3. Foreign Direct Investment [FDI] S.S. Ranjan

Category: Education

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Investment Management in International Business Foreign Direct Investment 1

Key Consideration for FDI:

Key Consideration for FDI What is FDI? Why is FDI increasing? Why do firms choose FDI over exporting or licensing to enter a foreign market? Why are certain locations attractive for FDI? How does political ideology influence government policy over FDI? From a host or source country perspective, what are FDI’s costs and benefits? How can governments restrict or encourage the FDI? 2

What is FDI ?:

What is FDI ? The flow of funds (investments) from one country to another for any activity including industrial development, infrastructure and manufacturing Foreign direct investment (FDI) happens when a firm invests directly in facilities in a foreign country Investment Outflow and Investment Inflow are the nature of FDI The current FDI is related to investment in developing countries and Less Developed Countries (LDCs) 3

What is FDI ?:

What is FDI ? A firm that engages in FDI becomes a multinational enterprise (MNE) Multinational = “more than one country” Factors which influence FDI are related to factors that stimulate trade across national borders It do not include foreign investment in stock market It is to increase business opportunities across nations To avoid crisis focus must be on projects rather than investments in the firm’s equity 4

Extent of FDI ?:

Extent of FDI ? It involves ownership of entity abroad for production Marketing or Service R&D Raw materials or other resource access Parent has direct managerial control The degree of direct managerial control depends on the extent of ownership of the foreign entity and on other contractual terms of the FDI No managerial involvement = Portfolio Investment 5

Why is FDI Increasing ?:

Why is FDI Increasing ? FDI growing faster than world trade Political risk issues Economic reason issues Globalization Historically, FDI flow was to developed countries from other developed countries Much of this to the US Since 1985 there has been an increase of FDI towards developing countries Much to the emerging Asian and Latin America economies Africa lagging 6

Criteria’s for FDI:

Criteria’s for FDI ■ Expected profitability ■ Relative cost and price for local procurements ■ Political stability and systems ■ Confidence in macro economic policies ■ Legal enforcement laws and consequences ■ Quality of contracting and sub contracting ■ Transaction cost ■ Competing firm in the investing nation ■ Time frame of ROI ■ Criteria’s for reinvestment and further expansion ■ Consideration of CSR. 7

Forms or Modes of FDI:

Forms or Modes of FDI FDI forms Purchase of existing assets Quick entry, local market know-how, local financing may be possible, eliminate strong and unknown competitors, buying problems New investment No local entity exists or is available for sale, local financial incentives may encourage, no inherited problems, long lead time to generation of sales or other desired outcome Participation in an international joint-venture Shared ownership with local and/or other non-local partner 8

Alternative Modes of Market Entry:

Alternative Modes of Market Entry FDI FDI - 100% ownership FDI < 100% ownership, International Joint Venture --FDI > 100% ownership, Equal Share, Minority Participation Strategic Alliances (non-equity) Franchising Licensing Exports Direct and Indirect 9

Pattern of FDI:

Pattern of FDI Follow main competitors Oligopolistic industries Interdependence of the few major competitors forces immediate strategic responses International product life-cycle Diverse Models (Other Patterns) of FDI Combines ownership specific, location specific and global specific advantages that drive FDI choice over a decision to enter through licensing 10

Eclectic Paradigm of FDI :

Eclectic Paradigm of FDI Ownership advantage: Creates a monopolistic advantage which can be used to prevail in markets abroad Unique ownership advantage protected through ownership e.g., Brand, technology, economies of scale, management know-how Location advantage: The FDI destination local market must offer factors (land, capital, know-how, cost/quality of labor, economies of scale) such that it is advantageous for the firm to locate its investment there Global advantage: Transaction costs of an arms-length relationship -- licensing, exports -- higher than managing the activity within the MNE’s boundaries 11

Why FDI?:

Why FDI? FDI over exporting High transportation costs, trade barriers FDI over licensing or franchising Need to retain strategic control Need to protect technological know-how Capabilities not suitable for licensing or franchising 12

Foreign Direct Investment:

Foreign Direct Investment Merits ● More managerial controls over the operations ● Tool for bringing cross border knowledge ● More accountable on performance in host country ● Can provide a successful export strategy. ● Paves the way for entering into foreign marketing ● Benefits both domestic industry and the consumers ● Tool for bringing product design & quality characteristics ● It is non debt creation and ROI depends upon the performance of the investor’s project. ● In boosting the host country’s economic growth. ● It makes possible the bigger economic revival. ● Money, technology and human expertise may contribute in advancement of the host nation’s firms. ● Free access to market place gives more protection to consumers. ● For the investor party it gives freedom from quota and other business restrictions. ● Brand popularity and preference may grow in many folds depending upon product performance and acceptance 13

Foreign Direct Investment:

Foreign Direct Investment Demerits ● Greater risk compared to exporting or licensing ● Profit ratio may vary ● To take care of lots of uncertainties. ● Various restrictions for firm’s locations affecting product cost ● May face more restriction to guard the host nation’s firms ● Risk of confiscations to overrule parameters ● Risk of existence in business for the players from the host nations. ● Force to abide by the labour law of the host nation’s govt. inclination. It may be against of the investor’s ethics or expectations. ● Risk of colonial rebirth if not taken precautions. ● Risk of more unemployment or underemployment for the investor’s country 14

Government Policy and FDI:

Government Policy and FDI The Radical View: Inbound FDI harmful; MNEs Are an instrument of improper domination Exploit host to the advantage of home country Extract profits from host country; give nothing back Keep LDCs backward/dependent for investment, technology and jobs The Free Market View: FDI should be encouraged Adam Smith, Ricardo, et al: international production should be distributed according to comparative advantage The MNE increases the world economy, efficiency because it brings to bear unique ownership advantages on the local economy’s comparative advantages 15

Government Policy and FDI:

Government Policy and FDI Home country Outward FDI encouragement Risk reduction policies (financing, insurance, tax incentives) Outward FDI restrictions National security, BoP Host country Inward FDI encouragement Investment incentives Job creation incentives Inward FDI restrictions Ownership extent restrictions (national security; local nationals can safeguard host country’s interests 16

Decision Framework for FDI:

Decision Framework for FDI Export FDI FDI FDI License Yes Import Barriers? No No Yes No Are transportation costs high? Is Technical know-how easy to license? Tight control over foreign operations? Is know-how valuable and Is protection possible? No Yes Yes No Yes 17

PowerPoint Presentation:

Major M&A Deals Undertaken Abroad by India Inc. USD 12.1 billion Tata Steel buys Corus Plc USD 6 billion Hindalco acquired Novelis Inc. USD 1.6 billion Suzlon Energy Ltd. acquires REpower USD 730 million Videocon Industries acquired Daewoo Electronics Corporation Limited USD 1.58 billion Essar Steel acquired Algoma Steel 18

PowerPoint Presentation:

Major M&A and Investments Announcements in India USD 11 billion Vodafone buys Hutch USD 1.7 billion Plans to spend on its development operations in India over the next four years USD 1 billion Plans investment in private equity, real estate, and private wealth management USD 0.98 billion Aditya Birla Group increased its stake in Idea Cellular by acquiring 48.14-percent stake USD 0.905 billion Renault, Nissan and Mahindra & Mahindra has initiated a automobile plant project in Chennai. Mylan Laboratories acquired a majority stake in Matrix Laboratories USD 0.74 billion 19

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