International Business StrategyCentre for Financial and Management Studies 3 Damian Tobin is Lecturer in Chinese Business and Management at the Centre for Financial and Management

module: c371 m471 | product: 4566

International Business Strategy

International Business Strategy Centre for Financial and Management Studies

© SOAS University of London First published: 2013; Revised: 2014, 2015, 2016, 2018, 2019

All rights reserved. No part of this module material may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, including photocopying and recording, or in information storage or retrieval systems, without written permission from the Centre for Financial and Management Studies, SOAS University of London.


Module Introduction and Overview

Contents

1 Introduction to the Module 2

2 The Module Authors 2

3 Study Materials 3

4 Module Overview 3

5 Learning Outcomes 4

6 Assessment 5

Reference 11

Specimen Examination 13


2 University of London

1 Introduction to the Module Welcome to the module International Business Strategy. In a rapidly changing

world, companies that operate across national boundaries are increasingly

the norm – domestic businesses serving local markets tend to be smaller, less

innovative, less profitable, than those that roam the world searching for

favourable opportunities. On the other hand, there are bigger hazards in

unfamiliar territories, and intelligence is required to assess markets, capital

requirements, financing methods, risk, marketing techniques, and organisa-

tional forms, to enable the opportunities to be seized.

This module aims to provide frameworks, techniques and examples to help

you participate successfully in the exciting and risky world of international

business.

Your study of international business strategy in this module is based mainly

on case studies of a wide variety of businesses – from Carrefour, a Europe-

an-based retailer; to Alibaba.com, a China-based web-centred intermediary

for manufacturers; from Amazon, an online retailer; to Daimler-Chrysler, a

cross-border automobile manufacturer; and from Vestel, a manufacturer

exporting from one location; to Dell, a computer manufacturer operating

globally.

Some of the businesses you will study are successful, some have made big

mistakes, others are unsure about their future success. The exposure to a

variety of degrees of success will help you to assess strategic options in your

own career.

The approach is not technical – you will be introduced, for example, to the

reasons for and the basis of currency hedging in cash management but will

not go into the mathematical calculations required to implement successful

hedging.

After completing this module, you should be able to test the utility of the

various frameworks and strategies in the light of several experiences of

business internationalisation, in terms of the lessons they offer, both positive

and negative.

To facilitate your learning, there are many Review Questions and Exercises

in the units. You will get feedback and advice on your progress with the

module in the comments on your assignments, and to help you prepare for

the final examination there is a Specimen Examination Paper at the end of

this Module Introduction and Overview.

2 The Module Authors Norman Flynn is Programme Director of Public Policy and Management

programmes at CeFiMS. He is the author of Miracle to Meltdown in Asia

(Oxford University Press) and, in addition to his role at SOAS, he has held

academic positions at the London Business School and the London School of

Economics, and was Chair Professor at City University of Hong Kong.


Centre for Financial and Management Studies 3

Damian Tobin is Lecturer in Chinese Business and Management at the

Centre for Financial and Management Studies, SOAS University of London

and is academic director of the International Business Administration

programme. He has published topics related to China’s enterprise reform,

corporate governance and public finance. His articles have appeared in such

academic journals as World Development, Corporate Governance: An Interna-tional Review, and Asian Case Research Journal.

3 Study Materials In addition to the eight units of the Study Guide, this module has a range of

case material compiled in a two-volume collection of Case Studies. There is

also a collection of articles and extracts from other sources in a Module Reader.

You will read parts of a textbook written by Charles Hill and Thomas Hult.

Charles Hill is Professor of International Business at the University of

Washington, and has worked extensively as a consultant to international

firms. Thomas Hult is director of the International Business Center at

Michigan State University.

Hill CWL and GTM Hult (2017) International Business: Competing in the Global Marketplace, 11th Edition. New York, McGraw-Hill Edu-

cation.

Where there are gaps in the textbook coverage, these will be supplemented

by articles reprinted in the Module Reader.

4 Module Overview The module consists of eight ‘units’, each with its own core text, set readings,

questions and exercises.

Unit 1 International Investment 1.1 The Economics of International Investment 1.2 International Investment 1.3 Mergers and Acquisitions

Unit 2 Choice of Entry Strategy 2.1 Strategy Basics – Cost and Value 2.2 International Strategy 2.3 Entry Strategy 2.4 Case Studies 2.5 Feedback on Case Studies

Unit 3 International Production and Sourcing 3.1 Economic Criteria 3.2 Beyond Offshoring 3.3 Case Studies 3.4 Managing the Global Supply Chain 3.5 Feedback on Case Studies



Unit 4 International Marketing 4.1 Marketing Mix 4.2 Global Marketing 4.3 Case Studies 4.4 Feedback on Case Studies

Unit 5 International Organisation 5.1 Introduction 5.2 Organisational Architecture 5.3 Strategy and Architecture 5.4 Case Studies 5.5 Feedback on Case Studies 5.6 A Successful Example – Siemens

Unit 6 Financial Management in the International Business 6.1 Investment Decisions 6.2 Financing Decisions 6.3 Money Management 6.4 Managing Foreign Exchange Risk 6.5 Case Studies

Unit 7 Assessing Country Competitiveness 7.1 Determinants of National Competitive Advantage 7.2 Company Strategy 7.3 Case Studies 7.4 Feedback on the Case Studies

Unit 8 Assessing Country Risk 8.1 Introduction 8.2 What is Political Risk? 8.3 Country Risk 8.4 A Strategic Perspective 8.5 Summary 8.6 The Examination

5 Learning Outcomes When you have completed your study of this module, you will be able to:

• analyse the principles underlying decisions to invest in countries other than the home base

• discuss the basics of business strategies of cost advantage and differentiation

• explain the analysis behind decisions about where to locate production operations

• explain some of the reasons why marketing and pricing strategies can succeed or fail according to the conditions in different countries

• identify the variety of structural arrangements available to the international business



• analyse the options for dealing with currency risk in an international project or business

• analyse the elements that make a location suitable for investment projects

• list and define the types of political risk involved in establishing a business in another country.

