| | | | 1 | ‘ 12 Foreign Direct Investment and | Collaborative Strategies | | Objectives (FOI) and the impact of FDI flows on 1 of FDI lances, and other collaborative250 TEENATION, MOC AnD investi industrialized coin, regions of the wong PU increasingly FDI is also flowing into the developing Latin America, ag , MT the 39905 there has been a large influx of FDI into Asi In this chapter iy, Euro the growth in Foy iy, "2" these global trends in FDI and examine the reasons for country’s economy, 5 sider the impact of FDI on both the home and the host Joint ventures ang go, "3 its implications forthe global economy. We also discuss strategies raises copy laborative agreements between companies. Each of these investment, while og <* #24 controversial issues. Some countries welcome inward agreements help cog» 2ttiously protect their domestic industries. Collaborative they raise competion «S10 develop their research, production, and markets, but wes. These and related issues are developed in this chapter. Na 12.2 Foreign Economy Investment in the Global eum, 12.2.1 Portfol ig ° investment Before considering the . ish between twe ns of foreign investment, itis important to dis f, ment (Portfolio invesige™™S Of investment: portfolio investment and direct invest deposits; anE OTHE fing, tt volves the acquisition of stocks and shares, financial international arena get! €Ssets in order to earn a return on surplus funds. [nthe stock markets and othey ;@™90UNts of portfolio investment flow between the world's markets ot hold curren. 22"Cial centres, Investors purchase shares on foreign stocc ‘money’ across frontierg 9, 4°P°sits at foreign banks, transfering large sums of “hot tives markets are now regis MVestor confidence or interest rates rise and fall. Deriva are contracts Which are «posible fora vastincrease in these capital flows. Derivatives ites, or equities. A deriyar"!¥€d! ffom underlying assets such as currencies, commod- a ature V°S Contract may be for the purchase of currency at an agreed pate (a forward exchange contract) for the purchase of a option to sell an amoung °° On a futur date a futures contract), ort may grant an option). These contracts, Of Shares ata fxed price within a specified time (a share with insurance or a ‘hes, 7% Aumerous similar variants, provide one of the parties pany bears the risk in repg’°” 8Ainst fluctuations in the price of the asset the other eee ce ia agreed price Ineach funds, either in the form eY°StOTs are searching for a pro sold at a higher price. Pory terest and dividends or when their financial assets are inscirutional investors Lijge, CMO investors may be financial institutions and broke ‘surance companies or pension funds, industrial and le use for their surplusFOREIGN DIRECT INVESTMENT. 251 commercial companies, or individuals, Their investments are often sensitive to eco nomic fluctuations or perceived weaknesses iran economy and, when there is turmoil in world markets, movements of portfolio investment may precipitate financial crashes such as the Asian financial crisis of the late 1990s. These investment flo tend to respond quickly when confidence is damaged, but their movements often lying strengths and weakne: s in economies and their institutions. the activities of portfolio investors are sometimes criticized as wasteful specu lation, their funds also help to provide capital and a variety of financial services and their activities send important market signals, 22.2.2 Direct investment rect investment is fundamentally different. 1¢ European Commission defines foreign direct investment (FDI) as ‘the establishment or acquisition of income "try over which the investing firm has control." FDI may include the building of a new plant on a greentield (or brownfield) site as well as or merger. ‘Control’ would normally imply not only the ownership of shares in an operation but also some degree of management control. This may include a joint venture, especially where the company in question hi shareholding, as in the case of Volkswagen in its joint venture with Skoda; Vol wagen has a 70 per cent shareholding and management control of Skoda. However, there is no generally agreed definition of ‘control’. The IMF uses the term ‘significant degree of influence’, which may imply a stake of less than 50 per cent FDLinvolves a he part of a company. It is usually, though not ly, regarded as a longterm commitment on the part of the investing fir S an expansion strategy or a new strategic direction rather than simply surplus funds. Its basic purpose is of course to generate a financial return, like portfolio investment, but the means of doing so and the impli mmpany and the host country are quite different. A company which builds a major v plant abroad may not be able to sell the plant at an acceptable price if the investment is a failure. Nor can the company easily recover its investment in Uaining of its foreign workforce, for example. FDI is therefore the most complete form of market entry strategy and the one which involves the highest risks, but it stegic decision on weer: 12.2.3 The measurement of FDI lis normally measured in value terms. Estimates of its value are based on the fxpenditure of foreign companies on new plant and equipment or the purchase of aired foreign company. This approach raises numerous problems. ‘emnational comparisons of FDI are only possible if a common currency is used. The| | reece Taverne Normally civals< brs cs 4 ify ve arg bard avta Pl co a ep SLE, ALAS sh on an BC . —> Yrceur es fous cat pan, Oram gy een OT SONS. 4 ir ob abe Pee le bn ne alg ed eka les Us kettle tert, = Fen wt toa fy log Po orm LenkteefS D cabemkah4 DT = te of psec be pegeress ene252 INTERNATIONAL TRADE AND US dollar usualy fulfils cis role, but where exchange rates fuctuate wildly, as y the Russian 701 th during the 1990s, for example, the value of FDI may change sub, stantially as the currency’s dollar value changes. Each country has its own methods of calculating FDI and the reliability of ta Collection may also vary. Ideally, it ‘would be preferable to calculate