INTERNATIONAL INVESTMENT THEORIES.

Why does FDI occur? A sophomore taking his or her first finance course might answer with the obvious: Average rates of return are higher in foreign markets. Yet given the pattern of FDI between countries that we just discussed, this answer is not satisfactory, and Canada and the United Kingdom are both major sources of FDI in the United States and important destinations for FDI from the United States. Average rates of return in Canada and the United Kingdom cannot be simultaneously below that of the United States (which would justify inward U.S.FDI) and above that of the United States (which would justify outward U.S.FDI).The same pattern of two-way investment occurs on an industry basic. By the end of 2007, for example, U.S firm had invested $8.0 billion in the chemical industry in the Netherland.While Dutch Firm had invested $44.7 billion in the U.S chemical industry. This pattern cannot be explained by national or industry differences in rates of return .We must search for another explanation for FDI.

Ownership  Advantages.

More powerful explanation for FDI focus on the role of the firm. Initially researcher explored how firm ownership of competitive advantages affected FDI .The ownership advantage theory suggests that a firm owning a valuable asset that creates a competitive advantage domestically can use advantage to penetrate foreign markets though FDI. The asset could be, for example, a superior technology, a well-knows brand name, or economies of scale. This theory is consistent with the observed patterns of international and industry FDI discussed earlier in this chapter. Caterpillar, for example, built factories in Asia, Europe, Australia, South America, and North America to exploit proprietary technologies and its brand name .Its chief rival, Komatsu, constructed plants in Asia, Europe, and the United States for the same reason.

 

 

 

 

 

Internalization Theory.

The ownership advantage theory only partly explains why FDI occur. It does not explains why a firm would choose to enter a foreign market via FDI rather exploit  For example, McDonald’s has successfully internationalized by franchising its fast-food operations outside the United States, while Boeing has relied on exporting to serve foreign customers.

Internalization theory addresses this question. In doing so, it relies heavily on the concept of transaction costs. Transaction costs are the costs of entering into a transaction, that is, those connected to negotiating, monitoring, and enforcing a contract. A firm must decide whether it is better to own and operate its own factory overseas or to contract with a foreign firm to do this through a franchise, licensing, or supply agreement. Internalization theory suggests that FDI is more likely to occur-that is, international production will be internalized within the firm-when the costs of negotiating, monitoring, and enforcing a contract with a second firm is high. For example, Toyota ‘primary competitive advantages are its reputation for high quality and its sophisticated manufacturing techniques, neither of which is easily conveyed by contract. As a result, Toyota has chosen to maintain ownership of its overseas automobile assembly plants.

Conversely, internalization theory holds that when transaction coast are low, firms are more likely to contract with outsider and internationalize by licensing their brands names or franchising their business operation. For example, McDonald’s is the premier expert in the United States in devising easily enforceable franchising agreements. Because McDonald’s is so successful in reducing transaction costs between itself and its franchisees, it is continued to rely franchising for its international operations.

Dunning’s Eclectic Theory

Although internalization theory addresses why firms choose FDI as the mode for entering international markets, the theory ignores the question of why production by either the company or a contractor, should be located abroad. In other words, is there a location advantage to producing abroad? This issue was incorporated by John Dunning in his eclectic theory, which combines ownership advantage, location advantage, and internalization advantage to form a unified theory of FDI. This theory recognizes that FDI reflects both international business activity internal to the firm. According to Dunning, FDI will occur when three conditions are satisfied.

1.      Ownerships advantage. The firm must own some unique competitive advantage that overcomes the disadvantage of competing with foreign firm in their home turfs. This advantage may be a brand name, ownership of proprietary technology, the benefits of economies of scale, and so on. Caterpillar, for example, enjoys all three of these advantages in competing in Brazil against local firms.

2.      Location advantage. Undertaking the business activity must be more profitable in a foreign location than undertaking it in a domestic location. For example, Caterpillar produces bulldozer in Brazil enjoy lower labor costs and avoid high tariff walls on good exported from its U.S. factories.

