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International Business Chapter Fourteen Direct Investment and Collaborative Strategies.

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1 International Business Chapter Fourteen Direct Investment and Collaborative Strategies

2 2 Chapter Objectives To clarify why companies may need to use modes other than exporting to operate effectively in international business To comprehend why and how companies make foreign direct investments To understand the major motives that guide managers when choosing a collaborative arrangement for inter- national business To define the major types of collaborative arrangements To describe what companies should consider when entering into arrangements with other companies To grasp what makes collaborative arrangements succeed or fail To see how companies can manage diverse collaborative arrangements

3 3 Introduction External influences upon a firm’s decision to handle its international operations itself or to collaborate with other companies include: –physical factors –societal factors –the competitive environment Internally, the mode of entry decision is influenced by a firm’s own objectives and strategies. The truly experienced MNE selects modes of entry according to the its capabilities, specific product characteristics, and foreign operating characteristics.

4 4 Alternative Types of Foreign Operations Foreign-owned operations (FDI) may be established either as start-ups (greenfield ventures) or via acquisition. Foreign-owned operations (FDI) may take the form of wholly-owned subsidiaries or joint ventures. Nonequity (collaborative) types of foreign operations include licensing and other contractual forms of business ventures. The resource-based view of the firm holds that each company has a unique combination of competencies and can maximize its performance by concentrating on those activities that best fit its competencies.

5 5 Fig. 14.3: Alternative Operating Modes for Foreign Market Expansion

6 6 Reasons Why Foreign Production May Be Preferable to Exporting Production costs are cheaper abroad than at home. Transportation costs to move products internationally are relatively high. Domestic capacity is insufficient. Products must be substantially altered in order to capture sufficient foreign demand. Governments restrict or prevent the importation of foreign products. Customers prefer products originating from a particular foreign country.

7 7 Foreign Direct Investment: Control Objectives Companies generally want controlling interests in their foreign operations for three reasons: internalization objectives [It’s more profitable to control operations internally (transaction cost theory); it’s strategically preferable to control operations internally.] appropriability objectives [Foreign investment is favored as a way to prevent potential competitors from gaining access to proprietary information (intellectual property and managerial know-how).] globalization objectives [Foreign investment provides the freedom to pursue global or transnational objectives by optimizing corporate strategies.]

8 8 Foreign Direct Investment: Comparative Advantages Acquisitions and start-ups offer largely opposite benefits to a firm. The advantages of an acquisition may include: –existing facilities, an existing labor force, and knowledgeable local management –existing goodwill and brand identification –an immediate cash flow –access to local financing –the avoidance of excess capacity [continued]

9 9 The advantages of a start-up, i.e., a greenfield venture, may include: –the existence of first-mover advantages due to a lack of viable competitors and available acquisitions –the opportunity to establish new (more efficient) facilities, to escape punitive labor contracts, to hire and train fresh labor forces, and to implement compatible managerial styles and practices, i.e., the avoidance of carry-over problems –the existence of government incentives –the availability of development capital –the creation of additional capacity

10 10 Collaborative Arrangements: Basic Motives Collaborative arrangement: a formal, long-term contractual agreement between or amongst firms Each partner in a collaborative arrangement has its own primary objective for operating internationally and its own motive for collaborating. –Scale alliances: provide efficiency through the pooling of similar assets so that partners can carry out business activities in which they already have experience –Link alliances: use complementary resources to expand into new business areas

11 11 Fig. 14.2: Collaborative Arrangements as International Business Operating Modes

12 12 Collaborative Arrangements: General Motives To spread and reduce costs [potential volume is relatively low; excess capacity exists] To specialize in core competencies [licensing may yield returns on products that lie outside of a firm’s strategic priority] To avoid or counter competition [markets are too small to support many competitors; firms combine to challenge a market leader] To secure vertical and horizontal links [savings and supply assurances exist across the value chain; horizontal economies of scope exist in distribution] To gain knowledge [learn about a partner’s technology, operating methods, and/or home markets]

13 13 Collaborative Arrangements: International Motives To gain location-specific assets [desire to overcome cultural, political/legal, competitive, and/or economic barriers] To overcome legal constraints [prohibition of foreign ownership in particular sectors; regulations affecting operations and profitability; effective protection of intellectual property rights] To diversify geographically [greater and faster spread of assets across countries; smoothing of sales and earnings cycles] To minimize exposure in risky environments [secure the safety of foreign assets and earnings; smooth risk across countries]

14 14 Fig. 14.4: Relationship of Strategic Alliances to Companies’ International Objectives

15 15 Collaborative Arrangements: Basic Considerations Dependencia theory: the out-of-vogue idea that emerging economies essentially have no power as host countries when dealing with large MNEs Bargaining school theory: the idea that the negotiated terms of foreign investments depend upon investors’ and host countries’ needs for one another’s assets When a firm is highly diversified and/or its operations are limited, existing foreign facilities and operations may not complement its planned expansion. The more a firm depends upon collaborative arrange- ments, the greater the likelihood that it will lose control over decisions regarding quality, flexibility, revenues, competition, expansion, and information-sharing.

