Hymer and the Emergence of the Internalization School

As noted above, Hymer’s basic argument was that an MNE needed some special advantage to offset the hypothesized higher costs14 (relative to indigenous firms) of operating abroad. Given the indus- trial organization theories advanced at the time (in the Mason- Bain15 tradition) the visceral answer he provided was that special advantages led to market power; and the exercise of monopoly or market power could suffice to offset the higher costs of operat- ing abroad. Unfortunately, Hymer didn’t probe hard enough for the nature, sources, and extent of any such market power. If it stemmed from innovation, or from superior skill, foresight, and knowledge, then it ought to be viewed differently from market power stemming from exclusionary behavior (Teece and Coleman, 1998).

Interestingly, Hymer appears to have been aware of the (Chicago school) work on transaction costs. I refer of course to the Coasian view that the firm substitutes (internalizes) the market where transactions can be organized more efficiently inside the firm rather than in a market.16 Indeed, in his thesis at p. 48 he notes that “the firm internalizes or supersedes the market—decentralized decision-making (i.e. a free market) is defective when there are certain types of interactions between firms; that is each firm’s behavior noticeably affects the other firms”. The subsequent dis- covery of his French-language paper “The Large Multinational Corporation” (1968) demonstrates conclusively that Hymer was familiar with the Coasian arguments, and as Casson notes, “he clearly anticipates by several years the work of McManus (1972), Buckley and Casson (1976) and others”.

While he may have been aware of Coase’s work, Hymer appar- ently didn’t fully appreciate the efficiency implications of Coase’s theories and their relevance to MNE. He was not able to properly connect and fully explore the fact that if MNEs possessed spe- cial advantages, they might find it advantageous to deploy their advantages via internal transfer rather than through contractual mechanisms.17

Hymer instead embraced the view that the MNE, if it has a special advantage, must somehow restrict competition, noting that “Direct investment in a foreign processing industry protects a firm against competition” (1976: 21). While he recognizes that the entry of competitors from abroad may shake up the industry, he con- cludes that “after a while it is more than likely that a certain stabil- ity will be achieved and that the industry will adopt some formula for market sharing” (p. 27). This view is entirely speculative, and no historical evidence was cited to support it.

Interestingly, Hymer does observe with prescience that “at the present time, the main formulae used amongst world scale firms are being tested because of reductions in trade barriers . . . ” (p. 27). Indeed, his article is very insightful in many ways. One statement that I was previously unaware of foreshadowed my own work:

What we are most interested in, however, are the economic motives for which a firm organizes on a multinational basis. First, the advantage the firm owns may be so complex and defined that it is extremely difficult and sometimes impossible to sell it. For instance, if the foreign firm needs occasional assistance in the field of management and technology in order to face various problems as they arise, it may prove to be impossible to specify in advance the nature of the help it expects from the American firm and the remuneration it will get for each intervention. On the con- trary, it will probably be more efficient to make a long run cooperation agreement based on sharing, with decisions being taken on an administra- tive basis rather than negotiated each time. The strength of a multinational enterprise stems from the fact that it can trade knowledge internally more quickly than two firms which have to negotiate conditions each time.

Pitelis correctly notes that Hymer’s emphasis on the role of market power in explaining the international scope of the business enter- prise was “a matter of choice, not ignorance” (p. 13). But it was the wrong choice, in terms of the subsequent development of the theory of DFI, in terms of intellectual developments in the theory of the firm,18 and in terms of development in the field of strategic management.

It does indeed appear that Hymer flirted with the internaliza- tion approach to the MNE; but he did not embrace it. McManus (1972) and Buckley and Casson (1976) did so. As Buckley and Casson succinctly put it “when markets in intermediate products are imperfect, there is an incentive to bypass them by creating internal markets. This involves bringing under common owner- ship and control the activities which are linked to the market. Internalization of markets across national boundaries generates MNEs” (p. 33). Buckley and Casson highlight the significance of industry-specific factors. They recognized knowledge markets as a domain in which “the incentive to internalize is particularly strong” (p. 39).