the volume rather than the value of FOL since a elit spent in one country or on one project may not produce the same level Brine os 2 dolar spent elsewhere. In other words, the marginal producrivin ofinvestment may vary. An estimate ofthe volume of FDI would have ra take account of the efficiency with which investment expendi each case. Volume would indical floor area or some simi erates productive assets in the quai DI, measured in terms of factory ‘measure, Such calculations are clearly problematic and it ‘would be dificul to finda single unit of measurement forall types of Fl Further problems arise when considering exactly wh FDI, When the German ele any, Siemens, built 2 new stateoftheart Cicony ona greenfield site near Newcastle in north-east England in the 199 Siemens's expenditure on the project was clearly ugh the project's value a included UK government grants. Ifthe company has subsequently reinvestea Profit Sree te Koperation, itis less clear whether this should be classed as De re profit is an asset of German company but the funds have not bees ly Wans meat fom Germany. Even additional funds invested by the German parens company sre Zecotded a5 FDI unless information on the use ofthis expital is end, ble. The company may also have a significant influence ever sume ofits rene cout te eo Subcontractors, pezhaps even a minority shareholding. These acthoricg could be treated as FDI, but itis unlikely in practice, In to withdraw ity of to include in an estimate of 98, Siemens announced its 'S operations from Newcastle. The sale ofits UK plant might PD ifit br as having a neutral effect the FDI stock if sold to a foreign firm, though in both cases investment and t would remain Seance ee yatiOn Of FDI also varies berween countries. Inward FDI in the UK. for Pelee eludes a large number of takeovers since UK takeover rules are re Zelaxed. In the US civil aviation industry, foreign ownership ed to 25 per sector te ae evel of investment would sill be classed as FDI. China opened its cent eno foreign joint ventures in 1962, provided the Chinese partner hela 50 per cent shareholdings: in py Provincial and local authorities relaxed these rales, Showing majority foreign ownership and management contiol, bur eke cents) cle aeeided to clamp down on foreign retail ownership in 1998. Such cherae vf wea daft aken into account when evaluating long-term FDI trends in Chine These difficulties cast doubt on the reliability o is restrict ‘omparability of FDI data, but FDI in setiigg rms (S, nevertheless, an extremely important international busing The v globa ing a histo: worl but i The offal 2997. alsot UK recip12.2.4 Global trends in FDI The vast increas: ‘DI since the late 1980s has been a prominent feature of the globalization of the world economy. In some respects, the recent process of globaliza tion has unique characteristics. This (s particularly true of the revolution in comput ing and information technology. But the present level of FDI is not unique from a historical perspective. It has been estimated that FDI was approximately 9 per cent of world output in 1913, about the same proportion as it was in the mid-ggos? Of purse, the actual amount of FDI and werld output were much higher in the 396 1913 was the culmination of a period of trade Inberalization, industrial expansion, and empire building by the major industrial nations. The period covering the two world wars and the interwar Great Depression was one of falling FDL The level of FDI has gradually recovered during the post-war years, v the rate of increase accelerating during the recent trends. The increase in the total value of FDI is particularly marked, Whereas the developed countries still do most of the investing and receive mos the investment, the proportion of total FDI going into the developing countries, espe ally into Asia and Latin America, has been increasing significantly. The flow of FDI into Eastern Europe has also been in generally on a smaller scale and from a much lower base. Itis worth noting that companies from some of the develop ing countries are now themselves becoming significant outward investors, The dominant investing country is the USA, with outward FDI of Suis billion in 997. The UK, Japan, Germany, and France are the other leading investors. The USA is also the main destination for FDI, receiving $9 billion in 1997, followed by China the Uk, and France. While these countries now generally head the lists of investing and recipient countries. it should be noted that a large multinational takeover or other one off investment may distort the figures in a particular year, so FDI figures tend to zy over time. The cumulative stock of FDI over a period ‘flong-term trends than the flow of FDI in a particular year. Up to 199 Table 12.1 Trends in FDI flows (Sbn.) 2 last decade or more. Table 12.1 illustrates ime isa better indication the USA had 1985 Inward FO! Developed countries 8 Developing count 22 Centraleastern Europe unsere FO) Developed countries Developing counties tralfaiter Curope234 INTERNATIONAL TRADE AnD invesrutent Chane 2 cumulative EDI stock of $721 billion, well ahead of the Uk (S274 bi China (S217 bill Avvibrant economy and high corporate profitability continue to Most attractive location for FDL, Whilst the world, the EU countries are the big Netherlands, France, and major outw tion) ang make the USA the this investment comes from all ove, est investors in the USA, with Germany, the he UK heading the list in 1997. Several EU cou 4 investors and about half of this investment g countries, especially Germany in Eastern tries are s0eS outside the EU, EU and Austria. are now the most important source of FD, rope. The main inward investors into the EU were the USA. se aban. and Norway in 1997, Asian countries receive about rwe th into developing countries and about half of Asia has long been the largest investor in Asia, thou Kong (predominantly the latter| is now at the major destination for F Investment in Africa is st zerl rds of all FDI going ie goes into China alone. Japan investment from China