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International Business
7.10.2014
Class 4
FDI
ENTRY STRATEGIES
Course materials could be
found at
• http://pub.econom.nsu.ru/econom/
• Юсупова А.Т.
• International business
Previous class question
• Free trade….
A.Refers to a situation in which a government does
not attempt to restrict what its citizens can buy
from or sell to another country.
B.Reduces the overall efficiency of the world
economy.
C.Describes the range of policy instruments that
governments use to intervene in international
trade.
D.Is a government payment to a domestic
producer.
Previous class question
Which of the following is not one of the
main instruments of trade policy?
A.Tariffs
B.Credit portfolios
C.Local content requirements
D.Administrative policies
Previous class question
Specific tariffs are:
A.Levied as a proportion of the value of the
imported good.
B.Levied as a fixed charge for each unit of a
good imported.
C.In the form of manufacturing or production
requirements of goods.
D.Government payment to domestic
producers.
Previous class question
Identify the incorrect statement pertaining to
trade barriers:
A.They raise the costs of exporting products to a
country.
B.They may put a firm at a competitive advantage
to indigenous competitors
C.They may limit a firm’s ability to serve a country
from locations outside of that country.
D.To conform to local content regulations, a firm
may have to locate more production activities in
a given market than it would otherwise.
Previous class question
___________ suggests that a government
should use subsidies to support
promising firms that are active in newly
emerging industries.
A.The infant industry argument
B.Strategic trade policy
C.Retaliation policy
D.The national security argument
Tariffs
Subsidies
Instruments of
Trade Policy
Import Quotas &
Voluntary Export
Restraints
Local Content
Requirements
Administrative
Policies
Foreign
Direct
Investment
FDI
FDI
• Direct investment in real or physical assets such
as factories and facilities in a foreign country
• Direction - production, R&D,marketing, sales
• Occurs when a firm invests directly in facilities to
produce or market a product in a foreign
country” and requires “an interest of 10 percent
or more in a foreign business entity (active
participation in management)
• Recent years (30 years) – significant increase,
rates higher that those for output and sales;
FDI
• 10% - defined by US Trade Department
• Firm with FDI – multinational enterprise .
• Portfolio investments in foreign countries –
less than 10%;
Forms of FDI
• Greenfield Investment: involves the
establishment of a new operation in a
foreign country;
• Acquisitions and Mergers: involve the
acquiring, or merging with, an existing
organisation within a foreign country
Types of FDI
• Horizontal FDI: refers to investment which is in the
same industry as that in which the firm operates in its
home country
• Vertical FDI: refers to investment in an industry which
provides inputs into a firm’s domestic operations.
Alternatively it could involve FDI in an industry which
markets and sells the outputs of the firm’s domestic
operations
• Conglomerate FDI: refers to investment with the focus
of manufacturing products which are not manufactured
by the firm’s domestic operations. Such products are
often unrelated to the parent company’s core business
Indicators of FDI
• Flow of FDI: refers to the amount of FDI
undertaken over a given time period (e.g. a
year) :
– Inflow of FDI: refers to the flow of FDI into a country
(i.e. foreign firms directly investing in the country).
– Outflow of FDI: refers to the flow of FDI out of a
country (i.e. firms undertaking FDI outside of the
country).
• Stock of FDI: refers to the total accumulated
value of foreign owned assets at a given time
Growth of FDI
• The reasons for FDI’s rapid growth, in
comparison to the growth of world trade and
world output:
• FDI is seen as a means of avoiding potential
future trade barriers.
• Political and economic changes, particularly
within developing nations where there has been
a move to a more democratic government and
free market economies has resulted in a growth
of FDI.
• The globalisation of the world economy has
contributed significantly to the growth in FDI
Forms of FDI
• Most FDI takes the form of mergers and acquisitions
rather than greenfield investments
• The reasons are:
• M&A are more quickly executed than greenfield
investments.
• M&A provide for the acquisition of existing strategic
assets, such as brand loyalty and production systems.
• M&A provide an opportunity to increase efficiency of the
acquired firm due to transferring technology, capital and
management skills
General situation with FDI
• Global FDI inflows totaled US$1.3 trillion in
2012, down 18% on 2011.
• 2010 and 2011 - increase,
• Developed economies - 90% decline in global
FDI.
