Foreign direct investment



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CHAPTER 6


FOREIGN DIRECT INVESTMENT

Chapter Outline
Opening Case: Starbucks’ Foreign Direct Investment
INTRODUCTION
FORIGN DIRECT INVESTMENT IN THE WORLD EECONOMY

The Growth of FDI

The Direction of FDI

Country Focus: Foreign Direct Investment in China

The Source of FDI

The Form of FDI: Acquisitions versus Green-Field Investments

Management Focus: Cemex’s Foreign Acquisitions
THE THEORY OF FORIGN DIRECT INVESTMENT
Why Foreign Direct Investment

The Pattern of Foreign Direct Investment

The Eclectic Paradigm
POLITICAL IDEOLOGY AND FOREIGN DIRECT INVESTMENT

The Radical View

The Free Market View

Pragmatic Nationalism

Shifting Ideology
COSTS AND BENEFITS OF FDI TO THE NATION STATE
Host Country Effects: Benefits

Host Country Effects: Costs



Country Focus: Foreign Direct Investment in Venezuela’s Petroleum Industry

Home Country Effects: Costs

Home Country Effects: Benefits

International Trade Theory and Foreign Direct Investment


GOVERNMENT POLICY INSTRUMENTS AND FDI
Home Country Policies

Host Country Policies

International Institutions and the Liberalization of FDI

IMPLICATIONS FOR BUSINESS


The Theory of FDI

Government Policy


SUMMARY OF CHAPTER
CRITICAL THINKING AND DISCUSSION QUESTIONS
INTERNET EXERCISES
CLOSING CASE: Electrolux
Learning Objectives

1. Be familiar with the forces underpinning the rising tide of foreign direct investment in the world economy.

2. Understand why firms often prefer direct investment as a strategy for entering a foreign market over alternatives such as exporting and granting foreign entities the right to produce the firm's product under license.
3. Appreciate why firms based in the same industry often undertake foreign direct investment at the same time.
4. Understand why certain locations are favored as the target of foreign direct investment activity.
5. Appreciate how political ideology influences government policy toward foreign direct investment.
6. Be conversant with the costs and benefits of foreign direct investment to receiving and source countries.
7. Have a good grasp of the different policy instruments that governments can use to restrict and encourage foreign direct investment.
OPENING CASE: Starbucks’ Foreign Direct Investment
Summary
This case describes Starbucks’ ascent from a single store to a globally known brand in just a decade. The case examines the company’s international expansion strategy and the tradeoffs that were made to ensure that the Starbucks experience was successfully replicated in other countries. The following questions can be helpful in directing the discussion:

Suggested Discussion Questions

QUESTION 1: How and why did Starbucks’ initial foray into foreign markets differ from its domestic operations?

ANSWER 1: Starbucks deviated from its domestic strategy of company owned stores when the company initially expanded into foreign markets by first establishing a joint venture with a local company in Japan, and then licensing its format to the joint venture. The company also transferred some American employees to the operation and required extensive employee training to ensure that the Starbucks experience was properly replicated in Japan. Starbucks also specified precise design parameters for all stores, again to ensure that customers would not only be buying coffee, but also a Starbucks experience.

QUESTION 2: Why did Starbucks change its expansion strategy in Asia? What role did control play in Starbucks’ decision to change its strategy?
ANSWER 2: Starbucks initially expanded into Asia via licensing agreements. However, when the company became disenchanted with some of the straight licensing agreements, Starbucks converted several of them into joint-venture arrangements or wholly owned subsidiaries. Starbucks made the changes in the strategy because they allowed the company to have greater control over the operations. For example, when its licensee in Thailand was having trouble raising financing for expansion, Starbucks simply stepped in and acquired the licensee in order to gain greater control over the expansion strategy. Similarly, in South Korea, where Starbucks initially licensed its format to a local company, Starbucks soon converted the licensing arrangement to a joint venture to gain greater control over the growth strategy in South Korea, and to help fund the operation.

QUESTION 3: Starbucks’ next target market is mainland Europe, including France and Italy. What challenges do you anticipate Starbucks will face in these markets? How should Starbucks approach the markets?

