4.Theories of International

4.Theories of International
Trade and Investment FM : FM : Anis Gunawan, MBA,MM,SP Copyright © 2014 Pearson Education Copyright © 2014 Pearson Education Inc.

International business 4. Theories of International
5. Functional Area excellence 4. Entering and operating in International Markets. 3.Strategy and opportunity assessment 4. Theories of International Trade and investment 2. The environment of International Business Foundation concepts of International business International Business: Strategy, Management, and the New Realities

Theories of International Trade and Investment
CA 1 Comp. Advantage 2 Copyright © 2014 Pearson Education

Mercantilism and Neomercantilism
Mercantilism: A belief popular in the 16th century that national prosperity results from maximizing exports and minimizing imports. Today, some argue for neomercantilism the idea that the nation should run a trade surplus. Supporters of neomercantilism include: Labor unions (who want to protect domestic jobs), Farmers (who want to keep crop prices high), and Some manufacturers (that rely on exports). But is neomercantilism best for all? The earliest explanations of international business emerged with the rise of European nation-states in the 1500s, when gold and silver were the most important sources of wealth, and nations sought to amass as much of these treasures, particularly gold, as possible. Nations received payment in gold for exports, so exports increased a nation’s gold stock, while imports reduced it because imports were paid with gold. Thus, exports were seen as good and imports as bad. Because the nation’s power and strength increases as its wealth increases, mercantilism argues that national prosperity results from a positive balance of trade achieved by maximizing exports and minimizing or even impeding imports. In essence, mercantilism explains why nations attempt to run a trade surplus—that is, to export more goods than they import. Even today many people believe that running a trade surplus is beneficial. They subscribe to a view known as neo-mercantilism. Labor unions (which seek to protect home-country jobs), farmers (who want to keep crop prices high), and certain manufacturers (those that rely heavily on exports) all tend to support neo-mercantilism. On the other hand, mercantilism tends to harm the interests of firms that import, especially those that import raw materials and parts used in the manufacture of finished products. Mercantilism also harms the interests of consumers because restricting imports reduces the choice of products they can buy. Product shortages that result from import restrictions may lead to higher prices—that is, inflation. When taken to an extreme, mercantilism may invite “beggar thy neighbor” policies, promoting the benefits of one country at the expense of others. China Copyright © 2014 Pearson Education

Copyright © 2014 Pearson Education
Free Trade The absence of restrictions to the flow of goods and services among nations. Free trade is usually best because it leads to: More and better choices for consumers and firms Lower prices of goods for consumers and firms Higher profits and better worker wages (because imported input goods are usually cheaper) Higher living standards for consumers (because their costs are lower). Greater prosperity in poor countries. Free trade is generally superior and should produce the following outcomes: ■ Consumers and firms can more readily buy the products they want. ■ Imported products tend to be cheaper than domestically produced products (because access to world-scale supplies forces prices down, mainly from increased competition, or because the goods are produced in lower-cost countries). ■ Lower-cost imports help reduce the expenses of firms, thereby raising their profits (which may be passed on to workers in the form of higher wages). ■ Lower-cost imports help reduce the expenses of consumers, thereby increasing their living standards. ■ Unrestricted international trade generally increases the overall prosperity of poor countries. Free Copyright © 2014 Pearson Education

Comparative Advantage
The foundation concept of international trade that answers the question of how nations can achieve and sustain economic success and prosperity. It refers to the superior features of a country that provide it with unique benefits in global competition. Comparative advantages are derived either from natural endowments or from deliberate national policies. Also known as country-specific advantage, comparative advantage includes inherited resources, such as labor, climate, arable land, and petroleum reserves, such as those enjoyed by the Gulf nations. Other types of comparative advantages are acquired over time, such as entrepreneurial orientation, availability of venture capital, and innovative capacity. Copyright © 2014 Pearson Education

Examples of National Comparative Advantage
France has a climate and soil superior for producing wine. Saudi Arabia has a natural abundance of oil for the production of petroleum products. Over time, Japan has acquired a superior base of knowledge and experience for producing cars. Over time, India has acquired a superior base of IT workers for producing computer software. What are the comparative advantages in your country? Copyright © 2014 Pearson Education Indonesia

