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Chapter 08 ‒ Foreign Direct Investment
8-7
There are three mains costs from inward FDI for the host country: the possible adverse
effects of FDI on competition within the host nation; adverse effects on the balance of
payments; and the perceived loss of national sovereignty and autonomy.
Home-Country Benefits
Home-Country Costs
The home country’s balance of payments can suffer from the initial capital outflow
required to finance the FDI; if the purpose of the FDI is to serve the home market from a
low-cost labor location; and if the FDI is a substitute for direct exports.
International trade theory suggests that home country concerns about the negative
different countries. To explore the information, go to {http://www.worldbank.org/}, click
on “countries,” and select the country in question.
Governments can both encourage and restrict FDI.
To encourage inward FDI, governments offer incentives to foreign firms to invest in their
countries, while they restrict inward FDI through ownership restraints and performance
Managers need to consider what trade theory implies, and the link between government
policy and FDI.
The direction of FDI can be explained through the location-specific advantages argument
associated with John Dunning.
A host government’s attitude toward FDI is an important variable in decisions about
Chapter 08 ‒ Foreign Direct Investment
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CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: In 2008, inward FDI accounted for some 63.7 percent of gross fixed
capital formation in Ireland, but only 4.1 percent in Japan (gross fixed capital formation
refers to investments in fixed assets such as factories, warehouses, and retail stores).
What do you think explains this difference in FDI inflows into the two countries?
ANSWER 1: One approach to this question is to look at government policy: Ireland is
QUESTION 2: Compare and contrast these explanations of FDI: internalization theory
and Knickerbocker's theory of FDI. Which theory do you think offers the best
explanation of the historical pattern of FDI? Why?
ANSWER 2: Knickerbocker's theory suggests that firms imitate other firms in
oligopolistic industries and will "follow the leader" in undertaking FDI in certain
countries, as sort of strategic defensive moves. This theory does not explain why the first
QUESTION 3: What are the strengths of the eclectic theory of FDI? Can you see any
shortcomings? How does the eclectic theory influence management practice?
ANSWER 3: Championed by British economist John Dunning, the eclectic theory of FDI
focuses on location-specific advantages in explaining the rationale and direction of FDI.
Location-specific advantages pertain to advantages that arise from using resources or
QUESTION 4: Read the Management Focus on Cemex and then answer the following
questions:
a. Which theoretical explanation, or explanations, of FDI best explains Cemex’s FDI?
b. What is the value that Cemex brings to the host economy? Can you see any potential
Chapter 08 ‒ Foreign Direct Investment
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drawbacks of inward investment by Cemex in an economy?
c. Cemex has a strong preference for acquisitions over greenfield ventures as an entry
mode. Why?
ANSWER 4:
a. Cemex is a cement company. Consequently, exporting is difficult because of the
weight of the product. If Cemex wants to expand into new markets, the company would
b. Cemex is the third largest cement company in the world and a powerhouse in Mexico
where it controls 60 percent of the market. Cemex is highly focused on efficient
manufacturing and customer service. Distributors are rewarded for their sales as are
c. Cemex has successfully acquired established cement makers in many countries. By
Another Perspective: Cemex’s website is available at: {http://www.cemex.com}.
QUESTION 5: You are the international manager of a U.S. business that has just
developed a revolutionary new personal computer that can perform the same functions as
existing PCs but costs only half as much to manufacture. Several patents protect the
unique design of this computer. Your CEO has asked you to formulate a recommendation
for how to expand into Western Europe. Your options are (a) to export from the U.S., (b)
to license a European firm to manufacture and market the computer in Europe, or (c) to
set up a wholly-owned subsidiary in Europe. Evaluate the pros and cons of each
alternative and suggest a course of action to your CEO.
ANSWER 5: In considering expansion into Western Europe, an international manager
might consider three options: FDI, licensing, and export. With export, assuming there are
no trade barriers, the key considerations would likely be transport costs and localization.
