7.2: Theories of Foreign Direct Investment

Question 1

What are the three complementary perspectives from which theories of foreign direct investment approach the phenomenon of FDI?

Answer 1

Explaining why a firm favors direct investment when alternatives like exporting and licensing are available.

Explaining why firms in the same industry often undertake FDI at the same time and favor specific locations.

Combining the above perspectives into the eclectic paradigm, which offers a holistic explanation of FDI by combining the best aspects of other theories.

Question 2

What are the two alternatives to foreign direct investment (FDI) that firms have for entering a foreign market?

Answer 2

Exporting: Producing goods at home and shipping them to the foreign market for sale.

Licensing: Granting a foreign entity the right to produce and sell the firm’s product in return for a royalty fee.

Question 3

Why might firms choose FDI over exporting and licensing, despite FDI being expensive and risky?

Answer 3

Firms may choose FDI over exporting and licensing due to limitations associated with the latter options.

FDI allows a firm to have greater control and access to the foreign market, which may not be possible with exporting or licensing.

Additionally, FDI enables firms to establish a physical presence in the foreign country, which can be crucial for building relationships, adapting to local conditions, and reducing cultural and operational risks.

Question 4

Why do many firms choose FDI over exporting and licensing, despite the potential expense and risk associated with FDI?

Answer 4

Firms often choose FDI over exporting and licensing because of the limitations associated with the latter options.

FDI provides greater control and access to foreign markets, which may not be achievable with exporting or licensing.

It allows firms to establish a physical presence in the foreign country, build relationships, adapt to local conditions, and reduce cultural and operational risks.

While FDI can be expensive and risky, its potential benefits often outweigh these drawbacks.

Question 5

What are some limitations of exporting as a strategy for entering foreign markets?

Answer 5

Exporting as a strategy for entering foreign markets has limitations, including:

Transportation Costs: For products with a low value-to-weight ratio that can be produced anywhere, high transportation costs make exporting unprofitable.

Trade Barriers: The presence of import tariffs or quotas imposed by governments can increase the cost of exporting compared to foreign direct investment (FDI) and licensing.

Protectionist Threats: Even the threat of potential trade barriers can drive firms to choose FDI over exporting as a way to reduce the risk of future trade restrictions.

Question 6

What is internalization theory in the context of foreign market entry strategies?

Answer 6

Internalization theory explains why firms often prefer foreign direct investment over licensing when entering foreign markets.

Question 7

What are the three major drawbacks of licensing as a foreign market entry strategy, according to internalization theory?

Answer 7

Giving away valuable technological know-how to potential foreign competitors.

Lack of tight control over production, marketing, and strategy in the foreign country.

Inability to license management, marketing, and manufacturing capabilities.

Question 8

Can you provide an example of a company that faced a drawback from licensing its technology in the past?

Answer 8

Yes, RCA licensed its color television technology to Japanese companies like Matsushita and Sony in the 1960s, which led to those Japanese companies entering the U.S. market and competing against RCA.

Question 9

Why might a firm prefer foreign direct investment over licensing in terms of control over strategy in a foreign market?

Answer 9

Firms might prefer foreign direct investment to retain control over strategy, such as pricing and aggressive marketing, to compete effectively and protect their brand in a foreign market.

Question 10

What could be a reason for a firm to want control over the operations of a foreign entity in terms of production?

Answer 10

A firm might want to take advantage of different factor costs across countries,

producing part of its product in a country with lower costs and importing other parts, which may not be accepted by a licensee due to reduced autonomy.

Question 11

What is the third problem with licensing related to a firm’s competitive advantage?

Answer 11

The third problem arises when a firm’s competitive advantage is based on management, marketing, and manufacturing capabilities, which are often difficult to license and reproduce as efficiently as the firm itself.

Question 12

Why are Toyota’s competitive advantages not easily licensable?

Answer 12

Toyota’s competitive advantages come from its management and organizational capabilities, which are organization-wide and embedded in its culture, making them difficult to articulate in a licensing contract.

Question 13

In what situations is foreign direct investment preferable to licensing, according to the text?

Answer 13

Foreign direct investment is preferable to licensing when:

The firm has valuable know-how that cannot be adequately protected by a licensing contract.

The firm needs tight control over a foreign entity to maximize market share and earnings.

The firm’s skills and know-how are not amenable to licensing.

Question 14

When is a firm more likely to favor foreign direct investment (FDI) over exporting as an entry strategy?

Answer 14

A firm is more likely to favor FDI over exporting when transportation costs or trade barriers make exporting unattractive.

Question 15

Why might a firm choose FDI over licensing or franchising?

Answer 15

A firm might choose FDI over licensing or franchising when it wants to maintain control over technological know-how, operations, business strategy, or when its capabilities are not suitable for licensing

Question 16

What are some strategic advantages of FDI mentioned in the text?

Answer 16

Access to technology, productive assets, market share, brand equity, and distribution systems.

Speeding up market entry.
Improving production in the firm’s home base.

Facilitating the transfer of technology from the acquired company to the acquiring company.

