Global Business and Strategy Week 5

Global Business and Strategy
6EC513
Lecture 5
Dr Sayantan Ghosh Dastidar

s.dastidar@derby.ac.uk
© Pearson Education 2012

Sensitivity: Internal
Outline
 International Investments
 Types of International Investments
 Methods of FDI
 International Investment theories
 International Monetary System

 Exchange rates
 Financing International Trade and Balance of Payments
www.derby.ac.uk/dbs
 Trade is the most obvious but not the only form of international business.
 Another major form is international investment, whereby residents of one
country supply capital to a second country.
 Types of International Investments

 International investment is divided into two categories:
 foreign portfolio investment (FPI) and
 foreign direct investment (FDI).
www.derby.ac.uk/dbs
FPI and FDI
 FPI
 Foreign portfolio investments (FPI) represent holdings of securities such as foreign stocks, bonds, or other
financial assets, none of which entails active management or control of the securities’ issuer by the investor.
Modern finance theory suggests that FPI will be motivated by attempts to seek an attractive rate of return as
well as the risk reduction that can come from geographically diversifying one’s investment portfolio.
 In 2012, for example, private U.S. citizens purchased $145 billion worth of foreign securities.
 Foreign official and private investors purchased $764 billion worth of U.S. corporate, federal, state, and local
securities
 FDI
 Foreign direct investment (FDI) is acquisition of foreign assets for the purpose of controlling them.
 FDI may take many forms, including purchase of existing assets in a foreign country, new investment in
property, plant, and equipment, and participation in a joint venture with a local partner.
www.derby.ac.uk/dbs
FDI
 The growth of FDI during the past 30 years has been phenomenal.
 As Figure 6.6 indicates, in 1980 the total stock (or cumulative value) of FDI received by
countries worldwide was $689 billion. Worldwide FDI as of 2011 topped $20.4 trillion.
 A growth of around 2860% in three decades
 This stunning growth in FDI—and its acceleration beginning in the 1990s—reflects the globalization of
the world’s economy.
 As you might expect, most FDI comes from developed countries.
 Surprisingly, most FDI also goes to developed countries.
www.derby.ac.uk/dbs
www.derby.ac.uk/dbs
www.derby.ac.uk/dbs
www.derby.ac.uk/dbs
Methods for FDI
 There are three methods for FDI:

 (1) building new facilities (called the greenfield strategy),
 (2) buying existing assets in a foreign country (called the acquisition

strategy or the brownfield strategy), and
 (3) participating in a joint venture.
www.derby.ac.uk/dbs
The Greenfield Strategy
 involves starting a new operation from scratch

 The firm buys or leases land, constructs new facilities, hires or transfers in managers and employees,
and then launches the new operation.
 Example: Mercedes-Benz automobile assembly plant in Alabama and Nissan’s factory in Sunderland,
England.
 The greenfield strategy has several advantages.

 A) the firm can select the site that best meets its needs and construct modern, up-to-date facilities.
Local communities often offer economic development incentives to attract such facilities because
they will create new jobs; these incentives lower the firm’s costs.
 B) The firm also starts with a clean slate. Managers do not have to deal with existing debts, nurse
outmoded equipment, or struggle to modify ancient work rules protected by intransigent labor unions.
www.derby.ac.uk/dbs
The Greenfield Strategy
 However, the greenfield strategy also has some disadvantages.

