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CHAPTER FIFTEEN
DIRECT INVESTMENT AND
COLLABORATIVE STRATEGIES
OBJECTIVES
15-1 Comprehend why export and import may not suffice for companies’ achievement of
IB objectives
15-2 Explain why and how companies make wholly owned foreign direct investments
15-3 Ascertain why companies collaborate in international markets
15-4 Compare and contrast forms of and considerations for selecting an international
collaborative arrangement
15-5 Grasp why IB collaborative arrangements fail or succeed
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 Fifteen 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.
CHAPTER OUTLINE
OPENING CASE: Meliá Hotels International
Meliá Hotels International is a Spanish hotel chain founded by Gabriel Escarre in 1956, leasing
his first hotel in Majorca. In 2000, Meliá merged with another Spanish hotel chain, TRYP, thus
adding 45 hotels in Spain. Meliá is now the largest hotel operator in
Spain, and Spain is the largest location for Meliá. Despite the importance of Spain to Meliá,
where it still concentrates 49 percent of its hotels, 75 percent of its current income is from
international operations.
I. INTRODUCTION
Companies must choose an international operating mode to fulfill their objectives and carry
out their strategies. When forming objectives and implementing strategies in a variety of
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country environments, firms must either handle international business operations on their
own or collaborate with other companies. 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. These can
range from wholly owned operations to partially owned subsidiaries, joint ventures, equity
alliances, licensing, franchising, management contracts, and turnkey operations.
II. WHY EXPORT AND IMPORT MAY NOT SUFFICE
Companies may find more advantages to locating production in foreign countries than export
to them. The advantages occur under six conditions:
When production abroad is cheaper than at home
When transportation costs are too high for moving goods or services internationally
When companies lack domestic capacity
When products and services need to be altered substantially to gain sufficient consumer
demand abroad
When governments inhibit the import of foreign products
When buyers prefer products originating from a particular country
[see Fig 15.2]
A. When it’s Cheaper to Produce Abroad
Competition requires companies to control their costs and to choose production
locations with costs in mind.
B. When Transportation Costs Too Much
Some products and services become impractical to export after the cost of
transportation are 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. When Domestic Capacity Isn’t Enough
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. When Products and Services Need Altering
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. When Trade Restrictions Hinder Imports
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.
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F. When Country of Origin Becomes an Issue
Consumers may prefer goods produced in their own country to 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. WHY AND HOW DO COMPANIES MAKE WHOLLY OWNED FDI
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. Reasons for Wholly Owned Foreign Direct Investment
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 four primary explanations for companies to make
a wholly owned FDI: market failure, internalization theory, appropriability theory, and
freedom to pursue global objectives, appropriability theory, and freedom to pursue
global objectives.
1. Market Failure. The failure of the market to connect firms as collaborators
will entice a company to enter with wholly owned operations only if it
perceives having operating advantages to overcome its liability of foreignness.
2. 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
• The company can avoid protracted negotiations with another company on
such matters as how each will be compensated for contributions
• 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. Freedom to Pursue a Global Strategy. When a company has a wholly
owned foreign operation, it may more easily have that operation participate in a
global 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 strategy.
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B. Acquisition versus Greenfield
FDI usually involves international capital movement, but could also involve the transfer
of other assets, such as managers or cost control systems. Companies can either acquire
an interest in an existing company or construct new facilities, known as a greenfield
investment.
1. Acquisition. 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. Making Greenfield Investments. 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.
3. Leasing. This is much like an acquisition, but one that forgoes the need to invest.
IV. WHY COMPANIES COLLABORATE
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. [see Fig 15.3]
A. General Motives for Collaborative Arrangements
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. To 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. Companies should periodically reappraise the question of internal versus
external handling of their operations.
2. To 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. To 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. To 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.
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5. To 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.
C. 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. To 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 location-specific
assets (e.g., distribution access or a competent workforce), firms may pursue
collaborative arrangements with local companies.
2. To 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. It is also helpful to have a
collaborative relationship with a local firm to protect assets. Some countries
provide protection only if intellectual property is exploited locally within a
specified time period. Local partners can monitor the illegal usage of the firm’s
intellectual property.
3. To 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. To Minimize Risk Exposure. The higher the risk managers perceive with
respect to a foreign operation, the greater their desire to form a collaborative
arrangement.
V. FORMS OF AND CHOICE OF COLLABORATIVE ARRANGEMENTS
A. Some Considerations in Choosing a Form
1. Trade-offs and Limitations. Operating modes for foreign operations differ in
the amount of resources a company commits and the proportion of the resources
it locates abroad. In this respect, there are trade-offs. Furthermore, a company
may be limited in entering a market with its preferred operating mode.
