Chapter 7 Foreign Direct Investment

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foreign direct investment or FDI

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Purchaseof physical assets or a significant amount of the ownership (stock) of a company inanother country to gain a measure ofmanagement control.

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portfolioinvestment

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Investment that does not involve obtaining adegree of control in a company.

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Factors that propelled thegrowth of FDI

-globalization
-mergersand acquisitions (M&A)

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Factors that propelled thegrowth of FDI

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emergingmarkets

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Increasing globalization is also causing agrowing number of international companies from ____________to undertake FDI

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lowered

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As countries _____ their tradebarriers, companies realizedthatthey could now produce

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Drivers of companies M&A

-Get a foothold in anew geographic market.

- Increase a firm’sglobal competitiveness.

-Fill gaps incompanies’ product lines in a global industry.

-Reduce costs of researchand development, production, distribution, and so forth.

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Driversof companies M&A

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European Union (EU) nations, the United States, Japan

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Among developed countries, ________, ______& ______account for the majority of world FDI inflows

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Reasons why companies engage inFDI

Internationalproduct life cycle

Marketimperfections (internalization)

EclecticTheory

MarketPower

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Reasonswhy companies engage in FDI

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internationalproduct life cycle theory

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Theory stating that a companybegins by exporting its product andthen later undertakes foreigndirect investment as the product movesthroughits life cycle

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internationalproduct life cycle theory

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internationalproduct life cycle theory

a good is produced in the home country becauseof uncertain domestic demand and to keep production close to the researchdepartment that developed the product

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internationalproduct life cycle theory


maturing product stage

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internationalproduct life cycle theory

the company directly invests inproduction facilities in countries where demand is great enough to warrant itsown production facilities

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internationalproduct life cycle theory

standardized product stage

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internationalproduct life cycle theory

a company builds productioncapacity in low-cost developingnationsto serve its markets around the world due to increased competition createspressures to reduce production costs.

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- limited power to explain whycompanies choose FDI over other forms of market entry
- fails to explain why firmschoose FDI overexporting activities
-it does not explain why other market entry modes are inferior or lessadvantageous options.

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Drawbacksof internationalproduct life cycle theory

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Marketimperfections theory

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Theory stating that when an imperfection in themarket makes a transaction less efficient than it could be, a company willundertake foreign direct investment to internalize the transaction and therebyremove the imperfection.

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Perfectmarket.

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A market that is said to operate at peakefficiency (prices are as low as they can possibly be) and where goods arereadily and easily available

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Kinds of Market Imperfections

1.Trade barriers

2.Specialized Knowledge

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Kinds of Market Imperfections

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SpecializedKnowledge

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unique competitive advantage of a company whichcould be the technical expertise of engineers or the special marketingabilities of managers

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The possibility that a company will create afuture competitor by charging another company for access to its knowledge isanother market imperfection that can encourage FDI

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eclectictheory

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Theory stating that firmsundertake foreign direct investment when the features of a particular locationcombine with ownership andinternalizationadvantages to make a location appealing for investment

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locationadvantage

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advantage of locating a particular economicactivity in a specific location because of the characteristics (natural oracquired) of that location usually natural resources or workforce

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ownershipadvantage

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company ownership of some special asset, such asbrand recognition, technical knowledge, or management ability

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internalizationadvantage

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arises from internalizing a business activityrather than leaving it to a relatively inefficient market

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marketpower theory

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Theory stating that a firm tries to establish adominant market presence in an industry by undertaking foreign directinvestment.

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dictate the cost of its inputs

and/or thepriceof its output.

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The benefit of market power is greater profitbecause the firm is far better able to _____________ & __________________

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vertical integration

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Extension of company activities into stages ofproduction that provide a firm’s inputs (backward integration) or that absorbits output (forward integration)

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Control
Purchase or Build decision(greenfield)
Production cost
Customer Knowledge
Following Clients
FollowingRivals

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Importantmanagement issues in FDI

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Many companies have strict policies regardinghow much ownership they take in firms abroad because of the importance ofmaintaining control But sometimes abandon such policies if a country demandsshared ownership in return for market access.

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Greenfieldinvestment.

