Foreign Direct Investment

What is foreign direct investment Company acquiring or merging with a firm in a different country A firm creating a ‘Greenfield’ operation in a different country A firm creating a subsidiary in a different country As a result The firm has significant control of its foreign operation Firm can affect managerial decisions of the foreign operation

Company acquiring or merging with a firm in a different country

A firm creating a ‘Greenfield’ operation in a different country

A firm creating a subsidiary in a different country

As a result

The firm has significant control of its foreign operation

Firm can affect managerial decisions of the foreign operation

FDI - Flow versus stock FDI occurs when a firm invests directly in facilities to produce and/or market a product in a foreign country Flow: Amount of FDI over a period of time (one year) Stock: Total accumulated value of foreign owned assets at a given point in time FDI is not the investment by individuals, firms or public bodies in foreign financial instruments

FDI occurs when a firm invests directly in facilities to produce and/or market a product in a foreign country

Flow: Amount of FDI over a period of time (one year)

Stock: Total accumulated value of foreign owned assets at a given point in time

FDI is not the investment by individuals, firms or public bodies in foreign financial instruments

Why is FDI important ? Firms want a presence in foreign markets Firms want control over growth of these foreign markets To gain first mover advantages To ward off competitors To determine locations, advertising and other related strategic decisions in the firm’s interest

Firms want a presence in foreign markets

Firms want control over growth of these foreign markets

To gain first mover advantages

To ward off competitors

To determine locations, advertising and other related strategic decisions in the firm’s interest

Trends in FDI Flow and stock increased in the last 20 years In spite of decline of trade barriers, FDI has grown more rapidly than world trade because Businesses fear protectionist pressures FDI is seen a a way of circumventing trade barriers Dramatic political and economic changes in many parts of the world Globalization of the world economy has raised the vision of firms who now see the entire world as their market

Flow and stock increased in the last 20 years

In spite of decline of trade barriers, FDI has grown more rapidly than world trade because

Businesses fear protectionist pressures

FDI is seen a a way of circumventing trade barriers

Dramatic political and economic changes in many parts of the world

Globalization of the world economy has raised the vision of firms who now see the entire world as their market

FDI outflows, 1982-2002 Fig 6.1

FDI flows by region Fig: 6.3

FDI outflows by select country 1998-2001 Fig: 6.5

Form Of FDI: Greenfield versus acquisitions Green field operation: Mostly in developing nations Mergers and acquisitions: Quicker to execute. Foreign firms have valuable strategic assets Believe they can increase the efficiency of the acquired firm More prevalent in developed nations

Green field operation:

Mostly in developing nations

Mergers and acquisitions:

Quicker to execute.

Foreign firms have valuable strategic assets

Believe they can increase the efficiency of the acquired firm

More prevalent in developed nations

FDI trends: 2001-2002 The value of FDI slumped almost 60 percent in 2001-2002 Slowdown in world economy Heightened geopolitical uncertainty since September 11, 2001 Bursting of the stock market bubble in the US

The value of FDI slumped almost 60 percent in 2001-2002

Slowdown in world economy

Heightened geopolitical uncertainty since September 11, 2001

Bursting of the stock market bubble in the US

Impediments to the sale of know-how Impediments to the sale of know how Risk giving away know-how to competitors Licensing implies low control over foreign entity Know-how not amenable to licensing

Two forms of FDI Horizontal Direct Investment FDI in the same industry abroad as company operates at home. Vertical direct investment Backward - investments into industry that provides inputs into a firm’s domestic production (typically extractive industries) Forward - investment in an industry that utilizes the outputs from a firm’s domestic production (typically sales and distribution)

Horizontal Direct Investment

FDI in the same industry abroad as company operates at home.

Vertical direct investment

Backward - investments into industry that provides inputs into a firm’s domestic production (typically extractive industries)

Forward - investment in an industry that utilizes the outputs from a firm’s domestic production (typically sales and distribution)

FDI when and why? Transportation costs are high Market Imperfections (Internalization Theory) Impediments to the free flow of products between nations Impediments to the sale of know-how Follow the lead of a competitor - strategic rivalry Product Life Cycle - however, does not explain when it is profitable to invest abroad Location specific advantages (natural resources)

Transportation costs are high

Market Imperfections (Internalization Theory)

Impediments to the free flow of products between nations

Impediments to the sale of know-how

Follow the lead of a competitor - strategic rivalry

Product Life Cycle - however, does not explain when it is profitable to invest abroad

Location specific advantages (natural resources)

VDI, when and why? Market power create entry barriers erode entry barriers Market imperfections Impediments to the sale of know-how Investments in specialized assets

Market power

create entry barriers

erode entry barriers

Market imperfections

Impediments to the sale of know-how

Investments in specialized assets

Decision framework How high are transportation costs and tariffs? Is know-how amenable to licensing? Is tight control over foreign operation required? Can know-how be protected by licensing contract ? Then license Export No Yes Yes Low No Yes No Horizontal FDI Horizontal FDI Horizontal FDI High