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CHAPTER 6
FOREIGN DIRECT INVESTMENT
Chapter Outline
OPENING CASE: Starbucks’ Foreign Direct Investment
INTRODUCTION
FORIGN DIRECT INVESTMENT IN THE WORLD EECONOMY
The Growth of FDI
The Direction of FDI
Country Focus: Foreign Direct Investment in China
The Source of FDI
The Form of FDI: Acquisitions versus Green-Field Investments
Management Focus: Cemex’s Foreign Acquisitions
THE THEORY OF FORIGN DIRECT INVESTMENT
Why Foreign Direct Investment
The Pattern of Foreign Direct Investment
The Eclectic Paradigm
POLITICAL IDEOLOGY AND FOREIGN DIRECT INVESTMENT
The Radical View
The Free Market View
Pragmatic Nationalism
Shifting Ideology
COSTS AND BENEFITS OF FDI TO THE NATION STATE
Host Country Effects: Benefits
Host Country Effects: Costs
Country Focus: Foreign Direct Investment in Venezuela’s Petroleum Industry
Home Country Effects: Costs
Home Country Effects: Benefits
International Trade Theory and Foreign Direct Investment
GOVERNMENT POLICY INSTRUMENTS AND FDI
Home Country Policies
Host Country Policies
International Institutions and the Liberalization of FDI
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IMPLICATIONS FOR BUSINESS
The Theory of FDI
Government Policy
SUMMARY OF CHAPTER
CRITICAL THINKING AND DISCUSSION QUESTIONS
INTERNET EXERCISES
CLOSING CASE: Electrolux
Learning Objectives
1. Be familiar with the forces underpinning the rising tide of foreign direct investment in the world economy.
2. Understand why firms often prefer direct investment as a strategy for entering a foreign market over
alternatives such as exporting and granting foreign entities the right to produce the firm's product under license.
3. Appreciate why firms based in the same industry often undertake foreign direct investment at the same time.
4. Understand why certain locations are favored as the target of foreign direct investment activity.
5. Appreciate how political ideology influences government policy toward foreign direct investment.
6. Be conversant with the costs and benefits of foreign direct investment to receiving and source countries.
7. Have a good grasp of the different policy instruments that governments can use to restrict and encourage
foreign direct investment.
OPENING CASE: Starbucks’ Foreign Direct Investment
Summary
This case describes Starbucks’ ascent from a single store to a globally known brand in just a decade. The case
examines the company’s international expansion strategy and the tradeoffs that were made to ensure that the
Starbucks experience was successfully replicated in other countries. The following questions can be helpful in
directing the discussion:
Suggested Discussion Questions
QUESTION 1: How and why did Starbucks’ initial foray into foreign markets differ from its domestic
operations?
ANSWER 1: Starbucks deviated from its domestic strategy of company owned stores when the company
initially expanded into foreign markets by first establishing a joint venture with a local company in Japan, and
then licensing its format to the joint venture. The company also transferred some American employees to the
operation and required extensive employee training to ensure that the Starbucks experience was properly
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replicated in Japan. Starbucks also specified precise design parameters for all stores, again to ensure that
customers would not only be buying coffee, but also a Starbucks experience.
QUESTION 2: Why did Starbucks change its expansion strategy in Asia? What role did control play in
Starbucks’ decision to change its strategy?
ANSWER 2: Starbucks initially expanded into Asia via licensing agreements. However, when the company
became disenchanted with some of the straight licensing agreements, Starbucks converted several of them into
joint-venture arrangements or wholly owned subsidiaries. Starbucks made the changes in the strategy because
they allowed the company to have greater control over the operations. For example, when its licensee in
Thailand was having trouble raising financing for expansion, Starbucks simply stepped in and acquired the
licensee in order to gain greater control over the expansion strategy. Similarly, in South Korea, where
Starbucks initially licensed its format to a local company, Starbucks soon converted the licensing arrangement
to a joint venture to gain greater control over the growth strategy in South Korea, and to help fund the operation.
QUESTION 3: Starbucks’ next target market is mainland Europe, including France and Italy. What challenges
do you anticipate Starbucks will face in these markets? How should Starbucks approach the markets?
