Caves (1996)

Management > Global Firm > Lectures > Independent Research > Caves > Failure of P assets > OLI and transaction costs

OLI and Transaction costs

“Transaction-cost analysis” underlies the eclectic paradigm, which “asserts the existence of three necessary conditions for the appearance of horizontal foreign investments”: OLI. Pp4-5
O: The firm acquires a value-adding proprietary asset
L: The firm efficiently applies the asset in various locations across the globe
I: The firm efficiently manages the decentralised application of the asset itself, rather than “renting it at arm’s length to another firm”

Caves criticises Dunning’s eclectic framework of lacking in explaining the entirety of MNE operations, such as vertical and diversified MNEs. Pg5

Some extensions
In “transaction-cost economies”, a transaction-specific asset is one which reduces the cost of transactions. Trust between people is a transaction-specific asset.

“The proprietary assets that drive foreign investment in some business services seem to be strongly transaction-specific.”

Proprietary assets can be improved upon through investment, but their deterioration can lead to divestment. Pg6

In response to localised demand and cost fluctuations in various places, transaction-cost economies can arise from efficiently shipping products from favourable sites.
If a firm’s factories produce a number of different products, then it might be more efficient for each factory to produce one good each, rather than producing all of them.

Externally-generated funds, such as debts and equity, have high transaction and opportunity costs, as the money has to be returned, rather than reinvested. Internally-generated funds (profits not paid to shareholders) have low opportunity costs, as the firm can use the money to invest in foreign operations.
This suggests that companies earning excess profits have the propensity to conduct foreign investment.

If the asset is a patent, trademark, or technology, then licensing or franchising may be chosen over direct investment. This is an example of an arm’s length deal.

This is also sometimes the best way for a firm to gain maximum return on investment, as it does not incur as many fixed costs, such as start up costs. Pg7

Hypothesis

Factors for Investment and Barriers to entry

FDI

Hymer on FDI

Further comments on FDI