978-1259929441 Chapter 8 Part 2

Unlock access to all the studying documents.

View Full Document

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

8-8

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

8-9

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

8-10

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

8-11

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

8-12

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