UGF Lecture 7

Internalisation

Three points can be observed about internalisation in MNEs:

"Any efficiency maximising form will internalise any intermediate product transaction that is more efficiently performed within the firm". This is not a theory, this is an observable fact. A firm will internalise if it believes it is necessary. However, this is a description, not an explanation. What is needed is an understanding of the potential characteristics of a market which will causes a firm internalise or externalise. There are a vast number of potential OAs about which to make this decision so it can be difficult to assess.
MNE economic theory explains that externalisation can be subject to costly failures, but does not analyse internal transactions. Although it may be inefficient to externalise, it may be equally inefficient to internalise. However, the more inefficient an external market, the greater the likelihood that internalisation will occur.
There is no specific international component to internalisation theory. It is part of a framework, meaning that it does not stand as a theory by itself, or as a "stand alone "theory. It simply describes the nature of a transaction between two independent firms. Within MNE theory, LAs determine that the two firms may be in different countries, which can mean higher transaction costs for externalisation. Alternatively, internalisation may be more difficult if two parts of the same firm are in different countries.