INTERNATIONALISATION STRATEGY OF THE AUTOMOBILE MANUFACTURING INDUSTRY

The concepts, models and ideas related to internationalisation has been provided by, who provided a comprehensive study that, discussed several theories in detail related to issues of internationalisation. These interests in the internationalisation strategies and processes of firms have arisen to the development of models used to illustrate how firms internationalise. Mintzberg, 1987 stipulated that strategy making is about changing perspectives and positions which involves international operations across borders (Welch and Luostarinen, 1988) encompassing changed perspectives and changed positions. Lyles (1990) also argued that the internationalisation theme concerning global competition has been viewed as the coming decade’s most important area of strategic management research. Therefore, this concept or idea of internationalisation is defined below to give a clear and vivid understanding as to what researchers in the past have been able to develop.

DEFINITION OF INTERNATIONALISATION

Cavusgil (1980) describes Internationalisation as the process through “which firms adopt international business activities” or the process by which firms “gradually increase their international involvement” (Johanson and Vahnlne 1977 p.23). According to Cavusgil (1980, pp. 273-8), it is “a gradual process taking place in incremental stages, and over a relatively long period of time” as a result of greater uncertainty, higher costs of information and the lack of experiential knowledge in foreign marketing activities . In other words, it involves the process of increased involvement in international operations which involve the inward and outward processes linked with the dynamics of international trade.

While some researchers have attempted to give clarity concerning trade flows (i.e. inter industry and intra industry trade) on a country level, others have given explanations as to the processes of internationalisation on an industry or firm level. For the purpose of this research however, the main focus would be on internationalisation processes on the industry level (i.e. the automobile industry). Certain factors, internal and external have played major roles to these processes and in understanding those processes, initial studies of internationalisation is explained below in detail.

The FDI theory and the establishment of chain or stage models of internationalisation are research areas identified by Johanson and Vahlne (1990) in the understanding and concepts of internationalisation.

THEORETICAL CONCEPTS OF INTERNATIONALISATION

To understand the concepts of internationalisation, Johanson and Vahlne (1990) identified three general research areas. They include; the establishment chain or stage models of internationalisation, FDI (I.e. Foreign Direct Investment) theory, and the network perspective.

FDI THEORY According to Ruigrok and Wagner (2003), FDI theories which are economics driven and hence focused on the factors located in the firms’ external environment gives an explanation as to why multinational companies exist. For example, Hymer (1970) theory of market imperfections and Buckley (1982, 1988); Buckley and Casson (1976, 1985) theory on internalisation have led to the concerns extending direct operations of firms and bringing collective ownerships and control of activities conducted by intermediate markets with links of firms and consumers. They argue that firms would expand their internal market so that transactions are carried out at a lower cost within the firm. In contrast to these views, Dunning (1980) and Fayerweather (1982) argue that the propensity of a firm to initiate foreign production would depend on the specific attractions of its home country such as internalisation gains, ownership specific advantages and location specific advantages, compared with resource implications of locating in another country.

THE ESTABLISHMENT CHAIN OR STAGE MODELS OF INTERNATIONALISATION

The establishment chain theory is also known as the stage model of internationalisation. It has been questioned by authors who have associated the Uppsala model with earlier works of Johanson & Wiederheim-Paul (1975) stating that these studies only concentrate on the exporting and non-exporting factor, identifying a number of firms that have been active in international markets shortly after they have been established. (Moen & Servais 2002). However, Zannder & Zander 1997 challenged that notion by stating that firms follow a number of alternative routes to foreign markets.

The establishment chain theory generally concerns the idea of incremental development in foreign markets as well as uni-linear sequences of servicing modes and how they should be de-emphasised in favour of irregular and reduced routes where different patterns of change is common (Turnbull and Ellwood, 1986; Zander 1997).

Mahoney (2000) contends that irregular processes are explained by the fact that a particular internationalisation process is embedded in a network of other internationalisation processes. They go on to further explain that at points where different processes collide, discontinuities may arise, i.e. a particular internationalisation process may break by taking a path that does not bear the imprint of the initial choice. In other words, they suggested that a particular internationalisation process is not an autonomous sequence of servicing modes, but instead, it is subject to the effect of other sequences of servicing modes.

