FDI flows and MNEs’ decision making process in terms of locating their FDI activities. Dunning’s eclectic paradigm has been the most influential framework for empirical investigation of FDI determinants for decades (Stefanovic, 2008).
The Theoretical Framework of the Eclectic Paradigm
The eclectic paradigm was initially developed by Dunning in 1977 and then it had been refined several times. It is suggested that Dunning’s eclectic paradigm is the most comprehensive framework to understand who, where, and how of FDI (Ramasamy, 2003). The eclectic paradigm is a mix of different theories of FDI and it aims to explore the motivations underpin FDI (Denisia, 2010). It is a holistic framework which can be used to evaluate the significance of factors influencing both the initial expansion of MNEs by foreign production and their subsequent activity growth (Stoian and Filippaios, 2008). The eclectic paradigm suggests that MNEs would get involved in FDI if they possess three different types of advantages, including ownership advantage, location advantage, and internalisation advantage (Xun, 2006). It is suggested that MNEs will face disadvantages compared with local firms in the host country due to international management issues such as language and cultural barriers, tax treatments, and monitoring local operations (Xun, 2006). In order for MNEs to compete with local firms, they must possess certain ownership advantages to make up for the disadvantages mentioned earlier. Ownership advantage refers to the possession of firm-specific assets which can provide a firm with a competitive advantage to compete at home and abroad (Shapiro, Gedajlovic, and Erdener, 2003). The ownership advantages might be derived from firm-specific intangible assets such as advanced technology which can be transferred within the MNEs at low cost (Xun, 2006). Moreover, the ownership advantages can either result in higher return or lower costs which can reduce the costs of operating in a foreign market or create competitive advantage for the local operations in the foreign country (Xun, 2006).
In terms of location advantages, it is suggested that MNEs should only make FDI to the locations which are attractive to them while the attractiveness of the locations are determined by a number of specific factors such as market potential, cultural distance, production costs, and investment risks (Xun, 2006). The location advantage refers to the extent and nature of location-specific or competitive attractions provided by countries to create the competitive advantages (Pheng and Jiang, 2006). The location advantage can potentially allow MNEs to make promising profits through the foreign operations in the host country. Moreover, it is suggested that the location advantages can be measured in terms of cultural similarities, market infrastructures, and the availability of lower production costs (Xun, 2006).
In addition, internalisation advantage refers to the extent to which MNEs possessing ownership advantages would choose to coordinate these advantages with the location advantages of foreign countries through internalisation rather than engaging in arm’s length transactions or contractual agreements with foreign firms (Dunning and Wymbs, 2001). Internalisation advantages can be developed when a MNE choose to internalise its key competitive advantage in order to minimise the transaction costs and maintain the competitiveness of foreign operations in the host markets (Xun, 2006). For example, certain management expertises might be the source of competitive advantage for the firm while the transfer of such expertises would be difficult and expensive. As a result, the company might choose to internalise such competitive advantage by assigning expatriate managers to the foreign operations rather than recruiting and training employees from local markets (Holsapple, Ozawa, and Olienyk, 2006). The internalised management expertises can create a competitive advantage for the foreign operations over its local competitors in the host country. Besides, it is suggested that a MNE should only get involved in FDI if all the three types of advantages are present in order to guarantee the success of the FDI and maximise its benefits (Xun, 2006).
Criticisms of the Eclectic Paradigm
The eclectic paradigm allows comparison between different theories by establishing the common ground between various approaches (Stoian and Filippaios, 2008). Such a mix of theories involved in the eclectic paradigm well reflects the diversity and complexity of international business. Despite the benefits of such a paradigm, it also received some criticisms. For example, the eclectic paradigm is criticised of having little predictive power since it incorporates many different factors as well as conflicting theoretical approaches (Jones, 1996). More specifically, the presence of the three types of advantages suggested by the eclectic paradigm might motivates MNEs to engage in FDI but they cannot predict whether the FDI would be successful since the foreign operation would be influenced by many other factors such an political condition, economic condition, cultural barriers, etc (Holsapple, Ozawa, and Olienyk, 2006). Accordingly, even if a MNE possesses all the three types of advantages, the success of the FDI made by the company still cannot be guaranteed. In addition, some scholars have criticised that the incorporation of ownership advantage to the eclectic paradigm is not necessary (Jones, 1996). The ownership advantage is developed based on the assumption that doing business in foreign markets would incur extra costs so MNEs must possess certain ownership advantage to compensate such extra costs (Holsapple, Ozawa, and Olienyk, 2006). However, it is suggested that the eclectic paradigm has paid too much attention on the extra costs incurred in doing business internationally while actually there might not be so much extra costs would involved in international business (Jones, 1996).
