BBDM3133 – International Business Management

T utorial 6

1. Differentiate between foreign direct investment (FDI) and portfolio investment.

Support your answer with relevant concept and discussions.

International flows of capital are at the core of foreign direct investment. Foreign direct
investment (FDI) is the purchase of physical assets or a significant amount of the ownership
(stock) of a company in another country to gain a measure of management control.
International flows of capital are at the core of foreign direct investment.

By contrast, Portfolio investment is the investment that does not involve obtaining a degree
of control in a company.

2. Explain market imperfection theory. Support your answer with relevant concept and
discussions.
A market that is said to operate at peak efficiency (prices are as low as they can possibly be
and where goods are readily and easily available is said to be a perfect market. But perfect
markets are rarely, if ever, seen in business because factors that cause a breakdown in the
efficient operation of an industry is called market imperfection. Market imperfections
theory states that when an imperfection in the market makes a transaction less efficient
than it could be, a company will undertake FDI to internalize the transaction and thereby
remove the imperfection. There are 2 market imperfections that are relevant to this
discussion: trade barriers and specialized knowledge.
3. Explain market power theory. Support your answer with relevant concept and
discussions.
The market power theory states that a firm tries to establish a dominant market presence in
an industry by undertaking FDI. The benefit of market power is greater profit because the
firm is far better able to dictate the cost of its inputs and/or the price of its output. One way
a company can achieve market power (or dominance) is through vertical integration—the
extension of company activities into stages of production that provide a firm’s inputs
(backward integration) or that absorb its output (forward integration). A company can
effectively control the world supply of input needed by its industry if it has the resources or
ability to integrate backward into supplying that input. Companies may also be able to
achieve a great deal of market power if they can integrate forwate to increase control over
 output.

4. Identify and discuss the management issue to Foreign Direct Investment (FDI) decision.

Companies investing abroad often wish to control activities in the local market, but even 100
percent ownership may not guarantee control.

Acquisition of an existing business is preferred when it has updated equipment, good

relations with workers, and a suitable location.

A company might need to undertake a greenfield investment when adequate facilities are
unavailable in the local market.

Firms often engage in FDI when it gives them valuable knowledge of local buyer behaviour or
when it locates them close to client firms and rival firms.