INTERNATIONAL BUSINESS ENVIRONMENT TOPIC 4. Foreign Direct Investment and Collaborative Arrangements

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1 INTERNATIONAL BUSINESS ENVIRONMENT TOPIC 4 Foreign Direct Investment and Collaborative Arrangements INTRODUCTION CAUTION! SLIDES ARE NOT ENOUGH TO FULLY GRASP THE CLASS CONTENTS YOU ARE ADVISED TO: Take notes and participate during the class Read reference textbooks and other materials as recommended Thoroughly prepare the assignments 07/06/2012 International Business Environment - JG DITTER 2 1

2 Today's topics 1. Foreign direct investment: basics 2. Foreign direct investment: economic analysis 3. Political economy of foreign direct investment 4. Collaborative arrangements / non equity modes of international business 07/06/2012 International Business Environment - JG DITTER 3 Foreign direct investment: a definition Definition Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country Greenfield investment Establishment of a wholly new operation in a foreign country Brownfield investment Acquisitions or mergers with existing firms in the foreign country 07/06/2012 International Business Environment - JG DITTER 4 2

3 Primary foreign direct investment motives Market seeking New or larger markets STRATEGIC RIVALRY Export complementarities Optimization and control of value chain (vertical integration), diversification of risk Export substitution Transport costs, trade barriers RISK MANA- GEMENT Resource seeking Natural resources, workforce, technology, brand 07/06/2012 International Business Environment - JG DITTER 5 FDI vs. international trade: the "4Ts" 07/06/2012 International Business Environment - JG DITTER 6 3

4 Foreign direct investment and market access H-O-S model New trade theory Foreign direct investment (export of capital) will prevail over exports in case of High transportation costs Actual or threatened trade barriers 07/06/2012 International Business Environment - JG DITTER 7 Foreign direct investment and the product life-cycle A company will begin by exporting its product and later undertake foreign direct investment as the product moves through its life cycle 07/06/2012 International Business Environment - JG DITTER 8 4

5 Foreign direct investment and market power Vertical integration strategy (suppliers, clients) FOREIGN DIRECT INVESTMENT Control over inputs (backward integration) Control over outputs (forward integration) 07/06/2012 International Business Environment - JG DITTER 9 Foreign direct investment and strategic rivalry Firms will try to be first on markets in order to raise obstacles to entry (1 st mover advantage) OLIGOPOLISTIC INDUSTRIES What one firm does has an immediate effect on its competitors, forcing them to take similar actions (herd / mimetic behaviour) Firms will try to match each others moves as a way of keeping each other in check (multipoint competition) 07/06/2012 International Business Environment - JG DITTER 10 5

6 Dunning's "eclectic" (OLI) paradigm Internalisation Response to actual or threatened trade barriers Control of foreign business activity (firms try to reduce transaction costs and internally capture the advantages of foreign asset ownership) Location Taking advantage from resource endowments (capital, labour, natural resources) or assets (incl. location externalities, subsidies, technologies) that are tied to a particular location Ownership Firms endowed with a distinctive competitive advantage (technology, brand, economies of scale, ) making up for market entry costs will try to take advantage of large number of markets 07/06/2012 International Business Environment - JG DITTER 11 Dunning's "eclectic" (OLI) paradigm (ctd) 07/06/2012 International Business Environment - JG DITTER 12 6

7 The Geely-Volvo case A Chinese company is buying Volvo from Ford for 1.2bn, making it China's biggest purchase of an overseas carmaker and one of its largest foreign investments. The acquisition of the loss-making Swedish unit by Zhejiang Geely Holding Group underscores China's arrival as a force in the global car industry, as well as flagging up its ambition to become a big player on the world business stage. The deal could help Geely realise the dream of its founder, Li Shufu, to become a big international carmaker. Even though Ford has done its best to ring-fence its intellectual property, Volvo has plenty of its own, especially in the critical area of safety, to which Geely will have access and which will lend credibility to its cars as its range expands in both scope and scale. It will also learn from Volvo about how to run a global supply chain and an international dealer network. But Mr Li believes that Volvo too will benefit. Most important, it will realise its potential in China, the world's biggest and fastest-growing vehicle market. Fifteen years ago Volvo outsold Audi in China, but these days the German premium brand's sales in the country dwarf Volvo's, which were only 22,000 cars last year. He also thinks that away from Ford and the Premier Automotive Group that used to house its upmarket brands, Volvo will have freedom to go into market segments that were previously closed to it because they were occupied by models from Jaguar, Land Rover or Ford itself. 07/06/2012 International Business Environment - JG DITTER 13 Government attitudes towards FDI Pragmatic nationalism FDI is favoured if its benefits prevail over its costs Radical criticism FDI is blamed as an instrument of economic domination Laissez-faire Comparative advantage shapes the distribution of international production 07/06/2012 International Business Environment - JG DITTER 14 7