6 Assessment Your performance on each module is assessed through two written assign-

ments and one examination. The assignments are written after Unit 4 and

Unit 8 of the module session. Please see the VLE for submission deadlines.

The examination is taken at a local examination centre in September/

October.

Preparing for assignments and exams

There is good advice on preparing for assignments and exams and writing

them in Chapter 8 of Studying at a Distance by Christine Talbot. We recom-

mend that you follow this advice.

The examinations you will sit are designed to evaluate your knowledge and

skills in the subjects you have studied: they are not designed to trick you. If

you have studied the module thoroughly, you will pass the exam.

Understanding assessment questions

Examination and assignment questions are set to test your knowledge and

skills. Sometimes a question will contain more than one part, each part

testing a different aspect of your skills and knowledge. You need to spot the

key words to know what is being asked of you. Here we categorise the types

of things that are asked for in assignments and exams, and the words used.

All the examples are from the Centre for Financial and Management Studies

examination papers and assignment questions.

Definitions

Some questions mainly require you to show that you have learned some concepts, by setting out their precise meanings. Such questions are likely to be preliminary and be supplemented by more analytical questions. Generally, ‘Pass marks’ are awarded if the answer only contains definitions. They will contain words such as:

Describe Contrast Define Write notes on

Examine Outline

Distinguish between What is meant by Compare List

Reasoning

Other questions are designed to test your reasoning, by explaining cause and effect. Convincing explanations generally carry additional marks to basic definitions. They will include words such as:



Interpret Explain What conditions influence What are the consequences of What are the implications of

Judgement

Others ask you to make a judgement, perhaps of a policy or of a course of action. They will include words like:

Evaluate Critically examine Assess Do you agree that To what extent does

Calculation

Sometimes, you are asked to make a calculation, using a specified technique, where the question begins:

Use indifference curve analysis to Using any economic model you know Calculate the standard deviation Test whether

It is most likely that questions that ask you to make a calculation will also ask for an application of the result, or an interpretation.

Advice

Other questions ask you to provide advice in a particular situation. This applies to law questions and to policy papers where advice is asked in relation to a policy problem. Your advice should be based on relevant law, principles and evidence of what actions are likely to be effective. The questions may begin:

Advise Provide advice on Explain how you would advise

Critique

In many cases the question will include the word ‘critically’. This means that you are expected to look at the question from at least two points of view, offering a critique of each view and your judgement. You are expected to be critical of what you have read.

The questions may begin:

Critically analyse Critically consider Critically assess Critically discuss the argument that

Examine by argument

Questions that begin with ‘discuss’ are similar – they ask you to examine by argument, to debate and give reasons for and against a variety of options, for example

Discuss the advantages and disadvantages of



Discuss this statement Discuss the view that Discuss the arguments and debates concerning

The grading scheme: Assignments The assignment questions contain fairly detailed guidance about what is

required. All assignments are marked using marking guidelines. When you

receive your grade it is accompanied by comments on your paper, including

advice about how you might improve, and any clarifications about matters

you may not have understood. These comments are designed to help you

master the subject and to improve your skills as you progress through your

programme.

Postgraduate assignment marking criteria

The marking criteria for your programme draws upon these minimum core

criteria, which are applicable to the assessment of all assignments:

• understanding of the subject

• utilisation of proper academic [or other] style (e.g. citation of references, or use of proper legal style for court reports, etc.)

• relevance of material selected and of the arguments proposed

• planning and organisation

• logical coherence

• critical evaluation

• comprehensiveness of research

• evidence of synthesis

• innovation/creativity/originality.

The language used must be of a sufficient standard to permit assessment of

these.

The guidelines below reflect the standards of work expected at postgraduate

level. All assessed work is marked by your Tutor or a member of academic

staff, and a sample is then moderated by another member of academic staff.

Any assignment may be made available to the external examiner(s).

80+ (Distinction). A mark of 80+ will fulfil the following criteria: • very significant ability to plan, organise and execute independently a

research project or coursework assignment

• very significant ability to evaluate literature and theory critically and make informed judgements

• very high levels of creativity, originality and independence of thought

• very significant ability to evaluate critically existing methodologies and suggest new approaches to current research or professional practice

• very significant ability to analyse data critically

• outstanding levels of accuracy, technical competence, organisation, expression.



70–79 (Distinction). A mark in the range 70–79 will fulfil the following criteria: • significant ability to plan, organise and execute independently a

research project or coursework assignment • clear evidence of wide and relevant reading, referencing and an

engagement with the conceptual issues • capacity to develop a sophisticated and intelligent argument • rigorous use and a sophisticated understanding of relevant source

materials, balancing appropriately between factual detail and key theoretical issues. Materials are evaluated directly and their assumptions and arguments challenged and/or appraised

• correct referencing • significant ability to analyse data critically • original thinking and a willingness to take risks.

60–69 (Merit). A mark in the 60–69 range will fulfil the following criteria: • ability to plan, organise and execute independently a research project

or coursework assignment • strong evidence of critical insight and thinking • a detailed understanding of the major factual and/or theoretical issues

and directly engages with the relevant literature on the topic • clear evidence of planning and appropriate choice of sources and

methodology with correct referencing • ability to analyse data critically • capacity to develop a focussed and clear argument and articulate

clearly and convincingly a sustained train of logical thought.

