PROBLEMS AND DEVELOPMENTS IN THE CORE ... - SSRN papers

PROBLEMSAND DEVELOPMENTSIN THE CORE THEORYOF INTERNATIONALBUSINESS Peter J. Buckley* Universityof Bradford Abstract.The establishedtheory of internationalbusiness is not without problems. It is necessary to specify the key relationships between internalisation and market structure and between internalisationand competitive advantage more carefully. This paper attempts to clarify the former relationshipby referenceto the work of Hymer and the latter by contrasting the nature of internalisationdecisions with those building shortrun competitive advantage. Avenues of development of the theory include the integration of nontraditionalconcepts and the reintegration of areas of research that have become divorcedfrom core internationalbusinesstheory. It is now generallyagreedthat an establishedtheory of the multinational enterpriseexists. The synthesis is based on internalisationtheory, the theory of location and competitivedynamics.An outline of this position together with the difficulties of empiricaltesting was given in an earlier article [Buckley 1988]. The synthesis relies on fundamental concepts derivedfrom Coase [1937],Kaldor[1934],modernindustrialorganisation theory,internationaltradetheoryand theoriesof monopolyand monopolistic competition(notablythe inheritorsof the traditionbegun by Hymer [1976]). Howevera number of problems remain in this emerging 'core theory.'This paper attempts to elucidatethese problemsand to suggest avenuesof development. ivWoissues of current importance in core internalisationtheory are examined-the relationshipbetweeninternalisationdecisionsand market structureand between internalisationand competitiveadvantage.These issues look to be technicalities.In fact, they illustratesome of the key problemsthat new approachesmust confront. *PeterJ. Buckley(B.A., M.A., Ph.D) is Professorof ManagerialEconomicsat the University of Bradford Management Centre and Visiting Professor of Economicsat the Universityof Readingand Oslo BusinessSchool (Oslo Handelshoyskole),Norway.He is chairmanof the U.K. Regionof the Academyof InternationalBusinessand a Fellowof the Academy.He has publishedwidely on the theory and strategyof the multinationalfirm. I am grateful for the comments of three anonymous referees on a previous draft. These comments have improved the paper in various directions which are not individually noted. Received: September 1989; Revised: December & January 1990; Accepted: February 1990.

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658 JOURNAL OF INTERNATIONALBUSINESS STUDIES, FOURTH QUARTER 1990

PROBLEMS IN CORE THEORY

The RelationshipbetweenInternalisationDecisions and MarketStructure

It has become fashionable for analysts to draw a distinction between theoriesbased on internalisation(as exemplifiedby Buckleyand Casson [1976; 1985])and those based on marketpower (exemplifiedby Hymer [1976]).An exampleof this line of argumentis Cantwell[1988].The two are not mutuallyexclusive,or competing,theoriesbut needto be combined to give a full and rich explanationof the growthof multinationalfirms. Such an explanation becomes complicated because of the interaction betweeninternalisationdecisions and marketoutcomes. The sourceof clues on ways to integratethese approachesis a surprising one-Hymer himself. In a recentlyrediscoveredpaperoriginallywrittenin French[Hymer1968;Casson 1989], Hymer providesa heuristicexplanation of the interactionof the internalisationof marketsand marketstructure. iWo sets of processesare at work:(1) internalisationdecisions,with industry size fixed, determine the number of firms in the industry; (2) marketstructure(i) governsthe opportunitiesfor horizontalexpansion, so that highly concentrated industries encourage diversification and (ii) particularmarketstructuresresult in imperfectionsthat induce price distortions within multistage processes, thus providing incentives for forwardor backwardintegration.These outcomes then feed back to a furtherroundof internalisationdecisions.Thusa dynamicprocessof interaction is described.In a static or slowly evolvingworldthis interactionis likelyto convergeon an equilibrium.A crudeform of this model is shown in Figure1. This frameworkis capableof extensionand of encompassing many currenttheoreticaldevelopments.For example,the choice of diversification into new product areas at home or internationalisationin the sameproductareahas been discussedby Wolf [1977].Therearealso possibilities of an approachto business strategymore groundedin theory. The political economyimplicationsof the differencein approachbetween internalisation-basedtheories and those that emphasise market power shouldnot be ignored.In workthat postdateshis 1968paper,Hymerintegratedthe 'Lawof IncreasingFirm Size' with 'The Lawof UnevenDevelopment'to providea powerfulcritiqueof the multinationalenterpriseas an institution[Hymer1970, 1971].Paradoxically,the othermajorcontributor to the Hymer-Kindleberger approachemphasisedthe roleof multinationals in improvingefficiency by increasingglobal competition, breaking up domestic monopolies and surmountinggovernment-imposedbarriersto freer competition [Kindleberger1969]. A synthesisof these views on the welfareimpact of multinationalsrecognises both welfaregains and welfare losses from the establishmentand growthof multinationalenterprises.Welfaregains arisewhen the replacement of an imperfectexternalmarketresultsin the superiorallocationof resourcesin the internalmarketand wherea new marketis createdwhere

