FOREIGN DIRECT INVESTMENT

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-1

Exporting May Not Be Feasible

When production abroad is cheaper than at home When transportation costs to move goods or services internationally are too expensive When companies lack domestic capacity When products and services need to be altered substantially to gain sufficient consumer demand abroad When governments inhibit the import of foreign products When buyers prefer products originating from a particular country
Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-2

Factors Affecting Operating Modes in International Business

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-3

Foreign Expansion: Alternative Operating Modes

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-4

Non-collaborative Foreign Equity Arrangements

Taking Control: Foreign Direct Investment Internalization Appropriability Freedom to Pursue a Global Strategy How to make FDI Buying Greenfield Investments

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-5

Foreign Direct Investment (FDI)

Purchase of physical assets or significant amount of ownership of a company in another country to gain some measure of management control

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-6

 Most governments set the FDI threshold at somewhere between 10 and 25 percent of stock ownership in a company abroad.

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-7

DRIVERS
Globalization of the world economy encourages firms to use FDI as a way to create low-cost production bases. It also prompts multinationals from advanced and emerging economies alike to buy up businesses in other markets Mergers and acquisitions have propelled long-term growth in FDI and will likely do so for the foreseeable future.
Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall
14-8

Theories that support FDI

Market Power Eclectic Theory Product Life Cycle Market Imperfection
When the features of a FDI to location combine with internalize a ownership transaction and that is made internalization inefficient advantages because of to make a a market location Copyright 2011 Pearson Education, Inc. imperfection appealing for publishing as Prentice Hall investment.

Based in the life cycle of the products

A firm tries to establish a dominant market presence in an industry by undertaking foreign direct investment.
14-9

ESTADSTICAS DE INVERSIN EXTRANJERA DIRECTA EN COLOMBIA Flujos de Inversin Extranjera Directa segn Balanza de Pagos - Principales pases 2009 a III Trimestre de 2011 US$ Millones
Posicin* Pas 2009 2010 Ene-Sept 2010 318,8 381,1 91,5 218,0 284,8 3,0 53,8 138,1 123,7 -146,5 46,7 45,7 72,5 -54,0 16,9 20,9 -7,2 5,3 -27,5 -0,7 12,2 8,7 5,6 -18,0 3,0 8,5 0,8 0,0 6,4 2,9 91,8 1.706,9 2.047,4 1.979,6 5.734 Ene-Sept 2011 326,6 664,8 605,1 274,7 89,8 19,0 -17,3 207,2 169,9 778,2 83,3 67,9 48,8 295,7 57,6 20,2 14,1 11,5 8,7 9,0 9,5 14,2 26,6 5,9 55,1 10,1 0,7 0,0 0,7 -0,7 132,6 3.989,5 2.510,3 4.321,1 10.821 % Part. 2010** 13,0% 20,8% 5,1% 9,6% 16,3% 0,3% 1,7% 6,7% 8,1% 2,7% 2,4% 2,4% 2,1% 0,4% 0,9% 0,3% 0,7% 0,3% 0,5% 0,1% 0,0% 0,4% 0,2% 5,2% 17% 42% 41% 100% % Part. III Trimestre 2011** 8,1% 16,6% 15,1% 6,9% 2,2% 0,5% 5,2% 4,2% 19,4% 2,1% 1,7% 1,2% 7,4% 1,4% 0,5% 0,4% 0,3% 0,2% 0,2% 0,2% 0,4% 0,7% 0,1% 1,4% 0,3% 0,0% 0,0% 3,3% 36,9% 23,2% 39,9% 100% % Var. 0910 -78,1% 24,7% -49,7% -58,3% 33,9% 48,0% -53,0% 107,9% 13,0% -57,9% -27,4% -17,7% 50,9% 63,7% 581,9% 80,7% -71,4% -27,3% -90,8% 219,4% 748,0% -18,7% -55,2% 36,8% 17,8% -3% % Var. III Trim 10 - III Trim 11 2,4% 74,4% 561,6% 26,0% -68,5% 543,1% 50,0% 37,4% 78,4% 48,6% -32,7% 240,0% -3,5% 119,7% -22,5% 62,1% 373,6% 1748,1% 18,2% -13,1% -88,8% 44,5% 133,7% 22,6% 118,3% 89%

1 ESTADOS UNIDOS 2 PANAMA 3 ESPAA 4 INGLATERRA 5 ANGUILLA 6 ISLAS VIRGENES 7 ISLAS CAYMAN 8 BERMUDAS 9 CANADA 10 PASES BAJOS 11 BRASIL 12 FRANCIA 13 MEXICO 14 CHILE 15 SUIZA 16 VENEZUELA 17 ALEMANIA 18 BAHAMAS 19 LUXEMBURGO 20 ANTILLAS HOLANDESAS 21 ITALIA 22 ECUADOR 23 URUGUAY 24 JAPON 25 ARGENTINA 26 PERU 27 SUECIA 28 LIECHENSTEIN 29 IRLANDA 30 DINAMARCA OTROS PASES SUBT. SECTORES NO PETROLEROS REINVERSIN DE UTILIDADES SECTOR PETROLERO TOTAL