Competitive Advantage
A foundation concept that explains how individual firms gain and maintain distinctive competencies, relative to competitors, that lead to superior performance. It refers to the distinctive assets, competencies, and capabilities that are developed or acquired by the firm. The collective competitive advantages held by the firms in a nation are the basis for the competitive advantages of the nation at large. Competitive advantage describes organizational assets and competencies that are difficult for competitors to imitate and thus help firms enter and succeed in foreign markets. These competencies take various forms, such as specific knowledge, capabilities, innovativeness, superior strategies, or close relationships with suppliers. Competitive advantage is also known as firm-specific advantage. In recent years business executives and academics such as Michael Porter have used competitive advantage to refer to the advantages possessed by both nations and individual firms in international trade and investment. To be consistent with the recent literature, we adopt this convention as well. Copyright © 2014 Pearson Education

Examples of Firm Competitive Advantage
Dell Dell’s prowess in the management of its global supply chain Samsung’s technological leadership in flat-panel televisions Cadbury’s capabilities in international marketing and distribution Herman Miller’s design strengths in office furniture (e.g., Aeron chairs) Copyright © 2014 Pearson Education

Absolute Advantage Principle
A country should produce only those products in which it has absolute advantage or can produce using fewer resources than another country In An Inquiry into the Nature and Causes of the Wealth of Nations, a landmark book published in 1776, Scottish political economist Adam Smith attacked the mercantilist view by suggesting that nations benefit most from free trade. Smith argued that mercantilism robs individuals of the ability to trade freely and to benefit from voluntary exchanges. By trying to minimize imports, a country wastes much of its national resources in the production of goods it is not suited to produce efficiently. The inefficiencies of mercantilism end up reducing the wealth of the nation as a whole while enriching a limited number of individuals and interest groups. Relative to others, each country is more efficient in the production of some products and less efficient in the production of other products. Smith’s absolute advantage principle states that a country benefits by producing primarily those products in which it has an absolute advantage or that it can produce using fewer resources than another country. Each country thus increases its welfare by specializing in the production of certain products, exporting them, and importing others. This approach allows the nation to consume more than it otherwise could, generally at lower cost. The exhibit illustrates how the absolute advantage principle works in practice. Consider two nations, France and Germany, engaged in a trading relationship. France has an absolute advantage in the production of cloth, and Germany has an absolute advantage in the production of wheat. Assume labor is the only factor of production used in making both goods. (Firms employ factors of production—for example, labor, capital, entrepreneurship, and technology—to generate goods and services.) In the exhibit, it takes an average worker in France 30 days to produce one ton of cloth and 40 days to produce one ton of wheat. It takes an average worker in Germany 100 days to produce one ton of cloth and 20 days to produce one ton of wheat. France has an absolute advantage in the production of cloth, since it takes only 30 days of labor to produce one ton compared to 100 days for Germany. Germany has an absolute advantage in the production of wheat, since it takes only 20 days to produce one ton compared to 40 days for France. If both France and Germany were to specialize, exchanging cloth and wheat at a ratio of one-to-one, France could employ more of its resources to produce cloth ,and Germany could employ more of its resources to produce wheat. According to the exhibit, France can import one ton of wheat in exchange for one ton of cloth, thereby “paying” only 30 labor-days for one ton of wheat. If France had produced the wheat itself, it would have used 40 labor-days, so it gains 10 labor-days from the trade. In a similar way, Germany gains from trade with France. (Labor Cost in Days of Production for One Ton) Copyright © 2014 Pearson Education

Comparative Advantage Principle
While Germany can make both items cheaper than France, it is still beneficial for Germany to trade with France. The key is the ratio of production costs. In the exhibit, Germany is comparatively more efficient at producing cloth than wheat: it can produce three times as much cloth as France (30/10), but only two times as much wheat (40/20). Germany should specialize in producing cloth and import all the wheat it needs from France. France should specialize in producing wheat and import all its cloth from Germany. Each country benefits by specializing in the product in which it has a comparative advantage and importing the other product. While a nation might conceivably have a sufficient variety of production factors to provide every kind of product and service, it cannot produce each with equal facility. The United States could produce all the car batteries its citizens need, but only at high cost. This occurs because batteries require much labor to produce, and wages in the United States are relatively high. By contrast, producing car batteries is a reasonable activity in China, where wages are lower than in the United States. It is advantageous, therefore, for the United States to specialize in a product such as patented medications, the production of which more efficiently employs the country’s abundant supply of knowledge workers and technology in the pharmaceutical industry. The United States is better off exporting medications and importing car batteries from China. The comparative advantage view is optimistic because it implies that a nation need not be the first-, second-, or even third-best producer of particular products to benefit from international trade. Indeed, it is generally advantageous for all countries to participate in international trade. Initially, adherents of the comparative advantage principle focused on the importance of inherited or natural resource advantages, such as fertile land, abundant minerals, and favorable climate. Thus, because South Africa has extensive mineral deposits, it produces and exports diamonds. Because Argentina has much agricultural land and a suitable climate, it grows and exports wheat. Because Russia has vast forests, it makes and exports wood products. Over time, however, it has become clear that countries can also create or acquire comparative advantages. Copyright © 2014 Pearson Education

