Chapter 7 - Foreign Direct Investments

Management Issues II - Purchase-or-Build

The purchase-or-build decision entails deciding whether to purchase an existing business or to build a subsidiary fresh from the ground up. Benefits of purchasing a firm include the existing company's goodwill in the marketplace, brand recognition, and access to financing. Drawbacks of purchasing existing facilities can include obsolete equipment, poor labor relations, and an unsuitable location. Building a new subsidiary can involve drawbacks such as obtaining the necessary permits, arranging financing, and recruiting local personnel.

Market Imperfections (Internalization) - Types

Trade barrier, such as a tariff. Company's unique competitive advantage, such as specialized knowledge, technical expertise, or special abilities embodied in employees.

International Product Life Cycle

a company will begin exporting its product and later undertake foreign direct investment as the product moves through its life cycle.

International Product Life Cycle - Stage 3 - Standardized Product Stage

competition from companies selling similar products pressures companies to lower prices to maintain sales levels. A search for low-cost production bases abroad begins and the home market may begin importing the product.

Eclectic Theory

firms undertake foreign direct investment when the features of a location combine with ownership and internalization advantages to make a location appealing for investment.

International Product Life Cycle - Stage 1 - New Product Stage

high purchasing power and buyer demand encourage a company to design and introduce a new product concept. Although there is virtually no export market initially, exports increase late in this stage.

Balance of Payments

is a national accounting system that records all payments to entities in other countries and all receipts coming into the nation.

Balance of Payments - Capital Account

records transactions involving the purchase or sale of assets. These assets include physical assets such as foreign direct investments in factories and equipment, and financial assets such as shares of stock in a company abroad.

Market Power Theory

states that a firm tries to establish a dominant market presence in an industry by undertaking foreign direct investment.

Eclectic Theory - Location Advantage

the advantage of locating a particular economic activity in a specific location because of its natural or acquired characteristics.

International Product Life Cycle - Stage 2 - Maturing Product Stage

the domestic market and markets abroad become fully aware of the existence of the product and its benefits. Demand rises and is sustained over a fairly lengthy period of time. Near the end of this stage, sales begin in developing nations and manufacturing is established there.

Market Imperfections (Internalization)

theory states that when an imperfection in the market makes a transaction less efficient than it could be, a company will undertake FDI to internalize the transaction and thereby eliminate the imperfection.

Portfolio Investment

Does not involve obtaining a degree of control in a company, recorded in the current account

U.S. Balance of Payments

Financial receipts from other nations are additions to the balance of payments accounts and recorded with a plus (+) sign. Payments to entities in other nations are reductions in the balance of payments accounts and recorded with a minus (-) sign.

Management Issues II - Customer Knowledge

Knowledge of customer and buyer behavior can be a key issue in the decision of whether to undertake FDI. A local presence can give companies valuable knowledge of customers that is unobtainable in the home market.

Eclectic Theory - Advantages

Location Advantage (optimal location) Ownership Advantage (special asset) Internalization Advantage (efficiency)

Worldwide FDI Flows

More than 82,000 multinational companies with over 810,000 affiliates drive global FDI flows. Developed countries account for about 49% of all world FDI—the main recipients being the European Union, the United States, and Japan. Developing and emerging markets account for about 45% of global FDI, with the largest portions going to China and India. Outflows of FDI from emerging economies are also on the rise.

Host Promotion Methods - Promote

Offer insurance to cover the risks of investing company assets abroad. Grant loans to firms wishing to increase their investments abroad. Offer tax breaks on profits earned abroad or negotiate special tax treaties. And apply political pressure to get other nations to relax their restrictions on FDI inflows.

Host Promotion Methods

One method that host countries can use to promote FDI inflows are financial incentives. Tax incentives and/or low-interest loans to attract investment are common. But if bidding wars arise between locations competing for the investment, the cost of the FDI for taxpayers may be more than what the jobs actually pay. Other methods to promote FDI inflows include infrastructure improvements. Infrastructure improvements in the host country can include better seaports for containerized shipping, improved roads, and advanced telecommunications systems.

Host Restriction Methods

One method that host countries can use to restrict FDI inflows are ownership restrictions. Governments can prohibit foreign companies from investing in certain industries or owning certain types of businesses. They may also require foreign investors to hold less than a 50% stake in a local firm. Other methods to restrict FDI inflows include performance demands. Such demands can dictate the portion of a product's content that originates locally, stipulate that a portion of output must be exported, or demand that certain technologies be transferred to local businesses.

Yearly FDI Inflows

Peaked at an all-time high if $1.9 trillion in 2007. The global crisis then caused lower FDI flow in 2008 and 2009. Following the credit crisis the global recession that followed, healthy companies are driving FDI higher once again

Management Issues II - Production Costs

Production costs are important inputs to the FDI decision. Some prominent costs include worker benefits, employee training programs, and burdensome regulations. Lower research and development costs can encourage FDI but these costs can be outweighed by supply factors, such as access to top scientists and technical experts.