2. What’s the Purpose? Alliance Types. Alliances vary by objective and by place
in the value chain. These variances have led to terms that describe different
types. Scale alliances aim to provide efficiency for partners by pooling similar
operations; such as airlines have done by combining their lounges. In a link
alliance, firms use their partners’ complementary resources to expand into a new
business. A vertical alliance connects firms in different links of their value
chains, such as a food franchiser with a franchisee. A horizontal alliance, such
as the Mexican joint venture between Mercedes and Infiniti, enables each
partner to extend its product offerings (in this case, a new compact car) on the
same level of the value chain. Coopetition, such as the Mercedes-Infiniti
example, refers to collaboration while competing.
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3. Prior Company Expansion. Companies’ experience and assets in a foreign
country influence their choices of operating mode when introducing new
products or businesses.
4. Compensation. Collaboration also implies sharing revenues and knowledge.
How to divide revenue is not clear-cut because many variables influence the
outcome. Factors such as government mandates, partners’ perception of risk, and
competitive constraints are all important in the agreement.
POINT-COUNTERPOINT:
Should Countries Limit Foreign Control of Key Industries?
POINT: Countries should limit foreign control of key industries in order to protect their
economic and security interests, especially in key industries such as transportation, mass media,
and energy. History has shown that home governments have used powerful foreign companies to
influence policies in the countries where they operate, and that foreign companies have used their
home governments as instruments to improve their interests in a country. Whenever a company is
controlled from abroad, decisions about that company can be made abroad, possibly to the
detriment of the host country.
COUNTERPOINT: Decisions made by foreign companies are not likely to be much different
than decisions made by local companies. MNEs staff their foreign subsidiaries mainly with
nationals of the countries where they operate, and make decisions based on a good deal of local
advice. Their decisions have to adhere to local laws and consider the views of suppliers and
customers. Protection of certain industries from foreign control could reduce competitiveness in
those industries and harm, rather than help, the local people. Those who argue for limits are
relying on the outdated dependencia theory, which holds that emerging economies have
practically no power in their dealings with MNEs. More recent bargaining school theory states
that the terms for a foreign investor’s operations depend on how much the investor and host
country need the other’s assets. Countries and foreign companies need each other, and both will
lose if limitations are placed on foreign control.
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
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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 resources (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 Considerations. 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. Companies
commonly negotiate a “front-end” payment to cover transfer costs when
technology is involved. In addition, they usually charge fees based on actual usage.
Licensors of technology do this because it usually takes more than simply
transferring explicit knowledge, such as through reports. The move requires the
transfer of tacit knowledge as well, such as engineering.
3. Licensing to Subsidiaries. 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
franchisee’s 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.
1. Franchise Organization. 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
subfranchises in the country or region.
2. Operational Modifications. Franchise success is derived from three factors:
product standardization, effective cost control, and high identification through
promotion. 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.
D. 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.
E. 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
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of turnkey facilities are industrial-equipment and construction companies; projects may
cost billions of dollars; customers most often are government agencies or large MNEs.
1. Contracting to Scale. One characteristic that sets the turnkey business apart
from most other international business operations is size of the contract.
2. Making Contacts. The nature of the business requires executives with top-level
contacts abroad.
3. Marshaling Resources. Many turnkey operations are in remote areas and
necessitate massive housing construction and the importation of personnel.
F. Joint Ventures (JVs)
Although usually thought of as 50/50 companies, JVs may nonetheless involve more
than two companies and ones in which a partner owns more than 50 percent. When
more than two organizations participate, the venture is sometimes called a consortium.
JVs may also involve a partner owning over 50 percent, such as ANA’s ownership of 67
percent in Air Asia Japan. [see Figure 15.4].
1. Possible Combinations. Examples of the many combinations of JV
partnerships include:
Two companies from the same country joining together in a foreign market
(e.g., NEC and Mitsubishi [Japan] in the United Kingdom)
A foreign company joining with a local company (e.g., Barrick [Canada] and
Zijin Mining Group in China)
Companies from two or more countries establishing a joint venture in a third
country (e.g., Mercedes-Benz [Germany] and Nissan [Japan] in Mexico)
A private company and a local government forming a joint venture, or mixed
venture (e.g., Mitsubishi [Japan] with the government-owned Exportadora de
Sal in Mexico)
A private company joining a government-owned company in a third country
(e.g., BP Amoco [private British-U.S.] and Eni [government-owned Italian] in
Egypt)
G. 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.
VI. WHY COLLABORATIVE ARRANGEMENTS FAIL OR SUCCEED
All collaborative arrangement parties must be satisfied with performance; otherwise, the
arrangement may fail.
