Nature and Scope of International Business

International Business is the process of focusing on the resources of the globe and objectives of
the organizations on global business opportunities and threats.

International business defined as global trade of goods/services or investment. More

comprehensive view does not focus on the “firm” but on the exchange process
Free Trade occurs when a government does not attempt to influence, through quotas or duties,
what its citizens can buy from another country or what they can produce and sell to another
country.

The Benefits of Trade allow a country to specialize in the manufacture and export of products
that can be produced most efficiently in that country. The Pattern of International Trade displays
patterns that are easy to understand (Saudi Arabia/oil or Mexico/labor intensive goods). Others
are not so easy to understand (Japan and cars).

Nature of International Business

1. Accurate Information
2. Information not only accurate but should be timely
3. The size of the international business should be large
4. Market segmentation based on geographic segmentation
5. International markets have more potential than domestic markets

Scope of International Business

1. International Marketing
2. International Finance and Investments
3. Global HR
4. Foreign Exchange

Need for International Business

1. To achieve higher rate of profits

2. Expanding the production capacity beyond the demand of the domestic country
3. Severe competition in the home country
4. Limited home market
5. Political conditions
6. Availability of technology and managerial competence
7. Cost of manpower, transportation
8. Nearness to raw material
9. Liberalization, Privatization and Globalization (LPG)
10. To increase the market share
11. Increase in cross border business is due to falling trade barriers (WTO), decreasing costs in
telecommunications and transportation; and freer capital markets
Reasons for Recent International Business Growth

1. Expansion of technology
2. Business is becoming more global because
3. Transportation is quicker
4. Communications enable control from afar
5. Transportation and communications costs are more conducive for international operations
6. Liberalization of cross-border movements.
7. Lower Governmental barriers to the movement of goods, services, and resources enable
Companies to take better advantage of international opportunities

Problems in International Business

1. Political factors
2. High foreign investments and high cost
3. Exchange instability
4. Entry requirement
5. Tariffs, quota etc.
6. Corruption and bureaucracy
7. Technological policy
Internationalization
Internalization has been of great interest to nearly every company. There is no single and
universally accepted definition of internationalization but from an economics point of view, it is
defined as the process where business gets more involved in the international markets. In the
contemporary world, businesses begin their operations domestically but must draw up a long-
term plan on how the business will be going international. Internationalization phenomenon has
significantly changed the landscape for most business resulting to a very dynamic market
situation with severe competition for the companies.

The reason behind going for international market varies from one company to another. However,
most firms pursue internationalization because domestic market has become inadequate because
of the economies of scale and multiple opportunities that are available in the foreign markets.
Most successful executives will always want to try another market after any successful one.

Internationalization has been one of the strategies being used by most executives to reduce the
cost of operations. Businesses with overhead costs can have the excess cost cut down in
countries that have relatively deflated currencies as well as low cost of living. Most business in
the United States finds it relatively cheaper operating in countries that have free trade
arrangement with U.S.

One way in which internationalization help companies reduce the cost of doing is business is
through reduced labor costs. Companies that are interested in going international usually look for
those markets that have a low cost of leaving as that makes it cheaper hiring employees in such
countries. There are those companies that consider going international when in the financial
crisis. Executives of companies that are experiencing a financial crisis in the domestic market
will formulate the budget and go for the foreign markets. Institutions are commonly defined as
humanly made constraints the give economic, social interactions and political shape. The
institution can also be looked at as a wide range of structures that widely affect contract
enforcement, protection of investors, economic outcome, property rights, and even political
system.

Institutions play a very crucial role in the market economy. The main aim of institutions is to
ensure that there is effective functioning of the market mechanism. This sees to it that those
firms that take part in the market can carry out their transactions without suffering undue loss or
being exposed to risk. Some of the reason behind the popularity of internationalization among
current companies include opening up of trade borders by most countries across the world,
elimination of trade barriers among many others.

