Chapt 06 Spring 04 S

Chapter 6: 

Chapter 6 Foreign Direct Investment (FDI) IB 150 Spring 2004 Professor Robert F. Bohl

Introduction: 

Introduction a firm invests directly in facilities to produce and/or market a product in a foreign country. Foreign Direct Investment (FDI) occurs when: Once a firm undertakes FDI and is involved directly in more than one country, it becomes a multinational enterprise (MNE). and /or a U.S. citizen,organization, or affiliated group takes an interest of ________ or more in a foreign business entity (U.S. Dept. of __________________ definition).

FDI and FPI: 

FDI and FPI There’s a significant difference between Foreign Direct investment (FDI) and Foreign Portfolio Investment (FPI). Government _________________ Foreign _____________________ FPI: investment by individuals, firms, or public bodies in foreign _____________________________________ . FPI does not involve taking a significant equity stake in a foreign business entity.

FDI in the World Economy: 

FDI in the World Economy The Flow of FDI: The amount of FDI undertaken over a given ___________________________ (normally a year) The Stock of FDI: The total accumulated value of foreign-owned assets at a ________________________. Outflows of FDI: The flow of FDI out of the country Inflows of FDI: the flow of FDI into the country Review of Definitions:

Trends in FDI: 

Trends in FDI In the last 20 years: The flow increased until 2001, then decreased dramatically due to an economic slowdown. There’s been changes in the source of FDI (outflows). There’s been changes in the recipients of FDI (inflows). The stock of FDI also increased during the period, but the rate of increase slowed in 2001.

FDI World Outflows1982-2002: 

FDI World Outflows 1982-2002 1991-1995 Data: JETRO 1996-2002 Data: UNCTAD

FDI OutflowsSelected Nations 1985 - 2002: 

FDI Outflows Selected Nations 1985 - 2002 US $Billions During the later 90s, strong economies in the US and the UK had given firms the capital to invest abroad. Daimler-Chrysler Merger UNCTAD Data

What Accounts for the Growth in the Flow?: 

What Accounts for the Growth in the Flow? FDI is a way of circumventing future ____________. The shift toward democracy and free market economics encourages FDI. Deregulation of telecommunications, etc Privatization of utilities and major state-owned companies Liberalization of trade and investment Japanese auto companies invest in US production facilities during the 1980s and early 1990s to avoid tariffs and quotas.

What Accounts for the Growth in the Flow?: 

Global firms want a significant ________________ in every part of the world; Firms can lower costs by basing individual production (and _____________ ) activities at the optimal location for that activity. Small and medium-sized firms are becoming more active in FDI. BMW, Mercedes, Nissan, Honda, Toyota, and others build major facilities in the US. What Accounts for the Growth in the Flow? many believe that it’s important to have production and/or marketing operations close to their major customers. Some firms export product back to the home country. many subcontractors establish production facilities close to their major customers (auto parts suppliers).

Who Are the Recipients of FDI?: 

Who Are the Recipients of FDI? Economic progress; growing economies attract investment. Economic crisis… in Korea has attracted European (largely German) and American firms to low-priced acquisitions. However, the FDI is concentrating in relatively ________________ developing nations. The poorest countries risk becoming more and more marginalized as transnational corporations pass them by. a. Developing & Newly Industrialized Nations Liberalization of economic policies and privatization in other Asian countries (Indonesia, India, Malaysia, Philippines, R.O.K. Thailand). These factors also spurred increased investment in Latin America. — strong FDI growth in Brazil, Argentina, Mexico, Chile, during 1999 There’s been a continuation of FDI into some these nations due to:

Recipients of FDI(the U.S.): 

Recipients of FDI (the U.S.) It’s the largest and richest consumer market in the world. From 1985 through 1995 the U.S. dollar ___________________________ in respect to the Japanese yen and German mark. Some foreign firms believe that they can manage U.S. workers and assets better than U.S. managers. Foreign firms (mostly European) are playing an active role in an U.S. M&A boom, and also want a share of the ___________________ market. Some Mexican retailers are expanding into the Western U.S. and focusing on the expanding Hispanic market. The U.S. enjoyed a long economic boom b. U.S. Until recently there were increasing inflows into the U.S. because:

Recipients of FDI(Western Europe): 

c. Western Europe Reduces exchange _____________________________. Stimulates price _________________ (price transparency). Urges firms to step up their reorganization and M&A initiatives within the EU. insurance companies banks and financial firms Recipients of FDI (Western Europe) The launch of the ________ zone encourages FDI because it… …in the last decade Western European countries made _________________ direct investments in the U.S. than the other way around. This trend continued despite the decline of the euro through 2001. U.S. firms expand into Europe, but… telecommunications Q. Why?

