Transcript No Slide Title

Foreign Direct
Investment
8-1
Foreign Direct Investment
• FDI occurs when a firm invests directly in
facilities to produce and/or market a product
in a foreign country.
– Once a firm undertakes FDI, it becomes a
multinational enterprise (multinational =
more than one country).
8-2
FDI takes two forms
• Greed-field investment: establishing a wholly new
operation in a foreign country.
– Mostly in developing nations
• Acquiring or merging with an existing firm in the foreign
country.
– Quicker to execute
– Foreign firms have valuable strategic assets
– Believe they can increase the efficiency of the acquired firm
– More prevalent in developed nations
• Investing in foreign financial instruments (Portfolio
Investment) IS NOT FDI.
8-3
Trends in FDI
• Flow and stock increased in the last 20 years
• In spite of decline of trade barriers, FDI has grown
more rapidly than world trade because
– Businesses fear protectionist pressures
– FDI is seen a a way of circumventing trade barriers
– Dramatic political and economic changes in many parts of the
world
– Globalization of the world economy has raised the vision of
firms who now see the entire world as their market
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Slumping FDI
• Between 2000 and 2004 the value of FDI slumped
almost 50% from $1.2 trillion to about $620 billion
• The slowdown in FDI flows has been most
pronounced in developed nations
• The slowdown is probably temporary and reflects
three developments
– General slowdown in the growth rate of the world economy
– Heightened geopolitical uncertainty following the September
11, 2001 attack
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FDI Outflows
8-6
The Direction of FDI
• Historically, most FDI has been directed at the
developed nations of the world as firms based in
advanced countries invested in other markets
– The US has been the favorite target for FDI inflows
• While developed nations still account for the
largest share of FDI inflows, FDI into developing
nations has increased
– Most recent inflows into developing nations have
been targeted at the emerging economies of South,
East, and Southeast Asia
8-7
FDI Flow by Region
8-8
Worldwide FDI Flows
World FDI inflows

Developed (70%), developing (30%)

European Union: ~ 50% of world FDI
64,000 multinationals
Developing nations

China: 8% of world FDI

All of Africa: 2% of world FDI
with
870,000 affiliates
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The Shift to Services
• The shift to services is being driven by four
factors
– Reflects the general move in many developed economies away
from manufacturing and toward service industries
– Many services cannot be traded internationally
– Many countries have liberalized their regimes governing FDI in
services
– The rise of Internet-based global telecommunications networks
has allowed some service enterprises to relocate some of their
value creation activities to different nations to take advantage of
favorable factor costs
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Reasons for FDI Growth
Increasing
globalization
International mergers
and acquisitions
Entrepreneurship
and small firms
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EXPLAINATIONS FOR FDI
Market Imperfections (Internalization)
• Market imperfections are factors that inhibit markets from
working perfectly
– In the international business literature, the marketing imperfection
approach to FDI is typically referred to as internalization theory
• Company undertakes FDI to internalize a transaction that
is being made inefficient by a market imperfection
 Trade barriers
 (e.g., tariffs)
 Specialized knowledge
 (e.g., managerial ability)
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International Product Life Cycle
A company begins by exporting its product and later undertakes
foreign direct investment as a product moves through its life cycle
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Eclectic Theory
A firm undertakes FDI when location, ownership and
internalization advantages combine to make a location appealing
Location
advantage
Ownership
advantage
Internalization
advantage
(optimal location)
(special asset)
(efficiency)
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Market Power
A firm undertakes FDI to establish a dominant presence in an industry
Market power
= Greater profits
Vertical integration
Extends company’s activities
into stages of production that
provide its inputs (backward
integration) or absorb its outputs (forward integration)
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Pursuit Of Global Strategies
-
Easily to coordinate the participation of the wholy
owned foreign operations to participate in a global or
transnational strategy
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Complementarity of trade
and FDI
• Many exports would not occur if overseas
investments did not exist
– factor mobility via FDI often
stimulates trade because of the
need for:
»components
»complementary products
»equipment for subsidiaries
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Meaning of Foreign Direct
Investment (FDI)
Concept of control
• Control must accompany the investment
• 100 percent share does not guarantee control
– government intervenes in company operations
• Direct investment usually implies an ownership share of
10 to 25 percent

