What it means
Companies that set up factories, offices or shops abroad take on extra costs and risks compared with local firms. Dunning's framework, often called the OLI model, asks what has to be true for that investment to make sense.
The three letters stand for Ownership, Location and Internalisation, and a company usually needs all three to justify direct investment in another country. Ownership advantages are things the company has that rivals do not, such as a strong brand, patented technology, special skills or efficient processes.
These advantages let the firm compete against local businesses that know the market better. Without something distinctive, a foreign entrant would struggle to win customers.
Location advantages are features of the foreign country that make it attractive for producing or selling. They might include lower labour costs, access to raw materials, a large market, skilled workers or favourable trade rules.
If the home country is the best place to produce, there is no reason to move. Internalisation advantages explain why the company wants to run the activity itself instead of licensing it to a local partner.
A firm may fear losing control of its technology or quality standards, or find that contracts are costly to enforce. Keeping the activity in-house, perhaps through a wholly owned subsidiary, reduces those risks.
The framework is used in business strategy, international trade and finance to explain patterns of foreign direct investment. A finance team can use it as a checklist when assessing a cross-border expansion, asking whether each of the three conditions really applies.
It is described as eclectic because it pulls together several theories into one approach. Critics point out that the model is broad and hard to test with precise numbers.
It also developed over time, and later versions added factors such as institutions and strategic motives. Even so, it remains one of the most widely taught explanations of why companies become multinational.
In practice
Real-world examples.
Example
A software company with a unique analytics platform opens an office in Singapore. It has an ownership advantage, the region offers a growing customer base and skilled staff, and the company prefers to run the office itself to protect its source code. The company judges that the Singapore office will earn a better return than selling through a distributor.
Example
A clothing brand with a well-known name moves production to a country with lower labour costs. Because it wants tight control over quality, it builds its own factory instead of using an outside contractor. The extra cost is accepted as the price of protecting the brand.
Example
A restaurant chain enters a new country through franchising instead of owning its outlets. The chain's brand is an ownership advantage, but the weak local legal system makes the extra cost of running every outlet itself hard to justify. The chain therefore keeps its capital for markets where it can control the quality of service.
Case study
Seen in the real world.
This is a fictional story. Alderbrook Cycles, an invented bicycle maker, was considering building a plant overseas. The finance team used the eclectic paradigm as a checklist before committing $20,000,000.
On ownership, the firm had a patented lightweight frame that rivals could not copy. On location, the target country offered skilled workers and tariff-free access to a large market. On internalisation, the board worried that a local licensee could leak the design, so it chose a wholly owned plant.
All three conditions held, so the board approved the project. Had the team found no strong location advantage, it would have considered exporting from home instead. The story is fictional, but it shows how the framework turns a vague idea into three testable questions. The finance team later reused the same three questions for every proposed expansion, which made the board papers easier to compare.
Watch out
Common mistakes.
- Thinking only one of the three conditions is needed. The framework says ownership, location and internalisation advantages should all be present for foreign direct investment to make sense.
- Treating the model as a formula that gives a number. It is a qualitative framework for structuring decisions.
- Confusing it with a portfolio theory. It concerns the investment decisions of companies, not the choices of investors.
Questions
People also ask.
Who developed the eclectic paradigm?
The British economist John Dunning developed it, and it is also known as the OLI framework.
Why is it called eclectic?
It draws on several different theories of international business and combines them into one approach. It was designed to be flexible, so the details can be adapted to different industries.
When should a company use licensing instead of direct investment?
Licensing may suit a firm that has an ownership advantage but sees little risk in sharing it, or where running local operations would cost too much. Each choice has trade-offs between control, cost and speed of entry.
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