1. Fourth Edition
International
Business

2. CHAPTER 6
Foreign Direct Investment

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6-3
Chapter Focus
This chapter seeks to identify the economic
rationale that underlies Foreign Direct
Investment. For example, why do some firms
prefer FDI to exporting or licensing. Is the need
for control, part of the answer?

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6-4
Foreign Direct Investment
FDI occurs when a firm invests directly in
facilities to produce and/or market a product
in a foreign country.
Starbucks invested $10m in Japan in 1996.

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6-5
Foreign Direct Investment
FDI occurs when a firm invests directly in
facilities to produce and/or market a product
in a foreign country.
Once a firm undertakes FDI, it becomes a
multinational enterprise (multinational = more
than one country).

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Foreign Direct Investment
FDI takes two forms:
Green-field investment: establishing a wholly
new operation in a foreign country.
Example ; starbucks

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Foreign Direct Investment
FDI takes two forms:
Green-field investment: establishing a wholly
new operation in a foreign country.
Acquiring or merging with an existing firm in
the foreign country.
Example: Rank-Xerox, Grameen-Danone

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Foreign Direct Investment
NOTE:
Investing in foreign financial instruments
(Portfolio Investment like govt. bond, foreign
stocks) IS NOT FDI.

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Flow and Stock of FDI
Flow:
The amount of FDI
undertaken over a given
period of time (usually
one year).
Stock:
Total accumulated value
of foreign-owned assets
at a given time.

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FDI Outflows
1982-2000
0
200
400
600
800
1000
1200
1400
82-
86
92 94 96 98 2000
$ Billions
Figure 6.1

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FDI Flows by Region
0
100
200
300
400
500
600
90
92
94
96
98
2000
Value Exports
World GDP
World FDI
Figure 6.2
Index

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Reasons for FDI Growth
FDI circumvents potential future trade barriers.
Many firms preferred the US for FDI because of
the hostile trade attitude shown by the US

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Reasons for FDI Growth
FDI circumvents potential future trade barriers.
Dramatic political and economic changes occurring
in developing countries.(Opening up the economy in
India , China, Singapore,etc )

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FDI into Developed and Developing
Nations: 1990-2000
0
200
400
600
800
1000
1200
94 95 96 97 98 99 2000
Dev Nations
Devg. Nations
W. Europe
N. Amer.
Asia
L. Amer.
$Billion
Figure 6.3

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FDI Outflows by
Selected Countries, 1994-1999
0
50
100
150
200
250
300
1994 1995 1996 1997 1998 1999 2000
U.S.
U.K.
Netherlands
Germany
Japan
Spain
France
Figure 6.5

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6-16
The Form of FDI: Acquisitions versus
Greed-Fields
The majority of
investments is in the
form of mergers &
acquisitions:
Represents about 77%
of all flows in developed
countries.
Represent about 33% of
all flows in developing
countries.
Fewer target firms
to acquire.
Why the preference for
mergers & acquisitions?
Quicker to execute.
Foreign firms have
valuable strategic
assets.
Believe they can
increase the efficiency
of the acquired firm.

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FDI and Risk
FDI is expensive and risky compared to exporting or
licensing:
Costs of establishing facilities.
Problems with doing business in a different
Culture.
But still FDI occurs . Why???

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Horizontal FDI and Factor
Considerations
Horizontal FDI: when a firm invests in the same industry as
in the home country
Transportation Costs: High/low value to weight impacts
costs.
If the product is low in value-to-weight ration like soft drinks
Or cement , then transportation costs add to the costs.
Here , FDI is a better option.
If the product has a high value-to-weight ration then exporting
Is a better option unless there are other factors to consider.

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Horizontal FDI and Factor
Considerations
Market Imperfections (Internalization Theory): Factors
that inhibit markets from working perfectly. This
includes (1) governments impeding the free flow of
products between nations(Toyota), and (2)
impediments to the sale of know-how.(RCA, Matsushita &
Sony)
Strategic Behavior: Concentrated industries (oligopoly) tend
to mimic each other’s moves. Where there is
multipoint competition, competing firms match each
other’s moves to keep the competitor in check.
Example: Orascom Vs Telenor

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Horizontal FDI and Factor
Considerations
The Product Life Cycle: Suggests that foreign market
demand leads to FDI, probably not true and
therefore is not a good predictor of FDI.
Location-Specific Advantages: Advantages that arise
from using resource endowments or assets tied
to a particular location (Dunning - eclectic paradigm)
Example: Silicon Valley.

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Vertical FDI
Two forms:
Backward: Providing inputs (raw materials, parts)
for a firm’s domestic production processes.
Forward: An industry abroad sells the outputs of
the firm’s domestic production processes.

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Why Do Companies Engage in FDI?
Strategic Behavior: Can raise entry barriers or shut out
new competitors, or circumvent barriers established by
companies already doing business in the foreign country.
Alcoa and Alcan went to T&T to gain control over
bauxite.
Market Imperfections: Need to overcome lack of know-
how or the firm must invest in specialized assets whose
value depends on inputs provided by a foreign supplier.

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Impediments to the Sale of Know-
how
Impediments to
the sale of know
how
Risk giving away
know-how to
competitors (BP
& Shell)
Licensing implies
low control over
foreign
entity(Kodak Vs
Fuji)
Know-how not
amenable to
licensing(Starbu
cks, P& G)

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A Decision Framework
Figure 6.6
Yes
How high are
transportation costs
and tariffs?
Is know-how amenable
to licensing?
Is tight control over
foreign operation
required?
Can know-how be protected
by licensing contract?
Then license
ExportExport
Horizontal FDIHorizontal FDI
Horizontal FDIHorizontal FDI
Horizontal FDIHorizontal FDI
High
Yes
No
Low
No
Yes
No