2. 1
Table of Contents
WHY COMPANIES ARE INVESTING ABROAD.................................................................................... 2
INVESTMENT RISKS ....................................................................................................................... 4
Economic Risk:.......................................................................................................................... 4
Exchange Risk:........................................................................................................................... 4
Political Risk:............................................................................................................................. 5
ENTRY MODELS and MODES .......................................................................................................... 6
FOUR MAIN REASON TO INVEST ABROAD....................................................................................... 7
Resource seeking:...................................................................................................................... 7
Market seeking:........................................................................................................................ 8
Efficiency seeking:..................................................................................................................... 9
Strategic asset seeking:.............................................................................................................10
FINAL THOUGHTS ON FOREIGN DIRECT INVESTMENT.....................................................................10
REFERENCES................................................................................................................................11
3. 2
Foreign direct investment (FDI) has mainly been characterized as being motivated by a firm’s
desire to exploit its existing proprietary advantages abroad (the internationalization model) or
as part of the firm’s equilibrium strategy in a game of imperfect international competition.
(Graham & Krugman. 1991)
Trade has traditionally been the principal mechanism linking national economies in order to
create an international economy. FDI is a similar mechanism linking national economies;
therefore, these two mechanisms reinforce each other. The trade effects of FDI depend on
whether it is undertaken to gain access to natural resources, to consumer markets or whether
the FDI is aimed at exploiting locational comparative advantage or other strategic assets such
as research and development capabilities. Most developing countries lack technology capability
and FDI to facilitate technology transfer and reduce the technology gap (TGAP) between
developing countries and developed countries. In fact, it is suggested that spillovers or the
external effects from FDI are the most significant channels for the dissemination of modern
technology (Blomstrom, 1989).
WHY COMPANIES ARE INVESTING ABROAD
The important question is “Why do companies invest abroad?” Dunning (1993) developed his
theory by synthesizing the previously published theories, because existing explanations could
not fully justify the existence of FDI. According to Dunning, international production is the
result of a process affected by ownership, internalization and localization advantages.
Dunning’s so-called OLI paradigm states that FDI is undertaken if ownership-specific
advantages (“O”) like proprietary technology exist together with location-specific advantages
(“L”) in host countries, e.g. low factor costs, and potential benefits from internalization (“I”) of
the production process abroad (Frenkel et al., 2004).
Companies prefer to invest in foreign markets for a several reasons, such as taxes, labor costs,
market seeking, regulations, access to higher income. In investment process, there are plenty
much different variations effect to expending abroad. Some of them may be positive but some
of them may be negative. This positive and negative effects depend on how do you invest, when
do you invest, and why do you invest. Investing abroad is not easy decision for any companies,
especially if they have not inherent stable company culture and management.
‘‘Firms’ decision making process involved in carrying out an “international strategy” may be
fruitfully viewed as follows: first of all, firms identify an opportunity which may be grasped
4. 3
outside the home country. Indeed, in order to possibly being grasped via a Foreign Direct
Investment, such opportunity must possess some transnational feature, and this is a necessary
condition for starting a decision process which may eventually result in a FDI. Thus, for
instance, think about a firm that decides to reduce production costs taking advantage of low
cost foreign work or to expand its market by selling its own products abroad. It is worth noting
that the act of catching the opportunity is the final aim of firm’s actions and this primordial
motive shapes the patterns of the decision and the effects it has on both the host and home
countries.’’ (Franco, Rentocchini, and Vittucci Marzetti, 2008)
We may start examination from the why and where to enter or invest abroad. Companies should
consider especially geographical features, cultural differences. While choosing location to
invest; transportation, raw materials, taxes, distance to neighbor markets, should be considered.
Additionally, cultural familiarities are important, people may not easily get used to new brands
if the brand is completely different and unknown.
Transportation and distance to natural resources is important because products costs substantial
amount of depends to this kind of production process costs. If the companies keep production
cost minimum level, they have to consider priorities cost of products. We may include raw
materials in this production process costs. The distance of factories to raw materials is very
important the terms of production costs. This location selection is not just about transportation
and raw materials. We should also examine taxation, government regulations, market, and low-
cost factors. About taxation, all countries have different taxation systems. In particular, we may
say that underdevelopment and still in developing process countries are clearly open to invest.