Question 17

Can you provide an example of a company using FDI for strategic advantages?

Answer 17

Geely’s acquisition of Volvo’s assets in 2010 is an example.

Geely wanted access to Volvo’s design engineering skills and brand equity, which were difficult to license.

The acquisition also gave Geely tight operational control over Volvo’s manufacturing activities.

Question 18

Why might design knowledge be challenging to license?

Answer 18

Design knowledge, like Toyota’s lean production knowledge, can be challenging to license because such skills are difficult to articulate, codify, or write down in a simple licensing contract.

Question 19

How can FDI help a firm improve its production in its home base?

Answer 19

FDI can help improve production in the firm’s home base by facilitating the transfer of technology, knowledge, and best practices from the acquired company to the acquiring company.

Question 20

What are some of the assets a firm can gain through FDI?

Answer 20

Through FDI, a firm can gain technology, productive assets, market share, brand equity, distribution systems, and more.

Question 21

What is an oligopoly, and why is it important in the context of FDI?

Answer 21

An oligopoly is an industry with a limited number of large firms.

In oligopolistic industries, firms are interdependent, and what one firm does can have an immediate impact on competitors, leading to imitative behavior.

This interdependence is important in understanding FDI.

Question 22

How does interdependence among firms in an oligopoly lead to imitative behavior?

Answer 22

Firms in an oligopoly often imitate each other’s actions, such as price cuts or capacity expansions, to maintain or gain market share due to the interdependence among competitors.

Question 23

How does Knickerbocker’s theory relate imitative behavior in FDI to oligopolistic industries?

Answer 23

Knickerbocker’s theory suggests that imitative behavior characterizes FDI in a manner similar to that seen in oligopolistic industries.

For example, if one firm in an oligopoly invests abroad, competitors may follow to avoid being at a disadvantage.

Question 24

Provide an example of imitative FDI behavior mentioned in the text.

Answer 24

An example is given where Toyota and Nissan responded to Honda’s investments in the United States and Europe by undertaking their own FDI in those regions.

Question 25

What is multipoint competition, and how does it relate to FDI?

Answer 25

Multipoint competition occurs when enterprises encounter each other in different regional or national markets.

Firms engage in multipoint competition to match each other’s moves in various markets to prevent rivals from gaining dominant positions and using profits to attack in other markets.

Question 26

What does internalization theory address in the context of FDI?

Answer 26

Internalization theory addresses why a firm chooses FDI over exporting or licensing as an entry strategy and whether FDI is more efficient for expanding abroad.

Question 27

What does the imitative theory of FDI explain, and what does it not address?

Answer 27

The imitative theory explains imitative behavior by firms in oligopolistic industries regarding FDI.

However, it does not explain why the first firm in an oligopoly chooses FDI over other strategies or the efficiency of FDI compared to exporting or licensing.

Question 28

Who championed the eclectic paradigm in the study of foreign direct investment?

Answer 28

The eclectic paradigm was championed by the late British economist John Dunning.

Question 29

What does Dunning mean by location-specific advantages in the context of FDI?

Answer 29

Location-specific advantages refer to advantages that arise from using resource endowments or assets specific to a particular foreign location, which a firm finds valuable to combine with its unique assets, such as technological, marketing, or management capabilities.

Question 30

Why does Dunning argue that combining location-specific assets with a firm’s unique capabilities often requires foreign direct investment (FDI)?

Answer 30

Dunning argues that licensing a firm’s unique capabilities and know-how is difficult.

Therefore, to combine location-specific assets with a firm’s unique capabilities, FDI is often required, which involves establishing production facilities where those foreign assets are located.

Question 31

Can you provide an example of a location-specific advantage mentioned in the text?

Answer 31

Natural resources like oil and minerals are examples of location-specific advantages.

Firms must undertake FDI to exploit these resources effectively.

Question 32

Why does Dunning suggest that firms should locate production facilities in countries with the most suitable labor costs and skills?

Answer 32

Dunning suggests this because labor is not internationally mobile, and it makes sense for a firm to locate production where local labor costs and skills align with its production processes.

Question 33

How does Silicon Valley serve as an example of location-specific advantage in knowledge generation?

Answer 33

Silicon Valley is a location-specific advantage for knowledge generation in the computer and semiconductor industries.

It concentrates intellectual talent and facilitates knowledge spillovers, giving firms a competitive advantage in these industries.

Question 34

What are knowledge spillovers, and how do they relate to foreign investment in Silicon Valley?

Answer 34

Knowledge spillovers refer to the diffusion of knowledge from one source to others in the same area. Firms benefit from knowledge spillovers by locating close to the source.

Foreign computer and semiconductor firms invest in Silicon Valley to gain access to these knowledge spillovers.

Question 35

How does Dunning’s eclectic paradigm contribute to the understanding of how location factors affect the direction of FDI?

Answer 35

Dunning’s theory helps explain how location-specific advantages influence the direction of FDI and why foreign firms invest in specific regions to gain access to unique location-specific knowledge and resources.