International Marketing

Lecture week 2Theories of internationalisation

Agenda

• Comparative and competitive advantage• Theories of international trade

Comparative advantage

• Country specific advantage• Superior feature of countries that provide it with unique

benefits in global competition– Natural endowments– Deliberate national policies– Acquired resources such as labour, climate, arable land, or

petroleum reserves as in the case of gulf countries– Other types of comparative advantage evolves over time such as

entrepreneurial orientation, venture capital and innovative capacity• Over time focus of cross border business shifted from

countries to firm

Competitive advantage

• Firm specific advantage• Distinctive assets/competencies of a firm;• Typically derived from cost, size or

innovation strengths, that are difficult for competitors to compete

Theories of internationalisation

National level Firm level

Why do nations trade? (classical theories)• mercantilism• absolute advantage principle• comparative advantage principle• factor proportion theory• product cycle theory

Why and how do firms internationalize? (firm internationalization)• internationalization process of firm• born globals

How can nation enhance their competitive advantage? ( contemporary theories)• competitive advantage of nations• porter’s diamond• national industry policy• new trade theory

How can internationalizing firms gain and sustain competitive advantage? FDI based• monopolistic advantage theory• internalization theory• dunning’s eclectic theoryNon FDI base• international collaboration venture• networks and relational assets

The mercantilist view (1500’s)

• Gold and silver most important resources, so collect as much as possible

• In simple terms, exports are good and imports are bad• Achieved positive Balance of Payments(maximizing export and

minimizing import)• Neo mercantilism: even today running a trade surplus is

beneficial• Mercantilism tends to harm the interest of the firm that import

raw materials and parts to manufacture finished products• Also harms the interest of consumers: reduces the choice and

increases the price• By contrast of mercantilism, free trade is preferred.

Absolute advantage

• Adam smith attacked mercantilism by suggesting that nations benefit mostly from free trade

• By minimizing import: reducing the wealth of nation• Relative to others, each country is efficient in production

of some products, while less efficient in production of others

• It states that a country benefit by producing only those products in which it has an absolute advantage or can use fewer resources to produce, than another country

• Country gain by specializing on these products, exporting them and then importing the products where it doesn’t have an absolute advantage

Absolute advantage- example

• France and Germany engage in trading• Assumption that the labour is the only factor of production• France:

– absolute advantage on production of cloth– Average worker takes 30 days to produce ton of cloth and 40 days to produce ton of

wheat

• Germany: – absolute advantage on wheat– Average worker takes 100 days to produce ton of cloth and 20 days to produce ton of

wheat

• If both were to specialize, France would employ more of its resources to produce cloth and Germany could employ more of its resources to produce wheat

• France can import 1 ton of wheat there by paying only 30 labour days. Had they produced themselves they would have used 40 labour days.

One ton of

Cloth Wheat

France 30 40

Germany 100 20

Comparative advantage• Political economist David Riccardo explained why

it is beneficial for two countries to trade, even though one of them have absolute advantage on production of all products

• What matter is not the absolute cost of production but rather how easily the two countries can produce the products

• It states that it can be beneficial for two countries to trade without barriers as long as one is more efficient at producing goods or services needed by other

Comparative advantage- example• Germany has absolute advantage on production of

both cloth and wheat• However Germany is efficient at producing cloth

than wheat: – it can produce three time as much cloth as France

(30/10) but – only two times as much wheat (40/20)

• Thus Germany should use all its resources in production of cloth and import all the wheat it need from France

• Each country benefit by specializing in the product in which it has comparative/relative advantage and obtaining the other through trade

• By doing so country can each produce and consume relatively more of products that they desire

One ton of

Cloth Wheat

France 30 40

Germany

10 20

Comparative advantage- continued• Another way to understand comparative

advantage is to consider opportunity cost• If Germany produces 1 ton of wheat it forgoes 2

ton (20/10) of cloth• If France produces 1 ton of wheat it forgoes only

1.33 ton (40/30) of cloth• Thus France should specialize in wheat• Similarly if France produces 1 ton of cloth, it

forgoes ¾ ton of wheat, but if Germany produces 1 ton of cloth they forgo only ½ ton of wheat

