International
Business
Fourth Edition
CHAPTER 6
Foreign Direct Investment
6-3
Chapter Focus
This chapter seeks to identify the economic
rationale that underlies Foreign Direct
Investment. For example, why do some firms
prefer FDI to exporting or licensing. Is the need
for control, part of the answer?
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6-4
Foreign Direct Investment
FDI occurs when a firm invests directly in
facilities to produce and/or market a product
in a foreign country.
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6-5
Foreign Direct Investment
FDI occurs when a firm invests directly in
facilities to produce and/or market a product
in a foreign country.
Once a firm undertakes FDI, it becomes a
multinational enterprise (multinational = more
than one country).
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6-6
Foreign Direct Investment
FDI takes two forms:
Greed-field investment: establishing a wholly
new operation in a foreign country.
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Foreign Direct Investment
FDI takes two forms:
Greed-field investment: establishing a wholly
new operation in a foreign country.
Acquiring or merging with an existing firm in
the foreign country.
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Foreign Direct Investment
NOTE:
Investing in foreign financial instruments
(Portfolio Investment) IS NOT FDI.
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Flow and Stock of FDI
Flow:
The amount of FDI
undertaken over a given
period of time (usually
one year).
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Stock:
Total accumulated value
of foreign-owned assets
at a given time.
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6-10
FDI Outflows
1982-2000
1400
1200
1000
800
600
$ Billions
400
200
0
8286
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92
94
96
98
2000
Figure 6.1
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6-11
FDI Flows by Region
600
500
Value Exports
300
World GDP
200
World FDI
Index
400
100
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20
00
98
96
94
92
90
0
Figure 6.2
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6-12
Reasons for FDI Growth
FDI circumvents potential future trade barriers.
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Reasons for FDI Growth
FDI circumvents potential future trade barriers.
Dramatic political and economic changes occurring
in developing countries.
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FDI into Developed and Developing
Nations: 1990-2000
1200
$Billion
1000
Dev Nations
Devg. Nations
800
W. Europe
600
N. Amer.
400
Asia
200
L. Amer.
0
94
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95
96
97
98
99
2000
Figure 6.3
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6-15
FDI Outflows by
Selected Countries, 1994-1999
300
250
200
150
1994 1995 1996 1997 1998 1999 2000
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U.S.
U.K.
Netherlands
Germany
100
Japan
50
Spain
0
France
Figure 6.5
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6-16
The Form of FDI: Acquisitions versus
Greed-Fields
The majority of
investments is in the
form of mergers &
acquisitions:
Why the preference for
mergers & acquisitions?
Represents about 77%
of all flows in developed
countries.
Represent about 33% of
all flows in developing
countries.
Fewer target
firms.
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Quicker to execute.
Foreign firms have
valuable strategic
assets.
Believe they can
increase the efficiency
of the acquired firm.
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6-17
FDI and Risk
FDI is expensive and risky compared to exporting or
licensing:
Costs of establishing facilities.
Problems with doing business in a different
Culture.
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Horizontal FDI and Factor
Considerations
Transportation Costs: High/low value to weight impacts
costs.
Market Imperfections (Internalization Theory): Factors
that inhibit markets from working perfectly. This
includes (1) governments impeding the free flow of
products between nations, and (2) impediments to
the sale of know-how.
Strategic Behavior: Concentrated industries (oligopoly) tend
to mimic each other’s moves. Where there is
multipoint competition, competing firms match each
other’s moves to keep the competitor in check.
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Horizontal FDI and Factor
Considerations
The Product Life Cycle: Suggests that foreign market
demand leads to FDI, probably not true and
therefore is not a good predictor of FDI.
Location-Specific Advantages: Advantages that arise
from using resource endowments or assets tied
to a particular location (Dunning - eclectic paradigm)
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Vertical FDI
Two forms:
Backward: Providing inputs (raw materials, parts)
for a firm’s domestic production processes.
Forward: An industry abroad sells the outputs of
the firm’s domestic production processes.
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Why Do Companies Engage in FDI?
Strategic Behavior: Can raise entry barriers or shut out
new competitors, or circumvent barriers established by
companies already doing business in the foreign country.
Market Imperfections: Need to overcome lack of knowhow or the firm must invest in specialized assets whose
value depends on inputs provided by a foreign supplier.
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Impediments to the Sale of Knowhow
Risk giving away
know-how to
competitors
Impediments to
the sale of know
how
Licensing implies
low control over
foreign entity
Know-how not
amenable to
licensing
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A Decision Framework
How high are
transportation costs
and tariffs?
High
Is know-how amenable
to licensing?
Yes
Is tight control over
foreign operation
required?
No
Figure 6.6 Can know-how be protected
by licensing contract?
Low
No
Yes
No
Export
Horizontal FDI
Horizontal FDI
Horizontal FDI
Yes
Then license
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