Comparative Advantage Principle (cont’d)
The principle applies to all goods. It reveals how countries use scarce resources more efficiently. Example Arguably, no country is better than Japan at making cars and cell phones. But because Japan is especially good at making cars, it concentrates its resources on making them. Other countries, such as China and Finland, focus on making cell phones. In this way, Japan makes maximal use of its resources, and the world gets great cars. Honda Consider the case of Japan. In the years following World War II, Japan systematically acquired a collection of advantages that benefited its consumer electronics industry. The investments made by Japan’s government, banks, and manufacturing firms paid off enormously. Companies like Hitachi, Panasonic, and Sony invested massive resources to acquire the knowledge and skills needed to become the world leader in consumer electronics. Today, Japan accounts for approximately half of the industry’s total world production, including digital cameras, flat panel TVs, and personal computers. More recently, South Korea made similar investments, giving rise to leading-edge firms like LG and Samsung. Copyright © 2014 Pearson Education

International Product Life Cycle Theory
Each product and its associated manufacturing technologies go through three stages of evolution: introduction, maturity, and standardization. In the introduction stage, the inventor country enjoys a monopoly both in manufacturing and exports. Example: The television set. In a 1966 article, Harvard Professor Raymond Vernon sought to explain international trade based on the evolutionary process that occurs in the development and diffusion of products to markets around the world. In his International Product Life Cycle (IPLC) Theory, Vernon observed that each product and its manufacturing technologies go through three stages of evolution: introduction, maturity, and standardization In the introduction stage, a new product typically originates in an advanced economy, such as the United States. Such countries possess abundant capital and R&D capabilities, providing key advantages in the development of new goods. Advanced economies also have abundant, high-income consumers who are willing to try new products, which are often expensive. During the introduction stage, the new product is produced in the home country, which enjoys a temporary monopoly. Philip Copyright © 2014 Pearson Education

International Product life Cycle Theory (cont’d)
3.Each product and its associated manufacturing technologies go through three stages of evolution: introduction, maturity, and standardization. 4.In the maturity stage, the product’s manufacturing becomes relatively standardized; other countries start producing and exporting the product. As the product enters the maturity phase, the product’s inventors mass-produce it and seek to export it to other advanced economies. Gradually, however, the product’s manufacturing becomes more routine and foreign firms begin producing alternative versions, ending the inventor’s monopoly power. At this stage, as competition intensifies and export orders begin to come from lower-income countries, the inventor may earn only a narrow profit margin. Copyright © 2014 Pearson Education

International Product life Cycle Theory (cont’d)
5. Each product and its associated manufacturing technologies go through three stages of evolution: introduction, maturity, and standardization. 6. In the standardization stage, manufacturing ceases in the original innovator country, which then becomes a net importer of the product. Today under globali-zation, for many products, the cycle occurs quickly. In the standardization phase, knowledge about how to produce the product is widespread and manufacturing becomes straightforward. Early in the product’s evolution, production required specialized workers skilled in R&D and manufacturing. Once standardized, however, mass production is the dominant activity and can be accomplished using cheaper inputs and low-cost labor. Consequently, production shifts to low-income countries where competitors enjoy low-cost advantages and can economically serve export markets worldwide. Eventually, the country that invented the product becomes a net importer. It and other advanced economies become saturated with imports of the good from developing economies. In effect, exporting the product has caused its underlying technology to become widely known and standardized around the world. As an example, consider the evolution of television sets. The base technology was invented in the United States, and U.S. firms began producing TVs there in the 1940s. U.S. sales grew rapidly for many years. However, once TVs became a standardized product, production shifted to China, Mexico, and other countries that offer lower-cost production. Today the United States imports nearly all its TVs from such countries. The IPLC illustrates that national advantages are dynamic; they do not last forever. Firms worldwide are continuously creating new products, and others are constantly imitating them. The product cycle is continually beginning and ending. Vernon assumed the product diffusion process occurs slowly enough to generate temporary differences between countries in their access and use of new technologies. But this assumption is no longer valid today: The IPLC has become much shorter as new products diffuse much more quickly around the world. Buyers in emerging markets are particularly eager to adopt new technologies as soon as they become available. This trend explains the rapid spread of new consumer electronics such as digital assistants and cell phones around the world. Copyright © 2014 Pearson Education

