Chapter 13: FDI

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Chapter 13 FDI Political Risk

• Why FDI?
• Prerequisites for an MNE
• Porter vs. Dunning
• How FDI?
• JV, strategic alliances, licensing, exporting,
  OR
• FDI greenfield, MA
• Where FDI?
• The Uppsala school
• Network perspective

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Competitive Advantage

• Besides FX risk, FDI comes with country risk and
  high agency costs
• A firm needs to have a sustainable,
  transferable competitive advantage large enough
  to motivate taking those risks
• Typical competitive advantages
• economies of scale and scope
• managerial expertise
• tech. advantage
• internal financial resources
• differentiated products

3

• Financial strength as a competitive advantage
• Due to possible local limitations caused by
  segmentation and lack of liquidity, MNEs may have
  an advantage in attracting financing (see Exhibit
  10.4, p. 312)
• Internal capital markets of a large MNE may be
  more efficient and liquid than local public
  markets

4
Diamond of national advantage

• What factors make winners in international
  competition?
• See p. 389
• Besides local production factors, also
  home-market competition, related industries and
  sophistication of customer base produce mean,
  lean MNEs
• This theory does not explain everything

5
The OLI paradigm

• Why FDI instead of less risky modes of entry?
• Owner-specific advantages transferable,
  firm-specific
• Location-specific advantages attract foreign
  firms
• Internalizable advantages the firm is better off
  internalizing its advantage than selling it

6
Internationalization process

• Uppsala school findings
• Growth in the home market precedes FDI
• Firms expand first to neighboring countries or
  countries within close psychic distance
• Firms with good experiences in initial FDI
  efforts go further
• Network approach
• subsidiaries and the parent as nodes
• internal and external networks

7
Modes of entry

• Joint venture
• Benefits include
• gain of local expertise
• gain of local reputation and contacts
• Potential conflicts arise from
• differing views about dividends, growth financing
• transfer pricing
• valuation of equity
• JV mode can subject the parent to local
  disclosure
• can provide data to local competitors
• Sometimes the JV mode is required by the host
  government

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Modes of entry

• Strategic alliances
• cross-ownership arrangement, or
• more elaborate co-operation in production, RD,
  etc.
• joint marketing and service agreements
• provide a quick way to enter a market

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Modes of entry

• Licensing
• Disadvantages
• lower profit potential compared to FDI
• loss of quality control
• helping out a potential future competitor?
• Advantage
• low financial commitment less country risk

10
Modes of entry

• Exporting
• Disadvantages
• limited profit potential
• more open to global competition
• Advantages
• very low political risk
• low initial investment

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Management of Political Risk

• General strategies
• Make your firm valuable to the host country
• Minimize amount of equity invested

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What can we do before the investment?

• Establish an agreement with the host gov't about
• level of dividends
• amount of local employment
• transfer pricing
• taxes
• environmental issues
• infrastructure commitments
• Political risk insurance can cover
• inconvertibility of currency
• expropriation
• civil unrest, war
• loss of business income

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Operating strategies

• Production
• Local sourcing for inputs - increases local
  employment
• however, exposes to local strikes, etc.
• Facilities location - consider spreading
  manufacturing operation over several countries

14

• Marketing Policies
• Brand name
• Control of distribution network
• Increase exports
• Financial Policies
• Limited equity investment
• borrow locally
• local equity investment - joint venture