3.      Internalization advantage .The firm must benefit more from controlling the foreign business activity than from hiring an independent local company to provide the service. Control is advantageous, for example, when monitoring and enforcing the contractual performance of the local company may misappropriate proprietary technology, or when the firm’s reputation and brand name could be jeopardized by poor behavior by the local company. All of these factors are important to Caterpillar.

Factors Influencing Foreign Direct Investment.

Given the complexity of the global economy and the diversity of opportunities that firms face in different countries, it is not surprising that numerous factors may influence a firm’s decision to undertake FDI. These can be as supply factors, demand factors, and political factors (see table 6.5)

TABLE 6.5 Factors Affecting the FDI Decisions

Supply Factors                        Demand factors                      Political factors

Production costs                 Customer access                     Avoidance of trade barriers

Logistics                        Marketing advantages           Economic development    Resource availability             Exploitation of competitive         incentives

                                                    Advantage

Access to technology            customer mobility

 

Supply Factors.

A firm’s decision to undertake FDI may be influenced by supply factors, including production costs, logistic, availability of natural resources, and access to key technology.

PRODUCTION COSTS.  Firms often undertake may be more attractive than domestic sites because of lower land prices, tax rates, commercial real estate rents, or because of better availability and lower costs of skilled or unskilled labor. For example, Intel built a new chip fabrication facility in Chengdu in China’s remote Sichuan province because labor and land costs were must lower than Shanghai, where the company already operates three facilities. Similarly, Samsung will build a $670 million mobile phone assembly plant in northern Vietnam to take advantage of the area’s low labor costs.

LOGISTICS. If transportation costs are significant, a firm may choose to produce in the foreign market rather than export from domestic factories. For example, Heineken has utilized FDI extensively as part of its internationalization strategy because its products are primarily water. Brewing its beverages close to where its foreign consumers live is cheaper for Heineken than transporting the beverages long distances from the company’s Dutch breweries. International businesses also often make host-country investments to reduce distribution costs. For example, Citrovita, a Brazilian producer of orange juice concentrate, operates a storage and distribution terminal at the Port of Antwerp rather than ship to European grocery chains directly from Brazil. Citrovita can take advantage of low ocean-shipping rates to transport its good in bulk from Brazil to the Belgian port. The company then uses the Antwerp facility to repackage and distribute concentrate to its customer in France, Germany, and the Benelux countries.

AVAILABILITY OF NATURAL RESOURCES. Firms may utilize FDI to access natural resources that are critical to their operation. For instance, because of the decrease in oil production in the United States, many U.S.-based oil companies have been force to make signification investment worldwide to obtain new oil reserves. Often international businesses negotiate with host government to obtain access to raw materials in return for FDI. For example, in 2007  the china National Petroleum Company created  a joint venture with state-owned Petroleos  de Venezuela that will invest $10 billion to extract, refine, and transport 1  million barrels of oil a day Venezuela’s Orinoco basin (see Map 6.1)

ACCESS TO KEY TECHNOLOGY. Another motive for FDI is to gain access to technology. Firms may find it more advantageous to acquire   ownership interests in an existing firm than to assemble an in-house group of research scientists to develop or reproduce an emerging technology. For instance, many Swiss pharmaceutical manufacturers have invested in small U.S. biogenetics companies as an inexpensive means of obtaining cutting –edge biotechnology. Similarly, in 2007 Korea‘s Doosan Infracore paid $4.9 billion for the Bobcat division of Ingersoll-Rand, in order to benefit from Bobcat’s superior technology, outstanding network, and skilled management team. Taiwan‘s Acer Inc., manufacturer of personal computers and workstations, paid $100 million in the 1990s for a pair of silicon Valley computer companies in the hope of leveraging their technology and existing distribution network to boost Acer’s share of the U.S. personal computer market.

Demand factors.

Firm also may engage in FDI to expand the market their products. The demand factors that encourage FDI include customer access marketing advantage, exploitation of competitive advantages, and customer mobility.

