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arises from internalizing a business activity rather than leaving it to a relatively inefficient marketMarket PowerThe market power theory states that a firm tries to establish a dominant market presence in an industry by undertaking foreign direct investment. The benefit of market power is greater profit because the firm is better able to dictate the cost of its inputs or the price of its output.
Companies can gain market power through vertical integration—the extension of activities into production that provide a firm's inputs (backward integration) or absorb its output (forward integration).Partnership RequirementsMany companies have strict policies regarding how much ownership they take in firms in other nations. Yet a nation may demand shared ownership in return for market access. Governments may use such requirements to shield workers and industries from exploitation or domination by large multinationals.Benefits of CooperationGreater harmony exists today between governments and international companies. Developing nations and emerging markets need investment, employment, tax revenues, training, and technology transfers. A country with a reputation for overly restricting the operations of multinationals can see its inward investment dry up. Cooperation can open communication channels to maintain positive relationships in the host country.Purchase-or-Build DecisionThe purchase-or-build decision of managers entails deciding whether to purchase an existing business or build a subsidiary abroad from the ground up—called a greenfield investment. An acquiring firm may benefit from the goodwill the existing company has built over the years and, perhaps, brand recognition of the existing firm. The purchase of an existing business also may allow for alternative methods of financing, such as an exchange of stock ownership. Factors that reduce the appeal of purchasing existing facilities are obsolete equipment, poor labor relations, and an unsuitable location. Adequate facilities are sometimes unavailable and a company must go ahead with a greenfield investment. Greenfield investments have their own drawbacks—obtaining the necessary permits and financing and hiring local personnel can be difficult in some markets.Production CostsLabor regulations increase the hourly cost of production, and benefits packages and training programs add to wage costs. Although the cost of land and tax rate on profits can be lower locally, they may not remain constant.Rationalized ProductionProduction in which components are produced where the cost of production is lowest. The components are brought together at one central location for assembly into the final product. Potential problem is that a work stoppage in one country can halt the entire production procesCost of Research and DevelopmentCost of developing subsequent stages of technology has led to cross-border alliances and acquisitions. One indicator of the significance of technology in foreign direct investment is the amount of R&D conducted by affiliates of parent companies in other countries. FDI in R&D