ANSWER 3: Most students will probably recognize that expanding into Europe, especially France and Italy
could be difficult. While the company found remarkable success in Asia, the coffee concept was relatively new
there, and customers not only bought coffee, but also an American experience. In France and Italy coffee
houses are already well established, and the company is likely find the markets much more difficult to break
into. Students may recommend that Starbucks expand into the market using joint ventures with local
companies. This approach will not only provide the company with local knowledge, but also allow it to
maintain some control over the operations.
Chapter Summary
This chapter focuses on the topic of foreign direct investment (FDI). FDI occurs when a firm invests directly in
new facilities to produce and/or market a product in a foreign country. At the outset, the chapter discusses the
growth in FDI, particularly by medium-sized and small firms. The theoretical underpinnings of FDI are
discussed, which describe under what circumstances it is advantageous for a firm to invest in production
facilities in a foreign country. The chapter also addresses the different policies that governments have toward
foreign direct investment. Some governments are opposed to FDI and some governments encourage it. Three
specific ideologies of FDI are discussed, including the radical view, the free market view, and pragmatic
nationalism. The chapter also provides a discussion of the costs and benefits of FDI from the perspective of
both the home country and the host country involved. The chapter concludes with a review of the policy
instruments that governments use to regulate FDI activity by international firms.
Chapter Outline With Lecture Notes and Teaching Tips
INTRODUCTION
A) This chapter is concerned with the phenomenon of foreign direct investment (FDI). Foreign direct
investment occurs when a firm invests directly in new facilities to produce and/or market in a foreign country.
Once a firm undertakes FDI it becomes a multinational enterprise.
Teaching Tip: Each year Fortune magazine publishes a list of the 500 largest global corporations in the world.
Fortune calls its list the "Global 500." This list can be accessed at
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{http://pathfinder.com/fortune/1997/specials/g500/intro.html}. The article contains an excellent discussion of
the role of global firms in the world economy.
Teaching Tip: Another web site that provides an excellent discussion of the role of multinational corporations
in the world economy is available at
{http://www.oecdobserver.org/news/fullstory.php/aid/446/The_trust_business.html}.
B) FDI takes on two main forms; the first is a green-field investment, which involves the establishment of a
wholly new operation in a foreign country. The second involves acquiring or merging with an existing firm in
the foreign country.
FOREIGN DIRECT INVESTMENT IN THE WORLD ECONOMY
A) When discussing foreign direct investment, it is important to distinguish between the flow and the stock of
foreign direct investment. The flow of FDI refers to the amount of FDI undertaken over a given time period
(normally a year). The stock of FDI refers to the total accumulated value of foreign-owned assets at a given
time. Outflows of FDI, meaning the flow of FDI out of a country, and inflows of FDI, meaning the flow of FDI
into a country are also discussed.
Teaching Tip: An excellent web site that provides a full array of information about foreign direct investment is
available at {http://www.columbia.edu/cu/lweb/indiv/business/guides/fordinv.html}.
The Growth of FDI
B) Over the past 20 years there has been a marked increase in both the flow and stock of FDI in the world
economy. The significant growth in FDI has both to do with the political economy of trade as outlined in the
previous chapter and the political and economic changes that have been taking place in developing countries.
The Direction of FDI
C) Another important trend is has been the rise of inflows into the US. The stock of foreign FDI in the US
increased more rapidly than US FDI abroad.
D) The rapid increase in FDI growth into the US may be due to the attractiveness of the US market, the falling
value of the dollar, and a belief by some foreign corporations that they could manage US assets and workers
more efficiently than their American managers.
E) It is difficult to say whether the increase in the FDI into the US is good for the country or not. To the extent
that foreigners are making more productive use of US assets and workers, it is probably good for the country.
The Source of Foreign Direct Investment
F) Not only has the flow of FDI been accelerating, but its composition has also been changing. For most of the
period after World War II, the U.S. was by far the largest source country for FDI. By 1990, however, the U.S.
share of FDI outflows had slumped to 10.3 percent, pushing the U.S. into second place behind Japan.
The Form of FDI: Acquisitions versus Green-Field Investments
G) The majority of cross-border investment is in the form of mergers and acquisitions rather than green-field
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investments. Firms prefer to acquire existing assets rather than undertake green-field investments because (1)
mergers and acquisitions are quicker to execute than green-field investments. (2) it is easier and perhaps less
risky for a firm to acquire desired assets than build them from the ground up, (3) firms believe that they can
increase the efficiency of an acquired unit by transferring capital, technology, or management skills.
