Ib case study 3

International Business: Case Study 3December 272010By:Rohan DesaiRoll No. 109PGDM-B FDI by VOLVO in South Korea ,[object Object],The brief about South Korea’s political ideology prior to 1990 are as follows: South Korea was established in 1948 as a democracy, political turmoil, and periods of military rule and martial law, were existent during much of the period in until the foundation of the Sixth Republic in 1987. A political party in South Korea is a volatile phenomenon, more dependent on its leader than on any ideology or formal organizational structure. The leader does not represent the party; rather it is the other way around; the party constitutes the leader’s support network. In other words, the leader is the party. This phenomenon was apparent just after liberation in 1945. By January 1948, the US military authorities listed 48 political parties, of which the U.S. characterized 18 as ‘rightist’, 6 were ‘Left’, 14 were ‘communist’, and 10 were ‘neutral’. South Korea has experienced the formation of some two hundred political parties since liberation. There were 160 parties by the end of Yushin period (1979). The transitory and entourage nature of Korean political parties are an apparent, and to date a continuing, characteristic of the political culture. Despite the initial plan of a unified Korea in the 1943 Cairo Declaration, escalating Cold War antagonism between the Soviet Union and the United States eventually led to the establishment of separate governments, each with its own ideology, leading to Korea's division into two political entities in 1948: North Korea and South Korea. In the North, a former anti-Japanese guerrilla and communist activist, Kim Il-sung gained power through Soviet support, and in the South, an exiled and right-wing Korean political leader, Syngman Rhee, was installed as president. In 1960, a student uprising led to the resignation of the autocratic President Syngman Rhee. A period of political instability followed, broken by General Park Chung-hee's military coup (the quot;
5–16 coup d'étatquot;
) against the weak and ineffectual government the next year. Park took over as president until his assassination in 1979, overseeing rapid export-led economic growth as well as severe political repression. Park was heavily criticized as a ruthless military dictator, although the Korean economy developed significantly during his tenure. The years after Park's assassination were marked again by political turmoil as the previously repressed opposition leaders all campaigned to run for president in the sudden political void. In 1980 there was another coup d'état by General Chun Doo-hwan against the transitional government of Choi Kyu Hah, the interim president and a former prime minister under Park. Chun assumed the presidency, triggering nationwide protests demanding democracy.. The National Assembly approved South Korea’s new constitution in October 1987, replacing the constitution of 1980. It was the first constitution to be revised and adopted by both the opposition and the ruling party. The new constitution changed the election of the president from indirect election to a direct election, and changed the president’s term from seven to five years. Reflecting the past influence of the armed forces on South Korea’s political life, the constitution stipulates that the armed forces maintain quot;
political neutralityquot;
. South Korean ideologies after 1990’s: The National Assembly consists of at least 200 members. Today there are 273 members, where five-sixths of the seats are won by popular first-past-the-post elections. The remaining seats are distributed among the parties winning five or more seats, based on the national vote. The elected members serve for four years. Since the presidential term is five years it is possible that a president will be under different political control from the legislature. The President performs his executive functions through the Cabinet. The Cabinet consists of 15 to 30 members, and is presided over by the President, who is solely responsible for deciding all important government policies. The President selects the Cabinet members upon recommendation by the Prime Minister. In addition to the State Council, the President has two presidential agencies under his direct control to formulate and carry out national policies: The Board of Audit and Inspection, and the National Intelligence Service. The Cabinet members do not need to be members of the National Assembly or to be approved by it, but they cannot hold positions in the armed forces. They have the right to lead and supervise their administrative ministries and deliberate major state affairs. Cabinet members can act on behalf of the President but only in separate cases when they have been given this authorization. They have the right to appear at the National Assembly and express their opinions. Members of the Cabinet are collectively and individually responsible only to the President. The Prime Minister nominally heads the Cabinet. The Prime Minister is appointed by the President, and approved by the National Assembly. As the principal executive assistant to the President, the Prime Minister supervises the administrative ministries and, under direction from the President, co-ordinates government policy. The Prime Minister can attend meetings in the National Assembly, and has the power to issue decrees in his own name. The Prime Minister can also recommend the President to appoint or dismiss members of the Cabinet. Korea only had its local elections in the early 1990s, and elections are held every four years. Today there are 16 provincial-level governments, and 235 lower-level local governments (municipal governments), including 72 city governments, 94 county governments, and 69 city district governments within the provincial-level cities like Seoul and Pusan. The 16 provincial-level governments consist of the seven largest cities in South Korea and nine provinces. Provincial governments basically serve as an intermediary between the central and municipal governments. Thus, their administrative systems resemble smaller versions of the central government's system. Municipal governments deliver services to the residents through an administrative district system. Each municipal government has several districts that serve as field offices for handling the needs of their constituents. District offices are engaged mainly in routine and simple administrative and social service functions. Role Model: South Korea closely adhered to the Japanese model of development. Chaebol, the groupings of affiliated companies who dominated South Korea's economy in the late 1980s were similar to Japanese keiretsu. The Japanese, dominated Korea from the late 1890s to 1945 and governed Korea as a colony from 19l0 to 1945, were responsible for the initial economic modernization of Korea. Before 1900 Korea had a relatively backward agricultural economy. Following the annexation of Korea in 19l0, Japan thrust a modern blend of industrial capitalism onto a feudal agrarian society. Again, the South Korean patterns of development after the early 1960s closely followed the methodology introduced by the Japanese fifty years earlier--industrialization from above using a strong bureaucracy that formulated and implemented economic policies. Many of the developments that took place in Chosen, the Japanese name for Korea during the period of colonization, had also occurred in pre-World War II Japan; they were implementation of a strong education system and the spread of literacy; the rise of a strong, authoritarian government that combined civilian and military administration to govern the state with strict discipline; the fostering and implementation of comprehensive economic programs by the state through its control of the huge national bureaucracy; the close collaboration between government and business leaders; and the development of industries by the major Japanese zaibatsu (commercial conglomerates). Thus we conclude that Japan has been the role model of South Korea. ,[object Object],After the Asian financial crisis in 1997/98, Korea was forced to pursue FDI-friendly policy initiatives in order to fulfill the conditionality of the International Monetary Fund (IMF) in exchange for standby credit. In the past decade, policy makers in Korea have striven to devise a new FDI policy regime appropriate to the age of globalization and acclimated to the global economy by welcoming Greenfield investment and M&As to augment investment activities which has thus lead to the development of a more competitive economy. This has meant dramatically shifting policy direction from conventional loan-based borrowing to an FDI-based development strategy. This saw the emergence of global brands such as Samsung, Hyundai, and LG. The following were the impact of inbound FDI in South Korea as a result of liberalization. ,[object Object]