1.198,2 262,3 337,1 420,2 -326,9 103,1 385,6 194,0 790,3 329,5 4,6 6,2 22,9 33,9 287,1 134,8 78,3 162,8 -109,1 -158,3 47,4 53,6 113,0 47,6 -647,2 -623,5 53,7 -6,1 65,4 47,5 51,3 42,2 -99,5 -23,3 4,7 7,2 99,6 -29,9 21,2 -0,5 10,7 17,5 1,0 6,6 7,8 14,1 0,7 -13,2 19,9 5,7 14,7 10,7 32,4 3,0 0,7 0,0 2,3 7,3 0,4 3,5 129,7 105,5 2.598,1 1.163,9 2.110,9 2.888,6 2.428,2 2.861,3 7.137 6.914

Fuente: Balanza de Pagos. Banco de la Repblica. Clculos Proexport

Copyright 2011 Pearson Education, Inc. * Posicin de acuerdo a los flujos de inversin acumulados desde 1994 hasta el tercer trimestre de 2011 **Participacin sobre el total de los pases con inversin neta positiva, sin reinversi n de utilidades ni inversi n en el sector petrolero (cuentas excluidas del total de la inversin por14-10 publishing as Prentice Hall pas y discriminadas en rubros independientes). Valor 2010: US$ 2.019,1 millones; Valor a III Trimestre de 2011: US$ 4.007,7 millones.

Flujos de Inversin Extranjera Directa segn Balanza de Pagos - Principales sectores 2009 a III Trimestre de 2011 US$ Millones
III Trimestre de 2010 1.979,6 1.637,5 218,7 83,8 1.021,0 506,6 1,6 206,6 15,4 63,1 5.734 III Trimestre de 2011 4.321,1 2.161,6 1.569,0 1.121,9 500,5 477,8 376,1 362,6 94,8 -164,4 10.821 % Var 09-10 17,8% -31,7% -54,6% 73,8% -26,6% 14,0% -28,4% 25,3% -3% % Var. III Trim 10 - III Trim 11 118,3% 32,0% 617,5% 1239,4% -51,0% -5,7% 23425,6% 75,5% 515,4% 89% %Part. 2010*** 38,5% 27,8% 3,6% 16,8% 6,1% 1,4% 4,0% 0,3% 1,5% % Part. III Trimestre 2011*** 39,3% 19,7% 14,3% 10,2% 4,6% 4,3% 3,4% 3,3% 0,9% -

Sector Sector Petrolero Minas y Canteras Comercio, Restaurantes y Hoteles Transportes, Almacenamiento y Comunicaciones Servicios Financieros y Empresariales Manufactureras Electricidad, Gas y Agua Construccin Agricultura Caza, Silvicultura y Pesca Servicios Comunales TOTAL

2009 2.428 3.025 594 348 720 621 -977 262 28 88 7.137

2010 2.861,3 2.066,3 269,6 -525,3 1.251,5 455,6 106,3 298,1 20,0 110,5 6.914

Fuente: Balanza de Pagos. Banco de la Repblica. Clculos Proexport *** Participacin sobre flujos de inversin positivos. Valor 2010: US$ 7.439,9 Millones; Valor III Trimestre 2011: US$ 10.985,4 Millones

Flujos de Inversin Extranjera Directa segn Balanza de Pagos - Trimestral 2006 a IIII Trimestre de 2011 US$ Millones
Trimestre I II 2006 2007 2008 2009 2010 2011 3.420,2 3.501,1 % Var 09-10 -22,1% -31,6% % Var 10 - 11 96,6% 14-11 82,3%

Copyright 2011 Pearson Education, Inc. 1.198,9 2.058,7 2.859,6 2.232,3 1.739,6 publishing as Prentice Hall
1.785,7 2.225,9 2.546,9 2.806,6 1.920,1

 Two forms of foreign direct investment (FDI) that do not involve collaboration are wholly owned operations and partially owned operations with the remainder widely held.

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-12

 To qualify as a foreign direct investment, the investor must have control. This can be established with a small percentage of the holdings if ownership is widely dispersed.

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-13

 The more ownership a company has, the greater its control over the management decisions of the operation.

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-14

 There are three primary reasons for companies to want a controlling interestinternalization theory, appropriability theory, and freedom to pursue global objectives.

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-15

Internalization
Control through self-handling of operations is known as internalization. Transactions cost theory holds that companies should organize operations internally when the costs of doing so are lower than contracting with another party to handle it for them.

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-16

Internalization may result in lower costs because:

Different operating units with the same company likely share a common culture which expedites communications The company can use its own managers, who understand and are committed to carrying out its objectives

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-17

 The company can avoid protracted negotiations with another company on such matters as how each will be compensated for contributions The company can avoid possible problems with enforcing an agreement

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-18

Appropriability theory
Is the idea that companies want to deny rivals and potential rivals access to resources such as capital, patents, trademarks, and management know-how that might be captured through collaborative agreements.

