Global Business 4th Edition Mike Peng Solutions Manual

Global Business 4th Edition Mike Peng
Solutions Manual
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CHAPTER 6
INVESTING ABROAD DIRECTLY
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. use the resource-based and institution-based views to answer why foreign direct
investment (FDI) takes place.
2. understand how FDI results in ownership, location, and internalization (OLI) advantages.
3. identify different political views on FDI based on an understanding of its benefits and
costs to host and home countries.
4. participate in two leading debates concerning FDI.
5. draw implications for action.
GENERAL TEACHING SUGGESTIONS

There are alternative approaches to stimulating interest in this subject.
 One approach is to stimulate negative discussion. Discuss a common
misunderstanding pertaining to offshoring. Point out that not all offshoring involves
shipping jobs overseas. Some is due to the need to be close to resources or to growing
markets. In recent years, the downturn in the U.S. economy was such that firms
would have no reason to expand in the U.S. because they were not able to sell all that
they are currently capable of producing. On the other hand, there were growing
markets in Asia. The need for a cost advantage to sell in those markets indicated that
is where the expansion should occur.
 A positive approach would be to point out that some firms may have at least some
people from its home base to assist in managing overseas operations and that might
result in future career opportunities.
OPENING CASE DISCUSSION GUIDE

Opening Case: Emerging Markets: Indian FDI in Britain
Almost half of India’s outward FDI goes to Britain, which has benefited from the investments.
For example, FDI from India has created more than 100,000 jobs in Britain. India has
encouraged FDI by reducing the tax rate for dividends from overseas investments. Cultural ties
also bind India and Britain, creating a strong bond between the countries. Investors must be
aware of risks though, including the fluctuation of foreign currency exchange rates. Future FDI
might be affected by politics in India and the growth of trade between India and China.
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
49
Chapter 6: Investing Abroad Directly
CHAPTER OUTLINE: KEY CONCEPTS AND TERMS

Sections I through IX of Chapter 6
I. UNDERSTANDING THE FDI VOCABULARY

1. Key Concepts
FDI refers to directly investing in activities that control and manage value creation in
other countries. MNEs are firms that engage in FDI. FDI can be classified as horizontal
FDI and vertical FDI.
Flow is the amount of FDI moving in a given period in a certain direction (inflow or
outflow). Stock is the total accumulation of inbound FDI in a country or outbound FDI
from a country.
2. Key Terms
 Downstream vertical FDI is a type of vertical FDI in which a firm engages in a
downstream stage of the value chain in a host country.
 FDI flow is the amount of FDI moving in a given period (usually a year) in a certain
direction.
 FDI inflow is inbound FDI moving into a country in a year.
 FDI outflow is outbound FDI moving out of a country in a year.
 FDI stock is the total accumulation of inbound FDI in a country or outbound FDI
from a country across a given period (usually several years).
 Foreign portfolio investment (FPI) refers to an investment in a portfolio of foreign
securities such as stocks and bonds.
 Horizontal FDI is a type of FDI in which a firm duplicates its home country-based
activities at the same value chain stage in a host country.
 Management control right is the right to appoint key managers and establish
control mechanisms.
 Upstream vertical FDI is a type of vertical FDI in which a firm engages in an
upstream stage of the value chain in a host country.
 Vertical FDI is a type of FDI in which a firm moves upstream or downstream at
different value chain stages in a host country.
II. WHY DO FIRMS BECOME MNEs BY ENGAGING IN FDI?

1. Key Concept
FDI results in economic gain. Firms seek ownership (O) advantages, location (L)
advantages, and internalization (I) advantages—collectively known as the OLI
advantages. The resource-based view suggests that the key word of FDI is D (direct),
which reflects firms’ interest in directly managing, developing, and leveraging their
firm-specific resources and capabilities abroad. The institution-based view argues that
recent expansion of FDI is indicative of generally friendlier policies, norms, and values
associated with FDI (despite some setbacks).
50
2. Key Terms
 Internalization refers to the replacement of cross-border markets (such as exporting
and importing) with one firm (the MNE) locating and operating in two or more
countries.
 Licensing is Firm A’s agreement to give Firm B the rights to use A’s proprietary
technology (such as a patent) or trademark (such as a corporate logo) for a royalty
fee paid to A by B. This is typically done in manufacturing industries.
 Location refers to advantages enjoyed by firms operating in a certain location.
 Market imperfection (market failure) is the imperfect rules governing
international transactions.
 OLI advantage is a firm’s quest for ownership (O) advantages, location (L)
advantages, and internalization (I) advantages via FDI.
 Ownership is an MNE’s possession and leveraging of certain valuable, rare, hard-to-
imitate, and organizationally embedded (VRIO) assets overseas in the context of
FDI.
III. OWNERSHIP ADVANTAGES

