06 - Investing Abroad Directly Flashcards
Foreign Portfolio Investment (FPI)
- An investment in a portfolio of foreign securities such as stocks and bonds that do not entail the active management of foreign assets
- “foreign indirect investment”
Foreign Direct Investment
- Investment in controlling and managing value-added activities in other countries
- Defined by the United Nations as involving an equity stake of 10% or more in a foreign-based enterprise
- Requires resource commitment
Horizontal FDI
Horizontal FDI duplicates its home country-based activities at the same value chain stage in a host country through FDI
Vertical FDI
If a firm through FDI moves upstream or downstream in different value chain stages in a host country
Upstream vertical FDI
- A type of vertical FDI in which a firm engages in an upstream stage of the value
Downstream vertical FDI
- A type of vertical FDI in which a firm engages in a downstream stage of the value chain in two different countries
FDI flow
The amount of FDI moving in a given period (usually a year) in a certain direction
FDI inflow
inbound FDI moving in a country
FDI outflow
Outbound FDI moving out of the country
FDI stock
the total accumulation of inbound FDI in a country or outbound FDI from a country across a given period of time (usually several years)
OLI paradigm
proposes that FDI is the most appropriate form of international business if three conditions are met
- Ownership advantages (O-advantages)
* Resources of the firm that are transferable across borders and enable the firm to attain competitive advantages abroad - Locational advantages (L-advantages)
* Advantages enjoyed by firms operating in certain locations - Internalization advantages (I-advantages)
* Advantages of organizing activities within a multinational firm rather than using a market transaction
Types of O-advantages
- Resources created in one country that can be exploited in other countries
- Capabilities arising from combining business units in multiple countries
- Capabilities arising from organizational structures and culture
Types of L-advantages
- markets
- location-bound Human Resources
- natural resources
- agglomeration
- institutions
I-advantages: Types of market failure
- asset specificity
- information assymetry
- dissemination risk
- tacit knowledge transers
L-advantages: MARKETS
Five reasons firms set up close to their markets
- Protectionism in the form of tariffs or non-tariffs barriers, may inhibit exports. However MNEs can overcome such barriers by setting up local production.
- Transportation Costs especially over long distances for e.g. persihable, breakable, heavy or bulky products can be a major barrier. Local production allows serving a market at lower costs.
- Direct interaction with the customer e.g. suppliers to the automotive industry need to produce near manufacturers to integrate in their supply chain.
- Production and sales of some services cannot be physically separated e.g. hotels, banking or consultancy
- Marketing assets may be more important for a fast-entry strategy. FDI enables MNEs to acquire local firms which control sought-after assets, e.g. distribution networks and brand names.
L-advantages: RESOURCES
natural resources and created assets like human capital and infratstructure
L-advantages: INSTITUTIONS
- e.g. clear and simple rules, low level of corruption and an efficient bureaucracy
L-advantages: AGGLOMERATION
- the location advantages that arise from clustering of economic activities in certain locations
- Advantages of locating in a cluster stem from
- Knowledge spillovers among closely-located firms that attempt to hire individuals from competitors
- Industry demand that creates a skilled labour force whose members may work for different firms without having to move out of the region
Internalization Advantages
- A key advantage of FDI over other modes is the ability to replace (“internalize”) external market relationships
- With one firm (the MNE) owning, controlling and managing activities in two or more countries
- Transaction costs are the costs of organizing a transaction
- searching for partners, monitoring product quality and enforcing contracts
- sub-optimal allocation of resources due to unrealized transactions (aka. opportunity costs)
- High transaction costs can result in market failure
- Imperfection of the market mechanism that make some transactions prohibitively costly
I-advantage: FDI VERSUS EXPORTING
Asset specificity: an investment that is specific to a business relationship (e.g. adapting production process to requirements of customer)
- can lead to opportunistic behavior
Creating an I-Advantage through FDI: Advantages of the MNE:
- reduce cross border transaction costs
- increases efficiencies
I-advantage: FDI VERUS LICENSING
Three reasons to prefer FDI to licensing
1. Dissemination risk: risk is associated with the unauthorized diffusion of firm-specific know-how
- if a foreign company grants a license to a local firm to manufacture or market a product, it runs the risk of the licensee, or an employee of the licensee, disseminating the know-how or using it for purposes other than those origingally intended
2. Certain types of knowledge may be too difficult to transfer to lincensees without FDI
- Tacit knowledge is non-codifiable, and acquistion and transfer require hands-on practice
3. FDI provides more direct and tighter control over foreign operations
I-advantage: FDI VERSUS OFFSHORE OUTSOURCING
Problems arising with Offshore Outsourcing
- Asset specificity can arise if the activity would require substantial specific investment by the service provider
- The outsourcing partner may use knowledge of the firms technology for other purposes, for instance helping competitors entering the industry
- For some activities companies may find it necessary to monitor the actual manufacturing process, rather than simply buying finished products
Licensing
Firm A’s agreement to give Firm B the rights to use A’s proprietary technology or trademark for royalty fee paid to A by B
National Institutions and FDI
- Consensus is that FDI leads to a win-win stituation for both home and host countries
- Most countries retain some institution that either (1) restrict the presence of FDI or (2) regulate the operations of FDI
- Host country institutions
- Outright bans on FDI
- Case by Case approvals of FDI
- Ownership requirements
- General regulatory institutions of business
- FDI specific regulation
- Corporate taxation
