Implications for FDI theories

Document(s) 2 of 3

It is generally accepted that Dunnings (1993) ownershiplocationinternalization (OLI)

framework (ownership-specific advantages, locational factors, and internalization) is most useful
in analyzing and explaining FDI. The prevalence of networking in inter- and intrafirm trade
demonstrated by the Hong Kong experience does not undermine the OLI framework in any
significant way. Indeed, networking is a form of internalizing the cross-border market in
intermediate products to minimize transaction costs. Complete internalization occurs in such
cases as the parentaffiliate relationship and the interaffiliate relationship in the same group.
Interfirm networking is something of greater interest because it represents only partial
internalization.
The reason for conventional parentsubsidiary networking is easy to understand. However, it is
more difficult to explain the emergence of interaffiliate relationships and even more difficult to
explain the increasing importance of interfirm networking. A major reason for the inter- and
intrafirm relationships is to be found in technological factors. With rapid technological change
and a high degree of specialization in parts and components, the need for networking is greater
and the scope for networking is wider. In the context of the value chain, this means that when
production becomes more complex and sophisticated, the value chain becomes longer and the
possibility of, and need for, establishing inter- and intrafirm networking become greater. The
different degrees and patterns of networking found in different types of firms may not reflect
their source of investment (local or foreign) but are related to the nature of the different value
chains. After economic and technological conditions change, the patterns of networking will be
different, reflecting business firms search for the optimal mix of internal organization and the
market. Parent companies have to give up some of their control over their subsidiaries so that the
subsidiaries can have a wider choice in procuring the required parts and components. Firms also
have to sacrifice certainty for greater exposure to the technological resources available elsewhere
among competitors. Traditional Chinese business firms network on the basis of cultural affinity,
which helps to reduce transaction costs (particularly legal costs). However, in a technologydominated environment, the need to pull technological resources together overrides the
importance of common cultural values.
In our survey, we found that a significant proportion of business-networking arrangements can be
explained on the basis of buyer-induced backward integration. This means that buyers today are
very particular about the quality, specifications, and reliability of the product they order. To
ensure quality control, firms undertake backward integration or networking with firms they can
rely on. We also found that factor markets are increasingly imperfect because of rapid
technological change and increasing specialization. Many of the suppliers of intermediate
products enjoy oligopolistic power. The buyers of intermediate products (as well as producers of
final products) have tried to overcome the market power of the suppliers by buying through
agents. Some interfirm relationships in marketing and distribution are established on this basis.

Thus, the prevalence of networking of firms has enriched internalization theories in the OLI
framework.
Networking also has some impact on the conceptualization of ownership-specific advantages in
the conventional OLI framework. Networking is an indication of a longer value chain and
disintegration of ownership-specific advantages into many highly specialized advantages. At the
same time, networking induces further disintegration of ownership-specific advantages because
it is in the interest of a firm to unbundle its ownership advantages in networking relationships, so
that cooperation with outsiders, as in strategic alliances, will be confined to a specific area,
without involving the entire firm. Today, the major ownership-specific advantage is
technological knowledge, which is a form of intangible asset with transaction costs that can be
significantly reduced through the internalization of markets. This also helps to explain the
increasing importance of firms networking activities.
An investing firm tends to be attracted, not just by a particular location, but also by the entire
subregion. For example, many of the firms investing in Hong Kong are attracted by Hong
Kongs being a focal point in the South China Economic Zone. This is one reason why so many
manufacturing companies have set up their RHQs in Hong Kong. A case in point is Digital
Equipment Company. Its affiliate in Taiwan is responsible for sourcing machinery and equipment
and intermediate products; Digital in Hong Kong is the RHQ that oversees corporate
management, planning, and coordination; and Digital in China does all the manufacturing. Most
firms are taking a subregional strategy when making decisions about FDI in the AsiaPacific
region. This is a form of internalization of the regional economy. Disintegration of ownershipspecific advantages has also given rise to the exploitation of different highly specialized
advantages in different parts of a subregion. It is commonplace today to find a foreign firm
setting up more than one affiliate, even in one locality in the host country.
Also, locational advantages are disintegrating because of the unbundling of ownership
advantages and a longer value chain. A location does not have to possess many locational
advantages to attract FDI; one or two advantages will do. Production is increasingly distributed
among numerous locations that each offer a few specialized locational advantages for a particular
activity in the value chain.
In sum, networking of business activities among firms does not fundamentally undermine the
OLI paradigm for FDI. However, some modifications should be made to the concepts of
ownership-specific advantages and locational factors in the conventional framework. More
importantly, studies on the networking activities have thrown important light on the nature of
internalization. This has given the conventional OLI paradigm even greater explanatory power in
the analyses of FDI.