50–59 (Pass). A mark in the range 50–59 will fulfil the following criteria: • ability to plan, organise and execute a research project or coursework

assignment • a reasonable understanding of the major factual and/or theoretical

issues involved • evidence of some knowledge of the literature with correct referencing • ability to analyse data • examples of a clear train of thought or argument • the text is introduced and concludes appropriately.

40–49 (Fail). A Fail will be awarded in cases in which there is: • limited ability to plan, organise and execute a research project or

coursework assignment • some awareness and understanding of the literature and of factual or

theoretical issues, but with little development • limited ability to analyse data • incomplete referencing • limited ability to present a clear and coherent argument.

20–39 (Fail). A Fail will be awarded in cases in which there is: • very limited ability to plan, organise and execute a research project or

coursework assignment



• failure to develop a coherent argument that relates to the research project or assignment

• no engagement with the relevant literature or demonstrable knowledge of the key issues

• incomplete referencing

• clear conceptual or factual errors or misunderstandings

• only fragmentary evidence of critical thought or data analysis.

0–19 (Fail). A Fail will be awarded in cases in which there is: • no demonstrable ability to plan, organise and execute a research

project or coursework assignment

• little or no knowledge or understanding related to the research project or assignment

• little or no knowledge of the relevant literature

• major errors in referencing

• no evidence of critical thought or data analysis

• incoherent argument.

The grading scheme: Examinations The written examinations are ‘unseen’ (you will only see the paper in the

exam centre) and written by hand, over a three-hour period. We advise that

you practise writing exams in these conditions as part of your examination

preparation, as it is not something you would normally do.

You are not allowed to take in books or notes to the exam room. This means

that you need to revise thoroughly in preparation for each exam. This is

especially important if you have completed the module in the early part of

the year, or in a previous year.

Details of the general definitions of what is expected in order to obtain a

particular grade are shown below. These guidelines take account of the fact

that examination conditions are less conducive to polished work than the

conditions in which you write your assignments. Note that as the criteria of

each grade rises, it accumulates the elements of the grade below. Assign-

ments awarded better marks will therefore have become comprehensive in

both their depth of core skills and advanced skills.

Postgraduate unseen written examinations marking criteria

80+ (Distinction). A mark of 80+ will fulfil the following criteria: • very significant ability to evaluate literature and theory critically and

make informed judgements

• very high levels of creativity, originality and independence of thought

• outstanding levels of accuracy, technical competence, organisation, expression

• outstanding ability of synthesis under exam pressure.

70–79 (Distinction). A mark in the 70–79 range will fulfil the following criteria: • clear evidence of wide and relevant reading and an engagement with

the conceptual issues



• develops a sophisticated and intelligent argument

• rigorous use and a sophisticated understanding of relevant source materials, balancing appropriately between factual detail and key theoretical issues

• direct evaluation of materials and their assumptions and arguments challenged and/or appraised;

• original thinking and a willingness to take risks

• significant ability of synthesis under exam pressure.

60–69 (Merit). A mark in the 60–69 range will fulfil the following criteria: • strong evidence of critical insight and critical thinking

• a detailed understanding of the major factual and/or theoretical issues and directly engages with the relevant literature on the topic

• develops a focussed and clear argument and articulates clearly and convincingly a sustained train of logical thought

• clear evidence of planning and appropriate choice of sources and methodology, and ability of synthesis under exam pressure.

50–59 (Pass). A mark in the 50–59 range will fulfil the following criteria: • a reasonable understanding of the major factual and/or theoretical

issues involved

• evidence of planning and selection from appropriate sources

• some demonstrable knowledge of the literature

• the text shows, in places, examples of a clear train of thought or argument

• the text is introduced and concludes appropriately.

40–49 (Fail). A Fail will be awarded in cases in which: • there is some awareness and understanding of the factual or

theoretical issues, but with little development

• misunderstandings are evident

• there is some evidence of planning, although irrelevant/unrelated material or arguments are included.

20–39 (Fail). A Fail will be awarded in cases which: • fail to answer the question or to develop an argument that relates to

the question set

• do not engage with the relevant literature or demonstrate a knowledge of the key issues

• contain clear conceptual or factual errors or misunderstandings.

0–19 (Fail). A Fail will be awarded in cases which: • show no knowledge or understanding related to the question set

• show no evidence of critical thought or analysis

• contain short answers and incoherent argument. [2015–16: Learning & Teaching Quality Committee]



Specimen exam papers CeFiMS does not provide past papers or model answers to papers. Modules

are continuously updated, and past papers will not be a reliable guide to

current and future examinations. The specimen exam paper is designed to

be relevant and to reflect the exam that will be set on this module.

Your final examination will have the same structure and style and the range

of question will be comparable to those in the Specimen Exam. The number

of questions will be the same, but the wording and the requirements of each

question will be different.

Good luck on your final examination.

Further information Online you will find documentation and information on each year’s examina-

tion registration and administration process. If you still have questions, both

academics and administrators are available to answer queries.

The Regulations are also available at www.cefims.ac.uk/regulations/,

setting out the rules by which exams are governed.

Reference Talbot C (2016) Studying at a Distance: A Guide for Students. 4th Edition, New

York, McGraw-Hill.

