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Chapter 17Foreign DirectInvestmentTheory andStrategy
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Foreign Direct InvestmentTheory & Strategy: Learning Objectives
Demonstrate how key competitive advantages supportMNEs strategy to originate and sustain foreign directinvestment
Show how the OLI paradigm provides a theoreticalfoundation for the globalization process
Identify factors and forces that must be considered inthe determination of where MNEs invest
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Foreign Direct InvestmentTheory & Strategy: Learning Objectives
Illustrate the managerial and competitive
dimensions of the alternative methods for
foreign investment Identify the strategies used by MNEs originating
in developing countries to compete in global
markets
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Sustaining & Transferring
Competitive Advantage
In deciding whether to invest abroad, management mustfirst determine whether the firm has a sustainablecompetitive advantage that enables it to compete
effectively in the home market In order to sustain a competitive advantage it must be:
Firm-specific
Transferable
Powerful enough to compensate the firm for the extradifficulties of operating abroad
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Sustaining & Transferring
Competitive Advantage
Some of the competitive advantages enjoyed byMNEs are:
Economies of scale and scope
Managerial and marketing expertise
Advanced technology
Financial strength
Differentiated productsCompetitiveness of the their home market
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Exhibit 17.1
Determinants of National CompetitiveAdvantage: Porters Diamond
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The OLI Paradigm &
Internationalization
The OLI Paradigm (Buckley & Casson, 1976; Dunning1977) is an attempt to create an overall framework toexplain why MNEs choose FDI rather than serve
foreign markets through alternative modes such aslicensing, joint ventures, strategic alliances,management contracts and exporting
The paradigm states that a firm must first have some
competitive advantage in its home market - O orowner-specificwhich can be transferred abroad
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The OLI Paradigm & Internalization
The firm must also be attracted by specific
characteristics of the foreign marketL orlocation
specificwhich will allow the firm to exploit its
competitive advantages in that market
Third,the firm will maintain its competitive position by
attempting to control the entire value-chain in its
industryI orinternalization This leads to FDI rather than licensing or outsourcing
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The OLI Paradigm & Internalization
Financial strategies are directly related to the
OLI Paradigm in explaining FDI
Strategies can be proactive , controlled inadvance by the management team
Strategies can also be reactive, depend on
discovering market imperfections
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Exhibit 17.2 Finance-Specific Factors andthe OLI Paradigm: X indicates a connection
between FDI and finance-specific strategies
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Where to Invest
Two related behavioral theories behind FDI that aremost popular are
Behavioral approach to FDI
International network theory
Behavioral ApproachObservation that firms tendedto invest first in countries that were not too far fromtheir country in psychic terms
This included cultural, legal, and institutional environmentssimilar to their own
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Where to Invest
International network theoryAs MNEs grow they
eventually become a network, or nodes that operate
either in a centralized hierarchy or a decentralized one
Each subsidiary competes for funds from the parent
It is also a member of an international network based on its
industry
The firm becomes a transnational firm, one that is owned by a
coalition of investors located in different countries
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How to Invest Abroad: Modes
of FDI
Exporting vs. production abroad
Advantages of exporting are
None of the unique risks facing FDI, joint ventures,
strategic alliances and licensing Political risks are minimal
Agency costs and evaluating foreign units are avoided
Disadvantages are
Firm is not able to internalize and exploit its
advantages
Risks losing market to imitators and global
competitors
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How to Invest Abroad: Modes
of FDI
Licensing/management contracts versus control ofassets abroad
Licensing is a popular method for domestic firms to profit
from foreign markets without the need to commit sizablefunds
Disadvantages of licensing are
License fees are likely lower than FDI profits although ROI may behigher
Possible loss of quality control Establishment of potential competitor
Possible improvement of technology by local license which thenenters firms original home market
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How to Invest Abroad: Modes
of FDI
Possible loss of opportunity to enter licensees market with FDI later
Risk that technology will be stolen
High agency costs