Companies are no longer secure staying in the domestic market and therefore most companies
tend to go for internationalization to be able to spread their risks. Internationalization has become
much easier due to the communication and technological advancement. Communication and
technological advancement are vital in ensuring that foreign businesses are properly and timely
operated without experiencing problems. Internationalization is achieved through very different
ways.
There are those companies that take part through exporting their products to foreign countries
and continue to strengthen their home market. Some adopt a highly aggressive approach which
includes acquiring firms, coming up with alliances, embrace joint venture or just establish their
subsidiary. All these entry strategies differ in regards to the risk associated with each, control,
level of resource commitment and return on investment that internationalization promises.

There are many entry modes that companies can use to join foreign markets but all these modes
can be categorized in two broad modes. The first mode is the non-equity mode, which comprises
of export and contractual agreements. The second mode is referred to equity mode of entry,
which is known to include wholly owned subsidies and joint ventures. From all the available
market entry, the one that offers the lowest risk level and the lowest market control is the export
and import.

The one with the highest risk level but highest market control is considered to be expected return
on investment. The expected return on investment is majorly connected with a direct investment
such as acquisition as well as Greenfield investments. Export and importing is the most common
strategy that most firms use to pursue internationalization. Export is known as the process of
selling services and goods to countries other than the domestic one. The company can directly be
involved in the export or use an agent.

The other strategy that is equally popular is licensing. International licensing firms are known to
give out licensee patent rights, copyrights, trademark rights, or even know-how on processes and
products. Licensee does a production of licensor’s products, marketing it within the assigned
territory and payment of licensor’s fee together with sales-related royalties in return. This
strategy is mostly welcome by foreign public authorities as it is the way through which
technology is leaked into the country.
Reasons for entering International Markets

Internationalization is more of an expansion of business from its home market into foreign
markets. The decision to internationalize is one of the strategic decisions that have a fundamental
effect on any firm and all its internal and external operations. It equally affects the management
of the company.

In the current world, the rate at which companies operate outside their domestic market has
significantly increased. Even though internationalization has become a very popular thing
amongst many companies around the world, it is highly important for every company to consider
their motives for going international. There are multiple reasons why companies consider going
international.

The most common reason for going international is the need for pursuing potential abroad and
the desire to diversify risk. Most companies consider expanding their product line in the foreign
market when launching a new product. Companies like Coca-Cola had only to introduce bottled
water after going to nearly every country in the world. In most cases domestic competition grows
so fierce to the extent that companies consider foreign markets so attracting.

It explains why Ford which was second after General Motors in United States market became
internationalized much faster compared to General Motors. Most of the Chinese firms are
considering internationalization due to intense competition in china’s market. The other good
reason for going to a foreign market is to avoid the risk that comes with operating in a single
market.

Most firms go international with an aim of diversifying risk. With an alternative market in a
foreign land can be greatly of help in offsetting negative results various uncertainties such as
economic downturns or political intolerance. Starbuck’s is a good example of companies that
enjoyed the advantages of going international during U.S. recession, which significantly
devastated sales within the home market. Foreign market covered company loses through the
overwhelming performance overseas.

Many other companies consider going international to achieve a different growth rate. Different
markets have different growth rate and most companies in slow-growth countries will always
consider internationalization with an aim of going to countries with faster growth rate.
Companies operating in the food industry have varied growth rate from one market to another.
The variations come when some countries experience maturity in say food production. Such
companies will; look for countries whose markets are still at the advancing stage.

Besides major reasons that attribute to profitability, companies equally consider going
international not to gain financially but to gain knowledge. There are so many firms that have
entered the international market to find out what need to be changed from the existing product to
make it acceptable globally. Government incentives also promote internationalization.

There are those companies that consider going overseas not for growth, not because of
competition in the domestic market but because the government gives them incentives to export
some of the local products. Through government incentives, most companies have managed to
access markets that they would have not accessed. So many countries such as the United States
provide its companies with a wealth of help to start the business of exporting products to foreign
countries.
EPRG Approach
Different attitudes towards company’s involvement in international marketing process are called
international marketing orientations. EPRG framework was introduced by Wind, Douglas and
Perlmutter. This framework addresses the way strategic decisions are made and how the
relationship between headquarters and its subsidiaries is shaped.

