Moffett_286383_16

Moffett_286383_16 - Chapter 16 Foreign Direct Investment...

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Chapter 16 Foreign Direct Investment Theory and Strategy T Questions Evolving into multinationalism 1. As a firm evolves from purely domestic into a true multinational enterprise, it must consider (a) its competitive advantages, (b) where it wants to locate production, (c) the type of control it wants to have over any foreign operations, and (d) how much monetary capital to invest abroad. Explain how each of these four considerations is important to the success of foreign operations. If a firm lacks sufficient competitive advantage to compete effectively in its home market, it is unlikely to have sufficient advantages of any type to be successful in a foreign market. This is because the competitive advantages of the home market must be enduring, transferable, and sufficiently powerful to enable the firm to overcome the assorted difficulties of operating in a foreign environment. Foreign operations must be located where market imperfections are such that the firm can take advantage of its competitive advantages to the degree necessary to earn a risk-adjusted rate of return above the firm’s cost of capital. The firm must decided upon the degree of control it will need over the foreign operation, recognizing that greater control usually involves both greater risk and a greater investment. Viewing a spectrum of degrees of control, licensing and management contracts provide a low level of control (along with a low level of financial investment); joint ventures necessitate a somewhat higher level of control; and Greenfield direct investments and/or acquisition of an existing foreign firm require the highest degree of control (along with a higher level of financial investment). The spectrum of investment approaches (licensing, management contracts, joint ventures, and direct investment) require in that order ever increasing investment of more monetary capital. The firm must decide if the benefits of greater investment (presumably greater profits, plus possibly acquiring market share or forestalling competitors from gaining a greater market share) are worth the differing amounts of monetary capital needed. Theory of comparative advantage 2. What is the essence of the theory of comparative advantage? The essence of the theory of comparative advantage is that a country should specialize in producing those goods and services for which it has a relative cost advantage compared to other countries, export a portion of those goods and services, and use the proceeds from those exports to import goods and services for which it has a relative cost disadvantage. The theory focuses on the concept of “relative advantage” for each country. Relative advantage means a comparison of the ratio of costs between items within one country to the ratio of costs within another country. A country might have an absolute advantage in everything, but it will still gain by specializing where its relative advantage is greatest.
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296 Moffett • Fundamentals of Multinational Finance, Second Edition Market imperfections 3.
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