Session 9: Foreign Direct Investments

Question 1

Opening Case: GEELY GOES GLOBAL
What’s Geely’s story?

Answer 1

• 1986 Starts as a manufacturer of refrigerators
• 1997 Enters the automobile sector
• 2000s Lacks the capacity to design and engineer its own models
• 2010 Purchase Volvo for $1.8 billion. China’s largest overseas
  acquisition by an automobile maker at the time.
• 2010s Chinese market extremely profitable for the Volvo brand
  manufactured domestically by Geely
• 2017 Starts a series of new foreign investments (Lotus, Proton, etc.)

Question 2

Foreign Direct Investments definition

Answer 2

One firm’s direct investments in facilities to produce or market a good or service in a foreign country.

Question 3

What do we learn about the enablers of FDI?

Answer 3

Positive economic performance originating from a FDI often encourages a firm to replicate similar FDI.

Question 4

Flow of FDI

Answer 4

refers to the amount of FDI undertaken over a given time period (normally a year).

Question 5

Stock of FDI

Answer 5

refers to the total accumulated value of foreignowned assets at a given time.

Question 6

Outflows of FDI

Answer 6

refers to the flow of FDI OUT of a country.

Question 7

Inflows of FDI

Answer 7

refers to the flow of FDI INTO a country.

Question 8

FDI takes two main forms:

Answer 8

1. Greenfield investment
2. Mergers and acquisitions

Question 9

1. Greenfield investment

Answer 9

Greenfield investments involve the establishment of a new operation in a foreign country.

Question 10

2. Mergers and Acquisitions

Answer 10

Acquiring or merging with an existing firm in the foreign
country.

Question 11

Advantages of M&A over Greenfield investment

Answer 11

• Quicker to execute
• Provides access to strategic assets
• Belief it is possible to improve the efficiency of the company being acquired

Question 12

What are the 2 alternatives to FDI?

Answer 12

1. Exporting
2. Licensing

Question 13

EXPORTING

Answer 13

Producing goods at home and then shipping them to the receiving country for sale.

Question 14

LICENSING

Answer 14

Granting a foreign entity (the licensee) the right to produce and sell the firm’s product in return for a royalty fee on every unit sold.

Question 15

FDI vs Exporting/licensing

Answer 15

• FDI is expensive. Must bear the cost of establishing or
  purchasing production facilities.
• FDI is risky. Doing business in a different culture and system
  increases possibility of mistakes.
• Export is (usually) at no extra cost, and risk is limited through
  native agents. In licensing, the licensee bear the cost of risk.

Question 16

Limitations of Exporting

Answer 16

• When transportation costs are added to production costs, it becomes unprofitable to ship products over a large distance.
• Products of low value-to-weight ratio can be produced in almost
  any location: Examples: cement, soft drinks
• Products with a high value-to weight ratio: transport costs are normally a very minor component of total landed cost.
  ✓ Examples: electronic components, medical equipment

Question 17

Internalization theory

Answer 17

explains why firms often prefer FDI over licensing as a strategy for entering foreign markets

Question 18

Limitations of Licensing

Answer 18

1. Licensing may result in a firm giving away valuable technological
   know-how to a potential foreign competitor.
2. Licensing does not give a firm the tight control over manufacturing, marketing, and strategy in a foreign country.
3. Companies build their competitive advantage on different capabilities, not all amenable for licensing.
   ▪ If advantage is rooted not in the products but on the management,
   marketing, and manufacturing capabilities licensing is not convenient

Question 19

How to explain the patterns in FDI flows? 2 key theories

Answer 19

Explaining FDI flows means identifying the principle that guide firms’ investments strategies ad internalization/offshoring decisions.

Two key theories.
1. Strategic Behavior
2. Eclectic Paradigm

Question 20

Strategic Behavior (F.T. Knickerbocker)

Answer 20

FDI flows are a reflection of strategic rivalry between firms
in the global marketplace.

