1
Chapter 6: Investing Abroad Directly
Chapter Outline
LO1: Identify and define the key terms associated with foreign direct investment
(FDI).
1. Key Concepts
The term Foreign Direct Investment (FDI) is defined as putting money into activities
that control and manage value-added activities in other countries. This is in contrast
to Foreign Portfolio Investment (FPI), which refers to holding securities, such as
stocks and bonds, of companies in countries outside one’s own but does not entail the
active management of foreign assets. Essentially, FPI is foreign indirect investment.
An MNE, by definition, is a firm that engages in FDI when doing business abroad.
2. Key Terms
LO2: Use the resource-based and institution–based views to answer why FDI takes
place.
1. Key Concepts
2
Chapter 6: Investing Abroad Directly
There must be economic gains from FDI. Given the tremendous complexities
associated with FDI, such gains must significantly outweigh the costs. What are the
sources of such gains? The answer, as suggested by British scholar John Dunning
boils down to firms’ quest for ownership (O) advantages, location (L) advantages,
and internalization (I) advantages—collectively known as OLI advantages.
2. Key Terms
LO3: Explain how FDI results in ownership advantages.
1. Key Concepts
All investments, including both FDI and FPI, entail ownership of assets. FDI
requires a significant equity ownership position. The benefits of direct ownership lie
in the combination of equity ownership rights and management control rights.
Specifically, the ownership rights provide the much-needed management control
rights. In contrast, FPI represents essentially insignificant ownership rights and no
management control rights. To compete successfully, firms need to deploy
overwhelming resources and capabilities to overcome their liabilities of foreignness.
FDI provides one of the best ways to facilitate such extension of firm-specific
resources and capabilities abroad. Many firms prefer FDI over licensing because FDI
reduces dissemination risks, provides tight control over foreign operations, and
facilitates the transfer of knowledge through “learning by doing.”
2. Key Term
Dissemination risk: The possibility of unauthorized diffusion of firm-specific
know-how
3
Chapter 6: Investing Abroad Directly
LO4: Identify the ways your firm can acquire and neutralize location advantages.
1. Key Concepts
Certain locations possess geographical features that are difficult to match by others.
Beyond natural geographical advantages, location advantages also arise from the
clustering of economic activities in certain locations, referred to as agglomeration.
Location advantages refer to the advantages that one firm obtains when operating in
a location due to its firm-specific capabilities.
2. Key Term
Agglomeration: The clustering of economic activities in certain locations
3. Discussion Exercise
LO5: List the benefits of internalization.
1. Key Concepts
4
Chapter 6: Investing Abroad Directly
2. Key Term
Intrafirm trade: International trade between two subsidiaries in two countries
controlled by the same MNE
LO6: Identify different political views on FDI and understand its benefits and costs
to host and home countries.
1. Key Concepts
The realities of FDI are intertwined with politics. There are three primary political
views on FDI. First, the radical view on FDI is hostile to FDI. On the other hand, the
free market view on FDI suggests that FDI, unrestricted by government intervention,
will enable countries to tap into their absolute or comparative advantages by
specializing in the production of certain goods and services. Most countries embrace
the pragmatic nationalism view on FDI, considering both the pros and cons of FDI
and approving FDI only when its benefits outweigh its costs. Underpinning
pragmatic nationalism is the need to assess the various benefits and costs of FDI to
host (recipient) countries and home (source) countries.
2. Key Terms
3. Discussion Exercise
As detailed in the chapter, FDI is not just an investment in another company but
includes the control and management of the operations of a firm by a foreign
company. Though more and more countries have adopted policies favorable to FDI
5
Chapter 6: Investing Abroad Directly
in recent years, there remains a shade of the radical view that FDI is a device of
cultural imperialism that will adversely affect the host country.
How would you, as the manager of an MNE, address these cultural concerns about
FDI? What are some practical steps you can take to show that FDI has great benefits
for the host country’s population? What actions should you strictly avoid so that you
do not offend cultural sensitivities?
LO7. List three things you need to do as your firm considers FDI.
1. Key Concepts
Managers should carefully assess whether FDI is justified in light of other foreign
entry models such as outsourcing and licensing. Further, savvy managers need to pay
careful attention to the location advantages in combination with the firm’s strategic
goals. Finally, managers are advised to be aware of the institutional constraints and
enablers governing FDI and enhance legitimacy in host countries.
Debate: Ethical Dilemma/Emerging Markets
Welcoming versus Restricting Sovereign Wealth Fund Investments
1. Key Concepts
2. Key Term
Closing Case Discussion Guide
FDI in the Indian Retail Industry
6
Chapter 6: Investing Abroad Directly
1. Key Concepts
India’s retail industry is the country’s largest provider of jobs, accounting for 40
million jobs and 10% of GDP. At present, 92% of retail sales in India are made in
tiny mom-and-pop shops (kirana).
Although India has been welcoming FDI in general since 1991, the retail industry is
conspicuous in being one of the last four industries with FDI restrictions.
Until November 2011, FDI in multi-brand stores had been banned altogether. To
attract more FDI, the government announced that foreign firms could now own 51%
of multi-brand retailers (up from zero) and 100% of single-brand retailers (up from
51%).
Once a state gave its consent to support FDI, asserted the Ministry, the state could
not withdraw its support merely because of a change of the party in power.
Video Case
Watch “Maximizing Investors: Contributions,” by Candice Brown Elliott at
Clairvoyante.
1. What did Elliott mean when she compared “dumb money” to “smart money”?
2. What did Elliott mean by a “double bottom line” and how could the concept be
applied to FDI?
3. How could her reference to the “Rolodex” be applied to a firm entering a new market
in a new overseas location?
7
Chapter 6: Investing Abroad Directly
4. Elliott had different objectives for the first level of investors as opposed to those on
the second level. What were those objectives and how might they be applied when
developing a venture in another country?
5. Elliott talked about turning away those who were interested in investing in her
company. Why would anyone do that regardless of whether the venture is domestic
or international?
Additional Discussion Material
(From Prep Cards)
Critical Discussion Questions
1. Identify the top five (or ten) source countries of FDI into your country. Then identify
the top ten (or 20) foreign MNEs that have undertaken inbound FDI in your country.
Why do these countries and companies provide the bulk of FDI into your country?
2. Worldwide, which ten countries were the largest recipient and source countries of
FDI last year? Why? Will this situation change in five years? How about 20 years
down the road? Why?
8
Chapter 6: Investing Abroad Directly
3. On Ethics: Undertaking FDI, by definition, means not investing in the MNE’s home
country. What are the ethical dilemmas here? What are your recommendations as (1)
MNE executives, (2) labor union leaders of your domestic (home-country) labor
forces, (3) host-country officials, and (4) home-country officials?
Review Questions
1. Explain the differences between horizontal and vertical FDI.
2. What distinguishes an MNE from a non-MNE?
3. Can you summarize each of the OLI advantages?
4. How can FDI be used to overcome high transaction cost and prevent market failure?
A market transaction between an importer and an exporter may suffer from high
transaction costs due to opportunism. There is the potential for opportunism on both
9
Chapter 6: Investing Abroad Directly
sides.
5. Compare and contrast the three political views on FDI.
6. What are the costs and benefits of inbound FDI to host countries and of outbound
FDI to home countries?