and Hong lar level. in Latin America, Brazil ig |, followed by Mexico, and the USA the ll much lower than in the other with South Aftica and Nigeria receiving just 0 main investor, main regions of the world er 40 per cent of thi investment in ‘oon 12.25 The impact of FDI for global and national economies FDI has grown more rapidly than eit 52s contributed greatly towards the globalization of boat, and the Ence of the world’s economies. On the one hand, kased in the developed counties, Faas he! dominant influence over the world eConomy and the national trade and financial iMstitutions. On the other hand, BDI has piobably enabled the emerging economies to Gaelee More rapidly than would otherwise have been poritie Some of the emer The rear ate HOW also producing major foreign investors of thels a ‘The investor’schome- country gains ¢ertain adv ges from having home-based MAES These companies repatriate profits and some of tncir sce ibs off on their country of origin, Smaller domestic Rie this helps to give these firms a measure of internat ‘aking their operations abroad, closing down pl ‘Suntry of new investment, This sometimes leads toe and untties, particularly in the developing we ‘companies from investing scarce funds aby has net benefits for the FDI generally hel ither trade or world t since the 29808. It cerdepend- nce the major investing firms are € countries to consolidate their jonal reputation be their suppliers and nal experience. MNES are also lants at home or depriving their home hat they are unpatriotic rid, prevent or restrict their road. Iis likely, however, that outward FD) home country in the long term ips to expand the world economy, Host couttriesvaresometimies more fearful of the eff inward FDI as evidence of a loss of control countries, 46, like international trade, ts of FDL They may see of their economy. Smaller or weaker in particular, often try to retain control over their domestic industry. Even It he ha ge a or Fiey 285 larger ones do this to protect what they regard as strate Bel te deve gna sills, and technology t also provides emplovmens and may help to develop key resources and aid regional segeneretion More importantly, FDI has been a major factor in the development of some of the emerging economies. nied the xe, Taiwan. for a number of years, o: China, moze recetrh have recog. Bed the contribution of FDI to the development of specific inde generally are now beginnin, sic industries. inward FDI, of ies. Countries benefits, to realize that FDI can bring substanti 12.3 The Determinants of FDI NCEPT in a few cases, it is mined by ign direct investment will be deter * cases. a potential investor will consider a wide of factors before taking such an important step. Some of these nn broad over arching factors which indicate the overall desirabiity of in esting abroad or the cee ernitability of a particular country, Other factors are mon specific to the needs of a particu! mang er any, lke the need to gain access to resources and markers Fea ice costs. These factors are considered in tum below and summarized in 12.3.1 Overarching factors in the FDI decision ® General motives Utimately, companies engage in FDI in order to in Select investment project ase their profitabili which offer the prospect of incr: extent the reasons for FD! are similar « also offers opportuni ities. tt can de The sed Ret retums. To this owever, FDI che focus of its activ © for portfolio investmen ‘© expand the company or to change t ie it business through diversifying into new products, extending ene lfeof an existing product or pecalizinginitscer anton: *DI may enable the be aa na competitive advantage overt rvalsby reducing eon or by being gist © enter a developing marker Rasemaver advecraee a broad sense, it maa, Company to extend its business interests or busier are and achieve oS esa & World reputation. Some MNEs have recently been turning ren ream ‘Blobal companies’ with a presence inal the savas ajor markets and "enables them to.dothis whist retaining control af their operrene * The business environment and business culture The business environ ent is a broad term which encompasses the framework of ment policies discussed below, as well as the eneral political and economicAno ae _——.——— Overarching Factors Ss [ / pay gen competitive advantage, market power y ‘world reputation, global presence The Business Environment and Business Culture ble political & economic envionment, absence of nuisance costs (ureaucracy& corruption), quality of lf; business culture: procedu ‘elationships & networks, preference for similar o familie cul Supportive Government Policies macroeconomic stabi ‘market liberalization. low corporate taxation bit. onnership & profitregulations, good education & traning, eficien infrastructure, financial incentives ‘ACountry's Stock of Created Assets’ tangible assets: infrastructure, distribution networks Intangible asets sl, technology, innovation ntellecua Property. organizational relationships, busines be ee | Access to Resources ge quantiles of resources are needed where specialized resources are immobile. where resources are core business eg, mining & petroleum Market Advantages ‘access to large & growing markets, regional export base, SME supply chains, benefits of local labour & supplies, local knowledge and accertance supports relationship marketing’, competitive advant Cost Reduction National competitiveness, low-cost raw materials, energy & labour, external economies of scale, nancial incentives, ow eavation & rnon-wage labour costs, reduced transport casts, internalized sperations Overcoming trade barriers natural bariers: culture & language: trade barrier: tariffs, quotas {mon-tari# barners, barriers ‘an be circumvented ar overcome by FOL more imp gyde, sin its preser governm, em Irela peace or the other the fina 1 often so and som. slush fu coruptt cerned a person The te nd atti This sut addi conduct whilstenvironment, Above all, investors like a stable political environment. This is probably more important than whether a country is in the uptum or dow cycle, since