The Eclectic Paradigm, also referred to as the Ownership-Location-
Internalisation (OLI) framework was developed by John Dunning in 1977. It is regarded as a paradigm and not a theory because it provides a complete statement of FDI activity by integrating three different principles which have been developed over time by many scholars. The Eclectic paradigm differentiates between Internalisation and Externalisation. Internalisation takes place when a firm undertakes FDI by operating on its own in at least one foreign country using ownership foreign market entry modes like IJV, Subsidiary, WOS or offshoring. Externalisation takes place when a firm does not undertake FDI and does not become an MNE but instead operates through others in at least one foreign country using contractual foreign market entry modes like Exporting, Licencing, Franchising, Strategic Alliance and Outsourcing.
Internalisation allows a firm to maximise profit in a world of imperfect
markets, by creating internal markets which involve bringing under common ownership and control the activities which are linked by the market. It is the internalisation of markets across national boundaries that generate MNEs (Buckley and Casson, 1976). Internalisation theory suggests two simple rules for a firms strategy and implementation. The first is that managers compare external transaction costs i.e. the costs of using the market, with internal agency costs to create a balance which determines the scope of the firm. The second rule is that managers should endeavour to reduce agency costs in relation to transaction costs in order to increase the scope of managerial control.
Ownership Advantages do not refer to legal ownership but rather in the
International Business literature means the capabilities, skills and strengths that make the focal firm successful in a foreign country. Such advantages include brands, technology, skilled HR, finance etc. Stephen Hymer suggests that MNEs undertake FDI in order to appropriate rent on certain skills and abilities. Location advantages refer to locationally fixed assets both natural e.g. oil or created assets e.g. Silicon Valley and other non-tradable assets. The acquisition of ownership advantages (strategic asset seeking) and location advantages (resource seeking) are motivations for FDI. Another motivation for FDI is market seeking, undertaken in order to raise a firms market share.
The Eclectic Paradigm brings together Ownership Advantages, Location
Advantages and Internationalisation theory and purports that FDI will not take place if the foreign location does not have sufficient attraction in comparison to the MNE home country i.e. all three (O-L-I) advantages must be present for the existence of MNE and for FDI to take place. The OLI framework provides a general explanation of FDI activity. More so, these OLI variables interact and affect FDI flows and this interaction is captured by the Investment Development Path (IDP) which states that countries progress through 5 stages in response to changes in these OLI advantages.