Companies are reluctant to transfer vital resources to another
organization without control
• Capital
• Patents
• Trademarks
• Management know-how
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Concern about control
Government concern—when foreign investors
control a company, decisions of national
importance may be made abroad
Investor concern—transfer of resources to
acquiring company
–appropriability theory—company
receiving resources may undermine the
competitive position of the company
transferring them
–Internalization—control by self-handling
of operations
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Control and Costs
Control inherent in FDI may:
• Decrease operating costs
• Increase rate of technology transfer,
due to:
• Parent and subsidiary share common corporate culture
• Company can use its’ own managers
• Company can avoid protracted negotiations with another
company
• Company can avoid problems of enforcing and
agreement
8-4
Methods for Making FDI
•
Assets employed: usually an international capital
movement that crosses borders
•
Acquisition: purchase of existing company
– Easy to execute
– Useful if local requirements mandate localized
adoption to operate
– Foreign personal may be hard to hire
– Best if international company is attempting to
acquire knowledge
– Gain goodwill and brand identification
•
Building: using local resources to start from construct
facilities and build a labor pool
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Buy-versus-Build Decision
Reasons for buying
• Does not add further capacity to the market
• Avoiding start-up problems
• Easier financing
Reasons for building
• No desired company is available for acquisition
• Acquisition will carry over problems
• Acquisition is harder to finance
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Relationship Of FDI To
Companies’ Objectives
FDI may be more risky than some other
forms of IB
• Businesses and governments are
motivated to engage in FDI in order
to:
– expand sales
– acquire resources
– minimize competitive risk
• Governments may use FDI for
political objectives
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Motivation for FDI as an Alternative or
Supplement to Trade
SALES EXPANSION
OBJECTIVES
•Overcome high transport
costs
RESOURCE
ACQUISITION
OBJECTIVES
•Savings through vertical
integration
•Domestic capacity
•Gains from scale
economies
•Savings through rationalized
production
RISK
MINIMIZATION
OBJECTIVES
•Diversification of
customer base (same
motivation as for sales
expansion)
Influence companies,
usually through factors
under resource
acquisition objectives
•Diversification of
supplier base (same
motivation as for
resource acquistion
objectives
•Trade restrictions
•Gain access to cheaper or
different resources and
knowledge
•Barriers because of
country-of-origin effects
(nationalism, product
image, delivery risk)
•Need to lower costs as
product matures
•Following customers
•Gain governmental
investment incentives
•Preventing competitors’
advantage
•Lower productions costs
abroad
POLITICAL
OBJECTIVES
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Why Host Intervenes in FDI
Initial FDI boosts economy
Balance of Payments
+
FDI may decrease import
demand
FDI may generate exports
Access technology
Obtain resources
and benefits
Access management skills
+
Create employment
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Why Home Intervenes in FDI
FDI
– Removes resources from the nation
– Can eliminate an export market
– Might eliminate domestic jobs
+ May improve national competitiveness
+ Can offshore ‘sunset’ industries
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Host Promotion Methods
Financial
incentives
Infrastructure
improvements
Low or waived taxes
Low-interest loans
Improved seaports, roads,
telecommunications
networks
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Host Restriction Methods
Ownership
restrictions
Performance
demands
Prohibit investment
in certain industries
or businesses
Local content reqts.
Technology transfers
Export targets
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Home Promotion Methods
Insurance on
assets abroad
Loans and loan
guarantees
Tax breaks on profits
earned abroad
Special tax
treaties
Persuade other nations
to accept FDI
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Home Restriction Methods
Higher tax rates on
foreign income
Sanctions on
specific nations
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