CHAPTER 8
FOREIGN DIRECT INVESTMENT
Case: Bridgestone Tire Company
- Increasing oligopolization of the Tire Industry
- New tires demand high-tech innovations, expensive Only few tire
companies can afford, the ones with high sales volume
- Bridgestone Tire Company is the world's largest manufacturer
of rubber products
- Exports started to increase as foreign consumers wanted Bridgestone
replacement s on the Japanese cars they had Purchased (original
equipment market)
- Establishing manufacturing presence overseas, vital for the
future growth of Bridgestone
- In 1988 Bridgestone bought Firestone's tire operations. Firestone
supplied 40% of Ford's needs, 21% of GM's.
- Why should Bridgestone manufacture automobile tires in the U.S.?
- 1. government-imposed restrictions on tire imports
- 2. Action taken against imports of Japanese vehicles
- 3. Japanese costs went up in relation to U.S. costs
- 4. High-transport costs for tires, which are bulky
- relative to their value
Why buy Firestone rather than starting up a new facility?
1. expectation of overcapacity in the industry
I - INTRODUCTION
Foreign Direct Investment is now more important than trade as
a vehicle of international transactions.
Overseas production facilities comprise a large and increasingly
vital part of international companies' global strategies
II - THE MEANING OF FOREIGN DIRECT INVESTMENT
Control:
For direct investment to take place, control must follow the investment.
Ownership of a minimum of 10% or 25% of the voting stock in a
foreign enterprise allows the investment to be considered direct.
However, government interference, and lack of control over inputs
may exert influence on the company.
The Concern about Control:
Many critics are concerned that the national interest of the host
country will not be best served if a multinational company makes
decision from afar.
Investor Concern:
Control is of paramount importance who are reluctant to transfer
resources such as patents, trademarks, management know-how.
Desire to deny rivals access to competitive resources is referred
to as the appropriability theory. Acquired technology can be used
to competitive advantage.
Ex: transistor technology
Control through self-handling of operations (internal to the organization),
rather than through contracts with other companies, is often called
internalization.
Methods of Acquisition:
Instead of capital movements an investor may transfer other types
of assets. Ex: managers, cost control systems, technology, know-how.
III - THE RELATIONSHIP OF TRADE AND FACTOR MOBILITY
The Trade and Factor Mobility:
Direct investment usually involves the movement of various types
of production factors as investors infuse capital, technology,
personnel, raw materials, or components into their operating facility
abroad.
Production factors move internationally. Factor movement is an
alternative to trade that may or may not be a more efficient allocation
of resources.
Substitution:
When the factor proportions vary widely among countries, pressures
exist for the most abundant factors to move to countries with
greater scarcity, where they can command a better return
Capital/labour ratios
Capital/land ratios
Capital moves globally more easily than does labour. Technology
in the form of more efficient machinery is more mobile than labour
is.
Thus, differences in labour productivity and costs explain much
of the movement of trade and direct investment.
Complementarity of Trade and Direct Investment
Companies usually send substantial exports to their foreign facilities.
FDI usually is not a substitute for exporting.
About a third of world trade is intra-firm trade
Many of the exports from parent to subsidiary would not occur
if overseas investment did not exist. In these cases, factor movements
stimulate trade rather than substituting for it.
IV - MOTIVATIONS FOR FDI AS AN ALTERNATIVE OR
SUPPLEMENT TO TRADE
A - Market Expansion: Investments versus Trade
Transportation: When the cost of transportation is added to production
costs, some products become impractical to ship over greater distances.
Ex: tires, soft drinks.
Horizontal Expansion: When companies invest abroad to produce
basically the same products that they produce at home.
Lack of Domestic Capacity: As long as a company has excess capacity
at its home-country plant (s) it may be able to compete effectively
export markets despite high transport costs.
Scale Economies: If the product is highly standardized or undifferentiated
form those of competitors, the cost per unit is apt to drop significantly
as output increases. Ex: ball bearings, alumina, semiconductor
wafers. And they can overcome transportation costs. Products that
are more differentiatedbenefit less by scale economies. For these
types of products, transport costs may dictate smaller plants
to serve national or regional markets.
Trade Restrictions: tariffs and non-tariff barriers act as an
enticement for making foreign direct investment. Removing trade
restrictions among a regional group of countries also may attract
direct investment.
Country-of-Origin Effects: fear that service and replacement parts
for imported products will be difficult to obtain.
Nationalism: buy locally produce goods
Product Image: manufacturing in a country that has lower-status
image for a particular product.
Delivery Risk: just-in-time manufacturing systems (JIT)
Changes in Comparative Costs: dynamic process.
B - Resource-Acquisition Investments
Resource acquisition imply a need to import from abroad, FDI is
a supplement rather than an alternative to trade.
Vertical Integration: control of the different stages (value chain)
as a product moves from raw materials through production to its
final distribution.
As products and their marketing become more complicated, there
is a greater need to combine resources that are located in more
than one country. Great interdependence among inputs and a strong
need to establish tight relationships in order to ensure that
production and marketing continue to flow.
Gain voice in the management of one of the foreign operations
by investing in it.
Increasing barriers to entry
Rationalized Production: producing different components and parts
in different parts of the world to take advantage of varying costs
of labour, capital, and raw materials.
Access to Production Factors: a company may establish a presence
in a country to improve its access to knowledge and other resources.
Product Life Cycle: New products are produced mainly in industrial
countries, mature produces are more likely to be produced in LDCs.
Governmental Investment Incentives: countries frequently encourage
direct investment inflows by offering tax concessions or a wide
array of other subsidies.
C - Diversification-Oriented Investments
Companies may pursue international business, at least partially,
to minimize cyclical swings in sales and profits and to reduce
the dependence on a few customers or suppliers.
D - Competitive Risk Minimization
Following Customers: the indirect exporters commonly follow their
customers when those customers make direct investments.
Preventing Competitor's Advantage: oligopolistic competition
E - Political Moves
Since the passing of colonialism, some countries continued to
pursue many of the old colonial aims by encouraging their domestically
based companies to control vital sectors in the economies of LDCs.
F - Buy-versus- Build Decision
Acquisition: avoiding start-up problems, easier financing, adding
no further capacity in the market.
Build: no desired company is available for acquisition; acquisition
is harder to finance; acquisition will carry over problems.
G - Advantages of Foreign Direct Investment
Are multinationals profitable because they are multinational or
multinational because they are profitable?
Very successful domestic companies are most likely to commit resources
to FDI.
Monopoly Advantage: Companies perceive that they hold some supremacy
over similar companies in the countries into which they go.
The advantage results from a foreign company's ownership of some
resources that is unavailable at the same price or terms to the
local company.
Cost of borrowing capital from different countries; currency oscillations
V - DIRECT INVESTMENT PATTERNS
Biggest growth in FDI has occurred in recent years.
During the 1980s, flows of FDI grew at about three times the rate
of world exports.
Country of Origin: 90% of all direct investment, coming from developed
countries
Mini-Multinationals
FDI flowing into the U.S.
Location of Investment: the major recipients of FDI are industrial
countries, which received 83% of the world's between 1986 and
1990, and about 85% in 1995.
Interest in Developed Markets: political instability in LDCs,
more investment have been market-seeking, more liberal FDI environment.
Economic Sector of Investment: Over time the portion of FDI accounted
for in the raw materials sectors that includes mining, smelting,
and petroleum has declined.
The portion in manufacturing, especially resource-based production
grew steadily from the 1920s to the early 1970s
FDI in the service sector (especially banking and finance) grew
rapidly, as did FDI in technology-intensive manufacturing.
COUNTERVAILING FORCES