Agenda for Today
What is FDI?
IB311: Foreign Direct Investment
↳ prodoctionlmanufracture
Arunee Tanvisuth, Ph.D.
BBA, Thammasat Business School
Semester 1/19, Nov 12’ 19 (#9)
Foreign Direct Investment
FDI occurs when a firm invests directly in
facilities to produce or market a good or
service in a foreign country
Once a firm undertakes FDI, it becomes a
multinational enterprise
Two Main Forms of FDI
Greenfield investment (organically)
The establishment of a new operation in a foreign
country able tobuy share
Acquiring or merging with an existing firm in
the foreign country (inorganically)
Minority (10-49%), majority (50-99%), or full
outright stake (100%)
Importance of FDI
Why Firms undertake FDI?
Benefits and Costs of FDI
Government Policy toward FDI
Implications for Managers
MNCs
M&A VS. Greenfield
M&As are quicker to execute than greenfield
investments
Google bought Fitbit tocompetewith Apple
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Foreign firms are acquired because those firms
have valuable assets (brand loyalty, customer
relationships, trademarks or patents, distribution
systems, production systems) and it is easier or less
risky for a firm to acquire those assets than to
build them from the ground up through a greenfield
investment
Firms make acquisitions because they believe they
can increase the efficiency of the acquired unit by
transferring capital, technology, or management
skills
 attractiveness

M&A by ChemChina
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FDI in the World Economy

China Chighest)

ChemChina has acquired a Swiss pesticides and

seeds group, Syngenta (#3 in GMO seeds) for $43 The Flow of FDI
billion The amount of FDI undertaken over a
In 2014, Monsanto sought to acquire Syngenta for a given time period (normally a year)
reported $40 billion, but Syngenta rejected the offer
The deal was prompted by China’s desire to use The Stock of FDI
Syngenta’s portfolio of top-tier chemicals and The total accumulated value of foreign-
patent-protected seeds to improve domestic owned assets at a given time
agricultural output. It is China’s biggest foreign
takeover to date. The Outflows of FDI
China has 19% of world population but 7% of world arable The flow of FDI out of a country
land Xi’s policy of food security
Syngenta's main competitors are Monsanto The Inflows of FDI
Company, BASF, Dow AgroSciences, Bayer The flow of FDI into a country
CropScience and DuPont Pioneer Thaigov invitemanyforiegn firmto invest in Thailand

FDI in the World Economy (2) Why FDI?

FDI has grown rapidly than world
trade and world output
Firms see FDI as a way of circumventing future
avoid trade barriers rising pressures of
protectionism (Trump)
The shift toward democratic political institutions
and free market economies has encouraged FDI
Globalization of the world economy also has a
positive effect on the volume of FDI
Why do firms go to the trouble of
establishing operations abroad
through foreign direct investment
(expensive and risky), when two
alternatives, exporting and licensing,
are available to them for exploiting
the profit opportunities in a foreign
market? cost

Firms believe that it is important to have transportation

Limitation of Exporting
_

tradebarrier

production facilities close to their major

-

customers Limitation of Licensing

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Limitations of Exporting Limitations of Licensing

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The viability of an exporting physical goods is often
According to “Internalization Theory”, licensing has
constrained by transportation costs and trade
3 major drawbacks as a strategy for exploiting
barriers
better
- to
produce
10cal foreign market opportunities
Products that have low value-to-weight ratio and Licensing may result in a firm’s giving away
that can be produced in almost any location… Cemex, valuable technological know-how to a potential
Mexican cement maker has expanded internationally Psurberry luxurgbandbags foreign competitor
by pursuing FDI
-

liscen production Licensing does not give a firm the tight control
Products that have high value-to-weight ratio, such
in Japan
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as electronic components, personal computers, ↳
Japanreduce the price foreign country that may be required to maximize
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Trade barriers such as import tariffs or quotas The firm competitive advantage is based on the
The wave of FDI by Japanese auto companies in the management, marketing, and manufacturing
U.S. since the mid 1980s has been partly driven by capabilities… these capabilities are often not
protectionist threats from Congress and by tariffs amenable to licensing
on the importation of Japanese cars

