Theme 1 – Theoretical foundations for studying IB & MNEs
IB = how outperform global competitors, which foreign market to enter, which entry mode to
choose, how to develop new products abroad, with which foreign firms to cooperate
IBM = managing complexity and uncertainty (cross border activity brings new challenges)
--------------------------------------------------------------
Three reasons importance IB
1) Understand how globalization has connected businesses, markets, people, and information
across countries.
2) To develop a global mindset.
3) To plan a career in business by understanding the barriers of doing business with partner from
other countries.
--------------------------------------------------------------
FDI = set up subsidiaries abroad, work in-house but location overseas
LOF = costs of doing businesses abroad and disadvantages of operating in a foreign market because
of lack of knowledge, cultural differences, political risk, host government policies etc. Any company
will face LOF when they are undertaking FDI. LOF is the result of distance.
FSAs = firm specific advantages that gives a firm competitive advantage because the MNE developed
special knowhow or capability that is unavailable/inimitable. MNE overcome LOF by providing
foreign subsidiaries with FSAs
--------------------------------------------------------------
Internationalization = the process of how firms become international (doing business outside the
home country). The decision to do international business.
Internalization = the decision to retain or acquire control of value chain activities, do you outsource
production or do it yourself
--------------------------------------------------------------
Main question in IB
When a firm is considering entering a new market, the firm needs to see what the boundaries of the
firm are. What parts of the business do you keep internally (internalize operations, do it yourself,
invest yourself, FDI, vertical integration) and what externally (outsourcing/export). This depends on
the asset specific of the product:
o High risk (high transportation costs) / high specific asset Through FDI you extent the
boundaries of the firm (=vertical integration) and internalize (do it yourself). No risk of
replication and protect knowledge by keeping it internally.
o Medium risk create strategic alliance (learn from partners, local knowledge acquisition
and strengthen firm performance in host countries)
o Low risk / low specific asset Outsource the boundaries of the firm. Enter the market by
selling/producing the product in another location
--------------------------------------------------------------
OLI model Ownership advantages (FSAs), Location advantages (CSAs) and internalization
advantages beneficial to pursue FDI (set up subsidiaries abroad) LOF (costs of doing business
abroad) MNE overcome LOF by providing foreign subsidiaries with FSAs or isomorphism strategy
--------------------------------------------------------------
Outsourcing vs FDI = internalization theory
o Outsourcing (other company) = turning over an organizational activity (production of input)
to an outside supplier/firm that will perform it on behalf of the focal firm. Work is ‘out-
house’. external market measures
o FDI (invest yourself) = set up subsidiaries abroad and the work is ‘in-house’ but the location
is overseas. internalize operations
--------------------------------------------------------------
Offshore = outsourcing to a firm abroad
Onshore = outsourcing to a domestic firm
1
,--------------------------------------------------------------
Vertical integration = extending boundaries (do it yourself), reduce focus core business and flexibility
Outsourcing = extending network (someone else does it), loss of critical know-how, inadequate
performance
--------------------------------------------------------------
Host country = foreign market = foreign firm direct investment enterprise
Home country = domestic market = domestic firm direct investor
--------------------------------------------------------------
Subsidiaries (dochter onderneming) = incorporated enterprise in host country, controlled by the
parent company
Parent company = incorporated enterprise which has a direct investment enterprise operating
E.g. BMW is parent company and MINI a subsidiary
--------------------------------------------------------------
CSAs vs FSAs
CSAs = country-specific advantages (linked to L-advantages of OLI model).
Location-bound (LB) = climate, culture, labor costs, reputation
Non-location bound (NLB) = technology
FSAs = firm-specific advantages
Location-bound (LB) = personnel, brand awareness
Non-location bound (NLB) = superior marketing/distribution skills, management skills,
knowledge skills, access to capital/raw material, product differentiation ability
--------------------------------------------------------------
Location-bound = deployable and exploitable only in limited geographic area, locatie gebonden.