Perlmutter’s EPRG framework consists of four stages in the international operations evolution.
These stages are discussed below.

Ethnocentric Orientation

The practices and policies of headquarters and of the operating company in the home country
become the default standard to which all subsidiaries need to comply. Such companies do not
adapt their products to the needs and wants of other countries where they have operations. There
are no changes in product specification, price and promotion measures between native market
and overseas markets.

The general attitude of a company’s senior management team is that nationals from the
company’s native country are more capable to drive international activities forward as compared
to non-native employees working at its subsidiaries. The exercises, activities and policies of the
functioning company in the native country becomes the default standard to which all subsidiaries
need to abide by.

The benefit of this mind set is that it overcomes the shortage of qualified managers in the
anchoring nations by migrating them from home countries. This develops an affiliated corporate
culture and aids transfer core competences more easily. The major drawback of this mind set is
that it results in cultural short-sightedness and does not promote the best and brightest in a firm.

Regiocentric Orientation

In this approach a company finds economic, cultural or political similarities among regions in
order to satisfy the similar needs of potential consumers. For example, countries like Pakistan,
India and Bangladesh are very similar. They possess a strong regional identity.

Geocentric Orientation

Geocentric approach encourages global marketing. This does not equate superiority with
nationality. Irrespective of the nationality, the company tries to seek the best men and the
problems are solved globally within the legal and political limits. Thus, ensuring efficient use of
human resources by building strong culture and informal management channels.

The main disadvantages are that national immigration policies may put limits to its
implementation and it ends up expensive compared to polycentrism. Finally, it tries to balance
both global integration and local responsiveness.

Polycentric Orientation

In this approach, a company gives equal importance to every country’s domestic market. Every
participating country is treated solely and individual strategies are carried out. This approach is
especially suitable for countries with certain financial, political and cultural constraints.

This perception mitigates the chance of cultural myopia and is often less expensive to execute
when compared to ethnocentricity. This is because it does not need to send skilled managers out
to maintain centralized policies. The major disadvantage of this nature is it can restrict career
mobility for both local as well as foreign nationals, neglect headquarters of foreign subsidiaries
and it can also bring down the chances of achieving synergy.
The Environment of International Business
International managers face intense and constant challenges that require training and
understanding of the foreign environment. Managing a business in a foreign country requires
managers to deal with a large variety of cultural and environmental differences. As a result,
international managers must continually monitor the political, legal, sociocultural, economic, and
technological environments.

The political environment

The political environment can foster or hinder economic developments and direct investments.
This environment is ever‐changing. As examples, the political and economic philosophies of a
nation’s leader may change overnight. The stability of a nation’s government, which frequently
rests on the support of the people, can be very volatile. Various citizen groups with vested
interests can undermine investment operations and opportunities. And local governments may
view foreign firms suspiciously.

Political considerations are seldom written down and often change rapidly. For example, to
protest Iraq’s invasion of Kuwait in 1990, many world governments levied economic sanctions
against the import of Iraqi oil. Political considerations affect international business daily as
governments enact tariffs (taxes), quotas (annual limits), embargoes (blockages), and other
types of restriction in response to political events.

Businesses engaged in international trade must consider the relative instability of countries such
as Iraq, South Africa, and Honduras. Political unrest in countries such as Peru, Haiti, Somalia,
and the countries of the former Soviet Union may create hostile or even dangerous environments
for foreign businesses. In Russia, for example, foreign managers often need to hire bodyguards;
sixteen foreign businesspeople were murdered there in 1993. Civil war, as in Chechnya and
Bosnia, may disrupt business activities and place lives in danger. And a sudden change in power
can result in a regime that is hostile to foreign investment; some businesses may be forced out of
a country altogether. Whether they like it or not, companies are often involved directly or
indirectly in international politics.

The legal environment

The American federal government has put forth a number of laws that regulate the activities of
U.S. firms engaged in international trade. However, once outside U.S. borders, American
organizations are likely to find that the laws of the other nations differ from those of the U.S.
Many legal rights that Americans take for granted do not exist in other countries; a U.S. firm
doing business abroad must understand and obey the laws of the host country.

