The character of the world today is very dynamic with various characteristics in one country being different from another country which would lead to Multi National Companies (MNCs) looking for ways and means to enter different market in order to gain the various resources in order to gain a comparative advantage.
When an organisation has made a decision to enter an overseas market, there are a variety of options open to it. These options vary with cost, risk and the degree of control which can be exercised over them. The simplest form of entry strategy is exporting using either a direct or indirect method such as an agent, in the case of the former, or countertrade, in the case of the latter. More complex forms include truly global operations which may involve joint ventures, or export processing zones.
This report we look at different attitudes of certain countries in terms of entry strategy whether it be Joint Venture or a Foreign Direct Investments. In doing so we take an indepth look at the advantages of Foreign Direct Investments and disadvantages of them and the same with Joint Ventures.
A look at the role FDIs have in the developing countries and the look at the ups and downs of Globalization in developing world.2
What are FDIs?
Foreign Direct Investment (FDI) can be defined as an investment made by one country in another for activities such as infrastructure, manufacturing and industrial development. Foreign direct investment (FDI) plays an extraordinary and growing role in global business. It can provide a firm with new markets and marketing channels, cheaper production facilities, access to new technology, products, skills and financing. For a host country or the foreign firm which receives the investment, it can provide a source of new technologies, capital, processes, products, organizational technologies and management skills, and as such can provide a strong impetus to economic development.
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In the resent years it can be seen that FDI policies have become the most essential economic policies for developing countries. When the investment done by the home country to another country, it is classified as ‘investment outflow’ and when foreign investment approaches the home country, it is defined ‘investment inflow’. Mutually inward and outward actions are encouraged in most of the countries around the world. In order to meet the criteria of FDI the investment must afford the parent enterprise control over its foreign affiliate. It may take many forms, such as a direct acquisition of a foreign firm, construction of a facility, or investment in a joint venture or strategic alliance with a local firm with attendant input of technology, licensing of intellectual property.
Types of FDI are:-
Outward FDI
Outward FDI can be defined as a domestic firm investing abroad. (i.e. John keells invested in Maldives to open few hotels such as Chaaya Lagoonand and Chaaya Reef. The capital invested is outward FDI to Sri Lanka.)
Inward FDI
Inward FDI for an economy can be defined as the capital provided from a foreign direct investor into the country, where it is inward FDI to that particular country. (i.e. General Motors decides to open a factory in Malaysia. They are going to need some capital. That capital is inward FDI for Malaysia.)
Vertical FDI
Vertical FDI is when a firm set up manufacturing facilities in multiple countries, each producing a different input or a stage of the firm’s production process. (i.e. Dell,
Horizontal FDI
Horizontal FDI is when a firm to establish manufacturing facilities in multiple countries, all producing essentially the same thing but for their respective domestic or nearby markets. (i.e.
Greenfield FDI
Is a form of foreign direct investment where a parent company starts a new venture in a foreign country by constructing new operational facilities from the ground up. In addition to building new facilities, most parent companies also create new long-term jobs in the foreign country by hiring new employees.
There are several areas that actually help both the country as well as the company such as:-
Stimulation of national economy
Foreign investments bring certain benefits to national economies. It can contribute to Gross Domestic Product (GDP), Gross Fixed Capital Formation (total investment in a host economy) and balance of payments. There have been studies indicating a positive link between higher GDP and FDI inflows.
FDI can also contribute toward debt servicing repayments, stimulate export markets and produce foreign exchange revenue).
Jumping the tariff wall (and other non- tariff barriers)
Certain MNC see Foreign Direct Investments as a way to overcome certain government imposed trade barriers. The Government tends to bring down such barriers and provide other incentives in order to induce and attract foreign investment. – In the trading of good and services FDI have opened a wide range of opportunities in both imports and exports. Products of superior quality are manufactured by various industries in India due to greater amount of FDI inflows in the country
Lower wage in host developing countries for labor.
