Economic Analysis of International Supply Chains: An Internalization Perspective
Casson, Mark, Journal of Supply Chain Management
INTRODUCTION: OVERVIEW OF INTERNALIZATION THEORY
Offshoring and outsourcing in global value chains have been extensively analyzed from a strategic management perspective (Gereffi & Lee, 2012; Gereffi, Humphrey & Sturgeon, 2005; Mudambi & Venzin, 2010). This article examines these issues from an internalization theory perspective. Internalization theory is a branch of economics and is widely used in international business studies to investigate multinational enterprises (Buckley & Casson, 2011). Economists adopt a systems view of international business. Their basic unit of analysis is the entire global economy, and within this, they distinguish different industries. Within each industry, they distinguish different final products, and for each final product, they analyze the supply chain that delivers it to market.
From an economic perspective, every stage of production of every commodity must compete for the resources it requires. Many resources are localized. Each location tends to specialize in those activities that make the best use of its distinctive resources. Each location imports the raw materials and semi-processed products required for its specialized local production and exports a proportion of the finished and semi-processed products that it has produced. These imports and exports, taken collectively, constitute the structure of global trade.
Production requires intangible inputs such as knowledge as well as tangible inputs such as raw materials. Some knowledge is public and is freely disseminated through education and training. Other knowledge is proprietary; in particular, it is owned by firms that have carried out research and development (R&D). They protect their knowledge through patents, trademarks and commercial secrecy. Knowledge can be shared between locations. But it is often risky to license independent firms to use proprietary knowledge, and so knowledge is internalized--it is exploited by the firm that developed it. When a knowledge-intensive firm invests abroad to exploit local resources at other locations, it becomes multinational, namely it owns and controls activities in different countries. Internalization theory predicts which types of knowledge will be retained by firms and which will be supplied under license to other firms. It also predicts which stages of production will be subcontracted to other firms and which will not.
In contrast to strategy theory, internalization theory does not examine supply chains from the standpoint of an individual firm but from the standpoint of the economic system as a whole. Some supply chains may be coordinated purely by market transactions between independent firms, each of which is responsible for a single stage of production, while others may be coordinated by a single firm that controls every stage of production. In between are numerous configurations. Internalization theorists argue that in the long run, competition will drive down supply chain costs so that only the most efficient method of supply chain coordination can survive. This will typically involve some combination of market and management, rather than relying solely on one or the other. It is a mistake to suppose that some firm always masterminds or orchestrates a supply chain, as it is only under specific circumstances that this is the most efficient solution.
Internalization theory explains the growth of offshoring and outsourcing in terms of changing underlying economic fundamentals, rather than as a consequence of autonomous innovations in business strategy. Given geographical differences in natural resource endowments, offshoring is always worthwhile when impediments to trade (e.g., tariffs and transport costs) are low, and outsourcing is usually worthwhile when knowledge is public and contracts are easy to enforce. From an internalization perspective, recent growth in offshoring has been driven by trade liberalization, falling transport costs and faster communication, while outsourcing has been stimulated by the emergence of new suppliers and greater security of property rights. …