CHAPTER FOURTEEN

DIRECT INVESTMENT AND

COLLABORATIVE STRATEGIES
CHAPTER OVERVIEW
Although most companies operating internationally would prefer exporting to other
market entry modes, there are circumstances in which exporting may not be feasible. In
these cases, companies may engage in direct investment in other countries, or enter
markets through various collaborative strategies such as joint ventures and alliances.
Collaborative strategies allow firms to spread both assets and risk across countries by
entering into contractual agreements with a variety of potential partners. Chapter
Fourteen first discusses reasons for not exporting and then explores the motives that drive
firms to engage in noncollaborative and collaborative arrangements, as well as the
various types of possible arrangements, including foreign direct investment, licensing,
franchising, joint ventures, and equity alliances. It goes on to explore the various
problems that may arise in FDI and collaborative ventures and concludes with a
discussion of the various methods for managing these evolving arrangements.

I.

INTRODUCTION
When forming objectives and implementing strategies in a variety of country
environments, firms must either handle international business operations on their
own or collaborate with other companies (Figure 14.2). Although exporting is
usually the preferred alternative since it allows firms to produce in their home
countries, participating in some markets may require using a variety of other equity
and nonequity arrangements (Figure 14.3). These can range from wholly owned
operations to partially owned subsidiaries, joint ventures, equity alliances, licensing,
franchising, management contracts, and turnkey operations.

II. WHY EXPORTING MAY NOT BE FEASIBLE

Companies may find more advantages by producing in foreign countries rather than
by exporting to them due to a variety of reasons.
A. Cheaper to Produce Abroad
Competition requires companies to control their costs and to choose production
locations with this factor in mind.
B. Transportation Costs
Some products and services become impractical to export after the cost of
transportation is added to production costs. In general, the farther the target
market is from the home country, the higher the transportation costs. Also, the
higher transportation costs are relative to production costs, the more difficult it
is to be competitive through exporting. Some services are impossible to export
and require establishing operations in the target country.

C. Lack of Domestic Capacity

As long as a company has excess capacity, it can service foreign markets and
price on the basis of variable rather than full costs. When demand exceeds
capacity, however, new facilities are needed and are often located nearer to the
end consumers in other countries.
D. Need to Alter Products and Services
Special requirements for products in some markets may require additional
investments that are often better made in the country the company intends to sell
to. The more that products must be altered for foreign markets, the more likely
production will shift to those foreign markets.
E. Trade Restrictions
Although import barriers have been on the decline, some significant tariffs
continue to exist. In these situations, avoiding barriers through production in the
target country must be weighed against other considerations such as the market
size of the country and the scale of technology used in production. When
barriers fall within a group of countries, companies may be attracted to make
direct investments to serve the entire region since the expanded market may
justify scale economies.
F. Country of Origin Effects
Consumers may prefer goods produced in their own country over imports
because of nationalistic feelings. For some products, consumers may prefer
imported goods from specific countries due to a perception that those products
are superior. Other considerations like the availability of service and
replacement parts for imported products, or adoption of just-in-time
manufacturing systems may influence production locations.
III. NONCOLLABORATIVE FOREIGN EQUITY ARRANGEMENTS
Two forms of foreign direct investment (FDI) that do not involve collaboration are
wholly owned operations and partially owned operations with the remainder widely
held.
A. Foreign Direct Investment and Control
To qualify as a foreign direct investment, the investor must have control. This
can be established with a small percentage of the holdings if ownership is
widely dispersed. The more ownership a company has, the greater its control
over the management decisions of the operation. There are three primary
reasons for companies to want a controlling interestinternalization theory,
appropriability theory, and freedom to pursue global objectives.
1. Internalization. Control through self-handling of operations is known as
internalization. Transactions cost theory holds that companies should
organize operations internally when the costs of doing so are lower than
contracting with another party to handle it for them. Internalization may
result in lower costs because:
Different operating units with the same company likely share a
common culture which expedites communications
The company can use its own managers who understand and are
committed to carrying out its objectives

