International Business The Challenges

of Globalization 9th Edition Wild

Solutions Manual
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 CHAPTER 7
FOREIGN DIRECT INVESTMENT

LEARNING OBJECTIVES:
7.1 Describe the worldwide pattern of foreign direct investment (FDI).
7.2 Summarize each theory that attempts to explain why FDI occurs.
7.3 Outline the important management issues in the FDI decision.
7.4 Explain why governments intervene in FDI.
7.5 Describe the policy instruments that governments use to promote and restrict FDI.

CHAPTER OUTLINE:

Introduction
Pattern of Foreign Direct Investment
Ups and Downs of FDI
Globalization
Mergers and Acquisitions
Worldwide Flows of FDI
Theories for Foreign Direct Investment
International Product Life Cycle
Market Imperfections (Internalization)
Trade Barriers
Specialized Knowledge
Eclectic Theory
Market Power
Management Issues and Foreign Direct Investment
Control
Partnership Requirements
Benefits of Cooperation
Purchase-or-Build Decision
Production Costs
Rationalized Production
Mexico’s Maquiladora
Cost of Research and Development
Customer Knowledge
Following Clients
Following Rivals
Why Governments Intervene in FDI
Balance of Payments
Current Account
Capital Account
Reasons for Intervention by the Host Country
Control Balance of Payments
Obtain Resources and Benefits

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 2 Ch 7: Foreign Direct Investment

Access to Technology
Management Skills and Employment
Reasons for Intervention by the Home Country
Government Policy Instruments and FDI
Host Countries: Promotion
Financial Incentives
Infrastructure Improvements
Host Countries: Restriction
Ownership Restrictions
Performance Demands
Home Countries: Promotion
Home Countries: Restriction
Bottom Line for Business
Foreign Direct Investment in Europe
Foreign Direct Investment in Asia

A comprehensive set of specially designed PowerPoint slides is available for use

with Chapter 7. These slides and the lecture outline below form a completely integrated
package that simplifies the teaching of this chapter’s material.

Lecture Outline

I. INTRODUCTION
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. It differs from portfolio investment—an
investment that does not involve obtaining a degree of control in a company. Most
governments set the threshold for an investment to be called FDI at anywhere
from 10 to 25 percent of stock ownership in a company abroad—the U.S.
Commerce Department sets it at 10 percent.

II. PATTERN OF FOREIGN DIRECT INVESTMENT

A. Ups and Downs of FDI
FDI inflows grew around 20 percent per year in the first half of the 1990’s
and expanded about 40 percent per year in the second half of the decade.
Global FDI inflows averaged $548 billion annually between 1994 and
1999. FDI inflows peaked at around $1.4 trillion in 2000 and then slowed.
FDI inflows benefitted from strong economic performance and high
corporate profits in many countries between 2004 and 2007, at which
point it reached an all-time record of more than $1.9 trillion. Global
recession meant declining FDI inflows in 2008 and 2009. FDI inflows
climbed greater in 2010, 2011, and 2012, then dipped to $1.3 trillion in
2014, and then rose to nearly $1.8 trillion in 2015 as the world emerged
from recession. (see Figure 7.1).

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 Ch 7: Foreign Direct Investment 3

