MBA/MBAA

Term VI
International Business

Sessions – 7

Prof. Abu Rehan Abbasi 1

Foreign Direct Investment

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International investment can be made
primarily in two ways

• Purchase of physical assets or a

Foreign significant amount of the ownership
Direct (stock) of a company in another
Investment country to gain a measure of
management control

• Investment that does not involve

Portfolio
obtaining a degree of control in a
Investment
company

• UN defines FDI as an equity stake of 10% or more in a foreign-based

enterprise. (UN World Investment Report, 2005)
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4
 Horizontal and Vertical FDI

• Horizontal FDI occurs when a firm duplicates its

home country-based activities in a host country
through FDI at the same value chain stage

Operations Operations
in Home in Host
Country Country
Value Chain

Value Chain
• INPUT • INPUT
• R&D • R&D
• Components • Components
• Final Assembly • Final Assembly
• Marketing • Marketing
• OUTPUT • OUTPUT
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 Horizontal and Vertical FDI
• Vertical FDI occurs when a firm undertakes a
different value chain activity in the host country
than its home country

Operations Operations
in Home in Host
Country Country
Value Chain

Value Chain
• INPUT • INPUT
• R&D • R&D
• Components • Components
• Final Assembly • Final Assembly
• Marketing • Marketing
• OUTPUT • OUTPUT

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 Horizontal and Vertical FDI
• Upstream Vertical FDI or Downstream Vertical FDI

Operations Operations
in Home in Host
Country Country
Value Chain

Value Chain
• INPUT • INPUT
• R&D • R&D
• Components • Components
• Final Assembly • Final Assembly
• Marketing • Marketing
• OUTPUT • OUTPUT

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Is Volkswagen an MNE?

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Das Auto

Volkswagen Group (www.vw.com)

• 48 production
facilities worldwide
• Sells to more than
150 countries
• Top-selling
manufacturer in
South America and
China
• China accounts for
around 30% of VW’s
total sales

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• Volkswagen would not have been an MNE if it
manufactured all its cars in Germany and
exported them to the rest of the world

• Licensing and franchising, or Outsourcing are

NOT direct foreign investments either

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Why do firms become MNEs? Or
Why do they engage in FDI?

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 Ownership refers to MNEs possession and leveraging
of VRIO resources
advantages

Location FDI or
advantages enjoyed by firms because they
do business in a certain place
advantages MNE

advantages gained by replacing other

Internalization cross-border transactions such as
advantages exporting, licensing or outsourcing with
those occurring within the firm

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 Benefits of direct Ownership

• A high degree of management control reduces

dissemination risk (e.g., Pizza Hut in Thailand)

• Provides a direct and tighter degree of control

over foreign operations (e.g., Starbucks in South Korea)

• Certain knowledge calls for FDI (e.g., producing

Cannabis)

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 Benefits of foreign Location

• Certain locations provide a natural geographical

advantage (e.g., Miami - the gateway to the Americas)

• Clustering of economic activities in certain

locations provides agglomeration-related
advantages (e.g., Dallas – for telecom equipment makers and
service providers)
• Knowledge spillovers (employee mobility)
• Skilled labor force
• The pool of specialized suppliers and buyers located in that
region

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 Benefits of foreign Location

• Lower Production Costs

• Reputation of foreign location (e.g., French perfume)

Making the best of the location is important.

Remember if you have gone to a foreign location so
can your competitors (e.g., Volkswagen first to enter China and had
a 60% market share in the 1990s)

Ultimately location advantages are obtained due to

firm-specific assets or its resources
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 Benefits of Internalizing a business activity

• Helps overcome Market Imperfections or Market

Failures (e.g., transactions between oil refiner and oil producer)

Oil
Industry
Value Chain

• Oil exploration
• Oil production
• Oil refinery
• Petrol
distribution

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 Benefits of Internalizing a business activity

International transaction costs are higher than domestic due to greater

uncertainty

If the supplier/buyer behaves opportunistically, difficult to enforce a

contract

Suing another party in a foreign court is costly and uncertain

Some firms may even choose to not do business abroad

FDI transforms international trade between two firms in two countries

into intra-firm trade between two subsidiaries controlled by the same
MNE

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 Effects of FDI on Home & Host Countries
(recipient of

Capital inflow, Loss of economic sovereignty

Country

Technology, Competition
Host

FDI)

Management knowhow, Capital outflow

Job Creation

Earnings
(Source of

Capital outflow
Country
Home

Exports of components & Job Loss

FDI)

services
Learnings from abroad

Benefits Costs

Effects of FDI

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Government Policy Instruments and FDI
MNE and Host Government Bargain

MNEs typically prefer to Host governments usually

minimize intervention from want to ensure a certain
host governments and degree of control and
maximize incentives minimize the incentives
provided provided to MNEs

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Government requirements may change after the initial FDI
entry

Round 1: MNE and Government negotiate a deal

Round 2: MNE enters and if all goes well earns profits that
may become visible

Round 3: Government (at times under domestic political

pressure) demands renegotiation of the deal
• MNE would have already invested substantial resources and may
often have to accommodate new demands

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Pattern of Foreign Direct Investment

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Worldwide Flows of FDI

• Driving FDI growth are more than 100,000 multinational companies

with more than 900,000 affiliates abroad.

• In 2012, developing countries attracted greater FDI inflows than did

developed countries.

• Developed countries account for 42 percent ($561 billion) of total

global FDI inflows.

• FDI inflows to developing countries accounted for around 52 percent

of world FDI inflows ($703 billion).

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Implications for Managers

• Carefully assess FDI requirement

• The search for location advantage should fit with

the firm’s strategic goals

• Do not take FDI-friendly policies for granted,

setbacks are likely. FDI policies likely to become
more protectionist.

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Principal References

Morris, Shad; Oldroyd, James (2022) International Business,

Wiley

Peng, Mike W; Srivastava, Deepak K. (2019) Global Business,

Cengage

Wild, John J; Wild, Kenneth L (2017) International Business: The

Challenges of Globalization, Pearson

Prof. Abu Rehan Abbasi 25

Thank You

Prof. Abu Rehan Abbasi 26