Why Toyota Prefer FDI? The Pattern of FDI

Observation suggests that firms in the same
Toyota’s competitive advantage in the global auto industry often undertake FDI at about the same
industry is known to come from its superior ability time
to manage the overall process of designing,
engineering, manufacturing, and selling automobiles Strategic Behavior
This theory based on the idea that FDI flows are a
These skills are difficult to articulate or codify,
reflection of strategic rivalry between firms in the
they cannot be written down in a simple licensing global marketplace
contract they are embedded in its organizational
The interdependence between firms in an oligopoly
culture, and culture is sth that cannot be licensed leads to imitative behavior few
major competitor
If Toyota were to allow a foreign entity to produce Oligopoly is an industry composed of a limited number
its cars under license the entity could not do so of large firms
as efficiently as Toyota A critical competitive feature of such industries is
This would limit the ability of the foreign entity to interdependence of the major players… what one firm
fully develop the market potential of that product does can have an immediate impact on the major
competitors, forcing a response in kind
Strategic Behavior
By cutting prices, one firm in an oligopoly can take
market share away from its competitors, thus the
interdependence between firms in an oligopoly leads
to imitative behaviors
Imitative behavior can take many forms in an
oligopoly raising prices, expanding capacity
Knickerbocker argued that the same kind of
imitative behavior characterizes FDI
Studies that have looked at FDI by U.S. firms and
Japanese firms based in oligopolistic industries
tended to imitate each other’s FDI
followed
F 1 St
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Toyota and Nissan responded to investment by Honda
in the U.S. and Europe by undertaking their own FDI in
the U.S. and Europe
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The Eclectic Paradigm
British economist, John Dunning proposed “location-
specific advantage”
Dunning means the advantages that arise from
utilizing resource endowments or assets that are
tied to a particular foreign location and that a firm
finds valuable to combine with its own unique assets
(such as technological, marketing, or management
capabilities)human resource
Dunning accepts the argument of internalization
theory that it is difficult for a firm to license its
own unique capabilities and know-how, therefore, he
argues that combining location-specific assets or
resource endowments with the firm’s own unique
capabilities often requires FDI
The Pattern of FDI (2)
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Multipoint Competition
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The multipoint competition arises when two or
more firms encounter each other in different
regional markets, national markets, or industries
Firms try to match each other’s moves in
different markets to try to hold each other in
check… to ensure that a rival does not gain a
commanding position in one market and then use
the profits generated there to subsidize
competitive attacks in other markets
Many economists favor Internalization Theory as
an explanation for FDI, although most would agree
that the imitative explanation tells an important part
of the story
The Eclectic Paradigm (2)
Natural resources (oil, other minerals), human
resources (low-cost, highly skilled labor)
Silicon Valley… the world center for computer and
semiconductor industry… knowledge being
generated in Silicon Valley with regard to the
design and manufacture of computers and
semiconductors is available nowhere else in the
world Silicon Valley has a location-specific
advantage
Many European, Japanese, South Korean, and
Taiwanese computer and semiconductor firms are
investing in the Silicon Valley because they wish to
benefit from the “externalities” that arise there

Political Ideology and FDI
The Radical View
The Free Market View
The Pragmatic Nationalism
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The Radical View (2)
From 1945 to 1980s, the radical view was very
influential in the world economy
Most communist countries (eastern Europe, China,
Cambodia, Cuba, etc.) and many socialist countries
(particular in Africa) were all opposed in principle to
FDI (in practice, China allowed FDI in the 1970s)
By the early 1990s, the radical position was in
retreat almost everywhere
The collapse of communism in eastern Europe
The poor economic performance of those countries
that embraced the radical position
The strong performance of those developing countries
that embraced capitalism rather than radical ideology
(e.g. Singapore, Hong Kong, and Taiwan)
-
The Radical View (hostile to inward FDI)
The Radical View argues that MNE is an instrument
of imperialist domination
MNE is a tool for exploiting host countries to the
exclusive benefits of their home countries… MNEs
extract profits from the host country and take
depend on them to their home country, giving nothing of value
oftheproduotion to the host country in exchange North afterthewar
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Korea
Key technology is tightly controlled by MNE and
important jobs in the foreign subsidiaries go to home-
country nationals rather than to citizens of the host
country hs Toyotai Honda technology design
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According to this view, no country should permit
foreign corporations to undertake FDI because they
can never be instruments of economic development,
only of economic domination
The Free Market View
The Free Market View argues that international
production should be distributed among countries
of Iabours
according to the theory of comparative advantage
division
MNE is an instrument for dispersing the production
of goods and services to the most efficient locations
around the globe
FDI by MNE increases the overall efficiency of the
world economy
Dell decided to move assembly operations for its
personal computer to Mexico to take advantage of
lower labor costs
U.S. consumers benefit from lower cost of PCs
Mexico gains from technology, skills, and capital that
Dell transfers with its FDI