DO NOT REMOVE THE QUESTION PAPER FROM THE EXAMINATION HALL

UNIVERSITY OF LONDON

CENTRE FOR FINANCIAL AND MANAGEMENT STUDIES

MSc Examination Postgraduate Diploma Examination for External Students

91DFMC371

INTERNATIONAL BUSINESS ADMINISTRATION


Specimen Examination This is a specimen examination paper designed to show you the type of examination you will have at the end of the year for International Business Strategy. The number of questions and the structure of the examination will be the same but the wording and the requirements of each question will be different. Best wishes for success on your final examination. The examination must be completed in THREE hours. Answer THREE questions, selecting at least ONE question from EACH section. The examiners give equal weight to each question; therefore, you are advised to distribute your time approximately equally between three questions.

PLEASE TURN OVER



Answer THREE questions; at least ONE from EACH section. Section A Answer at least ONE question from this section. 1. What are the main ways in which you can answer the

question: ‘what business is this company in?’ Illustrate your answer with examples. 2. What are the main issues involved when a company chooses

how to enter a new country market? Illustrate your answer with examples of successful and unsuccessful entry strategies.

3. Does ‘mass customisation’ mean that competitive strategy no

longer requires a choice between competing on cost and com-peting on product differentiation? Elaborate your answer with reference to relevant management theories and case materials.

4. Write notes on the following and how the terms are used in

international business? a) Market segments b) Price discrimination c) Intermediaries d) Viral marketing

Section B Answer at least ONE question from this section. 5. Why was Carrefour’s entry into Japan a failure, while its entry

into other Asian markets was successful? 6. Did reorganisation make Sony successful from 2000 onwards? 7. Discuss the reasons for the approaches to exchange rate risk of

two companies you have studied. 8. Why did Ireland and Singapore become successful economies

in the 1990s?

[END OF EXAMINATION]


Unit 1 International Investment

Contents

1.1 The Economics of International Investment 3

1.2 International Investment 5

1.3 Mergers and Acquisitions 8

1.4 Conclusion 13

References 15



Unit Overview In this unit you will be presented with two of the fundamental questions about international business:

• Why do individuals and companies invest in other countries? • What forms can that investment take?

The unit then moves on to the major form of investment – merger and acquisition (M&A) – and introduces the strategic reasons for and options in M&A activity. These three issues will form the foundation for much of the rest of the course.

Learning outcomes When you have completed your study of this unit and its readings, you will be able to

• analyse the principles underlying decisions to invest in countries other than the home base

• judge the relevance of each method of international investment – foreign direct investment and portfolio investment

• discuss the fundamentals of merger and acquisition strategy, including investment for market growth, synergy and diversification.

Reading for Unit 1

Module Reader Van den Berg H (2003) Chapters 5 ‘International trade and economic growth’ and 10 ‘The economics of international investment’. International Economics. New York, McGraw-Hill Higher Education. Gaughan PA (2007) Chapter 4 ‘Merger strategy’. Mergers, Acquisitions and Corporate Restructurings. 4th Edition. New York, Wiley.

As the module progresses you will also analyse case studies; this unit is concerned with some fundamentals and the readings here will be restricted to textbook accounts of the subject.



1.1 The Economics of International Investment In this section you will study the basic principles of investment, and international investment flows. We start with some fundamentals about investment, or the acquisition of assets.

1.1.1 Investment It is conventional to define international investment as the purchase of real and financial assets in a country other that that of the investor. It is also usual to define investment as an ‘intertemporal transaction’ – that is, a payment made in one period for an expected return in some future period. The only difference between a domestic and an overseas investment is the degree of risk and uncertainty involved. Your first reading is from a textbook, International Economics, by Hendrik Van den Berg. In this reading, the author develops a two-period model of consumption and investment, explaining that an equilibrium point balancing consumption and investment occurs, which reflects the economy as a whole’s preference for consumption now against consumption in the future. He then goes on to show that if there are better investment opportunities in another economy, investors will transfer some of their asset purchases there. This investment is financed in period 1 through a trade surplus, and in period 2 a trade deficit. This simple equilibrium model shows the relationship between investment and trade. It also demonstrates that savings levels vary across countries and over time, therefore the funds available for investment, at the economy level, varies between countries. Van den Berg then develops a partial equilibrium model for savings between two countries. What this model shows is that if there is no restriction on the flow of savings, differences in returns will be eliminated by the flow of loanable funds to the country where interest rates are highest, producing a gain for those whose funds were previously lent in the lower-interest country and a loss for those whose funds were previously invested in a higher-interest country, but that overall there is a net gain in welfare. As a simple summary, this is the argument for a free flow of funds among countries, together with an explanation for the resistance to the free flow of funds from those who own financial assets in the higher-interest countries.

Reading

Please read Van den Berg, Chapter 10, sections 10.2 ‘A General Equilibrium Model of In-

ternational Investment’, and 10.3, ‘A Partial Equilibrium Model of International Savings’.

Then you should read section 10.4, ‘Risk Reduction through International Diversification’,

where the argument is simply that international investment allows investors to gain the

rewards from investing in the places where returns are highest and that building a portfo-

lio of investments in many countries allows them to smooth the risks.

You should make notes as you read on the main points raised in the section above.

Van den Berg H (2003) Chapter 10 ‘The eco-

nomics of international investment’. Interna-tional Economics. Reproduced in the Module Reader.



So far, you have been studying, mainly, a two-period model, which would predict that international investment, given the free flow of funds, would equalise the return on assets throughout the world, as funds flowed to where they could get the best returns. In countries where capital is relatively scarce and therefore returns high, investors would buy assets until a global equilibrium return is reached. In such a world, corporate as well as individual investment strategies would be relatively simple – find those investment opportunities where equilibrium has not yet been reached and returns will be higher than those investment opportunities where there is equilibrium.

