Foreign Direct Investment

Foreign Direct Investment

• when a firm invests directly in new facilities to produce or market in a foreign country

• “cross-border investment made to acquire a lasting interest in enterprises that operate outside the investor’s economy”

• when the foreign investor owns at least 10% of company shares

• Greenfield investments, M&A, and JV

multinational enterprise (MNE)

• A firm engaged in FDI

• Has productive activities in 2+ countries

• Large: Apple, Samsung, Toyota, Unilever

• Small: small/medium firms internationalized via digital platforms

• Also MNC (corporation) / TNC

  • Transnational corporation (has not HQ)

greenfield investment

establishment of a wholly new operation in a foreign country

M&A

acquisition or merging with an existing firm

Motivation for FDI

• Growth Imperative

• Efficiency Imperative

• Knowledge Imperative

• Globalization of Customers & Competitors

• Government Policy

Growth Imperative

Penetrate new international markets

Efficiency Imperative

• Gain access to low-cost resources

• Leverage economies of scale and scope

Knowledge Imperative

• Gain access to knowledge and innovation abroad

• Build insider position in key centers of excellence

Globalization of Customers & Competitors

• Follow-the-customer going international

• Match or pre-empt competitor moves

Government Policy

• Overcome trade barriers

• Benefit from host country investment incentives

firms prefer FDI to either

Exporting or Licensing

Exporting

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

Licensing

• granting a foreign entity the right to produce and sell the firm’s product in return for a royalty fee on every unit that the foreign entity sells

• ex: Harley Davidson beef jerky

FDI is expensive and risky, why choose it?

The limitations of exporting and licensing and the advantages of FDI

Limitations of Exporting

• When transportation costs are high, exporting can be unprofitable

• FDI may be a response to trade barriers such as import tariffs or quotas

Limitations of Licensing

1. Internalization theory

2. Tacit Knowledge

Internalization theory

• Suggests that licensing could result in a firm’s giving away valuable, technological know-how to a potenital foreign investor (ex: Evian water)

• Licensing doesn’t give a firm the tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability

• Licensing may be difficult if the firm’s competitive advantage isn’t amendable (transferrable) to it

Tacit Knowledge

• Skills acquired through personal experience and practice

• Difficult or impossible to write down, explain, or teach through formal instruction

• Process capabilities are ____, they travel with people, not contracts

Advantages of FDI

• Will be favored over exporting when:

  • Transportation costs and trade barriers are high

• Will be favored over licensing when:

  • The firm wants control over its technological know-how, operations, and business strategy

  • The firm’s capabilities are not amenable to licensing

OLI Paradigm

• ownership, location, and internalization

• attempt to create an overall framework to explain why MNEs choose rather than serve foreign markets through alternative modes such as licensing, strategic alliances, management contracts and exporting

• the most influential theory for explaining the reasons MNEs engage in outward FDI

Ownership Advantage (Dunning)

• The company must have some distinctive firm-specific advantages to overcome the costs of being foreign

• e.g., Brand name, technology entrepreneurial skills

Location Specific Advantage (Dunning)

• The country must have certain location-specific advantages for the company to invest there

• e.g., Raw materials, low wages special taxes or tariffs

Internalization Advantage (Dunning)

• The company can more effectively leverage its strategic assets through its own subsidiaries than contractual relations with outside parties

• e.g., controlling the foreign activity

• 3rd party can damage brand name or copy licensing