 A)successful implementation takes time and patience.
 B) land in the desired location may be expensive.
 C) In building the new factory, the firm must also comply with various local and national regulations and
oversee the factory’s construction. It must also recruit a local workforce and train it to meet the firm’s
performance standards.
 D) And finally, by constructing a new facility, the firm may be more strongly perceived as a foreign enterprise.
 Disney managers faced several of these difficulties in building Disneyland Paris. They got the
land at bargain prices, but Disney was not fully prepared to deal with French construction
contractors. The park’s grand opening was threatened when local contractors demanded an
additional $150 million for extra work allegedly requested by Disney. And Disney clashed with its
French employees, who resisted the firm’s attempt to impose its U.S. work values and grooming
standards on them.
www.derby.ac.uk/dbs
The Acquisition Strategy
 A second FDI strategy is acquisition of an existing firm conducting business in the host country.
 Motivation: By acquiring a going concern, the purchaser quickly obtains control over the acquired firm’s
factories, employees, technology, brand names, and distribution networks.
 And, unlike the greenfield strategy, the acquisition strategy adds no new capacity to the industry. In times of
overcapacity, this is an obvious benefit.
 Sometimes international businesses acquire local firms simply as a means of entering a new market.
 At other times, acquisitions may be undertaken by a firm as a means of implementing a major strategic change.
 For example, the state-owned Saudi Arabian Oil Co. has tried to reduce its dependence on crude oil
production by purchasing “downstream” firms, such as Petron Corporation, the largest petroleum refiner
in the Philippines, and South Korea’s Ssangyong Oil Refining Company.
www.derby.ac.uk/dbs
Disadvantages of Acquisition strategy
 A) The acquiring firm assumes all the liabilities—financial, managerial, and otherwise—of the acquired firm.
If the acquired firm has poor labor relations, unfunded pension obligations, or hidden environmental
cleanup liabilities, the acquiring firm becomes financially responsible for solving the problem.
 For instance, Argentina’s YPF SA is being sued by the state of New Jersey for actions of Maxus
Energy Corporation, a firm it acquired in 1995. Maxus is accused of dumping dioxin, a carcinogenic
pesticide, in the Passaic River in the 1950s and 1960s.
 B) The acquiring firm must also spend substantial sums up front.

 The greenfield strategy, in contrast, may allow a firm to grow slowly and spread its investment
over an extended period.
www.derby.ac.uk/dbs
Joint Ventures
 Another form of FDI is the joint venture.

 Joint ventures (JV) are created when two or more firms agree to work together and create a jointly owned
separate firm to promote their mutual interests.
 International Corporate Cooperation

 Cooperation between international firms can take many forms
 The partners in a strategic alliance may agree to pool R&D activities, marketing expertise, or managerial
talent. For example, in the early 1990s, Kodak and Fuji—two fierce competitors in the film market—formed a
strategic alliance with camera manufacturers Canon, Minolta, and Nikon to develop a new standard for cam-
eras and film, the Advanced Photo System, to make picture taking easier
 Such forms of cooperation are known collectively as strategic alliances, business arrangements whereby
two or more firms choose to cooperate for their mutual benefit. It can be a method by which a firm can enter
or expand its international operations.
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Benefits of Strategic Alliances
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Ease of Market Entry

 A firm wishing to enter a new market often faces major obstacles, such as entrenched competition or hostile
government regulations. Partnering with a local firm can often help it navigate around such barriers.
 For example, IMAX recently targeted China as an important growth market for filmed entertainment. To
speed its entry, it entered into a $40 million JV with Wanda Cinema Line, the operator of China’s largest
theater chain, to build 75 IMAX theaters in China. IMAX will supply its specialized projection equipment,
while Wanda will build the theaters.
 Regulations imposed by national governments also influence the formation of JVs. Many countries are so
concerned about the influence of foreign firms on their economies that they require multinational corporations
(MNCs) to work with a local partner if they want to operate in these countries.
 For example, the government of Namibia requires foreign investors operating fishing fleets off its coast to
work with local partners.
www.derby.ac.uk/dbs
 Shared Risk
 Today’s major industries are so competitive that no firm has a guarantee of success when it enters a
new market or develops a new product. Strategic alliances can be used to either reduce individual
firms’ risks.
 For example, Boeing established a strategic alliance with several Japanese firms to reduce its
financial risk in the development and production of the Boeing 777 jet.
 Boeing, the controlling partner in the alliance, also hoped its allies would help sell the new aircraft
to large Japanese customers such as Japan Air Lines and All Nippon Airways.
www.derby.ac.uk/dbs
 Shared Knowledge and Expertise
 Still another common reason for strategic alliances is the potential for the firm to gain knowledge and
expertise that it lacks.
 A firm may want to learn more about:
 how to produce something,
 how to acquire certain resources,
 how to deal with local governments’ regulations,
 or how to manage in a different environment—information that a partner often can offer.
 The firm can then use the newly acquired information for other purposes.
www.derby.ac.uk/dbs
 Synergy and Competitive Advantage
 Firms may also enter into strategic alliances to attain synergy and competitive advantage. These
related advantages reflect combinations of the other advantages discussed in this section: The idea is
that through some combination of market entry, risk sharing, and learning potential, each collaborating
firm will be able to achieve more and to compete more effectively than if it had attempted to enter a
new market or industry alone.
 For example, creating a favorable brand image in consumers’ minds is an expensive, time-
consuming process, as is creating efficient distribution networks.
 These factors led PepsiCo to establish a JV with Thomas J. Lipton Co., a division of Unilever,
to produce and market ready-to-drink teas in the United States.
 Lipton, the global market leader in ready-to-drink teas, provided the JV with manufacturing
expertise and brand recognition in teas. PepsiCo supplied its extensive and experienced U.S.
distribution network.
www.derby.ac.uk/dbs
 International Investment theories
www.derby.ac.uk/dbs
Dunning's Eclectic Theory
 Dunning (1980) proposed the paradigm
 The eclectic paradigm is often viewed as the most comprehensive of FDI