1.1.2 Investment flows The question raised in this section is:

• Why does investment not all flow to countries where capital is scarcest, and returns highest?

The simple process of adding more investment to an economy will not produce economic growth because, as investments depreciate, an increasing level of savings is required to replace the stock of capital, and returns to investment will diminish. If this were not the case, economies could not have grown as fast as they manifestly have. The solution to this economists’ problem is technological change – each round of investment does not replace the old stock of machines but rather a new, improved, set. In a later section of this reading, Van den Berg uses Solow’s model to argue that international investment is a vehicle for generating technological change in the recipient countries. This was a major contribution, which led economic analysis away from static treatment of technology and from the assumption that all units of capital are substitutes for each other towards the more real-world case in which technology matters and rates of return on investments depend on more than the simple volume of investment in an economy. Not all investments in countries with small supplies of capital will be successful. Therefore, investment flows will depend not just on the existence of different average rates of return in different economies. Finally, you will study in this reading Van den Berg’s discussion of why investment does not flow as freely as the simple model might suggest.

Reading

Please turn to the Reader and study Van den Berg’s Section 5.3 setting out the Solow

Growth Model, Section 10.5 on his use of Solow’s model and Section 10.7, where Van

den Berg turns to the reasons why investment does not flow as freely as the simple mod-

el might suggest.

Make notes on the important issues raised in each section, and list the reasons giv-

en for the impediments to investment flows.

Van den Berg H (2003)

Sections 5.3 ‘The Solow growth model’, 10.5

‘International invest-

ment and economic growth’ and 10.7 ‘The

barriers to international

investment’. Interna-tional Economics. Reproduced in the

Module Reader.



Briefly, Van den Berg’s barriers to international investment, which you should have detailed in your notes, are these:

• government policies to restrict investment • risk • asymmetric information • exchange rate risk • the relative underdevelopment of international institutions.

These issues are dealt with in an introductory way, and we will come back to them in subsequent units. To make sure you have understood the extracts from the Hendrik Van den Berg extracts we have looked at, we will turn now to the Chapter summary.

Reading

To make sure you have understood the extracts from the Hendrik Van den Berg extracts

we have looked at, we will turn now to the summary at the end of it, on page 35 of your

Module Reader.

This module is designed from the perspective of business decision-making, so not all of

the elements of the chapter, especially those that argue for the welfare-maximising ef-

fects of international investment, will be relevant to you. It is not the purpose of this

module to justify or criticise the investment behaviours of corporations or individuals.

1.2 International Investment Before examining mergers and acquisitions, we will consider investment further – foreign direct investment (FDI) and portfolio investment.

1.2.1 Foreign direct investment and portfolio investment Individuals and companies can make investments in other countries in different ways. The difference between foreign direct investment and portfolio investment can be defined in terms of whether the investment gives the purchaser any control over the use of the asset. So, a small minority shareholding gives no control, but a large block of shares might give some control. The absolute level of investment under each definition is not specified, although Van den Berg suggests that a 10%+ holding begins to give some control to the stockholder. For a company, the important thing is the purpose of the investment – FDI implies that they want some control over the company in which the investment is to be made. We can also distinguish between vertical and horizontal FDI – the former being made to establish a supply chain in more than one country, the latter designed to replicate similar facilities in more than one country. About 18% of US investment in poor countries results in products being exported to the US. Rich-country-to-rich-country investment tends to be horizontal. We will look in more detail at global supply chains in Unit 4. The advantage that less

Van den Berg H (2003)

Section 10.8 ‘Conclu-sions’. International Economics. Reproduced

in the Module Reader.



developed countries have generally concerns labour costs, regulation strictness and taxation levels. There are many reasons why companies develop into multinational enterprises (MNE). One theory about what determines the boundary of the firm is the impact of transaction costs on a company as it purchases the goods and services to produce its products – where transaction costs are expensive, at some point it becomes more efficient to internalise the production of those goods and services rather than buy them. If by so doing the firm has to acquire the supplier companies or set up new ones and those companies are in another country, the logic of minimising transaction costs results in an MNE. A counter tendency is the going practice of outsourcing functions, especially manufacturing functions, to companies in another country. Here, the decision to outsource, usually for reasons of minimising costs, has the opposite effect – the main company stays a single-country enterprise. Another important reason for becoming an MNE is the impact of economies of scale. Some industries have very large ‘minimum efficient plant sizes’, especially in industries that have high research and development costs. In these cases, a single R and D operation and a spread of manufacturing plants close to markets makes the best economic sense. Some foreign investment is the result of restrictions on trade – for example, overseas investment in the European Union is a direct result of companies wishing to sell in Europe, but being at a disadvantage because of tariffs and non-tariff barriers to exporting. Similarly, companies may wish to avoid taxation and regulation by locating in another country. Portfolio investment is defined as the acquisition of securities in quantities that do not give the purchasers control over the enterprise invested in. For an indication of the scale of the flows of FDI, look at the global summary of FDI inflows in Table 1.1 below. As you study the table, consider these discussion points about the flow of FDI:

• Traditionally (i.e. the years before 2012), about twice as much FDI flows to developed as to developing economies. How has this changed since 2012?

• The European Union used to have has seven times the FDI inflow of China and over five times as much as the USA; how have these dynamics changed?

• Globally, FDI was on an upward trajectory until 2011; why do you think it has since slowed?

• The rate of growth of FDI in developed economies is faster than in developing economies, but developing countries too have suffered from a slowdown in global FDI. Why?

