Business case study: Free trade and foreign direct investment

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PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

Global Business Today
3nd Canadian Edition
Charles W. Hill - Thomas McKaig

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Foreign
Direct
Investment

Chapter 7

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Opening Case - Starbucks

In the late 1990s, Starbucks opened stores in Taiwan, China, Singapore, Thailand, New Zealand, South Korea, and Malaysia.

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

Photo of Starbucks in Taipei, Taiwan by W.T.G. Richardson

In Asia, Starbucks’ most common strategy was to license its format to a local operator in return for initial licensing fees and royalties on store revenues

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Definitions

Foreign Direct Investment (FDI)

The acquisition or construction of physical capital by a firm from one (source) country in another (host) country

Multinational Enterprise (MNE)

A firm that owns business operations in more than one country

Green Field Investment

Establishing a new operation
in a foreign country

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Foreign Direct Investment in the World Economy

Flow of FDI refers to the amount of FDI undertaken over a given time period (normally a year).
Stock of FDI refers to the total accumulated value of foreign-owned assets at a given time.

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Foreign Direct Investment in the World Economy

Outflows of FDI refers to the flow
of FDI OUT of a country.

This would mean Canadian companies buying property and/or setting up operations in another country

Example – TD Bank in Canada buying Commerce Bancorp in the U.S.
in 2007 and acquiring
all of their branches

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Foreign Direct Investment in the World Economy

Inflows of FDI refers to the
flow of FDI INTO a country.
When the CPR was being built across Canada, the government gave land to the CPR company and on this land the CPR built many elaborate hotels and resorts - some of which became famous Canadian landmarks – like the Royal York Hotel in Toronto.
In 2006, Fairmont (CP Hotels) sold out for $3.8 billion to Saudi Prince Alwaleed bin Talal bin Abdulaziz Alsaud
ThereforeCP Hotels were now foreign owned
In 2010 the Prince sold some shares and
dropped to 35 per cent from 58 per cent
ownership

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Growth of FDI

Selected Indicators of FDI and International Production, 1990–2009

Source: UNCTAD. based on the FDI/TNC database . UNCTAD GlobStat database. and IMF. 2007b)

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Growth of FDI

Selected Indicators of FDI and International Production, 1990–2009

Source: UNCTAD. based on the FDI/TNC database . UNCTAD GlobStat database. and IMF. 2007b)

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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UNCTAD

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

United Nations Conference on Trade and Development (UNCTAD)

Many people talking about FDI quote information from UNCTAD

UNCTAD, a United Nations entity, is the most authoritative and reliable source of information about global FDI by country and by activity and its statistics and diagrams are quoted equally by the right and left wings.

www.unctad.org

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Growth of FDI

FDI Prospects in Developed Countries, 2007–2009:

Responses to UNCTAD survey (per cent of respondents)

Source: 2007 World Investment Review

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Growth of FDI

Cross-border M&A Sales, by Sector and by Group of Economies,

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The World’s Top 100 Non-Financial TNCs, Ranked by Foreign Assets, 2005 ($ millions)

Source: UNCTAD/Erasmus University database, World Investment Report, 2003.

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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The Direction of FDI

Historically, most FDI has been directed at the developed nations around the world, as firms based in these countries invested in each others’ markets.
During the past few decades, the United States has been the favourite target of FDI inflows.

The U.S. is the only country in the world with a population over 200 million AND a comparatively high GDP per capita

Which simply means there are a lot of Americans, and they have a lot of money to buy stuff

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Source of FDI

Since World War II, the United States has been the largest source country for FDI,
a position it retained during the late 1990s and throughout the 2000s.

Meaning American companies are going to other countries and buying up other companies and resources

Other important source countries include

The United Kingdom,

France,

and Japan.

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Forms of FDI:
Acquisitions vs. Green Field Investment

FDI can take the form of:

Acquisition of, or a merger with, an existing local firm in the destination market

Green Field Investment in a new facility in the destination market

The majority of cross-border investment is in the form of mergers and acquisitions rather than Green Field Investments

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Definitions

Green Field Investment

This is a slang expression which originally referred to the fact that many of these types of investments involved the buying of real-estate and building something

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

That is to say: there was a “green field” and the land was bought for the purpose of erecting some structure

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Canada’s Case

FDI Flows into Canada and Canadian Direct Investment, 1993–2006 ($ billions)

- Companies of other countries investing in Canada

Source: Statistics Canada, CANSIM

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Canada’s Case

FDI Flows into Canada and Canadian Direct Investment, 2000 - 2009 ($ billions)

- Companies of other countries investing in Canada

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Canada’s Case

Canadian Foreign Direct Investment Abroad, by Top-10 Destinations,

2006 ($ billions)

Source: Industry Canada

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Canada’s Case

Canadian Foreign Direct Investment Abroad, by Top-10 Destinations,

2009 ($ billions)

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Canada - U.S.

