Transcript Slide 1

COURSE: GLOBAL BUSINESS MANAGEMENT
MGT610
DR. DIMITRIS STAVROULAKIS
PROFESSOR OF HUMAN RESOURCE MANAGEMENT
DEPT OF ACCOUNTING
TEI OF PIRAEUS
Unit 7: Entry Modes & Foreign Direct Investment
Training Material:
-“FDI”, entry from: Wankel, C. (ed.) (2009): Encyclopedia of
Business in Today’s World. London: Sage, 695-697.
-Chapter12 from: Hill, C.W.L., (2008): Global Business Today.
Irwin, McGraw-Hill (5th Edition).
Entry Modes
Entry Mode: A critical strategic decision, affecting future decisions
and operations of the MNC in a new market. Includes exporting,
licensing, franchising, contract manufacturing, turnkey projects,
and joint venturing.
Exporting: Entails physical transfer of merchandise to a foreign
market (with or without the mediation of an agent) for financial
gain. Piggyback is the practice through which a manufacturer
uses the sales & distribution network of another company in
order to dispose products. A safe activity, however confronted
with shortcomings such as high transportation costs, and
tariffs/barriers. Other non-tariff restrictions to trade are:
 Quotas are restrictions on quantities of certain products that are
allowed to be imported in certain countries.
 Discriminatory government procurements favor certain
companies, thus establishing informal monopolies. Governments
may also issue restrictive technical regulations and specifications,
which exclude the mainstream of competitors.
 Customs procedures may be lengthy, costly, and complicated,
therefore favoring bribery.
Licensing
The licensor grants the rights to intangible property to another
company (the licensee) for a specific period in return for a royalty
fee. In countries where there are barriers to investment, licensing
allows a foreign firm to exploit its know-how (intangible
property). It is appropriate mostly to newborn MNCs that lack
capabilities for international expansion. The licensor avoids
barriers to trade and exploits best the local market through the
infrastructure of the licensee. Disadvantages:
 Unrestricted dissemination of know-how and experience is likely
to lead to imitation practices and to the transformation of
licensees to potential competitors, particularly in countries
where patent protection is weak.
 Passive presence in foreign countries implies limited
opportunities for market learning.
 Investigating compliance of the licensee to the terms of
agreement in certain countries might be costly, complicated, or
even impossible.
 In case that the product performs better than expected, there are
limited opportunities for the licensor to bargain for better terms.
Franchise
Similar to license, but usually restricted to services. Also control
is tighter and the franchisee has to comply with strict rules on
how to conduct business. Extensive training of franchisees is
required in order to ensure quality of services. Allows rapid
expansion of MNC networks and fast cash through royalties.
Disadvantages:
 In specific sectors (food), cultural patterns may dissuade
consumers from adhering to foreign brand names.
 Unfavorable developments regarding a MNC in one country may
affect its whole franchise chain in others.
 The process should be incremental. However, some MNCs are
eager to pocket cash without questioning viability of franchisees,
a fact resulting in the creation of a fragile infrastructure. A
massive close-down of franchisees would be fatal.
 Infrequent inspections and inadequate control procedures lead to
degradation of quality standards, eventually eroding the brand
name.
Contract Manufacturing
Many MNCs (IKEA, Nike etc) subcontract local manufacturers to
produce items under the umbrella of their own brand name,
according to the same technical standards as their subs. The
contract is restricted solely to manufacturing. Products bear the
MNC brand name, while marketing & sales are undertaken
exclusively by the MNC. This entry mode may be selected either
because MNCs wish to exploit local resources, or to avoid heavy
taxation, or to overcome tariffs, quotas and other entry
barriers, or because this is explicitly required by the host
country government (China). Disadvantages:
 Difficulties in performing frequent inspections in local firms may
result in the violation of the agreed technical standards.
 Relocation of production may cause labor unrest and trade union
action due to the loss of employment positions in subs & HQ.