• Thus Germany should specialize in cloth• Opportunity cost of producing wheat in France is

lower and opportunity cost of producing cloth is lower in Germany

One ton of

Cloth Wheat

France 30 40

Germany

10 20

Limitations of early trade theory• The cost of international transportation• Government restriction such as tariff• Large scale production in certain industries

results in economies of scale, lower prices and therefore offset weak national comparative advantage

• The public sector can target and invest in certain industries, build infrastructure, or provide subsidies, all of which serve to boost firms competitive advantages

Factor proportion/endowments theory

• 1920’s, two Swedish economist, Eli Heckscher and his student Bertil Ohlin

• This view rests on two premises– 1st: product differs in the types and quantities of factors

that are required for their production– 2nd: countries differ in the type and quantity of production

factors that they possesses• Therefore according to this theory, – each country should export products that intensively use

relatively abundant factors of production– Import goods that intensively use relatively scarce factors

of production

Factor proportion/endowments theory

• For example – China: ample labour supply; emphasizes labour

intensive products such as textiles, utensils– USA: much capital; capital intensive products such as

pharmaceuticals• This theory differs from earlier trade theory by– Emphasizing the importance of each nations factor of

production– Not just efficiency but quantity of factors of

production held by countries also determine international trade pattern

Factor proportion/endowments theory

• This theory explained international trade pattern but it doesn’t account for all trade phenomena

• Leontief Paradox– US has more capital but analysis shows that US

exports more labour intensive and imports capital intensive as well.

International product cycle theory

• 1966, Harvard professor, Raymond Vernon• International trade is based on the evolutionary process that occurs in the

development and diffusion of products around the world• Technical innovation from Advanced countries that possesses abundant

capital and R&D capabilities• Three stage of products: introduction, growth and maturity• At introduction, new product produced at home and enjoys a temporary

monopoly: later mass production and seek to export to foreign markets• Standardization of manufacturing; foreign competitors; no more

monopoly; less profit• Competitor may enjoy the competitive advantage in producing the product;

by now the innovating country may be a net importer of the product• Thus a product goes through a life cycle, comparative advantage in its

production tends to shift from country to country.• For example TV sets

Contemporary theories

• Fostered a new types of competition• A race among nation to reposition

themselves as a attractive places to invest and do business

Competitive advantage of nations

• 1990, Harvard business professor, Michael Porter

• Competitive advantage of the nations depends on the collective competitive advantage of the nations firms

• The competitive advantage held by the nation tend to drive the development of new firms and industries with these same competitive advantage– For e.g. Japan; competent in high tech industries;

over time the development of new firms in this fields

Competitive advantage of nations

• An individual firms has competitive advantage when it possesses one or more sources of distinctive competence relative to others, allowing to perform better than others– For e.g. low cost operation of Tesco and Wall Mart

• At both firm and international level, competitive advantage grows out from innovation– Innovation eventually promotes productivity: more

productive the firm is, the more efficiently it uses resources

– The more effective a firm in a nation are, the more efficiently the nation uses its resources

Michael porters Diamond model• Competitive advantage at both the

company and national levels originates from the presence and quality in the country of the four major elements

• Firm strategy structure and rivalry: – nature of domestic rivalry; for example

design intensive industries in Italy

• Factor condition:– Every nation has relative abundance of

certain factor endowments that determine the nature of its national competitive advantage;

– For e.g. Germany abundance of workers with strong engineering skills, competitive advantage in global engineering and design industry

Michael porters Diamond model• Demand condition:

– Nature of home market demand for specific products and services;

– For e.g. Japan, hot weather, demanding customers, this condition led to leading producer and exporter of AC

• Related and supporting industries:– Presence of clusters of suppliers,

competitors and complementary firms that excels in particular industries;

– For e.g. silicon valley in California, one of the best place to launch a computer software.

National industry policy

• Competitive advantages does not derive entirely from the store of natural resources that each country holds

• Rather, as Porter emphasized, countries can successfully create new advantages

• Porters diamond: any country regardless of its initial circumstances can attain economic prosperity by systematically cultivating new and superior factor endowments– Nation can develop these endowments through proactive industrial policy

• Development of high value adding industries that generate substantial wealth in terms of corporate profit, worker wages and tax revenues– For e.g. Dubai: national industry policy to develop ICT sector

• Industries should be favourable to the business enterprises such as – tax incentive, low interest rate, development of good educational system,

strong national infrastructure, creation of strong legal and regulatory system.