You should also note that FDI data can be distorted by a single large transaction. For example, the 2005 data for the United Kingdom are distorted by a single, large, investment by Royal Dutch Shell. Table 1.1 includes a note that World FDI inflows are projected as the basis of the 199 economies for which data are available. Data are estimated by



annualising their available data, in most cases first quarter of data. The proportion of inflows to these economies in total inflows to their respective regions or sub-regions in 2011 is used to extrapolate the 2012 data.

Table 1.1 Foreign Direct Investment, by host region and host economy 2003–2012 (in billions of dollars)

Host region/economy 2003 2005 2012 Growth rate % (2011–2012)

World 637.8 896.7 1310.7 –18.3 Developed Countries 441.7 573.2 548.9 –32.1

Europe 358.9 449.2 293.5 –36.1

European Union (25) 349.1 446.3 287.0 –34.8

EU–15 327.6 407.7 –

France 42.5 48.5 58.9 43.8

Germany 27.3 4.9 1.3 –96.8

Italy 16.4 13.0 5.3 –84.7

Luxembourg 83.8 13.4 22.6 57.0

United Kingdom 27.4 219.1 62.5 22.2

New 10 European states 12.5 37.7

Czech Republic 2.1 12.5 10.0 84.3

Hungary 2.1 6.0

Poland 4.6 8.7 4.1 –78.2

United States 56.8 106.0 146.7 –35.3

Japan 6.3 9.4 48.5 –26.3

Developing Economies 172.1 373.5 680.4 –3.2 Africa 17.2 28.9 45.8 5.5

Egypt 0.2 4.1 3.5 –

Morocco 2.3 1.2

South Africa 0.7 7.2 6.4 10.3

Sudan 1.3 2.1

Latin America and the Caribbean 48.0 72.0 232.6 7.2

Argentina 1.7 4.2 11.0 27.3

Brazil 10.1 15.5 65.3 –2.0

Chile 4.4 7.0 26.4 52.7

Colombia 1.8 4.5 15.8 15.9

Mexico 12.8 17.2 17.4 –16.5

Asia 106.9 172.7 399.0 –9.5

West Asia 11.9 26.5 47.0 –3.3

Turkey 1.8 4.8 12.4 –22.1

South, East and South East Asia

China 53.5 60.3 119.7 –3.4

Hong Kong, China 13.6 39.7 72.5 –24.6

India 4.3 6.0 27.3 –13.5

Indonesia –0.6 3.5 19.2 –0.1

Korea, Republic of 3.8 4.5 9 –11.9

Malaysia 2.5 4.2 10 –16.8

Singapore 9.3 15.9 54.4 –15.1

Thailand 1.9 3.7 8.1 3.9

South East Europe & Common-wealth of Independent States

Russian Federation 8.0 26.1 44.1 –16.6

Romania 2.2 5.2

Kazakhstan 2.2 5.4 44.1 13.4

Source: UNCTAD



Exercise

After you have studied the direction of flows in the table, can you note what are the pos-

sible explanations for these trends?

One explanation for the persistently large flows to the European Union and the USA is the desire by companies to get over tariffs and other protectionist trade restrictions. It is also likely that companies want to locate their production close to these markets, and the difference in labour costs between these and other locations is less important than those considerations. Clearly, if labour costs were the dominant criterion, there would be a higher proportion of FDI flowing to low-wage economies. For a detailed discussion of FDI flows, see World Investment Report: http://unctad.org/en/Pages/DIAE/World Investment Report/WIR-Series.aspx.

1.3 Mergers and Acquisitions By now you should have an overview of some of the economic rationale for transnational investment, and a summary of the reasons why companies invest in countries other than their country of origin. One option for making an overseas investment is to take a stake in a company operating in the target country, whether a minority or majority stake. We now turn to the question of merger-and-acquisition strategy, or the reasons for and forms of investment in other companies, as a central element of international strategy.

1.3.1 Merger-and-acquisition trends Merger-and-acquisition activity occurs in waves, as conditions for agglomeration and the fashion for company management to use acquisition as a growth strategy comes and goes. The first wave of mergers in the USA (where this sort of activity started) dates back to 1879–1904 as US corporations attempted to establish monopoly positions in all the major industries. This was followed by the ‘anti-trust’ laws that still form the basis of US competition policy. The two subsequent waves of M&A activity occurred within the anti-trust laws and were designed for different purposes, whether the establishment of oligopolies (a small number of competitors in an industry) or other business strategies. ‘Modern’ M&A began with the fourth wave, 1981–1989. Here the mergers were of very high value, and large companies were involved. Investment banks became involved, offering advice and collecting fees; take-over and defence strategies were developed in great intricacy and there was much greater use of debt to finance take-overs. During this wave, the first significant multi-national merger-and-acquisition activity also took place – for example, the acquisition of Standard Oil by British Petroleum in 1987.



The fifth wave began in 1992. The features of the fifth wave were an increasing use of equity rather than debt to pay for the acquisitions; there was a period of consolidation as ‘roll-up’ deals picked up the smaller companies in an industry and amalgamated them with the larger. This was aided by the ability of specialised investment banks to offer, often complex, financing solutions to finance acquisitions. International acquisitions also took off during the fifth phase, with European deals almost matching US deals by 1999, at around US$1,500 million in value. Asian deals also took off, mostly based in Japan. The large amounts of external funding required for sustaining the repeated waves of M&A activity made it particularly susceptible to upsets in the global economy, such as the ‘dot-com’ crash and the financial crisis of 2007–08. To see the effect of this, please now study Figure 1.1 and Table 1.2, which shows the value of M&A deals, by value and by region, from 2000 to 2008, and M&A deals by region/economy of seller and purchaser in 2011 and 2012. When studying the data the following points are worth noting:

• the growth in the proportion of transnational deals over the period (Figure 1.1)

