Ibus 311--Chapter 6: Investing Abroad Directly

Front 1

IBUS Ch. 6 Learning Objectives

Back 1

After studying this chapter, you should be able to:

understand the vocabulary associated with foreign direct investment (FDI)

use the resource- and institution-based views to explain why FDI takes place

understand how FDI results in ownership, location, and internalization (OLI) advantages

identify different political views on FDI based on an understanding of FDI’s benefits and costs to host and home countries

participate in two leading debates on FDI

draw implications for action

Front 2

foreign direct investment (FDI)
[FDI Vocabulary]

Back 2

Investments in activities that control and manage value creation in other countries

Front 3

multinational enterprise (MNE)
[FDI Vocabulary]

Back 3

A firm that engages in foreign direct investment

Front 4

foreign portfolio investment (FPI)
[FDI Vocabulary]

Back 4

Investment in a portfolio of foreign securities such as stocks and bonds that do not entail the active management of foreign assets

Front 5

management control rights
[FDI Vocabulary]

Back 5

The rights to appoint key managers and establish control mechanisms

Front 6

FDI in General

Back 6

FDI is direct - requires significant equity ownership and provides the combination of equity ownership rights and management control rights

significant ownership rights provide much needed management control rights

FPI represents essentially insignificant ownership rights and no management control rights

To compete successfully, firms need to deploy overwhelming resources and capabilities to overcome their liabilities of foreignness; FDI provides one of the best ways to facilitate extension of firm-specific resources and capabilities abroad

Front 7

horizontal FDI
[FDI Vocabulary]

Back 7

A type of FDI in which a firm duplicates its home country-based activities at the same value chain stage in a host country

Front 8

vertical FDI
[FDI Vocabulary]

Back 8

A type of FDI in which a firm moves upstream or downstream in different value chain stages in a host country

Front 9

Horizontal FDI

Back 9

Operations in home country:
Value Chain--
INPUT
Research and Development
Components
Final Assembly
Marketing
OUTPUT

Operations in host country:
Same

Front 10

Vertical FDI

Back 10

Value Chain:
INPUT
Research and Development
Components
Final Assembly
Marketing
OUTPUT

Upstream vertical FDI: Components
Downstream vertical FDI: Marketing

Front 11

upstream vertical FDI

Back 11

A type of vertical FDI in which a firm engages in different stages of the value chain in two different countries

Front 12

downstream vertical FDI

Back 12

The amount of FDI moving in a given period (usually a year) in a certain direction

Front 13

FDI flow

Back 13

The amount of FDI moving in a given period (usually a year) in a certain direction

Front 14

FDI inflow

Back 14

Refers to inbound FDI moving into a country in a year

Front 15

FDI outflow

Back 15

Refers to outbound FDI moving
out of a country in a year

Front 16

FDI stock

Back 16

The total accumulation of inbound FDI in a country or outbound FDI from a country

Front 17

upstream vertical FDI

Back 17

A type of vertical FDI in which a firm engages in different stages of the value chain in two different countries

Front 18

downstream vertical FDI

Back 18

The amount of FDI moving in a given period (usually a year) in a certain direction

Front 19

FDI flow

Back 19

The amount of FDI moving in a given period (usually a year) in a certain direction

Front 20

FDI inflow

Back 20

Refers to inbound FDI moving into a country in a year

Front 21

FDI outflow

Back 21

Refers to outbound FDI moving
out of a country in a year

Front 22

FDI stock

Back 22

The total accumulation of inbound FDI in a country or outbound FDI from a country

Front 23

A firm’s quest for ownership (O) advantages, location (L) advantages, and internalization (I) advantages:
[OLI Advantages]

Back 23

Ownership
Location
Internationalization

Front 24

Ownership
[OLI Advantages]

Back 24

Refers to MNEs’ possession and leveraging of certain valuable, rare, hard-to-imitate, and organizationally embedded (VRIO) assets overseas in the context of FDI

Front 25

Location
[OLI Advantages]

Back 25

Refers to advantages enjoyed by firms operating in certain areas

Front 26

Internalization
[OLI Advantages]

Back 26

Refers to the replacement of cross-border markets (such as exporting and importing) with one firm (the MNE) locating in two or more countries

Front 27

Why do firms become MNEs by engaging in FDI? An OLI framework

Back 27

Ownership advantages
Location advantages
Internalization advantages

Leads to FDI/MNE

Front 28

dissemination risks
[Ownership Advantages]

