Download International Business

International Business
by
Daniels and Radebaugh
Chapter 8
Foreign Direct
Investment
© 2001 Prentice Hall
8-1
Objectives
To explain why investors and governments view direct investments
differently than portfolio investments
To demonstrate how companies acquire foreign direct investments
To evaluate the relationship between foreign trade and international
factor mobility, especially direct investment
To classify companies’ advantages from foreign direct investments
To show the major global patterns of foreign direct investment
© 2001 Prentice Hall
8-2
Meaning of Foreign Direct Investment (FDI)
Concept of control
• Control must accompany the investment
• 100 percent share does not guarantee control
– government intervenes in company operations
• Direct investment usually implies an ownership share of 10 to 25
percent
Concern about control
• Government concern—when foreign investors control a
company, decisions of national importance may be made
abroad
• Investor concern—transfer of resources to acquiring company
– appropriability theory—company receiving resources may
undermine the competitive position of the company
transferring them
– Internalization—control by self-handling of operations
© 2001 Prentice Hall
8-3
The Place of FDI in International Business
EXTERNAL INFLUENCES
PHYSICAL AND
SOCIETAL FACTORS
OPERATIONS
OBJECTIVES
STRATEGY
COMPETITIVE
ENVIRONMENT
MEANS
• Trade
• FDI
• Other equity and
nonequity
arrangements
© 2001 Prentice Hall
8-4
Methods of Acquisition
Companies may:
• Use their resources for FDI
• Acquire existing companies abroad
• Build a new company abroad
Resources for Acquisition
FDI usually is an international capital movement
Investor may transfer other assets to effect an FDI
• Company may use funds it earns in a foreign country to establish
an investment
• Can trade equity with companies in other countries
© 2001 Prentice Hall
8-5
Buy-versus-Build Decision
Reasons for buying
• Does not add further capacity to the market
• Avoiding start-up problems
• Easier financing
Reasons for building
• No desired company is available for acquisition
• Acquisition will carry over problems
• Acquisition is harder to finance
© 2001 Prentice Hall
8-6
Relationship of Trade and Factor Mobility
FDI requires the movement of various production factors
Trade theories and factor mobility
• Factor movement is an alternative to trade
– may or may not result in more efficient allocation of
resources
• FDI a major cause and means of factor movement
Substitution— inability to use foreign production factors may stimulate
efficient methods of substitution
• When factor proportions vary across countries, pressures arise
for the most abundant factors to move to an area of scarcity
• Restrictions make factor movements only partially mobile
internationally
– lowest costs occur when trade and production factors are
both mobile
© 2001 Prentice Hall
8-7
Relationship of Trade and Factor Mobility (cont.)
Complementarity of trade and FDI
• Many exports would not occur if overseas investments did not
exist
– factor mobility via FDI often stimulates trade because of the
need for:
» components
» complementary products
» equipment for subsidiaries
Relationship of FDI to companies’ objectives
• FDI may be more risky than some other forms of IB
• Businesses and governments are motivated to engage in FDI in
order to:
– expand sales
– acquire resources
– minimize competitive risk
• Governments may use FDI for political objectives
© 2001 Prentice Hall
8-8
Motivation for FDI as an Alternative or
Supplement to Trade
SALES EXPANSION
OBJECTIVES
RESOURCE ACQUISITION
OBJECTIVES
RISK MINIMIZATION
OBJECTIVES
POLITICAL
OBJECTIVES
Overcome high transport
costs
Savings through vertical
integration
Domestic capacity
Savings through rationalized
production
Diversification of
customer base (same
motivation as for sales
expansion)
Influence companies,
usually through factors
under resource
acquisition objectives
Gains from scale economies
Trade restrictions
Gain access to cheaper or
different resources and
knowledge
Barriers because of countryof-origin effects (nationalism, Need to lower costs as product
product image, delivery risk) matures
Lower productions costs
abroad
Gain governmental
investment incentives
© 2001 Prentice Hall
Diversification of supplier
base (same motivation as
for resource acquistion
objectives
Following customers
Preventing competitors’
advantage
8-9
FDI Motivations to Achieve Sales Expansion
Transportation—may raise costs so much that it becomes impractical to
export some products
• Horizontal expansion—companies move abroad to produce the
same products they make at home
• Plant capacity
– excess capacity may permit exporting despite high transport
costs
– excess capacity may permit variable cost pricing
• Scale economies
– in large-scale process technology, companies’ exports
reduce costs by spreading fixed costs over more units of
output
– in small-scale process technology, companies’ country-bycountry production reduces costs by minimizing
transportation expenses
© 2001 Prentice Hall
8-10
FDI Motivations to Achieve Sales Expansion (cont.)