1. Globalization
a. Companies got around trade barriers in the 1980s through
FDI. Increasing globalization is also causing a growing
number of international companies from emerging markets
to undertake FDI.
b. Uruguay Round of GATT further cut trade barriers, letting
firms produce in the most efficient locations and export to
markets. Set off further FDI into newly industrialized and
emerging markets.
c. Globalization also lets emerging-market companies use
FDI.
2. Mergers and acquisitions
a. M&As and their rising values propelled long-term growth
in FDI, but are falling off lately due to global credit crisis.
b. Power of largest multinationals seems to multiply each
year.
c. The value of cross-border M&As peaked in 2000 at around
$1.2 trillion (see Figure 7.2), accounting for about 3.7
percent of the market capitalization of all stock exchanges
worldwide. After three years of falling FDI, the value of
cross-border M&As rose to around $1 trillion by 2007.
M&A activity then cooled in 2008 and then fell
significantly in 2009 due to the global recession. The value
of cross-border M&A activity then fluctuated for several
years before climbing back to $721 billion by 2015. Many
cross-border M&A deals are done to:
i. Get a foothold in a new geographic market
ii. Increase a firm’s global competitiveness
iii. Fill gaps in companies’ product lines in a global
industry
iv. Reduce costs in R&D, production, or distribution
d. Entrepreneurs and small businesses also engage in FDI and
account for more of its growth.
B. Worldwide Flows of FDI
1. More than 100,000 MNCs with more than 900,000 affiliates drive
FDI flows.
2. In terms of share of global FDI inflows, in 2014, for the first time
developing countries attracted greater FDI inflows than developed
countries. FDI inflows to developing countries were around 55
percent ($699 billion) of total world FDI inflows ($1.28 trillion).
By comparison, developed countries accounted for 41 percent
($522 billion) of total global FDI inflows. The remaining roughly
four percent of global FDI went into countries across Southeast
Europe in various stages of transition from communism to
capitalism. FDI inflows reverted back to their traditional pattern in

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 4 Ch 7: Foreign Direct Investment

2015 whereby developing economies attracted less FDI (44 percent

of the world total) than developed nations did (55 percent).
3. FDI inflows to developing nations were mixed, with China
attracting most in Asia and India attracting a fair amount.
4. Outflows of FDI from developing Asian nations is also rising,
coinciding with the rise of these nations’ own global competitors.
Elsewhere, all of Africa drew in $54 billion of FDI in 2015, or
about 2 percent of the world’s total. FDI flows into Latin America
and the Caribbean $168 billion, or nearly 10 percent of the total
world FDI.

III. THEORIES OF FOREIGN DIRECT INVESTMENT

A. International Product Life Cycle
1. States a company will begin by exporting its product and later
undertake foreign direct investment as a product moves through its
life cycle.
2. In the new product stage, a good is produced entirely in the home
market. In the maturing product stage, a good is produced in the
home market and in markets abroad that are large enough to
warrant production facilities. In the standardized product stage, a
company builds production capacity in low-cost developing
nations to serve its markets around the world.
3. Yet the international product life cycle theory does not explain
why companies choose FDI over other forms of market entry.
B. Market Imperfections (Internalization)
When an imperfection in the market makes a transaction less efficient, a
company will undertake FDI to internalize the transaction and remove the
imperfection. In a perfect market, prices are as low as possible and goods
are easily available. Flaws in the efficient operation of an industry are
market imperfections.
1. Trade barriers
a. A trade barrier such as a tariff is a common market
imperfection.
b. Firms undertake FDI when market imperfections are
present.
2. Specialized knowledge
a. A unique competitive advantage may consist of specialized
knowledge, technical expertise, or special marketing
abilities.
b. Companies charge fees for product knowledge, but when a
company’s specialized knowledge is embodied in its
employees, the only way to exploit an opportunity may be
FDI.
c. A company may undertake FDI if charging another
company for access to its knowledge might create a future
competitor.

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 Ch 7: Foreign Direct Investment 5

C. Eclectic Theory
1. States that firms undertake foreign direct investment when the
features of a location combine with ownership and internalization
advantages to make a location appealing for investment. When
each advantage is present, a company will undertake FDI.
2. A location advantage is the advantage of locating a particular
economic activity in a specific location because of the
characteristics (natural or acquired) of the location.
3. An ownership advantage is the advantage that a company has due
to its ownership of some special asset, such as a powerful brand,
technical knowledge, or management ability.
4. An internalization advantage is the advantage that arises from
internalizing a business activity rather than leaving it to a relatively
inefficient market.
D. Market Power
1. The market power theory states that a firm tries to establish a
dominant market presence in an industry by undertaking foreign
direct investment.
2. The benefit of market power is greater profit because the firm is
better able to dictate the cost of its inputs or the price of its output.
3. Companies can gain market power through vertical integration—
the extension of activities into production that provide a firm’s
inputs (backward integration) or absorb its output (forward
integration).

