Amsterdam Business School
MBA International Business, part-time
Assignment week 4, November 18th, 2013
Case: PALLISER FURNITURE LTD.: THE CHINA QUESTION
Should we expect Palliser to engage in FDI in China right now, or not?
Michelle Donovan 10429859
Kivanc Ozuolmez 10429832
Palliser Furniture Ltd.’s main strategies are cost leadership, quick delivery and value
The eclectic paradigm
The eclectic paradigm, by combining many theories from different authors, attempts to
explain when and why a company will engage in foreign direct investment. Its three
components are Ownership (O), Location (L) and Internalization (I). If a company would gain
advantages in all three areas, it will engage in FDI.
As far as we know from the case, Palliser is not seeking to invest in China (or elsewhere) in
search of new markets. The O advantages they may have by investing in China (or elsewhere)
are resource-seeking and efficiency seeking, for example reducing labour, supply and friction
costs. Friction costs would be $2 lower per sofa coming from China than Mexico, labour costs
would be lower, and some components would also be cheaper (leather, wood, foam and
packaging). The risks associated with trading in a different currency would be reduced
because of the Chinese yuan being pegged to the US dollar. However, it is not clear from the
case whether these advantages could also be gained by doing more contracting work with
Chinese partners and/or suppliers, rather than building or buying its own factory in China.
Although the intellectual property and specialist knowledge is important for Palliser, a more
critical aspect is the length and trustworthiness of the operational investment. Palliser’s
hesitation about Chinese OEM suppliers and contracting might be a valid concern in terms of
the combination of the product life cycle, product designs and production uniqueness.
Therefore, direct ownership in China brings advantages over contracting.
Palliser is already aware of some of the advantages and disadvantages of location due to its
existing plants in Canada and Mexico and the associated friction costs, and due to its
experience in China, Indonesia, Thailand, etc. They already have offices in China and
Risk diversification and follow my leader theories may be the most relevant and guiding
theories for Palliser’s decision.
Besides cost efficiencies, lower shipment and transaction costs and labour related benefits,
starting production in China will help Palliser to benefit from the pegged exchange rate,which
it currently does not enjoy in the Indonesia and Mexico locations, which therefore are more
vulnerable. In addition, efficient Chinese workers, constitutionally structured and attractive
rules and regulations for FDIs make China a good place in which to diversify exchange rate,
government and labour related risks, relative to other Asian countries.
As many large North American and European furniture manufacturers moved their
manufacturing to China, follow my leader theory might also be a directive for Palliser’s
decision. According to the article, and Palliser’s estimations, currently their competitors that
manufacture in China enjoy the results of their strategic move, and target larger market shares
by price leadership. If there is no hidden magic in furniture manufacturing FDIs in China,
Palliser can benefit from similar supply and labour market. In addition, if the furniture
manufacturing moves increasingly to the same location, Guangdong province, we can expect
that the local supply and skilled labour market will mature, and offer better and wider options
with lower costs. This means; in the longer run, the local (Chinese) supply market will be
more attractive to Palliser.
By owning its own plant in China, Palliser could lower transaction costs, lower the unit cost
of production and benefit from economies of scale.
Perhaps Palliser could benefit from knowledge sharing, especially in the area of motion
products, which are quite new for them. If they based their new plant in Guangdong as above,
there may be a local pool of workers who have already been trained in the design and/or
construction of motion products and Palliser could make us of that.
However, it is worth noting that Palliser has not yet tried to rationalize the Mexico plant and it
is likely that they could save some costs there by creating efficiencies.
Conclusion based on Dunning article
All three elements needed for FDI are present, soDeFehr can and should go ahead with FDI.
However, at the same time, a reationalization program in Mexico should be carried out.
The Uppsala Internationalisation Model
Johanson and Vahlne’s article is more focused on the way companies become
internationalized (the “how”, not the “why” or the “when”). The mainly Swedish firms they
discuss were almost all market-seeking, which Palliser is not. They believe
internationalization happens step-by-step, first by exporting via agents, then setting up a
subsidiary sales office, then later producing in the host country. Furthermore they saw firms
expanding internationally first into countries where the culture, language, etc are more
familiar to them and therefore appear less risky. As knowledge and experience of the market
and the network of contacts increase, firms become more willing to expand to less familiar
Palliser has internationalized gradually and into more familiar countries first, as the model
predicts; the company started in Canadaand exports to the USA, and the production plant in
Mexico was opened in 1998. Of course, Canada, the USA, and Mexico are all members of
NAFTA, which should make trading between the three countries easier and more attractive.
They also produce in Indonesia, contract work to China and Thailand, and have sales offices
in China and Taiwan. However, the CEO DeFehr seems to be more familiar with Asian
countries and culture, as he has travelled and lived in Asia, than he is with Mexico. Doing
business in Mexico was not without risks due to lack of knowledge and/or experience, as the
company discovered over time, for example regarding the tax laws in Mexico and the
difficulties and extra costs associated with trucks crossing into the USA from Mexico.
Perhaps for DeFehr, had he been familiar with the Uppsala model, would have chosen China
over Mexico in 1998 for his production facility.
The fact that the company already has offices and contacts in China means that Palliser
already has a head start on the “advantage cycle” described by Johanson andVahlne (p21),
should he decide to start FDI in China. However, DeFehr should also be aware that opening a
plant in China “will change the power balance within the corporation”; presumably this is
why he insists that the Chinese operation would have to be a full-owned subsidiary and not a
The conclusion is that Palliser should go ahead with FDI in China.
Internalization theory aims to explain why a multinational enterprise is more efficient when it
owns and controls firm-specific advantages, but admits that other methods of foreign
expansion are possible, such as joint ventures and licensing, and that these can even be more
advantageous depending on the situation.Rugman asserts that the two most important
deciding factors regarding FDI are country-based factors (country-specific advantages, CSAs)
and firm-specific advantages (FSAs). Rugman takes a critical view of the OLI paradigm and
points out that it is based only on perceived opportunities in host countries and does not
consider the home situation.
Palliser’s FSAs are its brand and its knowledge of and efficiency in designing and
manufacturing its furniture to create value. However there are many similar companies who
are able to compete with Palliser so we believe their FSAs are low according to Rugman’s
definition. The high CSAs of China are the cheaper manufacturing costs (including low
labour and material costs). Using Rugman’s matrix we can see that Palliser falls into cell 1
which means they should proceed with FDI.
DeFehr seems to be ambivalent about owning in China. On one hand he says that he does not
want to participate in a joint venture, he only wants to be the sole owner. On the other hand,
he is not sure if he feels comfortable owning anything in China.Based on the literature, we
advise him to go ahead with FDI in China.
Dunning, J. (2000). The Eclectic Paradigm as an Envelope for Economic and Business
Theories of MNE Activity, International Business Review, 9, 163-190
Johanson, J. &Vahlne, J-E. (1997) The Mechanism of Internationalization. International
Marketing Review, 7 (4): 11-24
Rugman, A. (2011) Reconciling internalization theory and the eclectic paradigm.
Multinational Business Review, 18 (1): 1-12.