Negotiations that might delay the investment or complicate its

management can be avoided
The company can avoid possible problems with enforcing an agreement
2. Appropriability. Appropriability theory is the idea that companies want
to deny rivals and potential rivals access to resources such as capital,
patents, trademarks, and management know-how that might be captured
through collaborative agreements.
3. Pursuit of Global Strategies. When a company has a wholly owned
foreign operation, it may more easily have that operation participate in a
global or transnational strategy. Furthermore, the fact that most countries
have laws to protect minority shareholders interest means that sharing of
ownership may restrict a company from implementing a global or
transnational strategy.
B. Methods for Making FDI
FDI usually involves international capital movement, but could also involve the
transfer of other assets such as managers, cost control systems. Companies can
either acquire an interest in an existing company or construct new facilities,
known as a greenfield investment.
1. Reasons for Buying. Companies may acquire existing operations in
order to avoid adding further capacity to the market, to avoid start-up
problems, obtain easier financing, and get an immediate cash flow rather
than tying up funds during construction. A company may also save time,
reduce costs, and reduce risks by buying an existing company.
2. Reasons for Greenfield. Companies may choose to build if no suitable
company is available for acquisition, if the acquisition is likely to lead to
carry-over problems, and if the acquisition is harder to finance. In addition,
local governments may prevent acquisitions because they want more
competitors in the market and fear foreign domination.
II. MOTIVES FOR COLLABORATIVE ARRANGEMENTS
Each participant in a collaborative arrangement has its own basic objectives for
operating internationally as well as its own motives for collaborating with a partner.
A. Motives for Collaborative Arrangements: General
Companies collaborate with other firms in either their domestic or foreign
operations in order to spread and reduce costs, to specialize in particular
competencies, to avoid or counter competition, to secure vertical and/or
horizontal linkages and to learn from other companies.
1. Spread and Reduce Costs. When the volume of business is small, or
one partner has excess capacity, it may be less expensive to collaborate with
another firm. Nonetheless, the costs of negotiation and technology transfer
must not be overlooked.
2. Specialize in Competencies. The resource-based view of the firm
holds that each firm has a unique combination of competencies. Thus, a
firm can maximize its performance by concentrating on those activities that
best fit its competencies and relying on partners to supply other products,
services, or support activities.

3. Avoid or Counter Competition. When markets are not large enough for
numerous competitors, or when firms need to confront a market leader, they
may band together in ways to avoid competing with one another or combine
resources to increase their market presence.
4. Secure Vertical and Horizontal Links. If a firm lacks the competence
and/or resources to own and manage all of the activities of the value-added
chain, a collaborative arrangement may yield greater vertical access and
control. At the horizontal level, economies of scope in distribution, a better
smoothing of sales and earnings through diversification and an ability to
pursue projects too large for any single firm can all be realized through
collaboration.
5. Gain Knowledge. Many firms pursue collaborative arrangements in order
to learn about their partners technology, operating methods, or home
markets and thus broaden their own competencies and competitiveness over
time.
B. International Motives for Collaborative Arrangements
Companies collaborate with other firms in their foreign operations in order to
gain location-specific assets, overcome legal constraints, diversify
geographically and minimize their exposure in high-risk environments.
1. Gain Location-Specific Assets. Cultural, political, competitive, and
economic differences among countries create challenges for companies that
operate abroad. To overcome such barriers and gain access to locationspecific assets (e.g., distribution access or a competent workforce), firms
may pursue collaborative arrangements.
2. Overcome Governmental Constraints. Countries may prohibit or
limit the participation of foreign firms in certain industries, or discriminate
against foreign firms via tax rates and profit repatriation. Firms may be able
to overcome such barriers via collaboration with a local partner.
3. Diversify Geographically. By operating in a variety of countries, a firm
can smooth its sales and earnings; collaborative arrangements may also
offer a faster initial means of entering multiple markets or establishing
multiple sources of supply.
4. Minimize Exposure in Risky Environments. The higher the risk
managers perceive with respect to a foreign operation, the greater their
desire to form a collaborative arrangement.
III. TYPES OF COLLABORATIVE ARRANGEMENTS
While collaborative arrangements allow for a greater spreading of assets across
countries, the various types of arrangements necessitate trade-offs among objectives.
Finding a desirable partner can be problematic. A firm has a wider choice of
operating forms and partners when there is less likelihood of competition and when it
has a desired, unique, difficult-to-duplicate resource.
A. Some Considerations in Collaborative Arrangements
Two critical variables that influence the choice of collaborative arrangement are
a firms desire for control over its foreign operations and its prior expansion into
foreign ventures.