theories.
The eclectic paradigm specifies three conditions that determine whether a

company will internationalise via FDI:
1. Ownership-specific advantages;
2. Location-specific advantages; and
3. Internalisation advantages,
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Ownership-specific advantages
 To successfully enter and conduct business in a foreign market, the MNE must possess ownership-
specific advantages relative to other firms already doing business in the market.
 That is, it should hold knowledge, skills, capabilities, key relationships, and other assets that allow it to
compete effectively in foreign markets.
 These assets amount to the firm’s competitive advantages.
 To ensure international success, the advantages must be substantial enough to offset the costs the firm
incurs in establishing and operating foreign operations.
 The advantages should also be specific to the MNE that posses them and not readily transferable to other
firms, such as proprietary (copyrighted) technology, managerial skills, trademarks or brand names,
economies of scale, and access to substantial financial resources.
 The more valuable the firm’s ownership-specific advantages, the more likely it is to internationalise via
FDI.
www.derby.ac.uk/dbs
Location-specific advantages
 The second condition that determines whether a firm will internationalise via
FDI is the presence of location-specific advantages.
 The comparative advantages available in individual foreign countries, such

as natural resources, skilled labour, low-cost labour, and inexpensive
capital.
 The presence of location-specific advantages help persuade firms to locate

in certain countries.
www.derby.ac.uk/dbs
Internalisation advantages
 The third condition that determines FDI-based internationalisation is the presence
of internalisation advantages, benefits that the firm derives from internalising
foreign-based manufacturing, distribution, or other stages in its value chain.
 When profitable, the firm will transfer its ownership-specific advantages across
national borders within its own organisation rather than dissipating them to
independent, foreign entities.
 The FDI decision depends on which is the best option – internalisation versus
utilising external partners, whether they are licensees, distributors, or suppliers.
 Internalisation advantages include the ability to control how the firm’s products
are produced or marketed, the ability to prevent unintended dissemination of the
firm’s proprietary knowledge, and the ability to reduce buyer uncertainty about
the value of products the firm offers.
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Internalisation advantages
 Internalising value-chain activities helps minimise the disadvantages of dealing with external partners
for performing arms-length activities such as exporting and licensing.
 Internalisation also gives the firm greater control over its foreign operations.
 Another key reason companies internalise certain value-chain functions is to control proprietary
knowledge critical to the development, production, and sale of their products and services.
 Because independent foreign companies are outside the MNE’s direct control, they can acquire and
use the knowledge to their own advantage, perhaps becoming competitors in the process.
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Factors Influencing FDI
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 Logistics: If transportation costs are significant, a firm may choose to produce in the foreign market
rather than export from domestic factories.
 Access to Key technology : Another motive for FDI is to gain access to technology. Firms may find it
more advantageous to acquire ownership interests in an existing firm than to assemble an in-house
group of research scientists to develop or reproduce an emerging technology.
 Marketing advantages: FDI may generate several types of marketing advantages. The physical
presence of a factory may enhance the visibility of a foreign firm’s products in the host market. The
foreign firm also gains from “buy local” attitudes of host country consumers.
 Exploitation of Competitive advantages: FDI may be a firm’s best means to exploit a competitive
advantage that it already enjoys. An owner of a valuable trademark, brand name, or technology may
choose to operate in foreign countries rather than export to them
 .
www.derby.ac.uk/dbs
 Customer Mobility: A firm’s FDI also may be motivated by the FDI of its customers or clients. If one of
a firm’s existing customers builds a foreign factory, the firm may decide to locate a new facility of its
own nearby, thus enabling it to continue to supply its customers promptly and attentively. Equally
important, establishing a new facility reduces the possibility that a competitor in the host country will
step in and steal the customer. For example, Japanese parts suppliers to the major Japanese
automakers have responded to the construction of Japanese-owned automobile assembly plants in the
United States by building their own U.S. factories, warehouses, and research facilities.
 Economic development Incentives: Most democratically elected governments—local, state, and