investors are more concerned about an economy's future potential than jut political stability is crucial. Wars and civil unrest are an obvious fe or destruction of property may result. Turbulent changes of to volatility in the business environment, leading to the nationalization or confiscation of foreign assets. It is noticeable that FDI into North em Ireland appears to have been directly affected by the relative probabilities of peace or continued civil unrest during the twists and turns of the ‘peace process’. On the other hand, whereas po: inthew. the financial crisis, direct investors seem to be more content to bide their time. am of its economic ts present state. case where Loss wernment may also le: ke of es and by businesses are hampered by bureaucratic proced corruption. In a number of African countries customs and other public officials are often so poorly paid that they rely on bribes to supplement theft i ‘ome, In Russia contracts. Bureaucracy ar funds’ to bribe public officals in order to ol ruption represent the “nuisance costs’ of doing business in the countries con- cerned and may act as a negative factor in the FDI decision, These factors, and also the general quality of life ina particular city or country, affect the willing personnel to work abroad, The term ‘business culture’ describes the ways in which people conduct business and atticudes towards various types of business activity in a particular country. Bus ess culture is greatly influenced by the general culture and traditions of a country This subject is discussed at length in Chapter 5, At one level, a foreign firm has to take account of the practi s of the host country’s business procedure address and greeting, use of language and body movements, dress codes, methods of conducting business, and so on. At another level, there are the complexities of busi ‘ess relationships and networks which reflect the patterns of society as a whole, Whilst it is possible for a foreign investor to adapt to these cultural differences, ‘mistakes can easily De made and inadequate prep: tration and even the failure ofa project. In order t jon can lead to oid these pitfalls some MNEs adopt a cautious approach to FDI, par larly in the early stages of internationalization, venturing initially into countries which have a similar or familiar business culture. Thus, British companies venture into the USA, with its Anglo-Saxon culture, or into France, with its different but familiar culture, and Spanish and Portuguese companies are major investors in Latin America, In practice, business cultures sometimes turn o expected and numerous other fa to be less familia may influence these investin ™ Supportive government policies Bisoften argued that pote ot tax concessions from the host government. Indeed, govern ants seem to competepn ies 258 turenwarionas rexo# au invesritenT with each other to provide the largest incentives, Sometimes this happens within the = Acot European Union when investors are enticed by regional funds from a common Euro. uNcTat ean budget as wells by individual government schemes. It may even happen within country a single country when competing regional agencies outbid each other to attract a byathes prestigious investor, Whilst these efforts may confirm the importance of FDI to the then host counuy, itis doubtful whether a long term cost-benefit analysis would indicate nesived net benefits in each individual case. This is because, where a firm is attracted by tabour ncentives which are not complemented by a generally favourable investment cl janavat mate, the firm is less likely to stay for the long term, Competing incentives mi oat simply create an ‘incentive merry-go-round’, leaving redundant workers and other The bu: resources in its wake (see Chapter 6 on ‘social dumping’) mayals Clearly, governments do resort to these short-term strategies and investors are Thes ~ Sometimes attracted by them, If they are used sparingly to help overcome the availab mmherited disadvantage’ of a decaying industrial infrastru a legacy of redur ine dant skills in a particular region, government financial support may be justified. F meet they distort investment location by encouraging firms to make inappropriate shore created term decisions, they are more difficult ro justif logical Much more important are government policies which provide a supportive bust eatin ness environment. These inchide macroeconomic stability and market liberalization forfor Macroeconomic stability helps to ensure low inflation, low interest rates, anda stable been 6 exchange rate Inflation raises production costs and puts pressure ona firm either to dal po raise its prices orto reduce its profit margins. Icalso makes it difficult to estimate the wechnc rice of a longterm contract. High interest rates increase the cost of capital. ‘we Exchange rate instability increases a firm's foreign exchange exposure and a falling busine currency may severely reduce the value of repatriated profits. Market liberalization ay allows the foreign investor to enter markets, make flexible use of resources, and have the freedom to make its own decisions. The ‘Anglo-Saxon’ economies (especially the Usa) are often cited as examples of countries with flexible labour markets and deregu: = lated markets generally (see Section 8.2.2), Privatization often accompanies market 12.3, liberalization and this provides an oppo: oF to acquire an ry established enterprise and its markets. a Aci Supportive government policies may include low corporate taxation in general, as i well as ‘tax holidays stors) and policies such as tax credits to encour Hier age research and investment in technology, fot example. The conversblity ofc nee rencies and regulations on foreign ownership or the repatriation of profits are also oe important. Investors may be attracted by policies which promote high standards of sec education and taining and create an efficient industrial infrastructure through pub- ee lic investment, privatization, or deregulation, Increasingly. governments around the fess world are realizing the importance of creating a policy environment which i attract ive to foreign investors. As more countries adopt such policies, investors will of Pp é course become more demanding. This may again stimulate competition between fe governments to attract FDL If this competition encourages them to provide the best 3 envionment for busines, this wil benefit domestic as well as fregn fms 2 md ice, there is still some way to go in many countriesFOREIGN DIRECT INVESTMENT 259 = Acountry’s stock of ‘created assets’ UNCTAD uses the term ‘created assets’ to describe a wide range of assets which a country has developed over time.