ANSWER 3: Most students will probably recognize that expanding into Europe, especially France and Italy could be difficult. While the company found remarkable success in Asia, the coffee concept was relatively new there, and customers not only bought coffee, but also an American experience. In France and Italy coffee houses are already well established, and the company is likely find the markets much more difficult to break into. Students may recommend that Starbucks expand into the market using joint ventures with local companies. This approach will not only provide the company with local knowledge, but also allow it to maintain some control over the operations.

Chapter Summary
This chapter focuses on the topic of foreign direct investment (FDI). FDI occurs when a firm invests directly in new facilities to produce and/or market a product in a foreign country. At the outset, the chapter discusses the growth in FDI, particularly by medium-sized and small firms. The theoretical underpinnings of FDI are discussed, which describe under what circumstances it is advantageous for a firm to invest in production facilities in a foreign country. The chapter also addresses the different policies that governments have toward foreign direct investment. Some governments are opposed to FDI and some governments encourage it. Three specific ideologies of FDI are discussed, including the radical view, the free market view, and pragmatic nationalism. The chapter also provides a discussion of the costs and benefits of FDI from the perspective of both the home country and the host country involved. The chapter concludes with a review of the policy instruments that governments use to regulate FDI activity by international firms.
Chapter Outline With Lecture Notes and Teaching Tips
INTRODUCTION
A) This chapter is concerned with the phenomenon of foreign direct investment (FDI). Foreign direct investment occurs when a firm invests directly in new facilities to produce and/or market in a foreign country. Once a firm undertakes FDI it becomes a multinational enterprise.

Teaching Tip: Each year Fortune magazine publishes a list of the 500 largest global corporations in the world. Fortune calls its list the "Global 500." This list can be accessed at {http://pathfinder.com/fortune/1997/specials/g500/intro.html}. The article contains an excellent discussion of the role of global firms in the world economy.

Teaching Tip: Another web site that provides an excellent discussion of the role of multinational corporations in the world economy is available at {http://www.oecdobserver.org/news/fullstory.php/aid/446/The_trust_business.html}.
B) FDI takes on two main forms; the first is a green-field investment, which involves the establishment of a wholly new operation in a foreign country. The second involves acquiring or merging with an existing firm in the foreign country.
FOREIGN DIRECT INVESTMENT IN THE WORLD ECONOMY
A) When discussing foreign direct investment, it is important to distinguish between the flow and the stock of foreign direct investment. The flow of FDI refers to the amount of FDI undertaken over a given time period (normally a year). The stock of FDI refers to the total accumulated value of foreign-owned assets at a given time. Outflows of FDI, meaning the flow of FDI out of a country, and inflows of FDI, meaning the flow of FDI into a country are also discussed.
Teaching Tip: An excellent web site that provides a full array of information about foreign direct investment is available at {http://www.columbia.edu/cu/lweb/indiv/business/guides/fordinv.html}.
The Growth of FDI
B) Over the past 20 years there has been a marked increase in both the flow and stock of FDI in the world economy. The significant growth in FDI has both to do with the political economy of trade as outlined in the previous chapter and the political and economic changes that have been taking place in developing countries.
The Direction of FDI
C) Another important trend is has been the rise of inflows into the US. The stock of foreign FDI in the US increased more rapidly than US FDI abroad.

D) The rapid increase in FDI growth into the US may be due to the attractiveness of the US market, the falling value of the dollar, and a belief by some foreign corporations that they could manage US assets and workers more efficiently than their American managers.

E) It is difficult to say whether the increase in the FDI into the US is good for the country or not. To the extent that foreigners are making more productive use of US assets and workers, it is probably good for the country.
The Source of Foreign Direct Investment
F) Not only has the flow of FDI been accelerating, but its composition has also been changing. For most of the period after World War II, the U.S. was by far the largest source country for FDI. By 1990, however, the U.S. share of FDI outflows had slumped to 10.3 percent, pushing the U.S. into second place behind Japan.
The Form of FDI: Acquisitions versus Green-Field Investments
G) The majority of cross-border investment is in the form of mergers and acquisitions rather than green-field investments. Firms prefer to acquire existing assets rather than undertake green-field investments because (1) mergers and acquisitions are quicker to execute than green-field investments. (2) it is easier and perhaps less risky for a firm to acquire desired assets than build them from the ground up, (3) firms believe that they can increase the efficiency of an acquired unit by transferring capital, technology, or management skills.
THE THEORY OF FOREIGN DIRECT INVESTMENT
A) In this section of the text, several theories of foreign direct investments are discussed. These theories attempt to explain the observed pattern of foreign direct investment flows.
Why Foreign Direct Investment