Management contracts are similar to licensing insofar as theyprovide for some cash flow from foreign source without
significant investment or exposure
These contracts lessen political risk because the repatriation
of managers is easy
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How to Invest Abroad: Modes
of FDI
Joint ventures versus wholly owned subsidiary
Ajoint venture is a shared ownership in a foreign business
This is a viable strategy if the MNE finds the right local
partner
Some advantages include
The local partner understands the market
The local partner can provide competent management at all levels
Some host countries require that foreign firms share ownership withlocal partner
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How to Invest Abroad: Modes
of FDI
Joint ventures versus wholly owned subsidiary
Advantages of joint ventures
The local partners contacts & reputation enhance accessto host countrys capital markets
The local partner may possess technology that is
appropriate for the local environment
The public image of a firm that is partially locally ownedmay improve its position
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How to Invest Abroad: Modes
of FDI
Joint ventures versus wholly owned subsidiary
Disadvantages of joint ventures
Political risk is increased if wrong partner is chosen
Local and foreign partners have divergent views on strategy andfinancing issues
Transfer pricing creates potential for conflict of interest
Financial disclosure between local partner and firm
Ability of a firm to rationalize production on a worldwide basis if that
would put local partner at disadvantage
Valuation of equity shares is difficult
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How to Invest Abroad: Modes
of FDI
Greenfield investment versus acquisition
A greenfield investmentis establishing a facility starting
from the ground up
Usually require extended periods of physical construction andorganizational development
Here, a cross-border acquisition may be better because the
physical assets already exist, shorter time frame and financing
exposure However, problems with integration, paying too much for acquisition,
post-merger management, and realization of synergies all exist
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How to Invest Abroad: Modes
of FDI
Strategic alliances can take several different forms
First is an exchange of ownership between
two firms
It can be a defensive strategy against a takeover
In addition to exchanging shares, a separate joint venture can
be developed
Another level of cooperation may be a joint marketing or
servicing agreement
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Exhibit 17.3 The FDI Sequence: ForeignPresence and Foreign Investment
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Strategies Employed by Emerging
Market MNEs
Taking brands global
Engineering to innovation
Leverage natural resources
Export successful business model
Acquire offshore assets
Target a market niche
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Exhibit 17.4 Emerging MarketMultinationals and Their Global Strategies
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Summary of Learning Objectives
In order to invest abroad a firm must have a sustainablecompetitive advantage in the home market. This mustbe strong enough and transferable to overcome the
disadvantages of operating abroad Competitive advantages stem from economies of scale
and scope, managerial and marketing expertise,differentiated products, and competitiveness of the
home market The OLI Paradigm is attempt to create an overall
framework to explain why MNEs choose FDI ratherthan serve foreign markets through other methods
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Summary of Learning Objectives
Finance-specific strategies are directly related tothe OLI Paradigm, including both proactive andreactive strategies
The decision about where to invest is influencedby economic and behavioral factors
Psychic distance plays a role in determining the
sequence of FDI
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Summary of Learning Objectives
Most international firms can be viewed from a networkperspective. The parent firm and each of thesubsidiaries are members of the network
Exporting avoids political risk but not foreign exchangerisk. It requires the least up-front investment but itmight eventually have lost those markets to competition
Alternative modes of FDI exist, such as joint ventures,
strategic alliances, licensing, management contracts,and traditional exporting
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Summary of Learning Objectives
Licensing enables a firm to profit from foreign markets
without a major up-front investment,however
disadvantages include limited returns, possible loss of
quality control, and potential to establish futurecompetitor
The success of a joint venture depends primarily on the
right partner. For this reason a number of issues relatedto possible conflicts in decision making exist
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Summary of Learning Objectives
Six major strategies used by emerging market MNEsare:
Taking brands global
Engineering to innovation Leverage natural resources
Export successful business model
Acquire offshore assets
Target a market niche