Chapter Foreign Direct Investment 6

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 6-2 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

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 6-3 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

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 6-4 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

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 6-5 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

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 6-6 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

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 6-7 FDI outflows, Fig 6.1

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 6-8 Growth in world exports Fig 6.2 World GDP and FDI (index = 100 in 1990)

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 6-9 FDI flows by region Fig: 6.3

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Inward FDI flows Fig: 6.4 As a percentage of gross fixed capital formation, 2000

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved FDI outflows by select country Fig: 6.5

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved 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

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved FDI trends: The value of FDI slumped almost 60 percent in Slowdown in world economy Heightened geopolitical uncertainty since September 11, 2001 Bursting of the stock market bubble in the US

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Impediments to the sale of know-how Impediments to the sale of know how Risk giving away know-how to competitors Licensing implies low control over foreign entity Know-how not amenable to licensing

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved 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)

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved 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)

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved VDI, when and why? Market power create entry barriers erode entry barriers Market imperfections Impediments to the sale of know-how Investments in specialized assets

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Decision framework How high are transportation costs and tariffs? Is know-how amenable to licensing? Is tight control over foreign operation required? Can know-how be protected by licensing contract? Then license Export No Yes Low No Yes No Horizontal FDI High