Result of subsidiary’s initiatives local reputation, privileged relationships with domestic economic
actors, retail network
Non-location bound = can easily be transferred across locations, only these can fully be used for
exploitation to foreign country. Result of MNE’s network effort brand names, technological
knowledge
--------------------------------------------------------------
Shift in analysis
1. 1960: International economists dominated the field and focused on national competitiveness
at the country level, using national statistics on trade and foreign investment.
2. 1970s: the focus shifted to FDI by MNE and the transfer across borders of its FSAs. Analysis at
the firm level.
3. 1980s: more attention was devoted to the MNE as a differentiated network with the MNE
subsidiary as the unit of analysis.
--------------------------------------------------------------
3 levels of analysis different theories in IB at different levels, used to analyze MNE’s strategies
Country level key concepts = international trade, CSAs, FDI, PLC
1) Product Life-Cycle Theory (PLC) - Vernon’s (1966) 4 stages of manufacturing products, CSAs
2
, Firm level key concepts = monopolistic advantage, imperfect markets, internalization theory,
TCEs, MNEs and its FSAs, OLI model, Uppsala Model, psychic distance
1) Internalization theory – Ronald Coase (1937) transaction cost economics (TCE) & market
imperfections
Vertical integration or outsource? When a firm is considering entering a new market, should it rely
on external market measures (export) or internalize operations (FDI)?
Market imperfections generate TCEs, expense involved when buying/selling goods or services (e.g.
search and information costs, bargaining costs and policing/enforcement costs).
By investing in a foreign subsidiary rather than licensing, the company is able to send the knowledge
across borders while maintaining it within the firm, where it presumably yields a better return on the
investment made to produce it.
2) Internalization theory – Rugman (1981)
Emphasis on the ability of MNEs to create and control their FSAs. It is necessary but not a sufficient
condition for FDI to take place. MNEs and its FSAs are at the core of the analysis. FDI is firm-level
strategy decision rather than capital-market financial decision
3) Monopolistic advantage & imperfect final markets – Hymer (1960) 2 conditions for existence
of FDI (instead of trade)
1) MNE must have resources/knowledge (countervailing advantage) that can perform better
than a local firm. MNEs possesses FSAs to overcome LOF.
2) The market for selling this advantage must be imperfect, which means there is room for
developing monopolistic advantages
The company needs something extra compared to the domestic firm to offer, that is why the
company goes abroad (FDI) and move to a foreign market. This market needs to be imperfect
(barriers/limitations) that allow the company to develop a better product/position and develop a
monopolistic advantage over their competitors.
4) Eclectic paradigm/OLI Model – Dunning (1979) three-tiered framework OLI Model
To determine if it is beneficial to pursue FDI and to explain when we see FDI. The greater the net
benefits of internalizing cross-border intermediate product markets, the more likely a firm will prefer
to engage in foreign production itself
5) Scandinavian Uppsala Model / Stages Model – Johanson & Vahlne (1977) Process for
internationalization, based on 4 stages “Experimental market knowledge”. Compare potential
benefits of exploiting FSAs abroad with risks/costs of operating in unknow foreign environment
Uncertainty in going abroad incremental expansion (small steps because of risk averse) choice
less risky/commitment entry mode Psychic distance = uncertain of the host country characteristics
(to minimize first expand to nearby geographic/familiar/comfortable countries slow process and
gain more market knowledge overcome LOF and gain more international experience expand to
more distant country markets (e.g. Netflix case). Benefits of exploiting FSA abroad should always be
bigger than the risks of going abroad!
--------------------------------------------------------------
Subsidiary level key concepts = subsidiary, MNE network, subsidiary’s mandate, LB vs NLB FSAs
1) MNE as a network – Birkinshaw (1996)
MNE is viewed as a network rather than a monolithic hierarchy. The subsidiary becomes the key
building block of the MNE and unit of analysis.
Viewpoint: understanding each subsidiary’s idiosyncratic resource base, strategy, assigned role inside
the MNE, and linkages with other subsidiaries. Emphasis on organizational entrepreneurship or
‘subsidiary initiative’, rather than the parent company.
