FOREIGN DIRECT INVESTMENT IN TELECOM SECTOR OF PAKISTAN

M USMAN AFZAL

07000441

MSc INTERNATIONAL BUSINESS AND MANAGEMENT DISSERTATION

2008

CONFIDENTIALITY STATEMENT

This dissertation has been agreed as confidential between the students, university and sponsoring organisation. This agreement runs for two years from

(20 August 2008)

STATEMENT OF AUTHENTICITY

I have read the University Regulations relating to plagiarism and certify that this dissertation is all my own work and do not contain any unacknowledged work from

other sources.

WORD COUNT: 16,808

ABSTRACT

07000441

FOREIGN DIRECT INVESTMENT IN TELECOM SECTOR OF PAKISTAN

Keywords: FDI, Entry Modes, Determinants, Risks, Pakistan Telecom

Abstract

Pakistan telecom sector has attracted large inflow of foreign direct investment in recent

years. Government policy of deregulation and privatization has created an environment

conducive for foreign direct investment in telecom sector of Pakistan. This paper will

investigate all those factors which have contributed in attracting the foreign direct

investment in telecom sector of Pakistan. However, there are some risks associated with

the foreign direct investment in telecom sector due to the current political instability and

terrorism in the country. This paper will examine the risks associated with the foreign

direct investment in telecom sector of Pakistan. Subsequently it will explore entry

strategy for foreign companies to enter in Pakistan telecom market.

FOREIGN DIRECT INVESTMENT IN TELECOM SECTOR OF PAKISTAN

By

M USMAN AFZAL

07000441

2008

Dissertation submitted to the Bradford University School of Management in partial fulfilment of the requirements for the degree of Master of Science in Finance, Accounting and Management

MSc International Business & Management

Dedication

I would like to thank my supervisor, Mr. Ismo Kuhanen for his insightful and

constructive guidance over the last three months. His generous and disciplinary attitude

encouraged me to complete this dissertation. I would also like to pay special tribute to

my parents who supported and encourage me all through my master’s degree.

List of Abbreviations

3G- Third Generation

BMI- Business Monitor International LTD

FDI - Foreign Direct Investment

GDP- Gross Domestic Product

GSM- Global System for Mobile Communication

IMF- International Monetary Fund

OECD- Organization for Economic Co-operation and Development

PTA- Pakistan Telecom Authority

PTC- Pakistan Telecommunications

PTCL- Pakistan Telecommunication Company Limited

T&T- Telephone and Telegraph

UAE- United Arab Emirates

UNCTAD- United Nations Conference on Trade and Development

WLL- Wireless Local Loop

WTO- World Trade Organization

Table of Contents

List of Tables...................................................................................................................10List of Figures..................................................................................................................11Chapter 1. Introduction....................................................................................................13

1.1 Background............................................................................................................131.2 Research Gap.........................................................................................................151.3 Research Objective................................................................................................151.4 Research Questions...............................................................................................151.5 Research Structure.................................................................................................16

Chapter 2. Research Methodology..................................................................................172.1 Qualitative Method................................................................................................172.2 Philosophy.............................................................................................................172.3 Approach...............................................................................................................182.4 Purpose of the Research........................................................................................182.5 Research Strategy..................................................................................................192.6 Data Sources..........................................................................................................19

2.6.1 Secondary data................................................................................................192.6.2 Evaluation of secondary data..........................................................................202.6.3 Data Collection Sources.................................................................................20

Chapter 3. Literature Review.........................................................................................213.1 Foreign Direct Investment.....................................................................................213.2 Motives for Foreign Direct Investment.................................................................21

3.2.1 Market Seeking Motive..................................................................................213.2.2 Efficiency Seeking Motive.............................................................................223.2.3 Strategic Asset and Resource Seeking Motive...............................................22

3.3 Dunning’s Eclectic Paradigm................................................................................223.3.1 Ownership Advantage....................................................................................233.3.2 Localization Advantage..................................................................................233.3.3 Internationalization Advantage......................................................................23

3.4 Determinants of Foreign Direct Investment in Developing Countries..................243.4.1 Natural Resources...........................................................................................253.4.2 Market Advantages.........................................................................................263.4.3 Political Stability............................................................................................263.4.4 Labour Cost....................................................................................................273.4.5 Policy Variables..............................................................................................273.4.6 GDP Growth Rate...........................................................................................283.4.7 Inflation Rate..................................................................................................283.4.8 Openness of the economy...............................................................................293.4.9 Privatization....................................................................................................293.4.10 Infrastructure................................................................................................293.4.11 Regulatory Authority....................................................................................30

3.5 Entry Modes for Foreign Direct Investment.........................................................303.5.1 Exporting........................................................................................................313.5.2 Licensing........................................................................................................313.5.3 Greenfield.......................................................................................................313.5.4 Acquisitions....................................................................................................31

3.5.5 Joint Ventures.................................................................................................323.6 Factor Influencing the choice of entry mode.........................................................323.7 Foreign Direct Investment Risks...........................................................................34

3.7.1 Economic Risk................................................................................................343.7.2 Political Risk..................................................................................................353.7.2.1 Political Risk Type-1...................................................................................353.7.2.2 Political Risk Type-2...................................................................................353.7.3 Exchange & Currency Risk............................................................................35

3.8 Analysis of the Industry.........................................................................................363.8.1 SWOT Analysis..............................................................................................363.8.2 Competitive Environment..............................................................................36

Chapter 4. FDI in Telecom Sector of Pakistan................................................................374.1 Telecom Sector Overview.....................................................................................37

4.1.1 Fixed Market Overview..................................................................................374.1.2 Internet Market Overview..............................................................................374.1.3 Mobile Market Overview...............................................................................384.1.4 Growth of Telecom Sector in Pakistan...........................................................384.1.5 Major Players in Pakistan Mobile & Fixed Line Sector.................................394.1.5.1 PTCL...........................................................................................................394.1.5.2 Mobilink......................................................................................................394.1.5.5 CMPak.........................................................................................................404.1.6 Investment in Telecom Sector of Pakistan.....................................................414.1.7 Foreign Direct Investment in Telecom Sector of Pakistan.............................41

4.2 Determinants of foreign direct investment in telecom sector of Pakistan.............424.2.1 Market Size & Potential.................................................................................424.2.2 Inflation..........................................................................................................444.2.3 Labour Cost....................................................................................................444.2.4 Government Economic Policies.....................................................................444.2.5 Foreign Direct Investment Policy in Telecom Sector....................................454.2.6 Tariffs and Taxes in Telecom Sector..............................................................464.2.7 GDP Growth Rate & Openness of the economy............................................474.2.8 Infrastructure..................................................................................................484.2.9 Regulatory Authority......................................................................................484.2.10 Privatization..................................................................................................504.2.11 Telecom Related Suppliers in Pakistan........................................................50

4.3 Foreign Direct Investment Risks in Pakistan........................................................504.3.1 Political Risk..................................................................................................514.3.1.1 Political Risk Type-2...................................................................................514.3.1.2 Political Risk Type-1...................................................................................524.3.2 Currency Risk.................................................................................................52

Chapter 5. Analysis.........................................................................................................535.1 SWOT Analysis of Pakistan Telecom Sector............................................................53

5.1.1 Strengths.............................................................................................................535.1.1.1 Investor Friendly Government Policies.......................................................535.1.1.2 Regulatory Authority...................................................................................545.1.1.3 Labour Cost.................................................................................................54

5.1.2 Weaknesses.........................................................................................................545.1.2.1 Inflation.......................................................................................................545.1.2.2 Infrastructure...............................................................................................555.1.3 Opportunities..................................................................................................55

5.1.3.1 Market Size..................................................................................................555.1.3.2 Implementation of 3G Network...................................................................555.1.3.3 Competition.................................................................................................56

5.1.4 Threats................................................................................................................565.1.4.1 Political Risk Type-II..................................................................................565.1.4.2 Currency Risk..............................................................................................56

5.2 Pakistan Telecom Sector and Porter’s Five Forces...............................................575.2.1 Threats of New Entrants.................................................................................575.2.2 Bargaining Power of Customer......................................................................575.2.3 Bargaining Power of Supplier........................................................................575.2.4 Threat of Substitutes.......................................................................................575.2.5 Level of Existing Rivalry...............................................................................57

5.3 Entry Mode............................................................................................................585.3.1 External Factors..............................................................................................585.3.2 Internal & Home Country Factors..................................................................595.3.3 Choice of Entry Mode....................................................................................59

Chapter 6. Conclusion & Recommendations..................................................................616.1 Summary of the Research......................................................................................616.2 Limitations.............................................................................................................626.3 Future Recommendation.......................................................................................62

Appendix A.....................................................................................................................63Appendix B......................................................................................................................77Bibliography....................................................................................................................78

List of Tables

Table 1: Host Country Determinants of FDI...................................................................24Table 2: External & Internal Factors Influencing the Choice of Entry Mode.................33Table 3: Key Companies in Pakistan Telecom Sector....................................................41Table 4: Key Acquisitions in Pakistan Telecom Sector..................................................42Table 5: Investment Policies by Government of Pakistan...............................................45Table 6: Tariffs and Import Product Groups...................................................................47Table 7: Choice of Entry Mode.......................................................................................60

List of Figures

Figure 1: Cellular Subscriber Growth in Pakistan...........................................................38Figure 2: Telecom Industry Market Size (2005-2012)....................................................43Figure 3: Real GDP Growth of Pakistan.........................................................................47Figure 4: Depreciation of Pakistan Rupee.......................................................................52

Chapter 1. Introduction

This chapter will give a brief overview to the research and will highlight the overall

objectives of the research. It will also cover a review of the previous studies conducted

on this topic and will figure out the research gap. Finally it will review the whole

research structure.

1.1 Background

Foreign direct investment (FDI) is an important source of economic growth in this

globalized world. Foreign direct investment is generally considered as a phenomenon

for developed countries but in recent years the increase in foreign direct investment

flows to developing countries turned out to be higher than the increase in foreign direct

investment inflows to developed countries (Nunnenkamp, 2001). Factors like

availability of the natural resources, cheap labour, infrastructure, privatization, political

stability and government policies on FDI are the main determinants of FDI in

developing countries. Apart from providing a conducive and investor friendly

environment, developing countries pose significant risks such as political risk, exchange

risk, economic risk and neighbourhood risk for foreign investors.

Pakistan is a developing country with the world’s sixth largest population. Pakistan’s

economy is experiencing the longest spell of its economic growth in recent years.

Economic growth accelerated to 7.0 percent in 2006-07 at the back of robust growth in

agriculture, manufacturing and services. Pakistan’s real GDP has grown at an average

rate of 7.0 percent in the last 5 years because of an unprecedented increase in inflow of

FDI.

In the past few years, telecom sector of Pakistan have received record inflows of foreign

direct investment. Telecom sector attracted an estimated US$ 1.8 billion in foreign

direct investment during the fiscal year 2005-06 which accounts for 54% of the total

foreign direct investment in Pakistan (BMI, 2008). In fiscal year 2006-07, telecom

sector received US$ 1.824 million foreign direct investment, which is about 35% of the

total foreign direct investment in Pakistan (BMI, 2008). Pakistan telecom sector has

seen a tremendous cellular growth in recent years (PTA, 2007). According to BMI

(2008), Pakistan telecom sector has emerged as one of the fastest growing telecom

sector especially in relation to South Asian economies such including India, Bangladesh

and Nepal (See Appendix B). This rapid transformation is due to the investor friendly

liberalization measures taken by the government of Pakistan (Inam, 2007).

Privatization of PTCL and open licensing regime has seen a number of foreign telecom

companies investing heavily in telecom sector of Pakistan. Increase in use of cellular

and WLL services has also accounted for the growth of telecom sector in Pakistan.

Pakistan telecom sector grew at a rate of more than 80% (PTC, 2007).

Mergers and acquisitions is the preferred mode of entry for the foreign companies to

invest in the telecom sector of Pakistan. According to BMI (2008), ‘Liberal FDI policy

by the Government of Pakistan and deregulation and privatization of the telecom sector

has triggered a wave of international acquisitions in telecom sector of Pakistan’. During

the fiscal year 2006-07, US$ 2 billion worth of acquisitions were made in the telecom

sector of Pakistan.

