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Lecture 5: The Eclectic Paradigm

The Eclectic Paradigm, also referred to as the Ownership-Location-


Internalisation (OLI) framework was developed by John Dunning in 1977. It is
regarded as a paradigm and not a theory because it provides a complete
statement of FDI activity by integrating three different principles which have
been developed over time by many scholars. The Eclectic paradigm
differentiates between Internalisation and Externalisation. Internalisation
takes place when a firm undertakes FDI by operating on its own in at least one
foreign country using ownership foreign market entry modes like IJV,
Subsidiary, WOS or offshoring. Externalisation takes place when a firm does
not undertake FDI and does not become an MNE but instead operates through
others in at least one foreign country using contractual foreign market entry
modes like Exporting, Licencing, Franchising, Strategic Alliance and
Outsourcing.

Internalisation allows a firm to maximise profit in a world of imperfect


markets, by creating internal markets which involve bringing under common
ownership and control the activities which are linked by the market. It is the
internalisation of markets across national boundaries that generate MNEs
(Buckley and Casson, 1976). Internalisation theory suggests two simple rules
for a firms strategy and implementation. The first is that managers compare
external transaction costs i.e. the costs of using the market, with internal
agency costs to create a balance which determines the scope of the firm. The
second rule is that managers should endeavour to reduce agency costs in
relation to transaction costs in order to increase the scope of managerial
control.

Ownership Advantages do not refer to legal ownership but rather in the


International Business literature means the capabilities, skills and strengths
that make the focal firm successful in a foreign country. Such advantages
include brands, technology, skilled HR, finance etc. Stephen Hymer suggests
that MNEs undertake FDI in order to appropriate rent on certain skills and
abilities. Location advantages refer to locationally fixed assets both natural e.g.
oil or created assets e.g. Silicon Valley and other non-tradable assets. The
acquisition of ownership advantages (strategic asset seeking) and location
advantages (resource seeking) are motivations for FDI. Another motivation for
FDI is market seeking, undertaken in order to raise a firms market share.

The Eclectic Paradigm brings together Ownership Advantages, Location


Advantages and Internationalisation theory and purports that FDI will not take
place if the foreign location does not have sufficient attraction in comparison
to the MNE home country i.e. all three (O-L-I) advantages must be present for
the existence of MNE and for FDI to take place. The OLI framework provides a
general explanation of FDI activity. More so, these OLI variables interact and
affect FDI flows and this interaction is captured by the Investment
Development Path (IDP) which states that countries progress through 5 stages
in response to changes in these OLI advantages.