 Illicit labor practices of contractors (child labor, unsafe work
conditions, environmental issues) will backfire on the MNC brand.
 Emergence of contractors to potential competitors is likely, due to
their familiarization with the MNC practices and specifications.
Turnkey Projects
The MNC agrees to deliver to the foreign client the whole project
(design, construction, quality control, testing), ready to operate.
The package includes all issues, from maintenance to personnel
training.
 Are applicable in heavy industries which require advanced know-
how (hydro-electric plants, oil refineries, steel factories).
 Abound in oil-rich Middle East countries.
Advantages:
 Important economic returns.
 Less tricky than FDI, since long-term engagement is avoided in
high-risk countries.
Disadvantages:
 Emergence of potential competitors, since the local recipients
may eventually acquire the know-how
 Limited presence in strategic local markets. This problem may be
compensated through the acquisition of a minority equity interest
by the MNC.
Joint Venture
A firm that has been created by two or more independent
companies which pool resources in order to exploit assets of the
host country. The foreign partners benefit from the local partner’s
network and knowledge of the business environment.
Development costs & risks are shared. Often JVs are temporary,
formed in order to exploit specific assets (e.g. mines, oil deposits).
In certain countries, a joint venture is the only feasible mode of
entry (e.g. auto makers in China). Most common in Greek
supermarkets and retail chains worldwide (Tesco in Hungary,
Malaysia, China, Thailand).
Advantages include high rates of return, direct control over
operations, and contact with the market agents & government.
Drawbacks:
 Disputes may arise concerning allocation of resources and
ownership of patents & brand names. Caution is recommended
with regard to the selection of partners and terms of agreement.
 Emergence of conflict pertaining to cultural distance.
 Lack of total control over the JV incurs less profits for individual
participants.
Modes of entry
Exporting
Contract
Agreement
Joint
Venture
Acquisition
Greenfield
Invest
Risk
Low
Low
Moderate
High
High
Return
Low
Low
Moderate
High
High
Control
Moderate
Low
Moderate
High
High
Integration
Negligible
Negligible
Low
Moderate
High
FDI: Working Definitions
 “A category of international investment that indicates
an intention to acquire a lasting interest in an
enterprise operating in another economy. It covers all
financial transactions between the investing
enterprise and its subsidiaries abroad”. (European
Commission)
 “An investment involving a long-term relationship
and reflecting a lasting interest and control of a
resident entity in one economy in an enterprise
resident in an economy other than that of the
investor”. (UN)
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What is not FDI
 Non-equity investments.
 Portfolio investment: Investment that involves the
exchange of equity with the aim of attaining a return
on the invested capital, rather than achieve some
form of control.
 Licensing production or technology rights to another
company abroad.
 Strategic alliances.
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Terminology – contrast:
 Greenfield investment
A brand new project that lacks
any constraints set by previous
work. The metaphor concerns
the greenfield land, where there
is no need to reform an existing
structure.
A greenfield investment concerns
the creation of infrastructures in
regions where no previous
facilities exist. In addition to
creating new facilities, MNCs
also offer long-lasting jobs. It is
usually referred in contrast to
other business forms (M&A,
Franchise, Joint Ventures).
 Brownfield investment
Refers to undertaking
initiatives in places where a
“dirty business” (steel mill, oil
refinery) previously operated.
Purpose of the new business is
to clean up the area in order to
make it appropriate for
commercial use or for
residence.
Regional trends – Greenfield projects 2008-2009
• Decline in FDI most markets
• Biggest decline in Rest of Europe - by 40%
Source: fDi Markets database from fDi Intelligence, Financial Times Ltd
EC study: FDI attracted in regions that have:
 Access to a populous national market (national





market size effect).
Borders with the home country and/or language in
common with home country (proximity and culture
effect)
A high level of business English language
proficiency (internationalization effect)
Low corporate taxes and business incentives (fiscal
incentive effect)
Many advanced consumers with high purchasing
power (national GDP per capita)
Low unemployment level (proxy for few rigidities on
the labor market)
FDI attracted in regions that have (cont):
 A large share of other foreign investors (signal effect).
