1. Dr. Victor Z. Chen UNC Charlotte
Lecture 6
Dr. Victor Z. Chen
UNC Charlotte

2. Internalization Benefits: Export/License/Franchise or FDI?
Benefits of integration in general
Additional benefits of international integration
Additional Benefits
International integration
Synergies
Integration benefits without synergies
Integration in general

3. Part 1. Integration benefits without synergies

4. JV/merger to compete
Compare combined strength in each O advantage item with competitors.
Combined Os > Os of existing competitors

5. O advantages: WF vs. Top5 Ideal JV partner:
1. Only competitors that are lower in some Os would be willing to JV/Merger with WFC
2. Try hypothetical JV/merger with each of the willing competitor
3a. For additive Os, the after JV/merger O value would be the sum of both firms
3b. For non-additive Os (ratios), the after JV/merger O value would be between both firms (approximately the mean value if two firms are of similar sizes)
4. The ideal partner is the one with which the after JV/merger O values are higher than all other remaining competitors.
Company Name
No. of employees (k)
Total Assets (US$B)
ROA %
ROE %
Total Asset Turnover
# of Key Executives with International Work Experience
# of Foreign Subsidiaries
# of Countries of Foreign Subsidiaries
Bank of America Corp. (BAC)
208.00
0.82
6.83
0.040 2
100 28
Citigroup Inc (C )
219.00
0.84
6.65
0.050 4
108 30
Goldman Sachs Group Inc (GS)
34.40
860.17
0.86
8.50 79 10
JPMorgan Chase & Co (JPM)
243.36
1.02
9.83 39 7
Morgan Stanley (MS)
55.31
814.95
0.74
7.89 5 38
Wells Fargo & Co. (WFC)
269.10
1.18
11.15 80

6. Whom to merge/JV with? Total assets ($ billion)
Return on assets (ROA) (%)
Competitor 1 5 20
Competitor 2 8 15
Your company 10
Your goal: Increase in total assets, and highest ROA in the industry. ROA=net income/total assets So: net income = total assets x ROA Merged/JV net income= ∑ net income of each member Merged/JV total assets = ∑ total assets Merged/JV ROA = Merged/JV net income / Merged/JV total assets

7. Part 2. Synergies

8. A typical value chain curve
Source:
china_global_steinfield.pdf

9. Three Directions of Integration
Backward integration: the ownership of equity assets used earlier in the production cycle, such as an auto firm that acquires a steel company. Forward integration: the purchase of assets or facilities that move the company closer to the customer such as a computer manufacturer that acquires a retail chain, which specializes in computer products. Horizontal integration: the purchase of firms in the same line of business such as a computer chip firm, which acquires a competitor.
Vertical integration

10. Three Directions of Integration
A resource-based view
Suppliers
Raw materials and intermediate goods providers, designers, technology providers, etc.
Industry
Manufacturing & Production
Customers
Wholesalers & Retailers
backward
horizontal
forward

11. High-margin vs. low-margin value chain curves

12. Integration synergies: Three ways
Moving up in the value chain
Economies of scale
Economies of scope (e.g., to ensure standard quality)
A value-chain-based view

13. What was the motivation behind this?

14. Part 3. Additional Integration Benefits across Borders
Market failure
Tax advantages (No market failure)

15. 1. Market Failure: Hierarchy vs. Market

16. Institutional advantages: Market failure / Tax
Select Measures of Market-Supporting Institutions
Category
Specific examples US
Hong Kong SAR
China Mainland
Strong property rights
Registration of private property (days, % of property value)
Legal protection of private property (1-10, 10 best)
Investor protection (1-10, 10 best)
Intellectual property rights (IPR) protection (1-7, 7 best)
15.1, 2.1%
7.2
8.3
5.4
27.5, 7.7%
8.4
9.0
5.8
19.5, 3.4%
5.0
4.0
Free and fair competition
Easy entry
Low government consumption (1-10, 10 best)
Low government enterprises/investments (1-10, 10 best)
Low corporate tax
Low other taxes and fees
No informal competition
5.6 days
6.4
8.0
40% 4%
Very low
1.5 days
8.1
10.0
16.5%
6.5%
31 days
3.7
2.0
25%
43%
57.6%
Low transaction cost
Credit (% of adults covered by credit bureau; depth of information)
Strong auditing/reporting standards (1-7, 7 best)
Low trading barriers (hours)
Free trade agreements
Bilateral investment treaties
Freedom of migration
100%, 8.0
5.5 7
None with HK or China
No visa to HK, needs visa to China
96%, 7.0
6.2 20
With China
No visa to China or US
0%, 7.0
4.4
103
With HK
No visa to HK, needs visa to US
Strong contract enforcement
High corporate ethics
Legal resolution of contract claims (days, cost as % of claim)
4.8
420 days, 31%
360 days, 21%
4.2
453 days, 16%

17. Round-tripping and transshipment FDI
Round-tripping FDI
Company X(A) makes an initial investment from country A to country B to set up a new subsidiary X(B), which makes further investment (with or without new capital) back into country A as a country B foreign investor.
Transshipment FDI
Company X(A) makes an initial investment from country A to country B to set up a new subsidiary X(B), which makes further investment (with or without new capital) into country C as a country B foreign investor.

