The concept and theories of Internalisation

2.1 Introduction

Concept of Internationalisation

The last two decades has witnessed a growing interest in the area of internationalisation. However, despite the extensive use of the term internationalisation, few real attempts have been made to provide an operational definition of its meaning. Internationalization has been described as the outward movement of a firm’s operations. Piercy (1981), Turnbull (1985); it has also been defined as “…the process of increasing involvement in international operations” (Welch and Luostarinen, 1988, p. 36). Nevertheless, a universally accepted definition of the word “internationalisation” remains elusive with diverse interpretations being found in the literature. For example, one view considers internationalisation to be a pattern of investment in foreign markets based on logical economic analysis of ownership, location advantages and internalisation (Williamson 1975, Dunning 1988). A second view considers internationalisation to be a continuous process of evolution (Melin 1992) whereby a firm’s increase in international operations is a function of improved knowledge and market commitment (Johanson and Vahlne 1977).

A third view, though process-based, argues that internationalisation does not often entail a “smooth, unalterable course of development,” and may comprise of both ‘outward’ and ‘inward’ patterns of international growth (Welch and Luostarinen 1988, 1993). In addition, though Johanson and Vahlne (1977) imply that internationalisation is apparent for the most part in the markets entered and entry modes, Welch and Luostarinen (1988) argue that internationalisation also reflects in the firm’s market offering, organisational competence, workforce and structure.

Beamish (1990, p. 77) offers a fourth view on internationalisation by defining it as “…the process by which firms both increase their awareness of the direct and indirect influence of international transactions on their future, and establish and conduct transactions with other countries.”

This definition is possibly most practical in that it combines aspects of the three views discussed into one holistic explanation of the internationalisation concept. To begin with, Beamish’s (1990) definition integrates the firm’s pattern of foreign investments with its internal learning; by doing so, acknowledges that internationalisation has both economic and behavioural components. This definition is also process-based; which identifies the evolutionary nature of internationalisation. In addition, the definition is not restricted to outward patterns of investment and thus allows for the firm to be involved with inward internationalisation activities such as imports or countertrade. Finally, the definition suggests that relationships established in the course of international transactions could influence the organisation’s expansion to other countries.

Stemming from Beamish (1990) definition, three approaches to internationalisation can be identified:

1) The Economic approach

2) The Behavioural approach

3) The Relationship approach

2.2 Classic Theories of Internationalisation

2.2.1 Economic Approach

One of the pioneers of economic theory of internationalisation, Hymer (1976) states the desire to gain market power and monopolistic advantage is the driving force behind a firm’s decision to locate production facilities abroad. By embarking on such investments, the firm also broadens its networks, decreases competition amongst rivals while at the same time increasing the entry barriers to outsiders.

In considering what differentiates FDI from a portfolio investment, Hymer (1976) and Kindleberger (1969) assume that direct investment abroad is costly and risky and therefore the firm decides to engage in it because it gives the investor the control over the investment.

The most important of the motivations to exploit market imperfections by FDI is that it allows the firm to exploit collusion abroad and therefore weakens competition in the expectation that it will lead to larger profits. This advantage, based on financial, innovation,cost, or marketing aspects, is specific to ownership and is very important because it will allow the firm to successfully compete with indigenous firms in their own market.

This type of market imperfection is the kind of “ownership” advantage that a firm undertaking FDI must possess in order to counterbalance the relative advantages of native firms.

The second motivation is the firms’ advantage to operate, produce and/or market in any industry. The third motivation mentioned by Hymer (1976) is the drive of large firms towards diversification. Clearly, market imperfections not only alter the behavior of firms, but must also counterbalance the high costs of direct investment abroad.

Both Kindleberger’s (1969) and Hymer’s (1976) messages are very clear: perfect competition must be avoided for direct investment to succeed and this creates conflicts. Market imperfections can be created in four different ways. Firstly, in the goods markets, especially due to marketing skills, product differentiation, pricing, etc. Secondly, in factor markets,especially due to access to capital markets, superior management, “proprietary” knowledge

or better technology. Thirdly, through the creation of internal and external economies of scale (which are directly linked to market imperfections). Finally, through the governments’intervention in the production and trade, namely restricting output and entry.

Monopolistic Advantage Theory

This theory suggests that firm’s generate higher rents by making use of their specific assets which competitors are unable to replicate (Hymer, 1976). According to Hymer, direct foreign investors own some sort of proprietary or monopolistic advantage not accessible to local firms; these advantages could be either superior technology, economies of scale or superior knowledge in management or finance. In such cases, the investor is a monopolist or in most cases oligopolistic.

Dunnings Eclectic Paradigm/ OLI theory of Internationalisation

The eclectic paradigm has remained one of the dominant frameworks for analysing the determinants of foreign direct investments and foreign activities of MNEs. It sets out to explain the internationalisation of firms by identifying the ”factors, incentives and configurations” that drives a multi-national enterprise (MNE) to pursue foreign investment within a specific region. The eclectic paradigm is a “juxtaposition of the ownership-specific advantages of firms contemplating foreign production, the propensity to internalize the cross border markets for these, and the attractions of a foreign market for the production” (Dunning, 1988, p. 5). In other words, three conditions must before a firm engages in international activities; the firm must possess both an ownership (O) advantage and an internalization (I) advantage, while the foreign market must offer a location (L) advantage. The Eclectic Paradigm basically tries to answer three questions concerning foreign investments: (1) Based on present and potential ownership advantages, should a particular firm be involved in foreign markets?; (2) Based on location advantages, where should the firm invest abroad?; and (3) How should the firm serve foreign markets, should it be through internalization (FDI or sales subsidiaries) or through arms-length arrangements (such as licensing or export through intermediates)? (Oxelheim et al, 2001).

Ownership advantage here refers to firm-specific assets both tangible, e.g., products, technologies or human resources; and intangible, e.g., patents or brands ( Bevan and Estrin, 2004).These assets provide an advantage to the investing firm by either lowering the costs or generating higher revenue that can offset the transaction costs involved in overseas operations.

Location advantage means ”the advantages that arises from utilising resource endowments or assets that are tied to a particular foreign location and that a firm finds valuable to combine with its own unique assets” (Hill, 2009 p.253). This can include economic advantages (e.g. quantity and quality of factors of production, scope and size of market etc.); political advantages (e.g. government policies that encourage the flow of foreign investments) and socio-cultural advantages (e.g. language and cultural diversities etc).

Internationalisation advantage

Uppsala Theory of Internationalisation

This view on internationalization was inspired by Scandinavian researchers who are collectively referred to as the Uppsala School. The Uppsala model in general proposes that the process of internationalization is founded on an evolutionary and sequential build-up of foreign commitments over time (Johanson and Vahlne, 1977; Johanson and Wiedersheim-Paul, 1975). They identified four steps within this process which were distinguished by those firms with: no regular export activities; export activities via independent representatives or agents; the establishment of an overseas subsidiary; and overseas production/manufacturing units.