national—are vitally concerned with promoting the economic welfare of their citizens, many of whom
are, of course, voters. Many governments offer incentives to firms to induce them to locate new
facilities in the governments’ jurisdictions.
www.derby.ac.uk/dbs
FDI and other modes of entry
If home country production is found to be

more desirable than host country
production, the firm will choose to enter the
host country market via exporting.
Government policies can also have a major influence. High

tariff walls discourage exporting and encourage local
production, whereas high corporate taxes or government
prohibitions against repatriation of profits inhibit FDI.
www.derby.ac.uk/dbs
www.derby.ac.uk/dbs
Uppsala model
 Introduced by Johanson and Vahlne (1977)

 Another theory on firms’ internationalisation process.
 Knowledge, that is particularly important in the internationalisation process of firms, has the following
characteristics.
 First,it is market-specific:
 all foreign markets differ from each other, and only to a limited extent can knowledge acquired in
one foreign market be used in another.
 Secondly, the crucial knowledge is experience-based. It originates from the current foreign business
activities, and as such the knowledge acquisition is a learning-by-doing process.
 Thirdly, the crucial knowledge is embedded in individuals, i.e. the market-specific knowledge is
acquired through personal experience
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 internationalisation of the individual firms in an incremental manner
 These stages in a country specific market are

 1. No regular export activities
 2. Export via independent representatives (agents)
 3. Sales subsidiary, and
 4. Overseas production/manufacturing.
www.derby.ac.uk/dbs
Uppsala model contd
 The initial entry is to a foreign market which is familiar and closer in terms of
psychic distance to the host country, followed by subsequent entries in markets
with greater psychic distance.
 In terms of entry mode, the incremental expansion of market commitment

means that initial entry in a foreign market is typically some form of low
commitment mode (eg. minority joint ventures)
 followed by progressively higher levels of market commitment (eg. majority joint

venture and wholly owned subsidiary).
www.derby.ac.uk/dbs
Uppsala model
www.derby.ac.uk/dbs
 International Monetary System
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Gold Standard
 Earliest system  barter system
 Ancient reliance on gold coins as a medium of exchange led to GS.
 Before World War I, the world economy operated under the gold standard.
 Currency value directly linked to gold (example later).

 countries fixed the prices of their domestic currencies in terms of a specified amount of gold
 Most world currencies were convertible into gold.
Gold Standard
Any firm or individual could buy or sell their paper currencies in

exchange for gold.
 In 1821, the United Kingdom adopted the gold standard.
 During the nineteenth century, important trading countries—

including Russia, Austria-Hungary, France, Germany, and the
United States—did the same.
Sterling-based Gold Standard
 From 1821 until the end of World War I in 1918, the most important
currency in international commerce was the British pound sterling,
a reflection of the United Kingdom’s status as Europe’s dominant
economic and military power.
 Most firms accepted either gold or British pounds in settlement of

transactions. As a result, the international monetary system during
this period is often called a sterling-based gold standard.
Gold Standard_Example
 Each country pegged its value to gold.