The eclectic paradigm is also criticised of failing to take the role of managers into account. More specifically, the extent to which the three types of advantages are possessed by the MNE is largely determined by the senior management of the company so the accuracy and validity of the perception of the advantages are subjected to the interpretation of management (Cantwell and Narula, 2003). Besides, it is criticised that the three types of advantages in the eclectic paradigm cannot be isolated. For example, the location advantages could become ownership advantages in the long run (Klug, 2006).
Case Study of Huawei: Background
Huawei is a leading global ICT solutions provider which is headquartered in ShenZhen in China. It is the largest private ICT Company in the Chinese market. Its shares are totally owned by employees. Huawei is dedicated to customer-centric innovation and it has established end-to-end advantages in telecom networks, devices, and cloud computing. It is committed to create maximum value for telecom operators, enterprises, and solutions by providing competitive solutions and services. Moreover, Huawei has developed its presence in over 140 countries and it serves more than one third of the world’s population (www.huawei.com).
5.1 Ownership Advantages
The ownership advantages of Huawei can be reflected in a number of aspects. Firstly, Huawei has low cost advantage since its R&D and production activities are conducted in China so it has lower cost base compared with those competitors in the developed countries (Huawei Annual Report, 2010). This low cost advantage has motivated Huawei to enter a number of foreign markets. For example, when Huawei entered the US markets, its product price is 30% lower than those provided by local competitors (Huawei Annual Report, 2010). This low cost advantage has allowed Huawei to penetrate the markets quickly and the profits generated by such an ownership advantage can cover any additional costs incurred by Huawei’s operations in the US market (Holsapple, Ozawa, and Olienyk, 2006). However, the low cost advantage alone is not sufficient for Huawei to compete in the foreign markets in the long run since it operates in a high-tech industry. As a result, Huawei has set up a number of innovation centres in developed countries through FDI in order to learn and develop advanced technologies to enhance its R&D capabilities and maintain competitive in the foreign markets (Huawei Annual Report, 2010). Through such FDI into developed countries, Huawei can make up for its weakness in terms of technology and acquire sustainable competitive advantage for it to compete in the long term.
Brand reputation is another form of ownership advantage developed by Huawei while such an advantage is crucial to the success of Huawei in the global markets. For example, during the earlier stage of Huawei’s internationalisation, it has little brand awareness in the developed countries or even developing countries so the quality of its products is questioned. As a result, based on the eclectic paradigm, Huawei has to improve its brand awareness to create ownership advantage in order for it to compensate such disadvantage and succeed in the foreign markets (Holsapple, Ozawa, and Olienyk, 2006). The necessity of developing the brand awareness in the global markets has been highly recognised by Huawei which explains why it has established so many innovation centres in developed countries to acquire advanced technology to assure the customers of the quality of its products. Meantime, Huawei has made significant marketing efforts in promoting its brand and products in foreign markets and it has become a well known brand in the global telecom industry today (Huawei Annual Report, 2010). Besides, management expertise is another important form of ownership advantage which Huawei is looking to develop. As a result, it has closely cooperated with consulting companies such as Hay Group and PWC in order to improve the management efficiency in terms of human resource and finance (Huawei Annual Report, 2010). This provides evidences that the possession of certain ownership advantages as well as the need for more ownership advantages have driven Huawei to engage in FDI activities.