In the U.S., the acceptance of bribes or payoffs is illegal; in other countries, the acceptance of
bribes or payoffs may not be illegal—they may be considered a common business practice. In
addition, some countries have copyright and patent laws that are less strict than those in the U.S.,
and some countries fail to honor these laws. China, for example, has recently been threatened
with severe trade sanctions because of a history of allowing American goods to be copied or
counterfeited there. As a result, businesses engaging in international trade may need to take extra
steps to protect their products because local laws may be insufficient to protect them.

The economic environment

Managers must monitor currency, infrastructure, inflation, interest rates, wages, and taxation. In
assessing the economic environment in foreign countries, a business must pay particular
attention to the following four areas:

 Average income levels of the population. If the average income for the population is very low,
no matter how desperately this population needs a product or service, there simply is not a
market for it.

 Tax structures. In some countries, foreign firms pay much higher tax rates than domestic
competitors. These tax differences may be very obvious or subtle, as in hidden registration fees.

 Inflation rates. In the U.S., for example, inflation rates have been quite low and relatively stable
for several years. In some countries, however, inflation rates of 30, 40, or even 100 percent per
year are not uncommon. Inflation results in a general rise in the level of prices, and impacts
business in many ways. For example, in the mid‐1970s, a shortage of crude oil led to numerous
problems because petroleum products supply most of the energy required to produce goods
and services and to transport goods around the world. As the cost of petroleum products
increased, a corresponding increase took place in the cost of goods and services. As a result,
interest rates increased dramatically, causing both businesses and consumers to reduce their
borrowing. Business profits fell as consumers’ purchasing power was eroded by inflation. High
interest rates and unemployment reached alarmingly high levels.

 Fluctuating exchange rates. The exchange rate, or the value of one country’s currency in terms
of another country’s currency, is determined primarily by supply and demand for each country’s
goods and services. The government of a country can, however, cause this exchange rate to
change dramatically by causing high inflation—by printing too much currency or by changing the
value of the currency through devaluation. A foreign investor may sustain large losses if the
value of the currency drops substantially.

When doing business abroad, business people need to recognize that they cannot take for granted
that other countries offer the same things as are found in industrialized nations. A country’s level
of development is often determined in part by its infrastructure. The infrastructure is the
physical facilities that support a country’s economic activities, such as railroads, highways, ports,
utilities and power plants, schools, hospitals, communication systems, and commercial
distribution systems. When doing business in less developed countries, a business may need to
compensate for rudimentary distribution and communication systems.

The socio-cultural environment

Cultural differences, which can be very subtle, are extremely important. An organization that
enters the international marketplace on virtually any level must make learning the foreign
country’s cultural taboos and proper cultural practices a high priority. If a business fails to
understand the cultural methods of doing business, grave misunderstandings and a complete lack
of trust may occur.

Management differences also exist. In China, a harmonious environment is more important than
day‐to‐day productivity. In Morocco, women can assume leadership roles, but they are usually
more self‐conscious than American women. In Pakistan, women are not often found in
management positions, if they’re in the workplace at all.

In addition, the importance of work in employees’ lives varies from country to country. For
example, the Japanese feel that work is an important part of their lives. This belief in work,
coupled with a strong group orientation, may explain the Japanese willingness to put up with
things that workers in other countries would find intolerable.

Likewise, culture may impact what employees find motivating, as well as how they respond to
rewards and punishments. For example, Americans tend to emphasize personal growth,
accomplishment, and “getting what you deserve” for performance as the most important
motivators. However, in Asian cultures, maintaining group solidarity and promoting group needs
may be more important than rewarding individual achievements.

