Foreign Direct Investment

6-2

What is foreign direct investment

 Company acquiring or merging with a firm in
a different country
 A firm creating a ‘Greenfield’ operation in a
different country
 A firm creating a subsidiary in a different
country
 As a result
 The firm has significant control of its foreign
operation
 Firm can affect managerial decisions of the
foreign operation
 6-3

FDI - Flow versus stock

 FDI occurs when a firm invests directly in
facilities to produce and/or market a product
in a foreign country
 Flow: Amount of FDI over a period of time (one
year)
 Stock: Total accumulated value of foreign
owned assets at a given point in time
 FDI is not the investment by individuals,
firms or public bodies in foreign financial
instruments
 6-4

Why is FDI important ?

 Firms want a presence in foreign markets

 Firms want control over growth of these
foreign markets
 To gain first mover advantages
 To ward off competitors
 To determine locations, advertising and other
related strategic decisions in the firm’s interest
 6-5

Trends in FDI
 Flow and stock increased in the last 20 years
 In spite of decline of trade barriers, FDI has
grown more rapidly than world trade because
 Businesses fear protectionist pressures
 FDI is seen a a way of circumventing trade
barriers
 Dramatic political and economic changes in
many parts of the world
 Globalization of the world economy has raised
the vision of firms who now see the entire world
as their market
 6-6

FDI outflows, 1982-2002

Fig 6.1
 6-7

FDI flows by region

Fig: 6.3
 6-8

FDI outflows by select country

1998-2001
Fig: 6.5
 6-9

Form Of FDI: Greenfield versus

acquisitions
 Green field  Mergers and
operation: acquisitions:
 Quicker to execute.
 Mostly in
 Foreign firms have
developing nations valuable strategic
assets
 Believe they can
increase the
efficiency of the
acquired firm
 More prevalent in
developed nations
 6-10

FDI trends: 2001-2002

 The value of FDI slumped almost 60 percent

in 2001-2002
 Slowdown in world economy
 Heightened geopolitical uncertainty since
September 11, 2001
 Bursting of the stock market bubble in the US
 6-11

Impediments to the sale of know-how

Risk giving away

know-how to
competitors

Impediments to Licensing implies

the sale of know low control over
how foreign entity

Know-how not
amenable to
licensing
 6-12

Two forms of FDI

 Horizontal Direct Investment
 FDI in the same industry abroad as company
operates at home.
 Vertical direct investment
 Backward - investments into industry that
provides inputs into a firm’s domestic
production (typically extractive industries)
 Forward - investment in an industry that utilizes
the outputs from a firm’s domestic production
(typically sales and distribution)
 6-13

FDI when and why?

 Transportation costs are high
 Market Imperfections (Internalization Theory)
 Impediments to the free flow of products between
nations
 Impediments to the sale of know-how
 Follow the lead of a competitor - strategic rivalry
 Product Life Cycle - however, does not explain
when it is profitable to invest abroad
 Location specific advantages (natural resources)
 6-14

VDI, when and why?

 Market power
 create entry barriers
 erode entry barriers
 Market imperfections
 Impediments to the sale of know-how
 Investments in specialized assets
 6-15

Decision framework
How high are Low
Export
transportation costs and
tariffs?
No
High Horizontal FDI
Is know-how amenable to
licensing?
Yes Yes
Horizontal FDI
Is tight control over foreign
operation required?

No No
Can know-how be protected by Horizontal FDI
licensing contract?
Yes
Then license