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Investment made by a company in a new manufacturing or marketing facilities in a foreign

country is referred to as Foreign Direct Investment (eg) Investment made by Enron in
power plant in India
It is stipulated that the ownership of a minimum of 10 to 25 percent of voting shares is a
foreign company allows the investment to be considered direct.
The investment made by a company in a foreign country over a given period is called
Flow of Foreign Direct Investment( eg) 1 year
The total amount of investment made by a company in a foreign country at a given time is
called The Stock of Foreign Direct Investment

Purchase of existing assets in a foreign country
New investment in property, plant and equipment
Participation in joint venture with a local partner
Transfer of many types of assets like human resources, systems, technological know-how in
exchange for equity in foreign companies
Export of goods for equity. This method may not be used in the initial stage of the
establishment of the company
Through trading in equity: Companies also invest in the equity of the foreign companies by
purchasing the equity shares of the foreign company
Firms having competitive advantage domestically derived from its valuable assets
like technology, brand name and large scale economies extend their operations to
foreign markets through FDI
Caterpillar & Komatsu established its manufacturing facilities in North & south
America, Europe and Asia -- companies have competitive advantage domestically
in technology and brand name and established their operations in foreign countries
Explains the process by which firms acquire and retain one or more value-chain activities
inside the firm retaining control over foreign operations and avoiding the disadvantages of
dealing with external partners.
In contrast to arms-length entry strategies (exporting and licensing) which imply
developing contractual relationships with external business partners,
FDI provides the firm with control and ownership of resource
Internalization theory states that the domestic companies enter a foreign market through
FDI when the cost of transaction with a foreign firm is high
The domestic companies under these conditions internalizes its production, marketing and
other operations in foreign markets through FDI


Internalization theory fails to explain the reason for locating manufacturing facilities in a
foreign country
Companies locate their manufacturing facilities in a foreign country where there is location
John Dunning incorporates location advantage in addition to ownership advantage and
internalization advantage in his electic theory of FDI
According to Dunning, location specific advantages are derived by combining the
advantages of country location assets, mineral, human and other resources with other
specific advantages of the firm like, technology, technical know-how, management,
marketing capabilities etc
Companies go for FDI to get the competitive advantage by combining resource
endowments of the host country and unique strengths of the company
FDI will occur when three conditions are satisfied. They are ownership advantage, location
advantage and internalization advantage.
Raymond Vernons Product Life Cycle theory explains the pattern of FDI over a period of
Production moves from one country to another country during the different stages of the
product life cycle
Production takes palace in industrial countries during the introductory stage
Production moves to other industrial countries during the growth stage
Production moves to developing countries during the maturity stage
Factor endowments including capital vary among countries.
Some countries are rich in capital and pressure where others are not
Capital normally flows from those countries where the return on capital is low to those
countries where the return on capital is high
Capital mobility through direct investment often stimulates trade because of the need for
components, complementary products and equipment for subsidiaries
FDI enhances export to various other countries
Production Costs Companies invest in foreign countries in order to avail the benefits of
lower production costs like labour costs, land prices, commercial real estate rents, tax rates
Logistics If the cost of transportation from the domestic country to a foreign market is
high or the time of transportation to a foreign market is long, then the firms undertake FDI
(eg) Coca-Cola decided to make FDI mainly because its chief input is water

Resource Availability Companies locate their production facilities close to the source of
critical input (eg) U.S based oil- refining companies established their oil refining facilities
in Saudi Arabia and other Gulf countries
Availability of Quality Human Resource at low cost High quality human resources add
to the high value addition to the product. If such human resources are available at low cost ,
productivity increases and cost of value addition gets reduced
Access To Technology Firms prefer to have FDI in order to have access to existing key
technology rather than developing technologies
Demand Factors Companies select the FDI strategy in order to increase the total demand
for the products. These factors include:
Customer Access Certain business firms particularly fast food, service oriented and retail
outlets should locate their operations close to customers.
Marketing Advantages Companies can enjoy a number of marketing advantage by
locating their operations in a host country. These advantages include lower marketing costs,
accessibility to hands-on experience regarding customer and market handling, improving
customer service etc
Exploitation of Competitive Advantages Companies which enjoy competitive
advantage through, trademark , brand name , technology etc go for FDI in order to exploit
its competitive advantage in various foreign markets
Customer Mobility The companies which have one or few customers select the FDI
strategy along with their customers. In other words, the ancillary industrial units locate their
production facilities in those foreign countries where their parent companies locate their
production facilities
Political Factors Companies enter foreign markets through FDI in order to overcome the
trade barriers imposed by the host country or in order to avail the incentives offered by the
host governments
Avoidance Of Trade Barriers Companies establish production facilities in foreign markets
in order to avoid trade barriers like high tariffs, quotas etc
Economic Development Incentives- Government at different levels (i.e) Local, State and
National Levels offer incentives to attract domestic as well as foreign investment
Increase in sales and profits
To enter rapidly growing markets
Reduced costs
Consolidated Trade Blocs
Protect domestic markets
Acquire technological and managerial know-how


Inflow of foreign currencies in the form of dividend, interests etc
FDI increases export of machinery, equipment, technology etc from the home country to the
cost country.
Enhances the industrial activity of the home country thereby enhancing employment
Transfer of skills from the host country to the home country
Home countrys industry and employment position are at stake when the firms enter foreign
markets due to low cost labour
Current account position of the home country suffers as FDI is a substitute for direct exports
Resource Transfer Effects Resources which are scarce in the host country are transferred
from the foreign country. These resources include foreign capital, technology, machinery
and equipment, management and organisation. Transfer of these resources develop the host
country socially and economically
Employment Effects- FDI contributes for the establishment of new industries and business
directly and for the employment of existing economic activity
Balance of Payment Effects BOP position and foreign exchange reserves are very crucial
from the view point of external situation of a country. Foreign companies export the goods,
produced in the host country to a number of other countries. This activity helps the host
country to have foreign exchange earnings
Intensifying Competition Foreign MNCs have more competitive ability in view of their
large size, resource base and and wide spread operations when compared to that of domestic
companies. Pose severe competition and and threat to the domestic companies

Negative Effects on BOP Foreign companies repatriate their dividends to their home
countries that affect the current account. MNCs import the goods from its subsidiaries from
other countries (imports result in debit on the current account of BOP of the host country).
Some of the host governments fear that FDI affects the sovereignty and autonomy of the