Foreign direct investment (FDI) can be defined as "investment made to acquire lasting interest in enterprises operating outside of the economy of the investor." A parent enterprise and a foreign affiliate together form a multinational corporation (MNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate. The United Nations define control in this case as owning 10% or more of the ordinary shares or voting power of an incorporated firm, or its equivalent for an unincorporated firm (Wikipedia, 2008).
While FDI is considered to be accompanied by certain amount of risk to get unexpectedly low return on investment, and in some cases, even to loose completely an invested capital, this development approach is having significant advantages, causing many US companies to consider seriously this option as supplement to the direct trade arrangements.
There are four major types of business objectives, which outweigh the risks of FDI for the corporations, listed below (Daniels, Radebaugh, & Sullivan, 2001):
1. Sales Expansion.
In order to increase competitiveness in foreign markets, manufacturing and service providers are preferred to have a physical presence in those markets. Physical presence in different forms is a great way to circumvent trade barriers, official and hidden, to the new market. These barriers can be imposed by the government (in the form of foreign government pressure for local production) or media, or appear as psychological obstacles for the potential customers’ purchasing decision-making, based on prejudice to the country-of-origin of the manufactured product (Graham & Spaulding, 2004).
Among additional advantages we can note potential ability to decrease transportation costs from the country of manufacturing to the market, save on the human resources employment compensation in all areas of the company operations (manufacturing, marketing, sales, and technical support).
2. Resources Acquisition.
Reviewing the resources acquisition group of objectives, we can emphasize company’s potential savings through vertical FDI, where a firm establishes its manufacturing facilities, deliberately allocating different stages of production in different countries. These types of investment are developed based on the differences across countries in input costs and availability of the appropriate trained employees. An MNC involved in an extractive industry, where the endowment of natural resources is concentrated in certain countries, is an obvious example. Another example is the case in which a firm locates a certain labor-intensive stage of its production chain in a country with low labor costs; while at the same time locating production stages requiring substantial amounts of “human capital” in a nation where highly skilled workers are available (WTO, 1996).
Among additional advantages we can note general capability to increase total production capacity, increasing the operations portfolio, and gaining government incentives (sometimes, significant) for establishing business presence in these countries.
3. Risk Minimization.
To minimize risk of the business and financial instability, company can benefit from the FDI approach due to diversification. Diversification might appear in different forms. The most obvious form is product diversification, when one company is purchasing another company doing somewhat different activities than the purchaser, to seize new opportunities (Piana, 2005). Spreading its area of expertise for the wider application base, organization has better abilities to be flexible and survive unstable market demands for the particular products. Another form of diversification is a diversification of customer base, allowing leveraging the profits and risks throughout different customer clusters, saving company from severe hits that might be caused by recession and market saturation in one stand-alone country. And, finally, supplier base diversification helps to stabilize supply chain and secure components acquisition from vendors on safe and favorable conditions from multiple sources.
4. Political Objectives.
Some of the serious reasons in favor of FDI are tightly related to host government political and economic regulations. The FDI might also be driven by trade barriers, either existing measures - “tariff-jumping” FDI - or with the intention of reducing the probability of future protectionist measures, the so-called "quid pro quo" FDI (WTO, 1996).
Additional advantages might be gained, if the consumers on the host market are having certain, not very positive, sentiments towards the particular foreign product manufacturers, or the manufacturing nations. In these cases, local market penetration through locally produced and localized products will allow to improve the company’s product recognition and acceptance. There is a complicated interactive relationship between consumers and manufacturer. It is not manufacturer only, who make adjustments to the product in order to follow the consumer demand and capture the customer needs, but by introducing its goods in the daily life of the people, it changes their perception towards the manufacturing firm to some degree.
Daniels, J.D., Radebaugh, L.H., & Sullivan, D.P. (2001). Globalization and Business. New York: Prentice Hall. Ch. 5, pp. 111-113.
Graham, J.P. & Spaulding, R.B. (2004). Understanding Foreign Direct Investment (FDI). Retrieved August 8, 2008, from http://www.going-global.com/articles/understanding_foreign_direct_investment.htm
Piana, V. (2005). Foreign direct investment. Retrieved August 9, 2008, from http://www.economicswebinstitute.org/glossary/fdi.htm
Wikipedia (2008). Foreign direct investment. Retrieved August 8, 2008, from http://en.wikipedia.org/wiki/Foreign_direct_investment
World Trade Organization (1996, October 9). Trade and foreign direct investment. Retrieved August 9, 2008, from http://www.wto.org/english/news_e/pres96_e/pr057_e.htm
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