THE NETWORK PERSPECTIVE

According to this perspective, firms internationalise because other firms in their national network internationalise. The industrial system is made up of firms engaged in production, distribution and the use of goods and services. The relationship between firms is described as a network. Firms within the network rely on each other and their activities therefore need to be co-ordinated. These networks are stable and changing but the transactions take place within the framework of these established relationships. However, Johanson & Mattson 1988; Thorelli 1990; Ghauri 1992 argue that some new relationships are developed and some old ones are disrupted because of competitive activities.

Therefore, although there are competitive relationships in the network approach, interdependences are stressed. Firms develop and maintain relationships with other firms within the network which in most cases is of a cumulative nature as firms strive to establish prominent positions in their networks. The firm, at each point, has a position in the network which explains its relationship to other firms. A fundamental assumption however is the fact that a firm is solely dependent on its network while internationalising. A high degree of internationalisation would mean that there are strong relationships between different national networks which are thus considered as market investments. On the other hand, the firms which are highly internationalised would prefer to have a number of activities performed by subcontractors and can still have the desired control arising from these relationships

The above mentioned are the most established theoretical concepts of internationalisation. The establishment chain theory has initiated a vast amount of research which has suggested that omissions in the stage pattern in any one foreign market may result from learning across the firm. In other words, learning from other foreign markets.

MOTIVATIONS FOR INTERNATIONALISATION

Empirical studies done by Kogut & Chang, (1991); Pugel, (1985); and McClain (1983); have found a positive correlation between outward investment activities and intangible assets measured as R&D and advertising intensities. Foreign direct investment according to Kindleberger (1969) has been treated as a kind of international capital movement subject to interest rate differentials accompanied by differing degrees of control. Hymer (1960) argued that a monopolistic advantage encouraged firms to invest overseas. Caves (1971) interpreted it by identifying the sources of monopoly power with rent-yielding intangible assets such as technology and marking skills- the knowledge base of a firm.

Furthermore, another important stream of research on foreign direct investment done by Buckley & Casson, (1976); Hennart, (1982) and Rugman (1981) concerned multinational enterprises minimising transaction costs not only by internalizing technology or marketing know-how but also by internalising the sourcing of raw materials and intermediate goods (Hennart, 1982). For example, Hennart and Park (1994) showed that the larger a Japanese firm’s R&D expenditures, the greater it is to most likely manufacture in the United States. From the transaction mode perspective, Hennart (1991) and Hennart and Park (1993) examined the mode of Japanese entries into the United States and found that the higher the R&D expenditures, the more likely it is to enter via “Greenfield” operations rather than acquisition. However, they highlighted that R&D expenditures were not related to decisions concerning the choice of a joint venture or a wholly owned subsidiary structure.

While the monopolistic advantage theory and the transaction cost theory have explained the motivations for foreign direct investment to an extent; from different theoretical perspectives, the key motivations for this strategy identified by previous scholars are identified below.

KEY MOTIVATIONS FOR INTERNATIONALISATION

Resource seeking, market seeking, strategic asset-seeking and efficiency seeking according to the World investment report (WIR 1998) and Dunning 1993 are the key motivations for extending production activities across national boundaries.

Market Seekers- This motive for internationalisation focuses on how decision makers in an organisation acknowledge the importance of accessing specific target markets abroad. In other words, it focuses on demand aspects and the belief that an international direct presence is essential for this access that would focus on market seeking motives. Dunning (1993) argued that there are several other reasons why companies take such actions. He stipulates that firms carry out investments on foreign markets in order to exploit new markets and to take advantage of market share indicating that the Company would generate profit.

Furthermore, foreign governments encourage investments from companies in other countries by providing incentives such as subsidized labour; trade barriers also play a major role for companies to invest in these countries. According to Harris & Wheeler 2005, much of government export promotion policies centre on encouraging organisations to internationalise using business education and training. In essence, this fosters direct trade links in other countries and financial incentives.

Strategic resource seeking- These are intangible resources that deal with the technology and core competence of the firm; for example, patents, knowledge, skills of the employees and strategic supplies necessary for competitive advantage. The main motive is to sustain and strengthen the competitive position or to weaken that of their competitors (Dunning 1993)

Efficiency seekers- Dunning (1993) established that the purpose of efficiency seeking is to rationalize structures of established investments in order to gain from common governance. He argued that those benefits came from economies of scale and scope as well as risk diversification. In other words, efficiency seeking serves as an advantage because firms gain from factor endowments (value-adding activities that are labour or resource intensive), cultures, institutional arrangements, and economic systems which in most cases imply the concentration of production in limited number of places. Firms that seek efficiency are often experienced, large and diversified multinational enterprises.

