*** FDI1 ***

Various entry modes into foreign markets: advantages and disadvantages

Entry mode Advantage Disadvantage

NO OWNERSHIP INVOLVED

Exporting from home production scale economy; trade barriers; trade secrets kept transportation cost;

local marketing: by whom?

Turnkey little financial risk; may create efficient competitors;contracts possible where no long-term presence

FDI prohibited  [e.g., petrochemical plants]

Licensing low cost, low risks often lack of control over your own technology

[note: licensing and other types of contracts also used for FDI, outsourcing, …]

Franchising low cost, risks lack of control over quality; global strategic coordination difficult

[e.g., retail sector]

Entry mode Advantage Disadvantage

OWNERSHIP INVOLVED

Joint ventures access to local lack of controlpartner's knowhow over technology;in marketing, slow decision making personnel management, local government;shared risks and cost

Fully owned protection of high risks and high cost subsidiary technology;

fast decisions

BUSINESS DECISION: which mode of foreign entry?; what share of ownership, if ownership involved?

Foreign expansions with alternative ownership forms

Issue: which function to outsource and which to own?R&D, design, production, marketing/sales, …..

Original equipment manufacturer (OEM) outsources production

HP, Dell: both buy designed laptops from Quanta Computer in Taiwan

Qualcomm outsources production (known as a fab-less semi-conductor company

Apple?

Nike?

Coca-Cola?

SOME THEORIES ON FDI Efficiency considerations lead to various forms of FDI organizations

HORIZONTAL FDI: your FDI in the host country is in the same industry as in home country (e.g. following customers)

BACKWARD VERTICAL FDI: provides inputs into your home operation (e.g. resource FDI)

FORWARD VERTICAL FDI:receives from you the inputs produced in home country (e.g. sales/distribution channel FDI)

Vertical and horizontal integration often increases production efficiency due to scale economies.

Many theories try to explain why firms prefer FDI to pure "purchasing/selling arrangements“ [e.g. presence of trust in firms’ own FDI]

IMPORTANT FACTORS WHICH AFFECT FDI DECISIONS:

- TRANSPORTATION COSTS ($3-12 per auto tire)

- MARKET SIZE (e.g. economies of scale)

- MARKET IMPERFECTIONS (e.g. tariffs, quotas, .....)

- FEAR OF TECHNOLOGY/KNOW-HOW SPILLOVER (problems with technical licensing without ownership; but how much ownership?)

- FOLLOW-THE-LEADER AND/OR CUSTOMER, ME-TOO BEHAVIOUR (e.g. firms in Toyota/Honda/Nissan capital keiretsu firms)

- PLC STAGES ... AT SOME STAGE OF A PLC, YOU HAVE TO EXPLOIT FOREIGN MARKETS AND/OR SOURCE FROM FOREIGN LOW-COST PRODUCERS

- CORPORATE POLICY (to become multinational by policy?)

VARIOUS FORMS OF FOREIGN EXPANSIONS (ref. Head (111-129)) below

Home Country Foreign Country Home Centralization

(Exporting)

Replication

Foreign Centralization(Importing)

Home Centralization:

–Boeing commercial aircraft assembly in U.S. (mainly Seattle)

–Airbus commercial aircraft assembly in EU (mainly Toulouse)

Foreign Centralization:

–Mattel’s Barbie dolls (Dongguan, China)

–Panasonic’s TVs (Malaysia)

Area Sales Factories Employees

Americas 40% 32% 41%

Europe (Switz.)

40%(1.6%)

41%(1.8%)

34%(2.6%)

Asia, Africa & Oceania

20% 27% 25%

Nestle (replicator) had 254,000 Employees in 508 Factories in 85 Countries in 2002.

Strong economies of scale, that is plant-level fixed costs are high

Low trade costs to export to foreign country

Large home market

Home country has comparative advantage in production costs

The benefits of Home Centralization:

Strong economies of scale, that is plant-level fixed costs are high

Low trade costs to import from foreign country

Large foreign market

Foreign country has comparative advantage in production costs

The benefits of Foreign Centralization:

Absence of economies of scale, that is plant-level fixed costs should be low

Both markets are large

High trade costs impede exports & imports

Unimportant comparative advantages, that is costs of production similar across countries.

The benefits of Replication Form:

The following graphs show the tradeoffs between 'Home Centralization" and "Replication" strategies in terms of the foreign market size and distance

WH = home factory unit cost of productionWF = foreign factory unit cost of productionK = capital cost of building a new factoryT = transportation and trade costsMF = foreign market size (e.g. # of consumers)

Forms of multinational firms with multiple products

Upstream (U) creates inputs

Downstream (D) uses U inputs to create outputs

Example: ExxonMobil

Upstream: exploration and “production” in 40 countries

Downstream: refining and “marketing”

Owns 46 refineries, located in 26 countries

Operates 42,000 retail sites in 118 countries

The maps below show ExxonMobil's Upstream and Downstream operations.

Example: global iron and steel producers’ vertical resource FDI

Inputs (coal, iron ore) production iron and steel products

Global steel producers are joining the rush to feast on Canadian resources, tapping vast reserves of iron ore in a race to secure much-needed supply (March 2011).

-- India’s Tata Steel is the latest steel giant to tie up Canadian iron ore properties, signing a deal with a small upstart to advance a project in Quebec and

Labrador set to cost as much as $4.9-billion.

-- Deng Qilin, president of the Wuhan Iron & Steel Group Corp., said in an interview that negotiations with an unspecified Canadian partner will soon produce another deal, on the heels of agreements with Century Iron Mines Corp. and Adriana Resources Inc. to jointly develop

iron ore projects in northern Quebec.

Various forms of multinational operations for producing 2 vertically related products (various combinations of U and D)

E.g. U: auto parts D: passenger car

The firm wants to sell 2 related models of cars

Reasons for "vertical specialization":

Strong economies of scale, that is plant-level fixed costs are high

Low trade costs to export U to foreign country

Low trade costs to import D from foreign country

Home country has comparative advantage in production costs for U

Foreign country has comparative advantage in production costs for D"Branching form" examples:

Coca Cola’s concentrate (U) and bottling (D)Honda's engines (U) and car assembly (D)

Reasons for "branching form":Low trade costs on U, high on D

Low scale economies on D, high on UHome comp. adv. in U, weak comp. advs. in D

"Multi-sourcing form" examples:Refinery in one country, sourcing crude oil from multiple drilling sites (in different countries); Nike’s strategy of shoe manufacturing

Reasons for "multi-sourcing form":Low trade costs (for U & D)Diseconomies of scale for UUncertain comp. adv. for U.

More figures are found on Head, p.125.

Currently we are experiencing:(1)Falling trade costs

- more efficient transportation (containers, use of air transport)- lower tariffs, WTO oversight of disguised protection- technology-powered improvements in long distance communication

(2)This may be leading to increased "economies of scale"

The implications of (1) and (2) for multinational firms:Optimal configuration of your FDI network requires continuingly changing efficiency calculations; in

particular“Less Replication”, and more “Vertical Specialization”

But we also need to pay attention to industry-specific conditions:

Example: Compare various companies' foreign expansion strategies: Nestle, Boeing, Mattel

Their strategies are not likely to converge. (They will continue to pursue divergent strategies)