1. Key Concept
Ownership refers to MNEs’ possession and leveraging of certain valuable, rare, hard-to-
imitate, and organizationally embedded (VRIO) assets overseas.
2. Key Terms
 Dissemination risk is the risk associated with unauthorized diffusion of firm-
specific know-how.
IV. LOCATION ADVANTAGES

1. Key Concepts
Location refers to certain locations’ advantages that can help MNEs attain strategic
goals.
2. Key Terms
 Agglomeration is the clustering of economic activities in certain locations.
 Knowledge spillover is knowledge diffused from one firm to others among closely
located firms.
 Oligopoly is an industry dominated by a small number of players.
V. INTERNALIZATION ADVANTAGES
1. Key Concept
Internalization refers to the replacement of cross-border market relationship with one
firm (the MNE) locating in two or more countries. Internalization helps combat market
imperfections and failures.
2. Key Term
 Intrafirm trade involves international transactions between two subsidiaries in two
countries controlled by the same MNE.
51
VI. REALITIES OF FDI

1. Key Concepts
The radical view is hostile to FDI, and the free market view calls for minimum
intervention in FDI.
Most countries practice pragmatic nationalism, weighing the benefits and costs of FDI.
FDI brings a different (and often opposing) set of benefits and costs to host and home
countries.
2. Key Terms
 Contagion effect (also called imitation effect or demonstration effect) is the
reaction of local firms to rise to the challenge demonstrated by MNEs through
learning and imitation.
 Demonstration effect (also called the contagion effect or imitation effect) is the
reaction of local firms to rise to the challenge demonstrated by MNEs through
learning and imitation.
 Free market view is a political view that suggests that FDI unrestricted by
government intervention is best.
 Pragmatic nationalism is a political view that only approves FDI when its benefits
outweigh its costs.
 Radical view is a political view that is hostile to FDI.
 Technology spillover is technology diffused from foreign firms to domestic firms.
VII. HOW MNES AND HOST GOVERNMENTS BARGAIN

1. Key Concept
Forces affecting bargaining include common interests, conflicting interests, and
compromises as affected by each party’s strengths and perception of gain from the
bargain.
2. Key Terms
 Bargaining power is the ability to extract a favorable outcome from negotiations
due to one party’s strengths.
 Expropriation is the government’s confiscation of foreign assets.
 Obsolescing bargain is the deal struck by MNEs and host governments, which
change their requirements after the initial FDI entry.
 Sunk cost is the cost that a firm has to endure even when its investment turns out to
be unsatisfactory.
VIII. DEBATES AND EXTENSIONS

1. Key Concept
The first debate deals with whether FDI should be undertaken as opposed to outsourcing.
The second debate focuses on whether recent anti-FDI incidents represent mere
aberrations in the larger environment of having FDI friendlier policies or represent some
routine occurrences in the future.
2. Key Term
 Sovereign wealth fund (SWF) is a state-owned investment fund composed of
financial assets such as stocks, bonds, real estate, or other financial instruments
funded by foreign exchange assets.
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IX. MANAGEMENT SAVVY

1. Key Concept
Managers should carefully assess whether FDI is justified, in light of other options such
as outsourcing and licensing. Pay careful attention to the location advantages in
combination with the firm’s strategic goals. Be aware of the institutional constraints
governing FDI and enhance legitimacy in host countries.
2. Key Terms
None
53
END-OF-CHAPTER GUIDE
*Review Questions and Answers
*Critical Discussion Questions and Answers
*Global Action
*Closing Case
REVIEW QUESTIONS AND ANSWERS
1. What is the primary difference between FDI and FPI?