CUSTOMER ACCESS. Many types of international business require firms to have a physical presence in the market. For example, fast-food restaurants and retailers must provide convenient access to their outlets for competitive reasons.KFC cannot provide freshly prepared fried chicken to Japanese customers its restaurants in the United States; it must locate outlets in Japan to do so . Similarly, IKEA‘s success in broadening its customer base beyond its home market in Sweden is due to its opening a number of new stores worldwide.

MARKETING ADVANTAGES.  FDI may generate several types of marketing advantages. The physical presence of a factory may enhance the visibility of a foreign firm’s products in the host market. The foreign firm also gains from “buy local” attitudes of host country consumers. For example, through ads in such many magazines as Time and sports illustrated, Toyota has publicized the beneficial impact of its U.S. factories and input purchases on the U.S. economy.                      Firms may also engage in FDI to improve their customer service. Taiwan’s Delta products, which makes battery packs for laptop computers, was concerned that it could not respond quickly and flexibly enough from its factories in china and Thailand to meet the changing needs of its U.S. customers. As one of executives noted, if you “build in the Far East, you’re too far away. You can’t do last-moment modification while the product is on the ocean.” Accordingly, Delta shifted some of its production to a Mexican factory just across the border from Nogales, Arizona, to better serve its U.S. customers.

CUSTOMER MOBILITY. A firm’s FDI also may be motivated by the FDI of its customers or clients. If one of a firm existing customer builds a foreign factory, the firm may decide to locate a new facility of its own nearby, thus enabling it to continue to supply its customers promptly and attentively. Equally important, establishing a new reduces the possibility that a competitor in the host country will step in and steal the customer. For example, Japanese parts suppliers to the major Japanese automakers have responded to the construction of Japanese owned automobile assembly plants in the United States by building their own U.S. factories, warehouses, and research facilities. Their need to locate facilities in the United States is magnified by the automakers’ use Just- In –Time (JIT) inventory management techniques; IT minimizes the amount of part s inventory held at an assembly plants, putting a parts-supply facility located in Japan at a severe disadvantage. Likewise, after Samsung decided to construct and operate an electronics factory in northeast England, six of its Korean parts suppliers also established factories in the Vicinity.

Political factors.

Political factors may also enter into a firm’s decision to undertake FDI .Firms may invest in a foreign country to avoid trade barriers by the host country or take advantage of economic development incentives offered by the host government.

AVAOIDANCE OF TRADE BARRIERS. Firms often build foreign facilities to avoid trade barriers, For example, the Fuji Photo Film company invested $200 million its is Greenwood, south Carolina ,factory complex to begin manufacturing film for sale in the united states. Previously, the company supplied film its U.S. customers from its exporting to it, Fuji avoided a 3.7 percent tariff on film imposed by the United States and deflected claims by Kodak that Fuji was unfairly “dumping” Japanese-made  in the  U.S. market( dumping is explained in chapter 9).Other types of government policies may also impact FDI. Microsoft, for example, is locating a software development center in Richmond, British Colombia, in part to avoid limitations placed by the U.S. government on the number of highly  skilled immigrant workers who can obtain H-1B  works visas in any given year.

ECONOMIC DEVELOPMENT INCENTIVES. Most democratically elected governments-local, states, and national-are vitally concerned with promoting the economic welfare of their citizens, many of whom are, of course, voters. Many government offer incentives to firms to induce them to locate new facilities in the governments’ jurisdictions. Governmental  incentives that can be an important catalyst for FDI include reduced utility rates, employee training programs, and infrastructure additions (such as new roads and railroad spurs),and  tax reduction or tax holidays. Often MNCs benefit from bidding wars among communities eager to attract the companies and the jobs they bring. For instance, Georgia agreed to provide Kia Motors $400 million in incentives to capture that firm’s first   U.S. plant, which is expected to employ 2.500 workers once it becomes operational. Likewise, in 2006, Samsung Electronics announced it would locate its latest chip factory in Austin, after the city and the state granted it a $233 million incentive package.