978-1473758438 Chapter 6

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For use with Peng and Meyer, International Business 3e, 9781473758438, © Cengage Learning

EMEA 2019

Instructor Manual

Chapter 6: Investing Abroad Direct

(Prepared by Klaus E. Meyer, March 2019)

Introduction to the Topic

Learning Objectives

1. Understand the vocabulary associated with foreign direct investment (FDI)

3. Explain why ownership advantage are necessary for firms to engage in FDI

5. Explain and apply the concept on internalisation advantages

7. Explain how home and host country institutions affect FDI

9. Draw implications for action

General Teaching Suggestions

Next to trade and financial investment, direct investment is a cornerstone of international

business. This is the second chapter on basic transactions laying theoretical foundations. We

use John Dunning’s OLI framework to explain why when and where companies engage in

direct investment, and round up the chapter with a brief discussion of the impacts and the role

of institutional influences on FDI. This chapter contains a lot of vocabulary that is important

to appreciate theories of the MNE.

Opening Case Discussion Guide

The opening case outlines how Spanish firms have successfully expanded beyond their own

country since the late 1990s. It introduces some of the biggest names of Spanish business

that students elsewhere in Europe may not yet know. Ask students why they think Spanish

MNEs have evolved to forcefully over the past decade and half. For example, why did many

Spanish firms do their firm big international investments in Latin America? Moreover, the

EU integration has changed over the past several years which could stimulate some firms to

strengthen their EU operation.

Chapter Outline, Section by Section

Section 1: The FDI Vocabulary

Key Ideas

This section introduces, brief and concisely, key terms on FDI and MNEs, and introduces

some key data on FDI stock and flow on a national level.

Key Concepts

foreign direct investment (FDI)

Investment in, controlling, and managing value-added activities in other countries.

multinational enterprise (MNE)

A firm that engages in foreign direct investment and operates in multiple countries.

foreign portfolio investment (FPI)

Investment in a portfolio of foreign securities such as stocks and bonds.

joint-venture

An operation with shared ownership by several domestic or foreign companies

horizontal FDI

A type of FDI in which a firm duplicates its home country-based activities at the same value chain

stage in a host country.

vertical FDI

A type of FDI in which a firm moves upstream or downstream in different value chain stages in a host

country.

upstream vertical FDI

A type of vertical FDI in which a firm engages in an upstream stage of the value.

downstream vertical FDI

A type of vertical FDI in which a firm engages in a downstream stage of the value chain in two

different countries.

FDI flow

The amount of FDI moving in a given period (usually a year) in a certain direction.

FDI stock

The total accumulation of inbound FDI in a country or outbound FDI from a country across a given

period of time (usually several years).

Section 2: OLI Paradigm

Key Ideas

The OLI paradigm is the most used framework to explain international production (or foreign

direct investment), most instructors are likely to be familiar with. We introduce it here in

ways that aim to familiarize students with a range of other concepts important to explain why

and where MNEs undertake FDI. Table 6.1. provides a concise overview.

Key Concepts

OLI paradigm

A theoretical framework positing that ownership (O), locational (L) and internationalization (I)

advantages combine to induce firms to engage in FDI

ownership advantages

Resources of the firm that are transferable across borders, and enable the firm to attain competitive

advantages abroad

location advantages

Advantages enjoyed by firms operating in certain locations.

internalization advantages

Advantages of organizing activities within a multinational firm rather than using a market transaction

Section 3: Ownership advantages

Key Ideas

The first element of the OLI is ownership advantages, which some authors also call firm

specific advantages. This idea is taking the idea of resources and capabilities international,

and thus a critical aspect is their transferability to other countries.

Key Concepts

location-bound resources

Resources that cannot be transferred abroad

Section 3: location advantages

Key Ideas

We introduce here different types of location advantages that enable countries (or other

geographic entities) to attract foreign investors: markets, resources agglomeration and

institutions.

Key Concepts

agglomeration

The location advantages that arise from the clustering of economic activities in certain locations.

knowledge spillover

Knowledge diffused from one firm to others among closely located firms.

Section 4: Internalization advantages

Key Ideas

This part explains and applies the concept on internalisation advantages why and MNEs

undertake FDI rather than non-equity forms of international business. High cross-board

transaction cost may result in market failure. A key advantage of FDI is its ability to reduce

transaction costs.