IV. MANAGEMENT ISSUES AND FOREIGN DIRECT INVESTMENT

A. Control
Many companies invest abroad because they wish to control activities in
the local market (e.g., to ensure the selling price remains the same across
markets). Yet complete ownership does not guarantee control.
1. Partnership requirements
a. Many companies have strict policies regarding how much
ownership they take in firms in other nations.
b. Yet a nation may demand shared ownership in return for
market access. Governments may use such requirements to
shield workers and industries from exploitation or
domination by large multinationals.
2. Benefits of cooperation
a. Greater harmony exists today between governments and
international companies. Developing nations and emerging
markets need investment, employment, tax revenues,
training, and technology transfers.
b. A country with a reputation for overly restricting the
operations of multinationals can see its inward investment
dry up.

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6 Ch 7: Foreign Direct Investment

c. Cooperation can open communication channels to maintain

positive relationships in the host country.
B. Purchase-or-Build Decision
1. The purchase-or-build decision of managers entails deciding
whether to purchase an existing business or build a subsidiary
abroad from the ground up—called a greenfield investment.
2. An acquiring firm may benefit from the goodwill the existing
company has built over the years and, perhaps, brand recognition
of the existing firm. The purchase of an existing business also may
allow for alternative methods of financing, such as an exchange of
stock ownership.
3. Factors that reduce the appeal of purchasing existing facilities are
obsolete equipment, poor labor relations, and an unsuitable
location.
4. Adequate facilities are sometimes unavailable and a company must
go ahead with a Greenfield investment. Greenfield investments
have their own drawbacks—obtaining the necessary permits and
financing and hiring local personnel can be difficult in some
markets.
C. Production Costs
Labor regulations increase the hourly cost of production, and benefits
packages and training programs add to wage costs. Although the cost of
land and tax rate on profits can be lower locally, they may not remain
constant.
1. Rationalized production
a. Production in which components are produced where the
cost of production is lowest.
b. The components are brought together at one central
location for assembly into the final product.
c. Potential problem is that a work stoppage in one country
can halt the entire production process.
2. Mexico’s maquiladora
a. The 130-mile-wide strip along the U.S.–Mexican border.
b. Low-wage regional economy next to a prosperous giant is a
model for other regions split by wage or technology gaps.
c. Ethical dilemmas arise over the wage gap between Mexico
and the United States and lost U.S. union jobs to
maquiladora nonunion jobs. Maquiladoras do not operate
under the stringent regulations that firms in the United
States do.
3. Cost of research and development
a. Cost of developing subsequent stages of technology has led
to cross-border alliances and acquisitions.
b. One indicator of the significance of technology in foreign
direct investment is the amount of R&D conducted by
affiliates of parent companies in other countries. FDI in

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 Ch 7: Foreign Direct Investment 7

R&D appears to be spurred by supply factors such as

access to high-quality scientific and technical human
capital.
D. Customer Knowledge
1. The behavior of buyers is an important issue in the decision of
whether to undertake FDI. A local presence can give companies
valuable knowledge of customers that is unobtainable in the home
market.
2. Some countries have quality reputations in certain product
categories that make it profitable to produce there.
E. Following Clients
1. FDI puts companies near those firms they supply. “Following
clients” occurs in industries in which component parts are obtained
from suppliers with whom a manufacturer has a close working
relationship.
F. Following Rivals
1. FDI decisions resemble a “follow the leader” scenario in industries
with a limited number of large firms.
2. Many firms believe that not making a move parallel to that of the
“first mover” might result in being shut out of a lucrative market.

