Chapter 08 ‒ Foreign Direct Investment
Foreign Direct Investment
Learning Objectives
• LO8-1: Recognize current trends
regarding foreign direct investment
(FDI) in the world economy.
• LO8-2: Explain the different
theories of FDI.
• LO8-3: Understand how political
ideology shapes a government’s
attitudes towards FDI.
• LO8-4: Describe the benefits and
costs of FDI to home and host
countries.
The focus of this chapter is foreign direct
investment (FDI). The growth of foreign direct
investment in the last 25 years has been
phenomenal. FDI can take the form of a foreign
firm buying a firm in a different country, or
deciding to invest in a different country by
building operations there.
With FDI, a firm has a significant ownership in a
foreign operation and the potential to affect
managerial decisions of the operation.
The goal of our coverage of FDI is to understand
the pattern of FDI that occurs between countries,
and why firms undertake FDI and become
multinational in their operations as well as why
firms undertake FDI rather than simply exporting
products or licensing their know-how.
8
7
Chapter 08 ‒ Foreign Direct Investment
OUTLINE OF CHAPTER 8: FOREIGN DIRECT INVESTMENT
Opening Case: Starbucks’ Foreign Direct Investment
Introduction
Theories of Foreign Direct Investment
Why Foreign Direct Investment?
Management Focus: Burberry Shifts Its Entry Strategy in Japan
The Pattern of Foreign Direct Investment
The Eclectic Paradigm
Political Ideology and Foreign Direct Investment
The Radical View
The Free Market View
Pragmatic Nationalism
Shifting Ideology
Benefits and Costs of FDI
Host-Country Benefits
Host-Country Costs
Home-Country Benefits
Home-Country Costs
International Trade Theory and FDI
Government Policy Instruments and FDI
Home-Country Policies
Host-Country Policies
International Institutions and the Liberalization of FDI
Chapter 08 ‒ Foreign Direct Investment
CLASSROOM DISCUSSION POINT
Ask students for examples of foreign firms that have invested in the U.S. Jot them down
on the board.
Then, discuss why these companies invested in the U.S. Try to follow the framework
presented in the text, and refer back to the board during the presentation of the material.
Next, explore what the investment means for the U.S.
OPENING CASE: Starbucks’ Foreign Direct Investment
Summary
The opening case explores the foreign investment strategy of Starbucks, the iconic coffee
chain that grew from a single store in Seattle to a global chain of some 28,000 stores
located across 76 countries. The growth of Starbucks is remarkable both for its speed, just
40 years, and for its approach, mainly wholly owned stores with some joint ventures.
Starbucks is also credited for changing the global culture of coffee from what had been a
largely ordinary relatively standardized product to a highly tailored experience to be
shared with friends, enjoyed alone, or taken as part of business meeting, and more.
Discussion of the case can begin with the following questions:
QUESTION 1: Why did Starbucks enter Japan and China via a joint venture rather than
as wholly owned subsidiaries? What are the benefits of this approach? Do you see any
drawbacks?
ANSWER 1: After successfully establishing itself in the United States, Starbucks began
exploring opportunities to expand into foreign markets. In 1995, Starbucks entered into a
QUESTION 2: How did Starbucks ensure that its model was successfully transferred to
Japan? Why was this important to the company?
ANSWER 2: When Starbucks initially chose Japan as the target for its first foray into
foreign markets, the company took steps to ensure that the experiences of its customers in
Chapter 08 ‒ Foreign Direct Investment
QUESTION 3: Why did Starbucks change its strategy in China and Japan from a joint
venture format to a wholly owned subsidiary model? What is the company hoping to
achieve with this change?
ANSWER 3: Most students will probably agree that while a joint venture made sense for
Starbucks when it was just beginning to expand into foreign markets, today with 28,000
stores located across 76 markets, the company has accelerated the learning curve, making
wholly owned properties more attractive even in markets that are very different from the
LECTURE OUTLINE
This lecture outline follows the Power Point Presentation (PPT) provided along with this
instructor’s manual. The following provides a brief overview of each Power Point slide
along with teaching tips and additional perspectives.
Slide 8-3 What Is Foreign Direct Investment?
Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to
produce and/or market in a foreign country. Once a firm undertakes FDI it becomes a
multinational enterprise.
Chapter 08 ‒ Foreign Direct Investment
FDI can take the form of a greenfield investment, in which a wholly new operation is
established in a foreign country, or it can take place via acquisitions or mergers with
existing firms in the foreign country.
Trends in FDI
There has been a marked increase in both the flow and stock of FDI in the world
economy over the past 25 years.
The Direction of FDI
While the United States remains a top destination for FDI flows, South, East, and
Southeast Asia, and particularly China, are now seeing an increase of FDI inflows, and
Latin America is also emerging as an important region for FDI.
