Foreign Direct Investment



Foreign Direct Investment.

1. Firm become multinational when they undertake foreign direct investment (FDI). FDI is going in global basis.

2. Example of FDI :

a. SONY

b. TOYOTA

c. ROYAL DUTCH SHELL

d. IBM

e. GM

f. COCA COLA

g. MC DONALD’S

h. NESTLE

3. These examples have established their presence worldwide and become familiar household names.

What is FDI

1. Classic definition, is defined as a company from one country making a physical investment into building a factory in another country.

2. Investment can be direct (The direct investment in buildings, machinery and equipment) or indirect investment (portfolio investment).

Why need FDI

1. Can provide a firm with :

a. New markets and marketing channels.

b. Cheaper production facilities

c. Access to new technology

d. Products skills and financing.

e. Labor expertise.

2. For a host country or the foreign firm which receives the investment, it can provide ( a to the) as well as a strong impetus to economic development.

a. a source of new technologies

b. sources of capital

c. new processes

d. new products

e. organizational technologies and management skills

Important of FDI

1. Avoiding foreign government pressure for local production.

2. Circumventing trade barriers, hidden and otherwise.

3. Making the move from domestic export sales to a locally-based national sales office.

4. Have capability to increase total production capacity.

5. Gain Opportunities for co-production, joint ventures with local partners, joint marketing arrangements, licensing, etc;

Basic requirement for companies considering a FDI

1. Assessment of internal resources ( does the firm have senior management support for the investment and the internal management and system capabilities to support the set up times as awell as ongoing management of a foreign subsidiary?

2. Competitiveness ( has the company conducted extensive market research involving both the industry, product and local regulations)

3. Market expectations ( has information on local industry and foreign investment regulations, incentives, profit retention, financing, distribution and other factors as a vehicle to enter the market. The market is whether greenfield, acquisiton, merger, joint venture, etc)

4. Market analysis ( if the foreign economy, industry is charactized by government regulation, have risk been factored into the business plan? – risk – contry risk, foreign exchange risk, market risk, business risk, soverign risk,political risk, economic risk)

Key factors that important in firm decision to invest overseas:

1. Trade barrier

a. Government may impose tariffs, quotas, embargo and other restrictions on export and imports goods and services hindering the free flow of these products across national boundaries.

b. Sometimes governments may even impose complete bans in the international trade of certain products.

c. Government regulates international trade to raise revenue, protect domestic industries and pursue other econ. Policy objective.

d. Example: facing barrier to exporting its product to foreign market, a firm decide to move production to foreign countries as a means if circumventing the trade barriers. A classic example of – motivated FDI is HONDA’s investment in Ohio. Since the cars produced in Ohio would not be subject to US tariff and quotas, Honda could circumvent these barriers by establishing production facilities in the United States.

2. imperfect labor market

a. Example: suppose Samsung, a Korean conglomerate, would like to build production facilities for its customer electronic products to serve the North American markets. Samsung could locate its production facilities anywhere in North America if the firm is concerned only with circumventing trade barrier imposed by NAFTA. Samsung chose to locate its production facilities in northern Mexico rather than in Canada or the US, mainly because it wanted to take advantage of the lower costs of labor in Mexico.

b. Labor is immobile because of immigration barriers, firm themselves should move the workers in order to benefit from the underpriced labor services.

c. This one reasons MNCs are making FDIs is less developed countries such as Mexico, China, India and Southeast Asian countries like Thailand, Malaysia and Indonesia, where the labor services are underpriced relative to their productivity.

3. Intangible assets

a. MNCs often enjoy comparative advantages due to special intangible assets they posses. Example including technological, managerial and marketing know-how, superior R&D capabilities and brand names.

b. These intangible assets are often hard to packages and sell to foreigners.

c. In addition the property rights in intangible assets are difficult to establish and protect, especially in foreign countries where legal resources may not be readily available.

d. As a result, firms may find it more profitable to establish foreign subsidiaries and capture returns directly by internalizing transactions in these assets.

e. The theory internalization of FDI, stated that the firms have intangible assets with a public good property tend to invest directly in foreign countries in order to use these assets on a larger scale and at the same time avoid the misappropriations of intangible assets that may occur while transacting in foreign markets.

f. Example : Coca- cola has invested in bottling plants all over the word rather than, say licensing local firms to produce Coke. Reason- to protect the formula for its soft drink. If licensing a local firm to produce Coke, it has no guarantee that the secrets of the formula will be maintained. If not will hurt the coke’s sales. So 1960s Coca- cola withdraw from India coz government pressure.

