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Chapter Fourteen Direct Investment and Collaborative Strategies
Chapter Fourteen Direct Investment and Collaborative Strategies
To clarify why companies may need to use modes other than exporting to operate
effectively in international business
To comprehend why and how companies make foreign direct investments
To understand the major motives that guide managers when choosing a collaborative
arrangement for international business
To define the major types of collaborative arrangements
To describe what companies should consider when entering into arrangements with
other companies
To grasp what makes collaborative arrangements succeed or fail
To see how companies can manage diverse collaborative arrangements
CHAPTER OVERVIEW
Although most companies operating internationally would prefer exporting to other
market entry modes, there are circumstances in which exporting may not be feasible. In
these cases, companies may engage in direct investment in other countries, or enter
markets through various collaborative strategies such as joint ventures and alliances.
Collaborative strategies allow firms to spread both assets and risk across countries by
entering into contractual agreements with a variety of potential partners. Chapter
Fourteen first discusses reasons for not exporting and then explores the motives that drive
firms to engage in noncollaborative and collaborative arrangements, as well as the
various types of possible arrangements, including foreign direct investment, licensing,
franchising, joint ventures, and equity alliances. It goes on to explore the various
problems that may arise in FDI and collaborative ventures and concludes with a
discussion of the various methods for managing these evolving arrangements.
CHAPTER OUTLINE
OPENING CASE:
Cisco Systems
[See Map 14.1]
Globalization has pushed Cisco Systems into a broader range of markets in order to
follow the expansion patterns of its customers, solicit new business, and study new ideas
and products. Ciscos worldwide alliances spur the company to continue learning and to
refine its competencies. They enable it to meet customer needs that fall outside its areas
of core competencies, while simultaneously permitting Cisco and its partners to enhance
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INTRODUCTION
When forming objectives and implementing strategies in a variety of country
environments, firms must either handle international business operations on their
own or collaborate with other companies (Figure 14.2). Although exporting is
usually the preferred alternative since it allows firms to produce in their home
countries, participating in some markets may require using a variety of other equity
and nonequity arrangements (Figure 14.3). These can range from wholly owned
operations to partially owned subsidiaries, joint ventures, equity alliances, licensing,
franchising, management contracts, and turnkey operations.
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to. The more that products must be altered for foreign markets, the more likely
production will shift to those foreign markets.
E. Trade Restrictions
Although import barriers have been on the decline, some significant tariffs
continue to exist. In these situations, avoiding barriers through production in the
target country must be weighed against other considerations such as the market
size of the country and the scale of technology used in production. When
barriers fall within a group of countries, companies may be attracted to make
direct investments to serve the entire region since the expanded market may
justify scale economies.
F. Country of Origin Effects
Consumers may prefer goods produced in their own country over imports
because of nationalistic feelings. For some products, consumers may prefer
imported goods from specific countries due to a perception that those products
are superior. Other considerations like the availability of service and
replacement parts for imported products, or adoption of just-in-time
manufacturing systems may influence production locations.
III. NONCOLLABORATIVE FOREIGN EQUITY ARRANGEMENTS
Two forms of foreign direct investment (FDI) that do not involve collaboration are
wholly owned operations and partially owned operations with the remainder widely
held.
A. Foreign Direct Investment and Control
To qualify as a foreign direct investment, the investor must have control. This
can be established with a small percentage of the holdings if ownership is
widely dispersed. The more ownership a company has, the greater its control
over the management decisions of the operation. There are three primary
reasons for companies to want a controlling interestinternalization theory,
appropriability theory, and freedom to pursue global objectives.
1. Internalization. Control through self-handling of operations is known as
internalization. Transactions cost theory holds that companies should
organize operations internally when the costs of doing so are lower than
contracting with another party to handle it for them. Internalization may
result in lower costs because:
Different operating units with the same company likely share a
common culture which expedites communications
The company can use its own managers who understand and are
committed to carrying out its objectives
Negotiations that might delay the investment or complicate its
management can be avoided
The company can avoid possible problems with enforcing an agreement
2. Appropriability. Appropriability theory is the idea that companies want
to deny rivals and potential rivals access to resources such as capital,
patents, trademarks, and management know-how that might be captured
through collaborative agreements.
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POINT-COUNTERPOINT:
Should Countries Limit Foreign Control of Key Industries?
POINT: Countries should limit foreign control of key industries in order to protect their
economic and security interests, especially in key industries such as transportation, mass
media, and energy. History has shown that home governments have used powerful
foreign companies to influence policies in the countries where they operate, and that
foreign companies have used their home governments as instruments to improve their
interests in a country. Whenever a company is controlled from abroad, decisions about
that company can be made abroad, possibly to the detriment of the host country.
COUNTERPOINT: Decisions made by foreign companies are not likely to be much
different than decisions made by local companies. MNEs staff their foreign subsidiaries
mainly with nationals of the countries where they operate, and make decisions based on a
good deal of local advice. Their decisions have to adhere to local laws and consider the
views of suppliers and customers. Protection of certain industries from foreign control
could reduce competitiveness in those industries and harm, rather than help, the local
people. Those who argue for limits are relying on the outdated dependencia theory,
which holds that emerging economies have practically no power in their dealings with
MNEs. More recent bargaining school theory states that the terms for a foreign
investors operations depend on how much the investor and host country need the others
assets. Countries and foreign companies need each other, and both will lose if limitations
are placed on foreign control.
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C.
D.
E.
F.
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become a direct competitor. Such weaknesses may cause a drag on a venture and
even lead to the dissolution of the agreement.