Finally, language differences are particularly important, and international managers must
remember that not all words translate clearly into other languages. Many global companies have
had difficulty crossing the language barrier, with results ranging from mild embarrassment to
outright failure. For example, in regards to marketing, seemingly innocuous brand names and
advertising phrases can take on unintended or hidden meanings when translated into other
languages. Advertising themes often lose or gain something in translations. The English Coors
beer slogan “get loose with Coors” came out as “get the runs with Coors” in Spanish.
Coca‐Cola’s English “Coke adds life” theme translated into “Coke brings your ancestors back
from the dead” in Japanese. In Chinese, the English Kentucky Fried Chicken slogan
“finger‐lickin’ good” came out as “eat your fingers off.”

Such classic boo‐boos are soon discovered and corrected; they may result in little more than
embarrassments for companies. Managers should keep in mind that countless other, more subtle
blunders may go undetected and damage product performance in less obvious ways.

The Technological environment

The technological environment contains the innovations, from robotics to cellular phones, that
are rapidly occurring in all types of technology. Before a company can expect to sell its product
in another country, the technology of the two countries must be compatible.

Companies that join forces with others will be able to quicken the pace of research and
development while cutting the costs connected with utilizing the latest technology. Regardless of
the kind of business a company is in, it must choose partners and locations that possess an
available work force to deal with the applicable technology. Many companies have chosen
Mexico and Mexican partners because they provide a willing and capable work force. GM’s
plant in Arizpe, Mexico, rivals its North American plants in quality.

Consumer safety in a global marketplace

The United States leads the world in spending on research and development. As products and
technology become more complex, the public needs to know that they are safe. Thus,
government agencies investigate and ban potentially unsafe products. In the United States, the
Federal Food and Drug Administration has set up complex regulations for testing new drugs. The
Consumer Product Safety Commission sets safety standards for consumer products and penalizes
companies that fail to meet them. Such regulations have resulted in much higher research costs
and in longer times between new product ideas and their introduction. This is not always true in
other countries.
Reasons for Going International
1. Increase sales and profitability.

Going global can provide new sources of revenue, yield greater returns on investments and
secure long-term success for a business. The Internet makes it even easier to reach out to the
world for business.

2. Enter new markets.

Have you saturated your local, core market? Then look beyond your region and consider a
market overseas. Be sure to pick one that offers opportunity. You want a market where it’s easy
to enter, whose buyers desire your product or service. For example, is there a market for your
products or services in Ireland? If so, get a jump on your competitors and get there before they
do. This is called first-mover advantage.

3. Create jobs.

As you grow your business globally, you must support the additional workload. Hiring people is
the solution and we know that the strength of our country lies in its ability to create jobs that help
people live and prosper.

4. Offset slow growth in your home market.

Are you selling kale in your home market and only so many customers will buy it? Or are you
selling specialized software and there’s been a sudden decrease in demand for it? A way to
overcome low growth in your home market is to look at overseas markets. Protect your company
by exporting, using the Internet, licensing or franchising your products.

5. Outmaneuver competitors.

Taking one step to enter a new overseas market that your competitor hasn’t entered might
outmaneuver that domestic-only rival with stronger company performance.

6. Enlarge the customer base.

If the company currently has 1,000 customers, why not increase the base to 2,000 by entering a
foreign market via e-commerce or a collaborative sales partnership? You’ll need support to get
the work done so consider adding people to get the processes in place.

7. Create economies of scale in production.

Your company is ramping up and producing 20,000 hammers at once because an outfit in
Ireland, Japan or Australia wants to buy them and won’t buy a single case. The more you
produce, the greater the chances of lowering the per-unit manufacturing costs.
 8. Explore untapped markets with the power of the Internet.

With an e-commerce site, customers worldwide might eventually find you, provided you’ve
made it easy for them to do so. Move into the markets that generate a heavy concentration of
inquiries on your website. You may not have anticipated a particular geographic area would be a
ripe market, but the people there are telling you it is.

9. Make use of excess capacity off-season.

To insulate the business from seasonal sales fluctuations, find foreign markets to counterbalance
dips in demand. For instance, some firms gear up for the holiday season, only to see sales
nosedive in January. Sell to other nations with peak-buying seasons early in the new year to
avoid a winter sales slowdown.

