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GEB+3373+S2011+PP+Ch03+E-book-1 - Chapter 3 Investing...

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Unformatted text preview: Chapter 3 Investing Abroad Directly GEB 3373, Spring 2011 1 1 Investing Abroad Directly s MNEs often go abroad doing the same thing they do at MNEs home. That is, they perform the same stage of the value chain in the foreign location that they do at home. chain – This is called Horizontal FDI and is the mechanism most often This Horizontal referenced in discussions about FDI. referenced GEB 3373, Spring 2011 2 2 Investing Abroad Directly s MNEs may find themselves in a position that the best way MNEs to create value in the host country is to move upstream or downstream in the value chain when making a foreign direct investment. direct – This is called a Vertical FDI. This Vertical GEB 3373, Spring 2011 3 3 Investing Abroad Directly A distinction needs to be made in our discussion of foreign direct investment between investments made in the past and new incremental investments. and – This is the difference between stocks and flows: u Investments made in the past represent ownership in foreign facilities Investments which, in a balance sheet context, are assets in place, a STOCK. which, New investments made in the present period add to the stock and New represent FLOWS of wealth going to the foreign country. – These flows appear in the country’s Balance of Payments presentation. u u It should be noted that decisions to invest in a particular host country It might differ from decisions to reinvest or to grow the business in that same host country. same GEB 3373, Spring 2011 4 4 Investing Abroad Directly There are two broad models that purport to explain the circumstances that need to exist before a company will want to consider a foreign direct investment. want – Porter’s National Competitive Advantage Diamond – Dunning’s OLI paradigm GEB 3373, Spring 2011 5 5 Exhibit 16.6 Determinants of National Exhibit Competitive Advantage: Porter’s Diamond Competitive (1) Factor conditions (4) Firm strategy, structure, & rivalry (2) Demand conditions (3) Related and supporting Industries Source: Michael Porter, “The Competitive Advantage of Nations,” Harvard Business Review, March-April 1990. GEB 3373, Spring 2011 6 6 The OLI Paradigm and The Internalization Internalization s The OLI Paradigm is an attempt to create an overall The OLI framework to explain why MNEs choose FDI rather than serve foreign markets through alternative models such as licensing, joint ventures, strategic alliances, management contracts, and exporting. contracts, – “O” owner-specific (competitive advantage in the home market O” owner-specific that can be transferred abroad) that – “L” location-specific (specific characteristics of the foreign market L” allow the firm to exploit its competitive advantage) allow – “I” internalization (maintenance of its competitive position by I” internalization attempting to control the entire value chain in its industry) attempting GEB 3373, Spring 2011 7 7 Owner-Specific Advantages: Sustaining Owner-Specific and Transferring Competitive Advantage and s In deciding whether to invest abroad, management must In first determine whether the firm has a sustainable competitive advantage that enables it to compete effectively in the home market. effectively The competitive advantage must be firm-specific, The transferable, and powerful enough to compensate the firm for the potential disadvantages of operating abroad (foreign exchange risks, political risks, and increased agency costs). exchange There are several competitive advantages enjoyed by There MNEs. MNEs. s s GEB 3373, Spring 2011 8 8 Owner-Specific Advantages: Sustaining Owner-Specific and Transferring Competitive Advantage and s Economies of scale and scope: – Can be developed in production, marketing, finance, research and Can development, transportation, and purchasing development, – Large size is a major contributing factor (due to international Large and/or domestic operations) and/or s Managerial and marketing expertise: – Includes skill in managing large industrial organizations (human Includes capital and technology) capital – Also encompasses knowledge of modern analytical techniques and Also their application in functional areas of business their GEB 3373, Spring 2011 9 9 Owner-Specific Advantages: Sustaining Owner-Specific and Transferring Competitive Advantage and s Advanced technology: – Includes both scientific and engineering skills s Financial strength: – Demonstrated financial strength by achieving and Demonstrated maintaining a global cost and availability of capital maintaining – This is a critical competitive cost variable that enables This them to fund FDI and other foreign activities them GEB 3373, Spring 2011 10 10 Owner-Specific Advantages: Sustaining Owner-Specific and Transferring Competitive Advantage and s Differentiated products: – Firms create their own firm-specific advantages by Firms producing and marketing differentiated products producing – Such products originate from research-based Such innovations or heavy marketing expenditures to gain brand identification brand s Competitiveness of the home market: – A strongly competitive home market can sharpen a strongly firm’s competitive advantage relative to firms located in less competitive ones less GEB 3373, Spring 2011 11 11 Location-Specific Advantages: Why one Location-Specific Host Country Rather than Another Host s MNEs have many options to locate FDI MNEs almost anywhere in the world, so why do they choose one location over another? they GEB 3373, Spring 2011 12 12 Market Imperfections: A Rationale for Market the Existence of the Multinational Firm the s MNEs strive to take advantage of imperfections in national MNEs markets for products, factors of production, and financial assets. assets. Imperfections in the market for products translate into Imperfections market opportunities for MNEs. market Large international firms are better able to exploit such Large competitive factors as economies of scale, managerial and technological expertise, product differentiation, and financial strength than are their local competitors. financial s s GEB 3373, Spring 2011 13 13 Market Imperfections: A Rationale for Market the Existence of the Multinational Firm the s Strategic motives drive the decision to invest abroad and Strategic become a MNE and can be summarized under the following categories: following – Market seekers – Raw material seekers – Production efficiency seekers – Knowledge seekers – Political safety seekers s These categories are not mutually exclusive. GEB 3373, Spring 2011 14 14 Internalization: Why Companies Shift