V. GOVERNMENT INTERVENTION IN FOREIGN DIRECT INVESTMENT

Nations enact laws, create regulations, or construct administrative hurdles for
foreign companies. A bias toward protectionism or openness is rooted in a
nation’s culture, history, and politics. But FDI tends to raise output and enhance
standards of living. Besides philosophical ideals, countries intervene in FDI for
practical reasons.
A. Balance of Payments
1. National accounting system that records all payments to entities in
other countries and all receipts coming into the nation.
2. International transactions that result in payments (outflows) to
entities in other nations are reductions in the balance of payments
accounts and recorded with a minus (–) sign (see Table 7.1).
3. International transactions that result in receipts (inflows) from
other nations are additions to the balance of payments accounts and
recorded with a plus (+) sign.
4. Current account
a. National account that records transactions involving the
import and export of goods and services, income receipts
on assets abroad, and income payments on foreign assets
inside the country.
b. A current account surplus occurs when a country exports
more goods and services and receives more income from
abroad than it imports and pays abroad.

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8 Ch 7: Foreign Direct Investment

c. A current account deficit occurs when a country imports

more goods and services and pays more abroad than it
exports and receives from abroad.
5. Capital account
a. National account that records transactions involving the
purchase or sale of assets.
b. Financial assets such as stocks and bonds and physical
assets such as investments in plants and equipment.
B. Reasons for Intervention by the Host Country
1. Control balance of payments
a. Many governments see intervention as the only way to
keep their balance of payments under control.
b. Host countries get a balance-of-payments boost from initial
FDI flows. Local content requirements can lower imports,
providing an added balance-of-payments boost. Exports
from the FDI can further help the balance-of-payments
position.
c. When companies repatriate profits, they deplete the foreign
exchange reserves of their host countries; these capital
outflows decrease the balance of payments. Thus, a host
nation may prohibit or restrict nondomestic firms from
removing profits.
d. But host countries conserve their foreign exchange reserves
when international companies reinvest their earnings in
local manufacturing facilities. This improves the
competitiveness of local producers and boosts a host
nation’s exports—improving its balance-of-payments
position.
2. Obtain resources and benefits
a. Access to technology
Nations encourage FDI in technology because it increases
productivity and competitiveness.
b. Management skills and employment
FDI allows talented foreign managers to train local
managers in how to operate the local facilities. Some of
these managers will also go on to establish their own
businesses.
3. Reasons for Intervention by the Home Country
There are fewer concerns regarding the outflow of FDI among home
nations because they tend to be prosperous, industrialized nations.
1. Reasons for discouraging outward FDI
a. Investing in other nations sends resources out of the home
country and can lessen investment at home.
b. Outgoing FDI may damage a nation’s balance of payments
by reducing exports otherwise sent to international markets.

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 Ch 7: Foreign Direct Investment 9

c. Jobs resulting from FDI outflows may replace jobs at

home.
2. Reasons for promoting outgoing FDI
a. Outward FDI can increase long-run competitiveness (e.g.,
partnering as a learning opportunity).
b. Nations may encourage FDI in industries that use obsolete
technology or employ low-wage workers with few skills.

VI. GOVERNMENT POLICY INSTRUMENTS AND FOREIGN DIRECT

INVESTMENT
A. Host Countries: Promotion (See Table 7.2)
1. Financial incentives
a. Host governments commonly offer tax incentives or low-
interest loans to attract investment.
b. But incentives can create bidding wars between locations
vying for investment; the cost to taxpayers of snaring FDI
can be more than what the actual jobs pay.
2. Infrastructure improvements
a. Lasting benefits for communities surrounding the
investment location can result from local infrastructure
improvements—better seaports for containerized shipping,
improved roads, and increased telecommunications
systems.
B. Host Countries: Restriction (See Table 7.2)
1. Ownership restrictions
a. Governments impose ownership restrictions that prohibit
nondomestic companies from investing in certain industries
or owning certain types of business.
b. Another restriction is a requirement that nondomestic
investors hold less than a 50 percent stake in local firms.
Nations are eliminating such restrictions because
companies can choose another location.
2. Performance demands
a. Some performance demands dictate the portion of a
product’s content that originates locally, stipulates the
portion of output that must be exported, or requires that
certain technologies be transferred to local businesses.
C. Home Countries: Promotion (See Table 7.2)
1. Offer insurance to cover the risks of investments abroad.
2. Grant loans to firms wishing to increase their investments abroad.
3. Offer tax breaks on profits earned abroad or negotiate special tax
treaties.
4. Apply political pressure on other nations to get them to relax their
restrictions on inbound investments.
D. Home Countries: Restriction (See Table 7.2)

