Internalization and Knickerbocker’s theories

Internalization and Knickerbocker’s theories

            Foreign Direct Investment (FDI) describes the process where a firm invests directly in the assets of another company, which is located in a different country to produce goods and services. Through FDI, other countries build up infrastructure, create employment opportunities, and adopt new technology. Foreign Domestic Investment can be described by the Internalization theory and Knickerbocker’s theory. Internalization theory explains why firms prefer Foreign Direct Investments over the licensing of companies in a foreign country. According to the theory, licensing has major drawbacks, which makes FDI a better approach to expand firms in foreign countries. On the other hand, Knickerbocker’s theory asserts that firms aim to secure their market positions to outdo the competition by following decisions about setting up the location of other enterprises. Businesses tend to follow other enterprises’ choices of a foreign location. Both theories explain the trends in FDI, however, they differ in the discussion of determinants involved in each pattern, the established motives which firms have, and the depth that each theory goes into to explain most firms’ behavior.

Both internalization and Knickerbocker’s theories explain the patterns of foreign domestic investment (FDI). Firms tend to avoid exporting and licensing, as strategies to expand their markets in other countries (Meyer & Peng, 2016). The theories deal with the reasons behind FDI for such expanding companies, which do not prefer exporting or licensing approaches to grow investments. Internalization theory supports FDI by describing the limitations of licensing foreign businesses, while Knickerbocker’s theory addresses the behavior of these multinational companies. In both theories, companies decide to use FDI as the priority in growing their international markets, particularly in countries that have conducive environments for the production and marketing of their goods.

On the other hand, internalization theory focuses on industry-level determinants of Foreign Direct Investments, whereas Knickerbocker’s theory emphasizes on country-level factors. According to the internalization theory, firms develop new technology, which cannot be transferred to other enterprises due to transactional costs (Hamilton & Webster, 2018). Licensing other related firms has drawbacks, therefore, it is better to improve internal production techniques rather than giving away technological methods. Knickerbocker’s theory asserts that a firm seeks to select the best location for the production of goods and services. Choosing the location of enterprises is emphasized where the enterprise will choose countries with higher chances to reap more profits.

Additionally, the motives involved in the internalization theory are different from those that force firms into FDI in Knickerbocker’s explanation. Motivation in internalization theory erupts when firms realize they can maximize profits in a market that is imperfect (Meyer & Peng, 2016). These market imperfections include improper pricing of goods, unstable bargaining situations, and slow coordination of resources. Internal strategies are then implemented to improve the quality of goods and services, which leads to stable market prices.  In Knickerbocker’s theory, motives towards choosing a particular country to establish an enterprise are determined by access to the host country’s market and to match the competitor’s move. A firm will follow its competitors to avoid losing the strategic positions, which will suit productivity and market access for the goods. Besides, where competitive firms have settled in a particular country, other businesses tend to establish their enterprises in the same locations to reap profits associated with the strategic position of a firm.

Furthermore, the internalization theory addresses the reasons why the first enterprise decides to undertake FDI, while Knickerbocker’s theory only explains the imitative behavior of businesses in selecting locations. Analysis of licensing is addressed in internalization theory, where a firm will encounter drawbacks if it chooses to seek licenses for businesses in foreign countries (Iamsiraroj, 2016). First, licensing may expose their technological know-how to competitors in a foreign country. Also, a firm loses complete control over manufacturing, marketing, and strategy in a foreign country, as the new enterprise may impose business terms to maximize their profits in that specific location. Thirdly, the central firm may not utilize management and marketing plans as a competitive advantage compared to the enterprise in a foreign country, which has better chances of using such capabilities to outdo competitors. On the other hand, Knickerbocker’s theory only explains the motive of a firm’s decision to locate a firm to cope with the competition.

In conclusion, Foreign Domestic Investment (FDI) is preferred by most expanding businesses, which extend operations into other countries. The pattern adopted by firms in FDI is described through internalization and Knickerbocker’s theories. Internalization theory asserts that FDI is advantageous over licensing or exporting for expanding firms, while Knickerbocker’s argument explains that firms select the location of firms as their competitors to fight over strategic site benefits. Both theories explain the patterns and dynamics in FDI applied by expanding companies. On the other hand, the difference between the theories is the approach and the extent of explanation of the reasons behind FDI.

References

Hamilton, L., & Webster, P. (2018). The international business environment. Oxford         University Press.

Iamsiraroj, S. (2016). The foreign direct investment–economic growth nexus. International            Review of Economics & Finance, 42, 116-133.

Meyer, K., & Peng, M. W. (2016). International business. Cengage Learning.