B) Why do so many firms apparently prefer FDI to either exporting (producing goods at home and then shipping them to the receiving country for sale) or licensing (granting a foreign entity the right to produce and sell the firm’s product in return for a royalty fee on every unit that the foreign entity sells)? The answer lies in the limitations of these methods for exploiting foreign market opportunities producing goods at home and then shipping them to the receiving country for sale. Granting a foreign entity the right to produce and sell the firm’s product in return for a royalty fee on every unit that the foreign entity sells.

Limitations of Exporting
C) The viability of an exporting strategy is often constrained by transportation costs and trade barriers. Much foreign direct investment is undertaken as a response to actual or threatened trade barriers such as import tariffs or quotas.
Limitations of Licensing
D) There is a branch of economic theory known as internalization theory that seeks to explain why firms often prefer foreign direct investment to licensing as a strategy for entering foreign markets. According to internationalization theory, licensing has three major drawbacks as a strategy for exploiting foreign market opportunities.
(1) First, licensing may result in a firm’s giving away valuable technological know-how to a potential foreign competitor.

(2) Second, licensing does not give a firm the tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability.

(3) Third, a problem arises with licensing when the firm’s competitive advantage is based not so much on its products as on the management, marketing, and manufacturing capabilities that produce those products. Such capabilities are often not amenable to licensing.
E) So, when one or more of the following conditions holds, markets fail as a mechanism for selling know-how and FDI is more profitable than licensing. (i) when the firm has valuable know-how that cannot be adequately protected by a licensing contract, (ii) when the firm needs tight control over a foreign entity to maximize its market share and earnings in that country, and (iii) when a firm’s skills and know-how are not amenable to licensing.
Advantages of Foreign Direct Investment

F) It follows from the above discussion that a firm will favor FDI over exporting as an entry strategy when transportation costs or trade barriers make exporting unattractive. Furthermore, the firm will favor FDI over licensing when it wishes to maintain control over its technological know-how, or over its operations and business strategy, or when the firm’s capabilities are simply not amenable to licensing.


Teaching Tip: An article entitled "Constructing a Market Economy: A Guide to Countries in Transition" by Raymond Vernon (the author of the Product Life Cycle theory), discusses, among other things, the role of foreign direct investment in building a strong economy. The site is available at {http://www.cipe.org/publications/fs/ert/e20/ver_E20.htm}.
The Pattern of Foreign Direct Investment
G) Observation suggests that firms in the same industry often undertake foreign direct investment around the same time and tend to direct their investment activities towards certain locations.

Strategic Behavior


H) One theory used to explain foreign direct investment patterns is based on the idea that FDI flows are a reflection of strategic rivalry between firms in the global marketplace. Knickerbocker looked at the relationship between FDI and rivalry in oligopolistic industries (industries composed of a limited number of large firms). A critical competitive feature of such industries is the interdependence of the major players: what one firm does can have an immediate impact on the major competitors forcing a response in kind.
I) Knickerbocker’s theory can be extended to embrace the concept of multipoint competition (when two or more enterprises encounter each other in different regional markets, national markets, or industries.)
The Product Life Cycle

J) Vernon’s view is that firms undertake FDI at particular stages in the life cycle of a product they have pioneered. They invest in other advanced countries when local demand in those countries grows large enough to support local production. They subsequently shift production to developing countries when product standardization and market saturation give rise to price competition and cost pressures. Investment in developing countries, where labor costs are lower, is seen as the best way to reduce costs.

