© 2001 Prentice Hall8-1 International Business by Daniels and Radebaugh Chapter 8 Foreign Direct Investment

© 2001 Prentice Hall 8-1

International Businessby

Daniels and Radebaugh

Chapter 8Foreign Direct Investment


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


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


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


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


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


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


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


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


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


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


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


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


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


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


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


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


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

---

---

---

134,815

133,906

219,442

---

World’s Top 10 Foreign Direct investors, Ranked by Foreign Assets, 1997 (Assets and Sales in Billions of U.S. Dollars)


460

18166

Central and Eastern Europe Developed Countries Emerging Economies

FDI Inflows in Major World Regions, 1998


FDI Inflows in Major World Regions, 1998

1.9

595

52

Central and Eastern Europe Developed Countries Emerging Economies

Documents

© 2001 Prentice Hall8-1 International Business by Daniels and Radebaugh Chapter 8 Foreign Direct Investment