However, Pakistan despite of providing an environment conducive for foreign

investment poses significant risks as well. Pakistan is ranked 7 th in political risks study

carried out by Eurasia Group because of the ongoing political instability in the country.

The assassination of former primer minister Benazir Bhutto and sacking of Chief Justice

of Pakistan at the end of 2007 has caused further political instability in the country

which could have an impact on the inflow of foreign direct investment in the country

(BMI, 2008).

Therefore, based on the information above, this research will look into the factors that

have resulted into the large inflow of foreign direct investment in Pakistan telecom

sector. It will also look into the potential risks associated with the foreign direct

investment in telecom sector of Pakistan. Based on the analysis of these two factors, the

research will recommend the suitable entry mode for foreign investors to enter in

Pakistan telecom market.

1.2 Research Gap

Foreign direct investment in telecom industry in Pakistan is still into its initial stages.

Lots of variables have contributed in making Pakistan a better market for foreign direct

investment especially in telecom sector. However, the journal research on this issue has

been under researched. Jahanzeb (2006) assessed the FDI in Pakistan over the last 5

years in services sector. A lot of statistical data on foreign direct investment in Pakistan

is available from the government websites. World Investment Reports by UNCTAD

(2007) also gives an overview on the amount of foreign direct investment in Pakistan.

However, there is insufficient research on determinants of the foreign direct investment

and modes of entry in telecom sector in Pakistan. Some research has been done to

identify the impediments of foreign direct investment in Pakistan (Khan& Kim, 1999)

as they mentioned economic instability, taxation etc. Economic indicators explain

change in the economic situation of Pakistan since it is moving through a recovery

phase. The existing research has not accounted for the new socio-political, socio-

cultural and socio-economic environment of Pakistan. Moreover, there is insufficient

data available on the variables such as political instability and security risks which have

been changed dramatically in recent years and their impact on foreign direct investment.

1.3 Research Objective

To analyze the determinants and risks associated with foreign direct investment in

telecom sector of Pakistan

1.4 Research Questions

The research will answer the following questions:

1. What are the determinants of foreign direct investment in Pakistan telecom

sector?

2. What are the potential risks associated with foreign direct investment in telecom

sector of Pakistan?

3. What is the suitable entry mode for foreign direct investment in telecom sector

of Pakistan?

1.5 Research Structure

To achieve the research objectives, this report has been divided into seven chapters.

Chapter I Introduction

This chapter will introduce the research design and explains the

reasons for undertaking this reason. The research questions have

been identified after analyzing the research gap.

Chapter II Research Methodology

A relevant methodology is very important for the collection and

analysis of data. This chapter explains the methodology used in

this research along with the reasons for undertaking the specific

research method.

`Chapter III Literature Review

This chapter will provide the theoretical background to the

research. This chapter will also provide a critical analysis of the

models and theories which are used in this research.

Chapter IV Pakistan Telecom Sector

This chapter will provide the overview of the Pakistan telecom

sector. The determinants and risks of foreign direct investment in

telecom sector will be discussed in detail in relation with the

theoretical framework provided in chapter III.

Chapter V Data Findings and Analysis

This chapter will provide an in-depth analysis to achieve the

objectives of this report, the findings will be presented and

analysed in this section. The analysis will develop a ground for

the overall achievement of the objective.

Chapter VI Discussion and Conclusion

This chapter will present the conclusion based on the findings

and analysis of previous chapter. Also, the limitations of this

research will be discussed along with the some suggestions and

recommendations for future research in this area.

Chapter 2. Research Methodology

This chapter discusses the research methodology including research philosophy,

approach, strategy, purpose of the research, data collection and its analysis. The chapter

ends with the discussion on the limitations of this research thus providing implication

for future study in this area.

The research onion described by Mark Saunders, Philip Lewis and Adrian Thornhill

(2006) is used to analyze the philosophy, approach, purpose and strategy of research.

2.1 Qualitative Method

Qualitative method is a useful tool for research in management and business subjects

(Gummesson, 2000). Chauri & Gronhaug (2002) argue that qualitative method is useful

where the aim is to “uncover and understand a phenomenon about which is little

known”. Furthermore when a social process or event is beyond the study of quantitative

method, qualitative methods are most suitable that leads to the provision of in-depth

understanding of a social phenomenon (Chauri and Gronhaug, 2002). Since, current

research intends to explore the determinants and risks of foreign direct investment in

Pakistan telecom sector where no previous study has been conducted, qualitative

method seems the most suitable method to apply. Qualitative data enables the researcher

to explore and identify a wide range of issues, understand and explore the research more

holistically and deal with ambiguity, multiplicity and contradictions (Mason, 2002).

Apart from a number of advantages, there are a number of challenges associated with

conducting qualitative research. Qualitative research requires high engagement from

researcher and a great deal of effort such as intellectual, practical, physical, emotional

and big responsibility for the quality and result of a research. Furthermore, it requires

lot of resources and time. In contrast to quantitative research qualitative research is very

sensitive in nature that causes ethical and moral dilemmas.

2.2 Philosophy

According to Saunders, Lewis & Thornhill (2007), research philosophy relates to how a

researcher views the world or development of knowledge and the relationship between

knowledge and the process it is developed (Saunders, Lewis & Thornhill, 2007). The

major philosophy used in this research is ‘Positivism’. However, at times the research

will be employing the concepts of ‘Interpretivism’ as well. The reason for choosing the

‘Positivism’ philosophy is that it involves working with an observable social reality and

that the end product of such research can be law-like generalizations similar to those

produced by the physical and natural scientists (Remenyi et al., 1998). Positivism

philosophy involves working with the existing theory to develop hypothesis. According

to Saunders, Lewis & Thornhill (2007), the hypothesis developed will be tested and

confirmed, in whole or part, or refuted, leading to the further development of the theory

which then may be tested by further research. One of the key features of using

positivism philosophy is that research is conducted as far as possible, in a value free

way. According to Saunders, Lewis & Thornhill (2007), ‘The resources researcher

would claim to be external to the process of data collection in the sense that there is

little that can be done to alter the substance of the data collected.’

2.3 Approach

Qualitative research can be both deductive and inductive. Deductive approach involves

the development of a theory that is subject to a rigorous test (Saunders, Lewis &

Thornhill, 2007). Inductive approach on the other hand involves collection of data and

development of theory as a result of data collection. The approach used in this research

is deductive. Deduction approach is much quicker to complete as compared to inductive

which is much more protracted. One of the main features of deductive approach is that it

is a low risk strategy while inductive approach can be risky (Saunders, Lewis &

Thornhill, 2007). Since the research has to be conducted in a short span of time with

limited resources, therefore deductive approach is used.

2.4 Purpose of the Research

The purpose of this research is ‘exploratory’, because of the fact that it is a valuable

means of finding out ‘what is happening; to seek new insights; to ask questions and to

assess phenomenon in a new light’ (Robson, 2002). Since, the main aim of the research

is to analyze the determinants and risks associated with foreign direct in telecom sector

of Pakistan. Hence, exploratory strategy will be more useful as compared to explanatory

type which involves working with two or more variable, which is not the case in this

research. Exploratory strategy is useful because it allows the research to be flexible and

adaptable to change, which may result in the slight change of direction (Saunders,

Lewis & Thornhill, 2007). Also exploratory research is often used in those areas where

few or no studies have been conducted (Robson, 2002). In addition the exploratory

research helps to seek new insights and assess phenomenon, particularly useful to

clarify researcher understanding of a problem.

2.5 Research Strategy

The best suitable strategy for this research is case study. According to Robson (2002),

‘case study is a strategy for doing research which involves an empirical investigation of

a particular contemporary phenomenon within its real time context using multiple

sources of evidence’. There are two types of case study strategies i.e. single case study

and multiple case study. Single case study strategy is used since it gives the opportunity

to observe and analyze a phenomenon that few have considered before (Saunders,

Lewis & Thornhill, 2007). Also the research looks at the determinants and risks

associated with foreign direct investment in Pakistan telecom sector, therefore single

case study will be the most suitable strategy in this case.

2.6 Data Sources

There are two types of data sources i.e. primary and secondary data sources. Secondary

data is used in this research.

2.6.1 Secondary data

Secondary data can be defined as a data collection collected by others not specifically

with research question in hand (Stewart, 1984). The importance and advantage of using

secondary is emphasized by various scholars. The main advantage of using secondary

data is that it saves a lot of time and resources. Secondary data also enables the

researcher to analyze a wide range of data collected by others. In this research

secondary data is used extensively to analyze the determinants and risks associated with

foreign direct investment in Pakistan. However, there are some drawbacks associated

with secondary data method that pose challenges for the research. The data collected for

different sources may not always fit the objective of intended study. Although, it has

been mentioned that secondary data is easily accessible and cost saving some data like

company reports can not be obtained free of charge. In addition, the definition of

terminology may vary with the purpose of the research (Ghauri and Gronhaug, 2002).

Robson (2007) adds that assessing the credibility of secondary data may be complicated

and requires assessing its authenticity and credibility. Therefore, the evaluation of the

data is necessary prior to usage of secondary data.

2.6.2 Evaluation of secondary data

Evaluation of the data through secondary sources is an important part of the research

process. According to Stewart (1984), not all information obtained from secondary

sources is equally reliable and valid. Therefore, in order to provide the robustness of

research, reliability and validity of secondary data should be considered. Stewart (1984)

further argues that in order to evaluate secondary data question concerned “ the sources

of the data, measures used, the time of data collection, and the appropriateness of

analyses and conclusions should be raises routinely” (Stewart 1984, p. 23). Wallace and

Wray (2006) add that it is also important to check the methodology used and number of

evidences provide to make a conclusion.

For the purpose of ensuring the reliability and validity of the current research the above

mentioned were taken into consideration during the data collection process.

2.6.3 Data Collection Sources

Secondary data in this research is collected from a number of sources such as non

statistical sources, academic journals, online literature research and previous

dissertations. In order to ensure validity and reliability of the secondary data

information is acquired from reliable sources. Priority is given to the government

sources such PTA and PTCL annual reports to get the accurate information. Various

reports from Business Monitor Online are also used extensively since they contain most

up to date information. Reports from IMF, World Bank and UNCTAD are also used for

the statistical analysis.

Chapter 3. Literature Review

This chapter will provide the theoretical background to the research. It will provide an

in-depth review of the factors influencing the flow of foreign direct investment in

developing countries and choice of entry mode. It will also discuss the potential risks

associated with the foreign direct investment in developing countries. The second part

will review the findings of the first part in context of Pakistan telecom market.

3.1 Foreign Direct Investment

Foreign direct investment usually involves the establishment of the firm’s own control

over raw materials, components, production, distribution and marketing facilities abroad

(Bartels & Pass, 2000). In other words, foreign direct investment can be defined as,

“An investment involving a long term relationship and reflecting a lasting interest and

control by a resident entity in one economy (foreign direct investor or parent enterprise)

in an enterprise resident in an economy other than that of the foreign direct investor

(FDI enterprise or parent enterprise or foreign affiliate)” (United Nations, 2006). FDI

enables the investor to take control of the activities of enterprise e.g. raw materials,

production, marketing and distribution in the host country (Daniels et al., 2004).

3.2 Motives for Foreign Direct Investment

A number of theories have been presented in order to formalize the motives for foreign

direct investment. Theories of trade, investment and marketing form the basis for these

theories. Each of these theories contribute towards the understanding of the underlying

reasons for foreign direct investment or offers an explanation for a particular kind of

foreign direct investment., but there is no complete theory of foreign direct investment

(Harrison, Dalkiran and Elsey, 2000).

Firm expand internationally for a variety of reasons. Czinkota, Ronkainen and Moffett

(1994) argue that there are three motives for firms to involve in foreign direct

investment. These three motives are:

3.2.1 Market Seeking Motive

Marketing consideration and the corporate desire for growth are the main reason for

multinational enterprises to engage in foreign direct investment. A major cause for the

recent growth in foreign direct investment is because of the fact that multinational

enterprises follow their key clients abroad to pre-empt other vendors from servicing

them (Czinkota, Ronkainen and Moffett, 1994). This foreign direct investment can also

be due to the retaliation among various competitors i.e. competing with the key rivals in

their own country (Daniels et al., 2004).