K) What Vernon’s theory fails to explain, however, is why it is profitable for a firm to undertake FDI at such times, rather than continuing to export from its home base, and rather than licensing a foreign firm to produce its product.
The Eclectic Paradigm
L) The eclectic paradigm has been championed by the British economist John Dunning. Dunning argues that in addition to the various factors discussed above, location-specific advantages (that arise from using resource endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own unique assets) and externalities (knowledge spillovers that occur when companies in the same industry locate in the same area) are also of considerable importance in explaining both the rationale for and the direction of foreign direct investment.
POLITICAL IDEOLOGY AND FOREIGN DIRECT INVESTMENT
A) Historically, ideology toward FDI has ranged from a radical stance that is hostile to all FDI to the non-interventionist principle of free market economies. Between these two extremes is an approach that might be called pragmatic nationalism.

The Radical View

B) The radical view tracts its roots to Marxist political and economic theory. Radical writers argue that the multinational enterprise is an instrument of imperialist domination. They see MNEs as a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries. By the end of the 1980’s, however, the radical position was in retreat almost everywhere. There seem to be three reasons for this. First, the collapse of communism in Eastern Europe. Second, the generally abysmal economic performance of those countries that embraced the radical position, and a growing belief by many of these countries that, contrary to the radical position, FDI can be an important source of technology and jobs and can stimulate economic growth. And third, the strong economic performance of developing countries that embraced capitalism rather than ideology.


The Free Market View
C) The free market view argues that international production should be distributed among countries according to the theory of comparative advantage. The free market view has been embraced by a number of advanced and developing nations, including the United States, Britain, Chile, and Hong Kong.
Pragmatic Nationalism
D) The pragmatic nationalist view is that FDI has both benefits, such as inflows of capital, technology, skills and jobs, and costs, such as repatriation of profits to the home country and a negative balance of payments effect.
E) Recognizing this, countries adopting a pragmatic stance pursue policies designed to maximize the national benefits and minimize the national costs. According to this view, FDI should be allowed only if the benefits outweigh the costs.
Shifting Ideology
F) In recent years the center of gravity on the ideological spectrum has shifted strongly toward the free market stance.
COSTS AND BENEFITS OF FDI TO THE NATION STATE
Host Country Effects: Benefits
A) There are three main benefits of inward FDI for a host country: the resource transfer effect, the employment effect and the balance of payments effect.
Resource-Transfer Effects

B) FDI can make a positive contribution to a host economy by supplying capital, technology, and management resources that would otherwise not be available.


Employment Effects
C) The beneficial employment effect claimed for FDI is that FDI brings jobs to a host country that would otherwise not be created there.
Balance-of-Payments Effect

D) The effect of FDI on a country’s balance-of-payments accounts is an important policy issue for most host governments. A country’s balance-of-payments account is a record of a country’s payments to and receipts from other countries. The current account is a record of a country’s export and import of goods and services.

E) Governments typically prefer to see a current account surplus than a deficit. There are two ways in which FDI can help a country to achieve this goal. First, if the FDI is a substitute for imports of goods and services, the effect can be to improve the current account of the host country’s balance of payments. A second potential benefit arises when the MNE uses a foreign subsidiary to export goods and services to other countries.
Host Country Effects: Costs
F) Three main costs of inward FDI concern host countries; the possible adverse effects of FDI on competition within the host nation, adverse effects on the balance of payments, and the perceived loss of national sovereignty and autonomy.
Adverse Effects on Competition
G) Host governments sometimes worry that the subsidiaries of foreign MNEs operating in their country may have greater economic power than indigenous competitors because they may be part of a larger international organization.

Adverse Effects on the Balance of Payments

H) The possible adverse effects of FDI on a host country’s balance-of-payments position are twofold. First, set against the initial capital inflows that come with FDI must be the subsequent outflow of capital as the foreign subsidiary repatriates earnings to its parent country. A second concern arises when a foreign subsidiary imports a substantial number of its inputs from abroad, which results in a debit on the current account of the host country’s balance of payments.

National Sovereignty and Autonomy

I) Many host governments worry that FDI is accompanied by some loss of economic independence. The concern is that key decisions that can affect the host country’s economy will be made by a foreign parent that has no real commitment to the host country, and over which the host country’s government has no real control.