 Good infrastructure and accessibility (access effect).
 A highly educated regional workforce (skill effect).
 A high level of spending on R&D (innovation effect).
 Penetration of information & communication
technologies (ICT effect).
 A large presence of competitors, clients and suppliers
within the firm’s industry (agglomeration & clustering
effect).
 Fame as prominent social milieus and commercial
centers (fame effect).
 Low labor costs (labor effect).
Greek FDI - 2001
Level4.shp
0
220 - 272
1464 - 16073
109352 - 160656
553193 - 659206
Source: Bank of Greece, 2007
Greek FDI - 2006
Level4.shp
0
0 - 467.751
467.751 - 389590
389590 - 1364470
1364470 - 2457370
Source: Bank of Greece, 2007
Joint Ventures
Types of foreign direct investment
 BY ACTIVITY
 Horizontal FDI
 Similar plants at the same stage of the production process
located in different national markets
 “Market-seeking investment”
 Vertical FDI
 Plants operate at adjacent stages of a vertically related set
of production processes
 “Natural resource-seeking investment”
 Diversified FDI
 Plants’ outputs are not related to each other
 Risk diversification
 BY INVESTMENT STRATEGY
 Greenfield investment
Market entry by establishing a completely new plant
 Mergers and acquisitions
Market entry by acquiring an existing plant
 Joint Ventures
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Foreign Acquisition
HOME COUNTRY
HOST COUNTRY
Investment
MNE
Local Firm
Profit
Foreign Acquisition
Advantages
 Access to target’s local
knowledge
 Control over foreign
operations
 Control over target’s
technology



Disadvantages
 Uncertainty about target’s
value
 Difficulty in “absorbing”
acquired assets
 Risky if corporate governance
is underdeveloped in the
foreign country
When Is Acquisition Appropriate?
Developed market for corporate governance & control
Acquirer has high “absorptive” capacity
High synergy between the two firms
Acquisitions:
Problems
Too large
Acquisitions
Too much
diversification
Integration
difficulties
Inadequate
evaluation of target
Managers overly
focused on
acquisitions
Large or
extraordinary debt
Inability to
achieve synergy
Indicative Value Chain of a MNC
Company Infrastructure
R&D
Innovative
Capabilities
Production
Marketing
and Sales
Advanced
Technology
& KnowHow
IndustrySpecific
Marketing
Expertise
Organization, Coordination & HRM


What additional resources may the MNC need to enter a
foreign market?
Local expertise: marketing, government relations, etc.
Indicative Value Chain of a Local Firm
Company Infrastructure
R&D
Imitative
Capabilities
Production
Marketing
and Sales
Older
Technology
and KnowHow
CountrySpecific
Marketing
Expertise
Organization, Coordination & HRM
What may the MNC desire from a local firm?
 Complementary resources
 Not necessarily strength in every area
Complementarity of Resources
MNE’s Resources
Local Firm’s Resources
 Innovative capabilities
 Imitating capabilities
 Advanced technology
 Older technology and
and know-how
 Industry-specific
marketing expertise
 Organization structure
and systems
know-how
 Country-specific
marketing expertise
 Country specific
organization skills
Greenfield Entry
HOME COUNTRY
HOST COUNTRY
MNC
Profit
Investment
New Subsidiary
Company
Greenfield Entry
Advantages
 Avoids risk of
overpayment
 Avoids problem of
integration
 Retains full control
Disadvantages
 Slower startup
 Requires knowledge of
foreign management
 High risk and high
commitment
When Is “Green Field” Entry Appropriate?