Companies look to gain a comparative advantage over their competitors and one way of doing this is by ensuring the have cheaper labor in order to cut their costs. So countries that actually have cheaper labor attract a few MNCs looking forward to taking advantage of this characteristic. It also helps the host country by providing job to the unemployed and teaching those skills and traits need to become skilled in the workplace. FDI, where it generates and expands businesses, can help stimulate employment, raise wages and replace declining market sectors. FDI ensures huge amount of employment opportunities by aiding the setting up of industrial units in various corners of India
Infrastructure development and technology transfer
Parent companies can support their foreign subsidiaries by ensuring adequate human resources and infrastructure are in place. In particular “Greenfield” investments into new business sectors can stimulate new infrastructure development and technologies to host economies. These developments can also result in social and environmental benefits, but only where they “spill over” into host communities and businesses (ECOSOC 2000). Investment in research & development (R&D) from parent companies can stimulate innovation in production and processing techniques in the host country. FDI apparently helps in the outsourcing of knowledge from India especially in the Information Technology sector. It helps in developing the know-how process in India in terms of enhancing the technological advancement in India.
However there is also a bad side to FDIs,
More costly travel/communications abroad.
The cost of travelling and the cost of communicating would push the company way back. The cost of actually travelling to the host country for meeting with partners and government delegation and also the money used to transfer resources in the initial phase.
Not having a close familiarity with local business tax laws, business scene in general, and various government regulations.
The cost of studying and learning about the regulations and business norms are always challenging and the investors would have to be astute with the norms and practices both legally and in the workplace.
Language and culture differences
The adjustment of social cultures and language barriers is another hindrance and disadvantage of FDI. MNCs would have to acclimatize to the surrounding and also modifying products and customizing it standards in the country.
Higher wages/benefits must be paid to the personnel going abroad.
Certain occasions MNCs would have to pay higher wages to employees who decide to go abroad to a new location of the company.
Certain countries use different approaches such as Joint Ventures and Foreign Direct Investments due to their cultural norms. For example Japanese tend to be a lot more conservative with their risk, according to Hofstede’s theory this holds true
One of Hofstede’s cultural dimensions is called uncertainty avoidance. This dimension measures the extent to which a society feels uncomfortable with the ambiguity that typically arise from the unknown or surprises.
Cultures with high uncertainty avoidance try to minimize uncertainty through strict laws and rules as well as safety and security measures. People in these societies tend to be more emotional, and are motivated by inner nervous energy.
In general, societies with lower uncertainty avoidance are more tolerant of new and different opinions hence new horizons in business. The cultures prefer as few rules as possible such as the India.
India’s lowest ranking Dimension is Uncertainty Avoidance (UAI) at 40, compared to the world average of 65. On the lower end of this ranking, the culture may be more open to unstructured ideas and situations. The population may have fewer rules and regulations with which to attempt control of every unknown and unexpected event or situation, as is the case in high Uncertainty Avoidance countries.
Smart entrepreneurs and business owners know that Joint Ventures are the fastest and most effective way to radically increase sales and profits with virtually no money and no risk, as long as its done correctly.
The Advantages of Joint Ventures are speed, access, sharing of resources and the leveraging of underutilized resources, high profits, back end income, low or no risk opportunities and massive leverage.
The Disadvantages of Joint Ventures are the possibility of being ripped off or disappointed by unscrupulous and unprofessional JV partners, and hurting your reputation and/or customers and associates by associating with the wrong people, even unknowingly. There are certain advantages joint ventures have over FDIs and vice versa, they are
Advantages
Provide companies with the opportunity to gain new capacity and expertise
Companies who decide to test market a certain country would tend to go through a joint venture which another company in order to gain an insight into the market and access to greater resources, including specialized staff and technology. Reduces market development costs and risks due to the sharing of risk with the venture partner who means that the investor wouldn’t have to take the brunt of the liability and the risk would be shared.
Allow companies to enter related businesses or new geographic markets or gain new technological knowledge
Certain technological advantages might actually be another incentive as to why companies would like to seek a joint venture and also allows the companies to exist from non-core businesses in this era of divestiture and consolidation. There is other knowledge that might be insightful such as The local partner’s awareness of competitive conditions, culture, language, political system & business system is very beneficial.
Companies can gradually separate a business from the rest of the organization, and eventually, sell it to the other parent company.
Roughly 80% of all joint ventures end in a sale by one partner to the other. Joint ventures can be flexible. For example, a joint venture can have a limited life span and only cover part of what you do, thus limiting both your commitment and the business’ exposure
Disadvantages
It takes time and effort to build the right relationship and partnering with another business can be challenging. Problems are likely to arise if:
The objectives of the venture are not 100 per cent clear and communicated to everyone involved. So it is imperative that before a Joint Venture is enforced one should always write up a contract stating the purpose and all things relate to the business.
