Chapter 7

Foreign Direct
Investment
 Chapter Preview

• Characterize global FDI flows and patterns

• Discuss each theory that tries to explain FDI
• Identify important management issues in the
FDI decision
• Explain why home and host nations intervene
in FDI flows
• List the methods that nations use to promote
and restrict FDI
© Prentice Hall, 2008 International Business 4e Chapter 7 - 2
 Foreign Direct Investment

 Purchase of physical assets or

significant amount of ownership
of a company in another country
to gain some measure of
management control

 By contrast, portfolio investment

does not involve obtaining a
degree of control in a company

© Prentice Hall, 2008 International Business 4e Chapter 7 - 3

 Growth of World FDI vs. GDP

© Prentice Hall, 2008 International Business 4e Chapter 7 - 4

 Reasons for FDI Growth

Increasing
globalization

International mergers
and acquisitions

Entrepreneurship
and small firms
© Prentice Hall, 2008 International Business 4e Chapter 7 - 5
 Value of Cross-Border M&As

© Prentice Hall, 2008 International Business 4e Chapter 7 - 6

 Worldwide FDI Flows

World FDI inflows 70,000 multinationals

 Developed (58%), developing (36%)

 European Union: 33% of world FDI

Developing nations
 China: 9% of world FDI
with
 All of Africa: 3% of world FDI 690,000 affiliates
© Prentice Hall, 2008 International Business 4e Chapter 7 - 7
 International Product Life Cycle

A company begins by exporting its product and later undertakes

foreign direct investment as a product moves through its life cycle

© Prentice Hall, 2008 International Business 4e Chapter 7 - 8

 Market Imperfections
(Internalization)

Company undertakes FDI to

internalize a transaction that
is being made inefficient by
a market imperfection

 Trade barriers
(e.g., tariffs)
 Specialized knowledge
(e.g., managerial ability)

© Prentice Hall, 2008 International Business 4e Chapter 7 - 9

 Eclectic Theory

A firm undertakes FDI when location, ownership, and

internalization advantages combine to make a location appealing

Location Ownership Internalization

advantage advantage advantage
(optimal location) (special asset) (efficiency)

© Prentice Hall, 2008 International Business 4e Chapter 7 - 10

 Market Power

A firm undertakes FDI to establish a dominant presence in an industry

Market power
= Greater profits

Vertical integration
Extends company’s activities
into stages of production that
provide its inputs (backward
integration) or absorb its out-
puts (forward integration)

© Prentice Hall, 2008 International Business 4e Chapter 7 - 11

 Management Issues and FDI

Control
Control Purchase-or-build
Purchase-or-build
••Partnership
Partnershiprequirements
••Benefits
requirements decision
decision
Benefitsof
ofcooperation
cooperation

Production
Production costs
costs Customer
Customer
••Rationalized
Rationalizedproduction
••Cost
production knowledge
knowledge
CostofofR&D
R&D

Following
Following Following
Following
clients
clients rivals
rivals
© Prentice Hall, 2008 International Business 4e Chapter 7 - 12
 Balance of Payments
National accounting system that records all payments to entities
in other countries and all receipts coming into the nation

Current account Capital account

Records transactions Records transactions

involving the import and involving the purchase
export of goods and or sale of assets
services, income receipts (including assets such
on assets abroad, and as property and shares
income payments on of common stock in a
foreign assets inside the company)
country

© Prentice Hall, 2008 International Business 4e Chapter 7 - 13

 Why Host Intervenes in FDI

Initial FDI boosts economy

Balance of Payments FDI may decrease import

+ demand

FDI may generate exports

Access technology
Obtain resources
and benefits Access management skills
+
Create employment

© Prentice Hall, 2008 International Business 4e Chapter 7 - 14

 Why Home Intervenes in FDI

–– Removes
Removesresources
resourcesfrom
fromthe
thenation
nation
–– Can
Caneliminate
eliminatean
anexport
exportmarket
market
–– Might
FDI Mighteliminate
eliminatedomestic
domesticjobs
jobs

++ May
Mayimprove
improvenational
nationalcompetitiveness
competitiveness
++ Can
Canoffshore
offshore‘sunset’
‘sunset’industries
industries

© Prentice Hall, 2008 International Business 4e Chapter 7 - 15

 Host Promotion Methods

Financial Infrastructure
incentives improvements
Low or waived taxes Improved seaports, roads,
Low-interest loans telecommunications
networks

© Prentice Hall, 2008 International Business 4e Chapter 7 - 16

 Host Restriction Methods

Ownership Performance
restrictions demands
Prohibit investment Local content reqmnt.
in certain industries Technology transfers
or businesses Export targets

© Prentice Hall, 2008 International Business 4e Chapter 7 - 17

 Home Promotion Methods

Insurance on Loans and loan Special tax

assets abroad guarantees treaties

Tax breaks on profits Persuade other nations

earned abroad to accept FDI

© Prentice Hall, 2008 International Business 4e Chapter 7 - 18

 Home Restriction Methods

Higher tax rates on

foreign income

Sanctions on
specific nations

© Prentice Hall, 2008 International Business 4e Chapter 7 - 19

 Chapter Review

• Characterize global FDI flows and patterns

• Discuss each theory that tries to explain FDI
• Identify important management issues in the
FDI decision
• Explain why home and host nations intervene
in FDI flows
• List the methods that nations use to promote
and restrict FDI
© Prentice Hall, 2008 International Business 4e Chapter 7 - 20