FDI

PowerPoint

to accompany

Chapter 17

Foreign Direct Investment Theory and

Strategy

Multinational Business Finance (2nd Edition)

David Eiteman | Kevin Daly Subhrendu Rath | Arthur Stonehill

| Michael Moffett

Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442525894/Eiteman/Multinational Finance/2nd edition

Sustaining and Transferring Competitive Advantage

Investment abroad depend on

Competitive advantage that enables it to compete effectively in the home market.

Those advantage must be firm-specific, transferable, and powerful enough to compensate the firm for the potential disadvantages of operating abroad



Economies of scale and scope:

Can be developed in production, marketing, finance, research and development, transportation, and purchasing

Large size is a major contributing factor (due to international and/or domestic operations)

Managerial and marketing expertise:

Includes skill in managing large industrial organisations (human capital and technology)

and knowledge of modern analytical techniques and their application in functional areas of business



Advanced technology:

Includes both scientific and engineering skills

Financial strength:

Demonstrated financial strength by achieving and maintaining a global cost and availability of capital

This is a critical competitive cost variable that enables them to fund FDI and other foreign activities



Differentiated products:

Differentiated products originate from research-based innovations or heavy marketing expenditures to gain brand identification

Competitiveness of the home market:

A strongly competitive home market can sharpen a firm’s competitive advantage relative to firms located in less competitive ones



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The OLI Paradigm

A framework which explain why MNEs choose FDI rather than serve foreign markets through alternative models such as licensing, joint ventures, strategic alliances, management contracts, and exporting.

The OLI Paradigm and Internalisation


The OLI stand for

“O” ownership

Competitive advantage in the home market that can be transferred abroad

“L” location

specific characteristics of the foreign market allow the firm to exploit its competitive advantage

“I” internalisation

maintenance of its competitive position by attempting to control the entire value chain in its industry



The financial strength

Financial strategies are directly related to the OLI Paradigm

Proactive strategies

– strategies necessary to gain an advantage from lower global cost and greater availability of capital

Reactive strategies

– depend on discovering market imperfections




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Recent trends in FDI: Global view

FDI occurs when

investing directly in facilities to produce a product in a foreign country, or,

buying an existing enterprise in a foreign country



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Regional overview of FDI

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FDI - Australia

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Where to Invest?

The decision is influenced by behavioural factors.

The decision to invest abroad for the first time is not the same as the decision to reinvest abroad.

In theory,

A firm should search worldwide for market imperfections and comparative advantage until it finds a country where it expects to enjoy a competitive advantage large enough to generate a risk-adjusted return above the firm’s hurdle rate.

In practice,

The firms have been observed to follow a sequential search pattern as described in the behavioural theory of the firm.


Where to Invest?

The decision to invest abroad is often a stage in the firm’s development process.

Eventually the firm experiences a stimulus from the external environment, which leads it to consider production abroad.

Some important external stimuli are:

An outside proposal, from a quality source

Fear of losing a market

The “bandwagon” effect

Strong competition from abroad in the home market


How to Invest Abroad: Modes of Foreign Involvement

The globalisation process includes a sequence of decisions regarding where production is to occur, who is to own or control intellectual property, and who is to own the actual production facilities.


How to Invest Abroad: Modes of Foreign Involvement

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How to Invest Abroad: Modes of Foreign Investment Exporting versus production abroad:

Advantages to limiting a firm’s activities to exports

Exporting has none of the unique risks facing FDI, Joint Ventures, strategic alliances and licensing with minimal political risks

The amount of front-end investment is typically lower than other modes of foreign involvement

Disadvantages

the risks of losing markets to imitators and global competitors


How to Invest Abroad: Modes of Foreign Investment

Licensing and management contracts versus control of assets abroad:

Licensing is a popular method for domestic firms to profit from foreign markets without the need to commit sizeable funds

Disadvantages of licensing

Possible loss of quality control

Establishment of a potential competitor in third-country markets

Risk that technology will be stolen

High agency cost



Management contracts

Similar to licensing as they provide for some cash flow from a foreign source without significant foreign investment or exposure

probably lessen political risk because the repatriation of managers is easy


How to Invest Abroad: Modes of Foreign Investment Joint venture versus wholly owned

subsidiary:

A joint venture is here defined as shared ownership in a foreign business

Some advantages of a MNE working with a local joint venture partner are:

Better understanding of local environment

Providing for competent management

Satisfying local ownership requirements

Use of local partners’ contacts , reputation and know how

Public image of local partners



Potential conflicts or difficulties on Joint venture

Risk of selecting wrong partner

Divergent views critical decisions

Transfer pricing issues; and

Difficulties in the ability to rationalise production on a worldwide basis


How to Invest Abroad: Modes of Foreign Investment Greenfield investment versus acquisition:

Establishing a production or service facility starting from the ground up

A cross-border acquisition is clearly much quicker and can also be a cost effective way to obtain technology and/or brand names


How to Invest Abroad: Modes of Foreign Investment Strategic alliance

In one form of cross-border strategic alliance, two firms exchange a share of ownership with one another.

A more comprehensive strategic alliance, partners exchange a share of ownership in addition to creating a separate joint venture to develop and manufacture a product or service

Another level of cooperation might include joint marketing and servicing agreements in which each partner represents the other in certain markets.


Mini-Case Questions: Benecol How does the global licensing agreement split risk and return, in

a financial sense, between Raisio and McNeil?

How will the returns to Raisio accrue over the short, medium, and long terms under the agreement, assuming the product meets with relative success?

What are some of the possible motivations to Raisio and McNeil behind a milestone agreement? Assume the milestone payments are agreed-upon payments from McNeil to Raisio if:

Raisio successfully completes the expansion of its manufacturing capabilities for stanol ester

McNeil successfully introduces Benecol products in major industrial markets, overcoming regulatory hurdles or reaching specific sales goals

Documents

FDI