* They have been ‘created’ by human endeavour and, by the supportive actions of firms, governments, and other organizations. Some of these assets are tangible such as a country’s industrial infrastructure or distribution networks. Others are knowledge-based and are therefore intangible, These include labour and managerial skills, the level of technological knowledge, the capacity for innovation, the stock of intellectual property (patents, trade marks, etc), and rela tionships between governments, companies, universities, and other organizations. The business culture in a country and its people's attitude towards wealth creation may also be regarded as intangible ‘created assets These created assets are now generally more important in many industries than the availability of narural resources. Thus, a country with few natural resources may still be an attractive location for PDI, provided it offers a favourable environment in other respects. Japan could offer an attractive location for FDI with respect to some of its, created assets, despite its lack of raw materials, Its skilled labour and stock of techno- logical knowledge are key assets, but unfortunately its business relationships and culture have in some respects become liabilities, both for its own companies and also ‘or foreign investors (see Sections 8.2.4, 8.4.3, and 9.4.2) FDI into Japan, therefore, has been consistently low for a major industrialized nation, even before its recent finan- cial problems. Some firms may look for specific created assets like skilled labour or technology but, in general, created assets help to provide a broadly favourable business climate in a host country. These assets do not simply create a sympathetic business climate, they help to provide the combination of factors a multinational enterprise needs in order to be internationally competitive. 12.3.2 Specific factors in the FDI deci = Access to resources Historically, many industries were located close to raw materials or sources of energy especially iron are and coal, In the modern world of fast, low-cost transpo: available power supplies, and less reliance on bulk raw materials, investment decisions are less likely to be influenced by these factors. For many firms, the avail: ability of resources is no longer a limiting factor in their location decisions. In a few industries, access to resources is still crucial, however. This is clearly the case in the readily extractive industries such as mining and petroleum. A significant proportion of the FDI in the less developed countries is in these industries, particularly in Africa and entral Asian republics of Azerbaijan and Kazakhstan. In general, the Tesources may affect FDI decisions where raw materials, energy, or labour are re large quantities, where specialized resources are immobile, or where access to resources is a company’s core business. ocation ofBut tts The Republic of eland has apopultionafjust 37 milion andisstuatedon the periphery ofthe European Union. Yet during the rggosits economy recorded an average annual ‘rout rate of about 6 percent, reaching 10.4 per centin1g95.nd ¢.5in1g97. This ‘was the highest growth rate in the EU and one of the highest rates among the OECD countries Ireland's per capita GDP isnaw rising rapidlyandis soon likely to exceed that of the United Kingdom. This hasled some observers olen the Irish economy tothe “tiger economies’. Moreover, Ireland has achieved this economic performance whilst reducing its budget deficit and public debt and maintaining lowinflation aided by a series of wage agreements between workers and management. Its economic suc been accompanied, and to an extent caus has not been predominantlyin ireland! ‘computers, healthcare, financials ‘mentin information te has by large inflows of FO. Foreign investment raditional industries, thas been in ele 7 ices, and other high-technology sectors. US invest ‘chnology has been a particular feature, making Ireland the second largest exporter of computer software after the USA Sohow hasireland managed to attract FDlon this scale and in these industries? Fis even before itstarted to comply with the Maastricht Treaty'sconverg monetary union, the Irish government was zation. The rsh economy ie criteria for 3 adopting policies of macroeconomic: has close links with the UK, but italso has an open econ with exports and imports accounting for igh proportion of ts GDP. ireland hee ¢ growing and well-educated workforce, enabling foreign investors to recruit people with the required skils.Ithas received large amounts of EU funding, especially from the Cohesion Fund and ther structural funds. These funds, amounting to about sper cent of reland's GDP in recent years, have helped to improve the country’s industria Inf, structure. US investors have received encouragement from the US administration and thelrish {ndustral Development Authority has been activerot only in attracting foreign investors butalso in setting up support services for them. Ifthis were not enousgh, ireland also hes a corporate taxrate of o percent (due to rise to 125 percent in 2003). whichis particulary attractive to companies in sunriseindustries keen to maximize ther slender profit [Rargins.reland's experience illustrates many of the factors which determine FDI. In the longertermn, when some ofthe support policies recede, it should be possible to see nether Ireland provides the right kind of environment to pers suade its foreign