Unit 2

Foreign Direct
Investment - FDI
.
 Definition

• Foreign Direct Investment: The establishment of

a plant or distribution network abroad. Investors
can acquire part or all of the equity of an existing
foreign corporation either to control or share
control over sales, production, and research and
development.
 The basic questions of FDI
(6W+H)
Who? (is the investor)

What? (kind of FDI)

Why? (are we investing)

Where? (is the FDI going)

When? (do we invest)

How? (the mode of entry)

 Types of FDI
• Horizontal FDI arises when a firm duplicates its home
country-based activities at the same value chain stage in
a host country through FDI.
• Platform FDI Foreign direct investment from a source
country into a destination country for the purpose of
exporting to a third country.
• Vertical FDI takes place when a firm through FDI
moves upstream or downstream in different value
chains i.e., when firms perform value-adding activities
stage by stage in a vertical fashion in a host country.
Khi công nghệ nước đó trở nên lỗi thời, thì chuyển sang nước kém phát triển hơn
tận dụng nguyên liệu nước ngoài: Nguyên vật liệu và nhân công giá rẻ
Horizontal FDI là phổ biến nhất do 3 lí do trên
-Platform FDI:
 Example

Backward Prior Stage

Vertical of
Merger Production
Lat
er a
l Me
Rel rge
a r
Pro ted
duc Horizontal Merger
ts
Same Stage of
Production
i n g
y
r sif er
i ve erg s
D M
l ink Forward Later Stage
No Vertical of
Merger Production

TYPES OF MERGERS
 OLI theory

• O – who is an FD Investor?

• L - Where to invest?

• I – Why to invest?
 O = Ownership advantages

• Some firms have a firm specific capital known as

knowledge capital: Capital, Human capital
(managers), patents, technologies, brand,
reputation…

• This capital can be replicated in different countries

without losing its value, and easily transferred
within the firm without high transaction costs
 L – Localization advantages

Producing close to final consumers or downstream customers

Saving transport costs

Obtaining cheap inputs

Jumping trade barriers

Provide services (for most services production and delivery

have to be contemporaneous)
 I – internalization advantages
Why don't a firm just sign a contract with a
subcontractor (external agent) in a foreign country?
Because contracting out is risky: it implies
transferring the specific capital outside the firm and
revealing the proprietary information (e.g. how to
use the technology or the patent).
Problem:
If the agent interrupts the contract it can use the
technology to compete with the mother company
In the case of brands/reputation: if the agent
damages the brand reputation
 OLI approach - conclusions
• The eclectic, or OLI paradigm, suggests that the
greater the O and I advantages possessed by firms
and the more the L advantages of creating,
acquiring (or augmenting) and exploiting these
advantages from a location outside its home
country, the more FDI will be undertaken
• Where firms possess substantial O and I
advantages but the L advantages favor the home
country, then domestic investment will be preferred
to FDI and foreign markets will be supplies by
exports
 4 types of FDI derived from OLI
theory

• The typology of FDI was developed by Jere

Behrman to explain the different objectives of FDI:
• Resource seeking FDI
• Market seeking FDI
• Efficiency seeking (global sourcing FDI)
• Strategic asset/capabilities seeking FDI

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 Resource seeking FDI

• To seek and secure natural resources e.g.

minerals, raw materials, or lower labor
costs for the investing company
• For example, a German company
opening a plant in Slovakia to produce
and re-export to Germany

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 Market seeking FDI

• To identify and exploit new markets for the

firms` finished products
• Unique possibility for some type of services for
which production and distribution have to be
contemporaneous (telecom, water supply,
energy supply)
• Automotive TNCs have invested heavily in
China
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 Efficiency seeking FDI

• To restructure its existing investments so as

to achieve an efficient allocation of
international economic activity of the firms
• International specialization whereby firms seek to benefit
from differences in product and factor prices and to
diversify risk
• Global sourcing – resource saving and improved
efficiency by rationalizing the structure of their global
activities. Undertaken primarily by network based MNCs
with global sourcing operations.
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 Strategic asset/capabilities seeking
FDI
• MNCs pursue strategic operations through the purchase of
existing firms and/or assets in order to protect O specific
advantages in order to sustain or advance its global
competitive position
• Acquisition of key established local firms
• Acquisition of local capabilities including R&D, knowledge
and human capital
• Acquisition of market knowledge
• Pre empting market entrance by competitors
• Pre empting the acquisition by local firms by competitors
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 FDI theories on macro level
• Capital market theory
• One of the oldest theories of FDI (60s)
• FDI is determined by interest rates

• Dynamic macroeconomic FDI theory

• FDI are a long term function of TNC strategies
• The timing of the investment depends on the changes in the
macroeconomic environment ( PESTEL)
• „hysteresis effect“
 FDI theories on macro level
• FDI theory based on exchange rates
• Analyses the relationship of FDI flows and exchange rate
changes
• FDI as a tool of exchange rate risk reduction

• FDI theory based on economic geography

• Explores the factors influencing the creation of international
production clusters
• Innovation as a determinant of FDI – „Greta Garbo effect“
 FDI theories on macro level

