Foreign Direct

Investment

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Foreign Direct Investment

(FDI)
Definition:
Investment

from one country into another (normally by

companies, called MNs, Global or Transnational

Companies/Corporations, rather than governments) that involves
establishing operations or acquiring tangible assets, including
stakes in other businesses
FDI

is not just a transfer of ownership as it usually involves the

transfer of factors complementary to capital, including

management, technology and organisational skills.
FPI

(Foreign Portfolio Investment) represents passive holdings of

securities such as foreign stocks, bonds, or other financial assets,

none of which entails active management or control of the
securities' issuer by the investor.
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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

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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

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Why FDI ?
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 firms interest
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Different types of companies

Internationalcompanies have no foreign direct investments (FDI) and make their product
or service only in their home country. In other words, they're exporters and importers. They
have no staff, warehouses, or sales offices in foreign countries. The best examples of
international companies, in the strict sense, are exotic retail shops that sell imported
products, or small local manufacturers that export to neighbouring countries.

Multinationalcompanies cross the FDI threshold. They invest directly in foreign assets,
whether it's a lease contract on a building to house service operations, a plant on foreign
soil, or a foreign marketing campaign. Multinational companies, however, have FDI only in a
limited number of countries, and they do not attempt to homogenize their product offering
throughout the countries they operate in -- they focus much more on being responsive to
local preferences than a global company would.

Globalcompanies have investments in dozens of countries but maintain a strong

headquarters in one, usually their home country. Their mantra iseconomies of scale, and
they'll homogenize products as much as the market will allow in order to keep costs low.
Their marketing campaigns often span the globe with one message (albeit in different
languages) in an attempt to smooth out differences in local tastes and preferences.

Transnationalcompanies are often very complex and extremely difficult to manage. They
invest directly in dozens of countries and experience strong pressures both for cost reduction
and local responsiveness. These companies may have a global headquarters, but they also
distribute decision-making power to various national headquarters, and they have dedicated
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R&D activities for different national markets.
6

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Concepts related to MNCs

Aparent companyis an incorporated or unincorporated enterprise,

or group of enterprises, which has a direct investment enterprise
operating in a country other than that of the parent enterprise.

An affiliate enterprise is an incorporated or unincorporated

enterprise in which a foreign investor has an effective voice in
management. Such an enterprise may be a subsidiary, associate or
branch. Usually, the difference is from tax standpoint.
Asubsidiary is a separate legal entity from the parent, although owned by the parent
corporation.Usually, the subsidiary is wholly-owned by the parent corporation.
Anassociateis an incorporated enterprise in the host country in which an investor
owns a total of at least 10%, but not more than half, of the shareholders voting power.
Abranch office is not a separate legal entity of the parent corporation.It is a simple
structure, one of the following: a permanent establishment or office of the foreign
investor; an unincorporated partnership or joint venture between the foreign direct
investor and one or more third parties; land, structures (except structures owned by
government entities), and /or immovable equipment and objects directly owned by a
foreign resident; or mobile equipment (such as ships, aircraft, gas- or oil-drilling rigs)
operating within a country, other than that of the foreign investor, for at least one year.

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 Foreign

assets
Network spreading
Transfer price
Transnationality Index(TNI) is calculated as
thearithmetic meanof the following
threeratios(where "foreign" means outside of
the corporation's home country):
the ratio of foreign assets to total assets
the ratio of foreign sales to total sales
the ratio of foreign employment to total
employment
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Types of MNCs (Perlmutter)

MNC

are very different one to another

Perlmutter

(1969) has been among the

first to identify this heterogeneity and
he distinguished between three types
Ethnocentric
Polycentric
Geocentric

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Stephen Hymer (1960)

for

firms to own and control foreign value-adding

activities they must possess some kind of
innovatory, cost, financial or marketing
advantages - specific to their ownership - which is
sufficient to outweigh the disadvantages they
face in competing with indigenous firms in the
country of production

What

kind of advantages do we talk about?

Access to raw materials

Economies of scale
Intangible assets such as trade names, patents,
superior management etc
Reduced transaction costs when replacing an arm's
length transaction in the market by an internal firm
transaction
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Product Life Cycle theory

(Vernon, 1966)
The

product life cycle model (PLC) was a

critique of neoclassical comparative
advantage theory

The failure to deal with the role of innovation

in dealing with trade patterns
The lack of attention to the role of economics
of scale in determining such patterns

The

technological lead generated by a

firm may give it an edge in exports

The average income in a market determines

which market a product enters first
Due to high US income, new products are
introduced early in the US
US firms were also assumed to be innovative

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Next step theory of

internalization
Internalization

theory asks why

business transactions take place
within a firm (hierarchy) rather
than between independent firms
in a market
Firm specific advantage
Market imperfections

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Other theories
Ronald Coase -

Firms exist as an alternative

system to the market-price mechanism when it is
more efficient to produce in a non-market
environment.
Existence. Why do firms emerge?
Boundaries. Which transactions are performed
internally and which are negotiated on the market?
Organization. Why are firms structured in such a
specific way, for example as to hierarchy or
decentralization?
Heterogeneity of firm actions/performances. What
drives different actions and performances of firms?
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Other theories
John

Dunning the eclectic paradigm (OLI

theory) not only the structure of organization is
important, but:

Ownership

advantages (trademark, production

technique, entrepreneurial skills, returns to scale) .
Ownership specific advantages refer to the competitive
advantages of the enterprises seeking to engage inFDI.
Location advantages(existence of raw materials, low
wages, special taxes or tariffs).
Internalization advantages(advantages by own
production rather than producing through a partnership
arrangement such as licensing or a joint venture).