Home Country Effects: Benefits

J) The benefits of FDI to the home country arise from three sources. First, the capital account of the home country’s balance of payments benefits from the inward flow of foreign earnings. Second, benefits to the home country from outward FDI arise from employment effects. Third, benefits arise when the home country MNE learns valuable skills from its exposure to foreign markets that can subsequently be transferred back to the home country.


Home Country Effects: Costs

K) The most important concerns center around the balance-of-payments and employment effects of outward FDI. With regard to employment effects, the most serious concerns arise when FDI is seen as a substitute for domestic production.



International Trade Theory and Foreign Direct Investment

L) When assessing the costs and benefits of FDI to the home country, keep in mind the lessons of international trade (Chapter 4). International trade theory tells us that home country concerns about the negative economic effects of “offshore production” may be misplaced.


Government Policy Instruments and FDI
A) We have now reviewed the costs and benefits of the FDI from the perspective of both home country and host country. Before tackling the important issue of bargaining between the MNE and the host government, we need to discuss the policy instruments that governments use to regulate FDI activity by MNE’s. Both home countries and host countries have a range of policy instruments that they can use to regulate FDI activity by MNE’s. We will look at each in turn.
Home Country Policies

B) By their choice of policies, home countries can both encourage and restrict FDI by local firms.

Encouraging Outward FDI
C) Many investor nations now have government-backed insurance programs to cover major types of foreign investment risk.

Restricting Outward FDI

D) Virtually all investor countries, including the United States, have exercised some control over outward FDI from time to time.

Host Country Policies

E) Host countries adopt policies designed both to restrict and to encourage inward FDI.

Encouraging Inward FDI

F) It is increasingly common for governments to offer incentives to foreign firms to invest in their countries.

G) Incentives are motivated by a desire to gain from the resource-transfer and employment effects of FDI. They are also motivated by a desire to capture FDI away from other potential host countries.
Restricting Inward FDI
H) Host governments use a wide range of controls to restrict FDI. The two most common, however, are ownership restraints and performance requirements.
I) The rationale underlying ownership restraints seems to be twofold. First, foreign firms are often excluded from certain sectors on the grounds of national security or competition. Second, ownership restraints seem to be based on a belief that local owners can help to maximize the resource transfer and employment benefits of FDI for the host country.
International Institutions and the Liberalization of FDI
J) Until recently there has been no consistent involvement by multinational institutions in the governing of FDI. With the formation of the World Trade Organization in 1995, this is now changing rapidly.
Implications for Business
The Theory of FDI

A) The implications of the theories of FDI for business practice are straightforward. First, the location-specific advantages argument associated with John Dunning helps explain the direction of FDI. However, the location-specific advantages argument does not explain why firms prefer FDI to licensing or to exporting. In this regard, from both an explanatory and a business perspective, perhaps the most useful theories are those that focus on the limitations of exporting and licensing.


Government Policy
B) A host government’s attitude toward FDI should be an important variable in decisions about where to locate foreign production facilities and where to make a foreign direct investment.

Teaching Tip: A site entitled Business Monitor has a section that provides information about the regulations involving foreign direct investment in almost every country in the world (you have to look for the information in each country’s profile). The site can be accessed at {http://www.businessmonitor.co.uk/trading_blocks.shtml}.

Critical Thinking and Discussion Questions
1. In the 1990s, Japanese FDI in the United States grew far more rapidly than US FDI in Japan. Why do you think this is the case? What are the implications of this trend?
Answer: There are two primary explanations for the inequity in the growth of FDI between the US and Japan. Firstly, there has been a significant decrease in the US dollar relative to the Japanese Yen. This makes investment in the US more attractive to Japanese investors, and Japanese investments less attractive to US investors. Secondly, the nature of business in Japan, where long-term business relationships are important and investments can take a significant period of time to pay off, makes Japan a less attractive place to invest than the more open US economy. To the extent that the trend is simply a result of exchange rate changes, the trend will follow changes in exchange rates, and could reverse if the exchange rate change reverses direction. The implication of this is simply that the value of international investing between the US and Japan will be determined by the relative value of the currencies. To the extent that the trend is a result of structural differences in the economies of the US and Japan, it suggests that there will continue to be a disparity in the flows of FDI between the US and Japan. Hence Japanese companies will find it easier to compete in the US market against US competitors than US companies will be able to compete in Japan against Japanese competitors.
2. Compare these explanations of FDI: internalization theory, Vernon’s product life cycle theory, and Knickerbocker’s theory of FDI. Which theory do you think offers the best explanation of the historical pattern of FDI? Why?