• the increasing location of M&A activity in the European and Asian-Pacific regions (Figure 1.1)

Figure 1.1 Share of global M&A by geography of target (%)

Asia-Pacific

Europe

Americas

2000 2001 2002 2003 2004 2005 2006 2007 20081

2

3

4

5

Total value ($US trillion)

9 12 13 19 18 19 15 18 19

33 32 33 40 37 38 39 41

58 56 49 45 47 46 46 42 40

23 25 25 28 29 29 29 41 35

Year

Share of cross-border flows %

39

Source: Dealogics McKinsey analysis

• the effect of the financial crisis – leveraged buy-outs have by and large witnessed the biggest decline, while government activities such as government investments in financial institutions, investment by government-controlled corporate and sovereign wealth funds are less affected

• the differences between FDI patterns and M&A patters across the developed and developing economies (Tables 1.1 and 1.2); it is notable, for example, that although developing economies have been very successful in recent years in attracting large amounts of FDI, there has been far less M&A activity



• China is a case in point – China’s M&A sales activity is far smaller than inward FDI, suggesting that many companies prefer to enter China via wholly-owned subsidiaries, rather than by acquiring Chinese firms; it is also notable that China’s M&A purchases are higher, reflecting the international purchases of Chinese companies abroad.

Table 1.2 Mergers and Acquisitions, by region and economy of seller/purchaser 2011–2012 (in billions of dollars)

Net Sales Net Purchases

Region/economy 2011 2012 2011 2012 World 525,881 310,141 525,881 310,141

Developed Countries 409,691 258,003 400,929 176,292

Europe 200,363 135,352 145,542 26,775

European Union 172,257 119,707 117,050 310

France 24,325 11,467 3,303 -1,367

Germany 12,709 8,229 4,801 15,522

Italy 13,450 3,293 4,176 -1,680

Luxembourg 9,393 6,461 -20,751 -6,290

United Kingdom 35,691 35,313 53,876 -7,678

United States 134,103 66,259 130,210 78,721

Japan 4,991 1,278 62,687 35,612

Developing Economies 83,220 48,381 103,615 114,657

Africa 7,205 -1,195 4,812 592

South Africa 5,228 -879 4,252 821

Latin America and the Caribbean 20,689 20,011 18,659 28,149

Argentina -246 430 102 2,799

Brazil 15,422 15,299 5,540 7,427

Mexico 1,231 331 4,390 2,450

Asia 55,302 29,580 80,179 85,873

West Asia 9,713 4,295 6,136 8,852

Turkey 7,348 2,690 908 2,012

South, East and South East Asia

China 11,176 9,927 34,355 37,051

Hong Kong, China 1,028 2,787 11,293 13,237

India 12,577 2,456 6,072 2,657

Korea, Republic of 2,466 -1,767 4,019 5,508

Malaysia 4,517 721 3,909 9,293

Thailand 570 -72 4,996 5,448

Transition Economies 32,970 3,756 13,510 8,615

Russian Federation 29,705 5,617 5,084 7,791

Source: UNCTAD

At the end of this section you might like to consider whether the above points signal the end of the most recent wave of M&A activity; or are we about the see the beginning of a new wave, involving new investors, often state-led, and from different regions?



1.3.2 Merger strategy While not all mergers are transnational, M&A are an important element of international business strategy. Here we turn to the issue of merger strategy: why and how do companies merge?

Reading

Turn now to the reading, ‘Merger Strategy’, a chapter from a textbook by Patrick

Gaughan. In it, the author explains the main reasons and strategies for mergers.

As you read the chapter, you should make notes covering the main issues involved.

The first reason for merger is to achieve growth in a slow-growing industry. Company managements are always under pressure to grow their turnover, and building increased market share in a slow market is a long-term process. Acquisition of other companies is a faster route to growth. The danger, though, is that the increase in sales thus acquired may not result in increased profits. Managers’ pursuit of turnover growth might not be compatible with owners’ pursuit of increased profits.

Synergy

A concept often used in merger strategy is ‘synergy’. Gaughan defines three types of synergy that can result from a merger. The first is the ‘increase in value of the newly combined company’, above the combined value of the prior-to-merger companies, less any merger expenses: Net Acquisition Value = [VAB – (VA + VB)] – (P + E)

Where VAB = the combined value of the two companies VB = the market value of B VA = A’s measure of its own value P = the premium paid for B, over its share price E = the expenses of acquisition. The term in square brackets is the synergistic effect of the merger. The second type of synergy is ‘operating synergy’, through which the merged companies can either gain greater revenues together than apart (for example, by combined marketing), or achieve reduced costs (through economies of scale, for example). Gaughan is keen to remind you that the achievement of operating synergies of both types requires a great deal of management effort and strategic thinking. The third type of synergy is ‘financial’, where the cash flows of the merged companies are uncorrelated and the combined business has a less volatile cash flow. To this could be added the automatic currency hedge implied by a merger between companies operating in different currencies.

Gaughan PA (2007)

Chapter 4 ‘Merger strategy’. Mergers, Acquisitions and Cor-porate Restructurings. Reproduced in the

Module Reader.