On the other hand, Root (1987) noted that manufacturing and service internationalise for the following reasons:

Stagnation of home market and a faster growing foreign market

The need to follow domestic customers who have gone international

Firms in oligopolistic industries go abroad to match the international market entry of domestic rivals (also known as the bandwagon effect) or counter foreign firms penetrating domestic markets.

Search for greater sales volumes in order to reduce the unit cost of manufacturing overheads, thus strengthening competitiveness at home and abroad.

He finally concludes by stating that “the fundamental or strategic motives for internationalising or entering foreign markets becomes apparent only after it first tentative venture in that direction is made”

THEORIES OF INTERNATIONALISATION

The theories mentioned above are early theories on international trade and investments written by classical economists whose main concern was on the political economy of a nation (Tayeb 2000). Recently, the internationalisation processes has been explained with the use of simplified models and frameworks to analyse internationalisation processes. They include; The Uppsala model, The OLI framework, and the Product life cycle. These theories focus on firms that are heavily involved with exporting and international trade and are therefore relevant for this research.

UPPSALA MODEL Johanson and Vahlne 1977, 1990 argue that the central issues on the Uppsala model are concerned with knowledge acquisition, how organisations learn and how their learning affects their investment behaviours. According to Cyert & March 1963; Johanson & Wiedersheim-Paul 1975, a firm undergoes expansion starting from “psychically closer” countries in a sequential process in order to avoid uncertainty and minimise risks. The interplay between knowledge of and commitment to a particular foreign market (Johanson & Vahlne, 1977) comes as a result of the internationalisation pattern of the firm. Secondly, internationalisation processes are often slow and gradual (Johanson & Vahlne 1977, 1990) which usually comes as a result of the incremental expansion of a firm’s absorptive capacity (Cohen & Levinthal, 1990)

Examining theoretical assumptions and implications across various spatial and temporal contexts has sparked off a number of empirical studies since the Uppsala model was introduced (Andersen 1993, 1997; Casson, 1994; Forsgren, 2001; Hedlund & Kverneland, 1985; Sullivan & Bauerschmidt, 1990). Luis and Sergio’s (2004) article paid particular attention to an interesting argument on the notion that the Uppsala model pays little attention to the internationalisation processes of multinational corporations (MNC’s); a point which was acknowledged by the originators of the model (Johanson & Vahlne, 1990).

Secondly, decisions and implementation concerning foreign investments are made incrementally as a result of market uncertainty. This can be seen as a management learning process whereby learning through doing is the basic logic (Lindblom 1959, Quinn 1980, Johnson 1988). Therefore, as a result, the more a firm knows about the market, the lower the perceived market risk would be and the higher the level of foreign investment in that market. According to Johanson and Vahlne 1977, p. 34, “the firm postpones the each successive step into a certain market until the perceived risk associated with the new investment is lower than the maximum tolerable risk”. In other words, the perceived risk is the main function of the level of market knowledge acquired through owned operations.

OLI FRAMEWORK

The OLI framework provided by Dunning (1988) is also known as the Eclectic Paradigm. The model asserts that at any given moment in time, production financed by FDI and undertaken by MNEs would be determined by the configuration of three sets of forces.

The competitive advantages which firms of one country posses over another in supplying any particular market may arise due to either the firm’s privileged ownership of, or access to, a set of incoming generating assets or from their ability to co-ordinate these assets with other assets across national boundaries in a way that benefits them relative to their competitors, or potential competitors.

The extent to which firms perceive it to be in their best interest to internationalise the markets for the generation and the use of these assets; and by so doing, add value to them

The extent to which firms choose to locate these value adding activities outside their national boundaries.

The eclectic paradigm asserts that the significance of the advantages listed above and the configuration between them is most likely to be context specific; and is likely to vary across industries and geographical dimension among firms. For example, while the relationship to the comparative location advantages of the Chinese and Japanese manufacturing base for motor vehicles may be differently regarded by (say) Toyota than (say) the Honda Corporation. Furthermore, Arvidsson (1997) emphasizes that; it is favourable to internalize the function which may occur due to high transaction costs in the market for this specific function, instead of selling to local firms through a market.