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 10 Ch 7: Foreign Direct Investment

1. Impose differential tax rates that charge income from earnings

abroad at a higher rate than domestic earnings.
2. Impose sanctions that prohibit domestic firms from making
investments in certain nations.

VII. BOTTOM LINE FOR BUSINESS

This chapter presents foreign direct investment (FDI). Like trade decisions, many
factors influence a company’s decision about whether to invest in markets abroad.
Depending on the philosophy of home or host nations and the impact of FDI on
their economic health, a firm can be encouraged or dissuaded to invest in a nation.

A. Foreign Direct Investment in Europe - FDI inflows into the developing

(transition) nations of Southeast Europe and the Commonwealth of
Independent States hit an all-time high in 2008. The main reason for the
fast pace at which FDI is occurring in Western Europe is regional
economic integration (See Chapter 8).

B. Foreign Direct Investment in Asia - China attracts the majority of Asia’s

FDI, luring companies with a lower-wage workforce and access to an
enormous domestic market. Many companies already active in China are
upping their investment further, and companies not yet there are
developing strategies for how to include China in their future plans.

Quick Study Questions

Quick Study 1

1. Q: The purchase of physical assets or significant ownership of a company abroad

to gain a measure of management control is called what?
A: Foreign direct investment 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. It differs from portfolio investment—an
investment that does not involve obtaining a degree of control in a company.

2. Q: What are the main drivers of foreign direct investment flows?

A: Three main reasons for the large increases in FDI flows over the past couple of
decades are: (1) globalization, (2) mergers and acquisitions, and (3) increasing
FDI on the part of entrepreneurs and small businesses.

3. Q: Why might a company engage in a cross-border merger or acquisition?

A: Many cross border M&A deals are driven by a desire of companies to: (1) get
a foothold in a new geographic market, (2) increase a firm’s global
competitiveness, (3) fill gaps in companies’ product lines in a global industry, and
(4) to reduce costs of research and development, production, distribution, and so
forth.

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 Ch 7: Foreign Direct Investment 11

Quick Study 2

1. Q: What imperfections are relevant to the discussion of market imperfections

theory?
A: 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. Two important
market imperfections are trade barriers and specialized knowledge, such as
technical expertise of engineers or the special marketing abilities of managers.
Companies can eliminate the inefficiency of trade barriers (they increase the cost
of getting a product to market) by developing production facilities within the
market. Sometimes the only way a company can exploit the specialized
knowledge of its employees is to engage in FDI—the knowledge simply cannot be
licensed to another firm. Firms also can undertake FDI when they want to lessen
the risk of giving away a competitive advantage to other companies through
licensing agreements.

2. Q: Location, ownership, and internationalization advantages combine which FDI

theory?
A: The eclectic theory states that firms undertake foreign direct investment when
the features of a particular location combine with ownership and internalization
advantages to make a location appealing for investment. A location advantage is
the advantage of locating a particular economic activity in a specific location
because of the characteristics (natural or acquired) of that location. These
advantages have historically been natural resources but can also be acquired
advantages such as a productive workforce. An ownership advantage is the
advantage that a company has due to its ownership of some special asset, such as
a powerful brand, technical knowledge, or management ability. An internalization
advantage is the advantage that arises from internalizing a business activity rather
than leaving it to a relatively inefficient market. The theory states that when all
these advantages are present, a company will undertake FDI.