Lack of proper acquisition target
In-house local expertise
Embedded competitive advantage
Strong corporate culture
FDI according to timing
MNC & Market
Degree of internationalization
of the market
Low
High
Low
The early starter
The late starter
High
The lonely
multinational
The multinational
among others
Degree of
internationalization
of the firm
FDI according to timing
 The lonely multinational. A significant FDI has been made in a
host country, but it does not generate enough long-term
revenues because of lack of purchasing power, or absence of
demand for the product or service. This phase is characteristic of
developing countries at an early stage, or of a product that does
not fit the demand in the particular country (Lasser, 2003).
 The early starter. The market takes off but the competitive
landscape is not yet well established (greenfield). At this stage,
the choice is to take a first mover view or a follower view.
Empirical evidence suggests that to be the first to enter in an
emerging country can lead to a strong competitive advantage.
 The multinational among others. Various competitors have
already entered and are competing for market share in a high
growth, unstable context. New entry at this stage is hazardous
and requires either massive resources or a highly differentiated
competitive strategy. An acquisition or joint venture is indicated.
 The late starter. The competition is well-established and little
room for prospective entrants is left. Innovative products,
meticulous marketing, or inspiring management are necessary.
Alternative Strategies of Late Starters
Newborn MNCs, particularly from emerging countries, face
problems because strategic positions in the global market have
been already occupied by dominant competitors. In this respect,
the following strategies may be applied by late comers:
 Benchmark & Sidestep: Focuses on niche markets which have
been left over by powerful MNCs. A classic example concerns
Jollibee, a fast-food company that prevailed over McDonalds in
Philippines by extensively benchmarking McDonalds’
management & marketing practices. Thereafter it managed to
expand, focusing on culinary preferences of Filipinos who live
abroad.
 Confront & Challenge: Involves face-to-face competition with the
giants, through sophisticated strategies which exploit local
advantages. BRL Hardy, an Australian wine-maker, managed to
enrich its brands with varieties of wine produced by other winemakers through strategic alliances.
Country Risk
 Besides advantages, foreign countries bear inherent
risks for investors.
 Country risk results from a set of complex and
interdependent socio-economic, financial and political
factors. These factors are specific for a particular
country, but they can spread fast due to global
integration.
 On the other hand, a country can be easily
contaminated by negative regional or global forces.
Risk Assessment
 How much acceptable is high risk?
+
Risk Level
Unacceptable risk
Tolerable risk level if anticipated
Managed risk with proper
hedging or insurance
Acceptability
.
Main components of country risk
 Economic risk
 Financial risk
 Foreign exchange risk
Quantifiable but ultimately
Judgmental,Insurable and
Diversifiable
 Political risk
 Cultural environment risk
 Legal and contractual risk
Qualitative
Assessment
(repudiation, confiscation, bribes)
 Regional contamination risk
(spill-over effect)
 Systemic risk (global crisis)
.
Country Risk Assessment
 Economic risk: Low growth, inflation, low or declining
investment and savings ratios, interest rate rise,
structural weakness of the banking system, budget
deficit, liquidity and solvency risk (when a nation’s
capital assets are composed more of debt than of
equity) etc.
 Financial risk: Credit crunch, banking crisis, current
account deficit.
 Foreign Exchange risk: Drop in official international
reserves, devaluation, capital controls.
.
Country Risk Assessment (cont)
 Political Risk:
(1)The risk incurred by lenders, exporters, or
investors, when a payment or the repatriation of an
investment is restricted afterwards by the arbitrary
decision of the host country government. This
decision may be carried out through confiscation,
repudiation (refusal to endorse an agreement),
nationalization, default (breaking the promise of
paying back) etc.
(2)The risk owed to political turmoil, government
change, or deteriorating governance: lack of
transparency, political speculation, corruption,
nepotism, bureaucracy.