Why the Imbalance?: 

Why the Imbalance? In order to become global heavyweights, European companies ignored the weak euro and paid dearly to buy strategic U.S. assets: Unilever Group buys Ben & Jerry’s Deutsche Telekom buys Voice-Stream Nestle acquires Ralston Purina, Dreyer, Chef America Before the recent economic slowdown Europeans were looking at: The booming U.S. economy. the U.S.’s greater ________________. the potential for earning strong dollar profits. The trade of euros for dollars to purchase U.S. assets can also drive the value of the euro _________________________________. Meantime, the U.K. is not a member of the EMU, and the pound is a strong currency. Vodaphone buys Airtouch UBS AG buys PaineWebber Group Daimler-Benz + Chrysler

Why the Imbalance?: 

Q. Considering the weaker euro, why hadn’t U.S. multinationals acquired European assets at a greater pace? Euro profits converted to fewer dollars. Many U.S. MNEs are already global heavyweights, or made acquisitions in Europe decades ago. U.S. companies are more interested in a good strategic fit than (probably temporary) favorable exchange rates. labor complexities regulations U.S. companies don’t feel confident dealing in Europe. government interference difficulties in financing deals Why the Imbalance? The trick was to invest in Europe when the euro was about to rise — this happened but was difficult to predict.

FDI InflowsSelected Nations 1991 - 2002: 

FDI Inflows Selected Nations 1991 - 2002 1991-1995 Data: JETRO 1996-2002 Data: UNCTAD US $Billions

FDI InflowsSelected Regions 1970 – 2002: 

FDI Inflows Selected Regions 1970 – 2002 US $Billions The United Nations Conference on Trade and Development (UNCTAD) indicates world FDI inflows exceeded $1.4 trillion in 2000, but FDI dropped to 735,145 billion in 2001. UNCTAD Data

Gross Fixed Capital Formation: 

Gross Fixed Capital Formation A summary of the total amount of capital invested in factories, stores office buildings, and the like. All things being equal, the greater the capital investment in an economy, the more ______________________ its future growth prospects are likely to be. Q. How large a part does FDI contribute to fixed capital formation? Gross Fixed Capital Formation:

Inward FDI Flows as a Percentage of Gross Fixed Capital Formation: 

Inward FDI Flows as a Percentage of Gross Fixed Capital Formation UNCTD Data; WIR 2003

Types of FDI: 

Types of FDI FDI Merging with a foreign firm Acquiring part or full interest in a foreign firm. Green-field Investment M / A ______________________________________________________

Mergers & Acquisitions: 

Mergers & Acquisitions A large portion of FDI has been in the form of a merger (the joining of two existing firms), or an outright purchase (acquisition) of one firm by another. M&A activity can strengthen a firm’s international presence while ____________________________ industries. Daimler and Chrysler merge GM buys SAAB and Daewoo (part.) BMW buys Rover, Rolls Royce Volkswagen buys Bentley Hyundai takes over Kia Bridgestone acquires Firestone Ford acquires Jaguar, Volvo and Land Rover

Top 10 Industries for Cross-border M&As (sales): 

Top 10 Industries for Cross-border M&As (sales) Data: JETRO, Invest2000 and 2002

Exporting, Licensing, or FDI?: 

In return for these rights, the licensor collects a _____________________ on every unit the licensee sells. ______________________________ risk to domestic manufacturer. Licensing: Exporting, Licensing, or FDI? Exporting: The product may sold directly to an end-user, or “officially” represented and distributed by an importer / reseller. ________________________ risk and expense to domestic manufacturer. Selling a product into a foreign country. A domestic firm licenses, to a foreign firm, the right to produce its product, to use its production processes, or to use its brand name or trademark.