investors Main souree: Financia! Times Survey reland, 23 Sept. 1998.) = Market advantages access to resources has diminished in importance, access to m: ‘More important. Many of the markets in is become developed countries have been growin; y in recent years and some markers may n markets, especially in rapidly developi opportunity for further expansion, likely to attrac be approaching saturation, g countries, therefore pro he size and growth ra FDI. A foreign location may also as an export b kmarkets in the region, Proximity to markets is not just of benefit to large MNEs. Small and medium-sized enterprises (SMEs) are often suppliers to large companies ‘and may need to follow their customers abroad. FDI into Eastern Europe, for instance, has included large numbers of SMEs which make up the supply chains of their larger customers, ‘There are a number of advantages in being located close to the market. FDI within a target market enables the investor to employ a local workforce and to use local suppliers, This gives the firm access to local knowledge and understanding of the Jocal culture. It may also help the firm to gain acceptance of its product if its seen as belonging to the local community and making a positive contribution to the local ‘economy, This will of course depend on how the firm conducts itself. The present emphasis on ‘relationship marketing’ (discussed in Chapter 3) may also increase the desirability of being close to the market. The development of long-term relationships with customers. building up a picture of their require- ments and preferences, helps the supplier to focus its marketing more effectively on its customer profile. This reduces the cost of marketing and some of the trans, action costs involved in selling the product and improves the effectiveness of ‘a company's marketing effort. Proximity to the market may not be essential but ft is likely to make this process easier. It may also offer competitive advantages, A company may gain ‘first mover advantages’ by entering a market before its competitors or may attempt to catch up by following the competition, In both cases, the company will be able to respond more quickly if it is close to the market = Cost reduction YINEs sometimes transfer all or part of a production process to low-cost countries ia order to reduce their overall production costs and improve their international com Petitiveness, This i likely 10 occur where large amounts of basic raw materials nergy of labour are required in the production process. Hourly labour cost in Asia (excluding Japan, including both the wage and non-wage coms of labour, are onl about 5 percent of labour costs in Germany, for example, though German producti ity helps to reduce the gap in terms of unit labour costs. It is less likely that a company would seek a low-cost location for acces to specialist skis, management expertise advanced technology. or other high valueadding assets. firm may, of course achieve a cost reduction by taking advantage of external economies of scale in & country where dusters of highly skilled labour or technical support are in abun ance; the influx of South Korean investment into Wester Europe Curing the 9908 ‘ay, in par reflect tis motivation Cort motives are clearly an important factor in the FDI decisions of many com Panies. Despite this, MNEs stl collectively employ the majority of their workforce in ‘the high-cost industrialized countries, which suggests either that other factors are considered more important or that unit costs can be controlled without the need © lecare in lowcost countries. These costs are sometimes reduced for investors 1y financial inducements in the form of government grants or tax concessionsi 32 INTERNATIONAL Trae AND spy Similarly, low corporate tax tates and red 35 2 cost incentive. Prong help to ‘edtice transport costs, Ft offs a unique advan, anagement of ; coe anys Intemational op rations ig OOF reducing the transactigs “esis which would arise brent sep Overcoming trade barriers Finally, companies have oor ne With innumerable barren these are natural bars me by being leamed, employm: Thiet foreign markets. Some These can be overco through FDI an trade. ¢ ‘when attempting tg ers like cuiture oy Janguage through, t Of local worker Quotas, and a Z Product stand; ® Procedures. These wt discussed in Chapter g Tariffs and q a imvented by FD, . wich COUAY concerned. soo rege ROMaritT barriers suit have to be complied A ~ Hit, ut compliance is en 7 15 locally based and the company ke Iss a&cess to local offcans The USA and 2 number af European tr imposed quotas or r restraints on nm be hi ap; apr eve one, 0 fOFmalize the reasons for FD by developing or Pplying Pro theoretica] “xplanations. Some of hese ideas are derived fom the theories of i ofte agonal trade, investment, o- marketing. Bach of the, Contributes towards ou, rath Understanding of the wine P8 teasons for FDI or gre Ts an cular kind oF POY, but th “ere iS no complete theory of roy & Traditional theories of, international trade and investment in whose production they their resoure In traditional th Cut in the most productiy ‘XpOrt their See cubOMted from counties th, can pro ©*ploit their comparative hough not necessarily cian advane. theory o Heckscher and oj atural factor endown, efit the world as a whole The basic © Was later adapted in compay nents. Where land or the Heckscher-Ohy Te advantage stems from ¢ “sbour ae in plentifil sup lutely) better at pro | iN ModelFORSICN DIRECT investuenT 263 wall generally be lower. Not oaly will a country with resources develop its own industries which uce reign firms. Thus, these theories national trade. In its basic form, traditional th ities, I vundant or productive Ces, it will also attract, DI as well as for inter- these resour offer an explanation for Fi eric gnePs £0 explain why resourcedintensive aciy- vies oes. agriculture, and even tourism mee attracted to par. Scular countries or regions. if comparative advantage stems from ac: assets as Well as natural resourer industries which are in search of 4 Uicated assets. In