3.2.2 Efficiency Seeking Motive

Firms often engage in foreign direct investment to restructure their existing investments

in order to gain an efficient allocation of international economic activity. Efficiency

seeking investors are primarily concerned with the input costs such as communication

and transportation costs (Daniels et al., 2004). Efficiency seeking motive can be helpful

to those multinational enterprises who seek to benefit from economies of scale and

scope arising from similarities and differences in consumer tasters. These firms also

seek to benefit from international differences in product and factor prices to diversify

risk.

3.2.3 Strategic Asset and Resource Seeking Motive

Resource seeking companies are after either natural or human resources. Natural

sources are typically based on mineral, agriculture, or oceanographic advantages and

result in firms locating in areas where they are available (Czinkota, Ronkainen and

Moffett, 1994). In case of strategic asset seeking the availability of choices is therefore

tied to the availability of resources sought e.g. firms in the mining, oil and crop growing

industries have little choice but to go where the raw materials are located.

3.3 Dunning’s Eclectic Paradigm

Dunning’s eclectic paradigm is a synthesis of various approaches based on theories of

the firm, international trade, location and industrial organization (Harrison, Dalkiran

and Elsey, 2000). Dunning provided a combined explanation of the major factors which

determine the location of international production through foreign direct investment.

According to Dunning (1973, 1979 and 1981) these factors must be satisfied if the

decision to locate in a particular host country is to be successful. These three factors are:

3.3.1 Ownership Advantage

According to Dunning (1973, 1979 and 1981), multinational enterprises possess some

firm specific competitive advantages over local firms in serving some particular

national market. These advantages may include tangible and intangible control of

certain assets such as knowledge capital, human capital, patents, brand and reputation.

3.3.2 Localization Advantage

Localization advantage provides multinational enterprises with the opportunity to

exploit their ownership advantage by combining them with the host country’s specific

factor endowments, Dunning (1973, 1979 and 1981). These factor endowments

comprise of natural advantages (suitable climate, proximity to markets, availability of

raw materials and minerals) and the availability of relatively low cost input, especially

labour (Harrison, Dalkiran and Elsey, 2000). In order for international production to be

profitable, their must be some benefit to multinational enterprises derived from locating

at least part of their activities in another country rather than remaining at home.

3.3.3 Internationalization Advantage

According to Dunning (1973, 1979 and 1981), it must also be profitable for

multinational enterprises to exploit their ownership and localization advantage through

internalization rather than using arms-lengths markets. The assumption of market

imperfection and market failure provides the basis for the internalization advantage. An

internal transaction reduces the cost of search, buyer’s uncertainty, protects the quality

if intermediate products and can result in the avoidance of government intervention.

Internalization advantage arises because foreign direct investment allows a firm to

remain or become integrated (Harrison, Dalkiran and Elsey, 2000). Firms can achieve

the benefits of skilled labour and technology within the organization.

An important implication for the eclectic paradigm is that, as well as using low cost

locations, multinational enterprises establish a presence in areas where there are clusters

of closely related firms supplying anything from the smallest component to high quality

services (Harrison, Dalkiran and Elsey, 2000). Dunning’s eclectic paradigm gives a

deep insight into the phenomenon of why firm go for foreign direct investment and why

they choose to locate in a particular country. It is a unified approach which incorporates

both the internalization and ownership advantages and which views foreign direct

investment as an effective conduit through which the firm spreads its operations across

national borders and extends the use its ownership advantage through internalization

(Harrison, Dalkiran and Elsey, 2000). Internalization and ownership are firm specific

determinants of foreign direct investment where as the localization factor is location

specific and has a critical influence on host country’s inflow of foreign direct

investment. Markusen and Venables (1995) also worked along the same lines and came

up with the conclusion that foreign direct investment occurs when only these three

factors exist together.

3.4 Determinants of Foreign Direct Investment in Developing

Countries

Foreign direct investment is playing an important role in the economic and social

development of developing countries. Cho (2003) argues that nowadays virtually all

countries are actively seeking to attract foreign direct investment, because of the

expected favourable effect on income generation from capital inflows, advanced

technology, management skills and market know how. Kobrin (2005) argues that a

number of factors led to increased efforts by developing countries to attract flows of

foreign direct investment. A lot of research has been conducted in recent years to

indentify the determinants of foreign direct investment in developing countries.

Harrison, Dalkiran and Elsey, (2000) in their research findings figure out that it is

highly unlikely that foreign direct investment will be determined by a single factor. Cho

(2003) reviewed the key determinants and factors of foreign direct investment based on

the theories of international investment and listed three key determinants and factors

associated with the extent and pattern of foreign direct investment in developing host

countries: attractiveness of the economic conditions in host country; the policy

framework towards the private sector, trade and industry, and foreign direct investment

and its implementation by host governments; and the investment strategies by

multinational enterprises. Harrison, Dalkiran and Elsey (2000) argue that potential

investor consider a wide range of factors before taking such an important step. These

factors include the overall desirability of investing abroad or general suitability of a

particular country.

Table 1: Host Country Determinants of FDI

Key determinants that form the basis of foreign direct investment decisions are as

follows;

3.4.1 Natural Resources

Availability and access to natural resources play an important role in foreign direct

investment decision making process. Harrison, Dalkiran and Elsey (2000) argue that the

location of resources may affect foreign direct investment decisions where raw

materials, energy, or labour are required in large quantities, where specialized resources

are immobile, or where access to resources is a company’s core business. Dunning

(1993) also emphasized the importance of natural resources in attracting the foreign

direct investment and argued that natural resources play an important role especially

when resource rich countries do not have enough financial and technological

capabilities to extract these resources. Addison & Heshmati in their research findings

found a strong relationship between availability of natural resources and inflow of

foreign direct investment. However, the importance of natural resources as a

determinant of foreign investment has declined in last few years (Baniak, Cukrowski &

Herczynnski, 2002). For a lot of firms, availability of resources is no longer a limiting

factor in their investment decisions.

A positive relationship exits between the availability and access to natural resources and

inflow of foreign direct investment.

3.4.2 Market Advantages

As the importance of natural resources has declined, access to markets has become more

important in recent years. Many markets in developed countries have been growing

more slowly in recent years and some markets are even reaching saturation (Harrison,

Dalkiran and Elsey, 2000). This situation has created an opportunity for the foreign

investors to invest in the foreign markets of rapidly developing countries. Market

advantages include market size and growth rates. Market potential is commonly

measured by the size and growth of GDP and sometimes by the size and growth of

population, over urbanization or government consumption (Dunning, 1993 and

Crenshaw, 1991). UNCTAD (2000) emphasize that domestic market size and market

potentials are the main drivers of foreign investment in developing countries. Anamarr

(1996) conducted a research on the determinants of foreign direct investment in low

income economies and figured out that market size with low labour cost and high

capital return is one of the important factors considered by the foreign investors before

investing. Lucas (1993) on the other hand stated that the importance of market size as a

foreign direct investment determinant is overstated. However empirical literature often

found the size of the market and the market potentiality, typically driven by the level of

GDP and GDP growth rate; significantly affect foreign direct investment inflow

(Nunnenkamp, 2001).

A positive relationship exits between the market size and inflow of foreign direct

investment.

3.4.3 Political Stability

Political instability in the developing countries poses the biggest threat to attract the

foreign direct investment. Political instability provides a hostile environment for foreign

corporations, discouraging their investment (Bennett and Green, 1972). Basi (1963)

argues, executives report that political instability is the most important variable

influencing their foreign investment decisions aside from market potential. Kwang and

Singh (1999) in their findings indicate that a qualitative index of political risk has been

a significant determinant of foreign direct investment flows for countries that have

attracted historically sizeable investment flows and for countries that have not been very

successful in attracting such investment, socio political instability, proxies by negative

impact on investment flows. Addison & Heshmati (2004) also showed a positive

relationship between the political stability and foreign direct investment inflow.

A positive relationship exits between political stability and inflow of foreign direct

investment.

3.4.4 Labour Cost

Aqeel and Nishat (2004) argue that high nominal wages discourage foreign direct

investment, especially for firms who are in labour intensive production. Multinational

enterprises transfer all or part of a production process to low cost countries in order to

reduce overall production costs and improve their international competitiveness

(Harrison, Dalkiran and Elsey, 2000). However, some researchers have figured out that

high labour cost does not always discourage foreign direct investment (Moore, 1993).

Some companies can achieve cost reduction by taking advantage of external economies

of scale in a country where clusters of highly skilled labour or technical support are in

abundance (Harrison, Dalkiran and Elsey, 2000). Nunnenkamp (2002) argue that cheap

and skilled labour play an important role in attracting the foreign direct investment.

While low cost labour remains a locational advantage, the increasingly sought after

advantages are competitive combinations of wages, skills and productivity (UNCTAD,

2000).

A negative relationship exists between high labour cost and inflow of foreign direct

investment.

3.4.5 Policy Variables

Potential foreign investors are attracted by financial incentives or tax concessions from

the host government (Harrison, Dalkiran and Elsey, 2000). Supportive government

policies which include low corporation taxes and policies such as tax credits provide

conducive environment for foreign investors. Tax rates can have impact on the

profitability of the firms. Therefore, foreign investors tend to invest in countries having

low tax rates regimes. A lot of developing countries offer various tax break regimes to

multinational as an incentive to attract foreign direct inflows. Providing incentives for

capital formation, special investment allowances and investment tax credits increase the

inflow of foreign direct investment (OECD, 2003). Studies have shown a negative

relationship between tax rates and inflow of foreign direct investment in developing

countries (Shah & Masood, 2002). However, some studies have shown a positive effect

of taxes on inward foreign direct investment (Aqeel & Nishat, 2004).

Foreign direct investment policies also play an important role and are considered as an

important determinant of foreign direct investment to the host country. These policies

include the rules and regulations with regard to business operations. Foreign direct

investment policies are considered as a host country determinant (Asiedu, 2002).

3.4.6 GDP Growth Rate

A lot research has been conducted to find out the relation between GDP growth rate and

foreign direct investment and nearly all of them come to the conclusion that a positive

relationship exists between economic growth and foreign direct investment

(Chakrabarti, 2001). Countries that implement stable and credible macroeconomic

policies attract large amount of foreign direct investment.

A positive relationship exists between GDP growth rate and foreign direct investment

inflow.

3.4.7 Inflation Rate

One of the key economic determinants of foreign direct investment is the inflation rate.

Inflation increases the user cost of capital, and thus affects the profitability of foreign

direct investment in a negative way (de Mello, 1997). Excessive money supply, budget

deficits and a poorly managed exchange rate regime results in a high inflation rate. It

also reflects the poor economic conditions in the country, conditions that discourage the

flow of foreign direct investment (Calvo, Leiderman & Reinhart, 1995).

A negative relationship exists between the inflation rate and inflow of foreign direct

investment.

3.4.8 Openness of the economy

The ease with which investors can move capital in and out of a country (openness of the

economy) is also an important determinant of foreign direct investment flows

(Chakrabarti, 2001). This implies that countries with capital controls and restrictive

trade policies discourage inflows of foreign direct investment, compared with liberal

policies. Most of the studies on foreign direct investment in developing countries have

identified a positive relationship between openness and foreign direct investment

(Morisset, 2000).

Hence positive relationship exists between openness of the economy and inflow of

foreign direct investment.

3.4.9 Privatization

Privatization also plays an important role in attracting the inflow of foreign direct

investment in developing countries. Harrison, Dalkiran and Elsey (2000) argue that

privatization often accompanies market liberalization and this provides an opportunity

for the foreign investors to acquire an established enterprise and its markets. A study

conducted by UNCTAD (2000) figured out that privatization plays an important role in

attracting the foreign direct investment in some countries, as in the case of Chile, where

privatization contributed considerably to attract foreign direct investment. According to

World Bank (1995), ‘Privatization is predicted to promote more efficient operations,

reduce the financial burden on government budget expand service delivery, and increase

the level of foreign and domestic investment’.

Hence a positive relation exists between privatization and inflow of foreign direct

investment.

3.4.10 Infrastructure

Infrastructure facilities such as well developed networks of roads, airports, water supply,

uninterrupted power supply, telephones and internet access are important ingredients for

a business environment conducive to foreign investment (Khan & Kim, 1999).

Production costs tend to be higher in countries having less developed infrastructure.

