place in the country where the product is being developed, for example in the
United States (in principle the PLC theory pertains to high-tech products
which, at the time this theory was introduced – the 1950s – came largely from
the US). In the expansion phase, the product becomes more standardized and
the price falls a bit. Turnover increases sharply and production costs begin to
drop. To extend this phase, a company will attempt to export its product.
Because the price is still rather steep, exports will largely go to countries which
have a similar income level, for example Europe.
At the end of the expansion phase and the beginning of the maturity
phase, the company will begin to manufacture the product in Europe.
Turnover there will have increased to such an extent that it pays to set up
foreign production, particularly in view of import tariffs and transport costs. By
this time however, the product will have become so standardized that
European companies will be jumping on the bandwagon. By setting up its own
subsidiaries in Europe then, the American company is applying a defensive
strategy designed to protect its market position.
In the end the production process will be completely standardized, making
economies of scale and mass production possible. The quality (level of skill) of
the workforce in the production process becomes less important than how
much it costs. Production will therefore increasingly take place in labour-
abundant countries. This refers to elements of the classic theories of trade.
The product life cycle model made an important contribution to explain-
ing the enormous scope of direct investment by American companies in the
1950s and 1960s (see Chapter 2). However, the model fails to answer two
important questions. Firstly, why does one company in a country become a
multinational while another does not? Secondly, why would a company
choose to maintain control of the production process by setting up sub-
sidiaries? It would be much simpler to license the know-how required to man-
ufacture the product to a foreign company. Both of these questions are
answered by Dunning’s eclectic theory, which also incorporates the location-
specific advantages proposed in the classic theories of trade.
Dunning’s eclectic theoryDunning’s eclectic theory (Dunning & McQueen, 1982), also called the trans-
action cost theory of international production, is able to explain why firms pro-
duce abroad, how they are able to compete successfully with domestic firms and
where they are going to produce. In doing so, the theory selectively combines
elements of various other theories (hence the name ‘eclectic’). According to
Dunning, a company that wishes to set up production in a foreign country and
operate as a multinational must simultaneously meet three conditions: it must
have ownership advantages, location advantages and internalization advantages.
Ownership advantages, also known as firm-specific advantages, are specific
advantages in the production of a good or service which are unique to a particular
The International Division of Labour 17