THE THEORY OF FOREIGN DIRECT INVESTMENT
A) In this section of the text, several theories of foreign direct investments are discussed. These theories
attempt to explain the observed pattern of foreign direct investment flows.
Why Foreign Direct Investment
B) Why do so many firms apparently prefer FDI to either exporting (producing goods at home and then
shipping them to the receiving country for sale) or licensing (granting a foreign entity the right to produce and
sell the firm’s product in return for a royalty fee on every unit that the foreign entity sells)? The answer lies in
the limitations of these methods for exploiting foreign market opportunities producing goods at home and then
shipping them to the receiving country for sale. Granting a foreign entity the right to produce and sell the firm’s
product in return for a royalty fee on every unit that the foreign entity sells.
Limitations of Exporting
C) The viability of an exporting strategy is often constrained by transportation costs and trade barriers. Much
foreign direct investment is undertaken as a response to actual or threatened trade barriers such as import tariffs
or quotas.
Limitations of Licensing
D) There is a branch of economic theory known as internalization theory that seeks to explain why firms often
prefer foreign direct investment to licensing as a strategy for entering foreign markets. According to
internationalization theory, licensing has three major drawbacks as a strategy for exploiting foreign market
opportunities.
(1) First, licensing may result in a firm’s giving away valuable technological know-how to a potential
foreign competitor.
(2) Second, licensing does not give a firm the tight control over manufacturing, marketing, and strategy
in a foreign country that may be required to maximize its profitability.
(3) Third, a problem arises with licensing when the firm’s competitive advantage is based not so much
on its products as on the management, marketing, and manufacturing capabilities that produce those
products. Such capabilities are often not amenable to licensing.
E) So, when one or more of the following conditions holds, markets fail as a mechanism for selling know-how
and FDI is more profitable than licensing. (i) when the firm has valuable know-how that cannot be adequately
protected by a licensing contract, (ii) when the firm needs tight control over a foreign entity to maximize its
market share and earnings in that country, and (iii) when a firm’s skills and know-how are not amenable to
licensing.
Advantages of Foreign Direct Investment
F) It follows from the above discussion that a firm will favor FDI over exporting as an entry strategy when
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transportation costs or trade barriers make exporting unattractive. Furthermore, the firm will favor FDI over
licensing when it wishes to maintain control over its technological know-how, or over its operations and
business strategy, or when the firm’s capabilities are simply not amenable to licensing.
Teaching Tip: An article entitled "Constructing a Market Economy: A Guide to Countries in Transition" by
Raymond Vernon (the author of the Product Life Cycle theory), discusses, among other things, the role of
foreign direct investment in building a strong economy. The site is available at
{http://www.cipe.org/publications/fs/ert/e20/ver_E20.htm}.
The Pattern of Foreign Direct Investment
G) Observation suggests that firms in the same industry often undertake foreign direct investment around the
same time and tend to direct their investment activities towards certain locations.
Strategic Behavior
H) One theory used to explain foreign direct investment patterns is based on the idea that FDI flows are a
reflection of strategic rivalry between firms in the global marketplace. Knickerbocker looked at the relationship
between FDI and rivalry in oligopolistic industries (industries composed of a limited number of large firms). A
critical competitive feature of such industries is the interdependence of the major players: what one firm does
can have an immediate impact on the major competitors forcing a response in kind.
I) Knickerbocker’s theory can be extended to embrace the concept of multipoint competition (when two or
more enterprises encounter each other in different regional markets, national markets, or industries.)
The Product Life Cycle
J) Vernon’s view is that firms undertake FDI at particular stages in the life cycle of a product they have
pioneered. They invest in other advanced countries when local demand in those countries grows large enough to
support local production. They subsequently shift production to developing countries when product
standardization and market saturation give rise to price competition and cost pressures. Investment in
developing countries, where labor costs are lower, is seen as the best way to reduce costs.
K) What Vernon’s theory fails to explain, however, is why it is profitable for a firm to undertake FDI at such
times, rather than continuing to export from its home base, and rather than licensing a foreign firm to produce
its product.