• Gravity approach to FDI

• The closer two countries are (geographically,
economically, culturally etc. ) the higher will be the FDI
flows between these countries

• FDI theories based on institutional analysis

• Explores the importance of the institutional framework
on the FDI flows
• Political stability – key factor
 FPI

• Foreign Portfolio Investment: The purchase of

shares and long-term debt obligations from a
foreign entity. Portfolio investors do not aim to
take control of a corporation. They can liquidate
their investment at market value any time.
 FDI/FPI

• Form
• Management control
• Liquidity
• Strategic Approach: Foreign direct investment
decisions based on business strategies. Investors
seek access to raw materials, markets, product
efficiency, and “know-how”.
• Cash Flow: The total amount of cash that remains
in a company after it has paid taxes and other cash
expenses.
• Investment Incentives: benefits such as cash
grants, tax credits, accelerated depreciation, and
low interest-bearing loans, which are sponsored by
national or local authorities to attract foreign
investment.
• Exclusive Distributor: An independent sales agent who is
given the soles right, under contract, to sell a foreign
manufacturer’s products.
• Multiple Distributor: A sales agent who represents more
than one manufacturers.
• Royalty Payments: the payments made by a foreign
manufacturer to a company that has licensed the
manufacturer to produce its products.
• Joint Venture: A subsidiary formed by two or more
corporations.
•
 Joint venture enterprise
• A joint venture enterprise (JVE) is an enterprise
established in Vietnam on the basis of a joint venture
contract signed by two or more parties for the purpose
of conducting investment and business in Vietnam. A
joint venture contract may be entered into between:
• (i) a Vietnamese party and a foreign party;
(ii) a Vietnamese party and a wholly foreign owned
enterprise;
(iii) a JVE and a foreign party;
(iv) a JVE and a wholly foreign owned enterprise; or
(v) two JVEs.
Wholly foreign owned enterprise

• A wholly foreign owned enterprise (WFOE) is an

enterprise owned and established by one or more
foreign investors under which the investors will
manage the enterprise and assume full
responsibility for its debts and liabilities. An
existing WFOE in Vietnam may cooperate with
another WFOE and/or with foreign investors to
establish a WFOE. A WFOE may be established as
a joint-stock company, a limited liability company
or a partnership.
Business cooperation contract

• A business cooperation contract is a form of FDI

established via a contractual arrangement between
two or more parties without creating a legal
entity. The contract should stipulate the
responsibilities and distribution of profits and
liabilities between the parties.
 Foreign company branch vs.
representative office
• A foreign company branch established under
Vietnamese laws is regarded as the dependent unit
of a foreign investor. It is permitted to engage in
commercial activities which include investment.
On the other hand, a representative office, also a
dependent unit of a foreign investor, may be
established by a foreign investor, but only for
conducting market surveys and commercial
promotion activities permitted under Vietnamese
laws.
 Subsidiary/ branch/
representative office
• Capital own
• Independence/dependence
• Activities
 Multinational company

• The term ‘multinational’ is used for a company

which has subsidiaries or sales facilities throughout
the world.
• Another expression for this type of business
enterprise is ‘global corporation’
• Example: Coca Cola, Heinz, Sony, Hitachi, Akzo,
General Motors…
 Multinational strategy

• A strategy of adapting products and their marketing

strategies in each national market to suit local
preferences.
• Multinational strategy allows companies to closely
monitor buyer preferences in each local market and
respond quickly and effectively as new buyer
preferences emerge.
• It does not allow companies to exploit scale economies
in product development, manufacturing, or marketing.
 Global strategy

• A strategy of offering the same products using the same

marketing strategy in all national markets.
• The main benefit of a global strategy is its cost savings
due to product and marketing standardization.
• It allows managers to share lessons learned in one
market with managers at other locations.
• It may cause a company to overlook important
differences in buyer preferences from one market to
another.
 Licensing
• Licensing – Practice by which one company owning
intangible property (the licensor) grants another firm (the
licensee) the right to use that property for a specified
period of time.
• E.g.
-Hitachi (Japan) licenses from Duales System Deutschland
(Germany) technology to be used in the recycling of
plastics in Japan.
-Hewlett-Packard (United States) licenses from Canon
(Japan) a printer engine for use in its monochrome laser
printers.
 Franchising
• Franchising – A practice by which one company ( the
franchiser) supplies another (the franchisee) with
intangible property and other assistance over an
extended period.
• E.g.
-Jean-Louis David (France) awards franchises to
franchisees for more than 200 of its hairdressing salons
in Italy.
-Brooks Brothers (U.S) awards Dickson Concepts (Hong
Kong) a franchise to operate Brooks Brothers stores
 Distinguish

Licensing Franchising
• Practice by which one • A practice by which one
company owning company ( the
intangible property (the franchiser) supplies
licensor) grants another another (the franchisee)
firm (the licensee) the with intangible
right to use that property property and other
for a specified period of assistance over an
time. extended period.
• Franchising – A practice by which one company
( the franchiser) supplies another (the franchisee)
with intangible property and other assistance over
an extended period.
• Licensing – Practice by which one company
owning intangible property (the licensor) grants
another firm (the licensee) the right to use that
property for a specified period of time.