*** FDI1 ***
Various entry modes into foreign markets: advantages and disadvantages
Entry mode
Advantage
Disadvantage
NO OWNERSHIP INVOLVED
Exporting from home production
scale economy;
trade secrets kept
Turnkey
contracts
little financial risk;
possible where
FDI prohibited
[e.g., petrochemical plants]
Licensing
low cost, low risks
Franchising
low cost, risks
trade barriers;
transportation cost;
local marketing: by whom?
may create efficient competitors;
no long-term presence
lack of control over your own technology
[licensing and other types of contracts used in every FDI project]
[e.g., retail sector]
lack of control over quality;
global strategic coordination difficult
Entry mode
Advantage
Disadvantage
OWNERSHIP INVOLVED
Joint ventures
access to local
lack of control
partner's knowhow
over technology;
in marketing,
slow decision making
personnel management,
local government;
shared risks and cost
Fully owned
subsidiary
protection of
technology;
fast decisions
high risks and high cost
BUSINESS DECISION: which mode of foreign entry?;
what share of ownership, if ownership involved?
SOME THEORIES ON FDI
Efficiency considerations lead to various forms of FDI organizations
HORIZONTAL FDI:
your FDI in the host country is in the same industry as in home country (e.g.
following customers)
BACKWARD VERTICAL FDI:
provides inputs into your home operation (e.g. resource FDI)
FORWARD VERTICAL FDI:
receives from you the inputs produced in home country
(e.g. sales/distribution channel FDI)
Vertical and horizontal integration often increases production efficiency due to scale
economies.
Many theories try to explain why firms prefer FDI to pure "purchasing/selling
arrangements“ [e.g. presence of trust in firms’ own FDI]
IMPORTANT FACTORS WHICH AFFECT FDI DECISIONS:
- TRANSPORTATION COSTS ($3-12 per auto tire)
- MARKET SIZE (e.g. economies of scale)
- MARKET IMPERFECTIONS (e.g. tariffs, quotas, .....)
- FEAR OF TECHNOLOGY/KNOW-HOW SPILLOVER (problems with
technical licensing without ownership; but how much ownership?)
- FOLLOW-THE-LEADER AND/OR CUSTOMER, ME-TOO BEHAVIOUR
(e.g. firms in Toyota/Honda/Nissan capital keiretsu firms)
- PLC STAGES ... AT SOME STAGE OF A PLC, YOU HAVE TO EXPLOIT
FOREIGN MARKETS AND/OR SOURCE FROM FOREIGN LOW-COST
PRODUCERS
- CORPORATE POLICY (to become multinational by policy?)
VARIOUS FORMS OF FOREIGN EXPANSIONS (ref. Head (111-129)) below
Foreign Country
Home Country
Home Centralization
(Exporting)
Replication
Foreign Centralization
(Importing)
Home
Centralization:
–Boeing
commercial aircraft assembly in U.S. (mainly Seattle)
–Airbus
commercial aircraft assembly in EU (mainly Toulouse)
Foreign
Centralization:
–Mattel’s
Barbie dolls (Dongguan, China)
–Panasonic’s TVs
(Malaysia)
Nestle (replicator) had 254,000 Employees in 508 Factories in 85
Countries in 2002.
Area
Sales
Factories
Employees
Americas
40%
32%
41%
Europe
(Switz.)
40%
(1.6%)
41%
(1.8%)
34%
(2.6%)
Asia, Africa &
Oceania
20%
27%
25%
The benefits of Home Centralization:
Strong
Low
economies of scale, that is plant-level fixed costs are high
trade costs to export to foreign country
Large
home market
Home
country has comparative advantage in production costs
The benefits of Foreign Centralization:
Strong
Low
economies of scale, that is plant-level fixed costs are high
trade costs to import from foreign country
Large
foreign market
Foreign
country has comparative advantage in production costs
The benefits of Replication Form:
Absence
of economies of scale, that is plant-level fixed costs should be low
Both
markets are large
High
trade costs impede exports & imports
Unimportant
comparative advantages, that is costs of production similar
across countries.
The following graphs show the tradeoffs between 'Home Centralization" and
"Replication" strategies in terms of the foreign market size and distance
WH = home factory unit cost of production
WF = foreign factory unit cost of production
K = capital cost of building a new factory
T = transportation and trade costs
MF = foreign market size (e.g. # of consumers)
Forms of multinational firms with multiple products
Upstream (U) creates inputs
Downstream (D) uses U inputs to create outputs
Example: ExxonMobil
Upstream: exploration and “production” in 40 countries
Downstream: refining and “marketing”
Owns 46 refineries, located in 26 countries
Operates 42,000 retail sites in 118 countries
The maps below show ExxonMobil's Upstream and Downstream operations.
Various forms of multinational operations for producing 2 vertically
related products (various combinations of U and D)
E.g.
U: auto parts
D: passenger car
The firm wants to sell 2 related models of cars
Reasons for "vertical specialization":
Strong economies of scale, that is plant-level fixed costs are high
Low trade costs to export U to foreign country
Low trade costs to import D from foreign country
Home country has comparative advantage in production costs for U
Foreign country has comparative advantage in production costs for D
"Branching form" examples:
Coca Cola’s concentrate (U) and bottling (D)
Honda's engines (U) and car assembly (D)
Reasons for "branching form":
Low trade costs on U, high on D
Low scale economies on D, high on U
Home comp. adv. in U, weak comp. advs. in D
"Multi-sourcing form" examples:
Refinery in one country, sourcing crude oil from multiple drilling sites (in
different countries); Nike’s strategy of shoe manufacturing
Reasons for "multi-sourcing form":
Low trade costs (for U & D)
Diseconomies of scale for U
Uncertain comp. adv. for U.
More figures are found on Head, p.125.
Currently we are experiencing:
(1)Falling trade costs
- more efficient transportation (containers, use of air transport)
- lower tariffs, WTO oversight of disguised protection
- technology-powered improvements in long distance communication
(2)This may be leading to increased "economies of scale"
The implications of (1) and (2) for multinational firms:
Optimal configuration of your FDI network requires continuingly
changing efficiency calculations; in particular
“Less Replication”, and more “Vertical Specialization”
But we also need to pay attention to industry-specific conditions:
Example: Compare various companies' foreign expansion strategies:
Nestle, Boeing, Mattel
Their strategies are not likely to converge.
(They will continue to pursue divergent strategies)