LECTURE 12

FDI
 Foreign Direct
Investment

 Why do firms often prefer FDI to other market

entry strategies?
 Why do firms imitate competitors with FDI
strategies?
 Why are certain locations favored for FDI?

 What are key FDI related costs and benefits for

receiving and source countries?
 International Capital flows--
Forms
• FDI AND FIIs
•.

• GOVERNMENT, INSTITUTIONAL AND

PRIVATE CAPITAL
• HOME AND FOREIGN CAPITAL
• FOREIGN AID
• FDI is investment in real assets
such as factories, offices ,lands
,buildings, capital goods etc
• FII is investment in financial assets
such as in bonds and stocks,
denominated in national currency
 Foreign investment

Direct investment
Portfolio investment

Wholly owned Joint

Acquisition
subsidiary venture

GDR-A bank certificate issued in more than one country for INVESTMENT by FII
shares in a foreign company. The shares are held by a foreign GDR,ADR FCCB
branch of an international bank. The shares trade as domestic
shares, but are offered for sale globally through the various bank
branches.

FCCB- A type of convertible bond issued in a currency

different than the issuer's domestic currency. In other
words, the money being raised by the issuing company is in
the form of a foreign currency.
FORMS OF FOREIGN DIRECT INVESTMENT
BY TARGET
GREEN FIELD INVESTMENT- Direct investment in
new facilities or the expansion of existing
facilities.
TOYOTA IN UK AND TOYOTA IN NORTH AMERICA
 MERGERS AND ACQUISITIONS-Transfers of
existing assets from local firms to foreign firms
takes place; the primary type of FDI.
 Cross-border mergers occur when the assets and
operation of firms from different countries are
combined to establish a new legal entity.
 Cross-border acquisitions occur when the control
of assets and operations is transferred from a
local to a foreign company, with the local
company becoming an affiliate of the foreign
company.
FORMS OF FOREIGN DIRECT INVESTMENT
By direction
 Inward foreign direct investment is when foreign
capital is invested in local resources.

 Outward foreign direct investment, sometimes

called "direct investment abroad", is when local
capital is invested in foreign resources.
 Horizontal FDI
Investment in the same industry abroad as a firm operates in at
home.
e.g. Star bucks acquisition of Seattle coffee in Britain
Ford builds up automobile plant in Mexico.

 VERTICAL FDI
BACKWARD VERTICAL FDI--Where an industry abroad provides
inputs for a firm's domestic production process.
 oil refining, tin smelting, Royal Dutch, Alcoe
 Fords builds up engine in Mexico which ships engine to its
manufacturing site in Texas.

FORWARD VERTICAL FDI--Where an industry abroad sells the

outputs of a firm's domestic production.
 Ford buys seven dealerships in Mexico city which it uses to
distribute its cars made in Texas.
FORMS OF FOREIGN DIRECT
INVESTMENT
BY MOTIVE
• Resource-Seeking-
• Investments which seek to acquire factors of
production that are more efficient than those
obtainable in the home economy of the firm. In
some cases, these resources may not be
available in the home economy at all (e.g. cheap
labor and natural resources).

• This typifies FDI into developing countries, for

example seeking natural resources in the Middle
East and Africa, or cheap labor in Southeast Asia
and Eastern Europe.
 Market-Seeking
Investments which aim at either penetrating new
market or maintaining existing ones.

 Efficiency-Seeking
Investments which firms hope will increase their efficiency by
exploiting the benefits of economies of scale and scope, and
also those of common ownership

 Strategic-Asset-Seeking- A tactical investment

to prevent the loss of resource to a competitor.
 The Form of FDI: Acquisitions
versus Green-Fields
• Why the preference for mergers & acquisitions?
– Quicker to execute
 When German automobile company Daimler Benz decided it
needed a bigger presence in the U.S, it acquired Chrysler to
form Daimler Chrysler.
– Foreign firms have valuable strategic assets.
 Mittal –Arcelor
 NESTLE ANS ROWNTREES
– Believe they can increase the efficiency of the
acquired firm by transferring capital, technology,
managerial skills.

 Cemex global status is largely due to acquisitions.

DEMERITS OF FDI

• EXPENSIVE
• BUSINESS IS RISKY-SCHINDLER IN
INDIA.
 Why FDI?
FDI over exporting
– High transportation costs,
trade barriers.
– When the cost of transportation is added to
production costs, some products become
impractical to ship over greater distances.

– Products that have a low value to

weight ratio. e.g. cement, soft drinks,
Tyres
E.G. Cemex
 MARKET IMPERFECTIONS
Why firms prefer FDI than exporting, licensing?

1)Impediments To The Free Flow Of Products Between

Nations.
a) Trade Restrictions: tariffs and non-tariff barriers act as an enticement
for making foreign direct investment. Removing trade restrictions among a
regional group of countries also may attract direct investment.
Exporting –Tariff and quota, govt increase the attractiveness of FDI
Fdi by Japan in 1980’s in U.S was due to heavy tariff placed by U.S
govt.
2)IMPEDIMENTS TO THE SALE OF KNOWHOW
Licensing is not attractive as it initially
appears.
• Licensing may result in a firm giving away
its know-how to a potential foreign
competitor.
• Licensing does not give a firm a tight
control over manufacturing, marketing etc.
 In Thailand star bucks initially entered into a licensing agreement
with coffee partners, but when coffee partners found it difficult to
raise from Thai banks star bucks acquired coffee partners for
tighter control.