Already, their economies need to develop and improve, for this reason they welcome to new
investors. Therefore, this kind of underdevelopment countries have lower cost taxation systems.
Also governments have some regulations for gain new invests. They may reduce country
barriers, tax barriers, etc. Even some countries give free land (or they rent a land for long period)
to build factories and other supplements.
Market competition is the one of the main factor to invest abroad. If there are tough market
conditions, some companies may avoid enter to new markets because of rivalry conditions.
Starting from the zero in the completely different and new market and take a place in an already
existence market sharing may be very compeller. That’s why, market features such as monopoly
markets, and oligopoly markets are very important to enter foreign market decision process.
Moreover, low cost factors are very fundamental feature to invest abroad. It depends on what
is your area of specialization but we may say that one of the most important elements is low
5. 4
cost factors during invest abroad. Nowadays there are lots of companies moving abroad for use
that low cost advantages.
We should evaluate that companies not just invest abroad for producing something but also
they invest overseas to sell products and gain more profit. Companies have some special market
targets; this occur because lack of products, low level of competitors, some opportunities of
markets such as you may sell unique products. Furthermore, if the investing country share
familiarity culture with its neighbor companies may extend other countries in same area easily.
INVESTMENT RISKS
Plenty of main risks need to be considered when expanding abroad such as economic, political,
currency, regulatory, additional costs risks. Especially small business may not accomplishment
easily these risks. In this point timing also come forward and takes a special role in the investing
process. If companies investing abroad and taking some risks they have to be ready to provide
indemnification. Otherwise they may lose already established and stable place in their home
market.
Economic Risk: a significant change in the economic structure or growth rate that produces a
major change in the expected return of an investment. Risk arises from the potential for
detrimental changes in fundamental economic policy goals (fiscal, monetary, international, or
wealth distribution or creation) or a significant change in a country’s comparative advantage
(e.g., resource depletion, industry decline, demographic shift). Economic risk often overlaps
with political risk in some measurement systems since both deal with policy. (Meldrum, 2000)
Economic risk may country pay its debts back or may not. In this content most important thing
is the economic stabilization and financial power of country. If country has really strong
economy, then should provide reliable investments. International investing carries more risk
than domestic investing. The risk that company may be disadvantaged by exchange rate
movements. And also some government regulations.
Exchange Risk: an unexpected adverse movement in the exchange rate. Exchange risk includes
an unexpected change in currency regime such as a change from a fixed to a floating exchange
rate. Economic theory guides exchange rate risk analysis over longer periods of time (more than
one to two years). Short-term pressures, while influenced by economic fundamentals, tend to
be driven by currency trading momentum best assessed by currency traders. In the short run,
6. 5
risk for many currencies can be eliminated at an acceptable cost through various hedging
mechanisms and futures arrangements. Currency hedging becomes impractical over the life of
plant or similar direct investment, so exchange risk rises unless natural hedges (alignment of
revenues and costs in the same currency) can be developed. (Meldrum, 2000)
Political Risk: risk of a change in political institutions stemming from a change in government
control, social fabric, or other non-economic factor. This category covers the potential for
internal and external conflicts, expropriation risk and traditional political analysis. Risk
assessment requires analysis of many factors, including the relationships of various groups in a
6 country, the decision-making process in the government, and the history of the country.
Insurance exists for some political risks, obtainable from a number of government agencies and
international organizations. (Meldrum, 2000)
Political decisions which made by ruler may effect companies during their expanding process
or currently located companies may give up being in the country and decided to move another
place. If the political climate already unstable or start to being waving, investors may reconsider
to invest in a country. We may say even if the country economically powerful but politically
unstable the country may not be good candidate for investment.
