1. International Marketing
Lecture week 3
Theories of internationalisation

2. Agenda Comparative and competitive advantage
Theories of international trade

3. 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

4. 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

5. 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
Transaction cost approach
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 theory
Non FDI base
international collaboration venture
networks and relational assets

6. 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.

7. 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

8. Absolute advantage- example
One ton of
Cloth
Wheat
France 30 40
Germany
100 20
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.

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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.

15. 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

16. Contemporary theories
Fostered a new types of competition
A race among nation to reposition themselves as a attractive places to invest and do business

17. 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

18. 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

19. 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

20. 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.

21. 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.

22. New trade theory 1970, economists Paul Krugman
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

23. 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.

24. 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

25. Internationalization process of the firm
Domestic focus
Pre export stages
Experimental involvement
Active involvement
Committed involvement

26. An incremental approach to internationalization
Figure 3.1 implies that additional market commitment as a rule will be made in small incremental steps, both in the market commitment dimension and in the geographical dimension. Though there are exceptions (discussed on the following slide).
The geographical dimension in Figure 3.1 shows that firms enter new markets with successively greater psychic distance. In other words, firms begin to internationalize by going to those markets they can most easily understand.

27. Born globals A born global can be defined as a firm
that from its inception pursue a vision of becoming global and
globalize rapidly without any preceding long term domestic or internationalization period
(Oviatt and McDougall, 1994; Gabrielsson and Kirpalani, 2004).

28. 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

29. Born globals Distinguishing feature of born global firms:
Tend to be managed by entrepreneurial visionaries, who view the world as a single, borderless marketplace from the time of the firm’s founding.
Mostly born global’s are
small, technology-oriented companies that operate in international markets from the earliest days of their establishment.

30. ‘Organic’ versus ‘born global’
Managers’
mindset
External environment
Internal environment
Decision to internationalize
Organic
pathway
Born global
pathway
Home market
Home market
Export market A
Export market A
Export market N
Export market N
Source: Adapted from Âijö et al. (2005), p. 6.

31. Principles of the Transaction Cost Approach Model

32. Cost elements of the TCA model
Ex ante costs
Search costs
Contracting costs
Ex post costs
Monitoring costs
Enforcement costs
Transaction costs = ex ante costs (search + contracting costs)
+ ex post costs (monitoring + enforcement costs)

33. What is this?
When firms do business using an importer, agent, or distributor it is called _____.
Externalization

34. What is this?
When firms implement a global marketing strategy using their own subsidiaries, it is called _____.
Internalization

35. Limitations of the TCA framework
Excluding ‘internal’ transaction costs
Importance of ‘production cost’ is understated

36. 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

37. 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

38. 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

39. 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

40. Non FDI based explanations

41. 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

42. 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

43. The network model
The relationships of a firm in a domestic network can be used as bridges to other networks in other countries

44. An example of an international network
In Figure 3.5, it appears that one of the subsuppliers established a subsidiary in Country B. Here the production subsidiary Is served by the local company of the subsupplier. Countries E and F, and partly Country C, are sourced from the production subsidiary in Country B. It can be assumed that direct or indirect bridges exist between firms and different country networks The bridges are important initial steps abroad and in the subsequent entry of new markets.