• A firm’s know-how may not be amenable

to licensing in case of management and
marketing know-how. e.g cemex
STRATEGIC BEHAVIOUR
• F.T KNICKERBOCKOR
• RELATIONSHIP BETWEEN FDI and rivalry in
oligopolistic
• INTERDEPENDENCE
• FDI follows same pattern as price rivalry.

• FIRM A establishes its subsidiary in France

• Firm B and C decide if investment is successful
they will also follow.
• A discovers that there is some competitive asset
in France that it can repatriate to torment b and c
• B and C decides to follow A
• E.g Kodak and Fuji
The product Life cycle (pattern
of FDI)
• Vernon theory explain about FDI
• Firms that pioneer a production their
home market undertake FDI to
produce a product for consumption in
foreign market.
Location specific
advantages
• John dunning
• Explains nature and direction of FDI
• Firms have to establish production facilities at
where foreign resources are located known as
electric paradigm.
• E.g. oil and mineral gas, cheap labor
• Externalities-They are defined as third party (or
spill-over) effects arising from the production
and/or consumption of goods and services for
which no appropriate compensation is paid. 
 A Decision Framework

How high are LOW Export

transportation costs
and tariffs?
High
No
Is know-how amenable Horizontal FDI
to licensing?
Yes
Is tight control over Yes
Horizontal FDI
foreign operation
required?
No
Figure 6.6 No
Can know-how be protected Horizontal FDI
by licensing contract?
Yes
Then license
The benefits of FDI to host countries

• Resource transfer effect

Capital
Technology
Management
• Employment effects
• Balance of payment effects
• Effect on competition and economic
growth
The benefits of FDI to home countries
• Capital account of the home country, s BOP
benefits from inward flow of foreign earnings.
• Outward flow of FDI arise from employment
effects. positive employment effects arise when
the foreign subsidiary creates demand for home
country exports of capital equipment,
intermediate goods ,complementary products.
• Home country MNE learns valuable skills from its
exposure to foreign markets that can transferred
back to the home country.
UNITED NATIONS ECONOMIC COMMISSION
FOR ASIA AND FAR EAST– LISTED
FOLLOWING CONDITIONS
• POLITICAL STABILITY
• SECURITY OF LIFE AND PROPERTY
• REASONABLE OPPORTUNITIES FOR EARNING
PROFITS
• FACILITIES FOR IMMIGRATION AND EMPLOYMENT
OF FOREIGN TECHNICAL AND ADMINISTRATION
PERSONNEL
• ABSENCE OF COMPETITION BETWEEN STATE-
OWNED ENTERPRISES AND PRIVATE FOREIGN
CAPITAL
• A GENERAL SPIRIT OF FRIENDLINESS TOWARDS
FOREIGN INVESTORS
Direction and Source of
FDI
Most FDI flow has been to
developed countries from
developed countries
– Much to the US from EU, Japan
FDI increase to developing
countries since ‘85
– Much to the emerging Asian and
Latin America economies
– Africa lagging
FOREIGN DIRECT INVESTMENT
CONFIDENCE INDEX,2007
• The Foreign Direct Investment
Confidence Index is a regular survey
of global executives conducted by
A.T. Kearney. The Index provides a
unique look at the present and future
prospects for international
investment flows. Companies
participating in the survey account
for more than $3.8 trillion in annual
global revenue.
FOREIGN DIRECT INVESTMENT CONFIDENCE
INDEX,2007,INDIA
• China and India continue to rank first and second in the
2007 Foreign Direct Investment Confidence Index, a regular
survey of global executives conducted by management
consulting firm AT Kearney.
China leads the Index rankings for the fifth consecutive year
and ranks first among Asian investors, 34% of whom plan to
invest there over the next three years.
• India retains second place in the Index, a position it has
held since displacing the United States in 2005.

• The liberal investment regime, rapid growth of the

economy, strong macro economic fundamentals,
progressive de-licensing of sectors and the ease in doing
business has attracted global corporations to invest in India
• FDI inflows have recorded over five-fold increase in the last
three years, from US$ 2.2 billion in 2003-04 to US$ 15.7
billion in 2006-07. Simultaneously, FDI share in India's GDP
has increased from 0.77 per cent to 2.31 per cent.
• The share of FDI in total investment has more than
doubled from 2.55 per cent in 2003-04 to 6.42 2006-07.
• Destination India
• According to the AT Kearney FDI
Confidence Index 2007, India continues to
be the second most preferred destination
for attracting global FDI inflows, a position
it has held since 2005.
• UNCTAD's World Investment Report, 2005
considers India the 2nd most attractive
investment destination among the
Transnational Corporations (TNCs).
• Going by the international best practices
for calculating FDI would place India's total
FDI at US$ 19.5 billion in 2006-07 against
US$ 7.72 billion in 2005-06, representing a
whopping 153 per cent growth rate.
TOP 10 FDI
DESTINATIONS(2007)
1. CHINA
2. INDIA
3. UNITED STATES
4. UNITED KINGDOM
5. HONGKONG
6. BRAZIL
7. SINGAPORE
8. UNITED ARAB EMIRATES
9. RUSSIA
10.GERMANY
SOURCE-AT KEARNEY