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How to service a market?

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4 types of FDI in the OLI

The

typology of FDI was

developed by Jere Behrman to
explain the different objectives of
FDI:
Resource seeking FDI
Market seeking FDI
Efficiency seeking (global sourcing
FDI)
Strategic asset/capabilities seeking
FDI

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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 as 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
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FDI Inflows, 1986-2008 (USD

bil.)

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FDI Outflows, 1986-2008

(USD bil.)

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The Global Distribution of FDI

Inflows, 1986-2006

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FDI Inflows, 19802008

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FDI to Asia
According

to the World Investment Report 2014

(UNCTAD,2014), the investment climate in Asia
appears to be optimistic. All parts of Asia
registered increases in FDI flow except for West
Asia, whose FDI declined for the fifth consecutive
year as a result of instability in many parts of the
region. The Association of Southeast Asian
Nations (ASEAN) performed outstandingly well in
terms of FDI flow, with a new high of US$125
billion in 2013, a seven percent increase from
2012. East Asia also saw a significant rise in FDI
inflow, which the report attributed to growing
inflows in China, the second largest FDI recipient
globally after the United States.

See more at: http://www.asiabriefing.com/news/2014/06/un-worldinvestment-report-2014-asia-top-fdi-destination/#sthash.19BBsAof.dpuf

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Forms Of FDI:
Greenfield vs. Acquisitions
Green

field
operation:
Mostly in
developing
nations

Mergers

and
acquisitions:
Preferred Method
(70%-80%)
Quicker to execute.
Foreign firms have
valuable strategic
assets
Believe they can
increase the efficiency
of the acquired firm

More

prevalent in
developed nations

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Forms of FDI
Horizontal, Vertical, Conglomerate
- Horizontal: where the company
carries out the same activities abroad
as at home (for example, Toyota
assembling cars in both Japan and the
UK).

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Horizontal - FDI when and

why?
Transportation costs are high
Low Value to Weight Ratio
Cement, Coke, etc
Look at component that Transportation is of total landed costs

Market

Imperfections (Internalization Theory)

Impediments to the free flow of products between nations

Impediments to the sale of know-how (licence)
Follow

the lead of a competitor - strategic rivalry

Location specific advantages (natural resources)
Oil, gas, labour

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Vertical FDI
Vertical

FDI
Two Types (or both)
Backward - investments into industry that
provides inputs into a firms domestic
production (typically extractive industries)
Forward - investment in an industry that
utilizes the outputs from a firms domestic
production (typically sales and
distribution)
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Vertical- FDI Why

Strategic

Behaviour

By vertically integrating, you can shut

out new competitors out of an industry
Create entrance into a market

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Conglomerate FDI
-

Conglomerate: where an unrelated

business is added abroad. This is the
most unusual form of FDI as it
involves attempting to overcome
two barriers simultaneously entering a foreign country and a new
industry. This leads to the analytical
solution that internationalisation and
diversification are often alternative
strategies, not complements.

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Impediments to the sale of

know-how
Risk giving away
know-how to
competitors
Impediments to
the sale of know
how

Licensing implies
low control over
foreign entity
Know-how not
amenable to
licensing

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Decision framework
How high are
transportation costs and
tariffs?

High
Is know-how amenable to
licensing?

Yes

Low
No

Horizontal FDI
Yes

Is tight control over foreign

operation required?

No

No
Can know-how be protected by
licensing contract?

Export

Horizontal FDI

Horizontal FDI

Yes
Then license
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Benefits of FDI to
Home/Host Countries
Home

Culture/philosophy/research & development

New jobs, new industries

Host
Investment (savings)
Managerial expertise
Technology transfer
Access to marketing networks

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Concerns over FDI

Host Country
Crowding out of domestic investment
Limited technological and managerial expertise transfer
Elimination of domestic competition and control over local
resources
Goals of foreign investors vs. development goals of host
government
Impact on the environment in countries with weak or no
regulation
Impact on growth and income distribution
Negative impact on local politics
Dilemma for host countries: attract MNCs to capture the
benefits that FDI can offer, but they need to ensure that
activities by MNCs actually deliver those benefits

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Concerns over FDI

Home

country

Taxes
Jobs
Political interests vs business
interests

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