Business / Kogut And Zander'S Theory Of Evolutionary Theory Versus Internationalization Theory
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Autor: anton 27 June 2011
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There are many theories given by different group of researchers about the existence of multinational enterprises or MNE's. According to John Cantwell, it was in the 1970's and 1980's that many theories on MNE's were proposed. These theories were either general theories of MNE's which were called the main institution for international production or the theories on foreign direct investment, the means by which international production is done ( Pitelis, Christos N. and Sugden, Roger, The nature of the Transnational firm, Pg 10). Amongst the most famous are the Hymer's theory of international production, the internalization theory put forward by Buckley and Casson, Dunning's Eclectic Paradigm, and the evolutionary theory given by Kogut and Zander. Hymer's theory is based on the assumption of market failure and market imperfection and he argues that firms internationalize to increase their market power. The internalization theory is based on transaction costs and market imperfection. Dunning's eclectic paradigm explains the nature of MNE's as to why and when firm decides internationalize or setup production abroad. Evolutionary theory is based on the knowledge and resource based view of the firm (Dr. Ramirez, Paulina, lecture 2, International Business Theories).
Here we will discuss the main issues of the internalization theory given by Buckley and Casson and the evolutionary theory given by Kogut and Zander and compare the two theories. To understand these theories lets first discuss what are MNE's?
Multinational Enterprises as the name suggests are firms that own assets and has operations in more than one country. An equity capital stake of 10% or more or voting power is the threshold for control of assets (UNCTAD WIR 2005, Pg 297). There are about 60,000 MNE's across the world as identified by United Nations but the biggest 500 of them account for 80% of the total foreign direct investment (Rugman, Alan M. and Hodgetts, Richard M., International Business, 3rd edition, Pg 38). A firm can carry out its international trade activities in many ways, it can be done through licensing, or franchising, or exports through own sales representatives or through agents or contractors, or by the means of foreign direct investment.
The internalization theory and the evolution theory explain about the existence of the MNE's but are very contrasting in their approach. In this essay, we will discuss how the evolutionary theory is a more satisfactory approach than the internalization approach for the existence of MNE's.
Internalization theory of the MNE's
The internalization theory was given by Buckley and Casson and is based on Coase's (1937) criticism of neoclassical economics (Pitelis, Christos N. and Sugden, Roger, The nature of the Transnational firm, Pg 17). Other scholars such as Alan Rugman, Hennart etc have also talked about the theory of internalization.
Internalization is the process in which a firm instead of buying or selling goods in different countries tries to internalize the process or produces in-house i.e. setup a production facility in another country rather than buying from another firm. The internalization theory is based on transaction cost. The main assumption of this theory is that the market is imperfect and hence the firms maximize their profit. When market is imperfect for intermediate goods then it involves common ownership and control. And this internalization across border gives rise to multinational enterprises. There is also greater tendency for firms to internalize in case of R&D and where there is market for knowledge. This is due to the time gap between the initiation and completion of the research. For example in case of pharmaceuticals industry it takes years to develop a medicine and the firms do not know how the market will behave in future. Moreover the government and health agencies will give more consideration in terms of cost and acceptance of the drug if the production is based in their country. Also internalizing can be useful in the industries where the natural resources are location specific. In 1976, Buckley and Casson proposed that different production requires different combinations of inputs that can be best done in different countries. This depends on number of factors like cost, trade barriers, tax regime etc. For example the cost of setting up a software company in India will be much lesser than in California. Many countries give tax concession for MNE's and hence facilitate investment in their country.
There are many costs involved in internalization. These costs can be communication costs due to cultural differences, costs due to legal systems of the country which favors the local companies.
Buckley and Casson proposed that knowledge is a public good and hence can be transferred easily across the world. The basic assumption about this is that they consider everybody should have equal knowledge. They also stressed on the point that information is important as well and the cost related with information is a handicap for the firm.
Evolutionary theory was proposed by B Kogut and U Zander. The fundamental principle of this theory is that the firms are like social communities that specialize in creation and transfer of knowledge. MNE's are formed due to their enhanced efficiency as organizational vehicle to transfer knowledge across borders (Kogut, B and Zander U., Knowledge of the firm and evolutionary theory of multinational enterprises, Journal of International Business Studies, 2003, Pg 516). This theory stresses on the internally created knowledge that defines the firms comparative advantage and foreign direct investment is transfer of this knowledge. It can be anything like knowledge of technology, production, marketing etc. They explain that firms exist to create new knowledge and replicate this knowledge to expand in foreign markets (Kogut, B and Zander U., Knowledge of the firm and evolutionary theory of multinational enterprises, Journal of International Business Studies, 2003, Pg 525). In a way firms create knowledge, they transfer knowledge, gains knowledge from their subsidiaries and evolve.
The evolutionary theory states that most of the knowledge is tacit knowledge which is not easy to transfer. The tacit knowledge, which is difficult to codify is difficult to transfer to third parties and hence tend to be transferred internally. Kogut and Zander designed a questionnaire to measure the attributes of knowledge. They mentioned three parameters namely, codifiability as to how much knowledge can be coded, teachability as to how much it is difficult to transfer the knowledge to the new workers and complexity of knowledge that is how much it is difficult to transfer the knowledge. Moreover their research suggests that this tacit knowledge is more easily transferred to wholly owned subsidiary at lower cost than to third parties. This is because firms are like communities with established set of rules of how to cooperate and communicate within. Another reason for this behavior is that the transfer is more through experience which are shared more easily internally, and it is much easier to talk to your peers than to third member (Dr. Ramirez, Paulina, lecture notes 5, International Business Theories).