3. Q: Which FDI theory depicts a firm establishing a dominant market

presence in an industry?
A: The market power theory states that a firm tries to establish a dominant
market presence in an industry by undertaking foreign direct investment.
The benefit of market power is greater profit because the firm is far better
able to dictate the cost of its inputs or the price of its output.

Quick Study 3

1. Q: Where adequate facilities are not present in a market, a firm may decide to
undertake what?
A: Building a subsidiary abroad from the ground up is called a greenfield
investment. This is pursued when adequate facilities in the local market are
unavailable.

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12 Ch 7: Foreign Direct Investment

2. Q: A system in which a product’s components are made where cost of producing a

component is lowest is called what?
A: Rationalized production is when each of a good’s components is produced
where the cost of producing that component is lowest. A potential problem with
this production model is that a work stoppage in one country can bring the entire
production process to a standstill.

3. Q: What do we call the situation in which a company engages in FDI because the
firm it supplies has already invested abroad?
A: Firms commonly engage in FDI when the firms they supply have already
invested abroad. The practice of “following clients” is common in industries in
which producer source component parts from suppliers with who they have close
working relationships.

Quick Study 4

1. Q: The national accounting system that records all receipts coming in to a nation
and all payments to entities in other countries is called what?
A: A country’s balance of payments is a national accounting system that records
all payments to entities in other countries and all receipts coming into the nation.
The balance of payments helps a country monitor the flows of goods, services,
income, and transfer of assets between itself and other nations.

2. Q: Why might a host country intervene in foreign direct investment?

A: One reason host governments intervene in FDI is to control their balance of
payments. (1) Countries get a balance-of-payments boost from initial FDI flow
into their economies. (2) Local content requirements can lower imports, thereby
providing a balance-of-payments boost. (3) Exports generated by production
resulting from FDI can help the balance-of-payments position.
Another reason for intervening in FDI is to obtain resources and benefits.
(1) They may want access to technology. Nations encourage the import of
technology because it tends to increase the productivity and competitiveness of
nations. (2) They may want to obtain management skills and increase employment
levels. By encouraging FDI, nations can allow in talented managers to train local
managers in how to operate the local facilities—this is particularly important for
former communist nations that lack skilled managers. (3) Some of these managers
will go on to establish their own businesses, thereby expanding the economy and
employment opportunities within the nation.

3. Q: Why might a home country intervene in foreign direct investment?

A: There are generally fewer concerns regarding the outflow of FDI among home
nations because they tend to be prosperous, industrialized nations. FDI outflows
do not drastically affect the domestic economy. Nevertheless, there are reasons
why home countries discourage outward FDI. (1) Investing in other nations sends
resources out of the home country. (2) Outgoing FDI may ultimately damage a

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 Ch 7: Foreign Direct Investment 13

nation’s balance of payments by reducing exports that would otherwise be sent to

international markets. (3) Jobs resulting from outgoing investments may replace
jobs at home.
Home countries also promote outgoing FDI. (1) They may do so because
outward FDI can increase long-run competitiveness. (2) Nations may encourage
FDI in industries that they have determined to be “sunset” industries.

Quick Study 5

1. Q: What policy instruments can host countries use to promote FDI?

A: Host countries promote FDI by giving tax incentives, low-interest loans, and
infrastructure improvements.

2. Q: What policy instruments can home countries use to promote FDI?

A: To promote FDI, home countries can offer insurance, low-interest loans, tax
breaks, and apply political pressure.

3. Q: Ownership restrictions and performance demands are policy instruments used

by whom to do what?
A: Host nations restrict FDI through ownership restrictions and performance
demands.

4. Q: Differential tax rates and sanctions are policy instruments used by whom to do
what?
A: Home countries may try to restrict FDI by using differential tax rates and
performance demands.