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THE CORE THEORY OF INTERNATIONALBUSINESS

FIGURE1 The Interaction between Internalisation Decisions and Market Structure (after Hymer [1968]) Intrnalisation

l

lDecisionsl

of Firms Number in the Industry

Concentrated

NotConcentrated

Price Distortions

Horizontal Expansion at Home Limited Opportunities Horizontal Expansion

Diversification

Backward Integration

Forward Interation

At Home Abroad

At Home new industry

III

Abroad new industry

At Home Abroad

SameIndustry abroad(Internationalisation)

_

_

to Internalisation Feedback Decision

none existedbefore(internalisationof an externality).Welfarelosses arise wheremultinationalsmaximisemonopolyprofitsby restrictingthe outputof goods and servicesand where verticalintegrationis used as a barrierto entry.Further,multinationalsmayreducesocialefficiencybecausetheyprovide a more suitablemechanismfor exploitinga collusiveagreementthan does a cartel. By internalisinga collusiveagreement,multinationalsmake the enforcementof collusion more effective[Casson 1985;Buckley1989]. The dynamicelementsin welfareeffects are also important.An internal marketallowsgreaterinter-plant integration [Scherer1975]andcross-functional


integrationwithinthe firm (e.g., betweenproduction,marketingand R&D) and in the long run this will stimulateboth the undertakingof R&Dand its effectiveimplementationin productionand marketing.Consequently, dynamicwelfareimprovementis likelyto resultfrom moreeffectivedevelopments in technology. It is clearthat the welfareimplicationsof the operationsof multinationals requirecarefulanalysisand greaterattentionto empiricaldetail. It is also arguablethat political and social variablesrequiremore attention. Internalisation and Competitive Advantage

In the internalisationapproachthe firm is seen as an internalisedbundle of resourcesthat can be allocated(i) betweenproductgroups(changesin which are identified as conglomeratediversification)and (ii) between national markets(expansionin this directionis multinationaldiversification). The growthof the firm relativeto marketsis determinedby its internalisationdecisions.The firm growsby replacingor creatingneighboring marketsaccordingto the (positive)balancebetweenthe benefits of internalisationversusthe costs in each instance.The growthof the firm in this analysisis determinedby the net benefitsof internalcontrolrelativeto the extracost of usingimperfectexternalmarketsin intermediateproductsand services [Buckley and Casson 1976, 1985; Buckley 1983; Casson 1987; Buckley 1988]. However,in the modelsof competitiveadvantagederivingfromthe competitive strategyapproach[Porter1980, 1985, 1986],competitiveadvantageis definedas the advantageof one firm relativeto anotherfirm. Thus a firm can have a relativecost advantage,for example,derivingfrom economies of scale, an absolutecost advantagederivingfrom control of key inputs, superiorproducttechnologyor cheaperphysicaldistributionand product differentiationadvantagesarisingfromsuperiorproductsor moreeffective marketing.The concept of competitiveadvantageas used by Porter is directlyanalogousto Dunning'sfirm-specificadvantage[Dunning1981]. Unfortunatelythere has often been a confusion betweenthe concepts of internalisationand competitiveadvantagein the literature.The natureof these conceptsis, in fact, very differentboth from an analyticalpoint of view and from a strategicviewpoint.In contrastto the long-runnatureof internalisationbenefits it is a featureof competitiveadvantagesthat they must be defined over a given fixed time period, for it is possible for competing firms to catch up by rearrangingtheir resourcesto mimic or overtakethe 'leader'(definedas the firm with the greatestnet competitive advantages).It is implicit, and often explicit, in models of competitive advantagethat such advantagesexist in imperfectlycompetitivemarkets, althoughthe natureof the imperfectionis not alwaysspelled out. When theseimperfectionsaremadeexplicit,it is possibleto beginto see the interaction betweeninternalisationand competitiveadvantages.Much play is made of superiortechnologypossessedby leadingfirmsin the competitive


