Transcript (Textbook) Behavior in Organizations, 8ed (A. B. Shani)

Chapter 7
Foreign Direct
Investment
7-3
Foreign Direct Investment
• Why is FDI increasing in the world economy?
• Why do firms often prefer FDI to other market entry
strategies?
• Why do firms imitate competitors with FDI strategies?
• Why are certain locations favored for FDI?
• How does political ideology affect government FDI
policy?
• What are key FDI related costs and benefits for
receiving and source countries?
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Foreign Direct Investment
• Foreign direct investment (FDI): a firm
invests directly in foreign facilities
• A firm that engages in FDI becomes a
multinational enterprise (MNE)
- Multinational = “more than one country”
• Factors which influence FDI are related to
factors that stimulate trade
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7-5
Foreign Direct Investment
• Involves ownership of entity abroad for
-
production
Marketing/service
R&D
Access of raw materials or other resource
• Parent has direct managerial control
- Depending on its extent of ownership and
- On other contractual terms of the FDI
• No managerial involvement = portfolio investment
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7-6
FDI Growth in the World Economy
• FDI Outflow: $35 billion in ‘75 to $1.3 trillion in ‘00 to
$653 billion in ‘03
• FDI Flow (from all countries): from ‘92 to ‘02 up 292%,
compared to trade up 69% and world output up 28%
• FDI Stock: $3.5 trillion by ‘97 to > $7 trillion in ‘02
• In ‘02:
- 64,000 MNEs had:
• 850,000 foreign affiliates
• 53 million employees
• $17.7 trillion in sales
- $8 trillions global exports
• Conclusion:
FDI flow growing faster than world trade and world output
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Direction and Source of FDI
• Most FDI flow has been to developed countries
from developed countries
- Much to the US from EU, Japan
• FDI increase to developing countries since ‘85
- Much to the emerging Asian and Latin America
economies
- Africa lagging
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Forms of FDI
• FDI forms
- Purchase of assets: why? why not?
• Quick entry, local market know-how, local financing may be
possible, eliminate competitor, buying problems
- New investment: why? why not?
• No local entity is available for sale, local financial incentives, no
inherited problems, long lead time to generation of sales
- International joint-venture
• Shared ownership with local and/or other non-local partner
• Shared risk
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Alternative Modes of Market Entry
• FDI
- FDI - 100% ownership
- FDI < 100% ownership, International
Joint Venture
• Strategic Alliances (non-equity)
• Franchising
• Licensing
• Exports: Direct vs Indirect
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Why FDI?
• FDI over exporting
- High transportation costs, trade barriers
• FDI over licensing or franchising
- Need to retain strategic control
- Need to protect technological know-how
- Capabilities not suitable for licensing/franchising
• Follow few main competitors
- Immediate strategic responses
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Pattern of FDI Explanations
• International product life-cycle (Ray Vernon)
- Trade theory similarity
• Eclectic paradigm of FDI (John Dunning)
- Combines ownership specific, location specific,
and internalization specific advantages
- Explains FDI decision over a decision to enter
through licensing or exports
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Eclectic Paradigm of FDI (Dunning)
• Ownership advantage: creates a monopolistic advantage to be
used in markets abroad
- Unique ownership advantage protected through ownership
- e.g., Brand, technology, economies of scale, management knowhow
• Location advantage: the FDI destination market must offer
factors (land, capital, know-how, cost/quality of labor,
economies of scale) that are advantageous for the firm to
locate its investment there (link to trade theory)
• Internalization advantage: transaction costs of an arms-length
relationship --licensing, exports-- higher than managing the
activity within the MNC’s boundaries
Dunning, John H. (1980). “Towards an eclectic theory of international production:
Some empirical tests.” Journal of International Business Studies 11(2): 9-31
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Government Policy and FDI
• The radical view: inbound FDI harmful; MNEs
-
Are imperialist dominators
Exploit host to the advantage of home country
Extract profits from host country; give nothing back
Keep LDCs backward and dependent for investment,
technology and jobs
• The free market view: FDI should be encouraged
- Adam Smith, Ricardo, et al: international production
should be distributed per national comparative advantage
- An MNE increases the world economy efficiency
• Brings to bear unique ownership advantages
• Adds to local economy’s comparative advantages
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Host Country Effects of FDI
• Benefits
- Resource -transfer
- Employment
- Balance-of-payment (BOP)
• Import substitution
• Source of export increase
• Costs
- Adverse effects on the BOP
• Capital inflow followed by capital outflow + profits
• Production input importation
- Threat to national sovereignty and autonomy
• Loss of economic independence
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Government Policy and FDI
• Home country
- Outward FDI encouragement
• Risk reduction policies (financing, insurance, tax incentives)
- Outward FDI restrictions
• National security, BOP
• Host country
- Inward FDI encouragement
• Investment incentives
• Job creation incentives
- Inward FDI restrictions
• Ownership extent restrictions (national security; local nationals
can safeguard host country’s interests
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Decision Framework for FDI
Are transportation costs
high?
No
No
Export
Ye
s
Ye
s
Is know-how easy to
license?
Import
Barriers?
No
FDI
Yes
FDI
Yes
FDI
No
License
Ye
s
Tight control over foreign
ops required?
No
Is know-how valuable and
is protection possible?
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