GB20203/GD20003 INTERNATIONAL FINANCE
Foreign Direct Investment.
1. Firm become multinational when they undertake
foreign direct investment (FDI). FDI is going in
global basis.
2. Example of FDI :
a. SONY
b. TOYOTA
c. ROYAL DUTCH SHELL
d. IBM
e. GM
f. COCA COLA
g. MC DONALD’S
h. NESTLE
3. These examples have established their presence
worldwide and become familiar household names.
What is FDI
1. Classic definition, is defined as a company from one
country making a physical investment into building a
factory in another country.
2. Investment can be direct (The direct investment in
buildings, machinery and equipment) or indirect
investment (portfolio investment).
Madam Zakiah Hassan
2 Mac 2010 (Tue)
1/12
GB20203/GD20003 INTERNATIONAL FINANCE
Why need FDI
1. Can provide a firm with :
a. New markets and marketing channels.
b. Cheaper production facilities
c. Access to new technology
d. Products skills and financing.
e. Labor expertise.
2. For a host country or the foreign firm which
receives the investment, it can provide ( a to the) as
well as a strong impetus to economic development.
a. a source of new technologies
b. sources of capital
c. new processes
d. new products
e. organizational technologies and management
skills
Madam Zakiah Hassan
2 Mac 2010 (Tue)
2/12
GB20203/GD20003 INTERNATIONAL FINANCE
Important of FDI
1. Avoiding foreign government pressure for local
production.
2. Circumventing trade barriers, hidden and otherwise.
3. Making the move from domestic export sales to a
locally-based national sales office.
4. Have capability to increase total production
capacity.
5. Gain Opportunities for co-production, joint ventures
with local partners, joint marketing arrangements,
licensing, etc;
Madam Zakiah Hassan
2 Mac 2010 (Tue)
3/12
GB20203/GD20003 INTERNATIONAL FINANCE
Basic requirement for companies considering a FDI
1. Assessment of internal resources ( does the firm
have senior management support for the investment
and the internal management and system capabilities
to support the set up times as awell as ongoing
management of a foreign subsidiary?
2. Competitiveness ( has the company conducted
extensive market research involving both the
industry, product and local regulations)
3. Market expectations ( has information on local
industry and foreign investment regulations,
incentives, profit retention, financing, distribution
and other factors as a vehicle to enter the market.
The market is whether greenfield, acquisiton,
merger, joint venture, etc)
4. Market analysis ( if the foreign economy, industry is
charactized by government regulation, have risk
been factored into the business plan? – risk – contry
risk, foreign exchange risk, market risk, business
risk, soverign risk,political risk, economic risk)
Madam Zakiah Hassan
2 Mac 2010 (Tue)
4/12
GB20203/GD20003 INTERNATIONAL FINANCE
Key factors that important in firm decision to invest
overseas:
1. Trade barrier
a. Government may impose tariffs, quotas,
embargo and other restrictions on export and
imports goods and services hindering the free
flow of these products across national
boundaries.
b. Sometimes governments may even impose
complete bans in the international trade of
certain products.
c. Government regulates international trade to
raise revenue, protect domestic industries and
pursue other econ. Policy objective.
d. Example: facing barrier to exporting its
product to foreign market, a firm decide to
move production to foreign countries as a means
if circumventing the trade barriers. A classic
example of – motivated FDI is HONDA’s
investment in Ohio. Since the cars produced in
Ohio would not be subject to US tariff and
quotas, Honda could circumvent these barriers
by establishing production facilities in the
United States.
Madam Zakiah Hassan
2 Mac 2010 (Tue)
5/12
GB20203/GD20003 INTERNATIONAL FINANCE
2. imperfect labor market
a. Example:
suppose
Samsung,
a
Korean
conglomerate, would like to build production
facilities for its customer electronic products
to serve the North American markets. Samsung
could locate its production facilities anywhere
in North America if the firm is concerned only
with circumventing trade barrier imposed by
NAFTA. Samsung chose to locate its production
facilities in northern Mexico rather than in
Canada or the US, mainly because it wanted to
take advantage of the lower costs of labor in
Mexico.
b. Labor is immobile because of immigration
barriers, firm themselves should move the
workers in order to benefit from the
underpriced labor services.
c. This one reasons MNCs are making FDIs is less
developed countries such as Mexico, China,
India and Southeast Asian countries like
Thailand, Malaysia and Indonesia, where the
labor services are underpriced relative to their
productivity.
Madam Zakiah Hassan
2 Mac 2010 (Tue)
6/12
GB20203/GD20003 INTERNATIONAL FINANCE
3. Intangible assets
a. MNCs often enjoy comparative advantages due
to special intangible assets they posses.
Example including technological, managerial and
marketing know-how, superior R&D capabilities
and brand names.
b. These intangible assets are often hard to
packages and sell to foreigners.
c. In addition the property rights in intangible
assets are difficult to establish and protect,
especially in foreign countries where legal
resources may not be readily available.
d. As a result, firms may find it more profitable
to establish foreign subsidiaries and capture
returns directly by internalizing transactions in
these assets.
e. The theory internalization of FDI, stated that
the firms have intangible assets with a public
good property tend to invest directly in foreign
countries in order to use these assets on a
larger scale and at the same time avoid the
misappropriations of intangible assets that may
occur while transacting in foreign markets.
f. Example : Coca- cola has invested in bottling
plants all over the word rather than, say
licensing local firms to produce Coke. Reason- to
protect the formula for its soft drink. If
licensing a local firm to produce Coke, it has no
guarantee that the secrets of the formula will
Madam Zakiah Hassan
2 Mac 2010 (Tue)
7/12
GB20203/GD20003 INTERNATIONAL FINANCE
be maintained. If not will hurt the coke’s sales.
