Chapter 7
Foreign Direct
Investment
Chapter Preview
• Characterize global FDI flows and patterns
• Discuss each theory that tries to explain FDI
• Identify important management issues in the
FDI decision
• Explain why home and host nations intervene
in FDI flows
• List the methods that nations use to promote
and restrict FDI
© Prentice Hall, 2008
International Business 4e
Chapter 7 - 2
Foreign Direct Investment
 Purchase of physical assets or
significant amount of ownership
of a company in another country
to gain some measure of
management control
 By contrast, portfolio investment
does not involve obtaining a
degree of control in a company
© Prentice Hall, 2008
International Business 4e
Chapter 7 - 3
Growth of World FDI vs. GDP
© Prentice Hall, 2008
International Business 4e
Chapter 7 - 4
Reasons for FDI Growth
Increasing
globalization
International mergers
and acquisitions
Entrepreneurship
and small firms
© Prentice Hall, 2008
International Business 4e
Chapter 7 - 5
Value of Cross-Border M&As
© Prentice Hall, 2008
International Business 4e
Chapter 7 - 6
Worldwide FDI Flows
World FDI inflows

Developed (58%), developing (36%)

European Union: 33% of world FDI
70,000 multinationals
Developing nations

China: 9% of world FDI

All of Africa: 3% of world FDI
© Prentice Hall, 2008
International Business 4e
with
690,000 affiliates
Chapter 7 - 7
International Product Life Cycle
A company begins by exporting its product and later undertakes
foreign direct investment as a product moves through its life cycle
© Prentice Hall, 2008
International Business 4e
Chapter 7 - 8
Market Imperfections
(Internalization)
Company undertakes FDI to
internalize a transaction that
is being made inefficient by
a market imperfection
 Trade barriers
(e.g., tariffs)
 Specialized knowledge
(e.g., managerial ability)
© Prentice Hall, 2008
International Business 4e
Chapter 7 - 9
Eclectic Theory
A firm undertakes FDI when location, ownership, and
internalization advantages combine to make a location appealing
Location
advantage
Ownership
advantage
Internalization
advantage
(optimal location)
(special asset)
(efficiency)
© Prentice Hall, 2008
International Business 4e
Chapter 7 - 10
Market Power
A firm undertakes FDI to establish a dominant presence in an industry
Market power
= Greater profits
Vertical integration
Extends company’s activities
into stages of production that
provide its inputs (backward
integration) or absorb its outputs (forward integration)
© Prentice Hall, 2008
International Business 4e
Chapter 7 - 11
Management Issues and FDI
Control
• Partnership requirements
• Benefits of cooperation
Production costs
• Rationalized production
• Cost of R&D
Purchase-or-build
decision
Customer
knowledge
Following
clients
© Prentice Hall, 2008
Following
rivals
International Business 4e
Chapter 7 - 12
Balance of Payments
National accounting system that records all payments to entities
in other countries and all receipts coming into the nation
Current account
Capital account
Records transactions
involving the import and
export of goods and
services, income receipts
on assets abroad, and
income payments on
foreign assets inside the
country
© Prentice Hall, 2008
Records transactions
involving the purchase
or sale of assets
(including assets such
as property and shares
of common stock in a
company)
International Business 4e
Chapter 7 - 13
Why Host Intervenes in FDI
Initial FDI boosts economy
Balance of Payments
+
FDI may decrease import
demand
FDI may generate exports
Access technology
Obtain resources
and benefits
Access management skills
+
Create employment
© Prentice Hall, 2008
International Business 4e
Chapter 7 - 14
Why Home Intervenes in FDI
FDI
– Removes resources from the nation
– Can eliminate an export market
– Might eliminate domestic jobs
+ May improve national competitiveness
+ Can offshore ‘sunset’ industries
© Prentice Hall, 2008
International Business 4e
Chapter 7 - 15
Host Promotion Methods
Financial
incentives
Infrastructure
improvements
Low or waived taxes
Low-interest loans
Improved seaports, roads,
telecommunications
networks
© Prentice Hall, 2008
International Business 4e
Chapter 7 - 16
Host Restriction Methods
Ownership
restrictions
Performance
demands
Prohibit investment
in certain industries
or businesses
Local content reqmnt.
Technology transfers
Export targets
© Prentice Hall, 2008
International Business 4e
Chapter 7 - 17
Home Promotion Methods
Insurance on
assets abroad
Loans and loan
guarantees
Tax breaks on profits
earned abroad
© Prentice Hall, 2008
Special tax
treaties
Persuade other nations
to accept FDI
International Business 4e
Chapter 7 - 18
Home Restriction Methods
Higher tax rates on
foreign income
Sanctions on
specific nations
© Prentice Hall, 2008
International Business 4e
Chapter 7 - 19
Chapter Review
• Characterize global FDI flows and patterns
• Discuss each theory that tries to explain FDI
• Identify important management issues in the
FDI decision
• Explain why home and host nations intervene
in FDI flows
• List the methods that nations use to promote
and restrict FDI
© Prentice Hall, 2008
International Business 4e
Chapter 7 - 20