Morisset (2000) argue that countries having good infrastructure facilities attract more

foreign direct investment as compared to countries having poor infrastructure facilities.

A well developed infrastructure increase the productivity of investments and therefore

increase the inflow of foreign direct investment (Asiedu, 2002).

A positive relationship exists between infrastructure and inflow of foreign direct

investment.

3.4.11 Regulatory Authority

Presence of a sound regulatory framework and regulatory authority to enforce the

relevant laws and regulations are very important for inflow of foreign direct investment

(Sun, 2002). A country’s free and fair regulatory framework helps in assuring the

foreign investors that their investment is permitted and once they enter into the market

their investment will be protected (Sun, 2002). The role of the regulatory body is to

provide a conducive and investor friendly environment and also to administrator the

different kind of difficulties and problems associated with the foreign investment in the

host country.

3.5 Entry Modes for Foreign Direct Investment

In exploiting its competitive advantages on an international scale a firm have a number

of broad options, including exporting, entering into strategic alliances with foreign firms

through, for example, cross-licensing deals and joint venture investments and wholly-

owned green field and takeover investments (Buckley and Casson, 1976). Each of these

modes has its own pros and cons and the selection of the an appropriate mode of entry

will depend not only on the firm-specific advantages, but also on the structural

characteristics of the target market (size and growth of primary demand, level of

supplier concentration, extent of product differentiation, complexity and ownership of

distribution channels, etc.) and in host country trade and investment policies

(investment incentives and foreign ownership limitations), (Bartels & Pass, 2000).

3.5.1 Exporting

Exporting is a low risk strategy and foreign companies employ this strategy to test out

an overseas market. Exporting requires little investment. Small companies normally

employ exporting on an international level mainly because of their comparative lack of

capital resources and marketing clout (Deresky, 2003).

3.5.2 Licensing

An international licensing agreement allows the right to a firm in the host country to

either produce or sell a product or both (Deresky, 2003). Licensing is mainly used by

small and medium sized enterprises and is used as a complement to exporting. The

greatest advantage of licensing is that it avoids the quotas and tariffs imposed on exports

(Deresky, 2003). But on the other hand licensing is the least profitable way of entering a

market.

3.5.3 Greenfield

Greenfield project involves building a subsidiary from bottom up to enable foreign sale

and/or production. This includes purchase of local/ host real estate, hiring and training

of employees using investors’ management, technology, know-how and capital.

Greenfield project gives the opportunity to create entirely a new organization by

combining the resources of investor and an asset acquired in host market. Greenfield

investment involves a gradual entry into the market.

3.5.4 Acquisitions

Acquisitions are ‘purchase of stock in an already existing company in an amount

sufficient to confer control’ (Kogut and Singh 1988, p.412). This involves the

integrations of investing company managerial skills with host company that possesses

production facilities, sales force, and market share. This facilitates speedy entry and

immediate access to local resources such as access to local networks, business licences

and reducing transaction costs. In some acquisitions in developing economies, the

control over assets is so extensive that the new operation almost resembles a Greenfield

investment, which Meyer and Estrin (2001) called ‘Brownfield’. According to

UNCTAD (2000), Cross- country acquisitions have become a prevailing facet of FDI

and approach of inward FDI in developing countries.

3.5.5 Joint Ventures

Joint Ventures (JVs) involve establishment of a new organisation with resource

contributions from two or more parent firms (Nakata & Sivakumar, 1997). The parents

share strategic and operational control of the firm. It is created as a new legal entity in

cooperation with two or more firms that both contribute resources. JVs facilitate the

smooth and quick access to resources; nature and type of JVs vary depending upon the

resource availability, concerns for control, and bargaining power of the coopering firms.

Partial acquisitions share some characteristics with both acquisitions and joint ventures.

The investor becomes involved with an existing firm rather than a newly created one,

but control is shared with other shareholders (Nakata & Sivakumar, 1997).

In practice, there are various obstacles in the way of firms attempting to enter a market

and can have an impact on choosing a particular type of entry mode (George et al.,

1992, Lowes et al., 1994). Access to key raw materials, component sources or

distribution channels may be controlled by established firms and therefore can limit

access to inputs or market outlets for foreign investors. Cost of financing investment in

plant and product differentiation and meeting initial operating loss may be prohibitively

high (Bartels and Pass, 2000). One or a combination of these factors may pose a

problem for a small scale, green-field type of entrant.

3.6 Factor Influencing the choice of entry mode

The choice of selecting a particular mode is influenced by a number of factors and

companies need substantial planning process to choose the right mode of entry.

According to Cateora & Ghuari (2006) the crucial factors influencing the choice of

entry mode is influenced by the market potential in the host country and it has to be

assessed against the company capabilities and resources available. The choice of entry

mode is a company decision but according to Franklin (1998) some factors need to be

considered before deciding an entry mode. He categorized these factors into external

and internal factors. According to Hollensen (2001) internal factors refer to firm’s size

and international experience. Firm’s have the influence on internal factors. External

factor’s are related to the target market and are beyond firm’s control. They play an

important role in choosing a particular mode of entry in the target market. External

factors include market potential, country risk, and investment policy, level of

competition and infrastructure facilities of the target market. According to Franklin

(1998), internal and external factors affect the company’s decision making process

either by encouraging and discouraging but no single factor can influence the decision

making process.

Franklin (2008) formulated a table to show which entry mode is favourable based on the

analysis of external and internal factors. The column with the highest number of factors

will determine the most suitable mode of entry.

Source: Franklin (1998)Table 2: External & Internal Factors Influencing the Choice of Entry Mode

3.7 Foreign Direct Investment Risks

Developing countries despite their investor friendly policies pose different kind of risks

and threats for foreign investors. According to Meldrum (2000), when foreign direct

investment takes place between two countries it involves various kinds of risks because

of the differences in national business systems of the countries. Meldrum (2000)

classified these risks as ‘Country Risks’. Warner (2002) in his research findings

presented the definition of country risk;

“Country risk incorporates all these sources of uncertainty in cross border trade that are

not present in domestic trade. Country risk arises from the potential changes in the

economic or political conditions within a particular country (or group of countries)”

(Warner, 2002)

According to Chan & Gemayel (2004), political and social disturbance, currency risk,

country financial risk and government regulations are most critical risks that affect the

investment decisions. Country risk can be broadly classified into three categories;

1) Political Risk

2) Economic Risk

3) Currency Risk

3.7.1 Economic Risk

Economic risk involves a sudden change in the economic structure and the growth rate

thus causing a significant change in the profitability of the investment (Meldrum, 2000).

Meldrum (2000) argues that economic risks arise from the unfavourable changes in the

economic policy variables (fiscal, monetary, international or wealth distribution or

creation) or due to significant change in a country’s comparative advantage ( resource

depletion, industry decline, demographic shift). In some developing countries, economic

risks are often driven by the political risks since both deal with the policy making.

Therefore, investors carefully examine the economic risks before making their

investment decision.

3.7.2 Political Risk

Tung (1998) defines, ‘Political risk is a general term referring to a variety of political

and quasi-political threats to the ownership or operation of foreign direct investment’.

Political risks pose threat to the profitability as a result of the forces external to the

industry and which may involve the role of government action as well (Wells, 1998).

These risks involve the risk of losing revenue or incurring costs due to changes in the

political environment of the country (McDonald, 2007). McDonald (2007) categorized

the political risk into two types;

3.7.2.1 Political Risk Type-1

Political risk type-1 involves dramatic changes in the political system of the host

country thus leading to radical change in policies towards the business community

(McDonald, 2007). This type of risk may lead to arbitrary governmental seizure of

assets, discriminatory regulations against the foreign companies and radical changes in

taxation system. McDonald (2007) argues that even politically stable systems can pose

political risk type-1. Political risk type-1 is difficult to measure in countries that are

political unstable.

3.7.2.2 Political Risk Type-2

Political risk type-2 involves changes forced on governments that affect the business

environment (McDonald, 2007). These changes include terror attacks, consumer and

investor pressure, ethnic and sectarian violence, social breakdown and dramatic changes

in public opinion (McDonald, 2007). Because of the above mentioned factors, political

risk type-2 is not restricted only to developing countries but also pose significant

challenges to developed economies of the world. McDonald (2007) argues that political

risk type-2 can be pronounced in countries undergoing radical political and economic

changes.

3.7.3 Exchange & Currency Risk

Meldrum (2002) defines exchange risk as, ‘An unexpected adverse movement in the

exchange rate’. Exchange risk involves a sudden change in the currency regime of a

country such as a change from a fixed to a floating exchange rate (Meldrum, 2000).

Currency risk involves the depreciation of home country’s currency and can have a

negative impact on the profitability of the firms. Exchange risk can have an uncertain

effect on the value and profitability of the firm (Alhajhouj, 2002). Foreign investors’

use hedging to reduce the effects of exchange risk in developing countries. Some of the

hedging techniques are as follows:

Future contract hedging

Forward contract hedging

Money market hedging

Currency option hedging (Alhajhouj, 2002)

3.8 Analysis of the Industry

In order to analyze the potential of the industry following tools is used;

3.8.1 SWOT Analysis

SWOT analysis is a strategic tool used to analyze the strengths, weaknesses,

opportunities and threats of a particular company, industry or a business. This can help

the companies in making the right choice before entering into any particular market.

3.8.2 Competitive Environment

Porter’s five forces model is used to analyze the industry environment. According to

Porter (1998), five forces determine the ultimate profit potential of an industry which

can help the company to identify the right strategic action.

Porter’s five forces are as follows:-

1. Barriers to Entry

2. Bargaining Power of Customers

3. Bargaining Power of Suppliers

4. Available Substitutes

5. Existing Rivalry

Chapter 4. FDI in Telecom Sector of Pakistan

4.1 Telecom Sector Overview

Since the birth of Pakistan in 1947, Telephone and Telegraph department was

responsible for providing the telecom services in Pakistan (PTA, 2007). Government of

Pakistan was overlooking the administration of T&T. T&T played the roles of regulator,

policy maker, operator and service provider in the country until 1990. PTC took

administrative control of T&T in year 1990 (BMI, 2008). In 1996, PTC became PTCL

as a result of part privatization of the operator monopolistic control of the

telecommunication services in Pakistan. But in December 2002, PTCL lost its

monopoly because of the deregulation of the telecommunication sector (BMI, 2008).

PTCL was privatized in year 2006 and UAE based Etisalat group now controls the

largest stake in PTCL (PTA, 2007). Pakistan telecom market is categorized in to fixed

line, internet and mobile sectors.

4.1.1 Fixed Market Overview

Pakistan fixed line market remained under the monopoly of PTCL until 2003. In 2004-

05 PTA issued 12 international long distances licenses, 35 fixed local loop licenses and

17 wireless local loop licenses (BMI, 2008). Currently there are 37 fixed local loop

licenses, 14 long distances licenses and 16 wireless local loop licenses issued to various

companies. The fixed line penetration in the country stands at 4.2 percent providing a

huge opportunity for expansion. The fixed line subscriber increased from 6.7 million at

the end of 2007 to 609 million at the end of March 2008.

4.1.2 Internet Market Overview

Pakistan internet market is still underdeveloped but it has grown considerably over the

last few years. By the end of 2008 there are 3.6 million subscribers and BMI (2008)

forecasts an increase of 5.7 million by the end of 2012. Introduction of WLL and

WiMax will further internet coverage around the country.

4.1.3 Mobile Market Overview

Pakistan mobile market has seen a rapid growth in recent years and mobile density in

Pakistan has risen to 48 percent BMI (2008). There are currently 77 million mobile

subscribers in Pakistan. Currently there are six telecom companies operating on GSM

network in Pakistan.

4.1.4 Growth of Telecom Sector in Pakistan

Pakistan telecom sector has seen a tremendous cellular growth in recent years (PTA,

2007). According to BMI (2008), Pakistan telecom sector has emerged as one of the

fastest growing telecom sector especially in relation to South Asian economies such

including India, Bangladesh and Nepal. This rapid transformation is due to the investor

friendly liberalization measures taken by the government of Pakistan (Inam, 2007).

Privatization of PTCL and open licensing regime has seen a number of foreign telecom

companies investing heavily in telecom sector of Pakistan. Increase in use of cellular

and WLL services has also accounted for the growth of telecom sector in Pakistan.