Currency risks mean, chancing in the relative valuation of currencies. These kind of changes
may build up some sudden gains and losses. It generally depends on financial power of
government but also it depends on political stability. Consisting of losses of value of currency,
may be cause of go bankrupt or withdraw. According to Bryan Borzykowski there are 4 ways
to protect from foreign-currency risk. These are Hedge your bets, Short an overvalued currency,
look for high interest rates, and Buy undervalued currencies. (Travelasia et al., 2014)
In some countries, international investing costs may be more expensive than investing other
countries because of there may be unexpected taxes, such as rental income taxes, profit taxes,
withholding taxes, withdrawal taxes. Moreover, it may be difficult to reach some information
about government regulations and it may be costly.
Furthermore, distance between two countries give rise to lack of connection ethnic and social
networks. Different languages, ethnicities, religions and social norms also very important
matter since business. Absence of shared monetary and political association, weak legal and
financial institutions, political hostilities are some of the main institutional risks. Lack of
common border, water access, adequate transportation or telecom links, physical remoteness,
different climates are creating geographic distance. Some of the most important discrimination
7. 6
for the economic distance are different consumer incomes, different costs and quality of natural,
financial and human resources, different information or knowledge.
ENTRY MODELS and MODES
In this part of our work we have to mention that there is two thought have emerged: stage model
and strategic model. Moreover, we will examine entry modes which are Non-equity modes and
Equity modes.
Stage models mean, enter to culturally and ethnically similar countries, beginning of the
internationalization process. It helps to gain confidence and economically power, so after that
enterprise business may enter culturally more distant countries in later process.
Strategic model mean, when company consider strategic goals such as market seeking, gain
profit, efficiency more than culture and ethnic roots, they may choose strategic model.
Non-Equity modes may have divided Exports and Contractual agreements. In this modes
business don’t pay and invest any money in to the country. Its occur through direct export,
indirect export, licensing/ franchising, turnkey projects, R&D contracts, Co-marketing. Non-
equity mode has some advantages and disadvantages for business. Advantages such as: better
control ever distribution, concentration of resources on production, no need to directly handle
export processes, low development costs, low risk in overseas expansion, ability to top into the
best locations for certain innovations at low costs, ability to reach more customers.
Disadvantages such as: high transportation costs for bulky products, marketing distance from
customers, trade barriers, less control over distribution (relative to direct export), inability to
learn how to operate overseas, little control over technology and marketing, may create
competitors, inability to engage in global coordination, may create efficient competitors, lack
of long term presence, difficult to negotiate and enforce contracts, may nurture innovative
competitors, may lose core innovation capabilities, limited coordination.
Equity modes may have divided Joint ventures and Wholly owned subsidiaries. In this modes
business pay and invest money to country. Its occur thought minority JV, 50/50 JV, Majority
JV, Green fields, Acquisitions. Equity mode has some advantages and disadvantages for
business. Advantages such as: sharing costs and risks, access to partners’ knowledge and assets,
politically acceptable, complete equity and operational control, protection of technology and
8. 7
know-how, ability to coordinate globally, some as green-field except slow speed, post-
acquisition integration problems.
After all short explanations we may mention some another important terms and its’ advantages
about invest abroad. Early and late movement is a significant issue for business. Early mover
advantages: business may be tech leader, preempt scarce resources, create entry barriers, avoid
clash with dominant firms at home, establish key ties with customers or government. Late
mover advantages: benefit from early mover investments, wait until tech uncertainty is
resolved, learn from early mover’s difficulty to adapt to the market and related changes.
FOUR MAIN REASON TO INVEST ABROAD
‘‘The importance of transition economies as investment sites for multinational corporations has
drastically increased over the last decade. With economic liberalization of Central and Eastern
European countries, former Soviet Union republics, and hefty developments in People’s
Republic of China and East Asian economies, vast market and production opportunities have
opened up for multinational businesses. Although a number of multinational corporations have
successfully managed to capitalize on these opportunities, a number of firms have been
significantly less successful in their internationalization efforts. Various internal and external
factors were shown to considerably affect success of multinational businesses in transition
economies setting.’’ (Kudina and Jakubiak, no date)
After all advantages, disadvantages, risks explanations, and short introduction we may say that
investing abroad is a pretty complicated and hard to decide process. Although there are lots of
reason to invest abroad, we may narrow these reasons in 4 main topics. These are Resource
seeking, market seeking, efficiency seeking, strategic asset seeking.
