Foreign Direct Investment

6-2

What is foreign direct investment

Company acquiring or merging with a firm in a different country

A firm creating a ‘Greenfield’ operation in a different country

A firm creating a subsidiary in a different country

As a result The firm has significant control of its foreign

operation Firm can affect managerial decisions of the

foreign operation

6-3

FDI - Flow versus stock

FDI occurs when a firm invests directly in facilities to produce and/or market a product in a foreign country Flow: Amount of FDI over a period of time (one

year) Stock: Total accumulated value of foreign

owned assets at a given point in time FDI is not the investment by individuals,

firms or public bodies in foreign financial instruments

6-4

Why is FDI important ?

Firms want a presence in foreign markets Firms want control over growth of these

foreign markets To gain first mover advantages To ward off competitors To determine locations, advertising and other

related strategic decisions in the firm’s interest

6-5

Trends in FDI

Flow and stock increased in the last 20 years In spite of decline of trade barriers, FDI has

grown more rapidly than world trade because Businesses fear protectionist pressures FDI is seen a a way of circumventing trade

barriers Dramatic political and economic changes in

many parts of the world Globalization of the world economy has raised

the vision of firms who now see the entire world as their market

6-6

FDI outflows, 1982-2002

Fig 6.1

6-7

FDI flows by region

Fig: 6.3

6-8

FDI outflows by select country1998-2001

Fig: 6.5

6-9

Form Of FDI: Greenfield versus acquisitions

Green field operation: Mostly in

developing nations

Mergers and acquisitions: Quicker to execute. Foreign firms have

valuable strategic assets

Believe they can increase the efficiency of the acquired firm

More prevalent in developed nations

6-10

FDI trends: 2001-2002

The value of FDI slumped almost 60 percent in 2001-2002 Slowdown in world economy Heightened geopolitical uncertainty since

September 11, 2001 Bursting of the stock market bubble in the US

6-11

Impediments to the sale of know-how

Impediments to the sale of know

how

Risk giving away know-

how to competitors

Licensing implies low control over

foreign entityKnow-how not amenable to

licensing

6-12

Two forms of FDI

Horizontal Direct Investment FDI in the same industry abroad as company

operates at home. Vertical direct investment Backward - investments into industry that

provides inputs into a firm’s domestic production (typically extractive industries)

Forward - investment in an industry that utilizes the outputs from a firm’s domestic production (typically sales and distribution)

6-13

FDI when and why?

Transportation costs are high Market Imperfections (Internalization Theory)

Impediments to the free flow of products between nations

Impediments to the sale of know-how Follow the lead of a competitor - strategic rivalry Product Life Cycle - however, does not explain

when it is profitable to invest abroad Location specific advantages (natural resources)

6-14

VDI, when and why?

Market power create entry barriers erode entry barriers

Market imperfections Impediments to the sale of know-how Investments in specialized assets

6-15

Decision framework

How high are How high are transportation costs transportation costs

and tariffs?and tariffs?

Is know-how amenable Is know-how amenable to licensing?to licensing?

Is tight control over foreign Is tight control over foreign operation required?operation required?

Can know-how be protected by Can know-how be protected by licensing contractlicensing contract??

Then licenseThen license

ExportExport

No

Yes

Yes

Low

No

Yes

No

Horizontal FDI

Horizontal FDI

Horizontal FDI

High