1. Foreign Direct Investment Theory and Strategy
Chapter 17
Foreign Direct Investment Theory and Strategy

2. Foreign Direct Investment Theory & Strategy: Learning Objectives
Demonstrate how key competitive advantages support MNEs’ strategy to originate and sustain foreign direct investment
Show how the OLI paradigm provides a theoretical foundation for the globalization process
Identify factors and forces that must be considered in the determination of where MNEs’ invest
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3. Foreign Direct Investment Theory & Strategy: Learning Objectives
Illustrate the managerial and competitive dimensions of the alternative methods for foreign investment
Identify the strategies used by MNEs originating in developing countries to compete in global markets
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4. Market Imperfections: A Rationale for the MNE
MNEs strive to take advantage of imperfections in national markets
These imperfections for products translate into market opportunities such as economies of scale, managerial or technological expertise, financial strength and product differentiation
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5. Sustaining & Transferring Competitive Advantage
In deciding whether to invest abroad, management must first determine whether the firm has a sustainable competitive advantage that enables it to compete effectively in the home market
In order to sustain a competitive advantage it must be:
Firm-specific
Transferable
Powerful enough to compensate the firm for the extra difficulties of operating abroad
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6. Sustaining & Transferring Competitive Advantage
Some of the competitive advantages enjoyed by MNEs are:
Economies of scale and scope
Managerial and marketing expertise
Advanced technology
Financial strength
Differentiated products
Competitiveness of the their home market
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7. Exhibit 17.1 Determinants of National Competitive Advantage: Porter’s Diamond
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8. The OLI Paradigm & Internationalization
The OLI Paradigm (Buckley & Casson, 1976; Dunning 1977) is an attempt to create an overall framework to explain why MNEs choose FDI rather than serve foreign markets through alternative modes such as licensing, joint ventures, strategic alliances, management contracts and exporting
The paradigm states that a firm must first have some competitive advantage in its home market - “O” or owner-specific – which can be transferred abroad
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9. The OLI Paradigm & Internalization
The firm must also be attracted by specific characteristics of the foreign market – “L” or location specific – which will allow the firm to exploit its competitive advantages in that market
Third,the firm will maintain its competitive position by attempting to control the entire value-chain in its industry – “I” or internalization
This leads to FDI rather than licensing or outsourcing
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10. The OLI Paradigm & Internalization
Financial strategies are directly related to the OLI Paradigm in explaining FDI
Strategies can be proactive , controlled in advance by the management team
Strategies can also be reactive, depend on discovering market imperfections
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11. Exhibit Finance-Specific Factors and the OLI Paradigm: “X” indicates a connection between FDI and finance-specific strategies
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12. Where to Invest
Two related behavioral theories behind FDI that are most popular are
Behavioral approach to FDI
International network theory
Behavioral Approach – Observation that firms tended to invest first in countries that were not too far from their country in psychic terms
This included cultural, legal, and institutional environments similar to their own
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13. Where to Invest
International network theory – As MNEs grow they eventually become a network, or nodes that operate either in a centralized hierarchy or a decentralized one
Each subsidiary competes for funds from the parent
It is also a member of an international network based on its industry
The firm becomes a transnational firm, one that is owned by a coalition of investors located in different countries
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14. How to Invest Abroad: Modes of FDI
Exporting vs. production abroad
Advantages of exporting are
None of the unique risks facing FDI, joint ventures, strategic alliances and licensing
Political risks are minimal
Agency costs and evaluating foreign units are avoided
Disadvantages are
Firm is not able to internalize and exploit its advantages
Risks losing market to imitators and global competitors
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15. How to Invest Abroad: Modes of FDI
Licensing/management contracts versus control of assets abroad
Licensing is a popular method for domestic firms to profit from foreign markets without the need to commit sizable funds
Disadvantages of licensing are
License fees are likely lower than FDI profits although ROI may be higher
Possible loss of quality control
Establishment of potential competitor
Possible improvement of technology by local license which then enters firm’s original home market
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16. How to Invest Abroad: Modes of FDI