Resource seeking:
We may simply define, companies looking for a cheaper resource. In this step main aim of the
business is that acquiring specific types of resources that they are not available to obtaining at
home or we may say obtaining at a lower cost. As we mentioned that some developing countries
has privileged systems for the investors. Some countries provide cheaper lands in order to
establish factories for companies. During invest process business look for cheaper cost of labor,
low product costs, low level of capital requirements, and easy access to natural resources.
9. 8
Comparing home and abroad labor costs may vary according to minimum wage. In this step
business prefer to move abroad to get more profit. Cost of labor may include health insurance,
retirement salary, bonus, launch voucher. These are the one of the main effects of the expense
of company. Easily reachable raw-materials, generally reducing product cost. That’s why
investing or moving production systems to abroad is significant in order to companies. Distance
between resources and factories may decrease transportation cost. We may mention technology
here, production technology also very important. Nowadays, as far as companies are
manufacturing new technologies and innovations but there are some companies that buy
existing technology. And buying existence technology is cheaper than create something new.
Both in terms of developing and researching process and spending time, may cause companies
to be left behind comparing to already existence companies in the market. While some states
allow the companies to set up in very small amount of money, but some of them require huge
amount of capital. At this point, companies tend to invest in countries that require less capital
to hold more money in their hands.
The investments made by companies to abroad in terms of distance to natural resources are also
very important. It is also very important to invest abroad not only in terms of raw materials but
also in using the existing technology, benefiting from the labor and being close to the markets
that are desired to be achieved. The difference in value between currencies allows companies
to become more profitable as they invest abroad.
Market seeking:
The new global economic environment is likely to have two major effects on the geographical
distribution of FDI. First, by placing a higher premium on environmental risk, it is likely to
steer MNE activity toward locations perceived to be friendly toward their home country regimes
and to be the least subject to terrorist attacks or political instability. Second, it is likely to add
to the competitive pressures in many industries and force companies to enhance their cost
efficiency. Faced by more price-driven competition, some MNEs may choose to relocate some
of their production facilities to low-cost developing and/or transition countries. At the same
time, because of their increased economic vulnerability, other MNEs may choose to reduce
their foreign equity stakes, particularly in advanced technology sectors, and conclude more
strategic alliances and subcontracting arrangements with foreign firms. (Tungodden, Stern, and
Kolstad, 2004)
10. 9
As we mentioned that market entry is divided into two part, these are early entry and late entry.
Both of them have their own advantages. The searching for a new market and the distance of
the other markets is very important from a strategic point of view. For example, entering a
market with close to cultural aspect of nations with the other markets, is make easy to transfer
another markets and regions. If entrance is being made completely foreign, there may be some
troubles in terms of recognition of the market, recognition of people and culture. But it is much
easier to switch to other markets in the same cultures after this initial acclimatization phase has
been bypassed and since the start of specialization.
It is important not only to be culturally but also product-based, filling the lack of product in a
market, in order to be first in that market. When you are the first in a market, there may be some
problems arise as consumers adopt and accept the product, if the product can take a place in a
market, it is a very important development for this company. At this stage, the company may
be the only hand on the product it enters into the country and may dominate the market. Thus
company may determine market conditions and creating a monopoly by it selves.
If the market has already existed in the same kind of products, the conditions may be quite
different. It may take a very long time for consumers to accept the new product and leave the
existing product. In this point companies may make some specific differences. These
differences may be reasonable prices and may be things like a sales samples.
Efficiency seeking:
The role of the states in international investments is quite large. When companies choose the
country, they will invest in, they have to consider the economic and legal regulations of the
countries. Not only state regulations but also in international treaties are very important. The
relations with the neighbors of the state and the international agreements also very important
from the aspect of companies. Companies can be benefit from a number of international
arrangements when they are subject to international agreements in states which they invest.
Thus companies are able to access some free trade areas and benefit from very low taxes.