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When a company builds a subsidiary abroad fromthe ground up

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Goodwill

brandrecognition

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The acquiring firm may also benefit from the_____ the existing company has built up over the years and _________ of theexisting firm

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exchange of stock ownership

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The purchase of an existingbusiness may also allow foralternativemethods of financing the purchase, such as an _____________________ between thecompanies

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*Obsolete equipment

* poor relations with workers

* unsuitablelocation

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Factors that can reduce the appeal of purchasingexisting facilities

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HR Policies
Mandated Benefits
Labor costs
Labor unions
Information
Personaland political contacts

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Factors in considering Build or Purchaseoperations

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rationalizedproduction

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approach to contain productioncosts/System ofproduction in which each of a product’s components is produced where the costof producing that component is lowest

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The behavior of buyers is frequently animportant issue in the decision to undertake FDI. A local presence can helpcompanies gain valuable knowledge about customers that could not be obtainedfrom the home market. Some countries have quality reputations in certainproduct categories.

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“following clients”

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The practice of _______________ is common inindustries in which producers source component parts from suppliers with whomthey have close working relationships.

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limited

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FDI decisions frequently resemble a “follow theleader” scenario in industries that have a ______ number of large firms.

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national competition

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The increased _______________ forinvestment is causing governments to enact regulatory changes that encourageinvestment. The majority of regulatory changes that governmentsintroducedin recent years are more favorable to FDI

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balanceof payments

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national accounting system that records allreceipts coming into the nation and all payments to entities in other countries

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current account

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Component of balance payment

Nationalaccount that records transactions involving the export and import of goods andservices, income receipts on assets abroad, and income payments on foreign assetsinside the country.

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merchandise account

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covers tangible goods such as computer software,electronic components, and apparel

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Positive

Negative

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“Export” of merchandise is assigned a ______value in the balance of payments because income is received. An “Import” isassigned a ______ value because money is paid to a firm abroad.

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services account

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involves tourism, business consulting, banking,and other services

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income receipts account

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Income earned on U.S. assets (subsidiary) heldabroad are remitted to home country

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current account surplus

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occurs when a country exports more goods andservices and receives more income from abroad than it imports and pays abroad.

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Current account deficit

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occurs when a country imports more goods andservices and pays more abroad than it exports and receives from abroad.

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capital account

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National account that records transactionsinvolving the purchase and sale of assets

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control the balanceof payments

Obtain resources and benefits.

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Reasons for Intervention by the Host Country

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FDIinflows arerecorded as additions tothe balance of payments

Localcontent requirements forlocal production (reduce the nation’s imports and improve itsbalance of payments)

Exportsgenerated by the new production operation can have a favorable impact

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Why governments see interventionas the only way to keep their balance of payments under control.

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foreign exchange reserves

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When companies repatriate profitsback to their home countries, they deplete the __________________of their hostcountries. These capital outflows decrease the balance of payments of the hostcountry. To shore up its balance of payments, the host nation may prohibit or restrict the nondomesticcompany from removing profits to its home country.Alternatively,host countries conserve their foreign exchange reserves when internationalcompanies reinvest their earnings.

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Access to Technology (increase productivity andcompetitiveness)
Management Skills andEmployment (createjobs, train locals)

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Government Intervention on FDI for resources and benefits

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Investingin other nations sends resources out of the home country.

OutgoingFDI may ultimately damage a nation’s balance of payments by taking the placeofits exports.

Jobs resulting from outgoing investments mayreplace jobs at home. T

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Reasons for Intervention to the outflow of FDIby the Home Country

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Sunset industries

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Industries that use outdated and obsoletetechnologies or that employ low-wage workers with few skills. This represents atrade-off for governments between a short-term loss of jobs and the long-termbenefit of developing workers’ skills.

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Taxincentives
Lowinterest loans
Infrastructureimprovements (seaports, roads, telecom)

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Methods of FDI Promotion by Host Countries

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OwnershipRestrictions

Performance Demands

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Methods of FDI Restriction by Host Countries

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Insurance

Loans

Taxbreaks

Political pressure

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Methods of FDI Promotion by Home Countries

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Differentialtax rates
Sanctions – prohibit investment in other nations

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Methods of FDI Restriction by Home Countries

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OwnershipRestrictions

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Prohibit nondomestic companies from investing incertain industries or from owning certain types of businesses.

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Differentialtax rates

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charge income from earningsabroad at a higher rate thandomesticearnings