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Foreign Direct Investment from Chap 6 of International Business


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Foreign Direct Investment
Occurs when a firm invests directly in facilities to produce and/or market a product in a foreign country.
What are the two forms of Foreign Direct Investment?
1. Green-Field Investment
2. Foreign Portfolio Investment
Describe Green-Field Investment
Involves the establishment of a wholly new operation in a foreign country.
Describe Foreign Portfolio Investment
Acquiring/merging with an existing firm in the foreign country. Investment by individuals, firms, or public bodies in foreign financial instruments
Occurs when a domestic firm--the licensor, licenses to a foreign firm--the licensee, the right to produce its product, use its production processes, or to use its brand name or trademark.

*The licensor collects royalty fees on every unit the licensee sells or on total revenues
What is the advantage of licensing over Foreign Direct Investment?
-The licensor does not have to pay for opening a foreign market-the licensee does that.

-The licensor doesn't have to bear the risks associated with opening a foreign market.
Foreign Direct Investment in the same industry in which a firm operates at home.
Horizontal Foreign Direct Investment
Investment in an industry that provides inputs for a firm's domestic operations, or it could be FDI in an industry abroad that sells the outputs of a firm's domestic operations.
Vertical Foreign Direct Investment
What is the flow of FDI?
refers to the amt of FDI undertaken over a given time period (normally a year)
What is the stock of FDI?
The total accumulated value of foreign-owned assets at a given time.
What are the outflows of FDI?
The flow of Foreign Direct Investment out of a country
What are the inflows of FDI?
The flow of Foreign Direct Investment into a country
Gross fixed capital formation
Summarizes the total amt of capital invested in factories, stores, office buildings, and the like.
What are some reasons firms prefer to acquire existing assets rather than undertake green-field investments?
1. Mergers and acquisitions are quicker to execute than green-field investments.

2. Foreign firms are acquired because these firms have brand loyalty, customer relationships, trademarks or patents, etc.

3. Also because they believe they can increase the efficiency by transferring capital, technology, or management skills.
Investment in the same industry abroad as a firm operates in at home.
Horizontal FDI
Why is Foreign Direct Investment Expensive?
A firm has to bear the costs of establishing production facilities in another country.
Why is Foreign Direct Investment Risky?
The problems associated with doing business in another culture where rules may be different.
When a firm exports, it doesn't bear the costs of FDI, and the risks can be reduced by using a native sales agent. When a firm licenses its know-how, it need not bear the costs or risks of FDI. So what are the 5 factors that can alter the attractiveness
1. Transportation costs
2. Market Imperfections
3. Strategic Behavior
4. The Product Life Cycle
5. Location Advantages
This is a reason why firms choose FDI over licensing.
When these costs are added to production costs, it becomes unprofitable to ship some products a long distance. This happens with products that have a low value-to-weight ratio and can be produced
Transportation costs
This is one of the reasons why firms choose FDI over licensing. These are factors that inhibit markets from working perfectly. This arises because of impediments to the free flow of products between nations, and impediments to the sale of know-how.
Market Imperfections
An industry composed of a limited number of large firms (ex: an industry in which 4 firms control 80% of a domestic market)
Arises when 2 or more enterprises encounter each other in diff regional markets, national markets, or industries. Economic theory suggests that rather like chess players jockeying for advantage, firms will try to match each other's moves in diff markets
Multipoint competition
Argues that once a foreign market is large enough to support local production, FDI will occur.
Product-Life Cycle Theory
The advantages that arise from using resource endowments or assets that are tied to a particular foreign location and that firm finds valuable to combine with its own unique assets.
Location-specific advantages
A network of informal contacts that allows firms to benefit from each other's knowledge generation
What are the 2 forms of Vertical FDI?
Backward Vertical FDI
Forward Vertical FDI
Describe Backward Vertical FDI
Provides inputs for a firm's domestic production processes.
Describe Forward Vertical FDI
An Industry abroad sells the outputs of a firm's domestic production processes. Less common than backward vertical FDI.
By vertically integrating backward to gain control over the source of raw material, a firm can ___________
raise entry barriers and shut new competitors out of an industry.
Backward Vertical FDI Can Occur when....
A firm has the knowledge/ability to extract raw materials in another country. There is no efficient producer in that country that can supply raw materials to the firm.
Vertical FDI can also occur when..
A firm must invest in specialized assets whose value depends on inputs provided by a foreign supplier.
An asset designed to perform a specific task and whose value is significantly reduced in its next-best-use.
Specialized Asset
When is licensing no longer an attractive option? One or more of these conditions may exist. (Three)
1. The firm has know-how that cannot be protected by a licensing contract.
2. The firm needs tight control over a foreign entity to maximize its market share and earnings in that country
3. Firm's skills and know how are not amenable to licensing
What are the 3 types of industries are licensing not generally good in?
1. High technology industries where protecting expertise is extremely important

2. Where competitive interdependence requires that firms maintain tight control over foreign operations so that they have the ability to launch coordinated attacks against global competitors (such as Kodak w/Fuji).

3. Industries where intense cost pressures require that multinational firms maintain tight control over foreign operations.
Essentially the service industry version of licensing, such as Mcdonalds
Foreign direct investment occurs when _______________________________________________________________________________
A firm invests directly in facilities to produce a product in a foreign country.

When a firm buys an existing enterprise in a foreign country.
What are some factors that have characterized FDI over the years?
1. A rapid increase in the total volume of FDI undertaken
2. There has been some decline in the U.S. as a source for FDI
3. An increasing share of FDI is targeted toward the developing nations of Asia and Eastern Europe
4. There has been an increase in the amt of FDI undertaken by firms based in developing nations
An attempt to create barriers to entry by gaining control over the source of material inputs into the downstream stage of a production process.
Backward Vertical FDI
An attempt to circumvent entry barriers and gain access to a national market.
Forward Vertical FDI
This approach suggests that vertical FDI is a way of reducing a firm's exposure to the risks that arise from investments in specialized assets.
Market Imperfections approach
This is the most useful theory because it identifies how the relative profit rates associated with horizontal FDI, exporting and licensing vary with circumstances.
Market Imperfections Approach

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