 UK: 1 ounce of gold = £4.247.
 US: 1 ounce of gold = $20.67.
 Thus, £4.247 = $20.67 or equivalently:
 £1 = $4.867.
 As long as people had faith that they could exchange currency for gold, system worked well.
Collapse of Gold Standard
 World War I
 By financing war, gold reserves declined.
 Trade stopped and inflationary finance to fund war
 Readopted GS in 1920s
 Great Depression
 Bank of England started to run out of gold because
people started selling money and buy gold. So,
BOE abandoned GS.
 World War II
Bretton Woods Era
Representatives of 44
Countries Met in 1945
Avoid Conditions That Promote Global Peace

Caused WWII and Prosperity
Chapter 7 -
Dollar–based gold standard
 Bretton Woods participants agreed to peg the value of their

currencies to gold.
 For example, the par value of the U.S. dollar was set at $35 per ounce of
gold. Only the United States pledged to redeem its currency for gold at the
request of a foreign central bank.
 Thus, the dollar became the keystone of the Bretton Woods

system, and a U.S. dollar–based gold standard was established
Bretton Woods Era
 By mid-1971, the Bretton Woods system was tottering.
 On August 15, 1971, President Nixon announced that the United States would
no longer redeem gold at $35 per ounce.
 Consequently, the Bretton Woods system ended.
 Some key definitions
 What is exchange rate?;
 appreciation/depreciation;
 etc
Exchange rate
 The exchange rate is just a price.

 It is the relative price of two currencies that ultimately depends on
the price levels in two countries.
 A downward trend in an exchange rate means that a country is
experiencing more rapid inflation than another country.
 That is all.
 The exchange rate trend tells us nothing—absolutely nothing—about
productivity and real income growth in the two countries.
Direct quote: where foreign currency is fixed. Its like
saying 1 dollar=.78 pound
Indirect quote: where domestic currency is fixed. 1
pound=1.28 dollars
Exchange Cross Rates from the FT

website 25 Oct 2019
Appreciation and Depreciation
A fall in the value of one currency in terms of another currency is called

currency depreciation.
A rise in value of one currency in terms of another currency is called

currency appreciation.
 Balance of Payments
Financing International Trade
When we buy something from another country, we use the

currency of that country to make the transaction.
 A country’s Balance of Payments Accounts record its

international trading and its borrowing and lending.
Importance of BOP statistics
 International businesspeople need to pay close attention to countries’ BOP statistics because:
 1. BOP statistics help identify emerging markets for goods and services.
 2. BOP statistics can warn of possible new policies that may alter a country’s business climate, thereby
affecting the profitability of a firm’s operations in that country.
 For example, sharp rises in a country’s imports may signal an overheated economy and
portend a tightening of the domestic money supply. In this case attentive businesspeople
will shrink their inventories in anticipation of a reduction in customer demand.
 3. BOP statistics can indicate reductions in a country’s foreign-exchange reserves, which may mean
that the country’s currency will depreciate in the future, as occurred in Thailand in 1997. Exporters to
such a country may find that domestic producers will become more price competitive.
 4. As was true in the international debt crisis, BOP statistics can signal increased riskiness of lending to
particular countries.
www.derby.ac.uk/dbs
Four important aspects of the BOP accounting system
1. The BOP accounting system records international transactions made during some time period, for example, a
year.
 2. It records only economic transactions, those that involve something of monetary value.
 3. It records transactions between residents of one country and residents of all other countries.
 Residents can be individuals, businesses, government agencies, or nonprofit organizations
 4. The BOP accounting system is a double-entry system. Each transaction produces a credit entry and a debit
entry of equal size.
www.derby.ac.uk/dbs
Components of BOP
 The Major Components of the BOP Accounting System

 The BOP accounting system can be divided conceptually into four major accounts.
 The first two accounts—the current account and the capital account—record purchases of goods, services,
and assets by the private and public sectors. The official reserves account reflects the impact of central bank
intervention in the foreign-exchange market. The last account—errors and omissions—captures mistakes
made in recording BOP transactions.
 Current account: The current account records four types of transactions among residents of different
countries:
 1. Exports and imports of goods (or merchandise)
 2. Exports and imports of services
 3. Investment income (like dividends, interests)
 4. Gifts (or unilateral transfers)
www.derby.ac.uk/dbs
www.derby.ac.uk/dbs
Balance of Trade
 The difference between a country’s exports and imports of goods is called the balance on merchandise
trade. The United States, which has been importing more goods than it has been exporting, has a merchandise
trade deficit; China, which has been exporting more goods than it has been importing, has a merchandise trade
surplus.
 The fourth type of transaction in the current account is unilateral transfers, or gifts between residents of one
country and another. Unilateral transfers include private and public gifts.
 For example, foreign-born residents of UK who send part of their earnings back home to their relatives are
engaging in private unilateral transfers.
 The current account balance measures the net balance resulting from merchandise trade, service trade,
investment income, and unilateral transfers. It is closely scrutinized by government officials and policymakers
because it broadly reflects the country’s current competitiveness in international markets.
www.derby.ac.uk/dbs
Financing International Trade
The capital and financial account records UK investment
abroad and foreigners’ investments in the UK.
The change in reserve assets shows the net increase or