CONNECT
Video Case
Did You Know That the Value of Foreign Direct Investment Has Been Growing Faster than
World Trade and World Output?
Summary
This activity focuses on foreign investment, why companies choose it, what it means to home and
host countries, and the role of government policy on a firm’s investment decisions.
Activity
Students are asked to watch a video on foreign investment and then respond to a series of
questions related to the video.
Chapter 08 ‒ Foreign Direct Investment
The Source of FDI
Since World War II, the U.S. has been the largest source country for FDI. The United
Kingdom, the Netherlands, France, Germany, and Japan are other important source
countries.
The Form of FDI: Acquisitions versus Greenfield Investments
Most cross-border investment is in the form of mergers and acquisitions rather than
greenfield investments.
CONNECT
Video Case
Foreign Investment
Summary
This activity focuses on patterns of foreign investment. Foreign investment has grown
substantially since World War II with the United States being both the largest recipient of foreign
investment and the largest source of foreign investment.
Slides 8-12 ‒ 8-18 Theories of Foreign Direct Investment
There are three theories that approach the various phenomena of foreign direct
investment from three complementary perspectives.
Why Foreign Direct Investment?
Why do firms choose FDI instead of exporting or licensing? Internalization theory
(also known as market imperfections theory) suggests that licensing has three major
drawbacks.
The Pattern of Foreign Direct Investment
Knickerbocker looked at the relationship between FDI and rivalry in oligopolistic
industries (industries composed of a limited number of large firms) and suggested that
FDI flows are a reflection of strategic rivalry between firms in the global marketplace.
Chapter 08 ‒ Foreign Direct Investment
CONNECT
Case Analysis
Burberry
Summary
This activity focuses on the benefits and drawbacks of licensing versus foreign direct investment.
Luxury apparel maker Burberry recently ended its licensing arrangement in Japan and opened its
own operations there instead.
The Electric Paradigm
According to the eclectic paradigm, in addition to the various factors discussed earlier, it
is important to consider:
• Location-specific advantages—that arise from using resource endowments or
assets that are tied to a particular location and that a firm finds valuable to
combine with its own unique assets.
• Externalities—knowledge spillovers that occur when companies in the same
industry locate in the same area.
CONNECT
Case Analysis
Exporting, Licensing, or FDI
Class Discussion
Understanding the choice between exporting, licensing, and foreign direct investment is essential
for managers making decisions about expanding into foreign markets. Choose a few companies
that have recently expanded into foreign markets and ask students to explain the strategic choices
for each firm.
Chapter 08 ‒ Foreign Direct Investment
Slides 8-19 ‒ 8-22 Political Ideology and Foreign Direct Investment
Ideology toward FDI ranges from a radical stance that is hostile to all FDI to the non–
interventionist principle of free market economies. Between these two extremes is an
approach that might be called pragmatic nationalism.
Pragmatic Nationalism
Pragmatic nationalism suggests that FDI has both benefits, such as inflows of capital,
technology, skills and jobs, and costs, such as repatriation of profits to the home country
and a negative balance of payments effect.
Shifting Ideology
Recently, there has been a strong shift toward the free market stance creating:
CONNECT
Click and Drag
Political Ideology and FDI
Summary
This activity explores political ideology toward FDI. Political ideology can range from radical to
free market to pragmatic nationalism. At one end of the spectrum is hostility toward inward FDI
while at the other end is the principle of free market economics.
Chapter 08 ‒ Foreign Direct Investment
There are four main benefits of inward FDI for host countries: resource transfer effects;
employment effects; balance of payments effects, and effects on competition and
growth.
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 and FDI
International trade theory suggests that home country concerns about the negative
economic effects of offshore production (FDI undertaken to serve the home market)
may not be valid.
CONNECT
Click and Drag
The Costs and Benefits of FDI
Activity
Students are asked to match various costs and benefits of FDI to the correct home country or host
country.
Class Discussion
Managers need to understand the costs and benefits of FDI for both the home country and for the
host country. Consider foreign investment near you and what benefits that investment has brought
to the local community. Are there any drawbacks to the investment?
Chapter 08 ‒ Foreign Direct Investment
CONNECT
Click and Drag
Why FDI?
Summary
This activity explores the choice of FDI as compared to exporting and licensing. Each entry
method means different things to the home and host country.
Class Discussion
Managers need to understand the costs and benefits of exporting, licensing, and foreign direct
investment. Develop a few decision scenarios that an organization may face regarding foreign
expansion and ask students to determine which entry mode makes sense and why. Then ask what
the choice means for the host country and for the home country.
Slides 8-32 ‒ 8-35 Government Policy Instruments and FDI
Home countries and host countries use various policies to regulate FDI.