The Free Market View (2)
Contrary to the Radical View, the
Free Market View stresses that such
resource transfers benefit the host
country and stimulate its economic
growth
The free market view argues that FDI
is a benefit to both the home country
and the host country
The Pragmatic Nationalism (2)
Until the 1980s, Japan’s policy was probably one of
the most restrictive among countries adopting a
pragmatic nationalist stance
Japan perceived that direct entry of foreign
(especially U.S.) firms with ample resources could
hamper the development and growth of its own
industry and technology
This belief led Japan to block the majority of
applications to invest in Japan
Only firms with important technology were allowed
to undertake FDI
IBM and Texas Instruments were able to set up wholly
owned subsidiaries in Japan by insisting that they
would neither license their technology nor enter into a
joint venture with a Japanese firm
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The Pragmatic Nationalism
In practice, many countries have adopted
neither a radical policy nor a free market
policy toward FDI but, instead, a policy that
can best be described as pragmatic nationalism
The Pragmatic Nationalism argues that FDI has
both benefits and costs
FDI can benefit a host country by bringing capital,
skills, technology, and jobs, but those benefits come
at a cost notgood enough
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Countries adopting a pragmatic stance pursue policies
designed to maximize the national benefits and
minimize the national costs… FDI should be allowed so
long as the benefits outweigh the costs
The Pragmatic Nationalism (3)
Another aspect of pragmatic nationalism is the
tendency to aggressively court FDI believed to be
in the national interest by offering subsidies in the
form of tax breaks or grants
Countries in the EU often seem to be competing
with each other to attract U.S. and Japanese FDI
by offering large tax breaks and subsidies
Britain has been the most successful at attracting
Japanese investment in the automobile industry…
Nissan, Toyota, and Honda have major assembly plants
in Britain what will happen to these investment
when Britain exits from the EU
Within the U.S., individual states often compete
with each other to attract FDI
Shifting Ideology
Recent years have seen a marked decline in the
number of countries that adhere to a radical ideology
Increasing number of countries are gravitating
toward the free market and have liberalized their
foreign investment open more
The surge in the volume of FDI worldwide
An increase volume of FDI directed at countries that have
recently liberalized their FDI regimes… China, India, and
Vietnam
In contrast, there is a shift to a more hostile
approach to FDI… Venezuela, Bolivia
In 2005, China National Offshore Oil Company withdrew a
takeover bid for Unocal after highly negative reaction in
Congress US oil company
Dubai-owned company withdrew its planned takeover of some
operations at 6 U.S. ports after negative political reactions
Host-Country Benefits
Resource-Transfer Effects
Many MNEs have access to financial resources
(from internal sources or capital markets) not
available to host-country firms
Technology (both in process and product
technology) can stimulate economic development
and industrialization
Less developed countries must rely on advanced
industrialized nations for much of the technology
required to stimulate economic growth, and FDI can
provide that
Foreign management skills acquired through FDI
may also produce important benefits for the host
country

Resource-Transfer Effects Host-Country Benefits (2)

Beneficial spin-off effects may also arise when local Employment Effects
personnel who are trained to occupy managerial, FDI brings jobs to the host country
financial, and technical posts in the subsidiary of a
Direct effects arise when a foreign MNE employs
foreign MNE leave the firm and help establish
a number of host-country citizens
indigenous firmsimproveuseknouiedgelearntfromlBMtostartownb.us
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labourforce