Foreign direct investment (FDI) is investing in, controlling, and managing value-added
activities in other countries. Foreign portfolio investment (FPI) refers to investment in a
portfolio of foreign securities such as stocks and bonds that do not entail the active
management of foreign assets.
2. Why does the resource-based view suggest that the key word of FDI is direct?
The key word in FDI is D (direct)—the direct hands-on management of foreign assets.
3. How does horizontal FDI compare to vertical FDI?

Horizontal FDI: a type of FDI in which a firm duplicates its home country-based
activities at the same value chain stage in a host country
Vertical FDI: a type of FDI in which a firm moves upstream or downstream at different
value chain stages in a host country
4. How does internationalization help combat market imperfections and failures?

Internalization replaces cross-border markets with one firm located in two or more
countries as a response to market imperfections and failures.
5. Briefly summarize each of the three OLI advantages.

OLI advantages: ownership (O) advantages, location (L) advantages, and internalization
(I) advantages.
Ownership refers to an MNE’s possession and leveraging of certain valuable, rare, hard-
to-imitate, and organizationally embedded (VRIO) assets overseas in the context of FDI.
Location refers to advantages enjoyed by firms operating in a certain location.
Internalization refers to the replacement of cross-border markets (such as exporting and
importing) with one firm (the MNE) locating and operating in two or more countries.
6. Discuss the pros and cons of FDI versus licensing.

FDI reduces dissemination risks, provides tight control over foreign operations, and
facilitates the transfer of tacit knowledge through “learning by doing.” Licensing
reduces the amount of fixed investment needed to expand but it also leaves one
vulnerable to limitations of the licensee.
54
7. Identify your own example of agglomeration that demonstrates your understanding of the
concept.
Agglomeration is the clustering of economic activities in certain locations. In regards to
the examples, the important thing is not so much the answer as the extent to which the
student demonstrates thought in providing the answer.
8. Compare and contrast the three political views of FDI.

The radical view is hostile to FDI. Tracing its roots to Marxism, the radical view treats
FDI as an instrument of imperialism and as a vehicle for exploitation of domestic
resources by foreign capitalists and firms.
The free market view suggests that FDI, unrestricted by government intervention, will
enable countries to tap into their absolute or comparative advantages by specializing in
the production of certain goods and services.
Most countries practice pragmatic nationalism —viewing FDI as having both pros and
cons and only approving FDI when its benefits outweigh costs.
9. Describe two benefits and two costs to a host country of FDI and to a home country of
FDI.
Host country benefits include the capital inflow that can help improve a host country’s
balance of payments and technology spillovers (from foreign technology) that are
diffused domestically. Such spillovers may produce a demonstration effect (sometimes
also called the contagion or imitation) effect: the reaction of local firms to rise to the
challenge demonstrated by MNEs through learning and imitation. Advanced management
know-how may be highly valued. FDI also creates jobs. Primary costs of FDI to host
countries include loss of sovereignty, and adverse effects on competition. Home country
benefits include repatriated earnings from FDI, increased exports of components to host
countries, and learning from FDI operations. Home country costs include capital outflow
and loss of jobs.
10. Given that outsourcing is a viable alternative to FDI, what issues should be considered
before a firm decides between the two?
The answer boils down to (1) how critical the activity being considered to perform
abroad is to the core mission of the firm, (2) how common the activity is being
undertaken by multiple end-user industries, and (3) how readily available the overseas
talents to perform this activity are.
11. ON CULTURE: Many people in the United States are opposed to both outsourcing and
FDI. Would it be easier to get such people to accept one of these alternatives, and if so,
which one? Why or why not?
The important thing is not so much the answer as the extent to which the student
demonstrates thought in providing the answer. Many who are opposed to both simply do
not want the products of U.S. based companies produced anywhere other than the U.S.
regardless of whether it involves outsourcing or FDI. Some may object more to FDI
because it involves not only the immediate production jobs but also may involve jobs
regarding establishment of production facilities and a greater permanent commitment to
production overseas.
55
12. Why do some countries object to inbound FDI?