18. Trans-shipment
For instance, in 2011, Sinopec, China’s largest oil refiner, acquired 30% of Galp Energia (Brazil) for $5.2 billion, but indirectly through its Hong Kong subsidiary, Sinopec International Petroleum Exploration and Development Corp (SIPC).

19. An idea for a special market of clients
Rather than directly serving US- China two-way FDI players as an M&A advisor, why not start by approaching US- HK-China three- way transshipment FDI players?

20. 1. Market Failure: Hierarchy vs. Market
Select Measures of Market-Supporting Institutions
Category
Specific examples US
Hong Kong SAR
China Mainland
Strong property rights
Registration of private property (days, % of property value)
Legal protection of private property (1-10, 10 best)
Investor protection (1-10, 10 best)
Intellectual property rights (IPR) protection (1-7, 7 best)
15.1, 2.1%
7.2
8.3
5.4
27.5, 7.7%
8.4
9.0
5.8
19.5, 3.4%
5.0
4.0
Free and fair competition
Easy entry
Low government consumption (1-10, 10 best)
Low government enterprises/investments (1-10, 10 best)
Low corporate tax
Low other taxes and fees
No informal competition
5.6 days
6.4
8.0
40% 4%
Very low
1.5 days
8.1
10.0
16.5%
6.5%
31 days
3.7
2.0
25%
43%
57.6%
Low transaction cost
Credit (% of adults covered by credit bureau; depth of information)
Strong auditing/reporting standards (1-7, 7 best)
Low trading barriers (hours)
Free trade agreements
Bilateral investment treaties
Freedom of migration
100%, 8.0
5.5 7
None with HK or China
No visa to HK, needs visa to China
96%, 7.0
6.2 20
With China
No visa to China or US
0%, 7.0
4.4
103
With HK
No visa to HK, needs visa to US
Strong contract enforcement
High corporate ethics
Legal resolution of contract claims (days, cost as % of claim)
4.8
420 days, 31%
360 days, 21%
4.2
453 days, 16%

21. 2. Tax Advantages (No Market Failure)
Now compare the quality of market institutions among US, China (mainland), and HK.
Do you control your operations in HK or trade with someone local?
Think from Hierarchy vs. Market
A focus on tax advantages

22. A transaction between two independent firms (in US and China)
Hong Kong SAR
China
Sales
US$ 8 million (market) ?
US$ 10 million
Costs of sales
US$ 5 million
Profit
Corporate tax rate
40%
16.5%
25%
Net profit
If you sell your goods/services from US to China following the open international market price (US$8 million), how much would be the total net profit?

23. In which country would your profit be made eventually?
A transaction between two subsidiaries (in US and China) of the same Multinational Enterprise (via internal transfer) US
Hong Kong SAR
China
Sales
? (intra-firm) ?
US$ 10 million
Costs of sales
US$ 5 million
Profit
Corporate tax rate
40%
16.5%
25%
Net profit
How would you price intra-firm exports of intermediate goods/services from the US to China? (fill these question marks) to maximize the total net profits?
In which country would your profit be made eventually?
How much would be the maximal total net profit?

24. In which country would your profit be made eventually?
A transaction between two subsidiaries (in US and China) of the same Multinational Enterprise through a profit settlement center in Hong Kong SAR Q4 US
Hong Kong SAR
China
Sales
? (intra-firm)
US$ 10 million
Costs of sales
US$ 5 million
Profit ?
Corporate tax rate
40%
16.5%
25%
Net profit
How would you price intra-firm exports of intermediate goods/services from the US to China via your HK subsidiary ? (fill these question marks)
In which country would your profit be made eventually?
How much would be the maximal total net profit?

25. Internalization Benefits
Integration benefits in general
Move up the value chain
Backward: Higher knowledge intensity
Forward: Higher customer market control
Horizontal: Economy of scale
Additional integration benefits across borders
Addressing market failure: Organizational costs < market costs
Tax advantages: Internal transfer

26. Contact
Victor Z. Chen
Belk College of Business
UNC Charlotte
+1 (704)