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advantagesmodel. In fact this resultrequiresadditionalassumptionson the natureof diffusion of technicalknow-how[Buckley1983].The firm as a devicefor slowingthe rateof diffusionof innovation[Johnson1970]or as of technologicalrent[Magee1977a,1977b]is a keystrand an 'appropriator' in this element of competitiveadvantage.The time span of such a technological lead will be limited (by the capabilityof followersto copy the technology).However,theremay be long-runadvantagesof internalising the R&D function with the productionfunction to facilitatethe smooth transitionof researchinto commercialisedproduction.Thereare costs too: firms can be locked into obsolescenttechnologythrougha captive R&D unit. Careshouldbe takento distinguishthe long-runbenefitsand costs of internalisedR&Dunits fromcompetitiveadvantagesgivenin the short run by a technologicallead. Similarargumentsapply to the marketingfunction. Thereare advantages given by integratingproductionand marketing-and costs too. However these vertical integration arguments apply to management versus the market.The competitiveadvantageliteratureconcernsthe superiorityof one firm's management over another. Competitive advantages are a measureof net wealth arisingfrom past entrepreneurialactivityand at a point of time are differentiallyavailable to individual firms. The key strategy issue is to derive maximum benefit from this net wealth by deployingit effectively.Hence the need to identify strengthsand weaknessesrelativeto competitorsand potentialcompetitorsand to seekto minimisethreatsandtakeadvantageof opportunitiesin the languageof business strategists. In this shorterrun, strategiccontext,internalisationcan be a weapon.Internalising the marketin key inputs (includingtechnology)can representa significantbarrierto entryto the industry.The abilityto use discriminatory pricingin an internalmarketallowsa firmto cross-subsidize highlycompetitive markets where there is a fear of entry. Elimination of bilateral bargainingmay further strengthena firm relativeto others faced with bargaininginstability. Further,internalisationof markets across internationalfrontiersallowsthe reductionof the firm'soveralltax bill relative to firmswho tradeat arm'slength. Consequently,internalisationdecisions can be a strategicweaponversusother firms in certaincontexts.It is undeniablethat certainmanagementswill see internalisationopportunitiesfaster than othersand may be more skilled-at the evaluationof such opportunities. This will createdifferentialsin the relativescope of firms with cost penalties for those with non-optimalscope ( at a given point of time). AVENUESOF DEVELOPMENT The Integration of Nontraditional Concepts

Internationalbusiness and multinationalenterprisesdo not exist in a vacuum.Theyare profoundlyafffectednot only by economicchangesbut also by social and political change.


Consequentlythe coretheoryof internationalbusinessmustexpandbeyond the narroweconomisticapproachto encompasssocial and politicaleffects. Such an integration, howeverdesirable [Casson 1988a; Dunning 1989; Buckley1989],is not straightforward.It is not possiblesimplyto 'bolt on' nontraditionalor unorthodoxconceptsfrompoliticalscience,sociologyor georgraphyand social anthropology[Buckleyand Casson 1989;Casson 1988b].The integrationof such conceptswill perforceproceedpiecemeal. It is thereforeessentialto examinethe theory for linkingpoints with such conceptsin the hope of buildingbridgesthat will bearthe weightthat they must carry. This crucialaspectof One such bridgeis the concept of entrepreneurship. in and developmenttheory role growth a decisionmakinghas long played [Schumpeter1934].It is also at the heartof much businessstrategytheorising. The conceptualisationof entrepreneurialactivity is no easy task [Casson 1982, 1988b]and its integrationwith analysesof businessstrategy is a problemthat has not yet been tackled successfully. The conceptof internalisationis itself a bridgeto other areas.An example of this is linkageswithwritingson organisationtheory,notablythe resourcedependenceapproach.The classicreferenceis Pfefferand Salancik[1978]. Such a link could reinforcethe hypotheseson the directionaldynamics underlyingthe growth of firms [Buckley1983]. Reintegrationof the Subject

