Exploring the Knickerbockers theory of oligopolistic competition

In accordance with Kaleem (2011), the Knickerbockers’ theory of oligopolistic competition involves readings, presentation, quizzes and resources. This theory forms part of the next approach to horizontal foreign direct investment (FDI). An oligopoly is a business industry in which a few firms control most of the market. For instance, an industry where four organizations control about 85% of the domestic market may be considered as an oligopoly. Examples of such industries include the oil and global tire industries. In the same line of thought, businesses in an oligopoly industry are quite sensitive to market share and loss of market share in such an industry is frequent an introduction to the extinction of a firm. Therefore, when one organization reduces prices, opens a new market or expands capacity, the other firms in the market have to quickly respond in kind or else risk loosing their market share. In that case, Knickerbockers’ theory is that when one oligopoly member undertakes FDI, the other members feel forced or constrained to imitate/copy that idea (Kaleem 2011).

On the other hand, the eclectic theory is based on the OLI paradigm which is a mix of three diverse theories of FDI that concentrate on a certain question of FDI=O+L+I. The O in the equation represents ownership advantages or firm specific advantages (Hill 2011). On the other hand, ‘L’ represents the location advantages while ‘I’ stands for internalization advantages. The organization’s specific advantage is normally intangible and can be transmitted within the international enterprise at a low cost (economies of scale benefits, technology, and brand name). According to Hill (2011), the advantages may result to lower costs or/and higher revenue that can counterbalance the costs of operating distantly in an abroad location. However, a multinational firm operating a plant in a foreign nation is faced with extra costs paralleled to a home competitor. These costs may include increased communication costs and distant operation, institutional, legal and language diversities, and lack of knowledge regarding local market conditions. Basically dunning’s theory ties together ownership advantage, internalization advantage, and location advantage.

In proportion to Ietto-Gillies (2005), the Knickerbockers’ theory is useful in explaining foreign direct investment because it is based on the notion that FDI flows are a strategic rivalry reflection between organizations in the global marketplace. The theory looks at the relationship between foreign direct investment and rivalry in oligopolistic industries. A critical competitive characteristic of an oligopoly industry is interdependence of the key players: this means that the actions of one firm may have an instant impact on the key competitors, constraining a response in kind (p. 88). For instance, if firm C is an oligopoly and cuts its prices, firm C has the ability to take away market share from its rivals, constraining them to respond with the same price cuts so as to retain their market share. This type of imitative behavior may take a number of forms in an oligopoly.

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One firm increases prices, the other firms follow the lead, and one firm expands its capacity and the competitors copy for fear that they may be left in a disadvantageous position in the near future. Based on this, Knickerbockers’ argued that a similar type of imitative behavior characterizes foreign direct investment. Taking an example of an oligopoly in the U. S, in which three firms Q, R and S dominate the market, firm Q decides to change the packaging of its products and brands. Apparently, firms R and S reflect in case this venture is successful, it may possibly lead to increased customer preference on the products and brands of firm Q hence giving the firm the advantage of properly packaged brands and the first firm to introduce such kind of packaging. Besides firm Q might realize some customer needs that other firms have not yet discovered and start working on them. Given these options, firm R and S decide to imitate firm Q and start packing their products in a similar manner (Hill 2011).

According to Hill (2011) there is sufficient evidence that such imitative characteristics lead to foreign direct investment. As a matter of fact, studies that looked at foreign direct investment by firms in the United States during the 1950s and 1960s indicate that organizations based in industries that are oligopolistic tended to imitate one another’s FDI.

A similar occurrence has been observed with reference to foreign direct investment undertaken by firms in Japan during the 1980s. For example, Nissan and Toyota responded in kind to investments by Honda in Europe and the United Sates by undertaking their own foreign direct investment in Europe and the United States. Moreover, it’s possible to expand Knickerbockers’ strategic behaviour theory to embrace the multipoint competition concept. Actually, multipoint competition results when two or more businesses come across each other in distinct national markets, regional markets, or industries. However, economic theory puts forward that to a certain extent like chess players jockeying for advantage, organizations will attempt to match the moves of one another in various markets to make an effort to hold one another in check. The main idea is to make sure that a competitor doesn’t gain a demanding position in one market and after that use the profits generated to minimize attacks that are competitive to other markets (Erdilek 1985, p. 68).

In relation to Hill (2011), Samsung Mobile Phone Company and Nokia Phone Company for instance, compete against one another in the global market. If Nokia enters a certain foreign market, Samsung will follow the lead. Surprisingly, Samsung feels compelled to imitate Nokia in order to ensure that Nokia doesn’t gain a position that is dominant in the global market that it could possibly leverage to gain competitive advantage in other markets. Nevertheless, the contrary also hold, with Nokia imitating Samsung when the firm is the first one to go into a foreign market.