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-19

Freedom to Pursue a Global Strategy

When a company has a wholly owned foreign operation, it may more easily have that operation participate in a global strategy

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-20

How to Make FDI

FDI usually involves international capital movement, but could also involve the transfer of other assets, such as managers or cost control systems.

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-21

Companies can either acquire an interest in an existing company or construct new facilities, known as a greenfield investment.

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-22

Buying
Companies may acquire existing operations in order to avoid adding further capacity to the market, to avoid start-up problems, obtain easier financing, and get an immediate cash flow rather than tying up funds during construction

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-23

Making Greenfield Investments.

Companies may choose to build if no suitable company is available for acquisition, if the acquisition is likely to lead to carry-over problems, and if the acquisition is harder to finance. In addition, local governments may prevent acquisitions because they want more competitors in the market and fear foreign domination.
14-24

ISSUES IN THE FDI DECISION

a. Control:
Many companies invest abroad because they wish to control activities in the local market (e.g., to ensure the selling price remains the same across markets). Yet complete ownership does not guarantee control

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-25

1. Partnership Requirements
Many companies have strict policies regarding how much ownership they take in firms in other nations.

Yet a nation may demand shared ownership in return for market access. Governments may use such requirements to shield workers and industries from exploitation or domination by large multinationals.
Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall
14-26

2. Benefits of Cooperation
Greater harmony exists today between governments and international companies. Developing nations and emerging markets need investment, employment, tax revenues, training, and technology transfers. A country with a reputation for overly restricting the operations of multinationals can see its inward investment dry up.
Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-27

 Cooperation can open communication channels to maintain positive relationships in the host country.

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-28

B. Purchase-or-Build Decision
The purchase-or-build decision of managers entails deciding whether to purchase an existing business or build a subsidiary abroad from the ground upcalled a greenfield investment.

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-29

1. An acquiring firm may benefit from the goodwill the existing company has built over the years and, perhaps, brand recognition of the existing firm. 2. The purchase of an existing business also may allow for alternative methods of financing, such as an exchange of stock ownership

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-30

3. Factors that reduce the appeal of purchasing existing facilities are obsolete equipment, poor labor relations, and an unsuitable location.

14-31

4.

Adequate facilities are sometimes unavailable and a company must go ahead with a greenfield investment. Greenfield investments have their own drawbacks obtaining the necessary permits and financing and hiring local personnel can be difficult in some markets.

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-32

c. Production Costs
Labor regulations increase the hourly cost of production, and benefits packages and training programs add to wage costs. Although the cost of land and tax rate on profits can be lower locally, they may not remain constant.

14-33

1. Rationalized Production
a. Production in which components are produced where the cost of production is lowest. The components are brought together at one central location for assembly into the final product. a. Potential problem is that a work stoppage in one country can halt the entire production process
Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall
14-34

2. Mexicos Maquiladora
The 130-mile-wide strip along the U.S.Mexican border.
Low-wage regional economy next to a prosperous giant is a model for other regions split by wage or technology gaps.

14-35

 Ethical dilemmas arise over the wage gap between Mexico and the United States and lost U.S. union jobs to maquiladora nonunion jobs. Maquiladoras do not operate under the stringent regulations that firms in the United States do

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-36

3. Cost of Research and Development

Cost of developing subsequent stages of technology has led to cross-border alliances and acquisitions. One indicator of the significance of technology in foreign direct investment is the amount of R&D conducted by affiliates of parent companies in other countries. FDI in R&D appears to be spurred by supply factors such as access to high-quality scientific and technical human capital.
Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall
14-37

d. Customer Knowledge
1. The behavior of buyers is an important issue in the decision of whether to undertake FDI. A local presence can give companies valuable knowledge of customers that is unobtainable in the home market. 1. Some countries have quality reputations in certain product categories that make it profitable to produce there.

14-38

Following Clients
1.FDI puts companies near those firms they supply. Following clients occurs in industries in which component parts are obtained from suppliers with whom a manufacturer has a close working relationship.

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-39

Following Rivals
FDI decisions resemble a follow the leader scenario in industries with a limited number of large firms.

Many firms believe that not making a move parallel to that of the first mover might result in being shut out of a lucrative market.

14-40

GOVERNMENT INTERVENTION IN FDI

Nations enact laws, create regulations, or construct administrative hurdles for foreign companies. A bias toward protectionism or openness is rooted in a nations culture, history, and politics. But FDI tends to raise output and enhance standards of living.

14-41

 Balance of Payments Reasons for Intervention by the Host Country

Control Balance of Payments Obtain Resources and Benefits

Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall

14-42

Reasons for Intervention by the Home Country

Reasons for discouraging outward FDI Investing in other nations sends resources out of the home country and can lessen investment at home.

Outgoing FDI may damage a nations balance of payments by reducing exports otherwise sent to international markets.
Jobs resulting from FDI outflows may replace jobs at home.
Copyright 2011 Pearson Education, Inc. publishing as Prentice Hall
14-43

Reasons for promoting outgoing FDI

Outward FDI can increase long-run competitiveness (e.g., partnering as a learning opportunity).
Nations may encourage FDI in industries that use obsolete technology or employ low-wage workers with few skills.

14-44