The Eclectic Paradigm
L) The eclectic paradigm has been championed by the British economist John Dunning. Dunning argues that in
addition to the various factors discussed above, location-specific advantages (that arise from using resource
endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own
unique assets) and externalities (knowledge spillovers that occur when companies in the same industry locate
in the same area) are also of considerable importance in explaining both the rationale for and the direction of
foreign direct investment.
POLITICAL IDEOLOGY AND FOREIGN DIRECT INVESTMENT
A) Historically, ideology toward FDI has ranged from a radical stance that is hostile to all FDI to the non84
interventionist principle of free market economies. Between these two extremes is an approach that might be
called pragmatic nationalism.
The Radical View
B) The radical view tracts its roots to Marxist political and economic theory. Radical writers argue that the
multinational enterprise is an instrument of imperialist domination. They see MNEs as a tool for exploiting host
countries to the exclusive benefit of their capitalist-imperialist home countries. By the end of the 1980’s,
however, the radical position was in retreat almost everywhere. There seem to be three reasons for this. First,
the collapse of communism in Eastern Europe. Second, the generally abysmal economic performance of those
countries that embraced the radical position, and a growing belief by many of these countries that, contrary to
the radical position, FDI can be an important source of technology and jobs and can stimulate economic growth.
And third, the strong economic performance of developing countries that embraced capitalism rather than
ideology.
The Free Market View
C) The free market view argues that international production should be distributed among countries according
to the theory of comparative advantage. The free market view has been embraced by a number of advanced and
developing nations, including the United States, Britain, Chile, and Hong Kong.
Pragmatic Nationalism
D) The pragmatic nationalist view is that FDI has both benefits, such as inflows of capital, technology, skills
and jobs, and costs, such as repatriation of profits to the home country and a negative balance of payments
effect.
E) Recognizing this, countries adopting a pragmatic stance pursue policies designed to maximize the national
benefits and minimize the national costs. According to this view, FDI should be allowed only if the benefits
outweigh the costs.
Shifting Ideology
F) In recent years the center of gravity on the ideological spectrum has shifted strongly toward the free market
stance.
COSTS AND BENEFITS OF FDI TO THE NATION STATE
Host Country Effects: Benefits
A) There are three main benefits of inward FDI for a host country: the resource transfer effect, the employment
effect and the balance of payments effect.
Resource-Transfer Effects
B) FDI can make a positive contribution to a host economy by supplying capital, technology, and management
resources that would otherwise not be available.
Employment Effects
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C) The beneficial employment effect claimed for FDI is that FDI brings jobs to a host country that would
otherwise not be created there.
Balance-of-Payments Effect
D) The effect of FDI on a country’s balance-of-payments accounts is an important policy issue for most host
governments. A country’s balance-of-payments account is a record of a country’s payments to and receipts
from other countries. The current account is a record of a country’s export and import of goods and services.
E) Governments typically prefer to see a current account surplus than a deficit. There are two ways in which
FDI can help a country to achieve this goal. First, if the FDI is a substitute for imports of goods and services,
the effect can be to improve the current account of the host country’s balance of payments. A second potential
benefit arises when the MNE uses a foreign subsidiary to export goods and services to other countries.
Host Country Effects: Costs
F) Three main costs of inward FDI concern host countries; the possible adverse effects of FDI on competition
within the host nation, adverse effects on the balance of payments, and the perceived loss of national
sovereignty and autonomy.
Adverse Effects on Competition
G) Host governments sometimes worry that the subsidiaries of foreign MNEs operating in their country may
have greater economic power than indigenous competitors because they may be part of a larger international
organization.
Adverse Effects on the Balance of Payments
H) The possible adverse effects of FDI on a host country’s balance-of-payments position are twofold. First, set
against the initial capital inflows that come with FDI must be the subsequent outflow of capital as the foreign
subsidiary repatriates earnings to its parent country. A second concern arises when a foreign subsidiary imports
a substantial number of its inputs from abroad, which results in a debit on the current account of the host
country’s balance of payments.
National Sovereignty and Autonomy
I) Many host governments worry that FDI is accompanied by some loss of economic independence. The
concern is that key decisions that can affect the host country’s economy will be made by a foreign parent that
has no real commitment to the host country, and over which the host country’s government has no real control.
