Foreign Direct Investment


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Foreign Direct Investment

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Foreign Direct Investment

  1. 1. Foreign Direct Investment
  2. 2. What is foreign direct investment <ul><li>Company acquiring or merging with a firm in a different country </li></ul><ul><li>A firm creating a ‘Greenfield’ operation in a different country </li></ul><ul><li>A firm creating a subsidiary in a different country </li></ul><ul><li>As a result </li></ul><ul><ul><li>The firm has significant control of its foreign operation </li></ul></ul><ul><ul><li>Firm can affect managerial decisions of the foreign operation </li></ul></ul>
  3. 3. FDI - Flow versus stock <ul><li>FDI occurs when a firm invests directly in facilities to produce and/or market a product in a foreign country </li></ul><ul><ul><li>Flow: Amount of FDI over a period of time (one year) </li></ul></ul><ul><ul><li>Stock: Total accumulated value of foreign owned assets at a given point in time </li></ul></ul><ul><li>FDI is not the investment by individuals, firms or public bodies in foreign financial instruments </li></ul>
  4. 4. Why is FDI important ? <ul><li>Firms want a presence in foreign markets </li></ul><ul><li>Firms want control over growth of these foreign markets </li></ul><ul><ul><li>To gain first mover advantages </li></ul></ul><ul><ul><li>To ward off competitors </li></ul></ul><ul><ul><li>To determine locations, advertising and other related strategic decisions in the firm’s interest </li></ul></ul>
  5. 5. Trends in FDI <ul><li>Flow and stock increased in the last 20 years </li></ul><ul><li>In spite of decline of trade barriers, FDI has grown more rapidly than world trade because </li></ul><ul><ul><li>Businesses fear protectionist pressures </li></ul></ul><ul><ul><li>FDI is seen a a way of circumventing trade barriers </li></ul></ul><ul><ul><li>Dramatic political and economic changes in many parts of the world </li></ul></ul><ul><ul><li>Globalization of the world economy has raised the vision of firms who now see the entire world as their market </li></ul></ul>
  6. 6. FDI outflows, 1982-2002 Fig 6.1
  7. 7. FDI flows by region Fig: 6.3
  8. 8. FDI outflows by select country 1998-2001 Fig: 6.5
  9. 9. Form Of FDI: Greenfield versus acquisitions <ul><li>Green field operation: </li></ul><ul><ul><li>Mostly in developing nations </li></ul></ul><ul><li>Mergers and acquisitions: </li></ul><ul><ul><li>Quicker to execute. </li></ul></ul><ul><ul><li>Foreign firms have valuable strategic assets </li></ul></ul><ul><ul><li>Believe they can increase the efficiency of the acquired firm </li></ul></ul><ul><li>More prevalent in developed nations </li></ul>
  10. 10. FDI trends: 2001-2002 <ul><li>The value of FDI slumped almost 60 percent in 2001-2002 </li></ul><ul><ul><li>Slowdown in world economy </li></ul></ul><ul><ul><li>Heightened geopolitical uncertainty since September 11, 2001 </li></ul></ul><ul><ul><li>Bursting of the stock market bubble in the US </li></ul></ul>
  11. 11. 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
  12. 12. Two forms of FDI <ul><li>Horizontal Direct Investment </li></ul><ul><ul><li>FDI in the same industry abroad as company operates at home. </li></ul></ul><ul><ul><li>Vertical direct investment </li></ul></ul><ul><ul><li>Backward - investments into industry that provides inputs into a firm’s domestic production (typically extractive industries) </li></ul></ul><ul><ul><li>Forward - investment in an industry that utilizes the outputs from a firm’s domestic production (typically sales and distribution) </li></ul></ul>
  13. 13. FDI when and why? <ul><li>Transportation costs are high </li></ul><ul><li>Market Imperfections (Internalization Theory) </li></ul><ul><ul><li>Impediments to the free flow of products between nations </li></ul></ul><ul><ul><li>Impediments to the sale of know-how </li></ul></ul><ul><li>Follow the lead of a competitor - strategic rivalry </li></ul><ul><li>Product Life Cycle - however, does not explain when it is profitable to invest abroad </li></ul><ul><li>Location specific advantages (natural resources) </li></ul>
  14. 14. VDI, when and why? <ul><li>Market power </li></ul><ul><ul><li>create entry barriers </li></ul></ul><ul><ul><li>erode entry barriers </li></ul></ul><ul><li>Market imperfections </li></ul><ul><ul><li>Impediments to the sale of know-how </li></ul></ul><ul><ul><li>Investments in specialized assets </li></ul></ul>
  15. 15. 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