Dunning’s Eclectic Paradigm

Dunning correctly notes that internalization alone is not sufficient to explain the (productive) activities of MNEs outside their own borders, or the production of foreign-owned firms in the MNE’s home country.²⁰ The author (Teece, 1985) did recognize that MNEs will consider location factors in their decisions with respect to DFI, that is, DFI decisions are driven not just by “governance” or transaction costs, but by “production cost” considerations too. Accordingly, an MNE may set up a foreign subsidiary to access lower-cost inputs. Cost factors could thus drive DFI decisions. This is hardly a revolutionary idea, but it is not explicitly made in most versions of the internalization theory of the MNE.

The most comprehensive effort to date to bring various explana- tory factors together remains that of John Dunning. As Dunning puts it, his eclectic paradigm “is not a theory of the MNE per se, but rather of the activities of enterprises engaging in cross border and value-adding activities” (1993: 76). It accepts that the propensity of firms to own foreign-income-generating assets may be influenced by financial and/or exchange rate variables (p. 76). Dunning presents his framework as being descriptive and not normative. The tenets of Dunning’s eclectic paradigm are that three classes of factors²¹ jointly determine whether a firm is likely to engage in production activities abroad. These are now examined.

1. Ownership (asset) advantages vis-à-vis other firms in partic- ular markets This class of factors ties rather closely to the resources/dynamic capabilities theory developed in the field of strategic management.²² Dunning makes reference to intangible assets and “the resource (asset) structure of the firm” (p. 81) and to product innovations, production management, organizational and marketing systems, innovation capacity, organization of work, non-codifiable knowledge. He also references economies of scale and scope, favored access to resources, ability to include productive interfirm Practically all of Dunning’s examples align with the now extensive treatment of resources/dynamic capabil- ities literature applied in Section 6 below. What’s missing in Dun- ning’s treatment and ought to be added is a consistent recognition that (i) it is only the nonimitable elements of this capacity that can anchor competitive advantage; (ii) that there ought to be mech- anisms to orchestrate, sustain, and renew such resources/assets; (iii) dynamic capabilities are resident in the firm’s ability to create and refine its business models, routines, and procedures, while using investment protocols which ensure quality decisions free of bias. Amit and Schoemaker (1993) lay out a litany of decision- making biases; the ability of top management to avoid biases, make astute assessments about the future evolution of markets and technologies, and actually shape market outcomes can also be a measure of their dynamic capabilities.
2. Internalization advantages Assuming condition (1) is satisfied, the question then arises as to how best to exploit ownership advan- In particular, ought the assets to be commercialized offshore through direct investment, or through arm’s-length contracts with nonaffiliated enterprises? To the extent that the enterprise sees advantage in exploiting these assets through internalization, it will lead to increased scope for its international activities. Internalization advantages have several dimensions. One is the contractual efficiency side, adequately explored by a long list of authors including Buckley and Casson, Rugman, Teece, and Williamson. However, internalization cannot be considered inde- pendent of ownership/resource issues, and few have provided frameworks for doing so. One exception is the author (Teece, 1986a, 1986b) where a decision framework is provided which could be applied in a global context.²³
3. Location-specific-factors Assuming conditions (1) and (2) are satisfied, one must then take into account the spatial distribution of natural and created resource endowments. The condition of local infrastructure and the quality and cost of local inputs are what Dunning appears to have in mind. Clearly, in a world in which there are significant differences in factor costs, procurement in low- wage countries will incentivize MNEs to obtain supply offshore; but if competition and the nature of the procured product is such that small numbers bargaining conundrums are unlikely, then supply is likely to be outsourced, that is, the transactions will not be internalized.

The generalized predictions of Dunning’s paradigm are that the greater the relative ownership advantages of an enterprise, the greater the incentive to internalize, the more an enterprise finds it beneficial to exploit its ownership advantages from a foreign location, then the more likely it is to engage in outbound DFI. Conversely, a country is more likely to attract investors by foreign MNEs when the reverse considerations apply (p. 80). In short, this framework enables one to disaggregate the location decision and mode (governance) decisions.

This is analytically useful, and/or close to the approach used in Teece (1986b). The framework suggests that firms with specific assets that can be employed abroad will do so and profit. The para- digm would suggest that it is not only the possession of technology that gives the firm an edge overseas; it’s the ability to commercialize it internally.

The problem with the paradigm is that the three factors are presented as exogenous when the very transfer of technology and capability renders them endogenous, that is, it is frequently necessary for the MNE to transfer technology abroad in order to effectively access lower-cost inputs. Clearly, there is a need for a “dynamic” theory of the MNE.

Source: Teece David J. (2009), Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth, Oxford University Press; 1st edition.