8 The pragmatic view: FDI benefits and costs (host country) BENEFITS COSTS Capital inflow (balance of payments) Contribution to domestic GDP and employment Contribution to economic and social change Positive externalities (e.g. technology transfers) Retribution of investment (current account balance) Dependency on foreign decision-makers Loss of sovereignty and autonomy Competition to local corporations 07/06/2012 International Business Environment - JG DITTER 15 Cadbury's case: fear for jobs Cadbury will accept defeat in its battle to stay independent today by recommending a 12bn takeover from US rival Kraft that threatens to reignite a fierce debate about the vulnerability of British industry. The 186-year-old chocolate maker decided to throw in the towel late last night after a large foreign shareholder joined hedge funds in indicating it would accept an improved offer from Kraft [ ] The confectionery giant joins a list of British industrial names to have fallen to foreign takeovers in similar circumstances in recent years. More than 50 leading companies have gone, including BAA, Boots, Cazenove, Corus, ICI, Jaguar Land Rover, P&O, Pilkington and Scottish Power. Until now Cadbury had fought a public campaign to preserve its independence, attracting support from Lord Mandelson, the business secretary, who warned Kraft to expect "huge opposition" from the government if it wanted to make a "fast buck" by buying Cadbury. [ ] Cadbury unions have warned that up to 30,000 jobs would be put at risk by the deal as Kraft would be weighed down by some 22bn in debt. Kraft has a record of aggressive cost-cutting, and the union Unite said that between 2004 and 2008 it shed 19,000 jobs and closed 35 sites to help reduce its debt. The Guardian, Tuesday 19 January /06/2012 International Business Environment - JG DITTER 16 8

9 The pragmatic view: FDI benefits and costs (home country) BENEFITS COSTS Investment income (repatriation of earnings) Contribution to domestic GDP and employment Contribution to economic and social change Positive externalities Capital outflow (balance of payments) Job losses (relocations) Trade deficit (export substitution, import generation) 07/06/2012 International Business Environment - JG DITTER 17 Measures affecting foreign direct investment Fiscal measures (taxes, tax breaks) Structural measures (e.g. infrastructure) Legal measures (regulations) Financial measures (funding, loans, loan guarantees) 07/06/2012 International Business Environment - JG DITTER 18 9

10 Measures affecting foreign direct investment: examples FDI Promotion FDI Restriction Host country Home country Tax breaks Low interest loans Infrastructure improvement Tax breaks Loans, insurance and guarantees Political pressure on host country government Ownership restrictions Local contents requirements Technology transfer requirements Differential tax rates Sanctions 07/06/2012 International Business Environment - JG DITTER 19 Radical measures Argentina s president, Cristina Fernández de Kirchner, announced on Monday that the government would seize a majority stake in YPF, the nation s largest oil company. Under Mrs. Kirchner s plan, which she announced on national television, Argentina s government would take a 51 percent controlling stake in YPF, which is now majority-owned by a Spanish energy company, Repsol YPF. Of that new stake, Argentina s central government would get 51 percent and the country s provinces 49 percent. The plan is part of a bill submitted to Argentina s Congress that is widely expected to be approved. Mrs. Kirchner quickly ousted Sebastián Eskenazi as YPF s chief executive, naming two top aides, Julio de Vido and Axel Kicillof, to run the company. The expropriation would reassert state control over an important pillar of Argentina s economy, but it has already increased diplomatic tensions with Spain and the European Union. 07/06/2012 International Business Environment - JG DITTER 20 10

11 Beyond FDI: collaborative arrangements Equity modes Non equity modes Joint ventures Licensing Franchising Equity alliances Management contracts Turnkey operations 07/06/2012 International Business Environment - JG DITTER 21 Pros and cons of collaborative arrangements Rationale Shortcomings Access to location specific assets Geographical diversification Overcome governmental constraints (e.g. barriers to trade and FDI restraints) Minimize exposure to risky environments Lack of control over manufacturing, marketing, and strategy required for realizing experience curve and location economies Limits a firm's ability to coordinate strategic moves across countries by using profits earned in one country to support competitive attacks in another Proprietary (or intangible) assets could be lost 07/06/2012 International Business Environment - JG DITTER 22 11

12 The technology transfer issue In what many international executives see as a warning for other industries, European, Japanese and North American companies have spent years transferring, or selling, highspeed rail technology to state-backed Chinese partners in exchange for market access [through joint-ventures] only to be rewarded with shrinking market share in China as a result of state policies that favour local industry. Now these companies find their high-speed technology has been digested defined by the government as a multistep process of buying foreign technology, innovating on that existing platform then selling it under a domestic brand by former Chinese partners. Furthermore, the foreigners find themselves competing head-to-head for tenders all over the world with Chinese companies selling digested high-speed technology at discount prices, often with cheap state bank financing thrown in. 07/06/2012 International Business Environment - JG DITTER 23 Assignment: managerial implications Business strategy The decision whether and where to invest abroad will depend on a variety of factors and expected advantages Government policy Host governments attitude toward FDI is an important variable in decisions about where to make a foreign direct investment 07/06/2012 International Business Environment - JG DITTER 24 12