Wendy Jeffus

Harvard Summer School

International Business

Introduction Administration

– Project Proposals Due (Next Monday 7/18)– Friday’s Midterm Review

Finish Chapters 5 & 6 Slides Foreign Direct Investment: Dubai Case: Lakshmi Mittal and the Growth of Mittal

Steel Chapter 7: Foreign Direct Investment Midterm Wednesday!

Dubai – Past & Present

1991 2005

Dubai – Burj al-Arab

Dubai – Palm and the World

Dubai – Burj Dubai

Dubai – Dubailand Ski Dome

Case Assignment Lakshmi Mittal and the Growth of Mittal Steel

Present a 5-10min (timed) assessment of the case.

All group members must participate.

Wendy Jeffus

Harvard Summer School

Chapter 7: Foreign Direct Investment

What is the definition of FDI? Foreign Direct Investment is cross-border

investment of greater than 10% (portfolio investment is less than 10% often in the form of stock and bonds).– The flow of FDI refers to the amount of FDI

undertaken over a given time period– The stock of FDI refers to the total accumulated value

of foreign owned assts at a given time– The outflows of FDI refer to the flow of FDI out of a

country– The inflows of FDI refers to the flow of FDI into a

country

Market Imperfections Market imperfections are factors that inhibit

markets from working perfectly– Regulations– Tariffs– Quotas– Transportation costs– Management experience– Lower labor costs

Toyota (Japan)Decision to invest inthe US due in partto quotas on imports.In addition, believed“lean production”was hard to replicate.

P&G (U.S.) moved some of its back-office accounting to the Philippines

Dell (U.S.) call centers in India

IBM & Microsoft (U.S.) have software development in India

Foreign Direct Investment fDi Intelligence recorded 15,551 greenfield FDI

projects worth about $1500bn in 2008, creating an estimated 4 million direct jobs and 12 million indirect jobs worldwide

For your final project see: http://www.fdi.net/country/

http://www.zawya.com/story.cfm/sidZAWYA20090423111545

Which Country?Company Country

Nokia FinlandNovartis SwitzerlandPanasonic JapanPhilips NetherlandsPorsche GermanyPrada ItalyReuters BritainRolex SwitzerlandSamsung S. KoreaSAP GermanyShell Brit./Neth.Siemens GermanySmirnoff BritainSony JapanToyota JapanUBS SwitzerlandVolkswagen GermanyZara Spain

Where to Invest? Theory versus Practice

The decision to invest abroad is often a stage in the firm’s development process.

Eventually the firm experiences a stimulus from the external environment, which leads it to consider production abroad.

Some important external stimuli are:– An outside proposal, from a quality source– Fear of losing a market– The “bandwagon” effect– Strong competition from abroad in the home market– Connections – familiarity with a market – personal interest

The Eclectic Paradigm John Dunning (1988) The Eclectic Paradigm (or OLI Paradigm) is an attempt to create an

overall framework to explain why MNEs choose FDI rather than serve foreign markets through alternative models such as licensing, joint ventures, strategic alliances, management contracts, and exporting.

– “O” owner-specific (competitive advantage in the home market that can be transferred abroad)

– “L” location-specific (specific characteristics of the foreign market allow the firm to exploit its competitive advantage)

– “I” internalization (maintenance of its competitive position by attempting to control the entire value chain in its industry)

http://www.investmentsandincome.com/investments/oli-paradigm.html

Eclectic Paradigm (O-L-I)

Location Advantage:Location specific factors. These are external to

the firm including factor endowment, transportation cost, government regulation,

and infrastructure factors.

O.L.I.

Ownership Advantage:Firm specific unique competitive

advantage that overcome the disadvantages of competing with firms in their own market e.g. name recognition

and other core competencies.

Internationalization:Cost advantage from vertical and

horizontal integration, due to transactioncost caused by market failure

Examples of types of location-specific factors are markets, resources, production costs,

political conditions, cultural/linguistic affinities, concentration of knowledge development .

LocationFrance’s

wine industry

LocationChina’sZ-Park

Examples of types of ownership factors technology, knowledge, patent, know-how, size.

Japan’sauto industry

Examples benefits from controlling the foreign business activity, rather than hiring an independent local company to provide the service

Microsoft’sIntellectualProperty

http://bizeco.blogspot.com/2005_06_01_archive.html

Forms of FDI Greenfield operations:

– Usually only when an appropriate target is unavailable.

Mergers and acquisitions:– Quicker to execute– Acquire valuable strategic assets– Believe in the ability to increase the efficiency of the

acquired firm.

A Key Point Mergers are marriages between firms.

– They can be dysfunctional, unequal, unfair, and can result in expensive break-ups.

– To have a successful merger 1) chose your partner wisely 2) communicate goals 3) have a good lawyer.

Photo source: “For Bank of America and Merrill, Love Was Blind”

[1] http://www.bizjournals.com/baltimore/stories/2007/11/05/daily15.html[2] http://www.nytimes.com/2009/02/08/business/08split.html

John Thain, ML’s CEO

Ken Lewis,BoA CEO

Who’s “the Boss” BP/Amoco Merged in 1998

– A popular joke in Amoco hallways goes: What’s the British pronunciation of BP Amoco?