New Trade Theory Argues that economies of scale are an important factor in some industries for superior international performance, even in the absence of superior comparative advantages. Some industries succeed best as their volume of production increases. Example The commercial aircraft industry has very high fixed costs that necessitate high-volume sales to achieve profitability. Beginning in the 1970s, economists led by Paul Krugman observed that trade was growing fastest among industrialized countries with similar factors of production. In some new industries, there appeared to be no clear comparative advantage. The solution to this puzzle became known as new trade theory. It argues that increasing returns to scale, especially economies of scale, are important for superior international performance in industries that succeed best as their production volume increases. For example, the commercial aircraft industry has high fixed costs that necessitate high-volume sales to achieve profitability. As a nation specializes in the production of such goods, productivity increases and unit costs fall, providing significant benefits to the local economy. However, many national markets are small, and the domestic producer may not achieve economies of scale because it cannot sell products in large volume. New trade theory implies that firms can solve this problem by exporting, thereby gaining access to the much larger global marketplace. Several industries achieve minimally profitable economies of scale by selling their output in multiple markets worldwide. The effect of increasing returns to scale allows the nation to specialize in a smaller number of industries in which it may not necessarily hold factor or comparative advantages. According to new trade theory, trade is thus beneficial even for countries that produce only a limited variety of products. Embaer Copyright © 2014 Pearson Education

Comparative vs. Competitive Advantage
Copyright © 2014 Pearson Education

Critical Role of Innovation in National Economic Success
Innovation is a key source of competitive advantage. The firm innovates in four major ways. It can develop: (1) A new product or improve an existing product (2) New ways of manufacturing (3) New ways of marketing (4) New ways of organizing company operations. Many innovative firms in a nation leads to national competitive advantage At both the firm and national levels, competitive advantage and technological advances grow out of innovation. Companies innovate in various ways: They develop new product designs, new production processes, new approaches to marketing, new ways of organizing or training, and so forth. Firms sustain innovation (and by extension, competitive advantage) by continually finding better products, services, and ways of doing things. For example, Australia’s Vix ERG ( is a world leader in fare collection equipment and software systems for the transit industry. The firm has installed systems in subways, bus networks, and other mass transit systems in major cities like Melbourne, Rome, San Francisco, Stockholm, and Singapore. It has won numerous awards for its innovative products, which have allowed the firm to internationalize quickly. Vix ERG’s investment in R&D has been significant, running as high as 23 percent of the firm’s revenue. Innovation results primarily from research and development. Worldwide, more scientists and engineers are engaged in R&D than ever before. Among the industries most dependent on technological innovation are biotechnology, information technology, new materials, pharmaceuticals, robotics, medical equipment, fiber optics, and various electronics-based industries. The management consultancy Booz & Company ( annually reports on MNEs that spend the most on R&D, the Global Innovation Most top European, Japanese, and U.S. firms spend half or more of their total R&D in countries other than where they are headquartered. They do this for several reasons. First, they can gain access to talent—gifted engineers and scientists located around the world in countries like China and India. Second, they can cut costs by hiring lower-paid engineers and scientists abroad to replace higher-paid personnel in the home country. Third, by relocating R&D abroad, the firms can get closer to key markets, where they gain insights on specific characteristics of target markets during the product development process. This explains why, in addition to low-cost emerging markets, Europe and the United States are popular sites for R&D by foreign companies, as firms seek to understand and create new products for the world’s most lucrative markets. The more innovative firms in a nation, the stronger the nation’s competitive advantage. Copyright © 2014 Pearson Education

Critical Role of Productivity in National Economic Success
Productivity is the value of the output produced by a unit of labor or capital. It is a key source of competitive advantage for firms. The greater the productivity of the firm, the more efficiently it uses its resources. The greater the aggregate productivity of the firms in a nation, the more efficiently the nation uses its resources. Aggregate productivity is a key determinant of the nation’s standard of living. Innovation also promotes productivity, the value of the output produced by a unit of labor or capital. The more productive a firm is, the more efficiently it uses its resources. The more productive the firms in a nation are, the more efficiently the nation uses its resources. At the national level, productivity is a key determinant of the nation’s long-run standard of living and a basic source of national per-capita income growth. Copyright © 2014 Pearson Education

