Monopolistic Advantage Theory Essay ⋆ Business Essay Examples ⋆ EssayEmpire

Monopolistic advantage theory, first proposed by S. H. Hymer in his doctoral thesis and later expanded by C. P. Kindleberger, explains the reasons multinational corporations (MNCs) are able to compete successfully against local firms. It is a microeconomic theory that makes the firm the center, as well as the cause, of the international movement of capital and goods.

The monopolistic advantage theory elucidates why firms choose to internationalize their operations. Typically, MNCs are at a disadvantage compared to local firms because they have to cope with liabilities of foreignness, lack of local know-how, high cost of acquiring this knowledge in other countries, etc. However, these costs are offset by the existence of certain “monopolistic” advantages possessed by the MNC. Deploying these advantages abroad allows the MNC to glean profits that are not easily accessible to local firms and helps them attain success in international arenas.

Foreign direct investment (FDI) is an equity-based mode of international entry wherein physical investments are made by one company to build a factory in a different country, and also includes the acquisition of lasting interest in firms across national borders. FDI confers ownership rights and control over the foreign affiliate to the multinational firm. Specifically, they choose to enter international markets via FDI in order to capitalize on one or more unique monopolistic advantages that they possess. These advantages may arise from superiority in technological innovation, manufacturing processes, brand names, knowledge, patents, scale economies, or marketing skills in comparison to local firms. The advantages do not arise from location of production, but are specific to the firm. Further, they are owned by the firm and cannot be purchased by local competitors in the open market.

Under conditions of perfect competition, local firms would stand to benefit in two ways. First, they would be able to leverage inherent locational advantages such as physical proximity, favorable consumers, government protection, familiarity with rules, etc. Second, due to the efficient resource allocation situation, they would be able to buy technology or other advantages from the MNC. As a result, possessing these advantages would confer no special benefits or profits to competing multinational firms.

It is important to note that monopolistic advantage theory breaks away from the assumptions of perfect competition that existed in classical economic capital flow theory. Instead, it acknowledges the existence of market imperfections for the factors of production (land, labor, capital, management, proprietary knowledge, etc.) that tend to create barriers to competition from local firms. Due to the existence of these market imperfections, the advantages possessed by multinational firms cannot easily be purchased by local firms, creating quasi-monopolies. Under such conditions, foreign direct investment by MNCs is extremely lucrative, as it provides control over resources in foreign locations and a level of monopoly power vis-à-vis local competitors. Consequently, MNCs are able to acquire monopolistic rents and profits that exceed the costs and disadvantages of competing internationally.

The advantages possessed by foreign firms must satisfy the condition of relatively easy international transferability with minimal incremental cost to the firm. Hence they should be able to be deployed abroad without much adaptation or significant additional expense to the multinational firm. Common examples are the advantages that arise from technological patents, which can be leveraged across borders to recover sunk costs of investment in research and development and to gain profits from such firm specific knowledge. By exploiting their monopolistic advantages through FDI, multinational firms are able to achieve far superior rents than if they remained in their domestic nation.

Criticisms

Some of the major criticisms of the theory are that it fails to address how the monopolistic advantages occur, that it is static in nature, and that it assumes a large firm going international for the first time. Also, the use of the term monopolistic to describe firm advantages may be inaccurate. The advantages can occur from greater efficiencies and hence may be “Ricardian” in nature, as they represent returns that are in excess of the opportunity costs involved.

The theory may not be well suited to explain the activities of entrepreneurial firms or firms in emerging markets as they may not initially possess the monopolistic advantages that allow them to succeed in international markets. New ventures often develop monopolistic advantages after going abroad. The theory also does not explain why FDI will always be the preferred choice of market entry for multinational firms, or why several firms with the same monopolistic advantage may not choose to internationalize identically.

Regardless, the basic logic of monopolistic advantage theory and firm-specific advantages resonates well with later theories such as the resource-based view, and Michael Porter’s theory of competitive advantage, and provides explanations for the existence of FDI by multinational corporations.

Bibliography:

Jay B. Barney, “Firm Resources and Sustained Competitive Advantage,” Journal of Management (v.17/1, 1991);
Jagdish Handa, Monetary Economics (Routledge, 2009);
Stephen H. Hymer, The International Operations of National Firms: A Study of Direct Foreign Investment, Ph.D. diss., Massachusetts Institute of Technology, 1960 (MIT Press, 1976);
Charles P. Kindleberger, American Business Abroad: Six Lectures on Direct Investment (Yale University Press, 1969);
Charles P. Kindleberger, ed., The International Corporation: A Symposium (MIT Press, 1970);
Michael E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (Free Press, 1985);
Michael Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (Free Press, 1980);
John Romalis, “Factor Proportions and the Structure of Commodity Trade,” American Economic Review (v.94/1, 2004);
Birger Wernerfelt, “A Resource-Based View of the Firm,” Strategic Management Journal (v.5/2, 1984).

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