The firm uses its Ownership advantages in a foreign country despite having disadvantages versus local firms.
Why not sell the OA (as an intermediate good) to local firms, who can use it better? A local firm does possess its own advantage of being local and therefore may be able to use the OA more effectively in that location. But it is more advantageous not to because the market is inefficient, it is better to INTERNALISE than externalise.
Ownership advantages (OA) confer on the firm power in the market, or a cost advantage that outweighs the extra costs of doing business abroad.
* Technology (ability to create, acquire and upgrade)
* Management skills
* Marketing skills and well-known trade names
* Size of firm (economies of scale)
* Capital availability and financial expertise
* Entrepreneurial drive and vision
* Ability to foresee and take advantage of global production and marketing opportunities
The basic reason WHY FIRMS INTERNALISE use of the OA (rather than externalise it by selling it to another firm) is because the MARKETS FOR OA's, as intermediate goods, ARE VERY IMPERFECT ( i.e. costly and risky to use).
The reasons for this MARKET FAILURE differ according to the type of intermediate goods (i.e. inputs that play a role in a firm's ability to supply value to consumers). e.g. technology, management skills, marketing skills and trade names, raw materials
and component parts.
However there are functioning markets for such intermediate products in the form of:
technology licensing, management contracts, franchising and trademark licensing.
When it uses these mechanisms the firm externalises its OA. Thus it gains financial rewards from marketing the OA itself.
Alternatively it can internalise use of the OA; i.e. apply it itself to support its own production of the final product (or service) embodying the knowledge or skill.
Internalisation theory (Buckley and Casson, 1976).
These markets for intermediate goods are characterised by high risk and uncertainty as perceived by both buyers and sellers, the costs of making markets for OA's work are sometimes very high.
There are often very high transaction costs in such markets, in the form of: extensive and detailed negotiation or bargaining processes, the need to draw up very precise and, therefore, expensive legal contracts, the need to continually monitor the other side's compliance to the agreement and the need for legal action if the agreement is broken
Many of the risks and uncertainties (and, therefore, high transaction costs) of transferring an OA between independent firms through a market are avoided if it is transferred between two parts of the same firm (i.e. internalised).
An internalised transfer is often more efficient (i.e. costs less to organise and complete, including the practical complications associated with the transfer of know-how) than an externalised one.
Technology is seen as both a very likely source of OA...