• Developing economies - also loses;
FDI inflows by region (2012 compared
with 2011)
Region
Latin America and the Caribbean
Africa
Asia
European Union
United States
Europe
%
7.2
5.5
- 9.5
- 34.8
- 35.3
- 36.1
FDI in Russia
• FDI to Russia in 2012 US$ 11.090 billion (without off
shore investments)
Number of FDI projects and FDI jobs in
Russia
Year
2007
2008
2009
2010
2011
2012
Number of
projects
139
143
170
201
128
128
Number of
jobs
14934
12900
11834
8058
8362
13356
FDI in Russia by activities 2012
Activity
Number of jobs,
share
Manufacturing
Number of
projects,
share
46.9
Sales and Marketing
Logistics
38.3
4.7
0.5
0
Testing and servicing
R&D
Education and training
4.7
3.1
1.6
0.4
0.9
0
Other…
98.2
FDI in Russia by country of origin, 2012
Country
Number of jobs,
share
US
Number of
projects,
share
22.7
Germany
France
21.9
10.9
33.4
5
Japan
Finland
Italy
7
3.9
3.9
12
4.5
18
Other…..
8
FDI in Russia by region – recipient , 2012
Region
Moscow
St. Petersburg
Nizhniy Novgorod
Kaluga
Other…
Number of
projects,
share
31.3
8.6
7.0
5.5
Number of jobs,
share
0.5
4.5
13.3
16.2
Assignment
• Discuss positive and negative
consequences of FDI (you can choose an
example of any country)
Foreign Direct Investment
Theories
Cluster 1:
Why FDI?
Limitatio
ns of
Exporting
Limitations
of Licensing
Cluster 2:
Patterns of FDI
Strategic
Behaviour
Product Life
Cycle
Cluster 3:
Eclectic
Paradigm
Theory Cluster 1: Why Foreign Direct
Investment
• Limitations of Exporting: The possibility of a firm
exporting its goods to a foreign country is often
constrained due to transportation costs and trade
barriers
• Limitations of Licensing – Internalisation Theory:
Internalisation theory, also known as Market
Imperfections theory, highlights why firms may favour a
FDI strategy rather than a licensing strategy as a means
of entering a foreign market. Internalisation theory
advocates that the available external market fails to
produce an efficient environment in which the firm can
profit by using its technology or production of
resources....therefore the firm tends to produce an
internal market via investment in multiple countries, and
thus creates the needed market to achieve its objective
Circumstances under which FDI would be
more profitable than licensing:
In instances where the firm has valuable
intellectual capital which the licensing contract
would not be able to adequately protect;
In situations where the firm requires tight
control over the foreign licensee (e.g. to
maximise profitability and market share);
 In instances where the firm’s competitive
advantage lies in its skills and intellectual capital,
which could not be licensed
Cluster 2: Patterns of Foreign Direct
Investment
• Strategic Behaviour – Knickerbockers’
Theory: This theory argues that FDI flows
reflect strategic rivalry between firms in the
global marketplace. Knickerbocker conducted
research into oligopolistic industries and found
that a critical competitive feature was their
imitative behaviour.
• Product Life Cycle Theory (Vernon)- a trade
cycle emerges where a product is produced by a
parent firm, then by its foreign subsidiaries and
then anywhere in the world where costs are at
their lowest possible
Cluster 3: Eclectic Paradigm
• Identifies all of the following three factors in
being important determinants of FDI:
• Ownership specific factors (e.g. natural
endowments, capital, intellectual capital,
technology, management and marketing skills)
• Location specific factors (e.g. factor
endowments, market structure, government
legislation, political environment, legal
environment, cultural environment)
• Internalisation specific factors (inherent
capacity and flexibility to produce and market
through its internal subsidiaries)
• Foreign Market Entry Modes
Exporting
Wholly
Owned
Subsidiaries
Turnkey
FOREIGN
MARKET
Projects
ENTRY MODES
Joint
Licensing
Ventures
Franchising
Exporting
• Occurs when a firm maintains its production facilities in its home
country and sells its products.
• A firm can export goods directly to foreign customers or through
export intermediaries
• + Avoids considerable costs of setting up manufacturing
operations in a foreign country
• +May assist a firm to realise experience curve economies as well as
location economies
• - may not be the most profitable option if there are lower cost
locations for manufacturing the goods abroad.
• -may not be economical due to high transportation costs and tariff
barriers.
• -Export intermediaries, contracted by the firm to market and sell their
goods abroad, may have divided loyalties (e.g. through selling a
competitor’s product as well)
Turnkey Projects
• “contractor agrees to handle every detail of the project for a
foreign client, including the training of operation personnel”
• Common in chemical, pharmaceutical, petroleum refining and metal
refining industries
+
• Helps to earn significant economic gains from process technology
skills in foreign markets where FDI is restricted
• Potentially not as risky as conventional FDI.
• Firm entering in turnkey project has no long-term interest in the
foreign country, which is a weakness if the country proves to be a
major market for the product/service.
• The foreign entity may become a competitor.
