BUSM114 International Business Analysis- Foreign Direct Investment

International Business (IB) is about business or firms engaging in intercontinental (crossborder) economic activities and trading transactions and/or the activity of doing business abroad. The most important participants in International Business are known as MultiNational Enterprises (MNE) which-apart from making daily headlines-are firms participating in foreign direct investment by directly investing in, controlling and managing value- added activities in other countries.

The empirical evidence have identified two core theories which explain the evolution and the development of international business activity: (i) the Institution-Based Theory (IBT) and (ii) the Resource-Based Theory (RBT).

Required:

 

What is the role played by (i) the Institution-Based Theory (IBT) and (ii) the ResourceBased Theory (RBT) when it comes to MNE’s or IB’s in general “evolution”? You may illustrate your answer by referring to some specific examples What we mean by “evolution” of the MNE or International Business?

Answer

Introduction:

International business is considered as those business activities which are conducted at cross border and include dealing of goods and services between two or more countries. Transactions related to goods and services include capital, skills, and people for the purpose of international production of production of physical goods such as finance, banking, etc. at international level. International business can also be considered as globalization.

In other words, international business involves those firms which engaged in cross border economic activities, trading transactions, and activity of doing business abroad. Participants of international business are known as Multi - National Enterprises (MNE), and MNE are those firms which participates in foreign direct investment by directly investing, managing and controlling those activities which are value added in other countries.

Evolution and development of activities related to international business are evidenced by two core theories, and these theories are the Institution - Based Theory (IBT) and the Resource - Based Theory (RBT). This paper analyzes the role played by IBT and RBT in lieu of MNE and International business in general evolution. General evolution of MNE and IB involves foreign investment, offshoring and outsourcing, and foreign entry strategies. Lastly, paper is concluded with brief conclusion.

Evolution in international business and MNE:

What helps the firms in driven their strategy in case of international business, and what factors determine the success of the firm at global level? These two questions are considered as most important questions of the international business (Peng, 2004). It can be said that both the questions are addressed by two perspectives that are institutional based theory and resource based theory.

Role played by Institutional based theory:

Two big paradigms governing the field of international business and MNE, in 1980 industry based view dominant this field and in 1990 resource-based view of the firm dominant the field. In recent decades, both the perspectives move like pendulum for the purpose of answering the questions stated above. Recently, third perspective is introduced in this field and this perspective is considered as consideration of industry based view and resource based view, and this perspective is known as institution-based view. IBT includes both the factors that are economic (institutional economics) and sociological (institutional theory), and the main aim of IBT is to understanding the why firms differ in context of competitive advantage (Kang & Jiang, 2012).

In other words, this theory determines the rule of games in the society. As stated by North, this theory is developed for addressing the humanly issue that cause from political, economic and social factors. These factors impose restrictions on the behavior of business by putting legal, moral and cultural boundaries, and these boundaries differentiate between the legitimate and illegitimate activities. From theoretical point of view, it can be said that this theory is considered as efficient solution to the problem of organization in the competitive framework. Therefore, it can be said that IBT is the result of combination of both the theories stated above in context of business strategy. It drives the choices in strategies as a result of the dynamic interaction between organizations and the formal and informal institutional environment (Garrido, Gomez, Maicas & Orcos, 2014).

The impact of institution based theory on strategy of international business is pervasive in nature, and it serves various other functions. Institutions are considered as pervasive in nature because they shape the behavior of multiple actors such as individuals, firms, industries, and non-governmental organizations. It can be said that institution reduces the uncertainty level of different actors by providing the norms related to behavior of the firm and stated the boundaries to define the legitimate actions. Actors conduct their business and decide between the formal and informal factors stated in the framework defined by the institution. Uncertainty in such factors directly affects the decisions taken by actors, and also stated that inform decisions and actions are the result of the relevant institutions. Rational approach is provided by the institution for the purpose of justifying the compliance with the norm. There are three pillars of compliance, and these three pillars are regulative pillar, normative pillar, and cognitive pillar (Peng, Wang & Jiang, 2008).

This can be understood through example, as political systems of the nation shows uncertainty in context of the way in which transactions are affected by the government and the institutional structure stated by the government (Acemoglu and Johnson 2005). Logic related to political system which is predominant in nature states that political system which is democratic provides more certainty and predictability within the society. Therefore, it can be said that degree of political risk defines the institutional environment in the international business. By applying this logic to the decision making of MNE, it is clear that political system play important role in cross border transactions.

As stated above, foreign direct investment (FDI) is considered as most important feature of evolution of MNE. It must be noted that, institutional structure and governance play major role in attracting the foreign investments, and this statement is mainly suitable in case of transition countries.

The strategies used by the firm shows the translation of both formal and informal constraints with the institutional framework of nation. It must be noted that, formal institution and informal institutions are derived from the other sources in the institutional environment of the firm, but still both the factors contribute similarly while guiding the behavior off the firm. In case formal constraints are not complete and present then informal constraints can be used to guide the behavior of the firm.

Generally, it can be said that both formal and informal institutions combine for the purpose of governing the behavior of the firm. However, when formal constrains are not present then informal constraints play important role in reducing the uncertainty and guide the mangers in context of firm’s institutions that are societal activities, cultures, and ethics which are supported by normative and cognitive pillars.

Strategic behavior is affected by the normative pillar to the extent that strategies framed by the firm are related to the informal institutions in context of social norms. Strategic behavior is also affected by cognitive pillars to the extent that valued and shared beliefs are also incorporated in the decisions of the firm (Mathews 2006). Therefore, it is necessary to maintain the balance between the formal and informal institutions.

