Eclectic Paradigm

What is an 'Eclectic Paradigm'

An eclectic paradigm is a theory that provides a three-tiered framework for a company to follow when determining if it is beneficial to pursue direct foreign investment (DFI). The eclectic theory paradigm is based on the assumption that institutions will avoid transactions in the open market when internal transactions carry lower costs.

BREAKING DOWN 'Eclectic Paradigm'

For a direct investment in a foreign country to be beneficial, there must be a comparative advantage, an ownership advantage and an internalization advantage. The eclectic paradigm is considered a holistic approach, based on examining the entirety of the relationships and interactions of the various components. It provides a process to determine an organization’s strategy regarding the expansion of its operations through foreign direct investments.

The purpose is to determine if the examined approach provides more overall value than other national or international choices that may be available for the production of goods or services. Since most businesses focus on finding the most cost-effective option while still maintaining a particular quality, the eclectic paradigm may be evaluated for any scenario that shows promise.

Three Key Factors of the Eclectic Paradigm

Three main factors are considered as part of the eclectic paradigm analysis. The first goal is to determine if there is a comparative advantage to performing certain functions within a particular nation. Often, these considerations are fixed in nature; they apply to the availability and costs of resources when functioning in one location over another.

Ownership advantages surround issues relating to the proprietary information and various ownership rights a company may hold. This can include issues of naming, copyright, trademark or patent rights, as well as the use and management of particular internally available skills and those that can be acquired within a foreign market. The majority of ownership advantages are considered intangible in nature.

Internalization advantages are also considered. This concept focuses on determining if it is best for an organization to produce the particular product itself or consider a contract with a third party. At times, it may be more cost effective for an organization to work out of a different market location but keep the performance of the work internal. This is in comparison to outsourcing the production where the organization negotiates and contracts with local producers. This is only used if the company with which it is looking to contract can effectively meet the organization’s production needs at a lower cost than if the organization performed and managed the production itself.