The Buckley–Casson treatment of know-how focused on mar- ket power/pricing issues, less so on efficiency issues. They claim that “knowledge is a ‘natural monopoly’—and is best exploited through discriminatory pricing of some kind. Licensing systems cannot usually be designed to satisfy the discriminatory criteria, so that internalization is indeed appropriate. They also stressed monopoly/monopsony issues with respect to negotiating and noted that “the bargaining conflict may require some form of joint ownership to resolve it” (p. 39). Their suggestion that knowl- edge confers natural monopoly is perhaps too strong. Only when essential to production (i.e. there are no substitute technologies) and protected by patents (or other factors which make imitation difficult) is know-how likely to be a troublesome source of market power. But these circumstances are rare. My own work on the MNE, coming out of a study on technology transfer, emphasized not so much market control issues with respect to know-how, but the benefits associated with leveraging unique assets in new markets:

If the multinational firm possesses a distinct competitive advantage in the form of unique assets, then the exploitation of this advantage will typically enhance consumer welfare. The principal considerations which arise with respect to multinational rather than indigenous enterprises relate merely to the distribution of quasi rents associated with the employment of the firm’s unique assets. (Teece, 1981a: 12)


an important attribute of the multinational firm is that it is an organiza- tional mode capable of internally transferring knowhow among its various business units in a relatively efficient and effective fashion. Given the opportunities that apparently exist for international trade in knowhow, and given the transactional difficulties associated with relying on markets, one should expect to find multinational enterprises (MNEs) frequently selecting internal channels for technology transfer. (1981b: 87)

In a later paper (Teece, 1986b) and referencing Dunning (1981) I summarized the situation as follows:

A firm is likely to become multinational if (a) it has certain special assets which give it a competitive advantage over indigenous firms (the strategic advantage factor), (b) these assets are more economically utilized in pro- duction facilities in parts of the world beyond the firm’s domestic markets (the location factor) and (c) the best way to obtain full value from employ- ing the asset in foreign markets is to transfer the asset internally within the firm to another affiliated business unit (the transaction cost factor). All three must be present to explain foreign direct investment. (p. 27)

The work of the internalization school was a significant advance over Hymer. Hymer not only failed to explore internalization issues; he also failed to specify very well the sources of the MNE’s special advantage. Buckley and Casson (1976), Teece (1981a, 1981b, 1985, 1986b), and others stressed the role of intangibles and other difficult-to-imitate assets.19

The internalization thesis has taken criticism from a number of scholars, most notably Kogut and Zander (1993). However, their critique is more apparent than real. They too appear to embrace the major point of the internalization thesis; namely, cer- tain know-how can be transferred more effectively, conveniently, and efficiently inside the firm than through an arm’s-length license arrangement. Kogut and Zander stress that the firm is a social community for the creation and sharing of know-how. Accord- ingly, their emphasis is on how well firms can transfer technology internally compared to their competitors, and they suggest that this vitiates market failure considerations (Kogut and Zander, 1993: 627). However, this would seem to be a false attack or a mis- understanding of transaction cost economics. If MNEs do indeed have valuable tacit and codified knowledge which is relevant to business opportunities in other jurisdictions, then they will wish to (and need to) transfer know-how in order to stay competitive. In this sense it is true that the decision to transfer know-how will be driven by competitive considerations. However, the choice of mode of technology transfer ought still to depend upon the relative effi- ciencies of market (i.e. licensing) versus internal transfer. Whether one calls this market failure analysis is a matter of indifference or choice of terms. And, as Williamson (1975) notes, “market failure” ought to be a relative term as no mode of organization (market or internal transfer) is perfectly efficient. It’s relative efficiency that matters. Indeed, Kogut and Zander can be thought of, perhaps, as being earlier proponents of the capabilities approach advanced below, inasmuch as they do emphasize the relative capabilities of firms as an explanation for their DFI activities.

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

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