Home Country Effects: Benefits
J) The benefits of FDI to the home country arise from three sources. First, the capital account of the home
country’s balance of payments benefits from the inward flow of foreign earnings. Second, benefits to the home
country from outward FDI arise from employment effects. Third, benefits arise when the home country MNE
learns valuable skills from its exposure to foreign markets that can subsequently be transferred back to the home
country.
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Home Country Effects: Costs
K) The most important concerns center around the balance-of-payments and employment effects of outward
FDI. With regard to employment effects, the most serious concerns arise when FDI is seen as a substitute for
domestic production.
International Trade Theory and Foreign Direct Investment
L) When assessing the costs and benefits of FDI to the home country, keep in mind the lessons of international
trade (Chapter 4). International trade theory tells us that home country concerns about the negative economic
effects of “offshore production” may be misplaced.
GOVERNMENT POLICY INSTRUMENTS AND FDI
A) We have now reviewed the costs and benefits of the FDI from the perspective of both home country and host
country. Before tackling the important issue of bargaining between the MNE and the host government, we need
to discuss the policy instruments that governments use to regulate FDI activity by MNE’s. Both home countries
and host countries have a range of policy instruments that they can use to regulate FDI activity by MNE’s. We
will look at each in turn.
Home Country Policies
B) By their choice of policies, home countries can both encourage and restrict FDI by local firms.
Encouraging Outward FDI
C) Many investor nations now have government-backed insurance programs to cover major types of foreign
investment risk.
Restricting Outward FDI
D) Virtually all investor countries, including the United States, have exercised some control over outward FDI
from time to time.
Host Country Policies
E) Host countries adopt policies designed both to restrict and to encourage inward FDI.
Encouraging Inward FDI
F) It is increasingly common for governments to offer incentives to foreign firms to invest in their countries.
G) Incentives are motivated by a desire to gain from the resource-transfer and employment effects of FDI. They
are also motivated by a desire to capture FDI away from other potential host countries.
Restricting Inward FDI
H) Host governments use a wide range of controls to restrict FDI. The two most common, however, are
ownership restraints and performance requirements.
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I) The rationale underlying ownership restraints seems to be twofold. First, foreign firms are often excluded
from certain sectors on the grounds of national security or competition. Second, ownership restraints seem to be
based on a belief that local owners can help to maximize the resource transfer and employment benefits of FDI
for the host country.
International Institutions and the Liberalization of FDI
J) Until recently there has been no consistent involvement by multinational institutions in the governing of FDI.
With the formation of the World Trade Organization in 1995, this is now changing rapidly.
IMPLICATIONS FOR BUSINESS
The Theory of FDI
A) The implications of the theories of FDI for business practice are straightforward. First, the location-specific
advantages argument associated with John Dunning helps explain the direction of FDI. However, the locationspecific advantages argument does not explain why firms prefer FDI to licensing or to exporting. In this regard,
from both an explanatory and a business perspective, perhaps the most useful theories are those that focus on
the limitations of exporting and licensing.
Government Policy
B) A host government’s attitude toward FDI should be an important variable in decisions about where to locate
foreign production facilities and where to make a foreign direct investment.
Teaching Tip: A site entitled Business Monitor has a section that provides information about the regulations
involving foreign direct investment in almost every country in the world (you have to look for the information
in each country’s profile). The site can be accessed at
{http://www.businessmonitor.co.uk/trading_blocks.shtml}.
Critical Thinking and Discussion Questions
1. In the 1990s, Japanese FDI in the United States grew far more rapidly than US FDI in Japan. Why do you
think this is the case? What are the implications of this trend?
Answer: There are two primary explanations for the inequity in the growth of FDI between the US and Japan.
Firstly, there has been a significant decrease in the US dollar relative to the Japanese Yen. This makes
investment in the US more attractive to Japanese investors, and Japanese investments less attractive to US
investors. Secondly, the nature of business in Japan, where long-term business relationships are important and
investments can take a significant period of time to pay off, makes Japan a less attractive place to invest than
the more open US economy. To the extent that the trend is simply a result of exchange rate changes, the trend
will follow changes in exchange rates, and could reverse if the exchange rate change reverses direction. The
implication of this is simply that the value of international investing between the US and Japan will be
determined by the relative value of the currencies. To the extent that the trend is a result of structural
differences in the economies of the US and Japan, it suggests that there will continue to be a disparity in the
flows of FDI between the US and Japan. Hence Japanese companies will find it easier to compete in the US
market against US competitors than US companies will be able to compete in Japan against Japanese
competitors.