Trade restrictions
• Companies must produce in foreign country if they are to sell
there
– companies more likely to produce locally if market potential is
high relative to scale economies
• Trade restrictions favor big companies that can afford to commit
substantial resources abroad
Country-of-origin effects
• Consumers may prefer domestically produced goods because of
nationalism
– product image—belief that products are better
– delivery risk—hard to obtain service and replacement parts
from foreign suppliers
» affected by distance, possibility of strikes
© 2001 Prentice Hall
8-11
FDI Motivations to Achieve Sales Expansion (cont.)
Changes in comparative costs—exporters likely to have home-country
cost advantage
• Least-cost production location changes because of inflation,
regulations, transportation costs, and productivity
FDI Motivations to Acquire Resources
Vertical integration— company’s control of the different stages in making
its product
• Companies may combine resources located in different countries
– most vertical integration is supply-oriented
» designed to obtain raw materials in other countries
• Companies may gain certain economies through vertical
integration
© 2001 Prentice Hall
8-12
FDI Motivations to Acquire Resources (cont.)
Rationalized production—companies produce different components or
portions of their products in different countries
• Takes advantage of low labor costs, capital, raw materials, and
long production runs
• Companies own foreign production facilities to ensure a smooth
production flow
Access to production resources—company goes abroad to gain some
capability (e.g., knowledge) for entire organization rather than for a
specific product
Product life cycle theory— production often moves from one country to
another as a product moves through its life cycle
Governmental investment incentives—encourage FDI by offering tax
concessions or other subsidies
• Affect the comparative cost of production
– shift the least-cost production location
© 2001 Prentice Hall
8-13
Risk Minimization Objectives
Following customers—company can keep customers by following them
abroad
• Indirect exports—domestic good is embodied in a product that the
domestic customer exports
– indirect exporters commonly follow their customers when
they make direct investments
Preventing competitors’ advantage—company’s decision to invest
depends not so much on the benefits it gains but rather on what it
could lose by not entering the field
Oligopolistic industries—investors often establish facilities in a given
country at about the same time
• Companies experience capacity-expansion cycles concurrently
• Face changes in import restrictions or market conditions that
make FDI advisable
© 2001 Prentice Hall
8-14
Risk Minimization Objectives (cont.)
Political motives
• Governments give incentives to their companies to make direct
investments in order to
– gain supplies of strategic resources
– develop spheres of influence
© 2001 Prentice Hall
8-15
Advantages of FDI
Monopoly advantages before direct investment
• Companies invest directly only if they think they hold some
supremacy over similar companies in countries of interest
– monopoly advantage—results from a foreign company’s
ownership of some resource unavailable at the same price or
terms to the local market
– companies enjoy monopoly advantage if
» they can borrow capital at a lower interest rate than
companies from another country
» their home-country’s currency has high buying power
Advantages after direct investment
• Selling internationally is efficient
• Spreads the costs of operations
© 2001 Prentice Hall
8-16
Direct Investment Patterns
Location of ownership
• For worldwide FDI
– almost all ownership is by companies from developed
countries
– emerging economy ownership is increasing
Location of investment
• Most FDI occurs in developed countries because they have the
– biggest markets
– lowest perceived risk
– least discrimination toward foreign companies
Economic sector of investment
• FDI in raw materials has declined
• FDI in manufacturing has stabilized
• FDI in service sector and technology-intensive manufacturing has
grown rapidly
© 2001 Prentice Hall
8-17
World’s Top 10 Foreign Direct investors, Ranked by Foreign
Assets, 1997 (Assets and Sales in Billions of U.S. Dollars)
CORPORATION
General Electric
COUNTRY
United States
INDUSTRY
Electronics
FOREIGN
ASSETS
97.4
FOREIGN
SALES
24.5
FOREIGN
EMPLOYEES
111,000
2
Ford Motor
Company
United States
Automotive
72.5
48.0
174,105
3
Shell, Royal
Dutch
Netherlands/
United Kingdom
Petroleum
70.0
69.0
65,000
4
General Motors
United States
Automotive
---
51.0
---
5
Exxon
Corporation
United States
Petroleum
54.6
104.8
---
6
Toyota
Japan
Automotive
41.8
50.4
---
7
IBM
United States
Computers
39.9
48.9
134,815
8
Volkswagen
Group
Germany
Automotive
---
42.7
133,906
9
Nestlé SA
Switzerland
Food and
beverages
31.6
47.6
219,442
10
Daimler-Benz
Germany
Automotive
---
50.4
---
RANK
1
© 2001 Prentice Hall
8-18
FDI Inflows in Major World Regions, 1998
18
166
460
Central and Eastern Europe
Developed Countries
© 2001 Prentice Hall
Emerging Economies
8-19
FDI Inflows in Major World Regions, 1998
52
1.9
595
Central and Eastern Europe
Developed Countries
© 2001 Prentice Hall
Emerging Economies
8-20