A. Reasons for Failure
The major strains on collaborative arrangements are due to five factors:
• Relative importance to partners
• Divergent objectives
• Control problems
• Comparative contributions and appropriations
• Differences in culture
1. Relative Importance
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One partner may give more attention to the collaboration than the other—often 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.
1. Divergent 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.
2. Questions of Control
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.
3. Comparative Contributions and Appropriations
One partner’s 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 other’s 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.
4. Culture Clashes
Differences in both national and corporate cultures may cause problems with
collaborative arrangements, especially joint ventures.
a. Differences in Country Cultures. 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.
b. Differences in Corporate Cultures. In addition to national culture, differences
in corporate culture may create problems for joint ventures. For example, some
firms may have an entrepreneurial culture and others are risk averse. Compatibility
of corporate cultures is important to the success of joint venture projects.
B. Helping Collaborative Operations Succeed
Aside from awareness of and adjustment to the pitfalls we have discussed, the following
considerations help assure success when choosing among and managing operating forms:
Fitting modes to country differences
Finding and evaluating partners
Negotiating agreements: The question of secrecy
Controlling through contracts and trust
Evaluating continually
Adjusting the internal organization
1. Fitting Modes to Country Differences. A company should ordinarily commit more
of its IB resources to those markets that are most attractive and fit best with its
strategies and competence. The choice of operating mode directly affects this
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resource allocation inasmuch as different modes commit different levels of resources
and different portions of those resources abroad. Figure 15.5 illustrates a matrix
relating country attractiveness, a company’s competitive strength per country, and
operating forms.
2. Finding and Evaluating Potential Partners. Partner pairing should depend on
mutual assessment of each other’s resources, motivation, and compatibility.
3. Negotiating the Arrangement: The Question of Secrecy. Numerous collaborative
arrangements involve technology transfers. Because the value of many technologies
would diminish if they were widely used or understood, technology owners have
historically insisted on including contract provisions whereby recipients will not
divulge such information.
4. Controlling Through Contracts and Trust. Although both trust and contracts have
control limitations, there are provisions that should be included in any collaborative
agreement.
5. Evaluating Continually. Contracting with a capable and compatible partner is
necessary but insufficient to ensure success. A company must continually assess
partners’ performance and periodically assess the need for change in the type of
collaboration.
6. Adjusting Within the Internal Organization. As companies change operating
modes, they encounter pressures necessitating organizational adjustments. These
include organizational application of what they have learned and the need to alter
group and individual evaluations as operating forms change.
a. Learning and Its Applications. Evidence suggests that companies’
collaborative performance improves with experience. However, improvement
is most associated with similar types of collaborations, such as applying what a
firm has learned from JV operations in one country to JVs in another country.
b. Pressures from Switching Collaborative Modes. Changes in operating
mode, such as from exporting to foreign production to serve a market, cause
some individuals to gain and others to lose responsibilities.
LOOKING TO THE FUTURE:
Growth in Project Size and Complexity
More than a half-century ago, John Kenneth Galbraith postulates that because the cost of
development is often so high, it can only be carried out with firms of considerable size.
Galbraith’s conclusion overlooks several factors. Although firms can become ever larger through
mergers and acquisitions, collaborative arrangements are likely to be increasingly important in the
future as governments opt to restrict such activities because of antitrust concerns. At the same
time, companies might not be able to internalize the breadth of technology necessary to solve
these big problems. Also, most product development is much more modest than required to
unravel the gigantic projects. Collaborative arrangements will bring forth both opportunities and
problems as firms move simultaneously into new countries and to new types of contractual
arrangements with new partners. The more partners in a given alliance, the more strained the
decision- making and control processes will likely be.
CLOSING CASE: The Oneworld Airline Alliance
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[see Map 15.2]
The airline industry is almost unique in that its need to form collaborative arrangements has been
important almost from the start of international air travel because of cost, regulatory, and
competitive factors. In recent years, this need has accelerated because of airlines’ difficult profit
performance. No single airline has the capacity to serve the whole world, yet passengers want to
travel the whole world with a seamless experience. Thus, airlines have increasingly worked
together to provide more seamless experiences for passengers and to cut costs. Several notable
regulatory changes have occurred in
recent years. First, the U.S. domestic market has been deregulated. Once deregulation was
instituted, many U.S. airlines were competitively forced out of business. Second, similar
deregulation within Europe influenced the demise of some airlines. The high cost of maintenance
and reservations systems and the need to spread costs have led to cooperation involving multiple
airlines from multiple countries in the form of JVs and alliances such as the oneworld Alliance
which comprises 15 airlines. These alliances allow for considerable cooperation, such as
code-sharing; however, antitrust regulations (unless given immunity) prohibit their members from
coordinating routes, schedules, and prices.
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