Indirect effects arise when jobs are created in

iness

Similar benefits may arise if the superior

local suppliers, and when jobs are created because
management skills of a foreign MNE stimulate local
of increased local spending by employees of the
suppliers, distributors, and competitors to improve
MNE
their own management skills
When Toyota decided to open a new auto plant in
In 2012 the Indian government passed legislation to
France, it created 2,000 direct jobs and another
allow foreign enterprises like Walmart, Carrefour,
2,000 jobs in support industries
Tesco entry into the retail sector
Some argue that the jobs created by Japanese auto
These foreign retailers will make major investments in
companies in the U.S. have been more than offset by
distribution infrastructure such as cold storage
the jobs lost in U.S.-owned auto companies
facilities and warehouses
Host-Country Benefits (3)
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Balance-of-Payment Effects pmorelocal
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If FDI is a substitute for imports of
goods or services, the effect can be to
improve the current account of the host
country’s balance of payments
FDI by Japanese automobile companies in the
U.S. and Europe can be seen as substituting for
imports from Japan
The current account of the U.S. balance of
payments has improved because many Japanese
firms are now supplying the U.S. market from
production facilities in the U.S.
Host-Country Benefits (4)
Effects on Competition and Economic Growth
FDI in the form of a greenfield investment will
increase the number of players in a market and
thus consumer choice… which will increase the
level of competition in a national market
The long-term result may include increased
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productivity growth, product and process
innovations, and greater economic growth
FDI by large Western discount stores (Walmart,
Costco, Carrefour, and Tesco) in South Korea in
1996 have encouraged indigenous discount stores
such as E-Mart to improve the efficiency of their
own operations… more competition and lower
prices which benefit South Korean consumers
Balance-of-Payment Effects
When MNE uses a foreign subsidiary to
export goods and services to other
countries
According to UN report, inward FDI by foreign
multinationals has been a major driver of
export-led economic growth in a number of
developing and developed nations
China exports increased from $26 billion in 1985
to more than $250 billion in 2001 and $2.3
trillion in 2014…due to the presence of foreign
multinationals that invested heavily in China
during the 1990s
Effects on Competition and
Economic Growth
FDI’s impact on domestic competition may be
particularly important in the case of services, such as
telecommunication, retailing, and financial services,
where exporting is often not an option
Before the 1997 agreement sponsored by WTO, most of
the world’s telecommunications markets were closed to
foreign competitors, and in most countries, the market
was monopolized by a single carrier (often the SOEs)
The agreement has increased the level of competition in
many national marketsThai borrowhepfrom reqcireto openfinancial serviceforforkngnor
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FDI has increased competition and stimulated
investment in the modernization of telecommunications
networks around the world, leading to better service
The increased competition has resulted in lower prices
Host-Country Costs negative impact
Adverse Effects on Competition
Foreign MNE with greater economic power may drive
indigenous companies out of business and allow the firm
to monopolize the market… once the market is
monopolized, the foreign MNE could raise prices above
those that would prevail in competitive markets
try toprotect themselves fnm foriegnfirm
In India, Hindustan Lever Ltd., the Indian subsidiary
of Unilever, acquired its main local rival, Tata Oil Mills,
to assume a dominant position in the bath soap (75%)
and detergents (30%) markets
Hindustan Lever also acquired local ice cream makers
(Dollops, Kwality, and Milkfood) and increased its
market share from 0% in 1992 to 74% in 1997
Host governments have the right to review and block
any M&As that they view as having a detrimental
impact on competition
Host-Country Costs (3)
Possible Effects on National Sovereignty
and Autonomy
powerful firm
could influence
policy
Some host governments worry that FDI is
accompanied by some loss of economic
independence
Key decisions that can affect the host country’s
economy will be made by a foreign parent that has no
commitment to the host country
Most economists dismiss such concerns as
groundless and irrational
In a world in which firms from all advanced nations
are increasingly investing in each other’s markets, it
is not possible for one country to hold another to
“economic ransom” without hurting itself
Host-Country Costs (2)
negative impact
Adverse Effects on the Balance of Payments
The subsequent outflow of earnings from the
foreign subsidiary to its parent company… this
outflows show up as capital outflow on balance-of-
payments accounts
Host governments may restrict the amount of
earnings that can be repatriated back to home country
When a foreign subsidiary imports a substantial
number of its inputs from abroad
Japanese automobile companies tend to import many
component parts from Japan
Japanese firms responded by pledging to purchase
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75% of their component parts from U.S.-based
manufacturers (not necessary U.S.-owned
manufacturers)
Home-Country Benefits
The inward flow of foreign earnings… foreign
subsidiary creates demands fro home-country
exports of capital equipment, intermediate goods,
and complementary products
Positive employment effects arise when the foreign
subsidiary creates demand for home-country
exports
Foreign subsidiary learns valuable skills from its
exposure to foreign markets that can subsequently
be transferred back to the home country
GM invested in Isuzu and Ford invested in Mazda was
to learn about the production processes of their
Japanese partners
Home-Country Costs
The balance of payments suffers from the initial
capital outflow required to finance FDI… is usually
more than offset by the subsequent inflow of
foreign earnings
The current account of the BOP suffers if the
purpose of the foreign investment is to serve the
home market from a low-cost production location
The current account of the BOP suffers if the FDI
is the substitute for direct exports
With regard to employment effects, the most
serious concerns arise when FDI is seen as a
substitute for domestic production
Home-Country Policies and FDI
Policies to Encourage Outward FDI
Foreign risk insurance (risk of expropriation, war losses,
inability to transfer profits back home)
Capital assistance paytaxwhereyouearn
Tax incentives to eliminate double taxation of foreign
income
Political pressure to persuade host countries to relax their
restrictions on inbound FDI
Policies to Restrict Outward FDI
Exchange-control regulations to limit the amount of capital
outflows
Tax incentives to encourage their firms to invest at home…
to create job at home difftqx Foreignfirm
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The U.S. would lose hundred of thousands of jobs as U.S. Prohibit national firms from investing in certain countries
firms invest in Mexico to take advantage of cheaper labor for political reasons
and then export back to the U.S. Thai follow US action