International Institutions and the Liberalization of FDI
The World Trade Organization is trying to establish a universal set of rules designed to
promote the liberalization of FDI.
Slide 8-36 ‒ 8-39 Focus on Managerial Implications
FDI and Government Policy
Managers need to consider what trade theory implies, and the link between government
policy and FDI.
Chapter 08 ‒ Foreign Direct Investment
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
FDI-friendly while Japan has discouraged inward FDI. Both are trade-dependent
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 section titled “Burberry Shifts Its Entry
Strategy in Japan” and then answer the following questions:
a. Why did Burberry initially choose a licensing strategy to expand its presence in Japan?
b. What limitations of licensing became apparent over time? Should Burberry have
expected these drawbacks to arise?
c. Was terminating the Japanese licensing agreement and opening wholly owned stores
the correct strategy for Burberry? What are the risks here?
ANSWER 4:
a. For nearly half a century, Burberry’s licensing arrangement with Sanyo Shokai
generated revenues of about $800 million per year for the British apparel maker. For
Burberry, the arrangement was a good one because it allowed Burberry to avoid the costs
and risks of developing the iconic brand in Japan.
c. 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, Burberry
will have complete control over its store format, pricing, and branding—all of which are
critical for the retailer if it wants to maintain the integrity of its reputation as a maker of
high-end luxury apparel. That being said, Burberry will now incur all of the costs and
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 United
States, (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
Chapter 08 ‒ Foreign Direct Investment
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: Geely Goes Global
Summary
The closing case explores the acquisition of Sweden’s Volvo by Chinese giant Geely,
now the second largest private automobile manufacturer in China. Geely made the
decision to acquire Volvo in an effort to gain the engineering and design skills it needed
to successfully compete in the auto industry. So far, the acquisition has been a huge
success. Geely has been able to combine Volvo’s brand allure along with its engineering
design skill with its own prowess as a manufacturer. Today, Volvos are designed,
engineered, and tested in Sweden, and then manufactured in China or the United States.
Discussion of the case can begin with the following questions:
QUESTION 1: Why did Geely acquire Volvo? What are the benefits of acquisition?
What are the potential costs and risks?
ANSWER 1: When it initially ventured into the auto industry, Geely spent significant
time and effort trying to develop its own cars, but with little success. By acquiring Volvo,
Geely instantly acquired what it had been unable to develop itself and was able to rapidly
QUESTION 2: The Volvo acquisition allowed Geely to grow its sales in China. Why
might an acquisition have been preferred to simply licensing the brand and know-how
from Volvo (assuming that was an option)?
Chapter 08 ‒ Foreign Direct Investment
8-14
ANSWER 2: Most students will probably agree that for Geely an acquisition was
preferable to a licensing arrangement because it would allow each player to capitalize on
its strengths, but still allow Geely to call the shots. Geely has an advantage in
QUESTION 3: Following the Volvo acquisition, Geely built a new, wholly owned
factory to produce Volvo cars in the United States. Why was a direct investment strategy
preferred to other ways of growing the U.S. market, such as through exporting or
licensing the Volvo brand and designs to another producer?
ANSWER 3: Students will probably focus on a few key areas when responding to this
question. Some will note the value of producing within the target market. Students
exploring this point will probably suggest that being in the market allows Geely to better
understand its customer. Some students might point out that with U.S. production, Geely
QUESTION 4: What are the benefits of Geely’s investment in South Carolina to the
U.S. economy? What are the potential costs? Do you think it was in the interests of the
United States to let this investment proceed?
ANSWER 4: Geely’s South Carolina plant could be an economic windfall for the state.
The investment will bring jobs and capital investment as well as spillover benefits to the
local community. Furthermore, Geely plans to expand production in South Carolina
within a few years increasing its benefits. Many students will probably agree that while
there may be some drawbacks such as the repatriation to China of profits related to the
Chapter 08 ‒ Foreign Direct Investment
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.
CONNECT
Geography
Activity
Students are asked to respond to a series of questions related to the geographic location of several
countries.
Class Discussion
Understanding the geographic location of countries is essential to the understanding of
international business. Ask students to discuss the implications of the geographic locations of the
countries in this exercise on the subject matter.
INCORPORATING globalEDGE™ 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
An integral part of successful foreign direct investment 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
Chapter 08 ‒ Foreign Direct Investment
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
Additional Info:
The ranking of the largest transnational corporations in the world is an annex to the
annual World Investment Report published by the United Nations Conference on Trade
and Development (UNCTAD). There are two separate rankings, one for financial
corporations and another one for the nonfinancial corporations.
Exercise 2 Answer
Additional Info:
The Water and Wastewater Sector Brief can be reached by visiting the Resources section,
choosing Briefs and Case Studies on the left menu, and then clicking on the Water link.