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MGT520 - International Business - Lecture Handout 33

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FOREIGN DIRECT INVESTMENT

METHODS OF ACQUISITION:

Companies may accumulate foreign assets through acquisition (buying them) or by building these assets themselves.

Resources for Acquisition:

In order to acquire a foreign asset, firms usually move capital from one country (often the home country) to the country where the newly acquired facility is located (the host country). Sometimes, if the firm already has operations in the host country, it can simply use revenues from host country operations to acquire another facility. In such instances, no international capital movement would occur.

Buy versus Build Decision:

Instead of buying an existing foreign operation, the investing firm might decide to build a new facility from scratch.

Reasons for buying: The investing company might wish to acquire a locally existing name brand, might wish to avoid adding additional capacity to the industry, might wish to avoid having to hire and train new workers. Furthermore, by buying an existing company, the investor avoids inefficiencies during the start-up period and gets an immediate cash flow rather than tying up funds during construction.
Reasons for building: Companies often make investments where there is little or no competition, so finding a firm to buy may be difficult. Furthermore, when acquiring a firm, the investor inherits all the problems that exist in the firm. Finally, a foreign company may find local financing easier to obtain if it builds facilities.

THE RELATIONSHIP OF TRADE AND FACTOR MOBILITY

Trade Theories and Factor Mobility:

Factor movement is often an alternative to trade. If a Japanese firms buys a U.S. auto manufacturing facility, the factor (capital) movement will replace future trade (imports of autos manufactures in Japan) since the cars will now be produced by the Japanese firm in the United States.

Substitution:

When factor proportions vary widely among countries, pressures exist for the most abundant factors to move to countries with greater scarcity. If labor is abundant in Mexico (high unemployment) but scarce in the United States (low unemployment), Mexican labor will try to move to the United States. It might be cheaper in the end to allow Mexican labor into the United States to produce goods for the U.S. market than to simply import those goods from Mexico (see Figure 8.2 numerical example in chapter).

Complementarily of Trade and Direct Investment:

FDI usually affects trade. It can increase the recipient country’s exports of new products. It can increase the recipient country’s imports of equipment. It can also restrict trade when accompanied by local content laws or when local production substitutes for previously imported goods.

Relationship of FDI to Companies’ Objectives:

FDI allows companies to achieve their goals of expanding sales, acquiring resources, and/or minimizing risk.

FDI MOTIVATIONS TO ACHIEVE SALES EXPANSION

Transportation:

When companies add the cost of transportation to production costs, some products become impractical to ship over great distances. For these companies, it is necessary to produce abroad if they are to sell abroad. When companies move abroad to produce basically the same products they produce at home, their direct investments are horizontal expansions.

Lack of plant capacity:

Domestic capacity may adequately serve the domestic market (if there is excess capacity domestically, firms will usually produce domestically and export their surplus). If firms need to create additional capacity in order to serve foreign demand, it is likely that they will create capacity near the markets it is intended to serve.

Scale economies:

Firms that can achieve significant economies of scale on the production of their products will normally centralize production and export from the central production location. When firms need to tailor their products to individual markets, they are unable to achieve significant scale economies and will be more likely to produce differentiated products in a variety of foreign locations.

Trade Restrictions:

Governments often restrict imports. Consequently, a firm may find that they must produce in a foreign country if they are to sell there.

Country-of-Origin Effects:

Consumers have a favorable disposition to certain product/country combinations (for example, French perfume, Japanese cameras, and German cars). Therefore, there may be benefits to producing certain types of products in specific locations.

Nationalism:

Local consumers may wish to purchase locally produced goods (e.g., “buy American” campaigns in the USA).

Product image:

As mentioned above, consumers may choose a product based on where it was manufactured (e.g., German cars).

Delivery risk:

Service and replacement parts for foreign items are often expensive or difficult to obtain. Industrial consumers especially may be willing to pay a higher price to a nearby producer in order to reduce the risk of no delivery due to distance.

Changes in Comparative Costs:

A company may export because its home country has a cost advantage. However, changes in productivity and foreign exchange values may reverse comparative cost advantages, leading the firm to decide to engage in foreign direct investment.

FDI MOTIVATIONS TO ACQUIRE RESOURCES:

Vertical Integration:

Companies may engage in FDI in order to secure inputs to their production process or in order to control foreign distribution channels for their products. These are examples of vertical integration.

Rationalized Production:

Some companies produce different components or different portions of their product line in different parts of the world to take advantage of low labor costs, capital, and raw materials. This way each component can be produced in the country where conditions are most suited to manufacturing that particular item.

Access to Production Resources:

Many non-U.S. companies have offices in New York City to gain better access to what is happening in the U.S. capital market. Conversely, McGraw-Hill established an office in Europe to allow its personnel there to uncover European technical developments by visiting universities, trade associations, and companies.

The Product Life Cycle Theory:

According to the product life cycle theory discussed in Chapter 5, production will move from the home country in the early stages of the product’s life cycle, to other developed countries, and finally to developing countries.

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