Foreign Direct Investment 6 Chapter Foreign Direct Investment

Opening case-Starbucks Starbucks’ strategy Coffee house setting, blended coffees Superior customer service Attention to hiring, training, and compensation Motivation of employees Used nation-specific strategies Britain Japan Thailand Korea

What is foreign direct investment Company acquiring or merging with a firm in a different country A firm creating a ‘Greenfield’ operation in a different country A firm creating a subsidiary in a different country As a result The firm has significant control of its foreign operation Firm can affect managerial decisions of the foreign operation

FDI - Flow versus stock FDI occurs when a firm invests directly in facilities to produce and/or market a product in a foreign country Flow: Amount of FDI over a period of time (one year) Stock: Total accumulated value of foreign owned assets at a given point in time FDI is not the investment by individuals, firms or public bodies in foreign financial instruments

Why is FDI important ? Firms want a presence in foreign markets Firms want control over growth of these foreign markets To gain first mover advantages To ward off competitors To determine locations, advertising and other related strategic decisions in the firm’s interest

Trends in FDI Flow and stock increased in the last 20 years In spite of decline of trade barriers, FDI has grown more rapidly than world trade because Businesses fear protectionist pressures FDI is seen a a way of circumventing trade barriers Dramatic political and economic changes in many parts of the world Globalization of the world economy has raised the vision of firms who now see the entire world as their market

FDI outflows, 1982-2002 Fig 6.1

Growth in world exports Fig 6.2 World GDP and FDI 1990-2001 (index = 100 in 1990)

FDI flows by region Fig: 6.3

Inward FDI flows Fig: 6.4 As a percentage of gross fixed capital formation, 2000

FDI outflows by select country 1998-2001 Fig: 6.5

Form Of FDI: Greenfield versus acquisitions Green field operation: Mostly in developing nations Mergers and acquisitions: Quicker to execute. Foreign firms have valuable strategic assets Believe they can increase the efficiency of the acquired firm More prevalent in developed nations

FDI trends: 2001-2002 The value of FDI slumped almost 60 percent in 2001-2002 Slowdown in world economy Heightened geopolitical uncertainty since September 11, 2001 Bursting of the stock market bubble in the US

Impediments to the sale of know-how Risk giving away know-how to competitors Licensing implies low control over foreign entity Impediments to the sale of know how Know-how not amenable to licensing

Two forms of FDI Horizontal Direct Investment FDI in the same industry abroad as company operates at home. Vertical direct investment Backward - investments into industry that provides inputs into a firm’s domestic production (typically extractive industries) Forward - investment in an industry that utilizes the outputs from a firm’s domestic production (typically sales and distribution)

FDI when and why? Transportation costs are high Market Imperfections (Internalization Theory) Impediments to the free flow of products between nations Impediments to the sale of know-how Follow the lead of a competitor - strategic rivalry Product Life Cycle - however, does not explain when it is profitable to invest abroad Location specific advantages (natural resources)

VDI, when and why? Market power Market imperfections create entry barriers erode entry barriers Market imperfections Impediments to the sale of know-how Investments in specialized assets

Decision framework Low No High Horizontal FDI Yes Yes Horizontal FDI How high are transportation costs and tariffs? Export No High Horizontal FDI Is know-how amenable to licensing? Yes Yes Horizontal FDI Is tight control over foreign operation required? No No Horizontal FDI Can know-how be protected by licensing contract? Yes Then license