Foreign Direct Investment Theory and Strategy Multinational Business Finance (2nd Edition) Chapter 17 David Eiteman | Kevin Daly Subhrendu Rath | Arthur Stonehill | Michael Moffett Foreign Direct Investment Theory and Strategy

Sustaining and Transferring Competitive Advantage Investment abroad depend on Competitive advantage that enables it to compete effectively in the home market. Those advantage must be firm-specific, transferable, and powerful enough to compensate the firm for the potential disadvantages of operating abroad

Sustaining and Transferring Competitive Advantage Economies of scale and scope: Can be developed in production, marketing, finance, research and development, transportation, and purchasing Large size is a major contributing factor (due to international and/or domestic operations) Managerial and marketing expertise: Includes skill in managing large industrial organisations (human capital and technology) and knowledge of modern analytical techniques and their application in functional areas of business

Sustaining and Transferring Competitive Advantage Advanced technology: Includes both scientific and engineering skills Financial strength: Demonstrated financial strength by achieving and maintaining a global cost and availability of capital This is a critical competitive cost variable that enables them to fund FDI and other foreign activities

Sustaining and Transferring Competitive Advantage Differentiated products: Differentiated products originate from research-based innovations or heavy marketing expenditures to gain brand identification Competitiveness of the home market: A strongly competitive home market can sharpen a firm’s competitive advantage relative to firms located in less competitive ones

Sustaining and Transferring Competitive Advantage (Page 487)

The OLI Paradigm and Internalisation A framework which explain why MNEs choose FDI rather than serve foreign markets through alternative models such as licensing, joint ventures, strategic alliances, management contracts, and exporting.

The OLI Paradigm and Internalisation The OLI stand for “O” ownership Competitive advantage in the home market that can be transferred abroad “L” location specific characteristics of the foreign market allow the firm to exploit its competitive advantage “I” internalisation maintenance of its competitive position by attempting to control the entire value chain in its industry

The OLI Paradigm and Internalisation The financial strength Financial strategies are directly related to the OLI Paradigm Proactive strategies strategies necessary to gain an advantage from lower global cost and greater availability of capital Reactive strategies depend on discovering market imperfections

The OLI Paradigm and Internalisation (Page 489)

Recent trends in FDI: Global view FDI occurs when investing directly in facilities to produce a product in a foreign country, or, buying an existing enterprise in a foreign country

Recent trends in FDI: Global view (Page 490)

Recent trends in FDI: Global view (Page 491)

Recent trends in FDI: Global view Regional overview of FDI (Page 492)

Recent trends in FDI: Global view Regional overview of FDI (Page 492)

Recent trends in FDI: Global view Regional overview of FDI (Page 493)

Recent trends in FDI: Global view Regional overview of FDI (Page 494)

Recent trends in FDI: Global view Regional overview of FDI (Page 495)

Recent trends in FDI: Global view FDI - Australia (Page 495)

Recent trends in FDI: Global view (Page 496)

Recent trends in FDI: Global view (Page 497)

Recent trends in FDI: Global view (Page 498)

Where to Invest? The decision is influenced by behavioural factors. The decision to invest abroad for the first time is not the same as the decision to reinvest abroad. In theory, A firm should search worldwide for market imperfections and comparative advantage until it finds a country where it expects to enjoy a competitive advantage large enough to generate a risk-adjusted return above the firm’s hurdle rate. In practice, The firms have been observed to follow a sequential search pattern as described in the behavioural theory of the firm.

Where to Invest? The decision to invest abroad is often a stage in the firm’s development process. Eventually the firm experiences a stimulus from the external environment, which leads it to consider production abroad. Some important external stimuli are: An outside proposal, from a quality source Fear of losing a market The “bandwagon” effect Strong competition from abroad in the home market

How to Invest Abroad: Modes of Foreign Involvement The globalisation process includes a sequence of decisions regarding where production is to occur, who is to own or control intellectual property, and who is to own the actual production facilities.

How to Invest Abroad: Modes of Foreign Involvement (Page 500)

How to Invest Abroad: Modes of Foreign Investment Exporting versus production abroad: Advantages to limiting a firm’s activities to exports Exporting has none of the unique risks facing FDI, Joint Ventures, strategic alliances and licensing with minimal political risks The amount of front-end investment is typically lower than other modes of foreign involvement Disadvantages the risks of losing markets to imitators and global competitors

How to Invest Abroad: Modes of Foreign Investment Licensing and management contracts versus control of assets abroad: Licensing is a popular method for domestic firms to profit from foreign markets without the need to commit sizeable funds Disadvantages of licensing Possible loss of quality control Establishment of a potential competitor in third-country markets Risk that technology will be stolen High agency cost

How to Invest Abroad: Modes of Foreign Investment Management contracts Similar to licensing as they provide for some cash flow from a foreign source without significant foreign investment or exposure probably lessen political risk because the repatriation of managers is easy

How to Invest Abroad: Modes of Foreign Investment Joint venture versus wholly owned subsidiary: A joint venture is here defined as shared ownership in a foreign business Some advantages of a MNE working with a local joint venture partner are: Better understanding of local environment Providing for competent management Satisfying local ownership requirements Use of local partners’ contacts , reputation and know how Public image of local partners

How to Invest Abroad: Modes of Foreign Investment Potential conflicts or difficulties on Joint venture Risk of selecting wrong partner Divergent views critical decisions Transfer pricing issues; and Difficulties in the ability to rationalise production on a worldwide basis

How to Invest Abroad: Modes of Foreign Investment Greenfield investment versus acquisition: Establishing a production or service facility starting from the ground up A cross-border acquisition is clearly much quicker and can also be a cost effective way to obtain technology and/or brand names

How to Invest Abroad: Modes of Foreign Investment Strategic alliance In one form of cross-border strategic alliance, two firms exchange a share of ownership with one another. A more comprehensive strategic alliance, partners exchange a share of ownership in addition to creating a separate joint venture to develop and manufacture a product or service Another level of cooperation might include joint marketing and servicing agreements in which each partner represents the other in certain markets.

Mini-Case Questions: Benecol How does the global licensing agreement split risk and return, in a financial sense, between Raisio and McNeil? How will the returns to Raisio accrue over the short, medium, and long terms under the agreement, assuming the product meets with relative success? What are some of the possible motivations to Raisio and McNeil behind a milestone agreement? Assume the milestone payments are agreed-upon payments from McNeil to Raisio if: Raisio successfully completes the expansion of its manufacturing capabilities for stanol ester McNeil successfully introduces Benecol products in major industrial markets, overcoming regulatory hurdles or reaching specific sales goals