Back 28

risks associated with unauthorized diffusion of firm-specific know-how

Front 29

Why Firms Prefer FDI to Licensing
[Ownership Advantages]

Back 29

FDI reduces dissemination risk
FDI provides tight control over foreign operations
FDI facilitate the transfer of implicit knowledge through "learning by doing"

Front 30

agglomeration
[Location Advantages]

Back 30

location advantages that arise from the clustering of economic activities in certain locations

Front 31

knowledge spillovers
[Location Advantages]

Back 31

Knowledge diffused from one firm to others among closely located firms that attempt to hire individuals from competitors

Front 32

international transaction costs
[Internalization Advantages]

Back 32

tend to be higher than domestic costs - laws and regulations are typically enforced on a nation-state basis

Front 33

intrafirm trade
[Internalization Advantages]

Back 33

international trade between two subsidiaries in two countries controlled by the same MNE

Front 34

An International Market Transaction Between two companies in two countries

Back 34

Value Chain:
Oil exploration
Oil Production
Oil refinery
Gasoline distribution

An import/export contract can be made between an NNPC in Nigeria in the Oil production stage with BP in Great Britain's Oil Refinery stage
An International Market Transaction between two companies in two countries

Front 35

Combating Market Failure through FDI: One Company (MNE) in Two Countries

Back 35

Value Chain:
Oil exploration
Oil Production
Oil refinery
Gasoline distribution

In theory, there can be two possibilities: 1. BP undertakes upstream vertical FDI by owning oil production assets in Nigeria, or 2. NNPC understakes downstream vertical FDI by owning oil refinery assets in GB. In reality, the first scenario is more likely

Front 36

radical view
[Realities of FDI--Political Views]

Back 36

political view that is hostile to FDI

Front 37

free market view
[Realities of FDI--Political Views]

Back 37

political view that suggests that FDI, unrestricted by government intervention, will enable
countries to tap into their absolute or comparative advantages by specializing in the production of certain goods and services

Front 38

pragmatic nationalism
[Realities of FDI--Political Views]

Back 38

political view that approves FDI only when its benefits outweigh its costs

Front 39

technology spillovers
[Benefits and Costs of FDI to Host Countries]

Back 39

foreign technology
diffused domestically that benefits domestic firms and industries

Front 40

demonstration effect (contagion or imitation effect)
[Benefits and Costs of FDI to Host Countries]

Back 40

reaction of local firms to technology spillovers

Front 41

Benefits and Costs of FDI to Home Countries

Back 41

Repatriated earnings of profits from FDI

Increased exports of components and services to host countries

Learning via FDI from operations abroad

Front 42

Effects of FDI on home and host countries

Back 42

2x2 Box
Vertical: Recipients vs. sources
Side( B to Top): Home (source) countries, Host (recipient) countires
Horizontal: Effects of FDI
Bottom (L to R) : Benefits, Costs

Clockwise top left:
Cell 1: Capital inflow, technology, management, job creation
Cell 2: loss of sovereignty, competition, capital outflow
Cell 3: earnings, exports, learning from abroad
Cell 4: Capital outflow, job loss

Front 43

obsolescing bargain
[How MNEs and Host Governments Bargain]

Back 43

deal struck by MNEs and host governments, which change their requirements after initial FDI entry

Front 44

expropriation
[How MNEs and Host Governments Bargain]

Back 44

Government’s tactics that include removing incentives, demanding a higher share of profits and taxes, and confiscating foreign assets

Front 45

sunk costs
[How MNEs and Host Governments Bargain]

Back 45

point at which a firm has invested substantial sums of resources

Front 46

How MNEs Negotiate with host governments: The Three C's

Back 46

Common Interests
Conflicting interests
Compromises

Front 47

FDI versus Outsourcing

Back 47

A strategic debate is whether FDI (captive sourcing) or outsourcing will serve firms’ purposes better?

Front 48

Facilitating versus Confronting Inbound FDI

Back 48

Can foreigners and foreign firms be trusted in making decisions important to the local economy?

Front 49

Implications for Action

Back 49

Carefully access whether FDI is justified in light of other foreign entry modes such as outsourcing and licensing
Pay careful attention to the location advantages in combination with the firm's strategic goals
Be aware of the institutional constraints and enablers governing FDI and enhance legitimacy in host countries