E. Differences in Culture
Differences in both national and corporate cultures may cause problems with
collaborative arrangements, especially joint ventures. Firms differ by nationality
in terms of how they evaluate the success of an operation (e.g., profitability,
strategic market position and/or social objectives). Nonetheless, joint ventures
from culturally distant countries tend to survive at least as well as those between
partners from similar cultures.
V. MANAGING FOREIGN ARRANGEMENTS
As a collaborative arrangement evolves, partners need to reassess certain decisions in
light of their resource bases and external environmental changes.
A. Dynamics of Collaborative Arrangements
The evolutionary costs of a firms foreign operations may be very high as it
switches from one operational mode to another, especially if it must pay
termination fees. Thus, a firm must develop the means to evaluate performance
by separating the controllable and uncontrollable factors at its various profit
centers.
B. Finding Compatible Partners
A firm may actively seek a partner for its foreign operations, or it can react to a
proposal from another company to collaborate with it. Potential partners should
be evaluated both for the resources they can offer and their willingness to work
together. The proven ability to handle similar types of collaboration is a key
professional qualification.
C. Negotiating Process
Certain technology transfer considerations are unique to collaborative
arrangements; often pre-agreements are set up to protect concerned parties. The
secrecy of financial terms, especially when government authorities consult their
counterparts in other countries, is an especially sensitive area. Market conditions
may dictate the need for different terms in different countries.
D. Contractual Provisions
To minimize potential points of disagreement, contract provisions should
address the following factors:
Terminating the agreement if the parties do not adhere to the directives
Methods of testing for quality
Geographical limitations on the assets use
Which company will manage which parts of the operation outlined to the
agreement
What each companys future commitments will be
How each company will buy from, sell to, or use intangible assets that come
from the collaborative arrangement
E. Performance Assessment
All parties should establish mutual goals so all involved understand what is
expected, and a contract should spell out expectations. In addition to the
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Questions
1.
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airlines are free to discontinue service and to wage predatory price wars that put
competitors out of business, at which point the survivors will then raise prices.
Opponents also raise fears there may eventually be too few survivors to allow for the
competition that was envisioned by the proponents of deregulation; the high barriers
to entry in the industry further exacerbate this situation. Another major consideration
deals with the political dimensions of the question. Because most governments see
airlines as a key national industry, they oppose giving foreign carriers access to
domestic routes on grounds of both national security and consumer welfare.
2.
The president of Japan Air Lines has claimed that U.S. airlines are dumping air
services on routes between the United States and Europe, meaning they are selling
below their costs because of the money they are losing. Should governments set
prices so that carriers make money on routes?
It is very difficult to separate profits and losses on a route-by-route basis. While fares
and loads on certain routes may seem to be low, they may in fact be generating
marginal revenues that make major routes profitable. A second issue is that of price
elasticity. If governments were to set prices above the equilibrium point, traffic and
revenues, and hence profitability, would all fall. A third issue is that of ownership. If
privately owned carriers abandon routes to government-owned airlines, they could
well give advantages to those airlines that could then be used against them on other
routes. Finally, the issue of profitability raises the question of subsidies. It is nearly
impossible to determine whether dumping is taking place when competitors receive
so many direct and indirect subsidies.
3.
What will be the consequences if a few large airlines or networks come to dominate
global air service?
The consequences would be both positive and negative. On the positive side,
passengers should be able to travel almost anywhere in the world on a single airline
(or network). That in turn should minimize the risk of missed connections and lost
baggage. Operating economies should be realized as a result of the higher utilization
of airport gates and ground equipmentconsequent savings may or may not be
passed along to passengers through lower prices. On the negative side, it is quite
possible that minimal competition would lead to poor service and/or high prices. In
addition, competition among the destinations associated with particular airlines
would likely decline, as would the special services offered by the niche airlines.
4.
Some airlines, such as Southwest and Alaska Air, have survived as niche players
without going international or developing alliances with international airlines. Can
they continue this strategy?
When there is sufficient traffic on the city pairs that a route serves, there is little need
to have feeder or connecting routes for an airline to be profitable. In fact, without the
need for hubs to make connections, some airlines can operate in smaller but closerto-downtown airports, such as Midway in Chicago or La Guardia in New York. They
can avoid the costs associated with the transfer of bags to connecting flights and the
payment of overnight expenses to passengers who miss connections. In addition,
they may be able to overcome any disadvantages from small-scale operations by
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targeting their promotion to regional and niche groups and by running low-cost
operations that charge low fares. Conventional wisdom would suggest they can in
fact survive in their present operational mode and that attempts to expand and/or
modify their operations might make them more, rather than less, vulnerable.
WEB CONNECTION
Teaching Tip: Visit www.prenhall.com/daniels for additional information and
links relating to the topics presented in Chapter Fourteen. Be sure to refer your
students to the on-line study guide, as well as the Internet exercises for Chapter
Fourteen.
_________________________
CHAPTER TERMINOLOGY:
internalization, p. 489
appropriability theory, p. 489
resource-based view, p. 492
dependencia theory, p. 496
bargaining school theory, p. 496
_________________________
consortium, p. 502
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Exercise 14.2. Identify the various home countries of students in your class. Then
lead the class in a discussion of the likely types of collaborative arrangements
foreign firms might pursue in those countries. Be sure students cite the various
economic, political and cultural factors that would influence decisions regarding
viable collaborative strategies.
Exercise 14.3. While offering desirable advantages, licensing agreements also limit
the amount of control a licensor can exercise over a foreign production process.
Engage the students in a discussion of the type of firm that would most likely be
willing to allow a licensee to use its established brand name, and the type of firm that
would not be willing to do so. Explore the reasons for each position as well as the
reasons a licensee would be willing to accept a license that did not include rights to
the use of the associated brand name.
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