Internalization theory vs Evolutionary theory
Kogut's and Zander's evolution theory differs with internalization theory in many respects. Internalization theory is based on the fact that MNE's exist because there is market imperfection and opportunism. Kogut and Zander explains that market failure is not needed for the existence of MNE's. They say that even where there is no market failure the MNE's can exist. They propose that firms are like social communities (Kogut, B and Zander U., Knowledge of the firm and evolutionary theory of multinational enterprises, Journal of International Business Studies, 2003, Pg 516) to create and transfer knowledge. Their approach is resource and knowledge based. Firms differ in transfer of knowledge and same is the case when it comes to receive knowledge. This leads to a difference in cost of transferring knowledge across the firms and has an effect whether to license the knowledge or to transfer it within the firm and hence it is not related to opportunism.
Buckley and Casson emphasize more on market failure and discards ownership advantage of firms as reason for foreign direct investment as suggested in the evolutionary theory. Kogut and Zander argues that since it is difficult to transfer the tacit knowledge to third parties it is beneficial for intra firm transfers of the know-how knowledge which becomes the firms ownership advantage.
Another issue which is very important in the context of the two theories is that Buckley and Casson describes knowledge as public good and very difficult to protect, and assumes that everybody has the same level of knowledge in the market. And hence they say that knowledge can be transferred very easily and at very low cost. Kogut and Zander has different view of knowledge and they talk about the tacitness of knowledge. They argue that most of the knowledge is tacit and very difficult to codify and hence difficult to transfer. They further say that transfer cost or the communication cost increases as there is difference in culture, economic and linguistic nature of different countries and distance plays an important role in transferring tacit knowledge. For example, CEMEX a Mexican firm is one of the biggest multinational firms for cement products. Its expansion into foreign markets is based on the evolutionary theory of the firm (Dr. Ramirez, Paulina, Lecture notes 5). Cemex initially expanded in countries very close to Mexico such as US, Canada and Latin America. These countries were close to Mexico and the transfer of knowledge could take place easily. It further expanded in Spain in Europe which has similar culture and language as of Mexico (mainly Spanish and Portuguese) and hence knowledge could be transferred easily and cheaply. Later Cemex expanded to some other parts of the world showing evolutionary growth.
We have discussed the nature of the internalization theory and evolutionary theory and have tried to distinguish the key assumptions and arguments of the two theories. Evolutionary theory put forward by Kogut and Zander, in my, gives a more satisfactory view of the existence of multinational enterprises.
This is the called as period of globalization and multinational enterprises are the vehicles of this phenomena. Today's economy is a knowledge based economy which is very much dependant on the knowledge of the firm which results from innovation. Innovation and knowledge are key to the growth of any firm. Kogut and Zander are more accurate in saying that MNE's are the creators and transferors of knowledge. Most of the knowledge is tacit and it is very difficult to transfer tacit knowledge and it is expensive to transfer this type of knowledge between firms. So most of the transfer of tacit knowledge is intra firm transfer rather than inter firm transfer.
Kogut and Zander also talks about ownership advantage or firm specific advantage which they think is the key to the existence of MNE's in foreign markets. The ownership advantage can be in any field whether it is transfer of tacit knowledge, whether it is in marketing or in production or in operations and logistics or can be anything else. There should be a firm specific advantage for firms to succeed in foreign markets. In case of CEMEX, the firm specific advantage was its global IT systems, which tells the customer (in any part of the world) when their consignment of cement will be delivered (Ramirez, Paulina, Lecture notes 5).
There are criticisms for the evolutionary theory also. Many people believe that they are correct in saying that opportunism is not necessary for market failure and it is not the cause for existence of MNE's. But they talk about the difficulties of transferring the tacit knowledge which itself is a transaction cost and a case of market failure.
Overall the evolutionary theory explains the existence of firms in a more satisfactory way because they stress on the creation and transfer of knowledge and knowledge is the most important component of MNE's growth.
Ð²Ð‚Ñž Pitelis, Christos N. and Sugden, Roger, The nature of the Transnational firm.
Ð²Ð‚Ñž Dr. Ramirez, Paulina, lecture 2, International Business Theories.
Ð²Ð‚Ñž UNCTAD WIR 2005, www.unctad.org.
Ð²Ð‚Ñž Rugman, Alan M. and Hodgetts, Richard M., International Business, 3rd edition.
Ð²Ð‚Ñž Kogut, B and Zander U., Knowledge of the firm and evolutionary theory of multinational enterprises, Journal of International Business Studies, 2003.
Ð²Ð‚Ñž Dr. Ramirez, Paulina, lecture notes 5, International Business Theories.
Ð²Ð‚Ñž Dr. Ramirez, Paulina, lecture notes 1-6, International Business Theories.
Ð²Ð‚Ñž Tallman, S., The significance of Bruce Kogut's and Udo Zander's article, 'Knowledge of the firm and evolutionary theory of the multinational corporation', Journal of international business studies, Volume 34, No. 6, (Nov.2003).
Ð²Ð‚Ñž McFetridge, Donald G., Knowledge, Market failure, and the multinational enterprise: A comment. Journal of international business studies, Volume 26, No. 2, (2nd quarter, 1995).
Ð²Ð‚Ñž Love, James H., Knowledge, Market failure, and the multinational enterprise: A comment: A theoretical note. Journal of international business studies, Volume 26, No. 2, (2nd quarter, 1995).
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