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Chapter 4 part 2(Foreign Direct Investment)

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Chapter 4  part 2(Foreign Direct Investment) Chapter 4 part 2(Foreign Direct Investment) Presentation Transcript

  • Fourth Edition International Business
  • CHAPTER 6 Foreign Direct Investment
  • Chapter Focus
    • This chapter seeks to identify the economic rationale that underlies Foreign Direct Investment. For example, why do some firms prefer FDI to exporting or licensing. Is the need for control, part of the answer?
  • Foreign Direct Investment
    • FDI occurs when a firm invests directly in facilities to produce and/or market a product in a foreign country.
    • Starbucks invested $10m in Japan in 1996.
  • Foreign Direct Investment
    • FDI occurs when a firm invests directly in facilities to produce and/or market a product in a foreign country.
      • Once a firm undertakes FDI, it becomes a multinational enterprise (multinational = more than one country).
  • Foreign Direct Investment
    • FDI takes two forms:
      • Green-field investment: establishing a wholly new operation in a foreign country.
      • Example ; starbucks
  • Foreign Direct Investment
    • FDI takes two forms:
      • Green-field investment: establishing a wholly new operation in a foreign country.
      • Acquiring or merging with an existing firm in the foreign country.
      • Example: Rank-Xerox, Grameen-Danone
  • Foreign Direct Investment
    • NOTE:
    • Investing in foreign financial instruments (Portfolio Investment like govt. bond, foreign stocks) IS NOT FDI.
  • Flow and Stock of FDI
    • Flow:
      • The amount of FDI undertaken over a given period of time (usually one year).
    • Stock:
      • Total accumulated value of foreign-owned assets at a given time.
  • FDI Outflows 1982-2000 Figure 6.1
  • FDI Flows by Region Figure 6.2 Index
  • Reasons for FDI Growth
    • FDI circumvents potential future trade barriers.
    • Many firms preferred the US for FDI because of the hostile trade attitude shown by the US
  • Reasons for FDI Growth
    • FDI circumvents potential future trade barriers.
    • Dramatic political and economic changes occurring in developing countries.(Opening up the economy in India , China, Singapore,etc )
  • FDI into Developed and Developing Nations: 1990-2000 $Billion Figure 6.3
  • FDI Outflows by Selected Countries, 1994-1999 Figure 6.5
  • The Form of FDI: Acquisitions versus Greed-Fields
    • The majority of investments is in the form of mergers & acquisitions:
      • Represents about 77% of all flows in developed countries.
      • Represent about 33% of all flows in developing countries.
        • Fewer target firms to acquire.
    • Why the preference for mergers & acquisitions?
      • Quicker to execute.
      • Foreign firms have valuable strategic assets.
      • Believe they can increase the efficiency of the acquired firm.
  • FDI and Risk
    • FDI is expensive and risky compared to exporting or
    • licensing:
      • Costs of establishing facilities.
      • Problems with doing business in a different
      • Culture.
      • But still FDI occurs . Why???
  • Horizontal FDI and Factor Considerations Horizontal FDI: when a firm invests in the same industry as in the home country Transportation Costs: High/low value to weight impacts costs. If the product is low in value-to-weight ration like soft drinks Or cement , then transportation costs add to the costs. Here , FDI is a better option. If the product has a high value-to-weight ration then exporting Is a better option unless there are other factors to consider.
  • Horizontal FDI and Factor Considerations Market Imperfections (Internalization Theory): Factors that inhibit markets from working perfectly. This includes (1) governments impeding the free flow of products between nations(Toyota), and (2) impediments to the sale of know-how.(RCA, Matsushita & Sony) Strategic Behavior: Concentrated industries (oligopoly) tend to mimic each other’s moves. Where there is multipoint competition, competing firms match each other’s moves to keep the competitor in check. Example: Orascom Vs Telenor
  • Horizontal FDI and Factor Considerations The Product Life Cycle: Suggests that foreign market demand leads to FDI, probably not true and therefore is not a good predictor of FDI. Location-Specific Advantages: Advantages that arise from using resource endowments or assets tied to a particular location (Dunning - eclectic paradigm) Example: Silicon Valley.
  • Vertical FDI
    • Two forms:
      • Backward: Providing inputs (raw materials, parts) for a firm’s domestic production processes.
      • Forward: An industry abroad sells the outputs of the firm’s domestic production processes.
  • Why Do Companies Engage in FDI?
    • Strategic Behavior: Can raise entry barriers or shut out new competitors, or circumvent barriers established by companies already doing business in the foreign country.
    • Alcoa and Alcan went to T&T to gain control over bauxite.
    • Market Imperfections: Need to overcome lack of know-how or the firm must invest in specialized assets whose value depends on inputs provided by a foreign supplier.
  • Impediments to the Sale of Know-how Impediments to the sale of know how Risk giving away know-how to competitors (BP & Shell) Licensing implies low control over foreign entity(Kodak Vs Fuji) Know-how not amenable to licensing(Starbucks, P& G)
  • A Decision Framework Figure 6.6 Yes 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 Horizontal FDI Horizontal FDI Horizontal FDI High Yes No Low No Yes No