Pakistan telecom sector grew at a rate of more than 80% (PTA, 2007). The major factor

behind this impressive growth is the addition of the valued services and reduction in the

prices of the telecom services which has created an atmosphere of competition among

operators.

Source: PTA (2007)

Figure 1: Cellular Subscriber Growth in Pakistan

4.1.5 Major Players in Pakistan Mobile & Fixed Line Sector

4.1.5.1 PTCL

PTCL is the leading telecom operator in Pakistan with a strong presence in fixed line,

mobile and internet sectors (BMI, 2008). PTCL was privatized in year 2006 and UAE

based Etisalat group controls the largest stake in PTCL. Despite financial difficulties

PTCL remains the dominant leader in fixed line market with a share of 95%. PTCL

also owns Ufone which is the second ranked mobile operator in the country. Increase in

mobile usage and stiff competition from other telecom companies has resulted in a net

loss of PKR 9.5 billion in the first six months. Etisalat group after their takeover

restructured PTCL’s pricing and marketing policies in order to increase their market

share in broadband and mobile markets.

4.1.5.2 Mobilink

Mobilink is leading mobile operator in Pakistan with a market share of 40% and 30

million subscribers (BMI, 2008).Mobilink is a wholly owned subsidiary of Egyptian

based telecom group Orascom. Orascom initially had 88 percent stake in Mobilink but

in 2007, Orascom acquired the remaining 12 percent stake for US$ 290 million from a

local investor (BMI, 2008). Mobilink operates on the GSM network and provides a

number of value added services such as post-paid, prepaid, voice, data and multimedia

services. Mobilink provides the largest network coverage in Pakistan. Mobilink is

facing a stiff competition from other mobile operators and is losing its market share

gradually. In order to combat the threat of its competitors Mobilink launched the service

of BlackBerry in Pakistan, to gain a distinctive advantage in corporate market (BMI,

2008).

4.1.5.3 Warid Telecom

Warid telecom is the fourth largest mobile operator in Pakistan with a market share of

around 17 percent. Warid telecom was launched in year 2005 when UAE based group

Warid acquired the license for US$ 291 million. Warid telecom has faced a stiff

competition from other telecom companies but still managed to attract over 13 million

subscribers since its launch. In June 2007 Warid telecom sold 30 percent of its stake to

Sing Tel for US$ 2.9 billion. In order to gain a significant edge in a highly competitive

telecom market in Pakistan, Warid telecom has decided to launch streamed mobile TV

to its users and has signed an agreement with UK based ROK Entertainment to provide

this facility (BMI, 2008).

4.1.5.4 Telenor Pakistan

Telenor is the third largest mobile operator in Pakistan with a market share of

approximately 19 percent. Telenor Pakistan was established in year 2005 when a

Norway based group Telenor acquired the license for US$ 291 million. In nearly 3

years, Telenor has managed to attract over 15 million subscribers because of its

competitive pricing structure (BMI, 2008). In year 2007, Telenor became the first

mobile operator to provide mobile TV services, enabling the users to watch live TV

including local and international channels on their handsets (BMI, 2008). Telenor

Pakistan has pledged to invest US$ 1 billion for the development of its network in

Pakistan by year 2013.

4.1.5.5 CMPak

CMPak which was previously Paktel is 100% subsidiary of China Mobile. Paktel has

the honour of the first cellular service provider in Pakistan. In March 2007, China

Mobile acquired 88.86 percent stake in Paktel for US$ 284 million in cash (BMI, 2008).

In May 2007, China Mobile acquired the outstanding shares of Paktel and changed its

name to CMPak. CMPak launched a new brand name Zong in 2008 and since then it

has added 3 million more subscribers.

Source: BMI (2008)

Table 3: Key Companies in Pakistan Telecom Sector

4.1.6 Investment in Telecom Sector of Pakistan

Pakistan telecom sector has attracted a large amount of investment in recent years

because of the investor friendly environment created by Government Pakistan (BMI,

2008). PTA is responsible for awarding the licenses in a fair and transparent

environment through bidding process. Pakistan telecom sector attracted an investment

of nearly US$ 8 billion during the last four years (BMI, 2008). Mobile sector accounted

for nearly 66% of the total investment. LDI and WLL has also attracted large amount

of investment in year 2006-07.

4.1.7 Foreign Direct Investment in Telecom Sector of Pakistan

Telecom sector of Pakistan is the largest recipient of foreign direct investment in recent

years. Government of Pakistan’s economic policies of liberalization and privatization is

paying rich dividends in attracting the foreign companies to expand their infrastructure

in Pakistan. In the past few years, telecom sector of Pakistan received record inflows of

foreign direct investment. Telecom sector attracted an estimated US$ 1.8 billion in

foreign direct investment during the fiscal year 2005-06 which accounts for 54% of the

total foreign direct investment in Pakistan (BMI, 2008). In fiscal year 2006-07, telecom

sector received US$ 1.824 million foreign direct investment, which is about 35% of the

total foreign direct investment in Pakistan (BMI, 2008). Mergers and acquisitions is the

preferred mode of entry for the foreign companies to invest in the telecom sector of

Pakistan. According to BMI (2008), ‘Liberal FDI policy by the Government of Pakistan

and deregulation and privatization of the telecom sector has triggered a wave of

international acquisitions in telecom sector of Pakistan’. During the fiscal year 2006-07,

US$ 2 billion worth of acquisitions were made in the telecom sector of Pakistan.

Some of the key acquisitions in telecom sector of Pakistan are as follows;

China mobile acquired 100 percent stake in Paktel Limited. Initially China

mobile bought 88.6 percent share in Paktel for US$ 460 million (Inam, 2007).

Qatar Telecom has acquired 75 percent shares of Burraq Telecom for

Nationwide and International Telephony Networks (Inam, 2007).

Source: BMI (2008)Table 4: Key Acquisitions in Pakistan Telecom Sector

4.2 Determinants of foreign direct investment in telecom sector of Pakistan

4.2.1 Market Size & Potential

Because of the particular nature of the telecom industry, Pakistan with a population of

161 million offers vast potential for the foreign investors to invest in the telecom sector

of Pakistan (BMI, 2008). There are approximately 77 million mobile subscribers in

Pakistan by the end of 2007 (BMI, 2008). BMI (2008) indicated that there was an

increase of 28.5 million net additions to Pakistan’s wireless market, an average of 2.4

million per month and despite shadows over the sustainability of growth in Pakistan’s

mobile market, BMI (2008) forecasts an annual growth rate of 15% each year until

2012, when there will be around 135 million subscribers and a penetration of around

78%. Technology advancements such WLL and WiMax services and launch of mobile

TV services can provide an extra incentive for foreign investors to capture the market

share. PTA (2007) indicated that Pakistan telecom sector will continue to grow because

of the increase in demand for technologies such as VoIP and satellite access

technologies.

In a major development government of Pakistan has decided to open the telecom sector

of Azad Jammu & Kashmir and Northern Areas to private operators (PTA, 2007). Azad

Jammu & Kashmir boasts a population of nearly 4.5 million and provide an opportunity

to the telecom companies to gain the market share.

Introduction of 3G technology in Pakistan also offers market potential for foreign

investors to invest in the Pakistan telecom sector. The current technology in use is GSM

and PTA will run an auction for three 3G licenses by the end of this year (BMI, 2008).

BMI (2008) expects a rapid increase in 3G mobile subscribers in Pakistan in next few

years and predicts that the 3G market will account 11.9% of the entire mobile market by

year 2012. BMI (2008) in its report indicated that Pakistan telecom market offers a

potential return of 55% (see Appendix B).

Source: BMI (2008)

Figure 2: Telecom Industry Market Size (2005-2012)

The above mentioned findings illustrate that there is a positive relationship between

market size and inflow of foreign direct investment in telecom sector of Pakistan.

4.2.2 Inflation

Inflation in Pakistan has started to rise again. Government of Pakistan has been able to

maintain a low inflation rate in recent years but higher oil and gas prices has seen

inflation rise to 19.3 percent in May 2008 (BMI, 2008). BMI (2008) predicts the

inflation to rise further in coming months because of recent fuel and gas price hikes (of

10% and 30% respectively). High inflation will further deteriorate the economic

situation of the country and can have a negative impact on the inflow of foreign direct

investment in the country.

4.2.3 Labour Cost

Pakistan is the world’s sixth largest population and has got a huge amount of labour

resources. Khan& Kim (1999) in their research findings argue that a technically trained,

educated and cheap labour force are important factors in attracting foreign direct

investment. There is a shortage of trained and educated labour force in Pakistan as

compared to other developing economies. Pakistan’s adult literacy has been increasing

gradually in recent years. The overall literacy rate stand at 55% in years 2006-07

compared to 45% in year 2001-02, an increase of 10% over a six year period (ESP,

2007-08). However, with a strong base of economically active population, Pakistan has

an edge as it is a low wage economy with an average wage of $75-$100 a month for

unskilled workers, $100-$200 for skilled and $200-$500 for managerial workers

(Akhtar, 2007). Based on the empirical evidence of literature review and cheap labour

costs in Pakistan, a positive relationship exists between the labour cost and inflow of

foreign direct in telecom sector of Pakistan.

4.2.4 Government Economic Policies

Consistent economic policies play an important role to attract foreign direct investment

in the developing countries. Unfortunately, Pakistan’s track record in maintaining

consistent economic policies has been poor since its birth in 1947 (Khan & Kim, 1999).

Khan and Kim (1999) figured out that this change in policies with a change of

government as well as change in policy within the tenure of government has been quite

common in Pakistan. However under the rule of Prime Minister Shaukat Aziz

government of Pakistan provided investor friendly economic policies to attract the

foreign direct investment. The main features of the policy that’s assisted in attracting

foreign direct investment are open, unrestricted, technology-neutral licensing and

Pakistan Telecom Authority is made responsible to regulate the rates (Shahid, Lian &

Liu, 2007).

4.2.5 Foreign Direct Investment Policy in Telecom Sector

Shahid, Lian & Liu (2007) argue that relaxation of limitations on foreign direct

investment in telecommunications sector is very much in line with the liberalization and

competition in the telecommunication market. In order to attract foreign direct

investment in telecom sector, government of Pakistan has taken the following steps

Simplifying registration procedures for investors

Eliminating the requirement of minimum foreign equity in the services sector

after declaration of telecom sector as industry in the year 2004

Lifting the restriction from repatriation of the profits, by allowing foreign

investors to repatriate 100 percent of their profits

Reduction and, in some cases, exemption in duties, taxes and

technical/royalty/franchise fees (Shahid, Lian & Liu, 2007)

Source BOI Pakistan, (2007)

Table 5: Investment Policies by Government of Pakistan

The effectiveness of the Pakistan’s foreign direct investment policy is clearly evident

form the study conducted by WTO. According to WTO, “Pakistan’s foreign direct

investment policy regime is amongst the most liberal in the region. All economic sectors

are now open for foreign direct investment and in almost all sectors 100% foreign

ownership is allowed. No government sanction is required for making investment in

any sector of the economy (except arms and ammunitions; security printing, currency

and mint; high explosives, and radioactive substances). Pakistan provides full

protection to foreign investment under the Foreign Private Investment (promotion &

Protection) Act, 1976, and the Protection of Economic Reforms Act, 1992. Pakistan has

signed bilateral investment Agreement with 40 countries and agreements on avoidance

of double taxation with 51 countries. Foreign investors and technical and managerial

manpower does not require work permits and business work visas are issued liberally”

(Trade Policy Review of Pakistan, 2005).

These investor friendly government policies has helped in attracting foreign direct

investment in telecom sector of Pakistan and hence show a positive relationship

between foreign direct investment policy and inflow of foreign direct investment in

telecom sector of Pakistan.

4.2.6 Tariffs and Taxes in Telecom Sector

According to PTA (2007) telecom sector is a major contributor in generating revenues

for the government in the form of taxes, duties and regulatory charges. However

government of Pakistan is undergoing massive tax reforms aiming to reduce indirect

taxes that are consisted regressive taxes and according to BOI (2007) government of

Pakistan has offered 50% tax relief for non manufacturing sector in Pakistan.