PRODUCT LIFE CYCLE MODEL

According to this theory, a product goes through several stages of development with the first stage being the innovation stage. When the product is newly invented, it attracts high income groups as customers because its demand grows more rapidly in more developed countries where this target group is mostly present. At this stage, the production also starts in other advanced countries, sometimes in a subsidiary of the inventing country. If at this stage, the cost benefits of producing in the second or third country are large enough to offset transportation cost, then the foreign producer may export back to its home country. With the benefits of these operations, a number of firms start producing and exporting the product. The companies imitate the original innovating company and would often even produce in the same geographic locations. The second stage is the introduction of the product to the domestic market. The third stage is the export of the product while the final stage is the maturity stage. As the product becomes standardised at this phase, it is imitated and is even produced overseas by foreign markets.

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THEORETICAL CONCEPTS FOR ENTRY MODES BY MNE’s

From the points listed above, the choice of entry mode is an important part of a firm or industry’s decision to internationalise and it would depend on factors associated with the company’s business interest. Chang and Rosenzweig 2001 laid emphasis on the fact that firms are not only concerned with what foreign to enter, and on what activities they perform in those markets, but also on how to enter i.e. whether by Greenfield investment, by acquisition or by joint venture. This is because choosing a mode of entry can have enormous strategic consequences for the firm.

Research on the performance outcomes of foreign market entry strategies has been primarily considered from the perspective of multinational corporations (Ghosal 1987; Burgers 1989). The internationalisation trend for small and medium-sized enterprises (SME’s) has prompted increased research interest in explaining the factors that contribute to success, but sufficient theoretical framework is lacking (Lu & Beamish 2001) which is why the main focus of this research would be on Multinational Enterprises.

Entry modes have diverse implications depending on the degree of control the firm can exercise over foreign operations (Anderson & Gatignon 1986; Caves 1982; Root 1987), the resources it must commit to the foreign market (Hill et al 1990; Venon 1983); the risks it must bear to enter that market (Hill et al 1990; Hill & Kim 1988); and the share of economic rents the firm can generate and keep for itself (Anderson & Gatignon 1986; Buckley & Casson 1996). For these reasons, the entry modes used to penetrate foreign market can have a profound impact on the success of international operations, even among large multinational corporations (Hill et al 1990; Root 1987).

An excellent lens through which the benefits of relative costs are examined is provided by the transaction cost theory (Wiliamson 1975; 1985); and more importantly, for understanding how those costs and benefits vary based on the type of knowledge that is transferred between partners. This theory is also called the internalisation theory within the international business literature (Rugman 1981) and has been used to examine the entry mode choices of multinational firms (Denkamp 1995) on an extensive scale. It has also been advocated as a means of understanding the entry of entrepreneurial firms into foreign markets. However, the use of large samples of international new ventures has not been tested empirically.

Furthermore, the collaboration with local partners benefit multinational firms by providing knowledge and access that might otherwise be unobtainable or extremely costly to obtain experientially via internalisation or repeated arm’s-length market transactions (Kogut 1988). Specifically, local partners provide knowledge about local economies, politics, business customs, demands and tastes and other factors required to conduct business in their countries. Knowledge gained this way is particularly beneficial to high-technology firms because the geographic scope with which technology can be exploited is normally much wider that a firm’s marketing expertise (Buckley & Casson 1996), especially among international new ventures (Coviello & Munro 1992)

Hence, if the entry mode decision is considered such an important strategic decision and “the success of MNE’s under globalisation depends on the formulation and implementation of strategy” (Knight 2000 p. 13), then the strategic decisions on whether MNEs follow similar patterns as their large counterparts; and whether the strategic decision processes that influence success for larger companies should be examined.

ENTRY MODE CHOICES

Foreign market entry mode according to Calof (1993) is defined as institutional arrangements that allow firms to use their product or service in a country or “an institutional arrangement that makes possible the entry of a company’s products, technology, human skills, management, or other resources into a foreign country” (Root 1987 p.5).

Firms enter foreign markets in different ways. From a management perspective, firms entering new foreign markets choose from a variety of different forms of entry, ranging from:

Exporting (directly or through independent channels).

Licensing and franchising.

Foreign direct investment (FDI) i.e. joint ventures, acquisitions, & mergers.

Wholly owned new ventures.