1. Control. The loss of control over flexibility, revenues and competition is a

critical variable in the selection of forms of foreign operation. The more a
firm depends on collaborative arrangements, the more likely its control will
be lessened over decisions regarding quality, new product directions and
production expansion.

2. Prior Expansion of the Company. If a firm already owns and controls

operations in a foreign country, the advantages of collaboration may not be
as attractive as otherwise.
B. Licensing
Under a licensing agreement, a firm (the licensor) grants rights to intangible
property to another company (the licensee) to use in a specified geographic area
for a specified period of time; in exchange, the licensee ordinarily pays a royalty
to the licensor. Such rights may be exclusive or nonexclusive. Usually the
licensor is obliged to furnish technical information and assistance, while the
licensee is obliged to exploit the rights effectively and pay compensation to the
licensor. Intangible property may be classified as:
patents, inventions, formulas, processes, designs, patterns
copyrights for literary, musical, or artistic compositions
trademarks, trade names, brand names
franchises, licenses, contracts
methods, programs, procedures, systems.
1. Major Motives for Licensing. Licensing often has an economic motive,
such as the desire for faster start-up, lower costs, or access to additional
property rights (e.g., technology). For the licensor, the risks and costs of a
given venture are lessened; for the licensee, costs are less than if it had to
develop a product or process on its own. Cross-licensing represents the
situation in which companies in various countries exchange technology
rather than compete with each other with every product in every market.
2. Payment. The amount and type of payment for licensing arrangements
may vary. Each contract tends to be negotiated on its own merits; the
bargaining range is based on dual expectations. Both agreement-specific
and environment-specific factors may affect the value of a license.
3. Sales to Controlled Entities. Many licenses are given to firms owned in
part or in whole by the licensor. From a legal standpoint, subsidiaries are
separate companies; thus, a license may be required in order to transfer
intangible property.
C. Franchising
Franchising represents a specialized form of licensing in which the franchisor
not only sells an independent franchisee the use of the intangible property
essential to the franchisees business, but also operationally assists the business
on a continuing basis. In a sense, the two partners act like a vertically integrated
firm because they are interdependent and each produces a part of the product
that ultimately reaches the customer.

D.

E.

F.

G.

1. Organization of Franchising. A franchisor may penetrate a foreign

country by dealing directly with its foreign franchisees, or by setting up a
master franchise and giving that organization the right to open outlets on its
own or to develop sub-franchises in the country or region.
2. Operational Modifications. Franchise success is derived from three
factors: product standardization, effective cost control and high recognition.
Nonetheless, franchisors face a classic dilemma: the more they standardize
on a global basis, the lower the potential for product acceptance in a given
country; the more they permit adaptation to local conditions, the less the
franchisor can offer the franchisee, the higher the costs and the less the
control by the franchisor.
Management Contracts
A management contract represents an arrangement in which one firm provides
management personnel to perform general or specialized functions to another
firm for a fee. A firm usually pursues such contracts when it believes a partner
can manage certain operations more efficiently and effectively than it can itself.
Turnkey Operations
Turnkey operations represent a type of collaborative arrangement in which one
firm contracts with another to build complete, ready-to-operate facilities.
Usually, suppliers of turnkey facilities are industrial-equipment and construction
companies; projects may cost billions of dollars; customers most often are
government agencies or large MNEs.
Joint Ventures
A joint venture represents a direct investment in which two or more partners
share ownership. As a firms share of the equity declines, its ability to control a
given operation also declines. A consortium represents the joining together of
several entities (e.g., companies and governments) to combine resources and/or
to strengthen the possibility of pursuing a major undertaking. Other forms of
joint ventures include:
Two companies from the same country joining together in a foreign market,
such as NEC and Mitsubishi (Japan) in the United Kingdom
A foreign company joining with a local company, such as Great Lakes
Chemical (U.S.) and A. H. Al Zamil in Saudi Arabia
Companies from two or more countries establishing a joint venture in a
third country, such as that of Diamond Shamrock (U.S.) and Sol Petroleo
(Argentina) in Bolivia
A private company and a local government forming a joint venture
(sometimes called a mixed venture), such as that of Philips (Dutch) with the
Indonesian government
A private company joining a government-owned company in a third
country, such as BP Amoco (private British-U.S.) and Eni (governmentowned Italian) in Egypt
Equity Alliances
An equity alliance represents a collaborative arrangement in which at least one
of the collaborating firms takes an ownership position (usually a minority) in the

