Chapter Eight and Eleven

1
Session 11

• Chapter Eight and Eleven
• Foreign Direct Investment

2
The Meaning of Foreign Direct Investment

• FDI Means that Control follows Investment
• The Concept of Control
• Ownership share of at least 10 or 25 percent
• The Concern about Control
• Governmental Concern
• Relinquishing control to foreign investors
• Investor Concern
• Relinquishing technology and other competitive
  assets
• Quality issue (pressure for cheaper and faster
  transfer)

• Methods of Acquisition
• Movement of capital

3
Motivations for FDI

• Business and governments are motivated to engage
  in FDI in order to
• Expand sales
• Acquire resources
• Diversify sales and supplies
• Minimize competitive risk
• Governments may additionally be motivated by some
  desired political advantage

4
Foreign Direct Investment The defining concept
is control

• When businesses send their money, knowledge, and
  people abroad, they want to control what happens
• So they create or purchase units in foreign
  countries that they control.
• Control must accompany investment, or its not
  direct investment
• Defining direct investment for government
  statistics is arbitrary
• Usually 10 to 25 of a firms stock

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• Companies are reluctant to transfer their most
  vital resources to another organization without
  control
• Capital
• Patents
• Trademarks
• Management know-how
• Komatsu of Japan, Samsung of South Korea learned
  from US firms, then competed with them

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Control and Costs

• Control inherent in FDI may
• Decrease operating costs
• Increase rate of technology transfer
• Parent and subsidiary share common corporate
  culture
• Company can use its own managers
• Company can avoid protracted negotiations with
  another company
• Company can avoid problems of enforcing an
  agreement

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Motives for FDI

• Expand sales
• Acquire resources
• Minimize risk
• Political issues/motives

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Sales Expansion Motivation

• Transportation
• Lack of Domestic Capacity
• Excess usually leads to exporting rather than
  direct investment
• May be competitive because of variable cost
  pricing
• Scale Economies (transportation vs. type of
  technology)
• Large-scale process technology favor exports
• Highly differentiated products (small-scale
  process technology) favor FDI

• Trade Restrictions
• Lead to local production to serve the local
  market esp. if market potential is high relative
  to scale economies

• Country-of-Origin Effects
• Nationalism, Product Image, Delivery Risk

• Changes in Country Cost Advantages

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Resource-Acquisition Investments

• Vertical Integration
• In international vertical integration, raw
  materials, production, and marketing are often
  located in different countries

• Rationalized Production
• In rationalized production, different components
  or portions of a product line are made in
  different parts of the world.
• Advantages are
• Factor-cost differences
• Long production runs
• Hedging for exchange rate fluctuations
• Challenges are
• Satisfying governments that local production
  takes place
• Higher risk of work stoppages
• Record keeping

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Resource-Acquisition Investment

• Access to Production Factors
• A company may establish a presence in a country
  in order to improve its access to knowledge and
  other resources
• The Product Life Cycle Theory
• The product life cycle theory explains why
• New products are produced mainly in industrial
  countries
• Mature products are more likely to be produced in
  LDCs
• Governmental Investment Incentives
• Governmental incentives may shift the least-cost
  production location

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Diversification-Oriented Investments

• Sales - Sales Expansion Objective
• Supplies - Resource Acquisition Objective

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Competitive Risk Minimization

• Following Customers
• Preventing Competitors Advantage
• In oligopolistic industries (few sellers),
  competitors tend to make direct investments in a
  given country about the same time

13
Political Motives

• Governments take ownership of FDI or give
  incentives to direct investors in order to
• Gain supplies of strategic resources
• Develop spheres of influence

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Buy-versus-Build Decision

• Reasons for Buying
• Avoiding start-up problems
• More finance options available
• Capital infusion from home country
• Local financing
• Exchange of stock
• Adding no further capacity in the market
• Reasons for Building
• No desired company is available for acquisition
• Acquisition will carry over problems
• Local financing may be easier to obtain

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Advantages of Foreign Direct Investment

• Monopoly Advantages before Direct Investment
• Companies with unique advantages (inimitable
  competencies)
• Advantages after Direct Investment
• Companies with foreign investment tend to
• Be more profitable
• Have more stable sales and earnings
• Makes companies more successful at home
• Strategy of Direct Investment in the
  Internationalization Process
• Initially follows an export strategy
• Less true for subsequent ventures

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Investors Advantage

• Foreign direct investment is correlated with
  profitability.
• Why?
• Create supremacy over similar companies in
  countries of interest (monopoly)
• Sell more efficiently
• Foreign currency may have a high buying power
• May be able to borrow capital at a lower interest
  rate than companies from other countries
• Get to know markets, resource sources better

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Direct Investment Patterns

• Country of Origin
• Almost all ownership is by companies from
  industrial countries
• LDC ownership is increasing
• Location
• Industrial countries due to
• Biggest markets
• Lowest perceived risk
• Least discrimination toward foreign companies
• Economic Sector
• Highest growth in Services

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Direct Investment Patterns
Table 8.2
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Flow of FDI
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FDI in Developed Countries

• Most FDI is from developed countries TO developed
  countries
• Markets are larger in developed countries
• Political turmoil in emerging economies has
  discouraged investors
• Developed countries are committed to liberalizing
  direct investments among members
• Taxes
• Access to local capital
• Government procurement

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Example International Business Strategy and the
Political Legal Environment

• U.S.-Japanese Auto Trade Revisited
• When facing import competition, companies can
• Try to get protection
• Seek other market niches
• Make domestic output competitive
• Move abroad
• Approaches to the International Environment
• What kind of companies have the most to lose from
  protectionism? Big or small? Diversified or not?

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• But FDI in developing countries is growing
  rapidly
• especially China
• also India, Southeast Asia

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Stakeholders in FDI

• Stockholders
• Employees
• Customers
• Society inthe receiving country
• Often goalsof these stakeholders conflict

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Government Involvement in FDI

• Developed countries
• Deregulated markets
• Privatized national enterprises
• Liberalized private ownership
• Encouraged regional cooperation
• With this environment FDI flows surged from 202
  billion in 1990 to 1.3 trillion in 2000

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Cause-Effect Issues in FDI in developing (poor)
countries

• Inequitable income distribution
• Political corruption
• Environment debasement
• Social deprivation

• Higher tax revenues
• Employment
• Innovation
• Exports

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Major Strengths that MNEs Bring

• Investment
• Increased productivity
• Technology
• RD
• New capital equipment
• Trade
• Export expansion
• Lower-cost imports

• Human Resources
• Training
• Employment
• Managerial skills
• Environment
• Access to clean technologies
• Pollution-abatement skills
• Company-wide standards

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FDI and Balance-of-Payments Effects

• Countries that run trade deficits want to
  compensate by attracting an influx of capital
• Foreign aid
• Loans
• Foreign investment (FDI)
• Foreign direct investment improves balance of
  payments, at least in the short run
• BUT the investor will send profits home
• Nations fear FDI will hurt balance-of-payments
  more than it helps in the long run

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Home-Country Losses

• Displaces jobs
• Technology transferred abroad
• Loss of output
• Loss of exports
• Decrease local RD undertakings

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Home-Country Gains

• Lower prices
• Increase in demand for skilled-labor
• More optimum use of production factors
• Upgrading of resource quality
• Higher product demand
• Ability to observe foreign competitive conditions

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General Conclusions

• The pros and cons of foreign direct investment
  are like those of trade, only more so
• Offers the opportunity to greatly improve
  economies
• Can disrupt the cultural and economic fabric of
  the receiving nation

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