Calvet (1984); Caves 1982; and Root (1987) suggested that each of these entry modes is consistent with a different level of control. Control according to them means authority over operational and strategic decision making. Resource commitment means dedicated assets that cannot be redeployed to alternative uses without loss of value. A review of the literature of manufacturing firms by Hill et al (1990) suggests that while wholly owned subsidiaries can be characterised by a relatively high level of control and resource commitments, the opposite can be said of licensing agreements. With respect to joint ventures, although the levels of control and resource commitments vary with the nature of the ownership split between the manufacturing firms, their extent can nevertheless be said to lie between that of wholly owned subsidiaries and licensing agreements

From an economist’s perspective however, a company can enter a foreign market through exporting its product or transfer its resources in technology, capital, human skills, and enterprise to the foreign country, where they may be sold directly to customers or combined with local resources in the manufacturing process for sale to the local market.

FACTORS INFLUENCING THE CHOICE OF ENTRY MODE.

In order to expand the existing entry mode analysis beyond the narrow confines of each entry decision listed above in isolation; this research would also consider the extent of global concentration, global synergies and global strategic motivations exercised by manufacturing firms. This broader concept gives an opportunity to expressly consider and understand the strategic relationship a multinational firm envisages within the manufacturing industry on its operations across borders in reaching its entry mode decision.

The diagram below shows three groups of variables that are believed to influence entry mode decision. These variables are the global strategic variables which have already been highlighted as well as the already well established environmental variable (host country risk, location unfamiliarity, demand uncertainty, and competition intensity) and transaction-specific variables (i.e. the value of firm-specific-know-how and tacit nature of know-how)

Firm specific know-how is knowledge that is proprietary to a given firm. Tacit know-how involves non-codifiable knowledge not embodied in physical items such as capital, goods, equipment, and blueprints. While it is believed that this is collective, simultaneous considerations of all three groups of factors that determine the ultimate entry mode decision, it is also argued that environmental and transaction specific factors and global strategic

Source: Kim & Hwang 1992

Global concentration on the other hand, involves multinational corporations (MNC’s) increasingly finding themselves in industries that are characterised by a limited number of players who confront each other in many different national markets around the globe; i.e. the global industry has become highly concentrated. In such industries, conditions of oligopolistic interdependence spill over national creating a high level of competitive interdependence among players. When global competitive interdependence exists, the actions taken by an MNC in the manufacturing industry would often have repercussions in other national markets (Watson 1982; Kim & Mauborgne 1988). Competitive interdependence implies that organisations can influence one another not only directly, but also indirectly in any of the diverse national markets in which they compete.

INTERNATIONALISATION AND THE AUTOMOBILE MANUFACTURING INDUSTRY.

The automobile industry has played a significant role in the advancement of industrialisation in many countries in this century. Automakers have internationalised their operations for a number of reasons that have led way for moving production abroad. Its significance arises from the fact that the industry has been a major pioneer in inventing cutting edge innovations that has changed the organisation process of manufacturing. As a result, it has dramatically increased labour productivity and industrial development to varying degrees that has transformed the manufacturing industry as a whole.

There is a mounting interest in the internationalisation of Research and development (R&D) activities by multinational firms. The two motives for this are the exploitation of the firm’s technology abroad through adaptation of technologies and local circumstances and the creation of technologies through access to overseas technology and know-how. Recent work has suggested an increasing importance of foreign R&D associated with a growing role of global technology creation. Evidence provided by Kuemmerle, 1997 and Gerybadze and Reger 1999 has shown that more R&D sites are assigned the role of creators of basic technologies and developers of completely new products for world markets.

Foreign direct investment plays a major role in the internationalisation of R&D, and MNEs are the main actors (OECD 2008). According to UNCTAD 2005, more than 95% of the 700 firms with the largest R&D expenditure are MNEs; they account for close to half of the world’s total R&D expenditure and more than two-thirds of the world’s business R&D. An analysis of the top spenders reveals that over 80% come from Japan, Germany, France and the United Kingdom. Only 1% is from emerging countries but their importance is growing especially the MNEs from China, Korea, Brazil, South Africa and Chinese Taipei. In 2004, expenditure on R&D by top MNEs grew much more in the rest of the world (+17%) than the Triad (+4%); (UNCTAD 2005; European Commission 2005)

Based on the above, it is important to highlight and note the relative contribution that the theories of internationalisation play to manufacturing firms. In essence, the OLI framework, Uppsala model of internationalisation and the network perspective previously mentioned would be applied to the internationalisation of manufacturing firms so as to give a better understanding of the theoretical frameworks.