a broad sense, tr ing explanati for FDI, but it does not capture factors which affect FDI decisions in practice ditional theory provides an underly » Capital arbitrage theory arbitrage in capital markets is th lower price in one market and sol may be borrowed at a ‘ate, The arbitrag (o equalize prices free movement of between markets, cay highest return This theory has bee applicability to portfal wyutemational movements in interest rar aolicable to FDI, which responds to (ver, ina general sense, any Prospect of @ higher re ofen influenced by a combi Rther general explanation, process by which financial ld at a higher lower interest rate an does thi assets are bought at a Price in another. Alternatively, funds @ loaned to someone else at a higher 1 Gr Cour, to makwa profit but the effec of abit, seis fad a ates Between markets, provided there ie completely PMAL As long as there are price or interest rane Pial will be attracted to the markets where ft ca nces eam the Fo eblied to flows of foreign investment. It is easy to see its vauestment as this type of investment is often very sensitive fes and other factors. It is 1 long-term rather than short ‘investment willbe attra: In the case of FDI the ion of factors, 1m factors, How: icted to locations where there isa Profitability of an investment is $0 capital arbitrage theory only offers 4 * Product life-cycle theory ternon's theory of the product lifecycle iS sometimes applied to FDL* Vernon argued. guihe basis of empirical research {Rat & new product would initially be rane. ee, 3. in the USA, then a5 the US mare feveloped, opportunities for expor peso other advanced countries would anne When the US market reached maturity thse other markets would have Fe ATBE eRough Co justify investment in produ ‘ton plants in those dang markets mature, production would become Rote standard Teanc® Would become more intense. Producers i lowescost locations for production, proba his theory helps to explain whi Ps nntries are in due course countries. and price con Mould then look for bly in developing Y Products once manufactured in fe at lower cost in developin; ‘ountties, For exam, ‘countries and ple, a number of Euro. who formerly supplied the European textile2a AL TRADE AND industry, now have their main mark: most of the low-cost textile producers are based. Ina more limited way sometimes uct by licensing its production in a less developed country. This was the case when xtended the life of their prod. fed for its obsolescent Maestro rai ence in Bulg: Rover arran of vehicles to be produced under li gos. But herein lies one of the problems with this theory. It does not explain why a firm should engage in FDI rather than licensin even exporting from its home base, for example. Labour costs may be lower in. developing country but economies of scale could be achieved by concentrating pro- duction in an established plant at home, Product life-cycle theory helps why some products follow a particular pattern of production and F n why some products are first produced in developin; products sometimes appear simultaneously in different countries. xia in the mi explain It does not hy similar exp = Dunning’s eclectic theory of FDI ‘The eclectic theory of FDI brings together a number of explar be cla tions for FDIw fied either as ownershipspecific advantages (0), locationspecific advan- tages (L), or internalization advantages (1)’ For this reason it is also known as the OLI paradigm. Ownership-specific advantages arise because FDI allows a company to retain ownership ofits foreign subsidiaries {though FDI may involve control without fall ow ership). Ownership enables it to enjoy exclusiv research, management, supply chains ‘These fact use of patents, technology. and marketing techniques, ;ble it to obtain economies of scale at the level of the firm as a whole the plan the traditional theories of FDL Location pr labour, and markets. It may also help a firm government restric Internalizat integrated. Horizontal integration exists where a takeover extends a firm's main activit operations ai nt s cause FDI all internal expansion s abroad, Vertical integration extends its activities to ges of production, such as the control of suppli tributors. In both cases, integration enables a firm to ‘intemalize’ its 0 within the group and th juce the tr arise berween two independen careful use of t various divisions now becomes possible, enabling a firm to manage its resources and 1 tax lability. Ve s a greater degree of control over sup- ply. production, and markets. Internalization may also help a firm to retain the be lled labour and technology within the o ‘The eclectic theory of FDI provides a wide range of pi suggesting tha or dis rations sts that would ocherwise sfer pricing between the izatios ble explanations for FDI, re motivated by a co these factors. The theory tobe ation fer guidance on which factors are lik the important ones in particular circumstances. is probably realistic, but it does not of more f buye supply tumke 12.4 A joir of cor panie betws Wher legal equit It joint asset skill tech12.4 Collaborative Strategies Wntenendest fs These ince jlnevencre epreements, where two or where there smo equity participation, Tne ater may be of wo typer: ee. er are Duyerseller ageementethose which involve eter the purcose of supplies oF feces through subcontracting or exclusive supp) 2 supply specified services through licensing, franchising management contests and ment, oF agreements {0 = 12.4.1 Joint-venture agreements (JVAs) A jointventure agreement (JVA] may be de: more firms hold of control. The ve cribed as an agreement where two or ity capital in a venture over wihich they each hav 3re may be a separate operation set up by the shareholding com- Panies or one of the companies may hold shares in the other(s). AVA lies somewhere between a merger at one end of the spectrum and a strategic alliance at the other. When a merger takes place two or more independent firms join to became a single legal entity. Under a JVA the firms retain their one firm, may, in some instances, have