Question 21

Oligopoly

Answer 21

(industry composed of a limited number of large firms.)

Question 22

Multipoint competition

Answer 22

(arises when two or more
enterprises encounter each other in different regional markets, national markets, or industries.)

Question 23

Strategic Behavior: Implications

Answer 23

• Since in an oligopolistic situation there are very few firms, the actions of one firm (e.g. lowered prices) can trigger the other firms to mirror their actions in order to retain market share.
• This increases the likelihood of FDI as the entrance of a firm in a foreign country will most likely encourage the rest to follow.
• If firms do not replicate the entry of a firm in a market, that firm will
  most likely obtain a first mover advantage in such market
  ▪ Competing firms will closely follow each other’s moves in order to prevent a rival from becoming the leader in one market and using the profits they have gained to dominate other markets

Question 24

Strategy (strategic bahavior: implications)

Answer 24

Firms will try to match each other’s moves in different markets to try to hold each other in check

Question 25

Goal (strategic bahavior: implications)

Answer 25

To ensure a rival does not gain a commanding position in one market and then use the profits generated there to subsidized competitive attacks in other markets

Question 26

Examples (strategic bahavior: implications)

Answer 26

FDI by Japanese car manufacturers (Honda, Toyota, Nissan); FDI in the global tire industry (Michelin, Goodyear, Pirelli, Continental, Bridgestone)

Question 27

Eclectic Paradigm (John Dunning)

Answer 27

* Builds on Internalization argument: It is difficult for a firm to license its own capabilities and know-how * Firms must use FDI to combine their own unique capabilities with location-specific assets or resources * E.g.: Exploitation of natural resources (oil companies); low cost and highly skilled labour

Question 28

Eclectic Paradigm: Implications

Answer 28

→ To maximize the value of its internal assets and capabilities, the firm must pursue FDI, enabling new and more advantageous resource and know-how combinations. → Firms will establish production facilities where the foreign assets or resource endowments they want to recombine are located. → Location-specific advantages: Beyond natural resources and labour.

Question 29

Location-specific advantages

Answer 29

Advantages that arise from using resource endowments or assets that are tied to a particular foreign location and that a firm finds valuable to combine with its own unique assets (such as the firm’s technological, marketing, or management know-how). - CLUSTERS (e.g. Silicon Valley)

Question 30

Host Country Benefits

Answer 30

* Resource-transfer effects * Employment effects - FDI brings jobs to a host country * Balance of payment effects. * FDI is a substitute for imports of goods and services * MNE uses the subsidiary in the host country to export goods and services to other countries * Balance of payments from inward flow of foreign earnings. * Positive employment effects when a subsidiary demands home country exports of capital equipment. * Home country MNE learns skills transferable in technologies for use in the home country.

Question 31

Home Country Costs

Answer 31

* Balance of payments from outward FDI * Employment effect from outward FDI

Question 32

Host Country Benefits

Answer 32

* Resource transfer effects: Supplying capital, technology, and know-how otherwise unavailable * Employment effects: Job creation. →Are these new jobs, or are they substituting exiting ones? →What type of jobs? →M&A vs Greenfield Investments

Question 33

(Host Country Benefits) 2 Balance of payment effects:

Answer 33

1. FDI that operate as a substitute of foreign imports improve the balance of payment (what before was contributing to trade deficit, is now accounted as domestic production) 2. FDI can result in exporting subsidiaries, contributing to trade deficit reduction

Question 34

Host Country Costs

Answer 34

* Adverse effects on competition → Foreign subsidiaries have strong economic power to put local competitors out of market * Adverse effects on the balance of payments. → Against the initial capital inflow that comes with FDI must be the outflow of earnings to be repatriated * National sovereignty and autonomy

Question 35

Home Country Policy

Answer 35

* Encouraging outward FDI * Restricting outward FDI

Question 36

Host country policies

Answer 36

* Encouraging inward FDI * Restricting inward FDI