Diversification

A second motive for merger is diversification. Diversification can produce ‘conglomerates’, which consist of a portfolio of unrelated businesses. Many fourth-wave mergers were of this type, and they were followed by a period of ‘deglomerisation’, where buyers could add value by demerging unrelated businesses from their conglomerate parents, because the conglomerate management could not be successful in a range of unrelated activities. Diversification may be pursued to enable the company to move from less to more profitable activities. One of the most successful conglomerates developed through acquisitions was the US company General Electric (GE). In recent years, the company has added organic growth at 8% per annum to its history of growth through acquisition.1 A famous recent, unsuccessful, example involved the French water utility company, known at the time as Vivendi, whose CEO took the company into television production, films and music industries in the belief that these activities would be more profitable (and interesting) than supplying water. The new group made losses of €23.6 billions in 2002, the largest recorded loss by a French corporation. More usual is a move from a mature industry where growth is slow into faster-growing sectors. However, Gaughan’s summary of the evidence on diversification is that it tends to reduce rather than enhance company value after the mergers.

Economic motives

Mergers enable integration, either horizontal (between companies doing similar things) or vertical (among companies at different stages in the supply chain). Horizontal mergers are generally pursued to gain market share and market power. Vertical integration offers the chance to

• gain control over supplies (for example, the acquisition of oil and gas rights)

• gain cost advantages by internalising a supplier • reduce transaction costs • acquire specialist inputs previously bought in the market.

Gaughan also covers a variety of other motives, including the desire to improve the quality of management by acquisition, improve research and development capabilities, distribution networks and tax advantages. You should now have a grasp of the basics of merger strategies. In general, you should remember that mergers do not automatically result in improved profitability because

• the premium paid may be too high • the managers may have overstated the case for the merger and the

value of the merged entity (the ‘hubris hypothesis’) • the management skill required to make the new company work may

be lost after the merger as managers leave the target company • synergies are not realised.

1 See an interview with GE’s CEO at: http://www.ge.com/files/usa/company/investor/

downloads/harvard_business_review_ge.pdf



Gaughan wrote another book after the one you have been reading from, called Mergers: What Can Go Wrong and How to Prevent It 2, based on analysis the fifth-wave mergers. In that book he advocates joint ventures as a less risky strategy, especially when the purpose of the merger is to acquire a market presence in an overseas territory. We will return to the question of the best entry strategy in Unit 2 and to the reasons for success and failure of mergers when we look at the case of DaimlerChrysler, in Unit 5.

1.4 Conclusion In this unit you have been introduced to some of the economic analysis underlying the question of why companies decide to acquire assets in another country. You have seen that stark economic calculations of costs and returns are not the sole explanation for the decisions to acquire foreign assets, and that institutional factors and trade and other rules and regulations also affect the decision. You have also seen that M&A, one of the main ways in which companies can acquire assets in another country, has a wave pattern but is in trend growth and has spread from the USA to the rest of the world. However, the effects of M&A on a company’s profitability are not guaranteed to be positive. In many cases the combined value of the new company is less than the separate values of the old ones. In the next unit we turn to the question:

• What strategies must managers adopt to ensure that the international expansion of their company is profitable?

Unit 2, then, is concerned with the choice of entry strategy. The unit after that considers practical questions about production and sourcing in countries other than the home base.

Review Questions

To help you to review this unit, make sure that you are able to answer the following ten

questions, based on the readings.

1. Why do people and businesses acquire assets in other countries?

2. Why do interest rates differ between countries?

3. With no restriction on international investment, what would you expect to happen to rates of return in different countries?

4. What does the Solow model offer as an explanation for the fact that returns to investment do not always decrease?

5. Why is international investment smaller than it should be, if the equilibrium model was correct?

6. Why do companies pursue (a) vertical, and (b) horizontal integration?

7. What are the main reasons for the growth of Multinational Enterprises?

2 Gaughan (2005)



8. Why has the volume of Foreign Direct Investment and M&A activity traditionally been higher in developed than in developing economies? Is this changing?

9. What are the main types of ‘synergy’ that can result from mergers and acquisitions?

10. What are the obstacles to achieving synergy after a merger?

In summary, the main points covered by this unit are: • Investment decisions are not a simple matter of choosing to invest

where returns seem to be highest. Government policies, asymmetric information, exchange rate and other risks, the development of institutions all have an influence on where companies invest.

• Investments may be made in two basic ways – by directly buying or creating an asset, or by buying stock in already existing assets. Direct investment may be vertical or horizontal – investments that move capital from one rich country to another tend to be horizontal; investments from richer to poorer countries tend to be vertical.

• The main motivations behind direct investment to create a multi-national enterprise are: • internalising transaction costs • keeping control over proprietary knowledge • realising economies of scale • maintaining or improving reputation • getting over trade restrictions across boundaries • avoiding taxes • hedging exchange rate risk from exporting • substituting for poor or missing financial markets • anticipating favourable business conditions in the new location • finding low-cost locations for all or part of the value chain.

• Mergers and acquisitions occur in waves, some waves involving debt financing and others equity. Different waves have had different motivations. M&A activity also has different motivations: • to achieve growth in a slow-growing industry • managers’ desire to increase turnover by acquiring other companies • ‘synergy’ – merged organisations able to achieve greater sales or

profits than unmerged entities • diversification • to gain market share • to gain control over the value chain.



References Gaughan PA (2005) Mergers: What Can Go Wrong and How to Prevent It, 4th Edition. Hoboken NJ, Wiley.

Gaughan PA (2007) Mergers, Acquisitions and Corporate Restructurings. 4th Edition. New York, Wiley.

General Electric: Interview with GE Chief Executive Officer. Available from: http://www.ge.com/files/usa/company/investor/downloads/harvard_business_review_ge.pdf

UNCTAD: www.unctad.org

Van den Berg H (2003) International Economics. New York, McGraw-Hill Higher Education.

World Investment Report. Available from: http://www.unctad.org/wir.

Documents

International Business StrategyCentre for Financial and Management Studies 3 Damian Tobin is Lecturer in Chinese Business and Management at the Centre for Financial and Management