16 16 Collaborative Arrangements: Basic Types Licensing: a licensor grants a licensee rights to intangible property to use in a specified area for a specified period of time in exchange for a fee –Intangible property may be classified as: patents, inventions, formulas, processes, designs, or patterns copyrights for literary, musical, or artistic compositions trademarks, trade names, or brand names franchises, licenses, or contracts methods programs, procedures, or systems Cross-licensing: firms in various countries exchange technology, rather than compete with each other with every product in every market Many licenses are given to firms owned in whole or in part by the licensor as a means of legally transferring technology to a subsidiary. [continued]

17 17 Franchising: a specialized form of licensing in which the franchisor grants an independent franchisee the use of essential intangible property and opera- tionally assists the business on a continuing basis –Franchise success is derived from three factors: product standardization effective cost control high recognition The two partners act like a vertically integrated firm because (i) they are interdependent and (ii) each produces a part of the product that ultimately reaches the customer. A franchisor may deal directly with its foreign franchisees or set up a master franchise with the right to open outlets and/or develop sub-franchises on its own. [continued]

18 18 Management contract: an arrangement in which a contractor provides management personnel to per- form general or specialized functions to a client for a fee On the one hand, host countries and clients get needed assistance without foreign ownership or control of oper- ations; on the other, the management firm is able to generate revenues without making a capital investment. Turnkey operation: an arrangement in which one firm contracts with another to build complete, ready-to- operate facilities Usually, suppliers of turnkey facilities and operations are industrial-equipment manufacturers and construction companies; projects may cost billions of dollars; custo- mers are most often governments or large MNEs. [continued]

19 19 Joint venture: a direct investment in which two or more partners share ownership –Forms of joint ventures include: consortiums, i.e., the joining together of several entities to combine resources and perhaps pursue a major undertaking two firms from the same country joining together in a foreign market firms from two or more countries establishing an operation in a third country a private firm and a local government a private firm joining a government-owned firm in a third country Equity alliance: an arrangement in which at least one of the collaborating partners takes an ownership position (usually a minority) in the other(s) The purpose of an equity alliance is to solidify a collab- oration, thus making it more difficult to break a contract. The more partners in a joint venture or an equity alliance, the more complex the management of the arrangement.

20 20 Fig. 14.5: Control Complexity Related to Collaborative Strategy

21 21 Collaborative Arrangements: Problems Partners view the importance of a collaborative arrangement very differently. Partners have different objectives for a collaborative venture, particularly as a venture evolves over time. Partners disagree on control issues, or provide insufficient direction to a venture. Partners’ abilities to contribute, and their tendencies to appropriate each others’ contributions, change over time. Differences in both national and corporate cultures lead to (i) incompatible operations or (ii) conflicting evaluations of the success of a venture. Although joint ventures from culturally distant countries tend to survive at least as well as those between partners from similar cultures, nearly half of all joint ventures eventually fail.

22 22 Fig. 14.6: Alternative Dissolution of Joint Ventures

23 23 Managing Foreign Arrangements As a collaborative venture evolves, partners need to reassess the following factors in light of (i) their own resource bases and (ii) external environmental changes: the costs and other consequences of evolving to different modes of operation at various locations the proven abilities of potential partners, the resources they offer, and their willingness to work together pre-agreements designed to protect technology and the secrecy of financial terms, i.e., the negotiating process [continued]

24 24 contractual provisions concerning: –the termination of the agreement if parties do not adhere to its directives –methods of testing for quality –the geographical limitations of the venture’s use –which partner will manage which parts of the operation –the future commitments of each partner –the ways in which each partner will buy from, sell to, or use intangible assets that come out of the collaborative venture the stated expectations and actual performance of the venture the need for a change in the type of collaboration Over time, even though a partner is doing what is expected, a firm may determine that a collaborative venture is no longer in its best interest.

25 25 Fig. 14.7: Country Attractiveness— Company Strength Matrix

26 26 Implications/Conclusions Motivations for collaborative arrangements specific to international operations are to gain location-specific assets, to overcome legal constraints, to diversify across countries, and to minimize exposure in risky environments. Although the type of collaborative arrangement a firm chooses should match its strategic objectives, the choice will often mean a trade off amongst objectives. Each partner to a collaborative arrangement has a say in critical decisions, but the global performance of each partner may be improved in different ways.

27 27 The forms of foreign operations differ in terms of how many resources a firm commits and the proportion of resources committed at home rather than abroad. A firm may use more than one mode of operation within the same country, as well as in different countries or for different products. A common motive for jointly owned operations is to take advantage of complementary resources that firms have at their disposal. The dissolution of collaborative ventures can be planned or unplanned, friendly or unfriendly, mutual or non- mutual.

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