OLI FRAMEWORK AND THE INTERNATIONALISATION OF MANUFACTURING FIRMS

According to the eclectic theory, all three OLI factors (i.e. Ownership, location and internalisation) play a significant role to the entry mode decision and strategy of manufacturing firms. Dunning (1980, 1988) laid emphasis on the fact that the ownership advantages of a firm will dictate the internalisation advantages and that location advantages would depend on the combination of the two former advantages.

Moreover, following the OLI framework, Ekeledo and Sivakumar (1998) suggests that of the three factors, location advantages is the most important factor applicable to the internationalisation of manufacturing firms. This is because location is almost defined as where they choose to start up their international activity abroad which is the whole essence of their motive to investment. This distinction is likely made on the basis of their comparison of manufacturing and service firms as some services such as restaurants are non-separable from their location. It is most likely that for service firms, the internalisation factor would be the most important (Arvidsson, 1992a).

UPPSALA MODEL AND THE INTERNATIONALISATION OF MANUFACTURING FIRMS

Psychic distance is an issue addressed Johanson and Vahlne (1977) in explaining the fundamentals of firms facing internationalisation. According to them, this includes factors such as language barriers, culture as well as differences in consumer taste and preferences in values behaviours and attitudes.

Based on the experiences of Swedish manufacturing firms, Johanson and Wiedersheim-Paul (1975) highlighted four stages of the internationalisation process starting with exporting through independent representatives to a final phase of overseas production. The Uppsala internationalisation model assumes the process is made up of stages too and that manufacturing firms begin with less risky ventures in physically close markets and gradually increase it commitment and it geographical reach through a process of experiential learning.

Valne (1995) suggested that MNE’s engaged in manufacturing are influenced by their internal resources in terms of their business territory. That is, social networking and entrepreneurial quality may influence a firm’s ability to identify and acquire external resources, as well as its ability to utilize such resources for its operations and marketing mix. However, Andersen (1993) suggested that the Uppsala model of internationalisation which is based on empirical findings from manufacturing firms is more general and is further developed that other process models. He argues that the model applies both to small and large manufacturing firms and that time and space play a lesser role, giving the model higher generalisability that other process models.

NETWORK PERSPECTIVE AND THE INTERNATIONALISATION OF MANUFACTURING FIRMS

Most manufacturing firms are initially engaged in primary domestic networks. As argued by Johanson and Mattsson (1990), form internationalisation means that it develops business relationships in networks abroad. The internalisation theory also builds on the assumption that manufacturing firms which internationalise their operations possess some form of ownership advantage(s) compared to their local competitors. The explanatory power of the network perspective for manufacturing firms is that it is arguably highest for large firms with extensive international operations (Johanson and Vahlne 1990).

However, it is believed that networks are still relatively more important for service firms than for manufacturing firms. This is because of the buyer-seller relationship that exists in service firms and since services are usually often produced through personal interactions between the buyer and seller (Arvidsson 1997)

CHOOSING AN INVESTMENT LOCATION

The classical theory for profit maximisation was portrayed by Hymer (1976) and Kindleberger (1970) in describing the essential motives of firms to internationalise as ‘the exploitation of market imperfections and prospective gains in operation efficiency’. This means that choosing a location for investment can be a difficult process as it would entail tactical and well planned decisions in terms of the identification of favourable investment location, the scanning of environmental alternatives, weighing variables between the amount of risk and opportunities present as well as the collection and analysis of data for the variables amongst viable available options.

Studies like those of Buckeley and Casson 1976; Dunning 1981; Hennart 1982, 1991a see FDI as the result of two sequential decisions. Figure 2 gives a diagrammatic explanation as to the concerns about whether to manufacture abroad (i.e. the location decision) while the second is concerned with the firm’s decision to rent or sell it own firm specific advantages to local firms, or whether it would internalise their transfer (i.e. the governance decision).

In essence, it is emphasized that two types of variables simultaneously affect a firm’s decision to invest abroad: (a) those that determine the optimum location of production (location factors); (b) those that determine the optimal governance structure to exploit advantages (governance factors). In a broad sense, it could be argued that these variables are influenced significantly by the size and growth of the market, psychic distance, and government regulations on foreign direct investment, labour costs, and most importantly, the political stability.

