Internalization theory itself is based on the transaction cost theory. This theory says that transactions are made within an institution if the transaction costs on the free market are higher than the internal costs. This process is called internalization.
- Ownership advantages (trademark, production technique, entrepreneurial skills, returns to scale) Ownership specific advantages refer to the competitive advantages of the enterprises seeking to engage in Foreign direct investment (FDI). The greater the competitive advantages of the investing firms, the more they are likely to engage in their foreign production.
- Location advantages (existence of raw materials, low wages, special taxes or tariffs) Locational attractions refer to the alternative countries or regions, for undertaking the value adding activities of MNEs. The more the immobile, natural or created resources, which firms need to use jointly with their own competitive advantages, favor a presence in a foreign location, the more firms will choose to augment or exploit their O specific advantages by engaging in FDI.
- Internalization advantages (advantages by own production rather than producing through a partnership arrangement such as licensing or a joint venture) Firms may organize the creation and exploitation of their core competencies. 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 rather than license the right to do so.
|Categories of advantages|
| Form of
The idea behind the Eclectic Paradigm is to merge several isolated theories of international economics in one approach. Three basic forms of international activities of companies can be distinguished: Export, FDI and Licensing. The so-called OLI-factors are three categories of advantages, namely the ownership advantages, locational advantages and internalization advantages. A precondition for international activities of a company are the availability of net ownership advantages. These advantages can both be material and immaterial. The term net ownership advantages is used to express the advantages that a company has in foreign and unknown markets.
According to Dunning two different types of FDI can be distinguished. While resource seeking investments are made in order to establish access to basic material like raw materials or other input factors, market seeking investments are made to enter an existing market or establish a new market. A closer distinction is made by Dunning with the terms efficiency seeking investments, strategic seeking investments and support investments.
| Trade and FDI patterns
for industries and countries.
The eclectic paradigm also contrasts a country's resource endowment and geographical position (providing locational advantages) with firms resources (ownership advantages). In the model, countries can be shown to face one of the four outcomes shown in the figure above. In the top, right hand box in the figure above firms possess competitive advantages, but the home domicile has higher factors and transport costs than foreign locations. The firms therefore make a FDI abroad in order to capture the rents from their advantages. But if the country has locational advantages, strong local firms are more likely to emphasize exporting. The possibilities when the nation has only weak firms, as in most developing countries, leads to the opposite outcomes. These conditions are similar to those suggested by Porter's diamond model of national competitiveness.
Application in practice
In dependence of the categories of advantage there can be chosen the form of the international activity. If a company has ownership advantages like having knowledge about the target market abroad, for example staff with language skills, information about import permissions, appropriate products, contacts and so on, it can do a licensing. The licensing is less cost-intensive than the other forms of internationalization.
If there are internalization advantages, the company can invest more capital abroad. This can be achieved by export in form of an export subsidiary.
The FDI is the most capital intensive activity that a company can choose. According to Dunning, it is considered that locational advantages are necessary for FDI. This can be realized by factories which are either bought or completely constructed abroad.
- Hagen, Antje (1997). Deutsche Direktinvestitionen in Grossbritannien, 1871-1918 (Dissertation) (in German). Jena: Franz Steiner Verlag. p. 32. ISBN 3-515-07152-0.
- Twomey, Michael J. (2000). A Century of Foreign Investment in the Third World (Book). Routledge. p. 8. ISBN 0-415-23360-7.
- Dunning, John (1979). "Toward an Eclectic Theory of International Production: Some Empirical Tests". Journal of International Business Studies. 11 (1): 9–31. JSTOR 154142.
- Falkenhahn, Alexander; Roman Stanslowski (2001-11-27). "Das Eklektische Paradigma des John Dunning" (PDF). Seminar paper (in German). Retrieved 2009-02-19.
- Dunning, John H. (2000-4). "The eclectic paradigm as an envelope for economic and business theories of MNE activity" (PDF). Retrieved 2011-10-12. Check date values in:
- Gray, H. Peter (2003). "Extending the Eclectic Paradigm in International Business: Essays in Honor of John Dunning"; Edward Elgar Publishing
- "Kapitel 2.2 Eklektische Theorie" (PDF). Paper (in German). Verlag Dr. Kovac. 2009-03-09. Retrieved 2009-03-09.
- Stopford, John M.; Susan Strange; John S. Henley (1991). Rival states, rival firms. Cambridge University Press. p. 76. ISBN 0-521-42386-4.