So 1960s Coca- cola withdraw from India coz
government pressure.
4. Vertical integration
a. MNCs may undertake FDI in countries where
inputs are available in order to secure the
supply of inputs at a stable price.
b. MNCs with monopolistic / oligopolistic control
over the input market, this can be served as a
barrier to entry to the industry.
c. Many MNCs often find it profitable to locate
their manufacturing / processing facilities near
the natural resources (oil fields, mine deposits
and forest) in order to save transportation
costs.
d. Backward vertical FDI – an industry abroad
that produces inputs for MNCs.
e. Forward vertical FDI can take an example
where they involve industry abroad that sells a
MNC’s output.
f. Ex: US car makers found it difficult to market
their product in Japan, because most car
dealers in Japan have long and close
relationship with Japanese car makers and are
reluctant to carry foreign imports. So to
overcome this problem, US car makers began to
build their own network of dealership in Japan
to help sell their cars.
Madam Zakiah Hassan
2 Mac 2010 (Tue)
8/12
GB20203/GD20003 INTERNATIONAL FINANCE
Product life cycle
g. Raymond Vernon (1966) firm undertake FDI at
a particular stage in the life cycle of the
product that they initially introduced.
h. 3 stages: (1) introduce the product close to
customer and get feedback, (2) product mature
(3) standardized it becomes important to cut
the cost of production to stay competitive.
i. Ex : personal computers ( PCs) were first
developed by US firms ( such as IBM and Apple
Computer) and exported to overseas markets.
As PC’s became a standardized commodity,
however, the US became a net importer of PCs
from foreign producers based in such countries
as Japan, Korea and Taiwan as well as foreign
subsidiaries of US firms.
5. Shareholder diversification services.
a. If investors cannot effectively diversify their
portfolio holdings internationally because of
barrier to cross border capital flows, firms may
be able to provide their shareholders with
indirect diversification services by making their
direct investments in foreign countries.
b. When a firm holds assets in many countries, the
firm’s cash flows are internationally diversified.
c. Thus, shareholders of the firm can indirectly
benefit international diversification even if
they are not directly holding foreign shares.
Madam Zakiah Hassan
2 Mac 2010 (Tue)
9/12
GB20203/GD20003 INTERNATIONAL FINANCE
Terms:
(1) Inward FDI - when a foreign country invests in the
country in question.
(2) Outward FDI - when the home country invests
abroad.
(3) Green investment
- Which involve building new production faclities in a
foreign country
- is the investment in a manufacturing, office, or other
physical company-related structure or group of
structures in an area where no previous facilities exist.
- The name comes from the idea of building a facility
literally on a "green" field, such as farmland or a forest.
- Greenfield Investing is usually offered as an alternative
to another form of investment, such as mergers and
acquisitions, joint ventures, or licensing agreements.
(4) Brownfield investment
- used for a ‘dirty’ business purpose, such as a steel mill
or oil refinery, is cleaned up and used for a less polluting
purpose, such as commercial office space or a residential
area.
(5) Backward Vertical FDI
Madam Zakiah Hassan
2 Mac 2010 (Tue)
10/12
GB20203/GD20003 INTERNATIONAL FINANCE
- Where an industry abroad provides inputs for a firm's
domestic production process.
(6) Forward Vertical FDI
- Where an industry abroad sells the outputs of a firm's
domestic production.
(7) Merger & acquisition
- involve buying combining with or buying existing foreign
business. (from aspect of corporate strategy, corporate
finance and manegement dealing with the buying, selling
and combining of different companies that can aid,
finance or help a growing company in an industry). (expand
and takeover. Basically when they merger their names will
changed but not the acqusition. )
(8) Joint venture
-In general, a joint venture (“JV”) is an association of two
or more entities (whether corporate, government,
individual or otherwise) combining property and expertise
to carry out a single business enterprise and having a
joint proprietary interest, a joint right to control and a
sharing of profits and losses.
- Regardless of the scope of the undertaking, the nature
of the JV must: (1) be a separately identifiable entity;
(2) have an ownership interest in such entity by each
joint venture partner (“JVP”); and (3) have an active
Madam Zakiah Hassan
2 Mac 2010 (Tue)
11/12
GB20203/GD20003 INTERNATIONAL FINANCE
management involvement or deliberate rejection of the
right to such involvement by each JVP.
- JVs are common and successful in several industries.
For example, in the land development and construction
industries, JVs are often used to obtain sufficient
financing to acquire large land tracts or to undertake
major building projects. JVs are also common in the
manufacturing, mining, and service industries.
(9) Licensing aggrements
- This involves the supply of technology and know-how or
the use of a trademark or a patent for a fee. It offers
one way to generate revenue from foreign markets that
are otherwise inaccessible
(10) Transfer Pricing
- The pricing of goods and services that are bought and
sold (transferred) between members of a corporate
family. Ex: goods from the production division may be
sold to the marketing division, or goods from a parent
company may be sold to a foreign subsidiary.
Madam Zakiah Hassan
2 Mac 2010 (Tue)
12/12