New trade theory

• 1970, economists Paul Krugman• Classical theories failed to anticipate/explain some international trade

patterns– For e.g. trade was growing fastest between industrial countries that held similar

factors of production• This theory argues that increasing returns to scale, especially economies of

scale, are an important factor in some industries for superior international performance– For e.g. commercial aircraft has very high fixed cost; necessitate high volume sales

to achieve profitability• Specialization on the production of such goods; productivity increases;

lowers the cost; providing significant benefit to local economy• National market relatively small; to achieve economies of scale they can

engage in exporting• Thus trade is beneficial even for countries that produce only a limited

variety of goods

Why and how firms internationalize

• Earlier theories of international trade focused on why and how cross national business occurs among nations

• Beginning on 1960’s, however. Scholars developed the theories about the managerial and organisational aspects of firm internationalization.

Internationalization process of the firm• Developed in 1970’s to describe how firms expand

abroad• Gradual process that takes place in incremental stages

over a long period of time• Typically firm begin with exporting and progress to FDI • It all starts with innovation• Slow and incremental because of – uncertainty and uneasiness that managers experience, – mainly due to inadequate information about foreign markets

and – lack of experience with cross border transactions

Internationalization process of the firm

Domestic focus

Pre export stages

Experimental involvement

Active involvement

Committed involvement

Born globals and international entrepreneurship

• Questions the gradual and slow nature of internationalization

• Past couple of decades, many firms have internationalized early in their evolution

• Reasons:– Growing intensity of international competitor– Advances in communication and transportation

technologies; reduces the cost of venturing abroad

– Integration of world economies

How firms gain and sustain international competitive advantage

• FDI based theories• FDI stock refers to the total value of assets that MNE’s

own abroad via their investment activities• MNE’s invest millions abroad every year to establish and

expand factories and other facilities• Total FDI stock now constitutes some 20% of global GDP• Historically most of the worlds FDI was invested both by

and in western Europe, japan and US• But recently MNE, have begun to invest in emerging

markets

Monopolistic advantage theory• Key assumption, to become successful,

MNE must possesses monopolistic advantages over local firms in foreign markets– The firms controls one or more resources or

offers relatively unique products and services that provide it a degree of monopoly power relative to foreign market and competition

– The firm must keep these advantages to itself by internalizing them

Internalization theory• An explanation of the process by which – Firms acquire and retain one or more value chain

activities inside the firm, – Minimizing the disadvantages of dealing with external

partners and – Allowing for greater control over foreign operations

• Benefits that MNE’s derive from FDI based entry• For e.g. – P&G in Japan; considered exporting and FDI; – Trade barriers and risk of loosing control if exported so

P&G chose to enter Japan via FDI

Dunning Eclectic Paradigm• Framework that determines the extent and pattern of the value-chain

operations that companies own abroad• Three conditions that determine whether or not the company will

internationalize via FDI• Ownership specific advantage

– Firm should have unique knowledge, skills, capabilities, processes, relationships or physical assets

– These advantages should not be easily transferable to other firms– Managerial skills, technology, trademark, brand name, economies of scale

• Location specific advantage– Comparative advantage that exist in individual foreign country– Natural resources, skilled labour, low cost labour, inexpensive capital

• Internalization advantage– If internalize, firm can transfer owner specific knowledge into its foreign

subsidiaries– Ability to control how the firms product are produced or marketed, ability to

control the dissemination of the firms proprietary knowledge

Non FDI based explanations

International collaborative ventures

• Horizontal collaboration: – occurs at the same level of value chain

• Vertical collaboration: – occurs between partners at different level of

the value chain• Collaborative ventures classified into two

major types– Joint venture– Strategic alliance

Network and relational assets• Firms economically beneficial long term

relationship with other business entities such as manufacturers, distributors, suppliers, retailers, consultants, banks, transportation suppliers, governments and any other organisation that provide needed capabilities

• Continued interaction among the partners helps to build stable relationship based on cooperation

• Network linkages assists firms to enter foreign market, develop new market and develop new product