Those firms which share their environment of institution with each another may usually make similar type of decisions and deal with similar type of institutions. This can be understood through example, cultural as an informal institution guide the firm in making strategic decision in the absence of formal institution (Peng & Khoury, 2008).

Role played by resource based theory:

Recent, there are large number of firms from emerging economies have come to define and dominate new markets, and they enter in the field of global market and become global innovation leaders. Those firms which were specialized in providing the substitutes which were high quality but cheap such as Brazil’s Embraer, those firms which adopted fast second mover strategies such as Samsung, and those firms which offer outsourcing services such as Wipro are now actively indulged in the global productivity and innovation frontier. Additionally, there are number of small and medium sized firms which start their activities in abroad at their own account.

In this era of globalization, there are number of firms which are not able to cope with the changes occurred in the market competition on the basis of resources and capabilities which are owned by firm.  Therefore, rather than improving their own competencies, firms must concentrate on keeping long term relations with their business partners for the purpose of arranging their networks for getting other type of resources (De Man, 2004). Therefore, it can be said that opening of market and international division of labor gain, and internationalizing the activities of firm can be considered as important strategy for the firm for the purpose of ensuring sustainable growth. This process is known as the international process through which MNE develop its relationship with its partners in the foreign market. In what way firm can develop these networks in the foreign market and those areas where firms can invest for the purpose of getting resources is considered as major issue in context of international business. For solving these issues, RBT was developed and it helps the firms in getting competitive advantage.

From the period of 1990, Resource-based theory (RBT) dominates the market and it considered as most important theory of strategic management research. As per the argument stated by RBT differences in performances of firm is because of the firm heterogeneity. Those resources of the firm which are rare and valuable will help the firm in achieving sustained competitive advantage. From last few years, various branches with different assumptions and perspectives were introduced by the RBT. This theory extended the core tenants by stating the perspective for the purpose of explaining how inter-firm cooperation can help in generating the competitive advantage in sustainable manner. This theory stated argument that resources if generating in accurate way than it can help the firm in creating their competitive advantage as it can expand the boundaries of the firm and also create inter-firm relations. Therefore, firm can get competitive advantage not only from those internal resources which are owned by the firm but also from external resources which are got by the firm through its relational networks (Lavie, 2006).

As stated, internationalization is considered as process through which firm increase its involvement in international market, and foreign market is considered as that area in which entrant firm develops the relationship with other partners in foreign networks. This process is driven by efforts of the firm for the purpose of creating the value through coordinating their activities. It must be noted that this theory mainly emphasis on the access of resources, market, information, and technology by the firm. It also allowed the firm to share risk and outsource value-chain stages. Overall RBT theory in evolution of IB and MNE are:

• It allowed to firms to get specialization in core business of the value chain, division of labor improves the efficiency, and also provide scale and scope in context of economy.
• Firms in the relational network enjoyed the flexibility provided to them because they do not have fixed commitments to those activities which are not important for them, and this flexibility enables the firm to act quicker as compared to rivals.
• Firms can easily cut down the transaction costs through mutual awareness and by trusting their network members which help them in ensuring long term cooperation.
• It also allowed the firms to access key resources from the environment.

After considering above facts, it is clear that IBT and RBT play completely different roles in the IB and MNE, but still coordination between the two is necessary to driven the strategy of the firm and gaining competitive advantage (Wang, n.d.).

Conclusion:

There are number of scholars considered the fact that IBT in case of emerging economies and in developed economies also not only focus on industry conditions and firm capabilities, but it also focus on various other factors.  IBT with the combination of industry- and resource-based views developed formal and informal constraints which directly affected the strategy of the firm. In this paper, first we seriously consider the importance of institution, after that we worked on analytical logic. Lastly mechanisms in this context are underlying. On the other hand, Resource-based theory (RBT) dominates the market and it considered as most important theory of strategic management research. As per the argument stated by RBT differences in performances of firm is because of the firm heterogeneity. Those resources of the firm which are rare, valuable, non-substitutable, and difficult to imitate will help the firm in achieving sustained competitive advantage.

References:

Garrido, E. Gomez, J. Maicas, J. & Orcos, R. (2014). The institution-based view of strategy: How to measure it. BRQ Business Research Quarterly, Volume 17(2), Pp 82-101.

Kang, Y. & Jiang, F. (2012). FDI location choice of Chinese multinationals in East and Southeast Asia: traditional economic factors and institutional perspective, Journal of World Business, Volume 47 (1), pp. 45-53.

Lavie, D. (2006). The competitive advance of interconnected firms: An extension of the resource-based view. Academy of Management Review, 31(3), 638-658.

Mathews, J. (2006). ‘Dragon Multinationals: New Players in 21st Century Globalization’, Asia Pacific Journal of Management, Volume 23 (1), Pp- 5–27.

Peng, M. W. (2004). Outside directors and firm performance during institutional transitions. Strategic Management Journal, Volume 25(5), PP- 453–471.

Peng, M. Wang, D. & Jiang, Y. (2008). An institution-based view of international business strategy: a focus on emerging economies. Available at: https://www.academia.edu/3240077/An_institution-based_view_of_international_business_strategy_A_focus_on_emerging_economies. Accessed on 14^th November 2017.

Peng, M. & Khoury, T. (2008). Unbundling the institution based view of International business strategy. Available at: https://www.utdallas.edu/~mikepeng/documents/articles/Peng08KhouryOHIBRugman256-268.pdf. Accessed on 14^th November 2017.

Wong, J. A Relational View of Resources-based Theory: The case of Internationalization of Li & Fung Group. Available at: https://www.hraljournal.com/Page/4%20Jeng-Min%20Wong.pdf. Accessed on 14^th November 2017.