Transcript Lecture04 - Duke University`s Fuqua School of Business

MGRECON401
Economics of International Business
and Multinationals
LECTURE 4
Multinational Investments,
Outsourcing, and Ethics
4-2
Lecture Focus
What are the trends in FDI?
What determines the choice between FDI,
exporting, and licensing?
What are the benefits of a multinational?
Why is there often resistance to a multinational
in a developing country?
4-3
Multinationals and
Foreign Direct Investment (FDI)
MNC = a firm with significant operations in more
than one country.
FDI = when a firm invests directly in facilities to
produce and/or market a product in a foreign
country.
Once a firm undertakes FDI it becomes a
multinational corporation (MNC).
4-4
Foreign Direct Investment (FDI)
FDI takes two forms:
Green-field investment: establishing a wholly
new operation in a foreign country.
M&A: acquiring or merging with an existing firm
in the foreign country.
Investing in foreign financial instruments (Foreign
Portfolio Investment) IS NOT FDI.
4-5
Forms of FDI
Horizontal FDI = FDI in the same industry as the firm
operates at home.
Vertical FDI = FDI in either an industry that is
backward (e.g., provides an input) or forward (sales
and distribution) of a production/sales process.
4-6
Flow and Stock of FDI
Flow:
The amount of FDI undertaken over a given
period of time (usually one year).
Stock:
Total accumulated value of foreign-owned
assets at a given time.
4-7
World exports, GDP, and FDI
World GDP and FDI 1990-2001 (index = 100 in 1990)
4-8
Inward FDI flows by region
4-9
Inward FDI Flows as a Percentage of Gross
Fixed Capital Formation, 2000
4-10
FDI Flows by Region
4-11
US: FDI Inflow as a Percent of
Gross Fixed Capital Formation
4-12
US: Inward FDI Stock
as a Percent GDP
4-13
Obtaining Data on FDI
United Nations Conference on
Trade and Development (UNCTAD):
www.unctad.org.
4-14
Country Characteristics of FDI
FDI has grown rapidly. 2001 and 2002 saw a
dramatic drop.
Developed countries account for overwhelming
portion of outward and inward FDI.
4-15
Country Characteristics of FDI
Two-way FDI flows are common between pairs
of developed countries, even at the industry
level.
Most FDI is horizontal: most of output of
foreign country is sold in foreign country.
4-16
Country Characteristics of FDI
Political risk and instability seems to be an
important deterrent to inward FDI.
4-17
Firm and Industry
Characteristics of FDI
Large differences exist across industries in the
degree to which production and sales are accounted
for by MNCs.
MNCs tend to be important in industries and firms
that:
Have high levels of R&D to sales,
Employ large numbers of professional and technical
workers as a percentage of their total workforces,
Produce new and/or technically complex products, and
Have high levels of product differentiation and
advertising.
4-18
Firm and Industry
Characteristics of FDI
MNCs tend to be firms in which the value of
the firms’ intangible assets is large relative to
its market value.
FDI is positively related to the existence of
trade barriers that differ across industries.
Characterization of
MNCs in Developing Countries
4-19
Prevalent in labor-intensive stage of production in
Developing Countries
MNC pay higher wages than local firms
MNCs offer significant training
MNC create demand for related and supported
industries
MNC enhances productivity in developing
countries.
4-20
Characterization of
MNCs in Developing Countries
Developing countries historically resisted MNCs
Political uncertainly leads to high expropriation risk (Latin
America, Iran, …)
Thought they could go it alone; underestimated the
importance of human capital and technology
Developing countries now frequently offer substantial
inducement to MNC
Tax holiday, infrastructure, tariff protection
Flow of FDI to developing countries is also consequence of
lower expropriation risk (increasing recognition of
importance of MNC).
4-21
Characterization of
MNCs in Developing Countries
No clear evidence that MNC alter conditions of local
competition
Some tendency to buy out local competition
But MNC tend to locate in concentrated industries
Elimination of local competition may be due to a change in
optimal allocation of resources.
