Chapter- 08

Foreign direct investment

• Foreign direct investment (FDI) occurs when a firm invests directly in facilities to
produce or market a product in a foreign country.
• FDI inflow: Direct investment made by foreign investors in a domestic country.
• FDI outflow: Outward direct investment made by the residents of reporting economy
to external economy.
• An example of FDI is given in the opening case about Walmart's investment in Japan.
Walmart first became a multinational in the early 1990s when it invested in Mexico.

FDI takes on two main forms.

1. Greenfield investment
2. Merger and Acquisition
 Greenfield investment
It involves the establishment of a new operation in a foreign country.
Greenfield investments are a type of foreign direct investment where a
company starts its operation in the other countries as its subsidiary and
invests in the construction of offices, plants, sites, building products, etc.,
thereby managing its operations and achieving the highest level of the
controls over its activities.
Example
Suppose there is a company ABC Inc. which is having its headquarters in the
US. The company conducts research to know the demand for its product in
the country of India and found a huge demand for the product in India. So,
the management of the company decided to expand its business by creating
its subsidiary company in India and starts the operations there from the
ground level by constructing new production facilities, distribution hubs, and
the offices.
Example
• Coca-Cola, McDonald's and Starbucks are great examples of US firms that
have invested in greenfield projects around the world.

• In April 2015, Toyota announced its first green-field project in Mexico in three
years, costing US$1.5 billion for the new manufacturing plant in Guanajuato.
The factory is scheduled to open in December 2019 with an eventual goal of
hiring 3,000 employees and the capacity to produce 300,000 pickup trucks
per year
 Merger and Acquisition
• Acquiring or merging with an existing firm in the foreign country (Walmart's
entry into Japan was in the form of an acquisition).
• Acquisitions can be a minority (where the foreign firm takes a 10 percent to 49
percent interest in the firm's voting stock), majority (foreign interest of 50
percent to 99 percent), or full outright stake (foreign interest of 100 percent)
• A merger occurs when two separate entities combine forces to create a new,
joint organization.
• an acquisition refers to the takeover of one entity by another. Mergers and
acquisitions may be completed to expand a company's reach or gain market
share
 Successful Mergers and Acquisitions
•Disney and Pixar/Marvel
•Google and Android
•Exxon and Mobile

Exxon and Mobile Merger

In 2006, Walt Disney Co. acquired Pixar for $7.4 The Exxon and Mobile deal is a prime merger
billion. Since then, movies such as Finding Dory, example. In 1998, Exxon Corp. and Mobil Corp.
Toy Story 3, and WALL-E, have generated billions in made news when they announced their plans to
revenue. Three years after the Pixar acquisition, merge. At the time, the companies were the first
Disney’s CEO Bob Igner, set out to acquire Marvel and second largest U.S. oil producers.
Entertainment for $4 billion.
Facebook and Instagram in 2012
Disney and 21st Century Fox
Google and Android Acquisition
In 2005, Google acquired Android for an estimated $50 million.
The move made it possible for Google to compete in a market
owned by Microsoft with Windows Mobile and Apple’s iPhone.
This deal is one of Google’s biggest M&A deals because 54.5% of
U.S. smartphone subscribers use a Google Android device as of
May 2018.
 The Direction Of FDI
• Historically, most FDI has been directed at the developed
nations of the world as firms based in advanced countries
invested in the others. During the 1980s and 1990s, the
United States was often the favorite target for FDI
inflows.
• Inward investment into the United States remained high
during the 2000s. The developed nations of the European
Union have also been recipients of significant FDI inflows,
principally from U.S. and Japanese enterprises and from
other member states of the EU
• Driving much of the increase has been the growing
importance of China as a recipient of FDI, which attracted
about $60 billion of FDI in 2004 and rose steadily to hit
$101 billion in 2010
Problem………
• The majority of cross-border investment is in the form of mergers and
acquisitions rather than greenfield investments.
• UN estimates indicate that some 40 to 80 percent of all FDI inflows were in the
form of mergers and acquisitions between 1998 and 2009. In 2001, for
example, mergers and acquisitions accounted for some 78 percent of all FDI
inflows
When contemplating FDI, why do firms apparently prefer to acquire existing assets rather than
undertake greenfield investments?

• First, mergers and acquisitions are quicker to execute than greenfield

investments. Many firms apparently believe that if they do not acquire a
desirable target firm, then their global rivals will.
• Second, foreign firms are acquired because those firms have valuable
strategic assets, such as brand loyalty, customer relationships, trademarks
or patents, distribution systems, production systems, and the like. It is
easier and perhaps less risky for a firm to acquire those assets than to
build them from the ground up through a greenfield investment.
• Third, firms make acquisitions because they believe they can increase the
efficiency of the acquired unit by transferring capital, technology, or
management skills.
Why Foreign Direct Investment?

• FDI is expensive and Risky. So why do so many firms apparently prefer FDI over
either exporting or licensing?

