Topic 7:

FOREIGN
DIRECT
INVESTMENT
(FDI)
IBM530
 Learning Objectives
1. Understand the need for FDI in
international business
2. Assess the global trends in foreign direct
investment
3. Describe the characteristics of foreign
direct investment
4. Examine advantages and disadvantages
of foreign direct investment to firm,
host country and home country
BASIC CONCEPTS AND
DEFINITION
 FDI vs. FPI

RBP/UiTMKS/FPP/IBM530/535
FDI vs. FPI
What is Foreign Direct Investment
(FDI)?
Examples of Multinational
Enterprises
(MNEs)
Important Terms in FDI
Important Terms in FDI
 The 2 forms of FDI
Merger & Acquisition
(M&A)
 Merger: refers to the combination
process whereby at least 2
companies combine to form 1 single
company.
 Mergers occur with mutual consent
of the merging companies
 Acquisition: The purchase of 1
company by another in which no
new company is formed
 Can take the form of a hostile
takeover.
Greenfield
investment/venture
 Set up new production facilities
abroad
 Firm invest in production
manufacturing, office or physical
company-related structures or
administrative facilities
 E.g. Nestle, P&G, Toyota
 Acquisition & Greenfield
Merger &Acquisition Greenfield
Advantages: Advantages:
 Quick to execute  Can build subsidiary it wants
 Preempt competitors  Easy to establish operating routines
Possibly less risky

Disadvantages:
Disadvantages:  Slow to establish
 Disappointing results  Risky
 Overpay for firm  Preemption by aggressive
competitors
 optimism about value creation
(hubris)
 Culture clash.
 Problems with proposed synergies
 Acquisition or Greenfield?
Well-established,
incumbent firms.
Acquisition
Competitors
interested in
entry.

Embedded skills,
routines, culture.
Green-field

No competitors
Why firms prefer Merger & Acquisition (M&A) as
compared to Greenfield when expanding their
business abroad?

① M&A are quicker to execute than Greenfield

investment.
② Less cost ~ firms don’t have to start from
ground zero.
③ Easier & perhaps less risky for a firm to
acquired desired assets rather than build tem
from the ground up.
④ Firms believe that they can increase
efficiency of an acquired unit by transferring
capital, technology or management skills.
 Five major characteristics of
Foreign Direct Investment (FDI)
 1) FDI requires greater
resource and commitment
2) FDI is risky
3) FDI allow firms to achieve global scale
efficiency
4) In need to deal with different
culture
5) Firm must practice CSR in
any host country
7.1 FDI in the World Economy ~ There are two
ways to look at FDI:
 Trends in FDI
 Boththe flow and stock of FDI in the world economy
have increased over the last 35 years
 Reasons For Firm To Undertake FDI / FDI has grown
more rapidly than world trade and world output
because:
a) Firms still fear protectionist policies
b) The shift toward democratic political institutions
and free market economies encourages FDI
c) Globalization is prompting firms to ensure they
have a significant presence in many regions of the
world
d) FDI is seen a way of evading trade barriers
 The Direction of FDI

 Historically, most FDI has been

directed at the developed nations of the
world
 The United States is a favorite target
as is the European Union
 More recently, developing nations have
been the recipients of FDI
 South, East, and Southeast Asia, and
particularly China have received
significant inflows
 Latin America is also emerging as an
important region for FDI
 Factors Contributed to the Shifts from
Manufacturing to Services-Based Foreign
Investment
7.2 Theories of FDI ~ Two
Important Theories
 Theories of FDI :
International PLC Theory
 The international product lifecycle (PLC) theory states
that a company will begin by exporting its product and
later undertake foreign direct investment as a product
goes through its life cycle.
 A product passes through three stages:
i. New product stage
ii. Maturing product stage
iii. Standardized product stage
 The Eclectic Theory by Dunning
(OLI model)