In the field of international trade, until 2007, Canada and the United States shared the largest bilateral flow of goods, services, people, capital, and investments between any two countries in the world.
In 2008 China nudged passed Canada as top exporter to the United States

It should be noted a large part of Chinese exports to the U.S. are in fact from American companies in China, like Nike exporting to Nike USA, and subsidiary companies of Wal-Mart exporting to Wal-Mart USA

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Canada - U.S.

During this same time frame, Canada’s exports to the United States totalled $313 billion USD,
Mexican exports to the U.S. where $210 billion USD
The recent and dramatic strengthening in the Canadian dollar has given firms looking to expand south of the border substantially increased buying power
For the most part, gains in FDI outflow are owing to the rise of Canadian affiliates and subsidiaries in the United States.

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Why Foreign Direct Investment

…when two alternatives are
available?

Exporting and
Licensing

The question is an important one given that foreign direct investment can be both expensive and risky when compared to exporting and licensing.

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Why Foreign Direct Investment?

FDI is expensive because a firm
must bear the costs of establishing production facilities in a foreign country
or of acquiring a foreign enterprise.
FDI is risky because of the problems associated with doing business in a different culture where the “rules of the game” may be very different.

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

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Why Foreign Direct Investment?

Because limitations of exporting and licensing
are means for capitalizing on foreign market opportunities.

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

Limitations of Exporting Exporting is constrained by transportation costs and trade barriers. When transportation costs are added to production costs, it becomes unprofitable to ship some products over a large distance. Products of low value-to-weight ratio can be produced in almost any location Examples: cement, soft drinks Products with a high value-to weight ratio: transport costs are normally a very minor component of total landed cost. Examples: electronic components, personal computers, medical equipment

Limitations of Licensing Internalization theory explains why firms often prefer foreign direct investment over licensing as a strategy for entering foreign markets. Licensing may result in a firm giving away valuable technological know-how to a potential foreign competitor. Licensing does not give a firm the tight control over manufacturing, marketing, and strategy in a foreign country. When the firm’s competitive advantage is based not so much on its products, as on the management, marketing, and manufacturing capabilities that produce those products.

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Pattern of Foreign Direct Investment

Strategic Behaviour

Oligopoly

Multipoint competition

The Product Life Cycle
Eclectic Paradigm

Location-specific advantage

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The “Political Environment” and FDI

Government policy toward FDI has typically been driven by political ideology.
Historically, ideology toward FDI has ranged from a radical stance that is hostile to all, to the non-interventionist principle of free market economics

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

How Political Ideology effects Foreign Direct Investment

Starbucks – Seoul

By W.T.G. Richardson

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The “Political Environment” and FDI

The radical view

The radical view - Marxist political and economic theory
Argues that the multinational enterprise (MNE) is an instrument of imperialist domination
They see the MNE as a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

How Political Ideology effects Foreign Direct Investment

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The “Political Environment” and FDI

The radical view
They argue that MNEs extract profits from the host country and take them to their home country

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

How Political Ideology effects Foreign Direct Investment

Starbucks - Beijing

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The “Political Environment” and FDI

The free market view

argues that international production should be distributed among countries according to the theory of comparative advantage.
That is, countries should specialize in the production of those goods and services that they can produce most efficiently

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

How Political Ideology effects Foreign Direct Investment

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The “Political Environment” and FDI

Pragmatic Nationalism

In practice, many countries have adopted neither a radical policy nor a free market policy toward FDI, but instead a policy that can best be described as pragmatic nationalism.
The pragmatic nationalist view is that FDI has both benefits and costs.
FDI can benefit a host country by bringing capital, skills, technology, and jobs, but those benefits often come at a cost.

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

How Political Ideology effects Foreign Direct Investment

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Benefits of FDI to the Nation State

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Host Country	Home Country
Resource-transfer effects Employment effects - FDI brings jobs to a host country Balance of payment effects. FDI is a substitute for imports of goods and services MNE uses the subsidiary in the host country to export goods and services to other countries	Balance of payments from inward flow of foreign earnings. Positive employment effects when a subsidiary demands home country exports of capital equipment. Home country MNE learns skills transferable in technologies for use in the home country.

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Costs of FDI to the Nation State

PowerPoints by Prof. W. Tim G. Richardson, Seneca College and University of Toronto

Host Country	Home Country
Adverse effects on competition Foreign subsidiaries have strong economic power to put local competitors out of market Adverse effects on the balance of payments. Against the initial capital inflow that comes with FDI must be the outflow of earnings to be repatriated National sovereignty and autonomy	Balance of payments from outward FDI Employment effect from outward FDI