decrease in a country’s holdings of foreign currency reserves
that come about from the official financing of the difference
between the current account and the capital and financial
account balances.
Inflows and Outflows of Capital in the BOP System
Capital Account Transactions Credit Debit Credit can happen in 2 ways in

capital account-either foreigners
Foreign Ownership of Assets come and invest in my country
Increases
 (inward FDI)..they bring capital
from their country into my country
or our ownership of foreign asset
Ownership of Foreign Assets
Declines
 declines and we invest more on
domestic assets…
Debit—We invest on foreign
Ownership of Foreign Assets
Increases
 assets (outward FDI)..capital
leaves our country and goes to the
foreign country …..or, foreigners
Foreign Ownership of Assets start selling off assets in our
Declines
 country.
Chapter 7 -
 Errors and omissions: The last account in the BOP accounting system is the errors and omissions
account. One truism of the BOP accounting system is that the BOP must balance. In theory the
following equality should be observed:
 Current Account + Capital Account + Official Reserves Account = 0
 However, this equality is never achieved in practice because of measurement errors. The errors and
omissions account is used to make the BOP balance in accordance with the following equation: Current
Account + Capital Account + Official Reserves Account+ Errors and Omissions = 0
www.derby.ac.uk/dbs
Defining Balance of Payments Surplus and Deficit
Chapter 7 -
UK Current Account balance
www.derby.ac.uk/dbs
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Global Business and Strategy

Dr Sayantan Ghosh Dastidar

© Pearson Education 2012

 International Investment theories

 International Monetary System

 Types of International Investments

 As you might expect, most FDI comes from developed countries.

 Surprisingly, most FDI also goes to developed countries.

 There are three methods for FDI:

 (2) buying existing assets in a foreign country (called the acquisition

 (3) participating in a joint venture.

 involves starting a new operation from scratch

 The greenfield strategy has several advantages.

 However, the greenfield strategy also has some disadvantages.

 B) The acquiring firm must also spend substantial sums up front.

 Another form of FDI is the joint venture.

 International Corporate Cooperation

Ease of Market Entry

 The eclectic paradigm is often viewed as the most comprehensive of FDI

The eclectic paradigm specifies three conditions that determine whether a

2. Location-specific advantages; and

 These assets amount to the firm’s competitive advantages.

 The comparative advantages available in individual foreign countries, such

 The presence of location-specific advantages help persuade firms to locate

 Economic development Incentives: Most democratically elected governments—local, state, and

If home country production is found to be

Government policies can also have a major influence. High

 Introduced by Johanson and Vahlne (1977)

 These stages in a country specific market are

 In terms of entry mode, the incremental expansion of market commitment

 followed by progressively higher levels of market commitment (eg. majority joint

 Earliest system  barter system

 Ancient reliance on gold coins as a medium of exchange led to GS.

 Currency value directly linked to gold (example later).

 Most world currencies were convertible into gold.

Any firm or individual could buy or sell their paper currencies in

 In 1821, the United Kingdom adopted the gold standard.

 During the nineteenth century, important trading countries—

 Most firms accepted either gold or British pounds in settlement of

 Each country pegged its value to gold.

Avoid Conditions That Promote Global Peace

 Bretton Woods participants agreed to peg the value of their

 Thus, the dollar became the keystone of the Bretton Woods

 By mid-1971, the Bretton Woods system was tottering.

 Consequently, the Bretton Woods system ended.

 The exchange rate is just a price.

Exchange Cross Rates from the FT

A fall in the value of one currency in terms of another currency is called

A rise in value of one currency in terms of another currency is called

When we buy something from another country, we use the

 A country’s Balance of Payments Accounts record its

 The Major Components of the BOP Accounting System

The change in reserve assets shows the net increase or

Capital Account Transactions Credit Debit Credit can happen in 2 ways in

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