Key Concepts

Transaction costs

The cost of organizing a transaction

market failure

Imperfections of the market mechanism that make some transactions prohibitively costly

asset specificity

An investment that is specific to a business relationship

intra-firm trade

International trade between two subsidiaries in two countries controlled by the same MNE.

licensing

An external market transaction in which firms buy and sell technology and intellectual property rights.

dissemination risks

The risks associated with unauthorized diffusion of firm-specific know-how.

tacit knowledge

knowledge that is non-codifiable, and whose acquisition and transfer require hands-on practice.

Section 5: Benefits and costs of FDI

Key Ideas

This section provides a very brief introduction to the FDI spillovers literature by introducing

the main (possible) effects that FDI has on others in the home economy. Table 6.2 provides a

very condensed summary of a sprawling literature.

Instructors who feel this introduction is too brief can supplement it with my paper in JIBS

(2004, see reading to Chapter 1) or with the introduction to the paper collection (see readings

to this chapter).

Key Concepts

No new concepts

Section 6: National institutions and FDI

Key Ideas

Applying the institution-based view, we look at some of the institutions in home and host

economies that influence FDI decisions. This theme will be further deepened in Chapter 12

on foreign entry strategies.

Two In Focus deepen this section, one of state owned enterprises as MNEs, and one of

taxation and foreign investment. Both are highly topical issues. On SOEs, I have written two

blogs with Forbes and EIU, see links below. On Corporate taxation, I recommend the essay

by James Nebus in AIB Insights in issue 2/2016.

• http://www.forbes.com/sites/ceibs/2016/01/25/is-a-chinese-takeover-good-or-bad-for-your–

job/#116eff367ccb

• http://viewswire.eiu.com/index.asp?layout=EBArticleVW3&article_id=1873904171&channel_id=788

The ability to extract a favourable outcome from negotiations due to one party’s strengths.

obsolescing bargain

Refers to the deal struck by MNEs and host governments, which change their requirements after the

initial FDI entry.

sunk cost

Up-front investments that are non-recoverable if the project is abandoned.

expropriation

Government’s confiscation of private (foreign-owned) assets.

emerging economy MNEs

MNEs that originate from an emerging economy and are headquartered there.

sovereign wealth fund (SWF)

A state-owned investment fund composed of financial assets such as stocks, bonds, real estate, or other

financial instruments

Section 8: Implications for Practice

Key Ideas

The implications focus on the strategic decision to set up FDI projects, and thus link forward

to chapter 12.

Key Concepts

No new concepts

Review Questions

Review questions are provided to students on the website accompanying the book. They

directly ask to summarize the material provided in the text. Instructors may also use the

questions to structure their lectures or review sessions.

Review Questions

(as provided to students on the website)

Material in the Book

1. Distinguish key terminology with respect to FDI:

direct versus portfolio investment, horizontal

Pages 152-153

For use with Peng and Meyer, International Business 3e, 9781473758438, © Cengage Learning

EMEA 2019

versus vertical FDI, upstream versus downstream

FDI,

2. What inferences can you draw from analysing

respectively FDI stock or FDI flow data?

3. When do we call a firm a ‘multinational enterprise

(MNE)’?

4. Why do firms need ownership advantages to

5. What sort of locational advantages can attract

foreign investors, and why?

6. Why would firms want to ‘internalize’ cross-border

transactions within their organization?

7. Why would firms set up a FDI sales operation,

rather than export from the home country?

8. Why would firm set up a subsidiary to exploit a

technology rather than licensing that technology to

a local partner?

9. Why would firms set up a subsidiary to

manufacture abroad rather than outsource the

activity to an independent manufacturer?

10. What policies do national governments use to

control or restrict the activities of foreign MNEs?

11. What policies do national governments use to

control or restrict the activities of MNEs from their

own country?

12. How does national corporate taxation affect the

patterns of FDI?

13. What are the potential benefits and disadvantages

that local firms may experience as a result of FDI

coming to their country?

14. What are the potential benefits and disadvantages

that ordinary people – as consumer or workers –

may experience as a result of FDI coming to their

country?