 Dunning’s eclectic theory states that

firms will undertake foreign direct
investment when the features of a
particular location, combined with
ownership and internationalization
advantages, define the attractiveness of
a location for direct investment
The Eclectic Theory by Dunning
(OLI model)-Cont.
 OLI model/paradigm

RBP/UiTMKS/FPP/IBM530/535
7.3 Political Ideology and
FDI
 Ideology toward FDI has ranged
from:
i. a radical position that is hostile
(unfavorable) to all FDI; to
ii. the non-interventionist principle
of free market economies
 Betweenthese two extremes is an
approach that might be called
pragmatic nationalism
 The Radical View

 The radical view - the MNE is an instrument of

imperialist domination and a tool for exploiting host
countries to the exclusive benefit of their capitalist-
imperialist home countries
 The radical view has been in retreat because of:
i. The collapse of communism in Eastern Europe
ii. The poor economic performance of those countries
that had embraced the policy
iii. The strong economic performance of developing
countries that had embraced capitalism
The Free Market View

 The free market view -

international production should be
distributed among countries
according to the theory of
comparative advantage
 Countries should specialize in the
production of goods and services they
can produce most efficiently
 The MNE increases the overall
efficiency of the world economy
Pragmatic Nationalism

 The pragmatic nationalist view -

FDI has benefits, (inflows of
capital, technology, skills and
jobs) and costs (repatriation of
profits to the home country and
a negative balance of payments
effect)
 FDI should be allowed only if the
benefits outweigh the costs
 Shifting Ideology

 Inrecent years, there has been a

strong shift toward the free
market stance creating:
① A surge in the volume of FDI
worldwide
② An increase in the volume of FDI
directed at countries that have
recently liberalized their regimes
③ But, some countries are becoming
more hostile to FDI
7.4 Benefits and Cost of FDI
 The benefits and costs of FDI must be
explored from the perspective of firm and
both the host (receiving) country and the
home (source) country.
 Advantages & Disadvantages of FDI to a Firm

Advantages Disadvantages
1) Contribute to the firm higher 1) FDI is most complex & risky mode of
productivity. entry.
2) Increase export & import. 2) It is most expensive, complicated &
the most resources taxing.
3) Improved performance in production.
3) Impact the business of domestic firms
4) Positive spillovers from foreign firms if the domestic firms are not
will benefits domestic firms especially competitive enough to attract
in developing country. For example, potential customers.
gain in technology transfer from MNCs 4) MNCs are in advantage to sell
to domestic firms. products more cheaply because of
their economies of scale, & domestic
5) This will lead to increase productivity market will find it difficult to
of the domestic firms, hence increase compete.
average wage per worker.
5) Problem due to differences in culture
6) With better production, more & custom in other countries.
products may be produced & can be
6) Difficulties to locate suitable partners
sold to the international market. especially when they decide on M&A
strategy.
Advantages & Disadvantages
of FDI to Host Country
Advantages (Benefits) Disadvantages

1) Resource Transfer 1) Adverse Effects on

Effects Competition
2) Employment Effects 2) Adverse Effects on the
(FDI bring jobs) Balance-of-Payments
3) Balance-of-Payment 3) Perceived loss of
Effects National Sovereignty
and Autonomy
4) The Effect of
Competition 4) Possible unemployment
in the Host Country
5) Economic growth
Benefits of FDI to a Host Country
Benefits of FDI to a Host Country (cont.)
Benefits of FDI to a Host Country (cont.)
Disadvantages of FDI to a Host Country
Disadvantages of FDI to a Host Country
Advantages & Disadvantages
of FDI to Home Country
Advantages (Benefits) Disadvantages

1) Improve Balance-of- 1) Outflow of Earning to

Payments for Inward Foreign Countries
Flow of Foreign
2) Potential Job Loss
Earnings
2) Increase in Knowledge
from Operating in
Foreign Environment
3) Wide Range of Product
Choices to the
Consumers
Advantages of FDI to a Home Country
Disadvantages of FDI to a
Home Country
7.5 Government Policy
Instruments and FDI