“BP” – the Amoco is silent. BP was a giant family of small businesses

– London, glass walls, “peer groups,” and hard targets. Amoco operated under a classic pyramid with

heavy internal bureaucracy.– Chicago, closed doors, “aspirations,” strategic

planning counsels, and strict policies They even spelled organization and labor

differently!

Photo Source: http://www.albhydrocarbon.com/logot/bpamoco4.gifhttp://www.intermarkinc.com/Sponsors%20Home%20Page/BP_new.gif

Foreign Direct Investment Horizontal FDI - investment in the same industry

– Cemex (Mexico’s largest cement manufacturer acquired RMC (cement firm in Britain)

Vertical FDI – – Backward Vertical “upstream” - investment in inputs (i.e.

suppliers). Popular in oil, bauxite, & mining industries

– Forward Vertical “downstream” investment in outputs (i.e. customers)

Volkswagen bought dealers in the US

Licensing Licensing is basically selling “know-how” (i.e. technology,

brand, etc.) U2 Has Licensed it’s song “Get on Your Boots” for the

World Cup Games.– http://entertainment.gather.com/viewArticle.action?

articleId=281474978297047

June 10, 2010 For the first time FIFA has licensed imagery, including mascots and logos, to be transformed into a clothing brand, through Singapore-based Global Brands Group.

– http://www.ft.com/cms/s/0/a3849610-7427-11df-87f5-00144feabdc0.html

http://www.paulspins.com/0010fifa/graphics/_logo.jpg

Licensing vs. FDIChoose FDI when…

– Need to protect know-howRCA licensed its color TV technology to

Matsushita and Sony (oops).

– Want tight controlKodak wants its Japanese subsidiary to keep Fuji

busy.

– Think others can’t replicate your competitive advantage.

Toyota thinks foreign companies don’t get it.Photo source: Company websites

Franchising Franchising is the service industry’s version of licensing.

– McDonald’s chooses franchising because… Fast-food can’t be exported Economizes on costs and risks of foreign business Brand is easier to protect (than technology, for example) Control can be communicated through contracts and company

visits.

http://filtafryfranchise.info/wp-content/uploads/2010/02/franchise.jpg

Decision Making Grid For FDI

Political Ideology

RadicalView

PragmaticNationalism

FreeMarket

MNEs are instrumentsof imperialist domination

First, No Country has adopted the Radical or Free Market views in their pure forms

CubaCambodia

FDI benefits both countries“Come on In”

US,UK,

Note: While the U.S. is seen as one of the most open markets, the country still prohibits certain FDI (e.g. investment from Iran & Cuba)

Sweden,Mexico, S. Korea

Pragmatic Nationalism The pragmatic nationalist view is that FDI has

both benefits and costs– Allow FDI if benefits outweigh costs

Block FDI that harms indigenous industry Court FDI that is in national interest

– Tax breaks– Subsidies

Even free market economies block FDI– protect infant industry– anti-dumping – national security

Foreign Direct Investment (Host)

Benefits to Host Country Supply of capital and

other resources– Technology– Management

Employment BOP (Balance of Payments)

– Capital inflow, import substitution & subsequent exports

Competition– Increase in consumer

choice, lowers prices

Costs to Host Country Loss of national

sovereignty– Foreign parent has no

commitment to host country

Fear of monopoly power BOP

– Import of inputs from abroad

– Outflow of foreign subsidiary's earnings

Foreign Direct Investment (Home)

Benefits to Home Country BOP

– Inflow of foreign earnings Employment effects

– Foreign subsidiaries create demand for home-country exports

Reverse-resource transfer effect

– Foreign subsidiary learns skills abroad and transfers knowledge home

Costs to Home Country BOP

– Initial capital outflow– Export substitution

Export of jobs abroad

Policies and FDI (Home)

Encourage Outward FDI– Government backed

insurance programs– Capital assistance– Tax incentives– Political pressure

Example: Japan responded to political pressure from the U.S. in the ’80s and relaxed informal barriers

Discourage Outward FDI– Limit capital outflows– Tax incentives to invest at

home Example: Britain once

taxed foreign earnings higher than domestic earnings.

– Prohibit national firms from investing in certain countries

U.S. discourages investment in Cuba & Iran

http://www2.toysrus.co.jp/truj/english/index.html

Policies and FDI (Host) Encourage Inward

FDI– Tax concessions– Low interest loans– Grants/subsidies

Discourage Inward FDI– Ownership restraints

Prohibited operating in certain fields

Require that a significant proportion of the equity be owned by local investors

– Performance Restraints

Local Content Hiring Exports

Case Questions… Should Malone accept this position? What issues should she consider when making

her decision? What are the relevant benefits and costs of this

investment for Scotland and for the local community? Do the benefits outweigh the costs?

Is there a win-win solution?

Please note, I have decided to include this as a bonus questionon your mid-term exam. (you can earn up to 20 points)The maximum score on the mid-term is 100 points (100%).

The Negotiation Process

The negotiation process has been characterized as occurring within the context of “the four Cs”

– Common interests – Conflicting interests – Compromise– Criteria

Negotiation & Bargaining Power The outcome of any negotiated agreement depends on

the relative bargaining power of both parties Bargaining power depends on three factors

– The value each side places on what the other has to offer– The number of comparable alternatives available to each side– Each party’s time horizon

Midterm Prep Study Sheet (AKA “cheat sheet”) 3 hours 40 multiple choice 2 essay questions (10 points each) 1 bonus essay question (20 Points)

Questions?

Good luck!