15. Is FDI good or bad for the natural environment?

16. Explain the phenomenon of ‘obsolescing bargain’

in the relationship between MNEs and host

governments!

17. What is the role of sovereign wealth funds in the

global economy?

18. Explain the emergence of emerging economy

MNEs

Page 153-156

Page 152

Page 156-158 incl Table 6.1

Page 158-162 and Table 6.1

Page 163-164 and Table 6.1

Page 158

Page 165

Page 166

Page 166-168

Page 173-174

Page 172

Page 168-169, especially

Table 6.2

Page 167-167

Page 167

Page 173-174

Page 174-175

Page 174

Critical Discussion Questions

Closing Case

The closing case provides further opportunities to apply ideas and concepts learned in this

chapter in a real world setting. The Closing Case for this Chapter is “Politics and FDI in

Argentina” and focuses on FDI in an emerging economy, Argentina. Below are some indicative

responses to the case discussion questions.

Case Discussion Questions

(as provided in the book)

Indicative Responses

1. From a resource-based perspective,

what has motivated Repsol’s direct

investment in Argentina?

2. From an institution-based view,

how can companies protect their

interest in countries with instable

institutions, such as Argentina?

3. Why did the Argentinian

government act the way it did?

1. The key to this question is for

students to correctly identify

resources (also see Chapter 4), and

how they contribute to the firm’s

internationalization as O-

advantages.

2. This question is about identifying

possibly relevant institutions and

thus to demonstrate understanding

of the concept of institutions.

3. This question challenges students

to compare countries they know.

Key differences relate to influences

and results of privatisation and

renationalisation.

Further Learning Activities

In addition to the cases and discussion questions provided in the book, instructors may want

to use any of the following activities to further engage students with the material.

1. The Integrative Case “BMW faces Technological Disruptions” provides a brief

introduction to numerous technological changes affecting the automotive industry. In

2. The Integrative Case “Bharti Airtel Acquires Resources and Capabilities” have

been prepared to discuss the different strategies and motivations that drive FDI

EMEA 2019

capabilities (Chapter 4). They can also be used to discuss foreign entry strategies

(Chapter 12).

3. The case SSI Schaefer: Internationalization of Intra-Logistics introduces the notion

that companies traditionally operating as ‘manufacturing’ are moving to become

‘solutions provider’. This requires not only much higher degrees of customization and

4. Your MNE is looking to evaluate the industrial capability of various locations

worldwide. Based on readily available data concerning the potential and performance

of different countries, the information you provide will drive future investment by

your company. Choose a country each from Asia, Europe, North America, and South

America and summarize your findings about each. Of the four countries from four

continents, how would you rank them? Why?

5. The main premise for development at your company in the coming years is to shift its

offshore services to Africa. As such, you have been asked to develop a report that

evaluates which African countries have increased the possibility of creating a long-

term advantage for your company. Also, be sure to include the African countries that

have decreased their capacity to create a long-term advantage. Can you please

generate a top five list and a bottom five list from Africa for this purpose?

EMEA 2019

One resource which can be used is “A.T. Kearney: The Global Services Location

Index”. This website can be found by entering the search term “offshore services” at

the globalEDGE™ Resource Desk search box located at

http://globaledge.msu.edu/resourceDesk/. Once at the website, click on the View Data

link (found in the middle). Then, scroll to page 4 of the report for an evaluation of the

countries which have been included in the past two reports. Given the parameters of

the question, South Africa and Tunisia are the two countries which have increased as

a location to improve your company’s long-term advantage while Egypt and Ghana

have decreased. The nature of the measures used to determine the index can be found

on page 15 of the report. As such, there are three main categories (with the

appropriate sub-categories): financial attractiveness (compensation costs,

infrastructure costs, and tax and regulatory costs), people and skills availability

(remote services sector experience and quality ratings, labor force availability,

education and language, and attrition risk), and business environment (country

environment, infrastructure, cultural exposure, and security of intellectual property).

Search Term: “offshore services”

Resource Name: A.T. Kearney: The Global Services Location Index

Website: http://www.atkearney.com/index.php/Publications/global-services-location-

index.html

globalEDGE™ Tag: Rankings