After the historic slump of 1997 when South Korea opened its doors to FDI for hostile takeovers of its corporations, the impact was a dramatic increase in FDI from $3 billion in 1997 to $9.3 billion in 2000. The total stock of foreign investment in South Korea surged from $5.2 billion in 1990 to $62.7 billion by the end of the decade.Top FDI inflows received from South Korea due to liberalization through Indian companies like M/s. Posco India P. Ltd., Samsung India Electronics Ltd., Parry Confectionery Ltd., Samsung Electronics (India) Pvt. Ltd., Krishna Filaments Ltd., LG Electronics India Pvt. Ltd., Ezentech India Pvt. Ltd., Escorts Communications Ltd., Shinhan Plasto India Pvt. Ltd., Ripe Component Technologies P. Ltd. From August 1991 to June 2006, Government has approved 27,197 foreign collaborations (technical & financial) proposals with a corresponding foreign direct investment of Rs. 2,604.04 (US$ 70.33) billion. Out of this the total number of approvals with South Korea have been of the order of 625 (2.30% the total approvals) with an equity participation of Rs. 99.72 (US$ 2.67) billion (3.78% of the total Investment in US$ terms), South Korean companies rank 5th in the list of countries in terms of cumulative FDI approved from August 1991 to June 2006. Trade and investment ties have become an increasingly important aspect of the U.S.-South Korean relationship post liberalization. Korea is the United States' seventh-largest trading partner (ranking ahead of larger economies such as France, Italy, and India), and there are significant flows of manufactured goods, agricultural products, services and technology between the two countries. The United States and Korea launched negotiations on the Korea-U.S. Free Trade Agreement (KORUS FTA) on February 2, 2006. On June 30, 2007, the United States and Korea signed a comprehensive FTA that would eliminate virtually all barriers to trade and investment between the two countries. From the diagram given we can see the protectionist policies of South Korean government and as a result very less inflow of FDI was there till liberalization policies adopted by government. Korean government shifted its FDI policies from control and regulation to promotion and support with the enactment of new Foreign Investment Promotion Act (FIPA), 1998. The act opened many areas for foreign investors which was restricted earlier. FDI inflow reached in highest level in 1999 with US $ 9.88 billions Table demonstrates that South Korea’s Inflow of FDI/ Total Fixed Capital Formation and the Inward Stock of FDI as a Percentage of GDP as compared to the developed and the developing economies. Reasons for acquiring Samsung’s CED by Volvo: To gain an entry in the Asian sub continent and utilize all the resources available there. As a long term plan to set up its excavation factory in South Korea only. Reducing the price of the equipment and increase the quality at cheaper prices in South Korea as compared to that in Sweden. Taping existing infrastructure customer and distribution base of CED: Volvo entered South Korean market through acquisition as it helped the company to tap the existing customer and distribution base of the ailing company. As a result it reduces the initial infrastructure and distribution cost Gaining Cost Efficiency: When two companies come together by merger or acquisition, the joint company benefits in terms of cost efficiency. A merger or acquisition is able to create economies of scale which in turn generates cost efficiency. As the two firms form a new and bigger company, the production is done on a much larger scale and when the output production increases, there are strong chances that the cost of production per unit of output gets reduced. Resource and Market: Volvo and many other MNE consider South Korea as attractive market because of presence of large skilled labor .Apart from this its strategic location further act as a potential market for exporting to other Asian countries, Volvo also established a research and development center to leverage the acquisition and market. Increase market share: An increase in market share is one of the plausible benefits of mergers and acquisitions. In case a financially strong company acquires a relatively distressed one, the resultant organization can experience a substantial increase in market share. The new firm is usually more cost-efficient and competitive as compared to its financially weak parent organization. Establishment of SEZ: South Korean government is proactively providing world class facilities with IT/ITES Park and several Free economic zone. Six multi mullions free economic zones are created to attract FDI in country Favorable host country (South Korean) government policies: South Korean government with liberal policies attracts large FDI in the countries. Volvo sense the liberal government policies tax incentives and cash grant for building manufacturing establishments to those foreign companies which fulfill the requirements. ,[object Object]