We may say efficiency seeking means to enhance economies of scale and scope, logics
infrastructure, and risk diversification, to increase level of productivity of the whole
organization and decrease of costs of critical organizational process. ‘‘The oldest such
investments have been labor-seeking investments.’’ (foreign direct investment and
development, 1999) We may see clearly when we investigate wages of labor in developing
11. 10
countries, as real wages have risen over time in some of the reason, labor seeking investment
has moved on to other lower wage countries. This mobility is also of great importance in terms
of the countries invested in. improve. Its beneficial to the country in terms of the level of
prosperity as well as increasing the import and export of the invested country.
Strategic asset seeking:
Strategic asset-seeking primarily motivates these strategies in advanced economies in the form
of acquisitions of local firms (Guillén and Garcia-Canal 2009, Luo and Tung 2007, Mathews
2006). Firms engage in strategic asset-seeking FDI when they intend to seek technology based
resources and skills in a host country that are superior or not available in their home countries.
(Deng 2007, Makino et al. 2002, Kumar 2008, Chen and Chen 1998, van Hoesel 1999,
Belderbos 2003).
In this step companies have certain options to invest such as: acquisition and joint ventures. In
this context, companies are either partners with other companies or they are totally in possession
of all knowledge and technology accumulation by purchasing them completely. The most
benefit of this area of business is the sharing of technology and information. By merging with
others through acquisition, they may become larger and more experienced companies by
sharing pre-existing knowledge in their hands. Knowing the rules of law, the already established
ties with the consumer, cultural communication and the way of management already established
bring great advantages for the companies.
FINAL THOUGHTS ON FOREIGN DIRECT INVESTMENT
Foreign direct investment can be very useful for both countries and companies. Not only in
terms of increasing imports and exports, but also investments made in the service sector is
contribute greatly to the economy of the country. Companies prefer to stabilize the economic
and political situation of the country they will invest in. When companies invest abroad, they
may generally gain high growth rates from investment. Factors such as raw materials, labor,
transportation, taxes, affect investments of companies, they should be carefully considering
about negative effects such as inflation, state regulations, political conflicts, or other potential
problems that may rise.
12. 11
REFERENCES
Blomstrom, M. (1989), Foreign Investment and Spillovers: A Study of Technology Transfer to
Mexico, Routledge, London
Deng, P. (2007). Investing for strategic resources and its rationale: The case of outward FDI
from Chinese companies. Business Horizons, 50, 71-81.
Dunning, J.H. (1993), Multinational Enterprises and the Global Economy, Addison-Wesley
Publishing Company, Wokingham.
Foreign direct investment and development (1999) 1(10).
Franco, C., Rentocchini, F. and Vittucci Marzetti, G. (2008) ‘Why do firms invest abroad? An
analysis of the motives underlying foreign direct investments’, SSRN Electronic Journal, . doi:
10.2139/ssrn.1283573.
Frenkel, M., Funke, K. and Stadtmann, G. (2004), “A panel analysis of bilateral FDI flows to
emerging economies”, Economic Systems, Vol. 28, pp. 281-300
Graham, E.M.. & Krugman, P.R. (1991). Foreign direct investment in the United States.
Washington, DC: The Institute for International Economics.
Guillén, M.F. & García-Canal, E. (2009). The American model of the multinational firm and
the "new" multinationals from emerging economies. Academy of Management Perspectives,
23, 23-25.
Kudina, A. and Jakubiak, M. (no date) ‘The motives and impediments to FDI in the CIS’, SSRN
Electronic Journal, . doi: 10.2139/ssrn.1392754.
Meldrum, Duncan H. ‘Country Risk and Foreign Direct Investment.’ Business Economics, vol.
35, no. 1, 2000, p. 33. Academic Onefile, Accessed 16 Nov. 2016
Travelasia, Images, A., Images, G. and Borzykowski, B. (2014) 4 ways to protect yourself from
foreign-currency risk. Available at: http://www.cnbc.com/2014/04/02/4-ways-to-protect-
yourself-from-foreign-currency-risk.html (Accessed: 14 November 2016).
Tungodden, redagavo B., Stern, N.H. and Kolstad, I. (2004) Toward pro-poor Policies– aid,
institutions, and globalization, 490 dalis. Available at:
https://books.google.lt/books?hl=lt&lr=&id=R1KBWX329uIC&oi=fnd&pg=PA279&dq=effi
