1. © 2001 Prentice Hall8-1 International Business by Daniels and Radebaugh Chapter 8 Foreign Direct Investment

2. © 2001 Prentice Hall8-2 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

3. © 2001 Prentice Hall8-3 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

4. © 2001 Prentice Hall8-4 OPERATIONS OBJECTIVES MEANS Trade FDI Other equity and nonequity arrangements STRATEGY EXTERNAL INFLUENCES COMPETITIVE ENVIRONMENT PHYSICAL AND SOCIETAL FACTORS The Place of FDI in International Business

5. © 2001 Prentice Hall8-5 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

6. © 2001 Prentice Hall8-6 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

7. © 2001 Prentice Hall8-7 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

8. © 2001 Prentice Hall8-8 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

9. © 2001 Prentice Hall8-9 SALES EXPANSION OBJECTIVES Overcome high transport costs Domestic capacity Gains from scale economies Trade restrictions Barriers because of country- of-origin effects (nationalism, product image, delivery risk) Lower productions costs abroad RESOURCE ACQUISITION OBJECTIVES Savings through vertical integration Savings through rationalized production Gain access to cheaper or different resources and knowledge Need to lower costs as product matures Gain governmental investment incentives RISK MINIMIZATION OBJECTIVES Diversification of customer base (same motivation as for sales expansion) Diversification of supplier base (same motivation as for resource acquistion objectives Following customers Preventing competitors’ advantage POLITICAL OBJECTIVES Influence companies, usually through factors under resource acquisition objectives Motivation for FDI as an Alternative or Supplement to Trade

10. © 2001 Prentice Hall8-10 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-by- country production reduces costs by minimizing transportation expenses

11. © 2001 Prentice Hall8-11 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

12. © 2001 Prentice Hall8-12 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

13. © 2001 Prentice Hall8-13 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

14. © 2001 Prentice Hall8-14 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

15. © 2001 Prentice Hall8-15 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

16. © 2001 Prentice Hall8-16 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

17. © 2001 Prentice Hall8-17 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

18. © 2001 Prentice Hall8-18 RANK 1 2 3 4 5 6 7 8 9 10 CORPORATION General Electric Ford Motor Company Shell, Royal Dutch General Motors Exxon Corporation Toyota IBM Volkswagen Group Nestlé SA Daimler-Benz COUNTRY United States Netherlands/ United Kingdom United States Japan United States Germany Switzerland Germany INDUSTRY Electronics Automotive Petroleum Automotive Petroleum Automotive Computers Automotive Food and beverages Automotive FOREIGN ASSETS 97.4 72.5 70.0 --- 54.6 41.8 39.9 --- 31.6 --- FOREIGN SALES 24.5 48.0 69.0 51.0 104.8 50.4 48.9 42.7 47.6 50.4 FOREIGN EMPLOYEES 111,000 174,105 65,000 --- 134,815 133,906 219,442 --- World’s Top 10 Foreign Direct investors, Ranked by Foreign Assets, 1997 (Assets and Sales in Billions of U.S. Dollars)

19. © 2001 Prentice Hall8-19 460 18 166 Central and Eastern EuropeDeveloped CountriesEmerging Economies FDI Inflows in Major World Regions, 1998

20. © 2001 Prentice Hall8-20 FDI Inflows in Major World Regions, 1998 1.9 595 52 Central and Eastern EuropeDeveloped CountriesEmerging Economies