09 June 2005

Foreign Direct Investment (FDI) (Part III)

FDI Theories

Why do firms undertake FDI compared to exports? FDI is expensive due to costs of establishing production facility and risky due to problems related to doing business in an unfamiliar environment. However, firms still engage in FDI because of market imperfections related with exports such as:

• Transportation costs
• Trade barriers/government intervention
• Opportunistic behaviour of firms
• Bounded rationality
• Tight control needed for strategic reasons
• Tacit nature of knowledge

The most widely acclaimed theory on FDI is by John Dunnings - "Eclectic Paradigm", sometimes also referred to as the "OLI Theory".

John Dunnings Eclectic Paradigm

This theory ties together location advantage, ownership advantage, and internalisation advantage. “Eclectic” meaning deriving ideas from various sources. John Dunnings paradigm states that a firm will engage in FDI when all of the following three conditions are present:

• First, it must be more profitable to undertake a business activity in a foreign location than in a domestic location (location advantage). Examples of types of location-specific factors are markets, resources, production costs, political conditions, cultural/linguistic affinities, concentration of knowledge development.

• Second, the firm must own some unique competitive advantage that overcomes the disadvantages of competing with foreign firms in their own market (ownership advantage) such as technology, knowledge, patent, know-how, size.

• Third, the firm must benefit from controlling the foreign business activity, rather than hiring an independent local company to provide the service (internalisation advantage). This way the company can maintain their ownership advantages.

The more OLI advantages a firm possesses the greater the propensity of adopting an entrymode with a high control level such as wholly owned venture.

The OLI model was widely applied in the past to explain entry mode decisions and its basic ideas were supported by several empirical studies. But in spite of its eclecticism, its improved measurability, and its great explaining power the OLI model is solely a static one. It intends to explore all important factors impacting entry mode decisions but in fact fails to do so due to the neglect of strategic factors, characteristics of and situational contingency surrounding the decision maker, and competition.

This theory can be written in great detail, therefore anyone who is interested in this theory, please let me know as i would do my best to post more information as soon as possible.

17 comments:

Anonymous said...

this blog is so cool and interesting, wondering if u could send me some more information on Dunning. my email is b_jirh@hotmail.com thanks

Anna said...

Have an exam tomorrow and never understood what internalisation ment until now... thanks a lot for your clear explanation!

Anonymous said...

wondering if u could send me some more information on Dunning. my email is u5man_1@hotmail.com

Hussain said...

Hi, Just wondering if you can help me answer this question.
Does Dunning’s eclectic paradigm explain the development of multinational companies?
It will help me out alot if you can. Thank my email is:
hussaink@hotmail.co.uk

Aik Lee said...

Hey, really like ur blog, stumbled on it searching for dunnings eclectic paradigm. I'm studying international business and no where in my text is there a section on the eclectic paradigm. Can you send me any information explaining the paradigm in more detail. My email is qutelas@hotmail.com thnx alot:)

Anonymous said...

could you send me some further details about dunning's eclectic paradigm. thank you very much for your help and for your awesome blog. svpcog@gmail.com

geerisha nunkoo said...

the notes on your blog are interesting..lots of things are now clear! could you please send me more information about the OLI framework...how it can be applied to todays MNCs! thx... email me at drugscafe@yahoo.co.uk

Anonymous said...

hi, im an international business student i have to critically evaluate the usefulness of dunnings eclectic paradigm along with any strengths and weaknesses of it, i just stumbled across this and was wondering if you could still email me some information? i know its been a few years since u posted the post but i really need help as i cannot find it in my textbooks.Thank you my email is abztheman@hotmail.com

cali said...

Hi, could you send me more information on dunnings model. I need to know more detail about the advantages and disadvantages and how its explains a firms internationalisation process. This would really help thanks.
Email: caliriley@hotmail.co.uk

Anonymous said...

Hi i found your blog very helpful, but could you please send me more information on dunning's eclectic paradigm, in regards to whether it offers a theory or does it simply pull other approaches together.. its advantages and disadvantages, as well as the extent to which it explains the development of MNE'S... My email is bs06142@qmul.ac.uk..

ruks said...

hi, i found your information very useful, but could you please post or email me (bs06142@qmul.ac.uk)regardng the eclectic paradigm, as to whether it provides a theory or does it simply pull other approaches together?

Anonymous said...

Dear Ahsan,
Nice overview of the theory of MNE's. Like everyone else I would be delighted with extra info.

ra83@le.ac.uk

Thanks in advance

Anonymous said...

Dear Ashan
Nice overview of the thoery of MNE's. Like everyone else I would be delighted with some extra info.
ra83@le.ac.uk
Thanks In advance

Anonymous said...

overall good argument but could also involve transaction costs along with OLI.Can you tell the correct difference between Joint ventures and strategic alliances as an entry mode.
Could you also provide some sources for more references along with your blogs.

Anonymous said...

Hi,

I have need help. Monday i have an essay on Dunning paradigm and the topic is: Illustrate, with reference to firms involved in motor-vehicle production, oil, retailing, catering and other branches of the economy, the strengths and weaknesses of Dunning’s eclectic paradigm for explaining the emergence and subsequent development of multinational companies.

If you can help me and if your informations is usefull and available, please send me an e-mail at this adresse :

ptilouchou@hotmail.fr

Hang said...

Hi, Thanks for your useful blog, it is better than 3 text books in front of me :D. I can understand it better now but I need to wreite more on it. Could you please send me some more information, or journal etc which explain OIL Paradigm, its strengths and weeknesses and might be examples for each advantages. Thank you so much, My exam is in 2 days so I hope you will read this by then.
Pls send it to buith@aston.ac.uk if you can. Thanks

Anonymous said...

Hi Ashan, along with everyone else i would also be greatful for more info on Dunnings eclectic paradigm - especially in relation to any information you may have about its theoretical strengths and weaknesses.

Thanks in advance!

e-mail: ngdg20@bath.ac.uk