other(s). The purpose of an equity alliance is to solidify a collaborating contract,

thus making it more difficult to break.
IV. PROBLEMS OF COLLABORATIVE ARRANGEMENTS
Dissatisfaction with the results of collaboration can cause an arrangement to break
down. Problems arise for a number of reasons.
A. Collaborations Importance to Partners
One partner may give more attention to the collaboration than the otheroften
because of a difference in size. An active partner will blame the less active
partner for its lack of attention, while the less active partner will blame the other
for poor decisions.
B. Differing Objectives
Although firms may enter into collaborative arrangements with complementary
capabilities and objectives, their views regarding such things as reinvestment vs.
profit repatriation and desirable performance standards may evolve quite
differently over time.
C. Control Problems
When no single party has control of a collaborative arrangement, the venture
may lack direction; if one party dominates, it must still consider the interests of
the other. By sharing assets with another firm, a company may lose some control
over the extent and/or quality of the assets use. Further, even when control is
ceded to one of the partners, both may be held responsible for problems.
D. Partners Contributions and Appropriations
One partners ability to contribute technology, capital and other assets may
diminish (at least on a relative basis) over time. Further, in almost all
collaborations the danger exists that one partner will use the others contributed
assets, or take more than its fair share from the operation, thus enabling it to
become a direct competitor. Such weaknesses may cause a drag on a venture and
even lead to the dissolution of the agreement.
E. Differences in Culture
Differences in both national and corporate cultures may cause problems with
collaborative arrangements, especially joint ventures. Firms differ by nationality
in terms of how they evaluate the success of an operation (e.g., profitability,
strategic market position and/or social objectives). Nonetheless, joint ventures
from culturally distant countries tend to survive at least as well as those between
partners from similar cultures.
V. MANAGING FOREIGN ARRANGEMENTS
As a collaborative arrangement evolves, partners need to reassess certain decisions in
light of their resource bases and external environmental changes.
A. Dynamics of Collaborative Arrangements
The evolutionary costs of a firms foreign operations may be very high as it
switches from one operational mode to another, especially if it must pay
termination fees. Thus, a firm must develop the means to evaluate performance
by separating the controllable and uncontrollable factors at its various profit
centers.

B. Finding Compatible Partners

A firm may actively seek a partner for its foreign operations, or it can react to a
proposal from another company to collaborate with it. Potential partners should
be evaluated both for the resources they can offer and their willingness to work
together. The proven ability to handle similar types of collaboration is a key
professional qualification.
C. Negotiating Process
Certain technology transfer considerations are unique to collaborative
arrangements; often pre-agreements are set up to protect concerned parties. The
secrecy of financial terms, especially when government authorities consult their
counterparts in other countries, is an especially sensitive area. Market conditions
may dictate the need for different terms in different countries.
D. Contractual Provisions
To minimize potential points of disagreement, contract provisions should
address the following factors:
Terminating the agreement if the parties do not adhere to the directives
Methods of testing for quality
Geographical limitations on the assets use
Which company will manage which parts of the operation outlined to the
agreement
What each companys future commitments will be
How each company will buy from, sell to, or use intangible assets that come
from the collaborative arrangement
E. Performance Assessment
All parties should establish mutual goals so all involved understand what is
expected, and a contract should spell out expectations. In addition to the
continuing assessment of the ventures performance, a firm should also
periodically assess the possible need for a change in the type of collaboration.