Similarly, the expansion of Electrolux into Latin America, Asia, and Eastern Europe was partly driven by similar behaviors by its global rivals such as General Electric and Whirlpool. In fact, the foreign direct investment behavior of Electrolux, General Electric, and Whirlpool might be explained partly by multipoint rivalry and competition in a global oligopoly. Although Knickerbocker’s strategic behaviour theory and its extensions can be useful in explaining imitative foreign direct investment behavior by organizations in oligopolistic industries, it doesn’t give reasons as to why the first organization/company in oligopoly decides to undertake foreign direct investment, rather than to license or export. Contrary, the explanation on market imperfections addresses this issue. Also, the imitative theory doesn’t address the subject of whether foreign direct investment is more efficient than licensing or exporting for global expansions. Again, this issue is addressed by market imperfections (Hill 2011).

On the other hand, Dunning’s ‘eclectic’ theory argues that location-specific advantages are useful in explaining the direction and nature of foreign direct investment (FDI). Location-specific advantages refer to the advantages that result from using assets that are tied to a specific foreign location or resource endowments and that an organization considers valuable to combine with its own exceptional assets such as the organization’s marketing, technological and management know-how. Thus, Dunning argues that combining resource endowments or location-specific assets and the unique assets of the firm often requires foreign direct investment. It requires the company to establish production facilities where such resource endowments and foreign assets are located (Dunning 2002, p. 205).

Consistent with Dunning & Lundan (2008), clear example of Dunning’s ‘eclectic’ theory arguments are natural resources like oil and other minerals, which by their behavior are specific to certain locations. Nonetheless, Dunning puts forward that a company must undertake foreign direct investment so as to exploit such foreign resources. Subsequently, this explains the foreign direct investment undertaken by most global oil companies, which must invest where oil is located in order to combine their managerial and technological know-how with this precious location-specific resource (Dunning & Lundan 2008, p. 87).

Along the lines of Jones & Dunning (1997) also, low-cost highly-skilled labor is an obvious example of valuable human resources. The skill and cost of labor varies from one nation to another. In view of the fact that labor is not globally mobile, in accordance with Dunning’s ‘eclectic’ theory it is reasonable for a firm to locate production resources/facilities where the skills and cost of local labor are suitable to its particular processes of production. For instance, Electrolux is gradually building factories in China because in China there is an abundant supply of cheap but skilled and well-educated labor. Hence, besides other factors, China is a perfect location for manufacturing domestic appliances for both the Chinese and global market (Jones & Dunning1997, p. 19).

Nevertheless, Dunning’s theory has suggestions that go beyond basic resources like labor and minerals. Taking Silicon Valley into consideration, which is the global semi-conductor and computer industry centre. A number of global major semi-conductor and computer companies such as Silicon Graphics, Intel, and Apple Computer are located close to one another in the California Silicon Valley region. Consequently, much of the production development and cutting edge research in semi-conductors and computers take place in this region (Harzing & Ruysseveldt 2004, p. 71)

In line with Dunning’s (2002) arguments, know-how being generated in Silicon Valley with reference to the manufacturer and design of semi-conductors and computers is not available anywhere else in the world. Since its commercialized, that know-how spreads throughout the globe, but the leading knowledge edge generation in the semi-conductor and computer industries is found mainly in Silicon Valley. In the language of Dunning, this implies that Silicon Valley has a location-specific advantage in knowledge generation in the semi-conductor and computer industries.

Partly, this advantage results from the intellectual talent concentration in this region, and partly results from a network of informal contacts that enable firms to derive benefit from the knowledge generation of each other. Such knowledge is referred by economists as “spillovers” as externalities and a well-established theory gives the suggestion that firms can derive benefits from such externalities by locating near their source (p. 273). So far, this is the case, it is reasonable for foreign semi-conductor and computer firms to invest in production and research facilities so they also can gain knowledge about and use of valuable emerging knowledge before those located elsewhere, in so doing giving them a competitive advantage in international marketplace. Studies suggest that Japanese, Taiwanese, European, and South Korean semi-conductor and computer firms are highly investing in the Silicon Valley area, in particular because they wish to derive benefits from the externalities that come up in the region.

In a similar line of thought, others have argued that foreign direct investment in the United States industry of biotechnology has been motivated by the wish to gain access to the exceptional location-specific technological knowledge of the United States biotechnology firms. Basically, the country’s specific advantages may be economic, political, or social. Therefore, Dunning’s ‘eclectic’ theory is useful in addition to the Knickerbockers’ strategic behaviour theory for it helps in explicitly explaining how location factors impact the direction of foreign direct investment (Dunning & Gray 2003, p. 55).