Why FDI(and not alternatives)?: 

Why FDI (and not alternatives)? Q. Why or when does a firm go through the expense and risk of establishing operations abroad when they could export or license? A. There are a number of factors and/or theories that try to explain the relative attractiveness and timing of export, licensing, and FDI, as well as patterns of FDI:

Impediments to ExportingTransportation Costs: 

Impediments to Exporting Transportation Costs Shipping some products a long distance can add substantially to its _________________. This can cause: Uncompetitive pricing in the foreign market — if the seller doesn’t absorb part of the shipping cost. Depressed profits — if the seller tries to match lower local prices. a. Transportation Costs: Manufacturers are faced not only with production costs, but also the cost of getting the product to the customer. Landed Cost = __________________________________________________________

Impediments to ExportingTransportation Costs: 

Impediments to Exporting Transportation Costs Products with a ______________________________ ratio can be a problem as transport is a major component of the cost. Products with a high value-to-weight ratio have little impact on the relative attractiveness of exporting, licensing, or FDI

Impediments to ExportingTrade Barriers: 

Impediments to Exporting Trade Barriers Trade barriers decrease the profitability of exporting. Tariffs increase the cost of imported goods. Quotas or VERs can limit sales potential. Trade barriers do not have to be in effect, the threat is often enough to discourage export and encourage FDI. b. Trade Barriers:

Limitations of Licensing: 

Limitations of Licensing 1. Licensing may result in giving _________________________ to a potential foreign competitor. 2. Licensing does not give a firm tight control over manufacturing, marketing, and strategy in a foreign country. Market Imperfections / Internalization Theory: 3. A firm’s competitive advantage may not be amenable to licensing. As it is difficult for a firm to license its own unique assets, FDI is usually required – John H. Dunning’s ______________________________________.

The Pattern of FDI: 

The Pattern of FDI Setting prices Expanding capacity FDI According to F.T. Knickerbocker, to avoid being left in a disadvantageous position, rival firms in ___________________* industries tend to imitate one another in … * An industry composed of a few large firms market share (export market) first-mover advantage in a foreign country a ______________________________________ that can be brought back to the home country …because there is a strong fear of losing: a. Strategic Behavior (when and why):

The Pattern of FDI: 

The Pattern of FDI …an investment is made to produce the product in a developing country having lower labor costs. Firms undertake FDI at particular stages in the product life cycle. This theory by Raymond Vernon fails to identify when (or if) it may be more profitable to invest abroad. An investment is made in advanced foreign countries when the local demand is sufficient to support local production. Subsequently when product standardization and market saturation creates price competition and cost pressures… b. The Product Life Cycle (when and why):

The Pattern of FDI: 

The Pattern of FDI Gained by combining a firm’s own unique assets with the resources or assets of a particular foreign location. Natural resources (oil and other minerals) Low-cost, high-skilled labor Concentrated knowledge base (externalities, Porter’s clustering) c. ________________________________ (where and why):

Horizontal and Vertical FDI: 

Horizontal and Vertical FDI 1. ____________________________________ FDI: Occurs when a firm invests in the ____________________________ abroad as it operates in its home country. 2. ___________________________________ FDI: Occurs when a firm invests in an industry abroad that provides inputs into a firms domestic operations or sells its outputs. Foreign direct investment is divided into two subcategories:

Vertical FDI: 

Vertical FDI __________________ Selling Outputs Of Production _____________________ Inputs to Production PRODUCTION Vertical FDI takes two forms, backward and forward Q. Why do producers make vertical investments rather than relying on foreign sources and services? 1. Strategic Behavior (market power) 2. Market Imperfections

1. Strategic Behaviorand Vertical FDI: 

1. Strategic Behavior and Vertical FDI a. To create new entry barriers, i.e.. limit competition and strengthen control over the market by controlling the main source of raw material inputs Firms undertake vertical FDI: b. To erode competitors entry barriers, i.e. gain access to a national market by circumventing barriers established by competitors already in the market by buying or establishing proprietary distribution / sales channels

2. Market Imperfectionsand Vertical FDI: 

2. Market Imperfections and Vertical FDI 1. Impediments to the sales of know-how The market imperfections approach offers two explanations for vertical FDI: The risk of giving valuable know-how to licensees that subsequently may become potential competitors. The need to control the cost of raw materials (needed inputs) once a large investment is made to process those materials. 2. Investment in specialized assets

A Decision FrameworkExport / License / FDI: 

A Decision Framework Export / License / FDI How high are transportation costs and tariffs? Is know-how amenable to licensing? Is tight control over foreign operations required? Can know-how be protected by licensing contract? High Yes Yes Low No Yes No No