Rugman & Verberke (1992) also outlined these classifications on two parameters. The first parameter is related to the unit analysis which focuses on location advantages at country level and single industry and firm level. The second gives a distinction between trade and FDI as the outcome specific advantage (Rugman & Verberke 1992a) -Fig 2

From the diagram above, the perpendicular axis has been emphasized by Birkinshaw (2000) and Cantwell & Piscitello (1999) that the ‘trade focus’ on goods and the ‘investment focus on capital flows has been neglected by the ongoing sequential and internal network flow of know-how, whereby the direction and complexity of flows may be substantial to change over time. Therefore, the most favourable location for know-how development and the optimal diffusion of this know-how may change overtime within the framework of functioning international business networks, irrespective of initial FDI flows (Rugman and Verbeke 2001). These were further modified by Rugman and Verbeke (2001) in their framework analysing the new perspectives on location advantages.

KEY CONCEPTS

In order to comprehend why multinationals are attracted to certain locations, and how the government is able to create policies to enhance foreign investment; it is important to take into consideration the main conceptions concerning location/or location advantages in order to understand how these advantages have come about via locations and trade liberalisation as well as how countries are able to develop what they trade and produce.

There has been a wide acceptance in the last decade that traditional theories; based on comparative advantage cannot account for observed intra-industry trade (Davis 1995). As a result, Lancaster (1980) emphasized the large volume of intra-industry trade between similar countries as a puzzle. According to him ‘Intra-industry trade on a large scale, an undeniable fact of trade between modern industrial economies, is simply not a prediction of traditional trade theories.’ Balassa and Bauwens (1988) claim bluntly that ‘theorists of intra-industry trade hold that economies of scale are sine qua non condition of intra-industry specialisation; in the absence of scale economies, all product varieties could be produced domestically and no intra-industry trade would take place’.

In this light, Krugman and Obstfeld (1991) extended this explicitly and argued that ‘…the Ricardian model neglects the possible role of economies of scale as a cause of trade, which leaves it unable to explain the large trade flows between apparently similar nations…’ In other words, these claims are synthesized in the sense that traditional trade theories are difficult to account for a large volume of trade between countries which are similar in factor endowments and technology, a large share of which is in “differentiated” goods of similar factor intensity.

RECENT PERSPECTIVES ON LOCATION ADVANTAGES

The eclectic paradigm initiated by Dunning (1977, 1988, 1992, 1999, 2000) as well as Rugman’s (1981, 1996; Rugman and Verbecke 1992, 1998) internationalisation perspective on functioning multinational firms stem from the fact that location advantages vary for each international firm. It is however important to stress in this context that knowledge creation on firm level appears to be grounded in innovation systems localised. As a result, trade resulting from MNE activities are usually driven by the variation of these innovation systems (Dosi et al 1990).

A prominent feature in recent research on location advantages within the international economics literature is the increased attention paid to ‘created’ location advantages like R&D as opposed to the conventional factor endowments location advantage like labour pools or availability of capital. For example investments in R&D allow countries to specialize in high technology sectors and allow countries to have high growth rates (Grossman and Helpman 1991). These investments could create a major location advantage, depending on the international technology diffusion rates and to what extent an advantage can be maintained over time (Rugman & Verbeke, 1990).

Multinational firms exist because they posses some firm specific advantages which can be profitably combined with location advantages at a site outside their country (Rugman 1981; Dunning 1993). These advantages, which are also known as ownership advantages, are knowledge based assets like technological or organisational capabilities. Therefore, the purpose of a foreign operation is to exploit or augment their resources and capabilities (Anand & Delios 2002) which requires that the capabilities are at least in part shared with the foreign operation.

Conceptual research over the past decade has pointed out that industrial cluster, rather than nations may be a relevant unit of analysis (Audretsch 1998, Rugman & Verbecke 2002). This is because knowledge spillovers that are strengthened from Multinational firms via location advantages and local networks of the countries they operate in; occur as a result of cooperation and competition (Rugman & D’Cruz 2000; Dunning 2000) between the direct interaction of the transferor and recipient.