• Why do firms go to all of the trouble of establishing operations abroad through

foreign direct investment when two alternatives, exporting and licensing, are
available to them for exploiting the profit opportunities in a foreign market?
Why Foreign Direct Investment?
• Exporting involves producing goods at home and then shipping them to the
receiving country for sale.
• Licensing involves granting a foreign entity (the licensee) the right to produce and
sell the firm's product wherein a company authorizes another company by issuing
a license to temporarily access its intellectual property rights, i.e. manufacturing
process, brand name, copyright, trademark, patent, technology, trade secret, etc.
in return for a royalty fee. Microsoft Office

• Limitations of Exporting
• Limitations of Licensing
Limitations of Exporting Limitations of Licensing

• exporting strategy is often constrained by

According to internalization theory, licensing has
transportation costs (increased production
three major drawbacks as a strategy.
cost) and trade barriers.
• low value-to-weight ratio Thus Cemex, the (1) when the firm has valuable know-how that
cannot be adequately protected by a
large Mexican cement maker
licensing contract
• a high-value-to-weight ratio (e.g., electronic
components, personal computers, medical (2) when the firm needs tight control over a foreign
entity to maximize its market share and earnings in
equipment, computer software, etc.) that country
• trade barriers such as import tariffs or quotas
and cost of exporting rises (3) when a firm's skills and know-how are not
amenable to licensing.
• For example, the wave of FDI by Japanese
auto companies in the United States during
the 1980s and 1990s
 Benefits and Costs of FDI
HOST-COUNTRY BENEFITS
1. Resource-Transfer Effects
2. Employment Effects
3. Balance-of-Payments Effects
4. Effect on Competition and Economic Growth

HOST-COUNTRY COSTS
1. Adverse Effects on Competition
2. Adverse Effects on the Balance of Payments
3. National Sovereignty and Autonomy
Benefits and Costs of FDI

• HOME-COUNTRY BENEFITS
• HOME-COUNTRY COSTS
HOST-COUNTRY BENEFITS
Resource-Transfer Effects and Employment Effects

• a positive contribution to a host economy by supplying capital, technology, and management

resources that would otherwise not be available and thus boost that country's economic growth rate
• Economic Zone in Bangladesh( ex: Karnafuly Dry dock, CEIZ etc…). The creation of special economic
zones by the host country may be motivated by the desire to attract foreign direct investment (FDI).
• Bangladesh presently has 88 special economic zones, 59 set up by the government and 29 by private
investors. The Chinese Economic and Industrial Zone (CEIZ), to be developed near the southeastern
port of Chattogram. The Daily Star, more than 60 Chinese concerns have expressed interest in
investing nearly $280m in the zone. CEIZ will be able to eventually attract more than $1bn in foreign
investment, create 60,000 to 90,000 jobs, directly or indirectly, and ultimately boost industrialization
and develop the economy of the surrounding Chattogram district
Continue….
• For example, when Toyota decided to open a new auto plant in France, estimates
suggested the plant would create 2,000 direct jobs and perhaps another 2,000
jobs in support industries.
• When FDI takes the form of an acquisition of an established enterprise in the host
economy as opposed to a greenfield investment, the immediate effect may be to
reduce employment as the multinational tries to restructure the operations of
the acquired unit to improve its operating efficiency. However, even in such cases,
research suggests that once the initial period of restructuring is over, enterprises
acquired by foreign firms tend to grow their employment base at a faster rate
than domestic rivals
Balance-of-Payments Effects

A country's balance-of-payments accounts track both its payments to and its receipts from other countries.
Governments normally are concerned when their country is running a deficit on the current account of their
balance of payments.

The current account tracks the export and import of goods and services. FDI is a substitute for imports of goods
or services, the effect can be to improve the current account of the host country's balance of payments

A second potential benefit arises when the MNE uses a foreign subsidiary to export goods and services to other
countries. According to a UN report, inward FDI by foreign multinationals has been a major driver of export-led
economic growth in a number of developing and developed nations. For example, in China exports increased
from $26 billion in 1985 to more than $250 billion by 2001 and $969 billion in 2006
 Effect on Competition and Economic Growth
• Increased competition & lower price
• The long-term results may include increased productivity growth, product and
process innovations, and greater economic growth
 HOST-COUNTRY COSTS

• Adverse Effects on Competition

Host governments sometimes worry that the subsidiaries of foreign MNEs may have
greater economic power than native competitors

Thus Cemex, the large Mexican cement maker, the case when Cemex acquired RMC in
Britain Because an acquisition does not result in a net increase in the number of
players in a market, the effect on competition may be neutral. When a foreign
investor acquires two or more firms in a host country, and subsequently merges
them, the effect may be to reduce the level of competition in that market, create
monopoly power for the foreign firm, reduce consumer choice, and raise prices
 HOST-COUNTRY COSTS
• Adverse Effects on the Balance of Payments
The possible adverse effects of FDI on a host country's balance-of-payments position are twofold.
First, set against the initial capital inflow that comes with FDI must be the subsequent outflow of
earnings from the foreign subsidiary to its parent company. Such outflows show up as capital outflow
on balance-of-payments accounts. Some governments have responded to such outflows by restricting
the amount of earnings that can be repatriated to a foreign subsidiary's home country.
A second concern arises when a foreign subsidiary imports a substantial number of its inputs from
abroad, which results in a debit on the current account of the host country's balance of payments.

National Sovereignty and Autonomy

The concern is that key decisions that can affect the host country's economy will be made by a foreign
parent that has no real commitment to the host country, and over which the host country's
government has no real control.
HOME-COUNTRY BENEFITS
1. home country's balance of payments
2. employment effects
3. benefits arise when the home-country MNE learns valuable skills from its
exposure to foreign markets that can subsequently be transferred back to the
home country. This amounts to a reverse resource-transfer effect.
The theory of FDI suggest that-
1. Exporting is preferable to FDI and licensing when
transportation costs are less and trade barriers are negligible.
2. But when transportation cost or trade barrier increase, choice
is to be made between licensing and FDI.
3. Since FDI is expensive and risky; then licensing is preferable.
4. But licensing is not a good option when-
• A firm has valuable know – how that can’t be protected by the
licensing contract.
• A firm needs tight control over foreign firm to maximize market share.
• A firm’s skills and capabilities aren’t amenable to licensing.