Answer: Internalization theory seeks to explain why firms often prefer foreign direct investment to licensing as a strategy for entering foreign markets. According to internationalization theory, licensing has three major drawbacks as a strategy for exploiting foreign market opportunities: licensing may result in a firm giving away proprietary technology, licensing does not permit a firm to maintain tight control over its activities, and licensing is not appropriate when a firm’s competitive advantage is based not so much on its products as on the management, marketing, and manufacturing capabilities that produce those products.

Vernon’s product life cycle theory argues that firms undertake FDI at particular stages in the life cycle of a product they have pioneered. They invest in other advanced countries when local demand in those countries grows large enough to support local production. They subsequently shift production to developing countries when product standardization and market saturation give rise to price competition and cost pressures. Investment in developing countries, where labor costs are lower, is seen as the best way to reduce costs.

Finally, Knickerbocker’s theory of FDI suggests that firms follow their domestic competitors overseas. This theory had been developed with regard to oligopolistic industries. Imitative behavior can take many forms in an oligopoly, including FDI. .

The second part of this question is designed to stimulate classroom discussion and/or force students to think through these theories and select the one that they feel provides the best explanation for the historic pattern of FDI.

3. Read the opening case on Starbucks. Using the market imperfections approach to FDI, explain Starbucks’ approach to expanding its presence in Thailand, Great Britain, and Japan.
Answer: When Starbucks initially decided to license its format in Japan, the company realized that a pure licensing agreement would not give the company the control it needed to ensure that the Japanese licensees would closely follow Starbucks formula. Consequently, the company established a joint venture with a local retailer, and also transferred some employees to Japan. In Thailand, after initially establishing a presence via a licensing agreement, the company acquired the licensee to gain additional control. Control was also an issue in Britain where Starbucks acquired Seattle Coffee.
4. You are the international manager of a US business that has just invented a revolutionary new personal computer that can perform the same functions as IBM and Apple computers and their clones, but costs only half as much to manufacture. Your CEO has asked you to decide how to expand into the Western European market. Your options are (i) export from the US, (ii) license a European firm to manufacture and market the computer in Europe, and (iii) set up a wholly owned subsidiary in Europe. Evaluate the pros and cons of each alternative and suggest a course of action to your CEO.

Answer: In considering expansion into Western Europe, three options will be considered: FDI, licensing, and export. With export, assuming there are no trade barriers, the key considerations would likely be transport costs and localization. While transport costs may be quite low for a relatively light and high value product like a computer, localization can present some difficulties. Power requirements, keyboards, and preferences in model all vary from country to country. It may be difficult to fully address these localization issues from the US, but not entirely infeasible. Since there are many computer manufacturers and distributors in Europe, there are likely to be a number of potential licensees. But by signing up licensees, valuable technological information may have to be disclosed, and the competitive advantage lost if the licensees use or disseminate this information. FDI (setting up a wholly owned subsidiary) is clearly the most costly and time consuming approach, but the one that best guarantees that critical knowledge will not be disseminated and that localization can be done effectively. Given the fast pace of change in the personal computer industry, it is difficult to say how long this revolutionary new computer will retain its competitive advantage. If the firm can protect its advantage for a period of time, FDI may pay off and help assure that no technological know-how is lost. If, however, other firms can copy or develop even superior products relatively easily, than licensing, while speeding up knowledge dissemination, may also allow the firm to get the quickest large scale entry into Europe and make as much as it can before the advantage is lost.