Corruption Perception Index (CPI) 2010
Strategies for Countering Country-Specific Risks
Cultural and
Institutional Risk
Transfer Risk
Blocked Funds
Ownership Structure
Human Resource Norms
• Joint venture
• Local management &
staffing
• Pre-investment strategy to
anticipate blocked funds
Intellectual Property
Religious Heritage
• Fronting loans
• Understand and respect host • Legal action in host
• Creating unrelated exports
country courts
country religious heritage
• Support worldwide treaty
• Obtaining special
Nepotism and Corruption
to protect intellectual
dispensation
property rights
• Disclose bribery policy to both
• Forced reinvestment
employees and clients
• Retain a local legal advisor
Protectionism
• Support government
actions to create
regional markets
.
.
Country-Specific Risks
 Transfer risks concern the limitations on the MNC’s
ability to transfer funds into and out of a host country
without restrictions.
MNCs can react to potential transfer risk in 3 stages:
 Prior to making the investment, a firm can analyze the
effect of blocked funds
 During operations a firm can attempt to move funds
through a variety of repositioning techniques
 Funds that cannot be removed have to be reinvested in
the local country to avoid deterioration in real value
.
.
Transfer Risk
MNCs use mostly the following strategies for
transferring funds under restrictions:
 Alternative conduits for repatriating funds
 Transfer pricing goods & services between subs
 Leading and lagging payments
 Using fronting loans
 Creating unrelated exports
 Obtaining special dispensation
.
.
Transfer Risk (cont)
 Fronting loans: Transferring funds from parent to
host country. Certain countries (China) impose
restrictions to the entrance of foreign capital.
 A fronting loan is a parent-to-sub loan channeled
through a financial intermediary.
 The lending parent deposits the funds in an
international bank, let’s say in London.
 That bank in turn “loans” this amount to the
borrowing subsidiary.
 In essence, the bank “fronts” for the parent.
.
.
Transfer Risk (cont)
 Creating unrelated exports
 The main reason for strict exchange controls is the host
country’s inability to attract hard currency. Anything a MNC
can do to generate export sales helps the host country.
 For its contribution to the host country economy, the MNC
may ask for more currency repatriation.
 All costs of establishing and operating the sub are paid in local
currency.
 The MNC may organize regular expensive events, conferences,
and galas in the particular host country, all paid in local
currency.
 Special dispensation
 If the firm is in an important industry to the development of
the host country, it may bargain for a special exemption in
order to repatriate some funds.
.
.
Transfer Risk (cont)
 Transfer Pricing.
Sale contracts are signed between the sub and the parent, but
trade terms invariably seem to favor the parent (high prices
when the parent sells to sub, low prices when sub sells to
parent).
E.g. the sub purchases goods for $100.000 from the parent.
These goods had been previously purchased from another sub for
$10.000, and the parent simply had them repackaged.
Among others, it helps to justify high prices of MNC products in
the host country whenever invoices are examined by local
inspectors.
 Leading & Lagging Payments
They are based on calculated expectations of currency exchange
swings. In order to get enough funds out of the host country, if
the sub’s currency is likely to depreciate, the sub pays the parent
in advance. If the sub’s currency is likely to rise, then payments
are delayed.
Business Environment Risk Intelligence
BERI provides a Political Risk Index
assessing the social and political
environment of a country. It is built on the
opinion and scores provided by a hundred
experts with a diplomatic or political science
background. Governance quality is included
into political risk analysis along with
government effectiveness and social
indicators.
http://beri.com
Political Risk Services[1]: The PRS
analyses cover a hundred countries and are
updated on a quarterly basis.