Diamond Model Sources of National Competitive Advantage (cont’d)
1.Firm strategy, structure, and rivalry – The nature of domestic rivalry, and conditions that determine how a nation’s firms are created, organized, and managed. Example Italy has many top firms in design industries such as textiles, furniture, lighting, and fashion. Vigorous competitive rivalry puts these firms under constant pressure to innovate, which has propelled Italy to a leading position in design, worldwide. Firm strategy, structure, and rivalry refer to the nature of domestic rivalry and conditions in a nation that determine how firms are created, organized, and managed. The presence of strong competitors in a nation helps create and maintain national competitive advantage. Japan has the world’s most competitive consumer electronics industry, with major players like Nintendo, NEC, Sharp, and Sony producing semiconductors, computers, video games, and liquid crystal displays. Vigorous competitive rivalry puts these firms under continual pressure to innovate and improve. They compete not only for market share, but also for human talent, technical leadership, and superior product quality. Intense rivalry has pushed firms like Sony to a leading position in the industry worldwide and allowed Japan to emerge as the top country in consumer electronics. Italy fashion Copyright © 2014 Pearson Education

2.Demand conditions at home – the strengths and sophistication of customer demand. Example Japan is a densely populated, hot, and humid country with very demanding consumers. These conditions led Japan to become one of the leading producers of superior, compact air conditioners. Demand conditions refer to the nature of home-market demand for specific products and services. The strength and sophistication of buyer demand facilitates the development of competitive advantages in particular industries. The presence of highly demanding customers pressures firms to innovate faster and produce better products. For example, an affluent, aging population in the United States inspired the development of world-class health care companies such as Pfizer and Eli Lilly in pharmaceuticals and Boston Scientific and Medtronic in medical equipment. Copyright © 2014 Pearson Education

3.Factor conditions – Quality and quantity of labor, natural resources, capital, technology, know-how, entrepreneurship, and other factors of production. Example An abundance of cost-effective and well-educated workers give China a competitive advantage in the production of laptop computers. Factor conditions describe the nation’s position in factors of production, such as labor, natural resources, capital, technology, entrepreneurship, and know-how. Consistent with factor proportions theory, each nation has a relative abundance of certain factor endowments, a situation that helps determine the nature of its national competitive advantage. For example, Germany’s abundance of workers with strong engineering skills has propelled the country to commanding heights in the global engineering and design industry. China Copyright © 2014 Pearson Education

4.Related and supporting industries – the presence of suppliers, competitors, and complementary firms that excel within a given industry. Example The Silicon Valley in California is a great place to launch a computer software firm because it is home to thousands of knowledgeable firms and workers in the software industry. Related and supporting industries refer to the presence of clusters of suppliers, competitors, and complementary firms that excel in particular industries. The resulting business environment is highly supportive for the founding of particular types of firms. Operating within a mass of related and supporting industries provides advantages through information and knowledge synergies, economies of scale and scope, and access to appropriate or superior inputs. Copyright © 2014 Pearson Education