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2. Compare these explanations of FDI: internalization theory, Vernon’s product life cycle theory, and
Knickerbocker’s theory of FDI. Which theory do you think offers the best explanation of the historical pattern
of FDI? Why?
Answer: Internalization theory seeks to explain why firms often prefer foreign direct investment to licensing as
a strategy for entering foreign markets. According to internationalization theory, licensing has three major
drawbacks as a strategy for exploiting foreign market opportunities: licensing may result in a firm giving away
proprietary technology, licensing does not permit a firm to maintain tight control over its activities, and
licensing is not appropriate when a firm’s competitive advantage is based not so much on its products as on the
management, marketing, and manufacturing capabilities that produce those products.
Vernon’s product life cycle theory argues that firms undertake FDI at particular stages in the life cycle of a
product they have pioneered. They invest in other advanced countries when local demand in those countries
grows large enough to support local production. They subsequently shift production to developing countries
when product standardization and market saturation give rise to price competition and cost pressures.
Investment in developing countries, where labor costs are lower, is seen as the best way to reduce costs.
Finally, Knickerbocker’s theory of FDI suggests that firms follow their domestic competitors overseas. This
theory had been developed with regard to oligopolistic industries. Imitative behavior can take many forms in an
oligopoly, including FDI. .
The second part of this question is designed to stimulate classroom discussion and/or force students to think
through these theories and select the one that they feel provides the best explanation for the historic pattern of
FDI.
3. Read the opening case on Starbucks. Using the market imperfections approach to FDI, explain Starbucks’
approach to expanding its presence in Thailand, Great Britain, and Japan.
Answer: When Starbucks initially decided to license its format in Japan, the company realized that a pure
licensing agreement would not give the company the control it needed to ensure that the Japanese licensees
would closely follow Starbucks formula. Consequently, the company established a joint venture with a local
retailer, and also transferred some employees to Japan. In Thailand, after initially establishing a presence via a
licensing agreement, the company acquired the licensee to gain additional control. Control was also an issue in
Britain where Starbucks acquired Seattle Coffee.
4. You are the international manager of a US business that has just invented a revolutionary new personal
computer that can perform the same functions as IBM and Apple computers and their clones, but costs only half
as much to manufacture. Your CEO has asked you to decide how to expand into the Western European market.
Your options are (i) export from the US, (ii) license a European firm to manufacture and market the computer in
Europe, and (iii) set up a wholly owned subsidiary in Europe. Evaluate the pros and cons of each alternative
and suggest a course of action to your CEO.
Answer: In considering expansion into Western Europe, three options will be considered: FDI, licensing, and
export. With export, assuming there are no trade barriers, the key considerations would likely be transport costs
and localization. While transport costs may be quite low for a relatively light and high value product like a
computer, localization can present some difficulties. Power requirements, keyboards, and preferences in model
all vary from country to country. It may be difficult to fully address these localization issues from the US, but
not entirely infeasible. Since there are many computer manufacturers and distributors in Europe, there are
likely to be a number of potential licensees. But by signing up licensees, valuable technological information
may have to be disclosed, and the competitive advantage lost if the licensees use or disseminate this
information. FDI (setting up a wholly owned subsidiary) is clearly the most costly and time consuming
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approach, but the one that best guarantees that critical knowledge will not be disseminated and that localization
can be done effectively. Given the fast pace of change in the personal computer industry, it is difficult to say
how long this revolutionary new computer will retain its competitive advantage. If the firm can protect its
advantage for a period of time, FDI may pay off and help assure that no technological know-how is lost. If,
however, other firms can copy or develop even superior products relatively easily, than licensing, while
speeding up knowledge dissemination, may also allow the firm to get the quickest large scale entry into Europe
and make as much as it can before the advantage is lost.
5. Explain how political ideology of a host government might influence the process of negotiating access
between the host government and a foreign MNE.
