Foreign Direct Investment (FDI) & Country Attractiveness

Foreign Direct Investment (FDI)

•       Foreign direct investment (FDI): Strategy in which the firm establishes a physical presence abroad by acquiring productive assets, such as capital, technology, labor, land, plant, and equipment.

1. Represents substantial resource commitment.
2. Implies local presence and operations.
3. Firms usually invest in countries that provide specific comparative advantages.
4. Entails substantial risk and uncertainty.
5. Direct investors deal more intensively with specific social and cultural variables in the host market.

FDI: terminology

•       FDI Stock: total accumulated value of foreign-owned assets in a host country at a given point of time

•       Flow of FDI: additional (change in) FDI undertaken over a given period of time

•       Outflows of FDI: flow of FDI out of a country

•       Inflows of FDI: flow of FDI into a country

•       Flow and stock increased in the last 20 years

Important trends in global FDI

Despite declining trade barriers, FDI has grown more rapidly than world trade:

–      Businesses fear protectionist pressures

–      FDI is seen a way of circumventing trade barriers

–      Dramatic economic changes in many parts of the world

Between 2000 and 2004 the value of FDI slumped almost 50% from $1.2 trillion to about $620 billion

•       Growth of Service Industry FDI – Financial Industry (has led to contagion during GFC – to be discussed in greater detail later in this unit)

•       While developed nations still largest receivers of FDI, FDI into (and from) developing nations has increased

–      Most recent inflows into developing nations have been targeted at the emerging economies.

Service Multinationals

•       Firms that offer services—such as lodging, construction, and personal care—must offer them when and where they are consumed. 

•       Service firms establish either a
permanent presence via FDI
(e.g., retailing), or a temporary
relocation of  personnel (e.g.,
construction industry).

•       Many support services—such as
advertising, insurance, accounting,
and package delivery—are best
provided at the customer’s
location.

Extremes on the Spectrum of Political Ideology Toward FDI

Radical View: MNE’s exploit less-developed countries

–      Extract profits and act as instrument of domination, not development

–      Keep less-developed countries relatively backward and dependent on capitalist nations for investment, jobs, and technology

Free Market View - Nations specialize in goods and services that they can produce most efficiently

•       Resource transfers benefit and strengthen the host country

•       Positive changes in laws and growth of bilateral agreements attest to strength of free market view

No country has fully embraced the two extremes of the radical or ‘pure’ free market approach

The Political Economy of FDI

FDI in the world economy in 2012 is characterized by the dominance of “Pragmatic Nationalism”

“Pragmatic Nationalism” 

Governments seek to maximize national benefits and minimize costs of FDI i.e. make an economic evaluation of the costs and benefits to the host country’s economy and structure the political economy accordingly.

Benefits of FDI to Host Countries

Resource-Transfer &Employment Effects

Resource-Transfer Effects

–      Capital, Technology, Management

Employment Effects

Brings jobs that otherwise would not be created

–      Direct: host-country citizens employed in the multi-national enterprise

–      Indirect:

•       local suppliers

•       increased spending by employees of the multi-national enterprise

Benefits of FDI to Host Countries

Balance-of-payments effect.

Host country benefits from initial capital inflow when MNE establishes business.

A country may have a trade deficit or surplus depending on what it exports and imports.

Host country benefits if FDI substitutes for imports of goods and services.

Host country benefits when MNE uses its foreign subsidiary to export to other countries, in export taxes and the receipt of foreign currency.

Economic Growth:

–       productivity growth due to intensified competition and the need to invest in capital equipment, and R&D to compete.

–      product and process innovation, and greater economic growth

–       decreased prices benefit consumers.

Costs of FDI to Host Countries

 Profits brought home ‘hurts’ (debit) host’s capital account

MNC’s importing components has the same effect

Costs of FDI to Host Countries

Do you remember this example? Starbucks in the Forbidden City – Beijing

Attracting FDI

- Starbuck opened in 2000 by invitation. 

Vs Protecting Heritage

- Starbuck closed in July 2007 following protests that the store damaged a major historical site. (during the build up to the Olympic games).

What are the potential cultural costs of FDI?

Country Attractiveness, Competitiveness and  the ability to attract FDI

•       Country Competitiveness is the extent to which a country is capable of generating wealth, when measured against other countries, in world markets.

•       To be competitive, governments must create and sustain a domestic and international competitive environment that favors business operations (and attracts FDI).

•       The following contribute to country competitiveness:

–      Government policies, national values and culture, economic structures, economic and governmental institutions

–      Most governments have institutions that promote economic development by marketing competitiveness factors to MNEs.