Need for FDI: As demand for their products plummeted; many of the highly influential Korean conglomerates (chaebols) became unable to service their debts and were near to bankruptcy. These companies either wanted to sell off their stakes to boost their liquidity or be acquired over by foreign company, thereby transferring their ownership. It was recognized that allowing free flowing FDI was the only way to achieve this. Also as per the theoretical concept of impact of FDI, the FDI does not only bring capital but also it brings technology, knowledge and due to the spill over effect, development of process remains for the long run. FDI works as the catalyst for the economic growth of a country, especially for the developing countries like South Korea. Volvo was the reputed global company in automobile and industrial sector. Government thought Volvo’s global exposure will help ailing company more efficient with better productivity.

ASEAN Financial Crisis: The government of South Korea permitted this acquisition since after the economic crises of 1997, Korea’s long period of economic boom came to an abrupt end which produced a sharp drop in the economic activity in South Korea. The Korean currency slumped across the dollar, requiring the government to seek $58 billion in aid from the International Monetary Fund. As the demand for their products plummeted, dozens of highly leveraged Korean companies found themselves unable to service the debt that they had taken on during the boom years to finance their expansion. Many teetered on the edge of bankruptcy. The South Korean government responded by making the historic decision to remove many of the restrictions to foreign direct investment, including the regulations which prohibited foreign firms from making hostile takeovers of Korean enterprises.

Prior to 1997, South Korea allowed the FDIs in the retail sector only. These foreign investors revolutionized the retail sector. The entry of foreign competitors with access to significant capital resources simulated the local enterprises to increase their operating efficiency and reduce the prices. Also, the involvement of the foreign owners was increasing the private share in the industry. The government's share was reducing but it was for the better of the citizens. Hence, the acquisition of the money loosing construction equipment division of Samsung was allowed and as the case says, the old Korean emphasis on sales volume and market share was replaced by the a focus on product quality, operating efficiency and profitability. Initial response of CED’s employee s and South Korean citizens to this acquisition: Acquisition whether hostile or non hostile always comes with a tag of corporate restructuring which directly results in job cuts .As a result acquisition is always seen as an opposition agent from labour and trade unions and same was witnessed in case of Volvo acquisition in South Korea. Initially many Koreans and CED workers viewed the new wave of foreign investment with deep suspicion. The very next month after the acquisition was announced in January 1998, the workers of CED went on strike. As given in the case, 13% of 1655 employees at the plant left after the acquisition which was due to attrition and not layoffs. The foreign companies were seen with deep suspicion and were demonizes as the unwanted guests feeding off the local market like leeches. Although, in this case, after two years, it became clear that this acquisition was not one of these kind. The citizens were apprehensive because they saw the acquisition as the means through which the foreign company will exploit the resources of the Koreans for personal benefits. But, when Volvo invested in money and technology that helped the company they got motivated. ,[object Object],The following were the learning’s for MNEs from the case: ,[object Object]

Industry analysis for SBU: The analysis for setting up the business units must be well planned and a firm decision must be undertaken based on the intense analysis done. But this should be a gradual process and comes with experience doing operations in that country. Volvo decided to shut down its entire process from Sweden and move to South Korea due to this.

Understanding the opportunities and risks before making any investment: Samsung’s CED was already operating the country since 1974, so the government support was there, and since after the great slump of 1997 the South Korean government was more than willing to allow foreign investments to pump money in the ailing Korean companies which made acquisition and operation in Korea easy. Also since the setup was already there, just the financial support was required to pull the company out of the debt which it had accumulated. Volvo understood that using its managerial and technical expertise and coupling it with the low cost of production in Korea, it could make a healthy return on profit in a short time period.

Plotting countries on grids and matrices: After the data is collected on the host country, the MNE’s should use grids and matrices to understand the position of the company as well as the country on the BCG matrix, for risk assessment and understand the company attractiveness.

Rank on global scale: The managers have to be in touch with the developments of various economies to ascribe where the next big booming economy is going to happen. Here, Volvo sensed an opportunity and purchased the distressed Samsung CED firm.

Identify firm strategy: It is always recommended to be close to your business in the overseas location to establish what is good for the firm in terms of the implementation of the strategies.

Ib case study 3

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