International Country Risk Guide
measures and tracks corruption perception
in government, law and order,
expropriation risk, as well as the quality of
bureaucracy. These measures stem from
the subjective assessment of experts
around the world.
http://prsgroup.com
Thanks to its unique policy dialogue with more
than 180 countries, the World Bank has
developed a comprehensive database of
composite governance indicators, measuring
perceptions of voice and accountability,
political stability, government effectiveness,
regulatory quality, rule of law, and corruption.
www.worldbank.org/wbi/governance/
The London-based Economist Intelligence
Unit (EIU) provides a comprehensive é-year
forecasting country risk analysis on some
100 EMCs., on a quarterly basis. The EIU
method flows from expert’s answers to a
series of 77 predetermined qualitative and
quantitative questions.
http://eiu.com
To look upon governance and corruption,
Moody’s takes into consideration the
structures of social interaction, social and
political dynamics, as well as the
economic fundamentals. Moody’s relies on
the judgment of a group of credit risk
professionals to weigh the various risk
factors as well as the impact of each of
these factors upon business prospects.
http://moodys.com
Standard and Poor’s rating approach is both
quantitative and qualitative. It is based on a
checklist of 10 categories, including
governance and political risk. The political
risk factors gauge the impact of politics on
economic conditions, as well as the quality of
governance and the degree of government
support in the population. S&P assigns short
term and long-term ratings.
http://standardandpoors.com
Euromoney publishes ratings of some 180
countries since 1982 on a semi-annual basis.
The methodology is built from a blend of
quantitative criteria and qualitative factors
coming from surveys with about 40 political
analysts and economists. Political risk
receives a 25% weighting, as much as
economic performance. Countries are graded
on scale from 0 (worst) to 100 ( best).
www.euromoney.com
Institutional Investor’s ratings are
published twice a year since 1979 to assess
the creditworthiness of about 150
countries, based on a survey of some 100
international bankers’ perception of
creditworthiness, including economic,
financial and socio-political stability
criteria. The resulting score scales from
zero (very high chance of default) to 100
(least chance of default).
www.institutionalinvestor.com
Transparency International, a non-profit
non-governmental organization in Berlin,
provides an annual survey of corruption
practices in nearly 90 countries since 1995.
The Corruption Perception Index is based on a
wide network of information sources with
local NGOs, domestic and foreign
corporations, investors, and business contacts.
www.transparency.org
MH Bouchet/CERAM (c)
Heritage Foundation established
since 1985, in partnership with the
WSJ, an economic freedom index for
some 160 countries, both industrialized
and developing. The ranking is based
on various socio-political and
economic criteria, including political
stability, state interference, regulatory
framework, institutional strength, and
corruption scope.
www.heritage.org
PricewaterhouseCoopers’s Opacity
Index measures the lack of clear,
accurate, formal and widely
accepted practices in a country’s
business environment. As such, it
focuses on the relative state of
corrupt business practices, the
transparence of the legal system and
the regulatory framework. It
represents a quantitative approach
to measuring opacity and its
resulting extra risk premium that
stems from the additional business
and economic costs.
www.opacityindex.com/
The Institute for Management
Development’s World
Competitiveness Report analyses 49
industrialized and emerging economies
around the world based on a farreaching survey since 1989. Its analysis
of the institutional framework
addresses issues such as state
efficiency, transparency of government
policy, public service’s independence
from political interference, bureaucracy
as well as bribery and corruption.
www.imd.ch
Freedom House focuses since 1972 on
corruption levels in a number of
developing and transition economies
around the world. FH publishes an
annual assessment of state of freedom
in various countries on the base of
political rights and civil liberties.
Political stability and civil liberties are
ranked on a scale of 1 (best) to 7
(worst).
www.freedomhouse.org/ratings.index.h
tml
The Political and Economic
Stability Index of Lehman Brothers
and Eurasia measures relative
stability in around 20 EMCs by
integrating political science theories
with financial markets
developments. The monthly
evaluation uses both quantitative
and qualitative criteria, including
institutional efficiency, political
legitimacy, economic performance,
and government effectiveness.
www.legsi.com
Political and Economic Risk
Consultancy (PERC) specializes in
strategic business information and
analysis in East and Southeast Asia,
with emphasis on corruption and
business costs. Annual risk reports
survey over 1,000 senior expatriates
living in to obtain their perceptions of
corruption, labor quality, intellectual
property rights risks and other systemic
shortcomings.
www.asiarisk.com
MH Bouchet/CERAM (c)