Foreign Direct Investment (FDI)

Purchase of physical assets or significant amount of ownership of a company in another country in order to gain some measure of management control Most governments set the FDI threshold at somewhere between 10- 25% of stock ownership in a company abroad US Commerce dept. says that stock ownership above 10% constitutes FDI

Balance of Payments - Current Account

Records transactions involving the import and export of goods and services, income receipts on assets abroad, and income payments on foreign assets inside the country.

Reasons for FDI Growth - Mergers and Acquisitions

Rise and fall from year to year and tend to follow the health of national economies.

Market Power Theory - Vertical Integration

The extension of activities into production that provide a firm's inputs or absorb its output.

Management Issues III - Following Clients

The practice of following clients into markets abroad typically occurs when suppliers of component parts have close working relationships with their customers. FDI puts the supplier nearer their customers where they can better understand and anticipate their needs.

Management Issues III - Following Rivals

The practice of following rivals resembles a "follow the leader" scenario and is common in industries with a limited number of large firms. FDI is driven by a belief that not matching rivals' moves can mean losing a "first mover" advantage or being shut out of a lucrative market altogether.

What do we mean by a country's balance of payments and what is its usefulness?

A country's balance of payments is a national accounting system that records all payments to entities in other countries and all receipts coming into the nation. The system helps monitor a country's flows of goods, services, income, and asset transfers between itself and other nations. The balance of payments position sends warning signals about trade deficits with other nations.

The eclectic theory says that firms undertake FDI when location, ownership, and __________ advantages combine to make a location appealing for investment.

Internalization

Eclectic Theory - Ownership Advantage

Is a company advantage that arises from ownership of some special asset, such as a powerful brand, technical knowledge, or management ability.

Eclectic Theory - Internalization Advantage

Advantage that arises from internalizing a business activity rather than leaving it to a relatively inefficient market.

Management Issues I - Control

Although a company may invest abroad to increase its control in a local market, shared ownership also has advantages. Companies benefit from better communication with local government officials. Host countries benefit from worker and industry protection and more control over worker training and technology transfers.

A host government may encourage an initial FDI because the inflow can __________ its balance-of-payments position.

Boost

What is the difference between foreign direct investment and portfolio investment?

Foreign direct investment is the purchase of physical assets or a significant amount of the ownership of a company in another country to gain a measure of management control. Portfolio investment does not involve obtaining a degree of control in a company.

Reasons for FDI Growth - Mergers and Acquisitions - Many cross-border mergers and acquisitions are intended to:

Get a foothold in a new geographic market. Increase a firm's global competitiveness. Fill gaps in companies' product lines in a global industry. And reduce the cost of research and development, production, or distribution.

Reasons for FDI Growth - Drivers

Globalization encourages firms to use fDI as a way to create low-cost production bases Prompts multinational from both advanced and emerging economies to buy businesses in other markets Another driver is international mergers and acquisitions Mergers and acquisitions have propelled long-term growth in FDI and will likely do so for the foreseeable future

Home Intervention - Pros

Home countries may also promote outward FDI. FDI outflows can improve long-run competitiveness if partnering abroad provides a learning opportunity. FDI outflows can eliminate low-wage jobs in industries that use obsolete technology or employ low-skilled workers at home.

Home Intervention - Cons

Home countries may discourage outward FDI for several reasons: Investing in other nations sends resources out of the home country and lowers investment at home. An FDI outflow can damage a nation's balance of payments if the investment abroad eliminates an export market. And jobs created abroad by an FDI outflow may replace jobs in the home country.

Host Intervention II

Host countries also intervene in FDI to obtain resources and benefits. Encouraging FDI in new technological products and processes increases host country competitiveness and productivity. A host country can also obtain management skills and employment benefits if the FDI involves technical training of locals in how to operate facilities. Some of those managers may go on to establish their own homegrown businesses. In general, inflows of FDI tend to increase economic output and enhance standards of living in a host country.

Host Intervention I - Balance of Payments

Host countries get a balance-of-payments boost from initial FDI inflows. The host's balance-of-payments increases further if the FDI produces goods for export. When a company repatriates profits back to its home market, the host nation's foreign exchange reserves are reduced and the balance of payments declines. This entices some host nations to restrict foreign firms from repatriating profits. By contrast, a host country conserves its foreign exchange reserves when foreign companies reinvest earnings locally. This boosts the host nation's exports and improves its balance-of-payments position.

Home Restriction Methods

Impose a higher tax rate on income earned abroad than that levied on domestic earnings. And impose sanctions that prohibit domestic firms from making investments in certain nations

Market Power Theory - Benefit

Increased profits because greater power helps a firm to dictate the cost of its inputs and/or the price of its output.

Reasons for FDI Growth

Increasing Globalization International mergers and acquisitions