–      Country competitiveness may affect selection for operations locations, MNE innovation capacity, production and global strategy.

Country-Level Determinants of Competitiveness

Fundamentals include:

–      Science, education, and innovation

–      Economic soundness

–      Finance

–      Internationalization - refers to the extent to which a country participates in international trade and investment.

–      Openness - refers to the ease of which resources, goods, services, people, labor, technology, information and capital flow across boundaries.

•       In order to promote openness

–      Countries seek to negotiate lower trade barriers and protectionism

–      While promoting cultural acceptance of “global mindsets” among the population

A strategic approach to assessing country attractiveness

Distance in IB and the Attractiveness of Foreign Markets

Firms can exaggerate the attractiveness of foreign markets.

–       focusing on consumer wealth and propensity to consume which place too much emphasis on sales.

•        Distance has cultural, administrative or political, economic and geographic dimensions.

•       The attractiveness of a market depends, not only on the business environment in that country, but how distance affects your company and your product.… not all products are affected by distance in the same way.

The CAGE Distance Framework

A. T. Kearney Global Services Location In

FDI and the Multinational Firm  - Motives for Foreign Direct Investment

FDI Modes

•       Greenfield investment: Firm invests to build a new manufacturing, marketing, or administrative facility, as opposed to acquiring existing facilities

•       Acquisition: Direct investment in or purchase of an existing company or facility

•       Merger: Special type of acquisition in which two firms join to form a new, larger company

•       Collaborative models: subject of next lecture.

•       Wholly-owned: represents the highest commitment

•       Vertical vs. Horizontal FDI: expansion to upstream (or downstream) stages of value chain vs. expansion along the firm’s current stage of value chain

FDI and the Multinational Firm
 - Market Imperfections

•       Market imperfections are factors that inhibit markets from working

–      In the international business literature, the market imperfection approach to FDI is typically referred to as internalization theory

•       With horizontal FDI, market imperfections arise in two circumstances:

–      When there are impediments to the free flow of products between nations which decrease the profitability of exporting relative to FDI and licensing

–      When there are impediments to the sale of know-how which increase the profitability of FDI relative to licensing

•       The market imperfections offers two explanations for vertical FDI

–      There are impediments to the sale of know-how and products through markets

FDI and the Multinational Firm Retailers: A Special Case of Internationalization

Retailers typically internationalize via FDI - Retailing takes various forms:

•       Department stores (Marks & Spencer, Macy's)

•       Specialty retailers (Body Shop, Gap, Disney Store)

•       Supermarkets (Sainsbury, Safeway, Sparr)

•       Convenience stores (Circle K, 7-Eleven, Tom Thumb)

•       Discount stores (Zellers, Tati, Target)

•       “Big box stores” (Home Depot, IKEA, Toys "R" Us)

Wal-Mart has over 100 stores and 50,000 employees in China, sourcing almost all its merchandise locally and providing thousands of local jobs.

Barriers to Retailer Success Abroad

1. Culture and language barriers

•       E.g., differing product and service portfolio, store hours, store layout, relations between management and labor

2. Consumer loyalty to indigenous retailers

•       E.g., Galleries Lafayette in New York and Wal-Mart in Germany failed.

3. Legal and regulatory barriers

•       Countries have idiosyncratic laws that affect retailing. E.g., Germany limits store hours and requires recycling.

4. Developing local sources of supply

•       E.g., McDonald’s in Russia; KFC in China

Wal-Mart’s Mixed Experience

•       Germany: Failing to understand the market, Wal-Mart could not compete with local firms, and left the market.

•       Mexico: Built huge U.S.-style parking lots. But most Mexicans lack cars, and city bus stops were far away, so shoppers could not haul their purchases home. 

•       Brazil: Families do their big shopping on payday. Aisles were too narrow to accommodate
the rush.

•       Argentina: Wal-Mart’s red,
white, and blue banners,
reminiscent of the U.S.
flag, offended local tastes.

Success Factors for Retailers

1. Advance research and planning. French retailer Carrefour spent 12 years building its business in Taiwan to better understand Chinese culture.
2. Establish logistics and purchasing networks
   in each market. Well-organized sourcing and logistics ensure inventory is always maintained.
3. Assume entrepreneurial, creative approach. Virgin megastore expanded to Asia, Europe, and North America by using creative approaches.
4. Adjust business model to suit local conditions. In Mexico, Home Depot packages merchandise to suit smaller budgets and offers flexible payment plans.