Cost Advantages
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2. Cost advantages Reduce cost of trade Avoid trade barrier (costs from import/export) This positive effect of FDI relates to the trade diversionary aspect of regional integration. This type occurs when there are location advantages for foreign companies in their home country but the existence of tariffs or other barriers of trade prevent the companies from exporting to the host country. Even as free trade has become more prevalent, national protectionism can still surface from time to time. Countries tend to impose trade barriers as they don't think that importing alone would benefit their economies in terms of increasing producing capacity and improving technology uses. Moreover, buying foreign exports may lead to more and easier consumptions, as well as use up foreign currency reserves. Thus, companies may find it ineffective to focus solely on trade when expanding to foreign markets. The foreign companies therefore jump the barriers b y establishing a local presence within the host economy in order to gain access to the local market. The local manufacturing presence need only be sufficient to circumvent the trade barriers, since the foreign company wants to maintain as much of the value-added in its home economy. Foreign direct investment offers an alternative of producing goods wh ere they are sold. Fuji Photo Film Company has invested $200 million to set up a manufacturing plant in the US. Earlier, the company supplied film to its US customers from its factories in the Netherlands and Japan. While exporting to the US, Fuji was paying 3.7 percent tariff imposed by the US Government. This tax has been saved by producing film in the US itself. Logistics Home country’s multinational companies seek to invest in subsidiaries in foreign markets if the cost of shipping raw material is high. Coke and Pepsi have set up bottling plants in India as the cost of transporting water from the country is considerable. Also, international businesses often make investments in host countries to reduce distribution costs. The liberalization of Latin America markets brought a surge of foreign direct investment in transportation and physical distribution, and foreign logistic providers have upgraded the region’s transportation and warehousing facilities. Transaction Transaction costs are the costs of entering into a transaction, that is, those connected to negotiating, monitoring, and enforcing a contract. A firm must decide whether it is better to own and operate its own factory overseas or to contract with a foreign firm to do this
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Transcript of Cost Advantages
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through a franchise, licensing, or supply agreement. FDI is more likely to occur-that is,international production will be internalized within the firm-when the costs of negotiating, monitoring, and enforcing a contract with a second firm are high. FDI canproduce transaction costs for firms whose competitive advantages cannot be easilyconveyed by contracts or import and export.
For example, Toyota’s primary competitive advantages are its reputation for high quality
and its sophisticated manufacturing techniques-neither of which are easily conveyed bycontract. So Toyota has chosen to maintain ownership of its overseas automobileassembly plants. Conversely, when transaction costs are low, firms are more likely tocontract with outsiders and internationalize by licensing their brand names or franchisingtheir business operation. For example, McDonald’s is the premier expert in the United
States in devising easily enforceable franchising agreements. Because McDonald’s is sosuccessful in reducing transaction costs between itself and its franchisees, it hascontinued to rely on franchising for its international operations.
Take advantages of host countries resources
Foreign direct investment helps investors from foreign countries to invest and takeadvantage of certain resources which may be available in abundance in anothergeography or location for a much cheaper. The MNCs can utilize the host country'snatural resources and harvest such resources efficiently and manage to keep their costslow and thus increase their price competency
Location
Undertaking the business activity may be more profitable in a foreign location than
undertaking it in a domestic location. For example, Caterpillar (a USA company)produces bulldozers in Brail to enjoy lower labor costs and avoid high tariff walls ongoods exported from its U.S. factories.
Natural resources
Home countries tend to utilize FDI to access natural resources that are critical to them.Natural resources attract many multinational companies of home countries. Japan, forexample, is a densely populated island nation with very few natural resources of its own,especially forests. But Japan’s largest paper mill, Nippon Seishi, does more than simply
import wood pulp. The company owns huge forests and corresponding processingfacilities in Australia, Canada and US. THIS ENABLES Nippon Seishi to have access toan essential resource. Likewise, to access cheaper energy resources used inmanufacturing, several Japanese firms are relocating production on China, Mexico andVietnam, where energy costs are lower. US oil companies are a classic example. Becauseof the decrease in oil production in the US, many oil companies have been forced tomake significant investments worldwide to obtain new oil reserves.
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Low-cost factors (labor, real estates, taxes, etc.)
Home country’s firms seek competitive advantage through low production cost.
Obviously, these firms locate production facilities in low wage countries. It is just notlow labor cost; a host of other factors also figure in the low cost, for example, lower real
estate prices and lower taxes. Ford plans to export cars to South Africa from Chennai.Over two decades, more than 2000 maquiladoras have sprung up near the US-Mexicoborder. These plants take advantage of low wages to assemble American-madecomponents for re-export to the US. Besides, inside Mexico, Japanese, German andAmerican automotive firms have assembly facilities that ship final products to the USand elsewhere. Similarly, local incentives were the main motive behind establishingmanufacturing plant by Mercesdes in Alabama.
Key technology
One of the motives of home countries behind FDI is to gain access to technology. Manyof the Swiss Pharmaceutical companies, for example, have invested in US smallbiogenetics companies in order to gain cutting-edge technology. Similarly, IBM and LionBioscience AG (German Company) established a joint venture in 2001 in which thealliance partners will develop and market their computer technologies and data-miningsoftware, as a package to major drug makers and to other research laboratories trying toassimilate research data being generated in human gene research. The partners say thattheir alliance will shorten the discovery and development time for new medicines.Britain’s Smith Kline (now merged with pharmaceutical firm Glasgow) invested $86million in Cadus Pharmaceutical Corporation of New York to access the latter’s
yeastwork.
3. Exposure to other countries:
MNCs prefer to have exposure to many countries. An MNC by definition is a companywhich operates in many countries, so carrying out operations in other countries help themget exposure to such country related economic cycles. The reason to get this exposure canalso be attributed to the fact that as the number of countries the company operates in, thatmuch more it becomes diversified, so diversification leads to the company havingminimized its operational risks, meaning say that if an MNC operates in 20 countries, sayduring the course of the financial year due to some region-specific risk, 4 countries suffer
heavy losses, the company will not suffer much as the profits from the other 16 countriesmay more than offset the losses from these 4 countries, thus this diversification helpsprotect the interests of the shareholders of the foreign investing entity.