Sometimes MNC will spread out R&D, but mostly not
Little evidence on technology transfer
4-22
Alternatives to FDI
Exporting and licensing are the two main alternatives
to FDI.
Licensing = when a domestic firm (licensor) awards a
foreign firm the right to use its product, production
processes, brand name or trademark. In return, the
licensor receives fees and royalties.
4-23
Export or FDI
or
Domestic Firm wishes to sell Y in a Foreign country.
Fixed cost G to set up a plant in the Foreign country.
Per unit transportation cost t to ship the good.
Unit labor costs: chome and cforeign
FDI if:
cforeignY+ G < (chome + t)Y
G/Y < t + chome - cforeign
4-24
Video Clips
Open for Business: How India Has
Opened Its Economy to Foreign Markets
McDonald’s Everywhere
4-25
License or FDI
Internalization: Ownership and Control
What is the optimal span of ownership of a company?
When should it license to a foreign producer v. create a
foreign subsidiary?
When should it purchase v. produce intermediate goods?
Example: Henry Ford
steel mill
Glass factory
Rubber tree plantation in Brazil
Iron mine in Minnesota
Railroads and ships for transport
4-26
Market Imperfections
Relationship-specific Investment (Hold-up problem): an
investment is specific to a relationship if it is of less
value to parties outside the relationship.
Leads to ex-post monopoly power
Example: auto supply parts company.
Solution: long-term contracting, reputation, or
ownership.
Hold-up problem leads to vertical integration.
Examples without vertical integration: IKEA, Benetton,
and Nike.
4-27
Market Imperfections
Downstream Incentive Problem:
Double marginalization
Suppose mc = mc1 + mc2
Optimal for combined firm to set mr = mc
Firm 1 (upstream) charges p > mc1 to
downstream firm (due to monopoly power)
Then Firm 2 perceives mc = p + mc2, which will
lead Firm 2 to overprice the final product.
Example: Coke and Pernod-Ricard (distributor)
in France.
4-28
Market Imperfections
Transfer of knowledge.
Difficult to sell
Creates future competitors
4-29
Market Imperfections
Loss of control and difference in incentives
can create a conflict.
Attitudes towards risk may differ
Incentive to abuse reputation of parent
company
Unforseen contingencies: cost of haggling.
4-30
Cost of Internalization
Spanning Costs and core competence.
Optimal risk sharing and incentives.
4-31
Strategic Aspects of FDI
Prevent competitors from achieving a first
mover advantage.
More costly to enter later once a competitor is
established.
Option of waiting is also valuable.
4-32
Starbucks
Corporate icon known
the world over.
Has evolved from
Seattle-based coffee
house to global food &
retailing powerhouse.
Has changed the way
Americans think about
coffee – no longer a 50
cent drink!
4-33
Starbucks
Sales of $3.3 billion in 2002.
Sales growing by more than
20% annually!!
Stock has soared more than
2,200% over past 10 yrs –
better than Wal-Mart!!!
Today, there are 6,000
Starbucks worldwide and
company is gunning for
10,000 outlets by 2005.
Howard Schultz
4-34
Starbucks in Asia
Began overseas expansion in
‘95 with licensing deals in
Japan.
Switched to JVs after it was
disappointed with licensing.
Invested $10 million and
transferred employees from
North America.
Followed same strategy in
Thailand and Korea.
4-35
Video Clip
Starbucks: Building Relationships with
Coffee Growers
4-36
Nike



Describe the sense in which the monopolistic
competition model captures the interaction of firms
in the athletic shoe industry.
How does the monopolistic competition model explain
the rise in the variety of athletic shoes that we have
seen over the last decade or so?
Why do we not see intra-industry trade between the
US and the rest of the world in the athletic shoe
industry?
4-37
Nike
 How has Nike used its foreign production of
shoes as a source of competitive advantage?
 As Nike and other athletic shoe companies
produce their shoes in other countries, why
have they chosen to outsource their
production instead of relying on foreign
subsidiaries?
4-38
Nike
 Should the WTO allow countries to impose a
tariff on imports from countries that do not
abide by “fair labor practices?”
4-39
Video Clip
Nike CEO Phil Knight