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MGTMGT
372372International Business Management
Course Instructor: Mehree Iqbal (MeI)
Lecture 9 & 10
Chapter- 7
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Foreign Direct Investment
Learning Objectives:
-Foreign Direct Investment in theWorld Economy
-Horizontal FDI and the factorsstimulating horizontal FDI
-Vertical FDI and the factors
stimulating vertical FDI-Managerial implication
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Foreign Direct Investment inForeign Direct Investment in
the World Economythe World Economy
Flow of FDI: This refers to theamount of FDI undertaken over
a
given time period.Stock of FDI: This refers to the total
accumulated value of foreign-ownedassets at a given time.
Outflow of FDI: This means the flowof FDI out of a country.
Inflows of FDI: This means the flow
of FDI into a country.
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Trends in FDI:Trends in FDI:
During 1975 to 2000 FDI has increased from$25 billion to a
record $1.4 trillion. During 2000to 2002 FDI observed a slow
growth. However,by 2007 FDI flows to $1.8 trillion.
The growth of FDI has been more thanworld trade and world
output. Because,
1.Despite there has been general decline intrade barrier,
companies still fear protectionist.
FDI is a way to avoid future trade barrier. E.g.Japanese
companies started investing in USA tocombat US trade barriers.
(Cars)
2.Dramatic economic and political changes in
developing countries and increase of freemarket economies in
developing nations
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3. According to UN, laws governing FDI
created more favourable environment forFDI. (India changed
ownership policy)
4. Globalization of the world economy
has encouraged companies to think worldas their markets.
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- In 2001, China was the largestrecipient of FDI among
developing
nations. Chinas cheap labor, taxincentive and entry into the WTO
havestimulated its FDI inflow.
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After South, East and South East Asia,the next most important
region in thedeveloping world is Latin America.
- Africa attracts lowest inflow due to
political unrest, armed conflict andfrequent changes.
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The form of FDI: AcquisitionThe form of FDI: Acquisition
Vs. Green-Field InvestmentsVs. Green-Field InvestmentsFDI can
take the form of a green-field
investment in a new facility or anacquisition of or a merger
with anexisting local firm.
40% to 90% of FDI inflows are in theform of mergers and
acquisitionbetween 1998 to 2007.
In developing countries, only one thirdof FDI is in the form of
mergers andacquisitions as there are fewer firmsto acquire in
developing nations.
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Horizontal FDI:Horizontal FDI:
- Horizontal FDI refers to investment inthe same industry abroad
as a firmoperates in at home.
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Other alternatives: exporting orlicensing.
FDI is problematic than thesealternatives because,
1. It is expensive as setup cost of theproduction process is
involved.
2. It is risky as problems associated with
doing business in another culture arealso involved.
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- Still companies prefer FDIbecause of following factors,
Transportation costMarket imperfection
Strategic behavior
The product life cycle Location-specific advantages
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Transportation cost:Transportation cost:-
When transportation costs are added toproductions, it sometimes
become unprofitableto ship some products abroad
- Products that have low value-to-weight ratioand can be
produced in almost any locationshould not be considered for export.
E.g.cement, soft drinks
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However, products that have high value-to-weight ratio and can
only be produced in somekey strategic locations can be considered
forexporting. In this case, transportation cost willbe a little
percentage of production cost. E.g.
electronics, PC, medical equipment, computer
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Market imperfectionMarket imperfection
(Internationalization theory)(Internationalization theory)
Why firms do FDI over Exporting and Licensing?
Market imperfections are factors that inhibitmarkets from
working perfectly. Ininternational business market imperfectionsare
referred to as internationalization theory.
Two types of impediments exist in themarket. These reduce the
attractiveness ofexport and licensing and increase
theattractiveness of FDI.
1.Free flow of products between nations:By placing tariffs on
imported goodsgovernment increase the cost of exporting
relative to licensing and FDI. So to combat
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2. Impediment to sale of know-how: Ifknow-how is the key to
competitive advantageof a company, then they can earn greater
returnby selling know-how. But some companies try toavoid licensing
for certain reasons. For example,Nokia, instead of licensing its
technological
know-how, is more attracted towards FDI.Because,
-First, licensing may result in firms giving away
its know-how to a potential competitor. E.g. RCAcolor Television
example (pg 240)
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- Second, licensing does not give a firm thetight control over
manufacturing, marketingand strategy in a foreign country that may
be
required to profitably exploit its advantage inknow-how. With
licensing company canachieve royalty fee but sometimes forstrategic
and operational reason control is
necessary for which FDI is needed. Company may want to price and
market
aggressively which licensee may disagree asthat will cut down
his profit. E.g. Pizza-hut in
India. Company may want to take cost advantage of
a location and produce a part of final productin that location.
This may affect licensees
autonomy.
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- Third, a firms know-how may not beamenable to licensing. E.g.
Toyotas
competitive advantage is in itsinnovative production process
andmanagement know-how which isembedded in the whole
organization.
So this know-how cannot betransferred.
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Strategic Behaviour:Strategic Behaviour:
his theory suggests that FDI flows are areflection of strategic
rivalry betweenfirms in the global marketplace.Knickerbocker looked
at therelationship between FDI and rivalry inoligopolistic
industry.
ligopoly means when a limited numberof large firms exist in a
market.Interdependency of these firms lead to
imitative behavior.
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ultipoint competition: This ariseswhen two or more
enterprisesencounter each other in differentregional markets,
national markets or
industries.
.g. Indian and Bangladeshi mobileindustry.
.g. Kodak follows Fuji in any market
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Product life cycleProduct life cycle
Companies invest in different locationsat different phases to
comply with costpressure
Example- Garment industry
Explained in chapter 5
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Vertical FDIVertical FDIBackward vertical FDI: This means
investment into an industry abroad thatprovides inputs for a
firms domesticproduction process. This is more common inoil
extraction and mining industry.
Forward vertical FDI: here an industryabroad sells the output of
firms domesticproduction process. E.g. Volkswagen in USA.
Strategic behavior: By vertically integrating
backward to control over the source of rawmaterial, a firm can
raise entry barriers andshut new competitors out.
E.g. Alcoa in USA.
It will not be possible to attempt to
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Market imperfection:Market imperfection:
Following market imperfections explain thereason for vertical
FDI
Impediment to sale of know-how
Shell, BP all these companies do not sell the
know-how to oil suppliers of Saudi Arabia andKuwait rather they
purchase the oil fields. If thesuppliers learn the technology of
oil extractionthen in future they might become the competitor
of BP and Shell.
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Investment in specialized assets
Vertical FDI will occur when a firm must investin specialized
assets whose value depends oninputs provided by foreign
supplier.
