1. 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

2. 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

3. 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

4. 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

5. 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

6. Sustaining and Transferring Competitive Advantage
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7. 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.

8. 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

9. 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

10. The OLI Paradigm and Internalisation
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11. 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

12. Recent trends in FDI: Global view
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13. Recent trends in FDI: Global view
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14. Recent trends in FDI: Global view
Regional overview of FDI
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15. Recent trends in FDI: Global view
Regional overview of FDI
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16. Recent trends in FDI: Global view
Regional overview of FDI
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17. Recent trends in FDI: Global view
Regional overview of FDI
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18. Recent trends in FDI: Global view
Regional overview of FDI
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19. Recent trends in FDI: Global view
FDI - Australia
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20. Recent trends in FDI: Global view
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21. Recent trends in FDI: Global view
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22. Recent trends in FDI: Global view
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23. 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.

24. 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

25. 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.

26. How to Invest Abroad: Modes of Foreign Involvement
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27. 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

28. 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

29. 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

30. 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

31. 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

32. 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

33. 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.

34. 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