Answer: If a host country subscribes to pure free market principles, then there is little to negotiate about. It may
be possible, however, to negotiate with different regions of the country to obtain more favorable tax treatment
or access to local resources. If a host country subscribes to pure radical views, there is also little to negotiate
about since the government will likely prohibit any FDI. As a general rule, as the overall ideology of a country
moves from the left (radical) to the right (free market), the foreign MNE will need to spend less time
negotiating matters relating to access and control and more time on matters relating to incentives and most
favorable locations.
5. “Firms should not be investing abroad when there is a need for investment to create jobs at home!” Discuss.
Answer: This question is designed to stimulate classroom discussion or force your students to “think” about this
provocative issue. While there may be a need for investment and job creation at home, investors need to have
the capability to adequately manage their investments. Hence some local firm may be much more able to
exploit their technological advantages and invest internationally than they would be able benefit from domestic
investment. If firm's primary goal is to maximize their shareholder's value, then they and probably the economy
are better off if they invest where they can earn the best return. If firms from other countries have capabilities
for which local workers and assets are most appropriate, then it is better that they make the investments locally
and use these resources to their best use rather than having local firms use these resource sub-optimally.
Internet Exercises
TEXT EXERCISE 1
Overview
Germany is ready and open for business. The country is making a concerted effort to publicize its advantages
as a destination for foreign investment. Indeed, the country has established the German Centers of Excellence
to entice companies into the German market. The Centers of Excellence have established a website as a
resource for companies seeking to learn more about the German market.
Suggested Use in the Classroom
Students are asked to consider the role of the Internet in the global marketplace, and in particular, the
globalization of production. Many students will recognize how the Internet can be a tremendous
resource for companies seeking information on foreign markets and competitors. Indeed, many
students may advocate the notion of a country actively working to attract new investment via the
Internet. Knowledge is power, and certainly the fact that companies and governments have more
information about each other has changed the rules of the game.
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TEXT EXERCISE 2
Overview
Disney may be expanding its reach once again, this time by opening a theme park in Shanghai. However, the
news came as a surprise to government officials in Hong Kong who had only just committed substantial
resources to bring a theme park to Honk Kong, an investment that depended on visitors from Mainland China.
Now Hong Kong is crying foul. Disney isn’t talking.
Suggested Use in the Classroom
Students are asked whether governments should be involved in sponsoring and attracting foreign investment by
providing monetary incentives to corporations. This topic provides a good forum for debate. Many students
will probably argue that foreign companies bring many benefits to a host country including capital, jobs, and
technology, and that therefore it is in the best interests of the country for the government to attract investments
like the Disney one outlined in this case. Others however, may suggest the money could be better spent on a
country’s own firms—that by giving it to foreigners, local companies are actually hurt, and a country’s overall
national competitiveness is negatively affected.
CLOSING CASE: Electrolux
Summary
The closing case describes the steps taken by Electrolux to expand its presence in Eastern Europe, Latin
America, and Asia. Due to the slow growth in its traditional markets, and the fact that these markets had been
largely penetrated so that most sales were for replacement purposes, management knew that growth would have
to come from countries where there was still a large portion of the population that did not have household
appliances. Electrolux undertook a variety of approaches when investing in the new markets. A discussion of
the case can revolve around the following questions:
QUESTION 1: What were the primary motivating factors behind Electrolux’s decision to expand aggressively
into Asia, Eastern Europe, Latin America in the 1990s?
ANSWER 1: While Electrolux was already an international company, its primary markets were Europe and
North America. In these countries the market was fully penetrated, limiting sales to replacement goods and
population growth. Electrolux estimated this to be about 2-3%. In comparison, growth rates in Eastern Europe,
Latin America, and Asia were estimated to be around 20%. In addition this much higher growth rate,
Electrolux’s main global competitors were also targeting these markets. Thus unless it wished to be left behind,
the company needed to expand into these higher growth markets.
QUESTION 2: Why do you think Electrolux acquired Lehel in Hungary, but opted for green-field investments
to enter many other Eastern European countries?
ANSWER 2: Whereas it may seem that Electrolux did not have a single global strategy for expansion,
Electrolux realized that different locations required different types of investments. Where it could purchase
viable local firms, this was its preferred strategy. Yet in many countries the local firms may not have fit with
Electrolux’s needs, or asked too high a price. Thus it entered into joint ventures, green-field investments, and
other forms of foreign direct investment depending upon the needs in the market and the opportunities it
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foresaw. Any single approach would have failed to take into consideration the country differences identified in
Chapters 2 and 3.