Host-Country Policies and FDI Implications for Managers

Policies to Encourage Inward FDI Theory of FDI
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Tax concession, low interest loans, grants or
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Exporting is preferable to licensing and FDI so

subsidies
Kentucky offered Toyota an incentive package
worth $147 million to persuade it to build its U.S.
assembly plant there
Policies to Restrict Inward FDI
Ownership restraints… in some countries, foreign
companies are excluded from specific fields
(tobacco and mining in Sweden, 25% or less of
airline in the U.S.)
Performance requirements related to local
content, technology transfer, local participation in
top management
long as transportation costs are minor and trade
barriers are trivial บd
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FDI is preferable to Licensing when
Firm has valuable know-how that cannot be
adequately protected by a licensing contract
The firm needs tight control over a foreign entity
to maximize its market share and earnings
A firm’s skills and capabilities are not amenable to
licensing
Licensing is more common in fragmented, low-
technology industries
3rd International inrestment
Implications for Managers (2)
Government Policy
Investing in countries that have permissive
policies toward FDI is preferable to investing
in countries that restrict FDI
A firm considering FDI must often negotiate
the specific terms of the investment with the
host-country’s government
is good enough
The value each side places on what the other
has to offer
The number of comparable alternatives
available to each side
Each party’s time horizon to complete the
negotiation
period
MNCs (2)
MNCs may gain from their global presence in
a variety of ways. MNCs can benefit from
the economy of scale by…
spreading R&D expenditures and advertising costs
over their global sales
pooling global purchasing power over suppliers
utilizing their technological and managerial know-
how globally with minimal additional costs
using their global presence to take advantage of
underpriced labor services available in certain
developing countries, and gain access to special
R&D capabilities residing in advanced foreign
countries
Multinational Corporations (MNCs)
A corporate organization that owns or controls
production of goods or services in at least one
country other than its home country.
The two main characteristics of MNCs are their
large size and the fact that their worldwide
activities are centrally controlled by the parent
companies.
Importing and exporting goods and services
Making significant investments in a foreign country
Buying and selling licenses in foreign markets
Engaging in contract manufacturing — permitting a local
manufacturer in a foreign country to produce their
products
Opening manufacturing facilities or assembly
operations in foreign countries
Organization of MNCs
Multinational Organization
Organizations that plan and execute strategy on a
country-by-country basis
Ability to customize a set of value propositions
that match the unique demands of a country-
specific market
Country managers have a significant role in
determining the strategic positioning and
marketing approaches that they will use
HQ has very limited influence in articulating a
global mandate of strategic proportions that
would be follow by all the subsidiaries
Multinational Organization (cont)
This approach also limits the ability of individual
country operations to benefit from scale
efficiencies since the local markets are too small
The organization represents the trade-off between
flexibility and local customization against the
potential for reaping scale benefits and other
operational synergies
Fiat, the Italian auto manufacturer, championed the
use of this approach several decades ago
Fiat operated small-scale plants in countries where
there were limited competition or where country
governments offered subsidies to attract Fiat
Fiat was operating in much of Communist Eastern
Europe either in wholly owned venture or through
alliances with local manufacturers
Organization of MNCs (2)
Global Organization
Organizations that call for centralized planning
and decentralized execution
In scale-sensitive industries, efficiency and
operation costs are typically the key drivers of
competitive advantage
This approach offers firms the opportunity to