5. Explain how political ideology of a host government might influence the process of negotiating access between the host government and a foreign MNE.
Answer: If a host country subscribes to pure free market principles, then there is little to negotiate about. It may be possible, however, to negotiate with different regions of the country to obtain more favorable tax treatment or access to local resources. If a host country subscribes to pure radical views, there is also little to negotiate about since the government will likely prohibit any FDI. As a general rule, as the overall ideology of a country moves from the left (radical) to the right (free market), the foreign MNE will need to spend less time negotiating matters relating to access and control and more time on matters relating to incentives and most favorable locations.
5. “Firms should not be investing abroad when there is a need for investment to create jobs at home!” Discuss.
Answer: This question is designed to stimulate classroom discussion or force your students to “think” about this provocative issue. While there may be a need for investment and job creation at home, investors need to have the capability to adequately manage their investments. Hence some local firm may be much more able to exploit their technological advantages and invest internationally than they would be able benefit from domestic investment. If firm's primary goal is to maximize their shareholder's value, then they and probably the economy are better off if they invest where they can earn the best return. If firms from other countries have capabilities for which local workers and assets are most appropriate, then it is better that they make the investments locally and use these resources to their best use rather than having local firms use these resource sub-optimally.

Internet Exercises

TEXT EXERCISE 1

Overview
Germany is ready and open for business. The country is making a concerted effort to publicize its advantages as a destination for foreign investment. Indeed, the country has established the German Centers of Excellence to entice companies into the German market. The Centers of Excellence have established a website as a resource for companies seeking to learn more about the German market.
Suggested Use in the Classroom
Students are asked to consider the role of the Internet in the global marketplace, and in particular, the globalization of production. Many students will recognize how the Internet can be a tremendous resource for companies seeking information on foreign markets and competitors. Indeed, many students may advocate the notion of a country actively working to attract new investment via the Internet. Knowledge is power, and certainly the fact that companies and governments have more information about each other has changed the rules of the game.

TEXT EXERCISE 2


Overview
Disney may be expanding its reach once again, this time by opening a theme park in Shanghai. However, the news came as a surprise to government officials in Hong Kong who had only just committed substantial resources to bring a theme park to Honk Kong, an investment that depended on visitors from Mainland China. Now Hong Kong is crying foul. Disney isn’t talking.
Suggested Use in the Classroom

Students are asked whether governments should be involved in sponsoring and attracting foreign investment by providing monetary incentives to corporations. This topic provides a good forum for debate. Many students will probably argue that foreign companies bring many benefits to a host country including capital, jobs, and technology, and that therefore it is in the best interests of the country for the government to attract investments like the Disney one outlined in this case. Others however, may suggest the money could be better spent on a country’s own firms—that by giving it to foreigners, local companies are actually hurt, and a country’s overall national competitiveness is negatively affected.

CLOSING CASE: Electrolux
Summary
The closing case describes the steps taken by Electrolux to expand its presence in Eastern Europe, Latin America, and Asia. Due to the slow growth in its traditional markets, and the fact that these markets had been largely penetrated so that most sales were for replacement purposes, management knew that growth would have to come from countries where there was still a large portion of the population that did not have household appliances. Electrolux undertook a variety of approaches when investing in the new markets. A discussion of the case can revolve around the following questions:
QUESTION 1: What were the primary motivating factors behind Electrolux’s decision to expand aggressively into Asia, Eastern Europe, Latin America in the 1990s?
ANSWER 1: While Electrolux was already an international company, its primary markets were Europe and North America. In these countries the market was fully penetrated, limiting sales to replacement goods and population growth. Electrolux estimated this to be about 2-3%. In comparison, growth rates in Eastern Europe, Latin America, and Asia were estimated to be around 20%. In addition this much higher growth rate, Electrolux’s main global competitors were also targeting these markets. Thus unless it wished to be left behind, the company needed to expand into these higher growth markets.
QUESTION 2: Why do you think Electrolux acquired Lehel in Hungary, but opted for green-field investments to enter many other Eastern European countries?

ANSWER 2: Whereas it may seem that Electrolux did not have a single global strategy for expansion, Electrolux realized that different locations required different types of investments. Where it could purchase viable local firms, this was its preferred strategy. Yet in many countries the local firms may not have fit with Electrolux’s needs, or asked too high a price. Thus it entered into joint ventures, green-field investments, and other forms of foreign direct investment depending upon the needs in the market and the opportunities it foresaw. Any single approach would have failed to take into consideration the country differences identified in Chapters 2 and 3.

