Question

Explain with example how imitative behavior can take many forms in Oligopoly?

Answer 1

Answer :

An oligopoly is a business industry in which a few firms control most of the market. For instance, an industry where four organizations control about 85% of the domestic market may be considered as an oligopoly. Examples of such industries include the oil and global tire industries. In the same line of thought, businesses in an oligopoly industry are quite sensitive to market share and loss of market share in such an industry is frequent an introduction to the extinction of a firm. Therefore, when one organization reduces prices, opens a new market or expands capacity, the other firms in the market have to quickly respond in kind or else risk loosing their market share. In that case, Knickerbockers’ theory is that when one oligopoly member undertakes FDI, the other members feel forced or constrained to imitate/copy that idea

On the other hand, the eclectic theory is based on the OLI paradigm which is a mix of three diverse theories of FDI that concentrate on a certain question of FDI=O+L+I. The O in the equation represents ownership advantages or firm specific advantages. On the other hand, ‘L’ represents the location advantages while ‘I’ stands for internalization advantages. The organization’s specific advantage is normally intangible and can be transmitted within the international enterprise at a low cost (economies of scale benefits, technology, and brand name). According to Hill, the advantages may result to lower costs or/and higher revenue that can counterbalance the costs of operating distantly in an abroad location. However, a multinational firm operating a plant in a foreign nation is faced with extra costs paralleled to a home competitor. These costs may include increased communication costs and distant operation, institutional, legal and language diversities, and lack of knowledge regarding local market conditions. Basically dunning’s theory ties together ownership advantage, internalization advantage, and location advantage.

In proportion to Ietto-Gillies, the Knickerbockers’ theory is useful in explaining foreign direct investment because it is based on the notion that FDI flows are a strategic rivalry reflection between organizations in the global marketplace. The theory looks at the relationship between foreign direct investment and rivalry in oligopolistic industries. A critical competitive characteristic of an oligopoly industry is interdependence of the key players: this means that the actions of one firm may have an instant impact on the key competitors, constraining a response in kind . For instance, if firm C is an oligopoly and cuts its prices, firm C has the ability to take away market share from its rivals, constraining them to respond with the same price cuts so as to retain their market share

This type of imitative behavior may take a number of forms in an oligopoly:

One firm increases prices, the other firms follow the lead, and one firm expands its capacity and the competitors copy for fear that they may be left in a disadvantageous position in the near future. Based on this, Knickerbockers’ argued that a similar type of imitative behavior characterizes foreign direct investment. Taking an example of an oligopoly in the U. S, in which three firms Q, R and S dominate the market, firm Q decides to change the packaging of its products and brands. Apparently, firms R and S reflect in case this venture is successful, it may possibly lead to increased customer preference on the products and brands of firm Q hence giving the firm the advantage of properly packaged brands and the first firm to introduce such kind of packaging. Besides firm Q might realize some customer needs that other firms have not yet discovered and start working on them. Given these options, firm R and S decide to imitate firm Q and start packing their products in a similar manner (Hill 2011).

According to Hill (2011) there is sufficient evidence that such imitative characteristics lead to foreign direct investment. As a matter of fact, studies that looked at foreign direct investment by firms in the United States during the 1950s and 1960s indicate that organizations based in industries that are oligopolistic tended to imitate one another’s FDI.

A similar occurrence has been observed with reference to foreign direct investment undertaken by firms in Japan during the 1980s. For example, Nissan and Toyota responded in kind to investments by Honda in Europe and the United Sates by undertaking their own foreign direct investment in Europe and the United States. Moreover, it’s possible to expand Knickerbockers’ strategic behaviour theory to embrace the multipoint competition concept. Actually, multipoint competition results when two or more businesses come across each other in distinct national markets, regional markets, or industries. However, economic theory puts forward that to a certain extent like chess players jockeying for advantage, organizations will attempt to match the moves of one another in various markets to make an effort to hold one another in check. The main idea is to make sure that a competitor doesn’t gain a demanding position in one market and after that use the profits generated to minimize attacks that are competitive to other markets.

In relation to Hill (2011), Samsung Mobile Phone Company and Nokia Phone Company for instance, compete against one another in the global market. If Nokia enters a certain foreign market, Samsung will follow the lead. Surprisingly, Samsung feels compelled to imitate Nokia in order to ensure that Nokia doesn’t gain a position that is dominant in the global market that it could possibly leverage to gain competitive advantage in other markets. Nevertheless, the contrary also hold, with Nokia imitating Samsung when the firm is the first one to go into a foreign market.

Similarly, the expansion of Electrolux into Latin America, Asia, and Eastern Europe was partly driven by similar behaviors by its global rivals such as General Electric and Whirlpool. In fact, the foreign direct investment behavior of Electrolux, General Electric, and Whirlpool might be explained partly by multipoint rivalry and competition in a global oligopoly. Although Knickerbocker’s strategic behaviour theory and its extensions can be useful in explaining imitative foreign direct investment behavior by organizations in oligopolistic industries, it doesn’t give reasons as to why the first organization/company in oligopoly decides to undertake foreign direct investment, rather than to license or export. Contrary, the explanation on market imperfections addresses this issue. Also, the imitative theory doesn’t address the subject of whether foreign direct investment is more efficient than licensing or exporting for global expansions. Again, this issue is addressed by market imperfections.

On the other hand, Dunning’s ‘eclectic’ theory argues that location-specific advantages are useful in explaining the direction and nature of foreign direct investment (FDI). Location-specific advantages refer to the advantages that result from using assets that are tied to a specific foreign location or resource endowments and that an organization considers valuable to combine with its own exceptional assets such as the organization’s marketing, technological and management know-how. Thus, Dunning argues that combining resource endowments or location-specific assets and the unique assets of the firm often requires foreign direct investment. It requires the company to establish production facilities where such resource endowments and foreign assets are located.