Dynamic theories of FDI and entry modes

The transaction costs approach and OLI paradigm assume, implicitly or explicitly, that managers employ a deliberate and calculative approach to FDI location decision making (Buckley, Devinney, Louviere, 2007). In reality management decision making on where to locate an activity and how to control it may well be determined by limited information and risk aversion, both of which can be gradually overcome as companies gain international experience. At the same time, location factors of a potential host country for FDI are unlikely to be static and will depend on the level of economic development of the country.

In response to the static view of location factors and rational perspective of management decision making found in the early literature on the topic, two theories have considered the dynamics of FDI over time, one from a firm perspective (Uppsala model) and one from a country perspective

(Investment Development Path). These theories are discussed here in order to provide a complete picture of the main entry mode and FDI theories.

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(i) The Uppsala model

Johanson & Vahlne (1977) developed an organisational knowledge based perspective which has since become known as the Uppsala model or the internationalisation process model. The theory was developed on the basis of just four case studies of Swedish multinationals in different industrial sectors but has still succeeded to be recognised as a major contribution to the field of International Business.

Johanson & Vahlne argue that the internationalization of a firm is a step by step process of increasing commitments as a firm develops international experience. They identified the following steps as part of the ‗establishment chain‘, with each step representing an additional resource commitment:

1. Irregular export activities

2. Export via independent sales representative 3. Establishment of overseas sales subsidiary

4. Establishment of foreign manufacturing subsidiaries

They also observed that internationalisation of companies starts in foreign markets that are close to the domestic market in terms of psychic distance, which is defined as factors that make it difficult to understand foreign markets. Companies then move gradually into markets that are further away in terms of psychic distance.

Johanson & Vahlne (1990) also listed situations when firms do not necessarily follow the steps of the establishment chain as follows:

1. Firms with access to a large pool of resources

2. Firms with an ability to obtain relevant market knowledge in ways other than through direct experience, for example when markets are stable and homogeneous.

3. By using the experience obtained in similar markets.

The Uppsala model has been criticised on the basis that internationalisation of firms has accelerated (through, for example, international joint venture and merger & acquisition activity) and that firms start to internationalise soon after their birth (Oviatt & McDougall, 1994) or are even ‗born global‘

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(Knight & Cavusgil, 1996). However, Johanson & Vahlne (2009) argue that this increasing speed of internationalisation does not contradict the concept of the establishment chain. At the same time, they did recognise that developments in International Business theory and practice call for an extension of the Uppsala model, which they provided by adding the dynamics of the business network environment to their original model (Johanson & Vahlne, 2009).

The Uppsala model is useful in that it shows that a company‘s decision regarding FDI can depend on its multinational experience. Johanson & Vahlne also demonstrated that it is possible to build an influential theory on the basis of just four cases studies, which is somewhat of a rarity in the

International Business discipline. The research reported in this dissertation will also use a multiple case study, the results of which can be partly interpreted in the context of Johanson and Vahlne‘s internationalisation theory.

(ii) The Investment Development Path

A dynamic framework of the location drivers for different types of FDI at a country level has been made by Dunning & Narula (1996). According to their Investment Development Path (IDP) theory, countries can be classified into five stages of development, including developing (stages 1 and 2), newly industrialized (stage 3) and developed countries (stages 4 and 5). The IDP theory predicts that developing countries attract primarily resource seeking FDI, newly industrialized countries attract primarily market seeking FDI and developed countries attract primarily strategic asset seeking FDI. In other words, as countries develop, the main location factor shifts from the presence of natural resources to the attractiveness of a country‘s market and then to the state of a country‘s

infrastructure and availability of high quality created assets (Narula & Dunning, 2000). Analyses of location factors based on the IDP have found only limited support for the theory. For example, Galan, Gonzalez-Benito & Zuñiga-Vincente (2007) found that investments by Spanish MNEs into developed countries were largely driven by technological and infrastructure factors, as posited by the IDP. However, investment into less developed countries were not driven by the availability of natural resources, but by other factors such as social and cultural ties between the MNEs home and the host country. The MENA countries are not easy to classify according to the IDP, since several countries have high levels of GDP per capita as a result of energy endowments, while displaying other characteristics that would classify them at earlier stages of development. These countries attract market seeking FDI (as well as natural resource seeking FDI), while they have not yet gone

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through an industrialisation phase and are not in possession of significant high quality strategic assets that are characteristic of advanced economies. Despite the absence of a great deal of empirical support for the Investment Development Path and the fact that MENA countries can‘t easily be classified according to this framework, the IDP can be a useful reference point for interpreting the results of the research.