QUESTION 3: The company generally preferred FDI to exports as a mode of entry into foreign markets. Why do you think this is the case?
ANSWER 3: Once the company had committed itself to expansion, it had to decide how to achieve its goals. Cost considerations and import barriers made direct exporting from its Western European and North American plants uneconomical. Instead, the company turned to FDI.
QUESTION 4: What theory, or theories, best explains Electrolux’s FDI decisions during the 1990s: (a) the market imperfections approach, (b) the strategic behavior approach, (c) the product-life cycle approach, or (d) the location-specific advantages approach?
ANSWER 4: This question provides an excellent opportunity for students to test their knowledge of the four theories by explaining not only which theories best explain the company’s decisions (most students will probably focus on the market imperfections approach and the strategic behavior approach), but also why the other theories do not adequately describe Electrolux’s actions.
Country Focus: Foreign Direct Investment in China

Summary

This feature explores investment opportunities in China. In the late 1970s, China opened its doors to foreign investors. By 1997, the country was the recipient of some $45.2 billion dollars in foreign direct investment. China’s large population is a magnet for many companies and because high tariffs make it difficult to export to the Chinese market, firms frequently turn to foreign direct investment. However, many companies have found it difficult to conduct business in China, and in recent years investment rates have slowed. In response, the Chinese government, hoping to continue to attract foreign companies has established a number of incentives for would-be investors.

1. How do China’s political preferences affect its ability to attract foreign direct investment?

2. Much of China’s growth in foreign direct investment has come from neighboring countries. Discuss this trend, why it has occurred, and its implications.
Management Focus: Cemex’s Foreign Acquisitions
Summary
This feature examines Cemex’s rise to global status. Cemex is the world’s third largest cement company and Mexico’s largest multinational company. Cemex’s success story is largely the result of acquisitions. If the company had relied on green-field investments, it could not have become so large so fast.
1. Why does Cemex’s expansion strategy depend so heavily on acquisitions?
2. Why does Cemex have a preference for FDI over licensing arrangements?
3. Cemex’s homepage: {http://www.cemex.com}
Country Focus: Foreign Direct Investment in Venezuela’s Petroleum Industry
Summary
This feature focuses on Venezuela’s plan to significantly upgrade its domestic petroleum industry. The plan assigns a key role to foreign investment in Venezuela’s oil industry for the first time since the country nationalized all private oil companies in 1976. The feature focuses on Venezuela’s reasons for wanting foreign companies to be involved in its initiative. First, the initiative will be very expensive, and Venezuela needs outside capital. However, in addition, the country lacks the technological resources and skills of many of the world’s major oil companies. By letting foreign companies participate in its initiative to upgrade its own oil industry, Venezuela hopes to learn new technologies and oil refining techniques to use in the future.
Suggested Discussion Questions
1. Discuss how this feature illustrates the valuable role that foreign direct investment plays in the global trade picture?

2. Many protectionist minded people object to foreign direct investment, arguing that a company should provide jobs for its own citizens and not invest abroad. Similarly, people also argue that a government should keep foreign companies “out” in the interest of protecting local jobs. However, after reading this case, one could argue that foreign direct investment in Venezuela’s oil initiative could be a “win-win” proposition for all the parties involved. Justify this argument.

Additional Readings and Sources of Information
A China in the Image of America: {http://www.businessweek.com/bwdaily/dnflash/nov2002/nf20021115_7796.htm}
When Everything is Made in China: {http://www.businessweek.com/magazine/content/02_24/b3787031.htm}
Why do Human Rights Matter to Business: {http://web.amnesty.org/web/web.nsf/pages/ec_why}
The Java Joint that’s Swallowing France: {http://www.businessweek.com/bwdaily/dnflash/sep2002/nf20020911_8577.htm}
Planet Starbucks: {http://www.businessweek.com}
Electrolux Sweeps into America: {http://www.businessweek.com/bwdaily/dnflash/sep2002/nf20020923_3412.htm}








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