from Trade to FDI What causes companies to shift from mainly exporting toward overseas production and distribution? – It is a function of the relative cost of serving global markets u u Both fixed and variable costs are relevant The mix of fixed and variable costs is different in export operations than in overseas production GEB 3373, Spring 2011 6365, Fall 2010 15 15 Internalization: Why Companies Shift from Trade to FDI GEB 3373, Spring 2011 6365, Fall 2010 16 16 Internalization: Why Companies Shift from Trade to FDI GEB 3373, Spring 2011 6365, Fall 2010 17 17 Internalization: Why Companies Shift from Trade to FDI GEB 3373, Spring 2011 6365, Fall 2010 18 18 Internalization: Why Companies Shift from Trade to FDI GEB 3373, Spring 2011 6365, Fall 2010 19 19 Internalization: Why Companies Shift from Trade to FDI $ External Market costs Profit from Trade with no transaction costs Internal Market costs X3 X1 X2 X0 Profit after External External Market Market Costs Profit after Internal Market Costs Output X0 = Optimal level of gross world product in perfect trade market X1 = Optimal level of gross world product with external market costs Optimal X2 = Optimal level of gross world product with internal market costs X3 = Level of output at which it is profitable to switch from exporting (external market) to Foreign Direct Investment (internal market) in the case where frictions exist. GEB 3373, Spring 2011 20 20 How to go Abroad s s s External influences upon a firm’s decision to handle its international operations itself or to collaborate with other companies include: – physical factors – societal factors – the competitive environment Internally, the mode of entry decision is influenced by a firm’s own objectives and strategies. The truly experienced MNE selects modes of entry according to the its capabilities, specific product characteristics, and foreign operating characteristics. GEB 3373, Spring 2011 21 21 Alternative Types of Foreign Operations s s s Foreign-owned operations (FDI) may be established either as start-ups (greenfield ventures) or via acquisition. Foreign-owned operations (FDI) may take the form of wholly-owned subsidiaries or joint ventures. Nonequity (collaborative) types of foreign operations include licensing and other contractual forms of business ventures. The resource-based view of the firm holds that each company has a unique combination of competencies and can maximize its performance by concentrating on those activities that best fit its competencies. GEB 3373, Spring 2011 22 22 Fig. 14.3: Alternative Operating Modes for Foreign Market Expansion GEB 3373, Spring 2011 23 23 Reasons Why Foreign Production May Be Preferable to Exporting s s s s s s Production costs are cheaper abroad than at home. Transportation costs to move products internationally are relatively high. Domestic capacity is insufficient. Products must be substantially altered in order to capture sufficient foreign demand. Governments restrict or prevent the importation of foreign products. Customers prefer products originating from a particular foreign country. GEB 3373, Spring 2011 24 24 Foreign Direct Investment: Control Objectives Companies generally want controlling interests in their foreign operations for three reasons: s internalization objectives It’s more profitable to control operations internally (transaction cost theory); it’s strategically preferable to control operations internally. s appropriability objectives Foreign investment is favored as a way to prevent potential competitors from gaining access to proprietary information (intellectual property and managerial know-how). s globalization objectives Foreign investment provides the freedom to pursue global or transnational objectives by optimizing corporate strategies. GEB 3373, Spring 2011 25 25 Foreign Direct Investment: Comparative Advantages Acquisitions and start-ups offer largely opposite benefits to a firm. • The advantages of an acquisition may include: – existing facilities, an existing labor force, and knowledgeable local management – existing goodwill and brand identification – an immediate cash flow – access to local financing – the avoidance of excess capacity [continued] GEB 3373, Spring 2011 26 26 Foreign Direct Investment: Comparative Advantages s The advantages of a start-up, i.e., a greenfield venture, may include: – the existence of first-mover advantages due to a lack of viable competitors and available acquisitions – the opportunity to establish new (more efficient) facilities, to escape punitive labor contracts, to hire and train fresh labor forces, and to implement compatible managerial styles and practices, i.e., the avoidance of carry-over problems – the existence of government incentives – the availability of development capital – the creation of additional capacity GEB 3373, Spring 2011 27 27 Host Country Benefits from Inward Foreign Direct Investment Host countries see at least six major benefits from a policy of permitting FDI s Inflow of capital – credit entry in the Balance of Payments Reduce imports and stimulate exports – also helps Balance of Payments Gain access to new technology – Spillover effects give local benefits Acquire management expertise Local job creation in the FDI facility Secondary job creation from local sourcing GEB 3373, Spring 2011 28 28 s s s s s Host Country Costs from Inward Foreign Direct Investment Host countries also see at least three major costs from a policy of permitting FDI s Loss of economic sovereignty because MNEs make decisions that are in their best interests, not necessarily in the country’s best interest. Negative effects on local competitors. – For instance, cherry picking scarce skilled workers by paying higher salaries, thus disadvantaging local companies. s s Repatriation of earnings to the parent – Debit entries in the Balance of Payments lead to deficits. GEB 3373, Spring 2011 29 29 Home Country Benefits from Outward Foreign Direct Investment Home countries see at least three major benefits from outward FDI: s s s Inflow of repatriated earnings from foreign subsidiaries. Exports of components or services to foreign subsidiaries. Learning how to compete in other countries and discovering new ways of operating that can be transferred elsewhere. GEB 3373, Spring 2011 30 30 Home Country Costs from Outward Foreign Direct Investment Home countries also see at least two major costs from a policy of outward FDI s Initial capital outflows take money out of the home economy and are negative factors in the Balance of Payments. The job loss from shifting operations to other countries (offshoring or outsourcing) is politically sensitive. s GEB 3373, Spring 2011 31 31 ...
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