3
IB = how outperform global competitors, which foreign market to enter, which entry mode to
choose, how to develop new products abroad, with which foreign firms to cooperate
IBM = managing complexity and uncertainty (cross border activity brings new challenges)
--------------------------------------------------------------
Three reasons importance IB
1) Understand how globalization has connected businesses, markets, people, and information
across countries.
2) To develop a global mindset.
3) To plan a career in business by understanding the barriers of doing business with partner from
other countries.
--------------------------------------------------------------
FDI = set up subsidiaries abroad, work in-house but location overseas
LOF = costs of doing businesses abroad and disadvantages of operating in a foreign market because
of lack of knowledge, cultural differences, political risk, host government policies etc. Any company
will face LOF when they are undertaking FDI. LOF is the result of distance.
FSAs = firm specific advantages that gives a firm competitive advantage because the MNE developed
special knowhow or capability that is unavailable/inimitable. MNE overcome LOF by providing
foreign subsidiaries with FSAs
--------------------------------------------------------------
Internationalization = the process of how firms become international (doing business outside the
home country). The decision to do international business.
Internalization = the decision to retain or acquire control of value chain activities, do you outsource
production or do it yourself
--------------------------------------------------------------
Main question in IB
When a firm is considering entering a new market, the firm needs to see what the boundaries of the
firm are. What parts of the business do you keep internally (internalize operations, do it yourself,
invest yourself, FDI, vertical integration) and what externally (outsourcing/export). This depends on
the asset specific of the product:
o High risk (high transportation costs) / high specific asset Through FDI you extent the
boundaries of the firm (=vertical integration) and internalize (do it yourself). No risk of
replication and protect knowledge by keeping it internally.
o Medium risk create strategic alliance (learn from partners, local knowledge acquisition
and strengthen firm performance in host countries)
o Low risk / low specific asset Outsource the boundaries of the firm. Enter the market by
selling/producing the product in another location
--------------------------------------------------------------
OLI model Ownership advantages (FSAs), Location advantages (CSAs) and internalization
advantages beneficial to pursue FDI (set up subsidiaries abroad) LOF (costs of doing business
abroad) MNE overcome LOF by providing foreign subsidiaries with FSAs or isomorphism strategy
--------------------------------------------------------------
Outsourcing vs FDI = internalization theory
o Outsourcing (other company) = turning over an organizational activity (production of input)
to an outside supplier/firm that will perform it on behalf of the focal firm. Work is ‘out-
house’. external market measures
o FDI (invest yourself) = set up subsidiaries abroad and the work is ‘in-house’ but the location
is overseas. internalize operations
--------------------------------------------------------------
Offshore = outsourcing to a firm abroad
Onshore = outsourcing to a domestic firm
1
,--------------------------------------------------------------
Vertical integration = extending boundaries (do it yourself), reduce focus core business and flexibility
Outsourcing = extending network (someone else does it), loss of critical know-how, inadequate
performance
--------------------------------------------------------------
Host country = foreign market = foreign firm direct investment enterprise
Home country = domestic market = domestic firm direct investor
--------------------------------------------------------------
Subsidiaries (dochter onderneming) = incorporated enterprise in host country, controlled by the
parent company
Parent company = incorporated enterprise which has a direct investment enterprise operating
E.g. BMW is parent company and MINI a subsidiary
--------------------------------------------------------------
CSAs vs FSAs
CSAs = country-specific advantages (linked to L-advantages of OLI model).
Location-bound (LB) = climate, culture, labor costs, reputation
Non-location bound (NLB) = technology
FSAs = firm-specific advantages
Location-bound (LB) = personnel, brand awareness
Non-location bound (NLB) = superior marketing/distribution skills, management skills,
knowledge skills, access to capital/raw material, product differentiation ability
--------------------------------------------------------------
Location-bound = deployable and exploitable only in limited geographic area, locatie gebonden.