4. Vertical integration

a. MNCs may undertake FDI in countries where inputs are available in order to secure the supply of inputs at a stable price.

b. MNCs with monopolistic / oligopolistic control over the input market, this can be served as a barrier to entry to the industry.

c. Many MNCs often find it profitable to locate their manufacturing / processing facilities near the natural resources (oil fields, mine deposits and forest) in order to save transportation costs.

d. Backward vertical FDI – an industry abroad that produces inputs for MNCs.

e. Forward vertical FDI can take an example where they involve industry abroad that sells a MNC’s output.

f. Ex: US car makers found it difficult to market their product in Japan, because most car dealers in Japan have long and close relationship with Japanese car makers and are reluctant to carry foreign imports. So to overcome this problem, US car makers began to build their own network of dealership in Japan to help sell their cars.

Product life cycle

g. Raymond Vernon (1966) firm undertake FDI at a particular stage in the life cycle of the product that they initially introduced.

h. 3 stages: (1) introduce the product close to customer and get feedback, (2) product mature (3) standardized it becomes important to cut the cost of production to stay competitive.

i. Ex : personal computers ( PCs) were first developed by US firms ( such as IBM and Apple Computer) and exported to overseas markets. As PC’s became a standardized commodity, however, the US became a net importer of PCs from foreign producers based in such countries as Japan, Korea and Taiwan as well as foreign subsidiaries of US firms.

5. Shareholder diversification services.

a. If investors cannot effectively diversify their portfolio holdings internationally because of barrier to cross border capital flows, firms may be able to provide their shareholders with indirect diversification services by making their direct investments in foreign countries.

b. When a firm holds assets in many countries, the firm’s cash flows are internationally diversified.

c. Thus, shareholders of the firm can indirectly benefit international diversification even if they are not directly holding foreign shares.

Terms:

(1) Inward FDI - when a foreign country invests in the country in question.

(2) Outward FDI - when the home country invests abroad.

(3) Green investment

- Which involve building new production faclities in a foreign country

- is the investment in a manufacturing, office, or other physical company-related structure or group of structures in an area where no previous facilities exist.

- The name comes from the idea of building a facility literally on a "green" field, such as farmland or a forest.

- Greenfield Investing is usually offered as an alternative to another form of investment, such as mergers and acquisitions, joint ventures, or licensing agreements.

(4) Brownfield investment

- used for a ‘dirty’ business purpose, such as a steel mill or oil refinery, is cleaned up and used for a less polluting purpose, such as commercial office space or a residential area.

(5) Backward Vertical FDI

- Where an industry abroad provides inputs for a firm's domestic production process.

(6) Forward Vertical FDI

- Where an industry abroad sells the outputs of a firm's domestic production.

(7) Merger & acquisition

- involve buying combining with or buying existing foreign business. (from aspect of corporate strategy, corporate finance and manegement dealing with the buying, selling and combining of different companies that can aid, finance or help a growing company in an industry). (expand and takeover. Basically when they merger their names will changed but not the acqusition. )

(8) Joint venture

-In general, a joint venture (“JV”) is an association of two or more entities (whether corporate, government, individual or otherwise) combining property and expertise to carry out a single business enterprise and having a joint proprietary interest, a joint right to control and a sharing of profits and losses.

- Regardless of the scope of the undertaking, the nature of the JV must: (1) be a separately identifiable entity; (2) have an ownership interest in such entity by each joint venture partner (“JVP”); and (3) have an active management involvement or deliberate rejection of the right to such involvement by each JVP.

- JVs are common and successful in several industries. For example, in the land development and construction industries, JVs are often used to obtain sufficient financing to acquire large land tracts or to undertake major building projects. JVs are also common in the manufacturing, mining, and service industries.

(9) Licensing aggrements

- This involves the supply of technology and know-how or the use of a trademark or a patent for a fee. It offers one way to generate revenue from foreign markets that are otherwise inaccessible

(10) Transfer Pricing

- The pricing of goods and services that are bought and sold (transferred) between members of a corporate family. Ex: goods from the production division may be sold to the marketing division, or goods from a parent company may be sold to a foreign subsidiary.

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download