The avenueof developmentoutlinedabovemaylead to a degreeof diffuseness or fragmentationin a core theory which has previouslyhad the quality of coherenceor 'tightness.'The wideningof concepts is essential to encompassthe changingrealitiesof the worldeconomy.However,in so doing internationalbusinesstheorymay well be able to captureareasthat have to some degreedisengagedfrom the core theory.An exampleof this potentialrecaptureis the reinvigoratedfield of internationaltradetheory. Tradetheory has movedawayfrom its strictneoclassicalstraightjacketto becoming policy-orientatedand closely relatedto business strategy.The new 'strategictradetheory'takeson boardthe complicationsbroughtabout by imperfectmarkets.It is not necessaryto accept the policy conclusions that emergeto acknowledgethe importanceof this development.In the mediumterm, developmentsin strategictradetheorymakefull integration with the economictheoryof the multinationalenterprisemucheasier.(For reviews see Rugman [1986] Buckley [1989a]; see also Ethier [1986] Helpman and Krugman[1985].) The possibilitiesof reintegrationof strategictrade theory into the core theory of internationalbusiness are symptomsof a wider phenomenon. Conceptsfrom internationalbusinessare beginningto spill overto neighboring disciplinesand to achieve linkagesthat pull in relatedconcepts. This is happeningin the area of economics, broadlydefined. Howeverit is not the standardmarginalist,neoclassicalelementsof economicsthat are


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provingmost useful but the somewhatunorthodoxclassical,Austrianand mercantiliststrandsof economicthoughtthat aremost relevant.Again, let one examplestand for evidencein each case. Classicalgrowththeory, as expoundedby Adam Smith [1776]and reinterpretedby Josef Schumpeter [1934]puts disequilibriumstates and dynamicchangeas institutedby the entrepreneurat the center of the stage. Austrianapproachesto market processesand entrepreneurial foresightarecentralto the dynamicsof business change and development [Kirzner 1973, 1979; Mises 1963]. The statism exemplified by Friedrich List [1840] is being reinterpretedto providea basic theory for the 'developmentalstate'literaturewhich is felt to be an appropriatemodel for Japan (and possibly for Koreaand other newly industrialisingeconomies) [Johnson 1982]. The common thread of these approachesis attention to dynamics and disequilibriumat the levelsof the firm, marketsand internationalcompetitors. This gives a surprisinglycontemporaryfeel to the concepts. CONCLUSION The core theory of internationalbusiness is a well-establishedbasis on which futureresearchcan proceed.In common with any other theoretical approach,developmentsmust steera coursebetweenanalysingrealityand relativesimplicity.This trade-offwill varywith the task in handand particularlywith the problemthat theory is attemptingto tackle. Extensionof the core theory is necessaryin view of the impact of social and political changesthat cannot be takenas residuals.This extensionrequirescareful redefinitionof the relationshipbetweenkey explanatoryvariablesso that new developmentsgrow organicallyfrom the theory rather than being added in a piecemealand arbitraryfashion. REFERENCES Buckley,PeterJ. 1983.Newtheoriesof internationalbusiness:Someunresolvedissues.In M. Casson, ed., Thegrowthof internationalbusiness.London:GeorgeAllen & Unwin. . 1988.The limitsof explanation:Testingthe internationalisation theoryof the multinational enterprise.Journalof InternationalBusinessStudies,Summer2: 181-93. . 1989a. The frontiers of international business research. Mimeo, University of Bradford.

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