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 foreign direct investment (FDI). 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. The paradigm provides a strategy for the expansion of operations through FDI.

The purpose is to determine if a particular approach provides greater 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 quality, the eclectic paradigm may be used to evaluate any scenario with potential.

Three Key Factors of the Eclectic Paradigm

Three main factors are considered as components of the eclectic paradigm analysis - comparative advantage, ownership advantages and internalization advantages. For the first factor, the company must assess whether 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 compared to another.

For the second factor, ownership advantages that include proprietary information and various ownership rights that a company may hold are important considerations. For example, branding, copyright, trademark or patent rights and the use and management of internally available skills and those that can be acquired within a foreign market. The majority of ownership advantages are considered intangible in nature.

The third factor to be considered is internalization advantages. For example, is it best for an organization to produce the particular product itself or to consider a contract with a third party? At times, it may be cost-effective for an organization to operate from a different market location but to retain the performance of the work internally. The alternative is to outsource the production, which requires the organization to negotiate and contracts with local producers. This is only an option to consider if the company being considered as a contractor can effectively meet the organization’s production needs at a lower cost than if the organization performed and managed the production itself.

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