Government of Pakistan has also reduced their tariffs from 100% in 1980 to 21% in

2001 and the tariffs were further reduced by 14% during the year 2005. BMI (2008)

predicted Pakistan can attract a large amount of foreign direct investment in telecom

sector as long as country brings down its tariffs. Pakistani government has set up a zero

import duty on capital goods, plant and machinery equipment not manufactured locally

and zero import duty on raw materials used in the production of exports (see figure).

These investor friendly tariffs and tax rates have attracted foreign companies to invest in

the telecom sector of Pakistan. Hence there exists a positive relationship between the

tariffs and taxes and the inflow of foreign direct investment in telecom sector of

Pakistan.

Source: World Trade Organization

Table 6: Tariffs and Import Product Groups

4.2.7 GDP Growth Rate & Openness of the economy

Pakistan’s economy is experiencing the longest spell of its economic growth in years.

Economic growth accelerates to 7.0 percent in 2006-07 at the back of robust growth in

agriculture, manufacturing and services sector (BMI, 2008). According to BMI (2008),

Pakistan’s economy has been rated as one of the fastest growing economies in

comparison with other East Asian economies like Malaysia, Indonesia, Thailand and

Philippines which grew at the rates between 5% and 5.5%. BMI (2008) expects Pakistan

to maintain a 6-8% growth rate in the coming 5 years. Government policy of

deregulation, privatization & liberalization is paying rich dividends. There is an

unprecedented inflow in FDI. Pakistan has attracted a FDI of 2.2 billion US$ in year

2006 compared to 308.8 million US$ in year 2000. Compared with other emerging

economies in Asia, this puts Pakistan as one of the fast growing economies in the region

along with China, India and Vietnam (BMI, 2008). This stable economic growth makes

Pakistan an open economy for the foreign investors. Therefore there exists a positive

relationship between GDP and foreign direct investment inflow in telecom sector of

Pakistan.

Source: Datamonitor (2007)

Figure 3: Real GDP Growth of Pakistan

4.2.8 Infrastructure

Availability and cost of the infrastructure facilities such as water, power and

telecommunication services play an important role in attracting the foreign direct

investment (Khan & Kim, 1999). According to the research conducted by Khan and

Kim (1999), infrastructure facilities in Pakistan are poor as compared to the other

developing countries that have attracted large amount of foreign direct investment. But

in recent years, Pakistan has seen a rapid improvement in its infrastructure facilities

mainly because of the development projects undertaken by the government of Pakistan

(Farhat, 2008). Government of Pakistan has given special consideration to improve the

infrastructure of the country in order to attract foreign investors. One of the key projects

undertaken by the government of Pakistan is the development of Gwader port which

was opened in March 2008. One of the main challenges that Pakistan is facing is the

shortage of electricity because of the increase in demand of electricity. Tarbela Dam and

Mangla Dam account for nearly 50% of the electricity generated in Pakistan (Farhat,

2008). However, construction of new dams is in process and is expected to complete by

year 2012 (Farhat, 2008).

4.2.9 Regulatory Authority

Presence of an independent regulator is an important factor in order to create a

competitive environment and to liberalize the telecommunication sector (Shahid, Lian

& Liu, 2007). In order to create an environment conducive for foreign direct investment

in Pakistan, Pakistan telecommunications authority was established in 1996 under the

Pakistan Telecommunications (Re-Organizing) Act. PTA was formally under the

jurisdiction of Ministry of Information and Technology but in 2001 it gained the status

of an independent regulatory agency for the telecom industry in response to Pakistan’s

WTO commitments (BMI, 2008). The main functions and responsibilities of PTA are as

follows;

To regulate the operation and maintenance of telecom sector in Pakistan

To protect the interest of the consumers

To ensure non discrimination in telecommunication licensing

To improve and accelerate the infrastructure of telecommunication services to

all parts of Pakistan

To facilitate new entrants to survive in the presence of an incumbent operator

To support the modernization of the telecommunication sector through

privatization, de-regulation and liberalization

To maintain an effective and well defined regulatory environment in accordance

with the international laws

To protect Pakistan’s national and security interests

To create a rationalized and investor friendly tariff structure for the telecom

sector (BMI, 2008)

PTA since its inception has been able to maintain an investor friendly environment and

ensured a free and fair bidding process for new licenses. BMI (2008) in their repost

indicated that the independence of regulator in Pakistan is nearly 80% (see Appendix).

The effectiveness of regulator authority in Pakistan is also clearly evident from the

remarks of Telenor Pakistan’s CEO Tore Johnsen;

“We appreciate the presence of a stable regulatory environment with a clear licensing

framework…the Ministry of Information technology and the Pakistan Telecom

Authority has been successful in providing a level playing field and has fostered a

culture of industry consultation” (BMI, 2008). Presence of an independent and stable

regulatory authority has helped in attracting a large amount of foreign direct investment

in Pakistan. Hence, there exists a strong relationship between regulatory authority and

inflow of foreign direct investment in Pakistan.

4.2.10 Privatization

Government of Pakistan’s policy of privatization has attracted large amount of foreign

direct investment in recent years. Privatization in Pakistan was started in 1991 by Prime

Minister Nawaz Sharif and has shown an impressive growth in recent years (Husain,

2006). Some of the salient features of Pakistan’s privatization policy are;

Foreign Direct Investment is allowed in all sectors

Equal treatment of local and foreign investors

100% foreign equity allowed

Attractive tax and incentive packages

Reduction in the corporate tax rate from 39% in 2005 to 35% in 2007 for private

companies (PTA, 2007)

These policies resulted in privatization of a number of companies in recent years (ESP,

2007). Privatization of state owned PTCL in year 2006 resulted in a large inflow of

foreign direct investment in telecom sector of Pakistan.

4.2.11 Telecom Related Suppliers in Pakistan

A lot foreign telecom companies such as Nokia, Ericsson, Motorola and Siemens have

setup their business activities in Pakistan and are offering valuable services to the new

entrants to establish their networks across Pakistan. In addition to the foreign firms a

number of local firms are also providing similar services to the new entrants in the

telecom sector.

4.3 Foreign Direct Investment Risks in Pakistan

Pakistan in spite of providing investor friendly economic policies and a business

environment supportive of inward investment in telecom sector pose significant threats

to foreign investors (BMI, 2008). According to BMI (2008), Pakistan secures 11 th

position in their regional Business Environment Rankings largely due to the on going

political instability in the country. Pakistan has got the highest country risk of 10.6 (see

Appendix B) as compared to the other the regional countries (BMI, 2008).

Following are the main risks associated with the foreign investor’s decision to invest in

Pakistan.

4.3.1 Political Risk

4.3.1.1 Political Risk Type-2

Political stability is one of the important factors in attracting foreign direct investment

in developing countries because it creates confidence for foreign investors (MIGA,

1994). Pakistan is ranked 7th in political risks study carried out by Eurasia Group and

has faced political instability because of weak institutional role since its independence

in year 1947. Lack of institutional and judicial role and involvement of army has led to

the demise of four elected governments during the period 1988-1999. Changes in the

governments have also affected the inflow of foreign direct investment in Pakistan

during the year 1988 to 1999. Apart from the political instability other factors such as

the decision of Pakistan government in year 1998 to test the nuclear weapons also

hindered the foreign direct investment in the country. However, Pakistan has seen a

period of political stability under the dictatorship of President Musharraf and for the

first time in the history of Pakistan an elected government led by Prime Minister

Shaukat Aziz has been able to complete its tenure of 5 years. These five years of

political stability saw a large inflow of foreign direct investment in Pakistan especially

in the telecom sector. But removal of Chief Justice of Pakistan on 3 rd November 2007

and assassination of former Prime Minister Benazir on 27th December 2007 has led to

country wide protests and violence. Pakistan Peoples Party won the parliamentary

election on 18th February and vowed to bring the peace and stability in the country.

However, the new government is facing tough challenges on the issues of restoration of

judges and impeachment of President Musharraf. On 7th August 2008 government

coalition announced to impeach the President of Pakistan and vowed to reinstate the

deposed Chief Justice of Pakistan (BMI, 2008). This situation will create further

political unrest and will have a negative impact on the inflow of foreign direct

investment in the country.

Apart from political instability, Pakistan continues to fight against internal extremism

and sectarian violence within the country. Armed forces are carrying out operations

against militants in nearly every province of Pakistan. This has led to an increase in

suicide attacks and cross border terrorism in recent months. According to Eurasia

(2007), Pakistan’s security situation will further deteriorate in Tribal areas and North

West Frontier Province, posing serious implications for the country.

The above factors clearly indicate that Political Risk Type-2 is clearly high in Pakistan

and can discourage the inflow of foreign direct investment in the country.

4.3.1.2 Political Risk Type-1

Political risk type-1 involves change in the government policies with a change in

government. According to (Khan & Kim, 1999), Pakistan has a poor record in

maintaining consistent economic policies. But this situation has improved quiet

considerably in recent years. Under the dictatorship of President Musharraf, Pakistani

government has been able to maintain consistent investor friendly economic policies

and attracted a large amount of foreign direct investment in the country. However, with

inflation rising to a record high 11 percent government is facing a tough task to

maintain the consistency in economic policies. Hence, Political Risk Type-1 is

considerably high in Pakistan.

4.3.2 Currency Risk

Pakistani currency has depreciated a lot in recent months on the back of deteriorating

fundamentals, rising oil prices, sagging foreign exchange reserves and political

instability (BMI, 2008). Pakistani Rupee has depreciated by more than 13% percent

again the US Dollar since the start of year and it is expected that it will depreciate

further in coming months (BMI, 2008). This rapid decline in Pakistani Rupee could

further deteriorate the economic situation of the country and affect the inflow of foreign

investment.

Source: BMI (2008)Figure 4: Depreciation of Pakistan Rupee

Chapter 5. Analysis

This chapter will analyze the findings of the research data in connection with the

theoretical framework provided in chapter 3 and chapter 4.

5.1 SWOT Analysis of Pakistan Telecom Sector

SWOT analysis is used to analyze the state of Pakistan Telecom Sector.

5.1.1 Strengths

5.1.1.1 Investor Friendly Government Policies

Government of Pakistan’s policy of privatization and deregulation is a key strength for

Pakistan telecom sector in attracting the foreign investors. Privatization of state owned

PTCL to UAE based Etisalat group has been a significant milestone in this regard.

Apart from privatization and deregulation policies government of Pakistan has provided

various incentives to foreign companies to invest in the telecom sector of Pakistan.

Incentives such as simplifying registration procedure for telecom investors, eliminating

the requirement of minimum foreign equity in telecom sector and allowing the foreign

investors to repatriate 100 percent of their profits has helped the inflow of foreign direct

investment in telecom sector. Government of Pakistan has also reduced the tariffs by 14

percent in 2005. BMI (2008) in their annual report indicated that government of

Pakistan’s steps in bringing the tariffs down will encourage the inflow of foreign direct

investment in telecom sector of Pakistan. According to WTO, “Pakistan’s foreign direct

investment policy regime is amongst the most liberal in the region. All economic sectors

are now open for foreign direct investment and in almost all sectors 100% foreign

ownership is allowed. No government sanction is required for making investment in

any sector of the economy (except arms and ammunitions; security printing, currency

and mint; high explosives, and radioactive substances). Pakistan provides full

protection to foreign investment under the Foreign Private Investment (Promotion &

Protection) Act, 1976, and the Protection of Economic Reforms Act, 1992. Pakistan has

signed bilateral investment Agreement with 40 countries and agreements on avoidance

of double taxation with 51 countries. Foreign investors and technical and managerial

manpower does not require work permits and business work visas are issued liberally”

(Trade Policy Review of Pakistan, 2005).

The above analysis clearly indicates that investor friendly government policies act as a

potential strength for the Pakistan telecom sector.

5.1.1.2 Regulatory Authority

The rapid growth in every domain of the telecom sector and emergence of new telecom

companies has raised a number of regulatory issues in Pakistan telecom (PTA, 2007).

The role of PTA as an independent regulatory authority is an important strength for

Pakistan telecom sector in this regard. PTA is an independent regulatory authority who

is responsible for overall operations of telecom sector in Pakistan. PTA since its

inception has been able to maintain an environment conducive for foreign investment.