5.2 Location Advantages
Huawei’s choice of location for FDI has been changing in response to the location advantages in the host countries. For example, in the early stage of its globalisation, it chose to locate its FDI activities in large developing countries such as Russia, Brazil, and India. This is because these developing countries lack of advanced telecom technologies so Huawei has comparative advantages in technology which can meet the market demands (Huawei Annual Report, 2010). In addition, these developing markets have similar characteristics with those in China, such as large market size, huge market potential, low manufacturing and R&D costs, and undeveloped telecom infrastructure. Since Huawei is the largest ICT Company in China and it has been quite successful the Chinese market, its operating experience in China can be applied to those large developing countries to reduce the risk of investing in these markets. Also, the abundant engineering resources as well as the low labour and raw material costs can allow Huawei to localise its production unit and R&D facility quickly in order to save transportation costs. In this sense, Huawei’s choice to locate FDI in developing countries at the initial stage of internationalisation is justified according to the location advantages of these host countries.
During the later stage of Huawei’s internationalisation, it has shifted its emphasis from developing countries to developed markets. These developed markets have different location advantages which attracted Huawei to locate its FDI into these markets (Holsapple, Ozawa, and Olienyk, 2006). Firstly, these developed countries have human resources with advanced knowledge and skill in terms of technology which can help Huawei to enhance its R&D capability. Also, these developed countries have well-developed R&D infrastructure which can facilitate the product innovation of Huawei. Secondly, the developed countries require high-tech telecom products which usually with high profit margin. As a result, entering these markets can allow Huawei to compete in high-end market segment for higher profit return which is attracting. Thirdly, these developed countries usually have relatively more stable political and economic environment compared with those in developing countries. Accordingly, the risk of investing in these developed countries is less than which in developing countries (Shapiro, Gedajlovic, and Erdener, 2003). These location advantages in the developed countries have attracted Huawei to locate its FDI into these markets at the later stage of internationalisation.
5.3 Internalisation Advantages
The eclectic paradigm suggests that MNE’s abilities to internalise their ownership advantages to reduce transaction costs can be considered as internalisation advantage (Shapiro, Gedajlovic, and Erdener, 2003). This internalisation advantage is extremely crucial in the telecom industry since high-tech telecom technology is the core competitive advantage for a company. Moreover, it is difficult for a company to transact such technologies in external market since the technology might not be delivered to the buyer company without any loss (Shapiro, Gedajlovic, and Erdener, 2003). During the globalisation stage when Huawei has focused on investing in developing countries, it possesses comparative advantage in technology so that it internalises its technology across the boundaries by localising R&D activities to these developing countries and recruit local employees and provide them with appropriate training (Huawei Annual Report, 2010). Through this way, the key technology advantage of Huawei can be maintained in these developing markets.
On the other hand, during the globalisation stage when Huawei has focused on investing in developed countries, it has established innovation centre in these foreign markets and then key technical staff from the R&D department in China will be sent to the innovation centre to learn advanced technology. After that, these key technical staffs will bring the acquired new technology back to China (Huawei Annual Report, 2010). Through this process of internalisation, the advanced technology in developed countries can be transferred to the operations in China and transformed to a form of new ownership advantage (Shapiro, Gedajlovic, and Erdener, 2003). This also has motivated Huawei to engage in FDI activities in developed countries.
In conclusion, this essay has provided a critical evaluation of the Dunning’s eclectic paradigm. The increasing importance of FDI in the global economy has resulted in the development of a variety of theories to explain the determinants underlying FDI activities. Dunning’s eclectic paradigm has been considered as the most influential theoretical framework since it has incorporated the work by previous theorists. Despite the popularity of the framework in investigating the determinants of FDI, a number of criticisms have been received from other theorists including little predictive power, over-emphasise on additional costs in international business, ignorance of the role of manager, and interdependence among the three types of advantages. Although the eclectic paradigm has received some criticisms, it is still a useful analytical framework for MNEs to evaluate the merit of FDI. This essay has used Huawei as a scenario to illustrate how the eclectic paradigm can be applied in real life organisational context. Based on the analysis, it is found that Huawei’s FDI activities can be explained by the three types of advantages in the eclectic paradigm.
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