11.2 Approaches to international business
FDI is one of several approaches that firms can use to enter foreign markets.The following is a common sequence that firms use to develop foreign markets for their products:
1.Export of the goods produced in the source country.
2.Licensing a foreign company to use a process or product technology.
3.Foreign distribution of products through a subsidiary.
4.Foreign (international)production, which is the production of goods and services in a country that is controlled and managed by firms headquartered in other countries.
Steps 3 and 4 involve FDI.Moving from Step 1 to Step 4 requires larger commitments of resources and in some respects greater exposure to risk.While this sequence may be a chronological path for developing foreign sales, it is not necessary that all four steps are taken sequentially, as some firms jump immediately to Step 3 or Step 4.
The choice between exporting and FDI depends on the following factors: profitability,opportunities for market growth, production cost levels and economies of scale.For example,multinational firms have traditionally invested in Singapore and Hong Kong Special Administrative Region of China because of the low production costs.For the same reasons,Singapore and Hong Kong Special Administrative Region of China have traditionally exported goods to other countries or regions.Initially, exports precede FDI, but after having become familiar with factor and output markets in the foreign country, a firm will establish a production facility there.FDI allows a firm to circumvent actual or anticipated barriers to trade.Another motive for indulging in FDI is the appreciation of the domestic currency, which reduces the competitiveness of exports.
Step 2 is licensing, which may be defined as the supply of technology and know-how or may involve the use of a trademark or a patent for a fee.It offers one way to circumvent entry barriers to FDI.Under these circumstances licensing offers an opportunity to generate revenue from foreign markets that are otherwise inaccessible.Furthermore, the license owner may often not have the capital, experience or risk tolerance associated with FDI.Firms prefer FDI to licensing in the case of complex technology or when the risk of leakage of technological advantage to competitors exists.
Franchising is another form of entering a foreign market under contractual agreements.Companies with brand name products (such as KFC and Burger King)move offshore by granting foreigners the exclusive right to sell their products in a designated area.The parent company provides the technical expertise pertaining to the production process as well as marketing assistance for an initial fee and subsequent royalties that are related to turnover.
FDI may take one of the three forms: green-field investments, cross-border mergers and acquisitions, and joint ventures.Green-field investments occur when the investing firm establishes new production, distribution or other facilities in the host country.This is normally welcomed by the host country because of the job-creating potential and value-added output.Sometimes the term brown-field investment is used to describe a situation where the investment that is formally an acquisition resembles green-field investment.This happens when the foreign investor acquires a firm but almost completely replaces the plant and equipment, labor and product line.
FDI may occur via an acquisition of, or a merger with, an established firm in the host country (the vast majority of M&As are indeed acquisitions rather than mergers).This mode of FDI has two advantages over green-field investment: (i)it is cheaper, particularly if the acquired project is a loss-making operation that can be bought cheaply; and (ii)it allows the investor to get quick access to the market.Firms may be motivated to engage in cross border acquisitions to bolster their competitive positions in the world market by acquiring special assets from other firms or by using their own assets on a larger scale.
Whether a firm would choose M&As or green-field investment depends on a number of firm specific, host country-specific and industry-specific factors, including the following:
● Firms with lower research and development (R&D)intensity are more likely to indulge in M&As than those with strong technological advantages.
● More diversified firms are likely to choose M&As.
● Large multinational firms are more inclined to indulge in M&As.
● Cultural and economic differences between the home country and the host country reduce the tendency to M&As.
● Multinational firms with subsidiaries in the host country prefer acquisitions.
● The tendency towards M&As depends on the supply of target firms.
● Slow growth in all industry encourages M&As.
Cross-border acquisition of businesses is a politically sensitive issue, as most countries prefer to retain local control of domestic firms.It follows that although countries may welcome green-field investment, foreign firms’ bids to acquire domestic firms are often resisted and sometimes even resented.The underlying argument here is that M&As are less beneficial than green-field FDI, and may even be harmful, because they do not contribute to productive capacity and may be accompanied by lay-offs or the termination of some beneficial activities.If mergers and acquisitions take place in some sensitive areas (such as the media),then it may seem (perhaps justifiably)like a threat to the national culture or identity.
Whether or not cross-border acquisitions produce synergetic gains and how such gains are divided between acquiring and target firms are important issues from the perspective of shareholders’ welfare and public policy.Synergetic gains are obtained when the value of the combined firm is greater than the stand-alone valuations of the individual (acquiring and target)firms.If cross-border acquisitions generate synergetic gains, both the acquiring firm and the target firm’s shareholders gain wealth at the same time.Synergetic gains may or may not arise from cross-border acquisitions depending on the motive of acquiring firms.In general, gains will result when the acquiring firm is motivated to take advantage of market imperfections such as mispriced factors of production or to cope with trade barriers.
FDI can also take the form of joint ventures either with a host country firm or a government institution, as well as with another company that is foreign to the host country.One side normally provides the technical expertise and its ability to raise finance whereas the other side provides valuable input through its local knowledge of the bureaucracy as well as local laws and regulations.