Dunning’s Eclectic Paradigm Essay

Dunning’s Eclectic Paradigm Professor John Dunning proposed the eclectic paradigm as a framework for determining the extent and pattern of the value-chain operations that companies own abroad. Dunning draws from various theoretical perspectives, including the comparative advantage and the factor proportions, monopolistic advantage, and internalization advantage theories. Let’s use a real firm to illustrate the eclectic paradigm. The Aluminum Corporation of America (Alcoa) has over 130,000 employees in roughly 43 countries. The company’s integrated operations include bauxite mining and aluminum refining. Its products include primary aluminum (which it refines from bauxite), automotive components, and sheet aluminum for beverage cans and Reynolds Wrap ®. The eclectic paradigm specifies three conditions that determine whether or not a company will internationalize via FDI: ownership-specific advantages, location-specific advantages, and internalization advantages. To successfully enter and conduct business in a foreign market, the MNE must possess ownership-specific advantages (unique to the firm) relative to other firms already doing business in the market. These consist of the knowledge, skills, capabilities, processes, relationships, or physical assets held by the firm that allow it to compete effectively in the global marketplace. They amount to the firm’s competitive advantages. To ensure international success, the advantages must be substantial enough to offset the costs that the firm incurs in establishing and operating foreign operations. They also must be specific to the MNE that possesses them and not readily transferable to other firms. Examples of ownership-specific advantages include proprietary technology, managerial skills, trademarks or brand names, economies of scale, and access to substantial financial resources. The more valuable the firm’s ownership-specific advantages, the more likely it is to inter- nationalize via FDI. One of Alcoa’s most important ownership- specific advantages is the proprietary technology that it has acquired from R&D activities. Over time, Alcoa has also acquired special managerial and marketing skills in the production and marketing of refined aluminum. The firm has a well-known brand name in the aluminum industry, which helps increase sales. Because it is a large firm, Alcoa also profits from economies of scale and the ability to finance expensive projects. These advantages have allowed Alcoa to  maximize the performance of its international operations. Location-specific advantages refer to the comparative advantages that exist in individual foreign countries. Each country possesses a unique set of advantages from which companies can derive specific benefits. Examples include natural resources, skilled labor, low-cost labor, and inexpensive capital. Sophisticated managers recognize and seek to benefit from the host country advantages. Aloca- tion-specific advantage must be present for FDI to succeed. It must be profitable to the firm to locate abroad, that is, to utilize its ownership-specific advantages in conjunction with at least some location-specific advantages in the target country. Otherwise, the firm would use exporting to enter foreign markets.17 In terms of location-specific advantages, Alcoa located refineries in Brazil because of that country’s huge deposits of bauxite, a mineral found in relatively few other locations worldwide. The Amazon and other major rivers in Brazil generate huge amounts of hydroelectric power, a critical ingredient in electricity-intensive aluminum refining. Alcoa also benefits in Brazil from low-cost, relatively well-educated laborers, who work in the firm’s refineries. Internalization advantages are the advantages that the firm derives from internalizing foreign-based manufacturing, distribution, or other stages in its value chain. When profitable, the firm will transfer its ownership-specific advantages across national borders within its own organization, rather than dissipating them to independent, foreign entities. The FDI decision depends on which is the best option—internalization versus utilizing external partners—whether they are licensees, distributors, or suppliers. Internalization advantages include: the ability to control how the firm’s products are produced or marketed, the ability to control dissemination of the firm’s proprietary knowledge, and the ability to reduce buyer uncertainty about the value of products the firm offers. 18 Alcoa has internalized many of its operations instead of having them handled by outside independent suppliers for five reasons. First, Alcoa management wants to minimize dissemination of knowledge about its aluminum refining operations— knowledge the firm acquired at great expense. Second, compared to using outside suppliers, internalization provides the best net return to Alcoa, allowing it to minimize the costs of operations. Third, Alcoa needs to control sales of its aluminum products to avoid depressing world aluminum  prices by supplying too much aluminum into world markets. Fourth, Alcoa wants to be able to apply a differential pricing strategy, charging different prices to different customers. The firm could not differentiate its prices very effectively without the control over the distribution of its final products that internalization provides. Finally, aluminum refining is a complex business and Alcoa wants to control it to maintain the quality of its products.