PTA is responsible for the issuing the licenses to foreign companies through free and

fair bidding process. PTA has played an important role in helping the new telecom

companies to set up their network across the county and provided a level playing field

to all the operators in Pakistan telecom market. It has also improved the infrastructure of

telecom services across the country. These measures taken by PTA have made Pakistan

telecom more modern, efficient and attractive for foreign investors. Hence an

independent and fully functional PTA augurs well for the inflow of foreign direct

investment Pakistan telecom industry.

5.1.1.3 Labour Cost

One of the main strength for the Pakistan telecom sector is the availability of cheap and

well educated labour. Pakistan has an edge in the telecom market since it is a low wage

economy with an average wage of $75-$100 a month for unskilled workers, $100-$200

for skilled and $200-$500 for managerial workers (Akhtar, 2007). The cheap labour

costs act locational advantage for Pakistan and provides an added incentive for the

foreign investors to invest in telecom sector of Pakistan.

5.1.2 Weaknesses

5.1.2.1 Inflation

Inflation in Pakistan has risen considerably in the last few years on the back of high fuel

and food prices. High inflation can act as a weakness for the telecom sector since it will

have an impact on the purchasing power of the public.

5.1.2.2 Infrastructure

Infrastructure facilities in Pakistan are poor as compared to other developing nations

who have attracted foreign direct investment (Khan & Kim, 1999). One of the main

challenges for the Pakistan telecom sector is the shortage of electric supply. Pakistan in

recent years has failed to construct new dams and power generating facilities. In order

to cater the demand in electricity government of Pakistan has opened up new projects to

build new dams by 2012 (Mohsin, 2007). Poor infrastructure facilities can have a huge

impact on the decision of foreign companies to operate in Pakistan.

5.1.3 Opportunities

5.1.3.1 Market Size

Pakistan with a population of nearly 161 million people offers vast potential for the

foreign investors to invest in the telecom sector. Mobile density in Pakistan is still under

50 percent and there are approximately 77 million mobile subscribers in Pakistan (BMI,

2008). Pakistan has seen rapid rise in the use of mobile services in recent years with an

addition of 28.5 million subscribers per month. BMI (2008) forecasts an annual growth

of 15 percent each year till 2012, when there will be around 135 million subscribers and

a market penetration of around 78%. Government of Pakistan’s decision to open the

regions of Azad Jammu & Kashmir and Northern Areas to private sector also provide

telecom companies to expand their networks in those regions and gain market share.

Azad Jammu & Kashmir boasts a population of nearly 4.5 million and provide an

opportunity to the telecom companies to gain the market share.

This analysis clearly indicates that Pakistan telecom market offers huge potential for

foreign investors to invest.

5.1.3.2 Implementation of 3G Network

Introduction of 3G technology in Pakistan also offers market potential for foreign

investors to invest in the Pakistan telecom sector. The current technology in use is GSM

and PTA will run an auction for three 3G licenses by the end of this year (BMI, 2008).

BMI (2008) expects a rapid increase in 3G mobile subscribers in Pakistan in next few

years and predicts that the 3G market will account 11.9% of the entire mobile market by

year 2012.

5.1.3.3 Competition

There are currently five mobile companies operating in Pakistan on GSM network. The

competition among these companies is fierce and each company is trying to gain the

market share. This tough competition can be treated as threat as well but this provides

an opportunity to foreign companies to provide an incentive to the customers by

keeping the price low and also by providing the value added services.

5.1.4 Threats

5.1.4.1 Political Risk Type-II

One of the key threats to Pakistan telecom market is the political risk type-II which

deals with the political stability in the country. Pakistan since its inception has faced

political instability because of weak institutional role. Apart from political instability,

Pakistan continues to fight against internal extremism and sectarian violence within the

country. Armed forces are carrying out operations against militants in nearly every

province of Pakistan. This has led to an increase in suicide attacks and cross border

terrorism in recent months. According to Eurasia (2007), Pakistan’s security situation

will further deteriorate in Tribal areas and North West Frontier Province, posing serious

implications for the country.

Political instability could turn to economic uncertainty, which could affect the inflow of

foreign direct investment (BMI, 2008)

5.1.4.2 Currency Risk

Pakistani Rupee has been subject to sharp volatility in recent months on the back of

deteriorating fundamentals such as soaring oil prices, sagging foreign exchange reserves

and political turbulence (BMI, 2008). Pakistani Rupee has depreciated by more than 13

percent versus the US Dollar since the start of 2008 and it is expected to depreciate

further in next months. A weak currency will affect the profit potential of the firm and

discourage the investors to invest in Pakistan telecom sector.

5.2 Pakistan Telecom Sector and Porter’s Five Forces

Porter’s five forces model is used to analyze the industry environment. Porter’s five

forces model is helpful in determining the best suitable entry strategy for the foreign

companies.

5.2.1 Threats of New Entrants

Threat of new entrants in Pakistan telecom market is significantly high because of the

investor friendly government policies and an environment conducive for foreign direct

investment. Also, PTA is soon going to issue three licenses for 3G network to foreign

companies.

5.2.2 Bargaining Power of Customer

Bargaining power of customers is high in telecom sector of Pakistan. Currently there are

six mobile companies operating and each of them is offering different packages at

different prices with added value added services. Also, the price of switching from one

provider to another is fairly low. Hence, the buyer power in Pakistan telecom sector is

considerably high.

5.2.3 Bargaining Power of Supplier

Bargaining power of telecom related suppliers is low in Pakistan. A lot foreign telecom

companies such as Nokia, Ericsson, Motorola and Siemens have setup their business

activities in Pakistan and are offering valuable services to the new entrants to establish

their networks across Pakistan. In addition to the foreign firms a number of local firms

are also providing similar services to the new entrants in the telecom sector.

5.2.4 Threat of Substitutes

The only substitute to mobile services is the fixed line. PTCL is responsible to handle

the fixed line business in Pakistan and is facing an uphill task to add to its fixed line

subscriber because of the growing popularity of the mobile services. Hence, the threat

of substitutes is fairly low in Pakistan telecom market.

5.2.5 Level of Existing Rivalry

Currently there are six telecom companies operating on GSM network in Pakistan. The

rivalry among these companies is fierce and each company is facing tough battle to gain

market share. However, there is still a lot of market potential available to these firms,

since the mobile density in Pakistan is well under 50 percent.

5.3 Entry ModeThis section will try to analyze the entry strategy to enter in telecom sector of Pakistan.

The research shows that choice of entry mode is affected by external (Host Country)

and internal factors. Since, the research is being done on Pakistan telecom sector so the

research will assume the internal factors in order to identify suitable the entry strategy

for foreign direct investment in telecom sector of Pakistan. The analysis will be based

on the findings of Franklin (1998).

5.3.1 External Factors

The research clearly suggests that there is a high sales potential in Pakistan telecom

market. BMI (2008) indicated that there was an increase of 28.5 million net additions to

Pakistan’s wireless market, an average of 2.4 million per month and despite shadows

over the sustainability of growth in Pakistan’s mobile market, BMI (2008) forecasts an

annual growth rate of 15% each year until 2012, when there will be around 135 million

subscribers.

The competition in Pakistan telecom market is of oligopolistic type, as there are six

telecom companies competing to gain the market share. Mobilink is leading mobile

operator in Pakistan with a market share of 40% and 30 million subscribers (BMI,

2008).

Production costs in Pakistan telecom sector is assumed to be significantly low because

of the availability of cheap labour. Also, government of Pakistan has given 50 percent

tax relief to non-manufacturing sector in Pakistan (BOI, 2007).

Government of Pakistan have liberal and investor friendly policies for foreign direct

investment. Government has provided various incentives to foreign investors to invest

in the telecom sector of Pakistan.

Pakistan economy is dynamic and is experiencing the longest spell of its economic

growth in years. Economic growth accelerates to 7.0 percent in 2006-07 at the back of

robust growth in agriculture, manufacturing and services sector (BMI, 2008).

According to BMI (2008), Pakistan’s economy has been rated as one of the fastest

growing economies in comparison with other East Asian economies.

Political risk is significantly high in Pakistan because of the on going political crisis and

terrorism in the country.

Pakistani Rupee has been subject to sharp volatility in recent months on the back of

deteriorating fundamentals such as soaring oil prices, sagging foreign exchange reserves

and political turbulence (BMI, 2008). Pakistani Rupee has depreciated by more than 13

percent versus the US Dollar since the start of 2008.

5.3.2 Internal & Home Country Factors

The researcher assumes that the ‘Alpha Telecom’ is the company which is going to

invest in Pakistan telecom sector and following are the assumed internal and home

country factors related to ‘Alpha Telecom’ that will determine the choice of entry mode

to invest in Pakistan telecom sector.

Standard product

High Product Adaptation

Substantial Resources

High Commitment

Small Market

Oligopolistic Competition

High Production Cost

5.3.3 Choice of Entry Mode

Choice of entry mode to enter Pakistan telecom market is derived by putting the internal

and external factors in the table 1 mentioned in chapter 2.

Table 7: Choice of Entry Mode

It is clearly evident from the table the best suitable entry mode to invest in Pakistan

telecom sector is through equity investment or production. This means that the ‘Alpha

Telecom’ can either entry through acquisition or can do joint venture with other

company in Pakistan

Chapter 6. Conclusion & Recommendations

The previous chapter provided an in-depth analysis of the Pakistan telecom sector by

conducting the SWOT analysis and Porter’s fiver forces model. This chapter will

discuss the summary of the project. Also, the limitations of this research will be

discussed along with the some suggestions and recommendations for future research in

this area.

6.1 Summary of the Research

The objective of this research is to identify the determinants and risks associated with

foreign direct investment in Pakistan telecom sector and to identify the suitable mode of

entry to invest in Pakistan telecom sector.

The research identifies that Pakistan telecom market is one of the fastest growing in the

South Asian region. There is a lot of potential available in the Pakistan telecom market

since the mobile density in Pakistan is well under 50 percent. Government of Pakistan’s

policy of liberalization, privatization and investment protection are some of the key

strengths of Pakistan telecom market. Opening of the Northern areas and issuing of the

3G licenses will provide an opportunity to the foreign companies to expand their

network across the country. Presence of an independent and fully functional regulatory

authority and availability of cheap labour provides added incentive for foreign investors

in the telecom sector of Pakistan.

However, Political instability in the country is the biggest threat to attract the foreign

investors. High inflation and deprecation of the Pakistani Rupee could also have a

negative impact on the inflow of foreign investment in the market.

The research suggests that the best entry mode to invest in Pakistan telecom sector is

either through acquisition or joint venture. Since, it will provide the foreign company a

rapid access to the market and will help them in gaining the significant market share.

Note: In a major development President Pervaiz Musharraf stepped down as President

of Pakistan on 18th August. This major development has seen a slight appreciation of

Pakistan Rupee and also has a positive impact on the Karachi stock exchange. But

politically Pakistan is not stable yet.

6.2 Limitations

The major limitation in conducting this research was to get the primary data through

telephonic interviews and emails. The researcher tried to contact Pakistan Telecom

Authority and Warid Telecom but due to lack of corporation from the management of

Pakistan Telecom Authority and Warid Telecom, a considerable amount of time was

lost. The lack of primary data completely changed the structure of the research. Also,

there is insufficient data available on development of infrastructure facilities in

Pakistan.

6.3 Future Recommendation

This research can be used for future researches from the prospect of assessing the entry

strategy in Pakistan telecom sector. Researchers can take this study as a base and take it

further to enhance the scope of this study to optimum level by assessing the entry

strategy and post entry strategies for investing in Pakistan telecom sector. This research

can also act as a guideline for researches in other sectors of Pakistan.

Appendix A

FDI in Pakistan Telecom Sector

Student UB Number

07000441

TITLE OF DEGREE: Master of Arts

MODULE TITLE: Research Methods (MAN 4148M)

MODULE LECTURER: Dr Shona Bettany

STATEMENT OF AUTHORITY

We have read the University Regulations relating to plagiarism and certify that the above piece of coursework is all our own work and do not contain any unacknowledged work from any other sources.