Possible loss of opportunity to enter licensee’s market with FDI later
Risk that technology will be stolen
High agency costs
Management contracts are similar to licensing insofar as they provide for some cash flow from foreign source without significant investment or exposure
These contracts lessen political risk because the repatriation of managers is easy
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17. How to Invest Abroad: Modes of FDI
Joint ventures versus wholly owned subsidiary
A joint venture is a shared ownership in a foreign business
This is a viable strategy if the MNE finds the right local partner
Some advantages include
The local partner understands the market
The local partner can provide competent management at all levels
Some host countries require that foreign firms share ownership with local partner
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18. How to Invest Abroad: Modes of FDI
Joint ventures versus wholly owned subsidiary
Advantages of joint ventures
The local partner’s contacts & reputation enhance access to host country’s capital markets
The local partner may possess technology that is appropriate for the local environment
The public image of a firm that is partially locally owned may improve its position
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19. How to Invest Abroad: Modes of FDI
Joint ventures versus wholly owned subsidiary
Disadvantages of joint ventures
Political risk is increased if wrong partner is chosen
Local and foreign partners have divergent views on strategy and financing issues
Transfer pricing creates potential for conflict of interest
Financial disclosure between local partner and firm
Ability of a firm to rationalize production on a worldwide basis if that would put local partner at disadvantage
Valuation of equity shares is difficult
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20. How to Invest Abroad: Modes of FDI
Greenfield investment versus acquisition
A greenfield investment is establishing a facility “starting from the ground up”
Usually require extended periods of physical construction and organizational development
Here, a cross-border acquisition may be better because the physical assets already exist, shorter time frame and financing exposure
However, problems with integration, paying too much for acquisition, post-merger management, and realization of synergies all exist
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21. How to Invest Abroad: Modes of FDI
Strategic alliances can take several different forms
First is an exchange of ownership between two firms
It can be a defensive strategy against a takeover
In addition to exchanging shares, a separate joint venture can be developed
Another level of cooperation may be a joint marketing or servicing agreement
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22. Exhibit 17.3 The FDI Sequence: Foreign Presence and Foreign Investment
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23. Strategies Employed by Emerging Market MNEs
Taking brands global
Engineering to innovation
Leverage natural resources
Export successful business model
Acquire offshore assets
Target a market niche
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24. Exhibit 17.4 Emerging Market Multinationals and Their Global Strategies
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25. Summary of Learning Objectives
In order to invest abroad a firm must have a sustainable competitive advantage in the home market. This must be strong enough and transferable to overcome the disadvantages of operating abroad
Competitive advantages stem from economies of scale and scope, managerial and marketing expertise, differentiated products, and competitiveness of the home market
The OLI Paradigm is attempt to create an overall framework to explain why MNEs choose FDI rather than serve foreign markets through other methods
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26. Summary of Learning Objectives
Finance-specific strategies are directly related to the OLI Paradigm, including both proactive and reactive strategies
The decision about where to invest is influenced by economic and behavioral factors
Psychic distance plays a role in determining the sequence of FDI
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27. Summary of Learning Objectives
Most international firms can be viewed from a network perspective. The parent firm and each of the subsidiaries are members of the network
Exporting avoids political risk but not foreign exchange risk. It requires the least up-front investment but it might eventually have lost those markets to competition
Alternative modes of FDI exist, such as joint ventures, strategic alliances, licensing, management contracts, and traditional exporting
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28. Summary of Learning Objectives
Licensing enables a firm to profit from foreign markets without a major up-front investment,however disadvantages include limited returns, possible loss of quality control, and potential to establish future competitor
The success of a joint venture depends primarily on the right partner. For this reason a number of issues related to possible conflicts in decision making exist
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29. Summary of Learning Objectives
Six major strategies used by emerging market MNEs are:
Taking brands global
Engineering to innovation
Leverage natural resources
Export successful business model
Acquire offshore assets
Target a market niche
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