While transport costs may be quite low for a relatively light and high value product like a
computer, localization can present some difficulties. Power requirements, keyboards, and
preferences in models all vary from country to country. It may be difficult to fully
Chapter 08 ‒ Foreign Direct Investment
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McGraw-Hill Education.
potential licensees. A licensing arrangement, however, implies that valuable
technological information may have to be disclosed and that the firm’s competitive
advantage may be lost if the licensees use or disseminate this proprietary knowledge
improperly. FDI (setting up a wholly-owned subsidiary) is clearly the most costly and
time-consuming approach, but the one that best guarantees that critical knowledge will
not be disseminated and that localization can be done effectively. FDI will also place you
in the market into which you want to sell and allow you to be near the consumer. Given
the fast pace of change in the personal computer industry, it is difficult to say how long
this revolutionary new computer will retain its competitive advantage. If the firm can
protect its advantage for a period of time, FDI may pay off and help assure that critical
knowledge is not lost. If the innovation is not core and can be easily copied, then
licensing would allow the firm to get the quickest large-scale entry into Europe and make
as much as it can before losing advantage.
CLOSING CASE: Burberry Shifts Its Strategy in Japan
Summary
The closing case explores Burberry’s experience in Japan. Nearly 50 years ago, the
British luxury apparel maker signed a licensing agreement with Sanyo Shokai. The
agreement allowed Burberry to develop a market in Japan, yet avoid the cost and risk of
doing so. More recently, Burberry ended its licensing arrangement in favor of opening its
own stores in the country. While this new strategy implies that Burberry will bear all the
costs and risk of operating in Japan, it will also regain complete control over how its
brand is used and collect all profits associated with its brand. Discussion of the case can
begin with the following questions:
QUESTION 1: Why did Burberry initially choose a licensing strategy to expand its
presence in Japan?
ANSWER 1: For nearly half a century, Burberry’s licensing arrangement with Sanyo
QUESTION 2: What limitations of the licensing strategy became apparent over time?
Should Burberry have expected these drawbacks to arise?
ANSWER 2: As part of its licensing arrangement with Burberry, Sanyo Shokai had
discretion over how it used the brand. For Burberry this proved to be problematic as its
Chapter 08 ‒ Foreign Direct Investment
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QUESTION 3: Was terminating the Japanese licensing agreement and opening wholly-
owned stores the correct strategic move for Burberry? What are the risks here?
ANSWER 3: Most students will probably agree that Burberry had little choice but to end
its licensing arrangement with Sanyo Shokai. By opening its own stores in Japan,
QUESTION 4: To what extent does internalization theory explain Burberry’s experience
in Japan?
ANSWER 4: Many students will probably suggest that Burberry’s experience in Japan is
Another Perspective: To learn more about Burberry, go to {https://us.burberry.com/our-
history/}.
MHE INTERNATIONAL BUSINESS VIDEO LIBRARY
Please click here to visit our International Business Video Library which provides an
ongoing stream of updated video suggestions correlated by key concept and major topic.
Every new clip posted is supported by teaching notes and discussion questions. Please
feel free to leave comments in the library that you feel might be helpful to your
colleagues.
INCORPORATING globalEDGE™ EXERCISES
Use the globalEDGE™ site {globaledge.msu.edu/} to complete the following exercises:
Exercise 1
The World Investment Report published annually by UNCTAD provides a summary of
recent trends in FDI as well as quick access to comprehensive investment statistics.
Identify the table of largest transnational corporations from developing and transition
countries. The ranking is based on the foreign assets each corporation owns. Based only
on the top 20 companies, provide a summary of the countries and industries represented.
Do you notice any common traits from your analysis? Did any industries or countries in
the top 20 surprise you? Why?
Exercise 2
Chapter 08 ‒ Foreign Direct Investment
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An integral part of successful foreign direct investment (FDI) is to understand the target
market opportunities as well as the nature of the risk inherent in possible investment
projects, particularly in developing countries. You work for a company that builds
wastewater and sanitation infrastructure in such countries. The Multilateral Investment
Guarantee Agency (MIGA) provides insurance for risky projects in these markets.
Identify the sector brief for the water and wastewater sector, and prepare a report
identifying the major risks projects in this sector tend to face and how MIGA can assist in
such projects.
Answers to Exercises
Exercise 1 Answer
Exercise 2 Answer