At the heart of these debates is the age-old question discussed earlier: Can we trust
foreigners and foreign firms in making decisions important to our economy?
13. In the United States, many states and cities deliberately seek investment in their states
and communities by firms from other parts of the country. Why are some of those who
seek investment from elsewhere in the U.S. worried about investment from overseas?
demonstrates thought in providing the answer. Again, students should consider the
question of trusting foreigners and foreign firms in making decisions important to our
economy.
14. What issues should a savvy manager consider when evaluating a particular location for
FDI?
The quest for location advantages has to fit with the firm’s strategic goals. A given
location that might seem to be advantageous due to low labor costs might not be
advantageous in terms of the skills or other resources that are needed.
If a firm is searching for the best “hot spots” for innovations, certain low-cost locations
that do not generate sufficient innovations will not become very attractive.
15. Some Americans feel that U.S.-based firms should not undertake FDI in other countries
because it results in expanding business opportunities in those countries and does not
benefit the United States. How may the data on PengAtlas Map 2.3 be used to refute that
view?
The U.S. not only is engaged in FDI in other countries, it is also the recipient of FDI.
16. Consider PengAtlas Map 2.3 showing U.S. FDI, and then look at PengAtlas Maps 2.1
and 2.2. Given the possibility that some U.S. imports are from operations in which U.S.
firms have made FDI, how does that affect your view of the US trade deficit? Does it
make the deficit seem like less of a problem or greater? Explain your answer.
demonstrates thought in providing the answer. To the extent that the FDI has resulted in
importing what might otherwise have produced in the U.S., some will feel that it hurts
jobs but others may point out that the reason for such overseas production is that it offers
the U.S. consumer benefits in terms of lower prices and/or higher quality.
56
17. In questions 12, 13, and 15, we have noted controversies regarding FDI in terms of both
inflows and outflows. Regarding PengAtlas Map 2.3, public concern about FDI often
focuses on the FDI of U.S.-based companies, and some argue that investment going
overseas may otherwise have occurred within the U.S. However, the map also shows that
the U.S. is a major recipient of such investment from overseas—but some who oppose
FDI outflows also oppose FDI inflows. They fear that the United States is losing control
over its economy as a result of such inflows. Do you think the two views are compatible?
Why or why not?
demonstrates thought in providing the answer. Those who view exports, imports and
international investment (FDI) as desirable will feel that the two views are compatible
only in that the views do not recognize the value or international transactions – they may
be economic isolationists. Others will see the concerns as issues of involving loss to a
foreign country – loss of jobs or loss of control over domestic production.
CRITICAL DISCUSSION QUESTIONS AND ANSWERS
1. Identify the top five (or ten) source countries of FDI into your country. Then identify the
top ten (or 20) foreign MNEs that have undertaken inbound FDI in your country. Why do
these countries and companies provide the bulk of FDI into your country?
This is a question in which the answer is not as important as the thought process and the
ability to clearly articulate and document the answers.
2. Identify the top five (or ten) recipient countries of FDI from your country. Then identify
the top ten (or 20) MNEs headquartered in your country that have made outbound FDI
elsewhere. Why do these countries attract FDI from the top MNEs from your country?
This is a question in which the answer is not as important as the thought process and the
ability to clearly articulate and document the answers.
3. ON ETHICS: Undertaking FDI, by definition, means not investing in the MNE’s home
country. What are the ethical dilemmas here? What are your recommendations, as (1)
MNE executives, (2) labor union leaders of your domestic (home country) labor forces,
or (3) host country officials?
Again, this is a question in which the answer is not as important as the thought process
and the ability to clearly articulate. However, in discussing this question, you might use
comments in the General Teaching Suggestions and the Opening Case Discussion Guide.
57
GLOBAL ACTION
1. Your MNE is looking to evaluate the industrial capability of various locations