10. Travel to new countries.

Then there’s the fun factor in taking a business global. Not only will you connect with people
from all over the world, but you’ll also have an excuse to meet with them in person to grow the
relationship and the business. Treat it as an exciting learning adventure.
Analyzing International Entry Modes
The long-term advantages of doing international business in a particular country depend upon the
following factors −

 Size of the market demographically

 The purchasing power of the consumers in that market
 Nature of competition

By considering the above-mentioned factors, firms can rank countries in terms of their
attractiveness and profitability. The timing of entry into a nation is a very important factor. If a
firm enters the market ahead of other firms, it may quickly develop a strong customer base for its
products.

There are seven major modes of entering an international market. In this chapter, we will take up
each mode and discuss their advantages and disadvantages.

Exporting

An item produced in a domestic market can be sold abroad. Storing and processing is mainly
done in the supplying firm’s home country. Export can increase the sales volume. When a firm
receives canvassed items and exports them, it is called Passive Export.

Alternately, if a strategic decision is taken to establish proper processes for organizing the export
functions and for obtaining foreign sales, it is known as Active Export.

 Advantages − Low investment; Less risks

 Disadvantages − Unknown market; No control over foreign market; Lack of information about
external environment

Licensing

In this mode of entry, the manufacturer of the home country leases the right of intellectual
properties, i.e., technology, copyrights, brand name, etc., to a manufacturer of a foreign country
for a predetermined fee. The manufacturer that leases is known as the licensor and the
manufacturer of the country that gets the license id known as the licensee.

 Advantages − Low investment of licensor; Low financial risk of licensor; Licensor can investigate
the foreign market; Licensee’s investment in R&D is low; Licensee does not bear the risk of
product failure; Any international location can be chosen to enjoy the advantages; No
obligations of ownership, managerial decisions, investment etc.
 Disadvantages − Limited opportunities for both parties involved; Both parties have to manage
product quality and promotion; One party’s dishonesty can affect the other; Chances of
misunderstanding; Chances of trade secrets leakage of the licensor.

Franchising
In this mode, an independent firm called the franchisee does the business using the name of
another company called the franchisor. In franchising, the franchisee has to pay a fee or a
fraction of profit to the franchisor. The franchisor provides the trademarks, operating process,
product reputation and marketing, HR and operational support to the franchisee.

Note − The Entrepreneur magazine’s top ranker in “The 2015 Franchise 500” is Hampton
Hotels. It has 2,000 hotels in 16 countries.

 Advantages − Low investment; Low risk; Franchisor understands market culture, customs and
environment of the host country; Franchisor learns more from the experience of the
franchisees; Franchisee gets the R&D and brand name with low cost; Franchisee has no risk of
product failure.
 Disadvantages − Franchising can be complicated at times; Difficult to control; Reduced market
opportunities for both franchisee and franchisor; Responsibilities of managing product quality
and product promotion for both; Leakage of trade secrets

Turnkey Project

It is a special mode of carrying out international business. It is a contract under which a firm
agrees – for a remuneration – to fully carry out the design, create, and equip the production
facility and shift the project over to the purchaser when the facility is operational.

Mergers & Acquisitions

In Mergers & Acquisitions, a home company may merge itself with a foreign company to enter
an international business. Alternatively, the home company may buy a foreign company and
acquire the foreign company’s ownership and control. M&A offers quick access to international
manufacturing facilities and marketing networks.

 Advantages − Immediate ownership and control over the acquired firm’s assets; Probability of
earning more revenues; The host country may benefit by escaping optimum capacity level or
overcapacity level
 Disadvantages − Complex process and requires experts from both countries; No addition of
capacity to the industry; Government restrictions on acquisition of local companies may disrupt
business; Transfer of problems of the host country’s to the acquired company.

Joint Venture

When two or more firms join together to create a new business entity, it is called a joint venture.
The uniqueness in a joint venture is its shared ownership. Environmental factors like social,
technological, economic and political environments may encourage joint ventures.