QUESTION 3: The company generally preferred FDI to exports as a mode of entry into foreign markets. Why
do you think this is the case?
ANSWER 3: Once the company had committed itself to expansion, it had to decide how to achieve its goals.
Cost considerations and import barriers made direct exporting from its Western European and North American
plants uneconomical. Instead, the company turned to FDI.
QUESTION 4: What theory, or theories, best explains Electrolux’s FDI decisions during the 1990s: (a) the
market imperfections approach, (b) the strategic behavior approach, (c) the product-life cycle approach, or (d)
the location-specific advantages approach?
ANSWER 4: This question provides an excellent opportunity for students to test their knowledge of the four
theories by explaining not only which theories best explain the company’s decisions (most students will
probably focus on the market imperfections approach and the strategic behavior approach), but also why the
other theories do not adequately describe Electrolux’s actions.
Country Focus: Foreign Direct Investment in China
Summary
This feature explores investment opportunities in China. In the late 1970s, China opened its doors to foreign
investors. By 1997, the country was the recipient of some $45.2 billion dollars in foreign direct investment.
China’s large population is a magnet for many companies and because high tariffs make it difficult to export to
the Chinese market, firms frequently turn to foreign direct investment. However, many companies have found it
difficult to conduct business in China, and in recent years investment rates have slowed. In response, the
Chinese government, hoping to continue to attract foreign companies has established a number of incentives for
would-be investors.
1. How do China’s political preferences affect its ability to attract foreign direct investment?
2. Much of China’s growth in foreign direct investment has come from neighboring countries. Discuss this
trend, why it has occurred, and its implications.
Management Focus: Cemex’s Foreign Acquisitions
Summary
This feature examines Cemex’s rise to global status. Cemex is the world’s third largest cement company and
Mexico’s largest multinational company. Cemex’s success story is largely the result of acquisitions. If the
company had relied on green-field investments, it could not have become so large so fast.
1. Why does Cemex’s expansion strategy depend so heavily on acquisitions?
2. Why does Cemex have a preference for FDI over licensing arrangements?
3. Cemex’s homepage: {http://www.cemex.com}
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Country Focus: Foreign Direct Investment in Venezuela’s Petroleum Industry
Summary
This feature focuses on Venezuela’s plan to significantly upgrade its domestic petroleum industry. The plan
assigns a key role to foreign investment in Venezuela’s oil industry for the first time since the country
nationalized all private oil companies in 1976. The feature focuses on Venezuela’s reasons for wanting foreign
companies to be involved in its initiative. First, the initiative will be very expensive, and Venezuela needs
outside capital. However, in addition, the country lacks the technological resources and skills of many of the
world’s major oil companies. By letting foreign companies participate in its initiative to upgrade its own oil
industry, Venezuela hopes to learn new technologies and oil refining techniques to use in the future.
Suggested Discussion Questions
1. Discuss how this feature illustrates the valuable role that foreign direct investment plays in the global trade
picture?
2. Many protectionist minded people object to foreign direct investment, arguing that a company should provide
jobs for its own citizens and not invest abroad. Similarly, people also argue that a government should keep
foreign companies “out” in the interest of protecting local jobs. However, after reading this case, one could
argue that foreign direct investment in Venezuela’s oil initiative could be a “win-win” proposition for all the
parties involved. Justify this argument.
Additional Readings and Sources of Information
A China in the Image of America:
{http://www.businessweek.com/bwdaily/dnflash/nov2002/nf20021115_7796.htm}
When Everything is Made in China: {http://www.businessweek.com/magazine/content/02_24/b3787031.htm}
Why do Human Rights Matter to Business: {http://web.amnesty.org/web/web.nsf/pages/ec_why}
The Java Joint that’s Swallowing France:
{http://www.businessweek.com/bwdaily/dnflash/sep2002/nf20020911_8577.htm}
Planet Starbucks: {http://www.businessweek.com}
Electrolux Sweeps into America:
{http://www.businessweek.com/bwdaily/dnflash/sep2002/nf20020923_3412.htm}
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