The transfer of knowledge by MNEs is often for subsidiaries to achieve their objectives to achieve depending on the local competitive advantage and that of the subsidiary’s role. A subsidiary that is engaged in R&D or in the application of the latest technology in the production process would usually receive more knowledge from that parent company that a subsidiary, manufacturing products at later stages of the product cycle. Moreover, subsidiaries facing competition from technologically advanced local firms possibly will meet that challenge by upgrading technology with additional support from the parent MNE. Hence, the technology transfer within the MNE can be expected to increase with the technological sophistication of the local environment (Blomstrom et al 1994)

Furthermore, the literature by Caves 1971, Buckley & Casson 1976), in the internalisation firms, emphasize that firms prefer direct investment to transfer knowledge as knowledge has public good properties and FDI can prevent undesired diffusion. From the receiving country perspective, the diffusion would represent a desirable positive externality. However, governments must acknowledge that, unless they offer the transferor protection of his intellectual property, they may not get access to the know-how at all; hence, a bilateral bargaining situation

THEORIES EXPLAINING LOCATION ADVANTAGES

The focus on foreign direct investment as a tool used by MNEs to transfer and exploit abroad proprietary resources was first recognised by Hymer (1960). In he’s view; MNEs are bound to face disadvantages (e.g. language and cultural barriers, lack of knowledge on the local socio-economic and business system, and expropriation risks) in host countries which have been synthesised as ‘liability of foreignness’. Thus, MNEs that produce in host countries would not benefit the way indigenous firms from either localised network spill over effects or synergies from the combination of firm level and host country location advantages.

Product life cycle is a well known international business model instigated by Vernon (1976) which focuses on the symbiosis between home country location advantages in technological innovation and the resulting proprietary assets at the MNE level. From a dynamic point of view, MNEs were capable of linking their firm specific advantages with specific location advantages of the host country (i.e. demand patterns, supply capabilities, and labour costs). This dynamic approach aimed at explaining market seeking FDI, neglected two key aspects of the linkages between MNEs and location advantages. They neglected the fact that MNEs may use foreign markets to reduce risks, even though this was taken into account in a later publication by Vernon (1983); and the combination of host country location advantages to the MNE’s extension of its knowledge base. Nevertheless, Vernon’s approach went far beyond the conventional models that attempted to explain FDI flows as an almost mechanistic reaction to exogenous macro-level location advantages such as favourable exchange rates o relative labour costs (Aliber 1970; Cushman 1985; Culem 1988)

Furthermore, Dunning (2000) provides an excellent synthesis of the key location advantages by indentifying ten schools of thoughts on location advantages applicable to the four main types of FDI listed earlier in the literature (i.e. resource seeking, market seeking, efficiency seeking, and strategic asset seeking) -Fig 4.

As the eclectic paradigm has become a leading conceptual framework for the analysis of international expansion patterns of business firms; it has also built upon the interactions among ownership specific variables, internalisation incentive advantages as well as location-specific variables all of which are important frameworks within the context of this literature. As location-specific characteristics which contribute to competitive advantage are recognised to differ for different countries, sectors and firms (Dunning 1992); the eclectic paradigm therefore gives an interesting observation to the fact that at firm level, the location advantages appear to include elements such as the firms experience with foreign involvement, psychic distance variables, attitudes to risk diversification, and attitudes toward the centralisation of functions such as R&D.

In addition, it also allows for the identification of key location advantages of four different types of international production with its major strength in identifying the complexity of determining the practical implications for managers and public policy makers of specific location advantages (Rugman & Brewer 2001).

Porter’s perspective has been rightfully criticised by several international business scholars like Dunning (1993). Dunning has argued that “To suggest the competitive position of MNEs like IBM, NESTLE, and British America Tobacco (BAT) rests only on their access to the diamond of competitive advantage of their home countries is ludicrous- however, much of their initial foray overseas may have been based on such advantages”. Porter did acknowledge the strategic option for firms to ‘shift’ the ‘home base’ for specific businesses from the home country to a host country, in function to their relative CSAs.

However, the downside of Porter’s framework is that it concentrates on non-location bound FSAs developed by companies in their home country prior to engaging in FDI. As a result, he largely neglects the systemic advantages of MNEs resulting precisely from the common governance of internationally dispersed value added activities, each building upon an idiosyncratic bundle of CSA and the benefits of strategic asset seeking FDI, accruing to the MNE, whereby these assets may largely have been created on the basis of host CSAs (Rugman & Brewer 2001).

Rather than recognising that Honda now functions with at least two home bases (i.e. Japan and U.S) in the automobile industry, with the latter country being specialised in the design, development and upgrading of station wagons, Porter (1998a p335) argues that station wagons actually constitute a distinct business or product line, thus building upon a single home base, i.e. the US. In addition, according to Porter (1998a, 335) even the development of the two door civic coupe in the United States will be achieved using the United States as a ‘single home base’. A home base is thus defined as the location in which the most important decisions can be taken, largely independently from other locations.