Signature………………………………………………………………………………

………………………………………………………………………………………… April 25, 2008

Date: ………………………………………

Word Count: 2059 1

1In accordance with the UoB’s regulations excluding tables, footnotes and the appendix

Contents

Introduction......................................................................................................................3Defining the Parameters................................................................................................31) Purpose of the Study/ Concept Map....................................................................42) Literature review......................................................................................................43) Research Gap.........................................................................................................54) Research Gap Contribution...................................................................................65) Research Questions...............................................................................................66) Research Methodology..........................................................................................7

I. Philosophy............................................................................................................7II. Approach..............................................................................................................7III. Strategy................................................................................................................7IV. Data Analysis Approach.....................................................................................8

7) Sampling...................................................................................................................88) Data Collection........................................................................................................9

a) Primary Sources of Data....................................................................................9b) Secondary Sources of Data..............................................................................9

9) Limitations of Research.......................................................................................1010) Proposed Chapter Plan....................................................................................1111) Project Plan........................................................................................................1212) References.........................................................................................................13

Introduction

Pakistan’s economy has grown considerably in recent years because of the investor

friendly economic policies brought by the Government of Pakistan. Government’s

policy of deregulation, privatization & liberalization is paying rich dividends and has

attracted a large amount of foreign direct investment in the past few years. Low tariffs,

high consumer demand, intense competition and a government and regulator ready to

welcome inward investment have created a powerful impetus for growth in Pakistan’s

telecom sector. According to Business Monitor International, BMI, (2008), investment

levels continue to impress, as Pakistan’s mobile operators now fight it out for market

share amid network enhancement projects. In the last few years, many telecom

companies from Europe and Middle East have invested heavily in the telecom sector.

According to Business Monitor International, BMI, (2008), a total of US$2.7bn was

invested in infrastructure by Pakistan’s mobile operators in the fiscal year ending June

2007. China Mobile has recently invested in Pakistan’s telecom sector.

The research proposal covers the purpose, concept map, literature review, research

gap, research questions, and research methodology. In the light of these, it also

purposes the chapter plan but the important factor is that this chapter plan is subject

to change depending on the analysis of the primary and secondary data.

Defining the Parameters

Bell (2005) gave the concept of ‘defining the parameters’ for the research. Based on

his concept, the necessary parameters are described below:

1. Language of Publication: English

2. Subject Area: International Business Environment, International Business

Strategy

3. Business Sector: Telecom Industry

4. Geographical Area: Pakistan

5. Literature Type: Books, Journals, Company Reports, Government Policies,

World Bank Reports, International Monetary Fund Reports, Business Monitor

Online.

1) Purpose of the Study/ Concept Map

Pakistan is a developing country with the world’s sixth largest population. Pakistan’s

economy is experiencing the longest spell of its economic growth in years. Economic

growth accelerated to 7.0 percent in 2006-07 at the back of robust growth in

agriculture, manufacturing and services. Pakistan’s real GDP has grown at an average

rate of 7.0 percent in the last 5 years. There is an unprecedented inflow in foreign

direct investment in Pakistan. Pakistan has attracted a FDI of 4.1 billion US$ in year

2007 compared to 308.8 million US$ in year 2000. Foreign direct investment in

telecom sector accounted nearly 33 percent of the total foreign direct investment. The

study will try to explore the factors that have facilitated the large amount of foreign

direct investment in telecom sector in Pakistan. The theory of internationalization

insists on moving to different countries for low cost and high quality production,

Pakistan has begun to be sought as a better market. So, the research will investigate

those variables which have attracted the foreign investors to invest in telecom sector

in Pakistan. It will examine the incentives given by the government to the foreign

investors to invest in telecom sector. It will also provide the detailed overview of the

industry environment using the SWOT analysis. An overview of the political and risk

assessment factors will also be discussed in detail to identify the trends that have been

present in the past and may contribute to the present as well as future investment

trends in telecom sector. In conclusion, the current research will try to figure out the

strategies of the multinational firms who have invested in telecom sector in Pakistan.

2) Literature review

In recent years, South Asian countries have been the focus of foreign direct

investment. According to Business Monitor Online (2008), South Asian region is home

to high levels of telecoms growth; but in Pakistan infrastructure and subscriber growth

patterns seem unrivalled with the telecoms sector experiencing unusually high growth.

Love and Hidalgo (2000) argue that empirical studies show the domestic market size

and cost factor relate to the location of foreign direct investment. According to them,

market size measures are GDP, GDP/capita and growth in GDP of country. Pakistan’s

real GDP has grown at an average rate of 7.0 percent in the last 5 years. Asiedu (2002)

spotlighted that policy reforms brought about by the governments are the

determinants of FDI in developing countries. This can be proved by the fact that

Pakistan's government has been instrumental in the deregulation of Pakistan's

telecoms market, which in turn has led to competition, improved investment and

growth. Aqeel and Nishat, (2004) identified determinants of growth by considering

tariff rate, exchange rate, tax rate, credit to private sector and index of general share

price variables. Low tariffs, high consumer demand, intense competition and a

government and regulator ready to welcome inward investment have created a

powerful impetus for Pakistan’s telecom market. Investor friendly policies of Pakistani

Government have encouraged inward investment from the likes of Telenor and Warid

Telecom (Business Monitor, 2008). Although economic growth is likely to remain

robust in the short term, but Pakistan’ growing political instability and security issues

could hamper the foreign direct investment. According to ODI (1997), political

instability, in terms of crime level, riots, labor disputes and corruption, is an important

factor limiting substantial foreign investment into developing countries. On the other

hand there are other factors, for example, structural weakness of economy, shortage

of skilled labour and deficient technological capability. These factors can depress the

potential profitability of investment. Pakistan’s economy has improved most of these

factors in recent years but the political instability remains the biggest threat to attract

the foreign investment.

3) Research Gap

Foreign direct investment in telecom industry in Pakistan is still into its initial stages.

Lots of variables have contributed in making Pakistan a better market for foreign direct

investment especially in telecom sector. However, the journal research on this issue

has been under researched. Jahanzeb (2007) assesses the FDI in Pakistan over the last

5 years in SME sector. A lot of statistical data on foreign direct investment in Pakistan

is available from the government websites. World Investment Reports by UNCTAD

(2007) also gives an overview on the amount of foreign direct investment in Pakistan.

However, there is insufficient research on determinants of the foreign direct

investment in telecom sector in Pakistan. Some research has been done to identify the

impediments of foreign direct investment in Pakistan (Khan, A.H, & Kim H 1999) as

they mentioned economic instability, taxation etc. Economic indicators explain change

in the economic situation of Pakistan since it is moving through a recovery phase. The

existing research has not accounted for the new socio-political, socio-cultural and

socio-economic environment of Pakistan. Moreover, there is in sufficient data available

on the variables such as political instability and security risks which have been changed

dramatically in recent years and their impact in foreign direct investment.

4) Research Gap Contribution

In the light of above mentioned research objectives and literature review, it can be

argued that the areas identified in the research objectives have not been explored or

discussed in great depth. It is hoped that the objectives set in this report will try to

answer all these unanswered questions and will also try to contribute towards already

published research.

5) Research Questions

The research will try to answer the following questions:

4. What are the determinants and motives of foreign direct investment in

Pakistan telecom sector?

5. An overview of the industry environment using SWOT analysis

6. What are the entry strategies and challenges for the firms to invest in telecom

sector in Pakistan?

7. What variables have changed and their impact on the foreign direct investment

in telecom sector in Pakistan?

8. How the pr-entry strategies implicate the existing and future strategies of the

firms investing in telecom sector?

6) Research Methodology

The research onion described by Mark Saunders, Philip Lewis and Adrian Thornhill

(2006) is used to analyze the philosophy, approach and strategy of research.

I. Philosophy

The major philosophy used in this research will be ‘Realism’. According to Saunders,

Lewis & Thornhill (2007), realism is a branch of epistemology which is similar to

positivism in that it assumes a scientific approach to the development of knowledge.

This assumption underpins the collection of data and the understanding of that data.

Bhaskar (1989) argues that we can identify what we don’t see through the practical and

theoretical processes of the social sciences. The objective of the research is to assess the

industry environment and entry strategies, so ontology is not the right choice for this

particular research as according to Saunders, Lewis & Thornhill (2007), it is concerned

with the nature of reality.

II. Approach

The research will be employing inductive as well as deductive approach. Since, one of

the main objectives of the research is to figure out the variables which are responsible

for foreign direct investment in telecom sector of Pakistan, therefore inductive approach

will be used extensively. Only where there is a requirement of analyzing the quantitative

data, deductive approach will be used.

III. Strategy

In order to critically evaluate the industry environment and entry strategies, grounded

theory presented by Glaser & Strauss (1967) will be used as research strategy.

According to Goulding (2002), grounded theory strategy can be used to explore a wide

range of business and management issues.

IV. Data Analysis Approach

The research will be mainly comprised of qualitative data and will be inductive in

nature; hence analytical induction approach will be used to make the critical remarks.

Other theories do not cope with the philosophy, approach and strategy of the research

and cannot be used for that reason. Spreadsheets will be used for the analysis of the

quantitative data.

Figure 1: The Research ‘Onion’: Model Presented by Mark Saunders, Philip Lewis and Adrian

Thornhill (2006)

7) Sampling

Sample population will consist of telecom firms and Pakistan Telecom Authority which

is responsible for the policies and overall operations of telecom sector of Pakistan. Key

telecom companies i.e. Mobilink, Warid Telecom, U-fone and Telenor which have

invested heavily in recent years will be under the main focus. Because of the special

nature of this research, the data collection points are small. Henry (1990) advised

against using probability sampling technique for sample population of less than 50.

Because of the short time span and financial constraints the research will employ

homogenous sampling technique. Saunders, Lewis & Thornhill (2007) argue that

homogenous sampling technique focuses on one sub group in which all the sample

members are similar. This will help us to cover the topic in detail.

8) Data Collection

The research will employ both qualitative and quantitative data techniques to draw

conclusions. However, main emphasis will be given to collect and analyze the

qualitative data. The plan of the research will be mainly to use primary data collected

from both primary and secondary sources.

a) Primary Sources of Data

Primary data will be of utmost importance, since it will give us a true picture of what’s

happening in the real world. Primary research will be used to analyze the telecom

industry of Pakistan. It will also answer to some extent, the important question of what

sort of entry strategies firms are using to invest in telecom sector in Pakistan.

Following methods will be employed for collecting the primary data.

Interviews

Company reports

Industry reports published by government departments

b) Secondary Sources of Data

Secondary data will be of utmost importance in this research. Information will be

acquired from reliable sources. Priority will be given to government sources such as

Pakistan Telecom Authority in order to provide accurate information. Online website

such as Business Monitor Online will be used comprehensively because they contain

most up-to-date information. Journals and articles will be used extensively as well

because explanation of data from these sources will be more accurate. This research

will also include statistical analysis where information will be easily accessible from

company reports, IMF Reports, World Bank Reports and government websites.

9) Limitations of Research

There can be a lot of limitations and restrictions in carrying out the desired research.

There are limitations associated with questionnaires, if companies are not willing to

share information. The questionnaire in research project is to support findings which

will be drawn from secondary data. It’s not a primary research but a supportive tool for

research. The availability of primary data through interviews is not a surety as well.

There are financial and time constraints for the collection of primary data. Inductive

approach needs to be used in combination with deductive approach and both have

different roots to evolve. Therefore, there is no certainty of getting the desired results by

employing both the techniques. The qualitative data analysis also poses a threat because

it may involve human judgment errors. Data analysis techniques will also be employed

and data can astray the researcher if it is not valid or insufficient.

10) Proposed Chapter Plan

1. Introduction

1.1. Research Overview

1.2. Country Analysis

1.2.1. Political Factors

1.2.2. Economical Factors

1.2.3. Technological Factors

1.2.4. Legal Factors

2. Pakistan Telecom Sector Overview FDI in Telecom Sector

2.1. Industry Analysis

2.1.1. Strength

2.1.2. Weaknesses

2.1.3. Opportunities

2.1.4. Threats

3. Determinants of FDI in Pakistan Telecom Sector

3.1. Entry Conditions and Strategies

3.1.1. Examples of Warid Telecom & Telenor

3.2. Post Entry Scenario

3.2.1. Challenges

3.2.2. Future Strategies

4. Conclusion

Appendices & Bibliography

11) Project Plan

12) Reference for Purposal

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Saunders M. with Lewis P. & Thornhill A. (2007), ‘Research Methods for Business

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Appendix B

Source: BMI (2008)

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