Result of subsidiary’s initiatives local reputation, privileged relationships with domestic economic
actors, retail network
Non-location bound = can easily be transferred across locations, only these can fully be used for
exploitation to foreign country. Result of MNE’s network effort brand names, technological
knowledge
--------------------------------------------------------------
Shift in analysis
1. 1960: International economists dominated the field and focused on national competitiveness
at the country level, using national statistics on trade and foreign investment.
2. 1970s: the focus shifted to FDI by MNE and the transfer across borders of its FSAs. Analysis at
the firm level.
3. 1980s: more attention was devoted to the MNE as a differentiated network with the MNE
subsidiary as the unit of analysis.
--------------------------------------------------------------
3 levels of analysis different theories in IB at different levels, used to analyze MNE’s strategies
Country level key concepts = international trade, CSAs, FDI, PLC
1) Product Life-Cycle Theory (PLC) - Vernon’s (1966) 4 stages of manufacturing products, CSAs
2
, Firm level key concepts = monopolistic advantage, imperfect markets, internalization theory,
TCEs, MNEs and its FSAs, OLI model, Uppsala Model, psychic distance
1) Internalization theory – Ronald Coase (1937) transaction cost economics (TCE) & market
imperfections
Vertical integration or outsource? When a firm is considering entering a new market, should it rely
on external market measures (export) or internalize operations (FDI)?
Market imperfections generate TCEs, expense involved when buying/selling goods or services (e.g.
search and information costs, bargaining costs and policing/enforcement costs).
By investing in a foreign subsidiary rather than licensing, the company is able to send the knowledge
across borders while maintaining it within the firm, where it presumably yields a better return on the
investment made to produce it.
2) Internalization theory – Rugman (1981)
Emphasis on the ability of MNEs to create and control their FSAs. It is necessary but not a sufficient
condition for FDI to take place. MNEs and its FSAs are at the core of the analysis. FDI is firm-level
strategy decision rather than capital-market financial decision
3) Monopolistic advantage & imperfect final markets – Hymer (1960) 2 conditions for existence
of FDI (instead of trade)
1) MNE must have resources/knowledge (countervailing advantage) that can perform better
than a local firm. MNEs possesses FSAs to overcome LOF.
2) The market for selling this advantage must be imperfect, which means there is room for
developing monopolistic advantages
The company needs something extra compared to the domestic firm to offer, that is why the
company goes abroad (FDI) and move to a foreign market. This market needs to be imperfect
(barriers/limitations) that allow the company to develop a better product/position and develop a
monopolistic advantage over their competitors.
4) Eclectic paradigm/OLI Model – Dunning (1979) three-tiered framework OLI Model
To determine if it is beneficial to pursue FDI and to explain when we see FDI. The greater the net
benefits of internalizing cross-border intermediate product markets, the more likely a firm will prefer
to engage in foreign production itself
5) Scandinavian Uppsala Model / Stages Model – Johanson & Vahlne (1977) Process for
internationalization, based on 4 stages “Experimental market knowledge”. Compare potential
benefits of exploiting FSAs abroad with risks/costs of operating in unknow foreign environment
Uncertainty in going abroad incremental expansion (small steps because of risk averse) choice
less risky/commitment entry mode Psychic distance = uncertain of the host country characteristics
(to minimize first expand to nearby geographic/familiar/comfortable countries slow process and
gain more market knowledge overcome LOF and gain more international experience expand to
more distant country markets (e.g. Netflix case). Benefits of exploiting FSA abroad should always be
bigger than the risks of going abroad!
--------------------------------------------------------------
Subsidiary level key concepts = subsidiary, MNE network, subsidiary’s mandate, LB vs NLB FSAs
1) MNE as a network – Birkinshaw (1996)
MNE is viewed as a network rather than a monolithic hierarchy. The subsidiary becomes the key
building block of the MNE and unit of analysis.
Viewpoint: understanding each subsidiary’s idiosyncratic resource base, strategy, assigned role inside
the MNE, and linkages with other subsidiaries. Emphasis on organizational entrepreneurship or
‘subsidiary initiative’, rather than the parent company.
3