 Advantages − Joint ventures provide significant funds for major projects; Sharing of risks
between or among partners; Provides skills, technology, expertise, marketing to both parties.
 Disadvantages − Conflicts may develop; Delay in decision-making of one affects the other party
and it may be costly; The venture may collapse due to the entry of competitors and the changes
 in the partner’s strength; Slow decision-making due to the involvement of two or more decision-
makers.

Wholly Owned Subsidiary

Wholly Owned Subsidiary is a company whose common stock is fully owned by another
company, known as the parent company. A wholly owned subsidiary may arise through
acquisition or by a spin-off from the parent company.
Deming Eclectic OLI Model and Other Models
More and more companies nowadays decide to expand their business by crossing domestic
borders and by (re)locating certain value chain activities abroad. There are several motivations
for companies to do so. First of all, companies might be on the lookout for natural or strategic
resources such as physical, financial, technological or human resources that are more attractive
in foreign countries than at home. In other cases, the focal company might be simply looking for
new customers and sees a foreign market as a way to expand business and sell more products.
Finally it may be the case that the company seeks ways to increase efficiency in order to
create economies of scale and to cut costs per unit. Whatever the reason might be, management
will be faced with a tough decision: how are we going to enter a foreign country?

There is a wide variety of entry-mode strategies to choose from and they all have their own pros
and cons. Often used strategies are exporting, licensing, franchising, forming a strategic alliance,
creating a joint venture, acquiring, or starting from scratch with a greenfield investment. These
last three involve large equity investment and are therefore considered forms of Foreign Direct
Investment (FDI). A good way to at least exclude some of them is by using the so called OLI
paradigm (also known as the eclectic paradigm). OLI is an acronym for Ownership-, Location-
and Internalization- advantage. According to this paradigm, a company needs all three
advantages in order to be able to successfully engage in FDI. If one or more of these advantages
are not present, the focal company might want to use a different entry-mode strategy. Each of the
three advantages will be elaborated on below:
Ownership advantage
First of all, a company needs an ownership advantage in order to overcome the liability of
foreignness. Ownership refers to the possession of a certain valuable, rare, hard-to-imitate, and
organizationally embedded resource that allows a company to have a competitive advantage
compared to foreign rivals. The liability of foreignness however can be defined as the inherent
disadvantage that foreign firms experience in host countries because of their non-native status.
These disadvantages could vary from simply not speaking the local language to having limited
knowledge on the local customer demands. The question that management should therefore ask
itself is: does our firm have a certain competitive advantage that can be transferred abroad in
order to offset our liability of foreignness? This could for example be a strong brand name with a
great reputation, unique technological capabilities or huge economies of scale. Obviously the
answer on this question should be YES in order to explain your motives for expanding abroad in
the first place.

Location advantage
Secondly, there must be some kind of location advantage in the market the company is trying to
enter. Again, given the well-known liability of foreignness, host countries must offer compelling
advantages to make it worthwile to undertake FDI. These advantages can be simply geographical
(e.g. the Netherlands is in between great economies like the UK and Germany and is moreover
located next to the ocean) or are present because of the existence of cheap raw materials, low
wages, a skilled labor force or special taxes and tariffs. A great tool to determine these location
advantages is through Porter’s Diamond model. The question that management should ask itself
here is: are any of these location advantages present in the market we are thinking of entering? If
the answer on this question is NO, it might be wiser for management to keep production at home
and export products instead – assuming that there is demand in the foreign market. If the answer
is YES however, it might be interesting to perform certain value chain activities abroad either
through licensing/francising or through FDI.

Internalization advantage

To choose between licensing and FDI management should look at the final advantage:
internalization advantage. Is it more attractive to perform the value chain activity in-house than
to have it performed by an external party? Reasons to outsource certain activities to different
companies abroad might be because they are better at it, are able to do it cheaper, have more
local market knowledge, or because management simply wants to focus on other activities in the
value chain such as marketing or design. In this case management might want to license its
product design to an independent foreign company or outsource production to an original
equipment manufacturer (OEM). If the answer is YES however, the firm should keep control
over its activities and engage in FDI. This could be done through forming joint ventures with
local partners, acquiring existing local companies, or by starting from scratch through a
greenfield investment.