© 2001 prentice hall8-1 international business by daniels and radebaugh chapter 8 foreign direct...
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© 2001 Prentice Hall 8-1
International Businessby
Daniels and Radebaugh
Chapter 8Foreign Direct Investment
© 2001 Prentice Hall 8-2
ObjectivesTo explain why investors and governments view direct
investments differently than portfolio investmentsTo demonstrate how companies acquire foreign direct
investmentsTo evaluate the relationship between foreign trade and
international factor mobility, especially direct investmentTo classify companies’ advantages from foreign direct
investmentsTo show the major global patterns of foreign direct investment
© 2001 Prentice Hall 8-3
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 percentConcern 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
© 2001 Prentice Hall 8-4
OPERATIONS
OBJECTIVES
MEANS• Trade• FDI• Other equity and nonequity arrangements
STRATEGY
EXTERNAL INFLUENCES
COMPETITIVE ENVIRONMENT
PHYSICAL ANDSOCIETAL FACTORS
The Place of FDI in International Business
© 2001 Prentice Hall 8-5
Methods of AcquisitionCompanies may:
• Use their resources for FDI• Acquire existing companies abroad• Build a new company abroad
Resources for AcquisitionFDI usually is an international capital movementInvestor may transfer other assets to effect an FDI
• Company may use funds it earns in a foreign country to establish an investment
• Can trade equity with companies in other countries
© 2001 Prentice Hall 8-6
Buy-versus-Build DecisionReasons 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
© 2001 Prentice Hall 8-7
Relationship of Trade and Factor MobilityFDI requires the movement of various production factorsTrade theories and factor mobility
• Factor movement is an alternative to trade– may or may not result in more efficient allocation of
resources• FDI a major cause and means of factor movement
Substitution— inability to use foreign production factors may stimulate efficient methods of substitution
• When factor proportions vary across countries, pressures arise for the most abundant factors to move to an area of scarcity
• Restrictions make factor movements only partially mobile internationally
– lowest costs occur when trade and production factors are both mobile
© 2001 Prentice Hall 8-8
Relationship of Trade and Factor Mobility (cont.)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
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
© 2001 Prentice Hall 8-9
SALES EXPANSIONOBJECTIVES
Overcome high transportcosts
Domestic capacity
Gains from scale economies
Trade restrictions
Barriers because of country-of-origin effects (nationalism,product image, delivery risk)
Lower productions costs abroad
RESOURCE ACQUISITIONOBJECTIVES
Savings through verticalintegration
Savings through rationalizedproduction
Gain access to cheaper ordifferent resources andknowledge
Need to lower costs as productmatures
Gain governmentalinvestment incentives
RISK MINIMIZATIONOBJECTIVES
Diversification of customer base (samemotivation as for salesexpansion)
Diversification of supplierbase (same motivation asfor resource acquistionobjectives
Following customers
Preventing competitors’ advantage
POLITICAL OBJECTIVES
Influence companies,usually through factorsunder resourceacquisition objectives
Motivation for FDI as an Alternative or Supplement to Trade
© 2001 Prentice Hall 8-10
FDI Motivations to Achieve Sales ExpansionTransportation—may raise costs so much that it becomes
impractical to export some products• Horizontal expansion—companies move abroad to
produce the same products they make at home• Plant capacity
– excess capacity may permit exporting despite high transport costs
– excess capacity may permit variable cost pricing• Scale economies
– in large-scale process technology, companies’ exports reduce costs by spreading fixed costs over more units of output
– in small-scale process technology, companies’ country-by-country production reduces costs by minimizing transportation expenses
© 2001 Prentice Hall 8-11
FDI Motivations to Achieve Sales Expansion (cont.)Trade restrictions
• Companies must produce in foreign country if they are to sell there
– companies more likely to produce locally if market potential is high relative to scale economies
• Trade restrictions favor big companies that can afford to commit substantial resources abroad
Country-of-origin effects• Consumers may prefer domestically produced goods
because of nationalism – product image—belief that products are better– delivery risk—hard to obtain service and replacement
parts from foreign suppliers» affected by distance, possibility of strikes
© 2001 Prentice Hall 8-12