a majority share in the other, A strategic alliance iS a looser type of arrangement which does not normally involve ihe holding of equit separate legal starus the een common for JVAs to be used by companies from developing countries as, initial entry strategies to gain access to markets or natural resources in developed countries. Even large Japanese companies have used this type of strategy. For example, in 1983 Toyota set up its first manufacturing operation in the USA as a 50/50 joint venture with General Motors, As a short-term strategy, JVAs help to reduce the Hisks of complete FDI. More recently, JVAs have been seen as a valid longterm entry Strategy in their own right. Companies from developed capital-exporting countries ire now using JVAs as an alternative form of entry when seeking complementary assets in high technology as well as traditional industries. In such cases each partner ings different but complementary resources, markets, and skills to the joint WVAs are ski metimes used where governments want the benefits of technology, and other assets of foreign companies without losing complete ownership and ol. In Asia, Taiwan has used this strategy to good effect when devel its ‘schnology industries. JVAs have been encouraged in selected industries in China fe26 INTERNATIONA TRADE aNO tnvesrastny similar reasons. 5 also favoured joi than to develop strat Eastern European govemments during the 19905 have Preference to full FDI, but more for ‘Ownership reasons is, In this case, | Privatization has createg swagen’s joing shareholding er cent, Tetum for establisheg Plants, a low-cost wetbeducated fo 8. and an embryonic market. tre Czech gow. The nent has also retained the Skoda name and gained a revitalized ear manufactarer, The VW'Skoda joint venture hag wenetienced some ofthe disagreements Which are semiuon in this type of arrangemene JVAS, by their very nature, require their con. Senting parties to have common “Plectives and these can change overtime A strategic all firms which is meat’ SeneTally involve coopera lance is a nonequity Cooperation agreement intended to promote their joint competitive a ‘on in one or more of t foeatch and development, and man {Gr a project or may want to shane Plementary activites. Alliances in Siithis pe. An aliance may ain denied by gove: This type of at alliances is tered into an alia, “WBNeS to Rolls Royce prior to the sale 8 The allian, © between Rolls Kayce and BMW" enabled Rolls Shon of engines to meet modem efficiency and i whilst allowing BMW to move huss into the luxury BMW was outbid by Volks Sold by is parent company, Vickers, bry Aerospace, the owner of the RollsRoyee oe pent f0 se the name from the year 2003, leaving car market with the sngen When the Rolls Royce business BMW used its close links with Rare Royce brand name, to gain the lon Volkswagen with entley name, This tha Mlustrates not only the researce Production, and marker, ing benefits of an allance, but also indicates the enn ‘wth which the partners can end the allonee When it suits them, Despite the precatiousness of many stra increasing in recent years. An alliance allows i saree Oh and market expansion. The tne Saved can often provide significant Strategic advantages over rivals Indeed, a8 more fioms form alliances those which do seat mote likely tobe left Behin There is, ofcourse, a competiiny issue with Strategic alliances. Firms which “SSOPEEIE, especially in the market place we less alliances, theit popularity has been S Partners to speed up the processes of ke ind ofc tor thePeeneaiGestimated tobe about 500 airineallances around the word perueen intemationl arin and regional or local aiines there al links between major international ari tines, The four largest of these alia fifance (United Airlines oftheUS, Luthansa of Germany, canting [SAS]. Ai Canada, Varig of Graal, Tha ines, A New Zealand, se Ansett Australia), Qneword (British Airways, American Aine, Cathay Paciic ‘of Hong Kong, Canadian Aiines. and Quantas of Australia, joined by Iberia of Spain \d Finnair during 1596), ‘Wings (KLM of the Netherlands Continental Airlines ofthe Us and Alitalia), and an selena aiveen Delta Air Lines of the US, Suissa, Austrian aiines sade ena of AaGlim. The Oneworidaliance was formed afters two leading members, British US, UK, and EU competition satlanticlink-up unless they were INces are Star Wvian Airlines System authorities for failing to approve their proposed tran willing to give up large numbers of airport slots, Afances enable airlines to code-shave(seling tickets to destin alliance partners), cooperate om fares airport iounges, share information, aircraft use. Oneworld is at present. tations served by their share each other's frequent fyer schemes and Purchase aitport services jointly, and coordinate ‘unable to code share or cooperate on faresas they fave not yet received requlatory approval. Cooperation of ticle bring benefits to Fran ty Ost savings and the convenience of through-tickets evterton frequent prrsthemes,sharedinformation and other cities Hower, airline alliances increase Se market power ofthe majorairines, which they mayne aan fares or keep smaller meeettoF the market, Aliances are often fragile lasting only short time, though porta idence suggests that aitines are beginning to settle cows ny thelr preferred ncets Although alliances are generally loose arrangement equity stakes are te miesirvolved and the management of tne allencos becoming mars formal. In tearing industry, lances provide evidence ot melden: industry consolidation as Soba! competition intensifies. (Adapted from M. Shope ‘Airline tie-ups show thele aed Pome. Fnancil Times, 25 an. ogq and M Shape Toe ce fivesairine allce' Financial Times, 26 jan 1999) sey omPete. Competition between alliances re Actvidual ems. The cons to wort sin Places competition between mer and smaller non-aligned rivals face the increased risk ® behaviour. On the other hand, cooperation which leads raat nding improvements in product or service quality a ‘hnology, is a posit Pe of strategic alliances, "Re spread of tec