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MANAGEMENT OF
MULTINATIONAL
CORPORATIONS
10/30/2021 Foreign Direct Investment
Introduction
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The breakthrough in modern technological advancements
have made both domestic and international business much
easier than before.
Business executives are no-longer limited to their own
business environment, there are also concerned about
international environment. This is because they can invest in
the international business as obtainable at home
Foreign direct investment (FDI) occur when a firm invests
directly in new facilities to produce a product in a foreign
country or it may occur when a firm buys an existing
enterprise in a foreign country.
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FDI
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Foreign direct Investment (FDI) occurs when a firm invests
directly in facilities to produce or market a product in a
foreign country.
According to the US Department of Commerce, FDI occurs
whenever a U.S citizen, organization or affiliated group takes
an interest of 10 percent or more in a foreign business entity.
Once a firm undertakes FDI, it becomes a multinational
enterprise.
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Form of Foreign Direct Investment (FDI)
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FDI can take the form of a Greenfield investment in a new
facility or an acquisition of or a merger with an existing local
firm. However, most of cross-border investment is in the form
of mergers and acquisitions, rather than Greenfield
investment.
Some Forms are listed below
Mergers and acquisitions are quicker to execute than
Greenfield investment. This is an important consideration in
the modern business world, where markets evolve very
rapidly. Many firms apparently believe that if they fail to
acquire a desirable target of the firms; then global rivals will.
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Cont…
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Foreign firms are acquired because those firms have valuable
strategic assets, such as brand loyalty, customer relationships,
trade marks or patents, distribution systems production
systems and so on.
It is believe that it is (easier and perhaps less risky) to acquire
those assets than to build them afresh through a Greenfield
investment.
Firms make acquisition as the favorable choice because they
can increase the efficiency of the acquired unit of transferring
capital, technology or management skills.
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Why do Acquisition Fail?
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The acquiring firms often overpay for the assets of the
acquired firm. The price of the target firm can get bid up if
more than one firm is interested in its purchase;
the management of the acquiring firm is often too optimistic
about the value that can be created via an acquisition
Many acquisitions fail because there is a clash between the
cultures of the acquiring and acquired firm. After acquisition,
many acquired companies experience high management
turnover, possibly because their employees do not like the
acquiring company’s ways of doing things.
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Cont…
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Many acquisitions fail because attempts to realize synergies
by integrating the operations of the acquired and acquiring
entities often run into roadblocks/problems, and take much
longer than forecast. Differences in management
philosophy and company culture can slow the integration of
organizations
Many acquisitions fail due to inadequate pre-acquisition
screening. Many firms decide to acquire other firms without
thoroughly analyzing the potential benefits and costs.
many acquiring firms discovered that instead of buying a
well run business, they have purchased troubled
organization.
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Reasons For Growth of FDI
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Despite the general decline in trade barriers over the past 30
years.
Much of the recent increase in FDI is being driven by the
political and economic changes that have been occurring in
many of the worlds developing nations.
The globalization of the world economy is also having a
positive impact on the volume of FDI.
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Greenfield Investment
Greenfield Investment
Establishing a Greenfield venture in a foreign country is that it
gives the firm a much greater ability to build the kind of
subsidiary company its wants. For example, it is easier to
build an organization culture of an acquired unit.
Similarly, it is easier to establish a set of operating routines in
a new subsidiary than to convert the operating routines of
acquired unit.
This is a very important advantage for many international
businesses, where transferring products, competencies, skills
and knew-how from the established operations of the firms to
the new subsidiary are principal ways of creating value.
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Cont…
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In conclusion, the choice between making an acquisition
or establishing a Greenfield venture is not an easy one.
Both modes have their advantages and disadvantages.
If the firm is seeking to enter a market in which
enterprises and in which global competitors are also
interested in establishing a presence, acquisition may be
the better mode of entry.
On the other hand, if the firm is considering entering a
country in which there are no incumbent competitors to
be acquired, then a green field ventures may be the only
viable mode.
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Greenfield or acquisition or merger?
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For example, Xerox introduced the photocopier in
the United States, and it was Xerox that set up
product facilities in Japan (Fuji-Xerox) and Great
Britain (Rank-Xerox) to serve those markets. He
argued that firms undertake FDI at particular stages
in the life-cycle of a product they have pioneered.
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Cont…
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if the competitive advantage of the firm is based on
the transfer of organizationally embedded
competencies, skills, routines and culture, it may
still be preferable to enter via a Greenfield venture
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Reasons for Foreign Direct Investment
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One may wonder why firms take the trouble of
establishing operations abroad through foreign direct
investment when there are alternatives of entering
and licensing their goods. Exporting involves
producing goods at home and then shipped them to
the receiving country for sale.
While licensing involves granting a foreign entity the
right to produce and sell the firm’s product in return
for a royalty fee on every unit sold. If that be the
case, then why do firms apparently prefer FDI over
either exporting or licensing. 10/30/2021
Limitations of Exporting
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The viability of an exporting strategy is often constrained by
transportation costs and trade barriers. When transportation costs
are added to production costs, it becomes unprofitable to ship
some products over a long distance. This applies to products that
can be produced in almost any location. For example, cement.
Soft-drink, etc.
Some firms undertake foreign direct investment as a response to
actual or threatened trade barriers such as import tariffs or
quotas.
By placing tariffs on imported goods, governments can increase
the cost of exporting relative to foreign direct investment and
licensing.
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Limitations of Licensing
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Licensing may result in a firm’s giving valuable
technological know-how to a potential foreign competitor
That licensing does not give a firm the tight control over
manufacturing, marketing and strategy in a foreign country
that may be required to maximizes its profitability .
That licensing arises when the firms competitive advantage
is based not as much as its products as on the management,
marketing, and manufacturing capabilities that produce
these products. The problem here is that such capabilities
are often not amendable to licensing.
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Theories of Foreign Direct Investment (FDI)
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The product Life Cycle Theory
Raymond Vermon was postulator of this theory. He argued that
often times, firms that pioneer a product in their home markets
undertake FDI to produce a product for consumption in foreign
markets.
They invest in other advanced countries when local demand
in those countries grows large enough to developing
countries when product standardization and market
saturation gave rise to price competition and cost pressures.
Investment in developing countries, where labour costs are
lower is seen as the best way to reduce costs.
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Cont…
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However, the theory fail to explain why it is profitable for a
firm to undertake FDI at such times rather continuing to
export from its home base or licensing a foreign firm to
produce its product.
Product life cycle theory ignores these options and instead,
simply argues that once a foreign market is large enough to
support local production FDI will occur.
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The Electric theory
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This was championed by the British economist, John
Dunming. Dunming argues that in addition to the various
factors discussed above, location-specific advantages are also
of considerable importance in explaining both the rationale for
and the direction of foreign direct investment.
By location-specific advantages, Dunming means the
advantages that arise from utilizing resources endowments
that a firm finds valuable to combine with its own unique
assets (such as technological capabilities, marketing, or
management capabilities).
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Cont…
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Dinming accepts the argument of internalization theory that it
is difficult for a firm to license its `own unique capabilities
location-specific assets or resource endowments with the
firm’s own unique capabilities often requires foreign direct
investment.
That is, it requires the firm to establish production facilities,
where those foreign assets or resources endowments are
located.
The only shortcoming of the theory may be the culture and
government policy which may not work in favour of the
firm‟s operations.
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Thank You
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