Ethical Challenge

You are the U.S. senator deciding whether to vote yes or no on a new legislation. The
potential new law places restrictions on the practice of outsourcing work to low-wage
countries and is designed to protect U.S. workers’ jobs. These days it is increasingly
common for companies to promise manufacturing contracts to overseas suppliers in
exchange for access to that country’s market. Labor union representatives argue that
these kinds of deals cost jobs as factories close and parts are made in lower cost China.
They also say that the transfer of technology will breed strong competitors in other
nations and thereby threaten even more jobs at home in the future. Yet, others argue that
market access will translate to increased sales of products mad at home and, therefore
create new jobs at home.
A. 7-5 Do you think companies bear an ethical burden when the contract
production to factories abroad and reduce jobs at home? Students responses
will vary. However, if a company shifts production overseas because of
corporate greed and selfishness, then it would be unethical, however, if it was
done out of competitive necessity and the needs of the employees are a major
consideration during the process this it may be the most ethical action that can
be taken.

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14 Ch 7: Foreign Direct Investment

7-6 As senator, do you vote yes or no on the pending legislation? Explain.

A. The response to this question would be similar to response to question 7-5.
Students would probably suggest an amendment to the legislation taking into
account that would approve any move, if it was done out of competitive
necessity and the needs of the employees are a major consideration.

7-7 Depending on how you voted what policy instruments might you suggest that your
government introduce?
A: Students approach this issue from a variety of perspectives ranging from a total
free-market ideology to a protectionist one. Students must balance the short-term
gains of new business and greater profits against the short-term loss of jobs and
potential long-term loss of creating future competitors. One key issue here is
whether companies are transferring cutting-edge technologies or those that are a
generation old or more. Students must also consider social issues of lost jobs due
to manufacturing going abroad and the strong competitors arising from
transferring technologies abroad.

Teaming Up

Research Project. Imagine that you work for a car manufacturer and your team is
charged with evaluating the viability of a greenfield auto assembly plant in Mexico.
7-8 Q: What management issues should your team consider in making the evaluation?
Explain.
A: Foreign direct investment 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. It differs from portfolio investment—an
investment that does not involve obtaining a degree of control in a company.
Three main reasons for the large increases in FDI flows over the past couple of
decades are: (1) globalization, (2) mergers and acquisitions, and (3) increasing
FDI on the part of entrepreneurs and small businesses.

7-9 Q: For each FDI theory in this chapter, briefly describe a scenario in which the
theory explains why the company investment in Mexico.
A: Students should review the international product life cycle theory, market
imperfections theory, eclectic theory, and then relate it after some research to the
noted situation.

7-10 Q: What policy instruments can Mexico use to attract additional FDI inflows?
A: Mexico can provide financial incentives, either tax incentives or low interest
loans, or provide infrastructure improvements, such as improved roads or
increased telecommunications systems.

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 Ch 7: Foreign Direct Investment 15

Practicing International Management Case

World Class in the Deep South

7-19 Q: What are the pros and cons of Mercedes’ decision to abandon the culture and
some of its home country practices?
A: The major advantage of the investment is potential for increased sales and
market share. The major drawback is the possible dilution of the brand image that
Mercedes’ has in the market place.

7-20 Q: What do you think were the chief factors involved in Mercedes’ decision to
undertake FDI in the United States rather than build the M-class in Germany?

A: Mercedes chose the United States over Germany because U.S. labor costs were
lower. Alabama offered attractive tax refunds and other incentives to gain jobs
that the plant would create in and around Vance, Alabama and, the company
chose the U.S. market to develop an ultra-modern plant that would be a model for
its future international facilities.

7-21 Q: Why do you think Mercedes decided to build the plant from the ground up in
Alabama rather than buying an existing plant in, say, Detroit? List as many
reasons as you can and explain your answers.
A: First, Mercedes probably chose to build from the ground up because existing
facilities would not supply the cutting-edge environment it wanted for its latest
efforts in car-manufacturing technology, organizational design, and HRM
techniques. Second, it probably chose Alabama because of the mix of economic
factors, including low wages, a rural setting with a strong work ethic, and
financial incentives. Third, it wanted to create a unique work setting and
environment that reflected the firm’s values.

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