FDI Motivations to Achieve Sales Expansion (cont.)Changes in comparative costs—exporters likely to have home-
country cost advantage• Least-cost production location changes because of
inflation, regulations, transportation costs, and productivity
FDI Motivations to Acquire ResourcesVertical integration— company’s control of the different stages
in making its product• Companies may combine resources located in different
countries– most vertical integration is supply-oriented
» designed to obtain raw materials in other countries
• Companies may gain certain economies through vertical integration
© 2001 Prentice Hall 8-13
FDI Motivations to Acquire Resources (cont.)Rationalized production—companies produce different
components or portions of their products in different countries
• Takes advantage of low labor costs, capital, raw materials, and long production runs
• Companies own foreign production facilities to ensure a smooth production flow
Access to production resources—company goes abroad to gain some capability (e.g., knowledge) for entire organization rather than for a specific product
Product life cycle theory— production often moves from one country to another as a product moves through its life cycle
Governmental investment incentives—encourage FDI by offering tax concessions or other subsidies
• Affect the comparative cost of production– shift the least-cost production location
© 2001 Prentice Hall 8-14
Risk Minimization ObjectivesFollowing customers—company can keep customers by
following them abroad• Indirect exports—domestic good is embodied in a product
that the domestic customer exports– indirect exporters commonly follow their customers
when they make direct investmentsPreventing competitors’ advantage—company’s decision to
invest depends not so much on the benefits it gains but rather on what it could lose by not entering the field
Oligopolistic industries—investors often establish facilities in a given country at about the same time
• Companies experience capacity-expansion cycles concurrently
• Face changes in import restrictions or market conditions that make FDI advisable
© 2001 Prentice Hall 8-15
Risk Minimization Objectives (cont.)Political motives
• Governments give incentives to their companies to make direct investments in order to
– gain supplies of strategic resources– develop spheres of influence
© 2001 Prentice Hall 8-16
Advantages of FDIMonopoly advantages before direct investment
• Companies invest directly only if they think they hold some supremacy over similar companies in countries of interest
– monopoly advantage—results from a foreign company’s ownership of some resource unavailable at the same price or terms to the local market
– companies enjoy monopoly advantage if » they can borrow capital at a lower interest rate
than companies from another country» their home-country’s currency has high buying
powerAdvantages after direct investment
• Selling internationally is efficient• Spreads the costs of operations
© 2001 Prentice Hall 8-17
Direct Investment PatternsLocation of ownership
• For worldwide FDI – almost all ownership is by companies from developed
countries– emerging economy ownership is increasing
Location of investment• Most FDI occurs in developed countries because they
have the – biggest markets– lowest perceived risk– least discrimination toward foreign companies
Economic sector of investment• FDI in raw materials has declined• FDI in manufacturing has stabilized• FDI in service sector and technology-intensive
manufacturing has grown rapidly
© 2001 Prentice Hall 8-18
RANK1
2
3
4
5
6
7
8
9
10
CORPORATIONGeneral Electric
Ford Motor Company
Shell, Royal Dutch
General Motors
Exxon Corporation
Toyota
IBM
Volkswagen Group
Nestlé SA
Daimler-Benz
COUNTRYUnited States
United States
Netherlands/United Kingdom
United States
United States
Japan
United States
Germany
Switzerland
Germany
INDUSTRYElectronics
Automotive
Petroleum
Automotive
Petroleum
Automotive
Computers
Automotive
Food andbeverages
Automotive
FOREIGNASSETS
97.4
72.5
70.0
---
54.6
41.8
39.9
---
31.6
---
FOREIGNSALES
24.5
48.0
69.0
51.0
104.8
50.4
48.9
42.7
47.6
50.4
FOREIGNEMPLOYEES
111,000
174,105
65,000
---
---
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134,815
133,906
219,442
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World’s Top 10 Foreign Direct investors, Ranked by Foreign Assets, 1997 (Assets and Sales in Billions of U.S. Dollars)
© 2001 Prentice Hall 8-19
460
18166
Central and Eastern Europe Developed Countries Emerging Economies
FDI Inflows in Major World Regions, 1998
© 2001 Prentice Hall 8-20
FDI Inflows in Major World Regions, 1998
1.9
595
52
Central and Eastern Europe Developed Countries Emerging Economies