• Firm’s process technology is a source of competitive advantage
Licensing
•
•
•
•
•
•
•
A licensing agreement is where a firm (licensor) “grants specified intangible
property rights to the local licensee for a specified period of time in
exchange for a royalty fee”. Intangible property includes patents, formulas,
processes, designs, copyrights, trademarks and inventions. These allow the
licensee to manufacture and sell a product similar to the one which the
licensor has been producing in its home country
+
The firm (licensor) does not have to carry the risks and costs associated
with setting up a foreign operation
The firm does not have tight control over manufacturing, marketing and
strategy necessary for achieving experience curve economies and location
economies.
Limits a firm’s ability to implement a coordinated strategy to facilitate entry
into multiple foreign markets.
Firms potentially could lose control of their technological know-how
Franchising
• Franchising involves a foreign franchisor in granting “specified
intangible property rights to the local franchisee, which must abide
by strict and detailed rules as to how it does business”
• Franchising involves longer commitments than licensing and
provides greater control.
• +
• Little political risk and low cost involved.
• Fast and easy avenue for leveraging assets such as a brand name
• • Franchisor’s image may be tarnished due to franchisee not
upholding standards.
• Limits a firm’s ability to implement a coordinated strategy to facilitate
entry into multiple foreign markets
Joint Ventures
• Involves “establishing a firm that is jointly owned by two or more
otherwise independent firms.”
• Joint ventures are usually 50 / 50 arrangements where the two
parties (firms) share ownership and management control.
• +
• Firm benefits from partner’s knowledge of host country’s market.
• When costs and risks of entering a foreign market are high, it is
beneficial to share these costs with a partner firm.
• In certain countries, joint ventures are the only feasible entry mode
• • Risk of giving control of firm’s technology to partner.
• Firm does not have tight control over subsidiaries necessary to
attain experience curve economies and location economies.
• Inability to engage in global strategic coordination.
• Shared ownership arrangement could result in conflicts and battles
for control
Wholly Owned Subsidiaries
• Involves the investing firm in owning 100% of the new entity in the
host country.
• The subsidiary may be an acquired local business in the host
country, or may be a greenfield investment
+
• Maintain control over technological know-how and therefore the
firm’s competitive advantage
• Able to engage in strategic global coordination.
• Able to realise experience curve economies and location economies
• Most costly method of entering into and serving a foreign market.
• High risk involved where firm needs to learn how to do business in a
new culture
Assignment (5 points)
• Choose an example of any company
which operates at foreign markets and
analyze it’s entry mode.
• Presentation during the class
• Could be done in pairs
• General score – 25 points
 5 this assignment
 5 questions at final exam
 10 general analysis at final exam
 5 class participation
Fundamental Entry Decisions
Timing
Which Foreign
Markets?
of
Entry
Scale of Entry
& Strategic
Commitments
Which Foreign Markets?
•
•
•
•
•
Cost / Tax Factors: transportation costs, the wage rate, availability and
cost of land, as well as construction costs. Tax rates Investment incentives
Demand Factors: market size and growth, presence of customers, as well
as local competition
Strategic Factors: investment infrastructure (e.g. transportation,
telecommunications) as well as the manufacturing The presence of
complementary industries and special services such as auditing, banking,
insurance are also important to a foreign operation. Levels of workforce
productivity and the effectiveness of inbound/outbound logistics
Regulatory / Economic Factors potential host country’s industrial policies,
which may control new entrants and the degree of competition.. The
availability of “special economic zones” (e.g. free trade zones),
Socio-Political Factors: the degree of political stability, cultural barriers,
local business practices, government efficiency and corruption, attitudes
towards foreign businesses, community characteristics as well as pollution
control measures
Timing of Entry
The advantages of early entry into a
foreign market - “first-mover advantages” :
• Pre-empting rivals and securing demand
through establishing a strong brand name;
• Building sales volumes prior to rivals and
gaining experience in servicing the
customer over time
• Tying customers into their products and
services
Timing of Entry
The disadvantages of early entry into a
foreign market (“first-mover
disadvantages” ):
• primarily pioneering costs. - costs which a
later entrant would be able to avoid (such
costs include costs associated with
‘learning the rules of the game’ in the
foreign market, educating foreign
consumers about the product, etc.)
Scale of Entry and Strategic Commitments
• large scale, - rapid, involves the commitment of
significant resources - is a considerable strategic
commitment and can impact the nature of competition
within the market, making it easier for the firm to attract
customers and distributors, could also deter other foreign
entities from entering the market.
• potential disadvantage of the strategic commitment of a
large scale entry - it may leave the firm with insufficient
resources to enter into other attractive foreign markets,
thereby limiting the firm’s strategic flexibility
• the small scale entry - less risky as it provides the firm
with an opportunity to learn and adjust to the foreign
market.