Foreign Direct Investment I 03 19 2014 Introduction product in a foreign country FDI occurs when a firm invests directly in facilities to produce or market a US D of Com FDI occurs whenever a U S citizen organization or affiliated group takes an interest of 10 percent or more in a foreign business entity Investment in FDI become MNC E Two Main Forms country 1 Greenfield investment Establishing a new operation in a foreign 2 Acquiring or merging with an existing firm in the foreign country Foreign Direct Investment in the World Economy Flow of FDI the amount of FDI undertaken over a given time period Stock of FDI The total accumulated value of foreign owned assets normally a year at a given time Outflows of FDI the flow of FDI out of a country Inflows of FDI The flow of FDI into a country Trends in FDI world output FDI has grown significantly since 1975 more than world trade and Saw a slight hiccup during the recession of 2008 but was expected to recover by 2011 Several reasons explain its growth o Despite general decline in trade barriers over past 30 years firms still fear protectionist pressures FDI is a way to circumvent potential future or current protectionist pressures o Much of the increase has been driven by political and economic changes that have been occurring in many developing nations Shift towards democratic and market economies allows for more FDI Direction of FDI Largest share of FDI inflows is found in developed countries of EU US and Japan reciprocally investing in each other due to stable political systems and free market policies FDI inflows into developing nations has increased mostly targeting at South East and Southeast Asia Growing importance of China Next highest is in Latin America mainly Mexico and Brazil Africa receives littlest investment China main investors in Africa o Little investment in Africa is caused by political unrest armed conflict Gross Fixed Capital Formation Summarizes the total amount of capital invested in factories stores office buildings and the like Source of FDI US is largest source for FDI with UK France Germany the Netherlands and Japan close behind due to developed economy following WWII Form of FDI Acquisitions vs Greenfield Data suggest majority of cross border investment is mergers acquisitions FDI inflows into developed nations tend to be Greenfield Mergers are quicker and less costly if a company doesn t acquire a certain firm some competitor will Said companies can also have strategic assets such as brand loyalty customer relationships trademarks distribution systems production systems etc Easier to increase efficiency than to create efficiency Theories of FDI Attempts to explain the patterns of FDI Why Foreign Direct Investment Exporting Sale of products produced in one country to residents of Licensing When a firm licenses the right to produce its product production or brand name trademark to another firm in return for a another country royalty fee FDI may be risky costly compared to exporting or licensing Limitations of Exporting Constrained by transportation costs o Products with low value to weight ratio that can be produced in many locations are more beneficial to FDI than export o Products with high value to weight ratio transportation costs are minor and can easily be exported Threat of trade barriers o FDI avoids trade barriers quotas protectionist laws Limitations of Licensing Internalization Theory The argument that firms prefer FDI over licensing to retain control over know how manufacturing marketing and strategy or because some firm capabilities are not amenable to licensing aka market imperfections approach Three major drawbacks Found in above theory o Licensing may result in a firm s giving away valuable technological know how to a potential foreign competitor o Licensing does not give a firm the tight control over manufacturing marketing and strategy in a foreign country that may be required to maximize its profitability o Such capabilities are often not amenable to licensing even though a firm has the capability to produce some licensed product it may not have the efficiency ex Toyota s organizational culture Pattern of FDI One theory states that FDI flows are a reflection of strategic rivalry between firms in the global marketplace o Oligopoly An industry composed of a limited number of large o Feature of such is interdependence what one firm does can have an immediate impact on other competitors forcing firms reciprocation Multipoint Competition Arises when two or more enterprises encounter each other in different regional markets national markets or industries o Instead of jockeying for advantage firms will try to match each other s moves in different markets to attempt to hold others in check Case Study 03 19 2014 Notes from Ghemawat Case Study http www amitkarna info wp content uploads 2013 06 c2 Cemex pdf Supply Cement operating costs range from 20 50 per ton Labor well under 10 per ton Transportation can account for a third total delivered costs o High transportation costs versus low production costs equals limited distance a plant can deliver cement at competitive prices Low value to weight ratio Demand Long run demand directly related to GDP per capita Demand expected to be highest in Asian central America Caribbean and Sub Saharan African countries Cemex acquired established cement makers in Venezuela Colombia Indonesia The Philippines Egypt and several other countries all strategic based on projections Factors affecting demand conditions o Negative factors rainfall long coastline less road transportation sea transportation is more economic however remember limited distance cement can travel o Positive High population density warm climate but not extreme heat good access to roads History on Cemex companies Formed in 1985 due to the merger of two Mexican Cement Began horizontal growth looking at not only cement but also petrochemicals mining and tourism Due to looming threats of being bought out by Lafarge and Holderbank Cemex ceased horizontal diversification bought other domestic cement companies and created an industry too big to buy International Expansion Secured leadership in Mexico international expansion soon followed 2000 Cemex largest cement trader in the world with 13 million tons Identified new markets by first analyzing local structure at minimal volume cost before committing Trade sanctions from the US created need for Foreign Direct Investment rather than just exporting in order