worldwide. Based on readily available data concerning the potential and performance of
different countries, the information you provide will drive future investment by your
company. Choose a country from Asia, Europe, North America, and South America and
summarize your findings about each.
Of the four countries from four continents, how would you rank them? Why?
Exercise 1 Answers
One resource which can be used is “Global-production.com”. This website can be found
by entering the search term “global production” at the globalEDGE™ Resource Desk
search box located at http://globaledge.msu.edu/resourceDesk/. At the website, choose
one country for Asia, Europe, North America, and South America. When evaluating each
country, students may choose any of the four individual Industrial Capacity measures
(skill base, R&D capacity, infrastructure, or government) as well as the overall measure
(all indicators). Vigorous discussion may result upon comparison of these countries
across the different individual measures.
Search Term: “global production”
Resource Name: Global-production.com
Website: http://www.global-production.com/
globalEDGE™ Tag: Rankings
2. The main premise for development at your company in the coming years is to
shift its offshore services to Africa. As such, you have been asked to develop
a report that evaluates which African countries have increased the possibility
of creating a long-term advantage for your company. Also, be sure to include
the African countries that have decreased their capacity to create a long-term
advantage. Can you generate a top-five list and a bottom-five list from
Africa for this purpose?
Exercise 2 Answers
One resource which can be used is “A.T. Kearney: The Global Services Location Index”.
This website can be found by entering the search term “offshore services” at the
globalEDGE™ Resource Desk search box located at
http://globaledge.msu.edu/resourceDesk/. Once at the website, select and view the report.
Then, scroll through the report for an evaluation of the countries. The measures used to
determine the index belong in three main categories (with the appropriate sub-
categories): financial attractiveness (compensation costs, infrastructure costs, and tax and
regulatory costs), people and skills availability (remote services sector experience and
quality ratings, labor force availability, education and language, and attrition risk), and
business environment (country environment, infrastructure, cultural exposure, and
security of intellectual property).
Search Term: “offshore services”
Resource Name: A.T. Kearney: The Global Services Location Index
Website: http://www.atkearney.com/index.php/Publications/global-services-location-
index.html
globalEDGE™ Tag: Rankings
58
CLOSING CASE DISCUSSION GUIDE AND ANSWERS

Emerging Markets: Automobile FDI in Braziland Mexico
1. What are the costs and benefits of FDI inflows for a host country such as Brazil and
Mexico?
Brazil cost: high cost of living; expensive to conduct business; automobile industry can’t
stand alone
Brazil benefit: industry growth; innovation is supported (ethanol); generated opportunity
in local businesses
Mexico cost: not fostered domestic suppliers; industry innovation limited;
Mexico benefit: leveraging low-cost labor; export hub; modern infrastructure
2. If you were an executive working for an emerging automaker from China or India,
assuming your firm only has the ability to enter one Latin American country for the time
being, which country would you recommend: Brazil or Mexico?
demonstrates thought in providing the answer.
3. The automobile industry in both Brazil and Mexico is thriving. If you were a government
official from an African country (such as Morocco, Nigeria, or South Africa) who has
visited both countries and has been very impressed, which approach would you
recommend to your own government interested in attracting FDI from global automakers:
the Brazilian approach or the Mexican approach? Why?
demonstrates thought in providing the answer.
59

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Global Business 4th Edition Mike Peng

INVESTING ABROAD DIRECTLY

GENERAL TEACHING SUGGESTIONS

OPENING CASE DISCUSSION GUIDE

CHAPTER OUTLINE: KEY CONCEPTS AND TERMS

I. UNDERSTANDING THE FDI VOCABULARY

II. WHY DO FIRMS BECOME MNEs BY ENGAGING IN FDI?

III. OWNERSHIP ADVANTAGES

IV. LOCATION ADVANTAGES

VI. REALITIES OF FDI

VII. HOW MNES AND HOST GOVERNMENTS BARGAIN

VIII. DEBATES AND EXTENSIONS

IX. MANAGEMENT SAVVY

REVIEW QUESTIONS AND ANSWERS

1. What is the primary difference between FDI and FPI?

3. How does horizontal FDI compare to vertical FDI?

4. How does internationalization help combat market imperfections and failures?

5. Briefly summarize each of the three OLI advantages.

6. Discuss the pros and cons of FDI versus licensing.

8. Compare and contrast the three political views of FDI.

12. Why do some countries object to inbound FDI?

CRITICAL DISCUSSION QUESTIONS AND ANSWERS

1. Your MNE is looking to evaluate the industrial capability of various locations

CLOSING CASE DISCUSSION GUIDE AND ANSWERS

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