maximize the benefits of standardization
Downstream functions such as sales and
marketing and after-sale services are located
in the country where the customers are
located
Multinational Organization (cont)
Given the rapid strides toward globalization, the
emergence of homogenized market preferences, and
the decline in tariff and NTBs, the pressure to
adopt pure form of multinational strategies have
declined
This approach is ideal in settings where
Buyer preferences vary by country context where they
are located
Local legislative barriers require significant local
content in the products that are sold locally
It is feasible to obtain local scale economies owning to
the significant size of the local market (China, India)
The product does not lend itself to cost-effective
shipping across long distances, thus requiring local
manufacture and sale on a country-by-country basis
Global Organization (cont)
A global organization approach works if
The industry is populated by firms with the ability
to leverage cross border synergies, engage in
cross-subsidization across country markets
The industry is not subject to limiting tariff or
NTBs that inhibit free flow of goods and services
across borders
It is critical to achieve economies of scale to stay
cost competitive
Customer preferences across country markets are
relatively invariant and minor differences across
markets can be addressed at the local level
From a Multinational to a Global
Organization: Warner-Lambert
The pharmaceutical industry could benefit from global
R&D but had to cope with complex local regulatory issues
for new drugs
The confectionery industry could benefit from global
purchasing, standardized packaging, and manufacturing
economies of scale but still had to deal with the reality
that confectionery is food and, thus, highly local in flavor
and taste preferences
In creating a global line of business structure, WL
substantially reduced the power and authority of the
country subsidiaries and centralized major product
decisions involving branding, positioning, and packaging
WL successfully introduced a range of new products on a
global basis (ex. Lipitor)
Transnational Organization (cont)
The main difference between the
global strategy and the transnational
is that the operations are not always
centralized in the home country
The decentralization decision is based
purely on dimensions such as
economics and other location-specific
advantages
Organization of MNCs (3)
Transnational Organization
This approach attempts to synthesize the
benefits of multi-domestic and global approaches
The transnational approach is characterized by
Decentralization of assets across subsidiaries
Formal knowledge management structures that
promote inter-subsidiary sharing of best
practices and innovations
A blend of formal and informal relationships
and mechanisms across the organizational
hierarchy to leverage efficiency and flexibility
simultaneously
MNC Subsidiary
MNC subsidiary is any value-adding
organizational unit located outside the MNC’s
home-country base
Why traditional country-based authority and
power of subsidiary managers is decreasing
Global customers are emerging with demands for
consistent products and services on a worldwide basis.
MNCs are responding with global account-management
system that provide centralized negotiation for prices,
delivery, and so on, effectively taking these decisions
out of the hands of subsidiary managers
Global supply chains are being integrated so subsidiary
managers may no longer be involved in purchasing and
logistics decision making
MNC Subsidiary (2)
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Why traditional country-based authority and

power of subsidiary managers is decreasing
The Internet is injecting a level of transparency into
global markets that makes it easier and more
important for MNCs to become more integrated,
especially in their dealings with major customers
Global industries demand global integration, and fewer
and fewer companies can afford in a localization mode
even major food MNCs (Unilever, Nestle) recognize
that with some food products (ice cream, cereal, and
chocolate), a globally integrated approach is
strategically necessary
MNC’s R&D organizations are under pressure to
become more efficient and provide more consistent
services to MNC’s primary operating and product
development units