The Theory of Comparative Advantage Market Imperfections Sustaining and Transferring Competitive Advantage OLI Paradigm

1. Dr Raju Indukoori

2. 1. TheTheory of Comparative Advantage
2. Market Imperfections
3. Sustaining andTransferring Competitive Advantage
4. OLI Paradigm
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3. • Propounded by David Ricardo in 1817.
• It provides a basis for explaining and justifying
international trade in a model world assumed to
enjoy free trade, perfect competition, no uncertainty,
costless information, and no government
interference.
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4.  It has only 2 products for trade.
 Exporters in Country A sell goods or services to unrelated
importers in Country B.
 Firms in Country A specialize in making products that can be
produced relatively efficiently, given Country A’s endowment of
factors of production, that is, land, labor, capital, and technology.
 Firms in Country B do likewise, given the factors of production
found in Country B.
 In this way the total combined output of A and B is maximized.
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5.  Benefits of specialization are realized through international
trade as factors of production cannot move between A&B
 Benefits depends on
 terms of trade
 ratio at which quantities of the physical goods are traded.
 In perfectly competitive markets, each country’s share is
determined by
 Supply
 Demand
 Neither Country A nor Country B is worse off than before
trade, and typically both are better off.
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6.  It still a relevant for exports of goods and services supporting
global supply chain of both MNCs and domestic firms.
 Now the trade is one based more on services, and their cross-
border facilitation by telecommunications and the Internet.
 The source of a nations comparative advantage is still created
from the mixture of its own labor skills, access to capital, and
technology.
 It takes a relative advantage in costs, not just an absolute
advantage, to create comparative advantage.
 Clearly, the extent of global outsourcing is reaching out to
every corner of the globe.
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7. Dr Raju Indukoori
CHINA
PHILIPPINES
MEXICO
COSTA RICA S. AFRICA
INDIA
RUSSIA
EAST. EUROPE
UNITED
STATES
LONDON
PARIS
BERLIN
BUDAPEST
BOMBAY
HYDERABAD
BANGALORE
JOHANNESBURG
SAN JOSE
GUADALAJARA
MANILA
MOSCOW
MONTERREY
SHANGHAI
Data: Gartner, McKinsey, BW
Global Supply Chain Outsourcing of Comparative Advantage
MNEs based in many of the major industrial countries are outsourcing many of their
intellectual functions to providers based in many of the traditional emerging market countries.
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8. Popular in 19th century, cannot be applied now. Because
 countries do not appear to specialize only in those products
that could be most efficiently produced by that country’s
particular factors of production due to government
interference and ulterior motivations.
 capital and technology flow directly and easily between
countries.
 numerous modern factors of production more numerous
than in this simple model.
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9.  Although the terms of trade are ultimately determined by supply
and demand, the process by which the terms are set is different
from that visualized in traditional trade theory.
 Comparative advantage shifts over time, as less developed
countries become developed and realize their latent
opportunities.
 The classical model of comparative advantage did not really
address certain other issues, such as the effect of uncertainty and
information costs, the role of differentiated products in
imperfectly competitive markets, and economies of scale.
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10.  A Rationale for the Existence of the Multinationals.
 MNEs strive to take advantage of imperfections in
national markets for products, factors of production,
and financial assets.
 Imperfections in the market for products translate into
market opportunities for MNEs.
 Large international firms are better able to exploit such
competitive factors as economies of scale, managerial
and technological expertise, product differentiation,
and financial strength than are their local competitors.
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2. Market Imperfections

11. Strategic Motives : Drive the decision to invest abroad and
become an MNC. Independent and Mutually exclusive
strategies are as follows.
1. Market seekers
2. Raw material seekers
3. Production efficiency seekers
4. Knowledge seekers
5. Political safety seekers
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12. To compensate the firm for the potential disadvantages of
operating abroad, competitive advantage must be
 firm-specific
 transferable
 powerful enough
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13. FocusAreas
A. Economies of scale and scope
B. Managerial and marketing expertise
C. Advanced technology
D. Financial strength
E. Differentiated Products
F. Competitiveness in the domestic market
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14. A. Economies of scale and scope
 Can be developed in production, marketing, finance,
research and development, transportation, and purchasing
 Large size is a major contributing factor (due to international
and/or domestic operations)
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15. B. Managerial and marketing expertise
 Includes skill in managing large industrial organizations
(human capital and technology)
 Also encompasses knowledge of modern analytical
techniques and their application in functional areas of
business
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16. C. Advanced technology
 Scientific
 Engineering
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17. D. Financial strength
 Demonstrated financial strength by achieving and
maintaining a global cost and availability of capital
 This is a critical competitive cost variable that
enables them to fund FDI and other foreign
activities
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18. E. Differentiated products
 Firms create their own firm-specific advantages by
producing and marketing differentiated products
 Such products originate from research-based
innovations or heavy marketing expenditures to
gain brand identification
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19. F. Competitiveness of the home market
 A strongly competitive home market can sharpen a
firm’s competitive advantage relative to firms
located in less competitive ones
 This phenomenon is known as the diamond of
national advantage and has four components
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20. Porter’s Diamond: Competitive advantage determinants
1. Factor Conditions
2. Demand Conditions
3. Related and Supporting Industries
4. Firm’s Strategy, Structure and Rivalry
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21. 15-21
Competitive Advantage Determinants
1. Factor conditions
4.Firm strategy, structure & rivalry
3. Related & supporting Industries
2. Demand conditions
Porter’s
Diamond
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22. Potential disadvantages of MNC operating abroad
 Foreign exchange risks
 Political risks
 Increased agency costs
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23. It explains why MNCs choose FDI alternative models.
O (Owner-specific)
competitive advantage in the home market that can be transferred
abroad
L (location-specific)
Specific characteristics of the foreign market allow the firm to exploit
its competitive advantage)
I (Internalization)
Maintenance of its competitive position by attempting to control
the entire value chain in its industry
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24. Dr Raju Indukoori
Watch more on myYoutube Channel
https://www.youtube.com/channel/UCCM94XnsOoGDl0PnsaVfeNA

25. Dr Raju Indukoori
Watch more on myYoutube Channel
https://www.youtube.com/channel/UCCM94XnsOoGDl0PnsaVfeNA