FDI Based Explanations: Internalization Theory
Explains how the MNE chooses to acquire and retain one or more value-chain activities inside itself. Such ‘internalization’ provides the MNE with greater control over its foreign operations. Internalization avoids the drawbacks of dealing with external partners, such as reduced quality control and the risk of losing proprietary assets to outsiders. When Procter & Gamble first entered Japan, management initially considered exporting and FDI. With exporting, P&G would have had to contract with an independent Japanese distributor to handle warehousing and marketing of its soap, diapers, and other products. However, because of trade barriers imposed by the Japanese government, the strong market power of local Japanese firms, and the risk of losing control over its proprietary knowledge, P&G chose instead to enter Japan via FDI. It established its own marketing subsidiary and, eventually, national headquarters in Tokyo. This arrangement provided various benefits P&G would not have received had it entered Japan by contracting with Japanese distributors it did not own. Internalization theory explains the process by which firms acquire and retain one or more value-chain activities inside the firm, as P&G did in Japan. Internalizing value chain activities helps minimize the disadvantages of dealing with external partners for performing arms-length activities such as exporting and licensing. Internalization also gives the firm greater control over its foreign operations. For example, the MNE might internalize the supplier function by acquiring or establishing its own plant in the foreign market to produce needed inputs itself instead of buying them from a foreign, independent supplier. Or it might internalize the marketing function by establishing its own distribution subsidiary abroad, instead of contracting with an independent foreign distributor to handle its marketing in the foreign market. The MNE is ultimately a vehicle for bypassing the bottlenecks and costs of the international, inter-firm exchange of goods, materials, and workers. In this way, the firm replaces business activities performed by independent suppliers in external markets with business activities it performs itself. In the 1950s, for example, Sony followed a policy of exporting its products to Europe and North America. However, management soon realized it could accelerate and improve the performance of international operations by creating its own sales and production facilities in strategic markets abroad. Thus, in the 1960s, Sony internalized much of its global production and distribution channels by establishing company-owned subsidiaries in Europe, the United States, and other key markets. To ensure product quality, Sony internalized production of semiconductors and circuit boards for use in making cell phones and PlayStations. Recently, Sony transferred production of camcorders from a plant run by a joint venture partner in China to a wholly owned Sony plant in Japan. The move allowed Sony to improve supply-chain management and manufacturing of camcorders. In addition to consumer electronics, Sony has long been a major player in the movie industry through its subsidiary Sony Pictures Entertainment (SPE). Acquiring the Loews chain of movie theaters in the United States allowed SPE to internalize a substantial portion of the distribution channel for its film business, ensuring its movies would be supplied to thousands of movie screens. Since its founding, Sony has consistently internalized key units to maintain control over the most important links in its global value chains. Another key reason companies internalize certain value-chain functions is to control proprietary knowledge critical to the development, production, and sale of their products and services. Because independent foreign companies are outside the MNE’s direct control, they can acquire and use the knowledge to their own advantage, perhaps becoming competitors in the process. FDI allows the MNE to control and optimally use its knowledge in foreign markets. Example In China, Intel owns much of its value chain, to ensure that Intel knowledge, patents, and other assets are not misused or illicitly obtained by potential rivals. Copyright © 2014 Pearson Education

Example of the Eclectic Paradigm: Sony in China
Ownership Specific Advantages. Sony possesses a huge stock of knowledge and patents in the consumer electronics industry, as represented by products like the Playstation and Vaio laptop. Location Specific Advantages. Sony desires to manufacture in China to take advantage of China’s low-cost, highly knowledgeable labor. Internalization Advantages. Sony wants to maintain control over its knowledge, patents, manufacturing processes, and quality of its products. Thus, Sony entered China via FDI Let’s use Alcoa, the Aluminum Corporation of America ( to illustrate. Alcoa has more than 70,000 employees in thirty-five 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®. One of Alcoa’s most important ownership-specific advantages is the proprietary technology it has acquired through its R&D activities. It has also acquired special managerial and marketing skills in the production and marketing of refined aluminum. The firm has a well-known brand name that helps increase sales. As a large firm, Alcoa also profits from economies of scale and the ability to finance expensive projects. Such advantages allowed Alcoa to maximize profits in its international operations. The second condition that determines whether a firm will internationalize via FDI is the presence of location-specific advantages, the comparative advantages available in individual foreign countries, such as natural resources, skilled labor, low-cost labor, and inexpensive capital. For example, 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 from Brazil’s low-cost, relatively well-educated laborers who work in the firm’s refineries. The presence of these location-specific advantages helped persuade Alcoa to locate in Brazil via FDI. The third condition that determines FDI-based internationalization is the presence of internalization advantages, benefits 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 prevent unintended dissemination of the firm’s proprietary knowledge, and the ability to reduce buyer uncertainty about the value of products the firm offers. Alcoa had five reasons to internalize many of its operations instead of letting external suppliers handle them. First, its management wants to minimize dissemination of knowledge about its aluminum refining operations—knowledge the firm acquired at great expense. Second, internalization provides the best net return, allowing Alcoa to minimize the cost of operations. Third, Alcoa needs to control sales of its aluminum products to avoid depressing world aluminum prices through oversupply. Fourth, the firm wants to be able to apply a differential pricing strategy, charging different prices to different customers, a strategy it could not follow very effectively without the control over distribution that internalization provides. Finally, aluminum refining is a complex business, and Alcoa wants to control it to maintain the quality of its products. Sony Copyright © 2014 Pearson Education

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