Different cultures and management styles result in poor integration and co-operation.
Another main reason for a breakdown in joint venture is the co existence with other cultures and fact that managers from both parties can’t seem to understand each others cultures and norms. Shared ownership can lead to conflicts & battles for control if goals/objectives change or they take different views on strategy. Differences in culture and management style can create problems between the partners over settlement of claims, valuation of assets and liabilities, etc.
The partners don’t provide enough leadership and support in the early stages.
With the ownership being split 50/50, there will be certain conflicts that will arise between both the parties
Rapid change in the host country political or economic situation can create substantial losses for the investing corporation
Globalization
Globalization is a trend that has hit different corners of the world. It is the increasing global connectivity and integration in the economic, social, technological, cultural, political, and ecological spheres.
Globalization is a two-sided coin- it is both the world’s savior and its demon. The basic concept of Globalization is a good one. It is the world joining together as a community dedicated to improving the lives of all. It is responsible for improvements in the lives of people especially in the areas of travel, trade, communications, universal technology and cultural exchange
Countries look to aspire and gain in order to achieve a better way of life, in order to reach Globalization the barriers to international trade have been considerably lowered through international agreements – General Agreement on Tariffs and Trade (GATT). Particular initiatives carried out as a result of GATT and the World Trade Organization (WTO), for which GATT is the foundation, has included:
Promotion of free trade:
Reduction or elimination of tariffs; construction of free trade zones with small or no tariffs
Reduced transportation costs, especially from development of containerization for ocean shipping.
Reduction or elimination of capital controls
Reduction, elimination, or harmonization of subsidies for local businesses
Restriction of free trade:
Harmonization of intellectual property laws across the majority of states, with more restrictions.
Supranational recognition of intellectual property restrictions (e.g. patents granted by China would be recognized in the United States)
Globalization is responsible for all the various consumer products that are stacked on shelves in local supermarkets or large chain ones. It’s made international trade possible by facilitating the transport of products between various countries. So in short, there are greater choices of products that will guarantee consumer satisfaction. Moreover, it poses mutual economic benefits on both sides of the countries in trade. A multinational corporation from the U.S. makes a direct foreign investment in India by building branches in that country and setting factories for production. The corporation receives cheap labor which generates greater profit and in turn, India will benefit from more jobs from factories and financial capital entering the country.
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Socially, there is the spread of technology, knowledge and culture. People through one of the most important and revolutionary invention ever developed by mankind, the Internet, allows people to in touch with international news and unsurpassable amount of information regarding all sort of things. The proliferation of information generally increases people’s social, political and economics awareness of the world around them, therefore increasing intellect.
Politically, globalization is responsible for spreading differing political ideals ranging from democracy to communism. This increased awareness (assuming there is no censorship) allows people to weight pros and cons about differing beliefs and be able to make informed decisions or opinions in the political arena that shapes their government. And the undisputed major role of the media in assisting globalization, can expose corrupt governments to the public and therefore, pressure the removal of oppressive dictators.
For example MNCs like Nike and Reebok are globalized product and that actually shows in their operational activities. They are an American Firm but actually have outlets and manufacturing stations across the globe. Nike has subcontracted certain firms and outlets in developing countries such as Vietnam and Indonesia in the view to capitalize in the cheap labor in those countries.
In a more obvious example, a lot of American products are manufactured and made in Taiwan and China in order to capitalize with cheap skilled labor.
There are several other factors that country look into when it comes to Globalization as it has a variety of aspects which affect the world in several different ways such as:-
Industrial of worldwide production markets and broader access to a range of foreign products for consumers and companies
Financial – emergence of worldwide financial markets and better access to external financing for corporate, national and sub national borrowers.
Economic – realization of a global common market, based on the freedom of exchange of goods and capital.
Political – political globalization is the creation of a world government which regulates the relationships among nations and guarantees the rights arising from social and economic globalization.
Informational – increase in information flows between geographically remote locations
Cultural – growth of cross-cultural contacts; advent of new categories of consciousness and identities such as Globalism – which embodies cultural diffusion, the desire to consume and enjoy foreign products and ideas, adopt new technology and practices, and participate in a “world culture”
Transportation – fewer and fewer European cars on European roads each year (the same can also be said about American cars on American roads)
Greater international cultural exchange
Spreading of multiculturalism, and better individual access to cultural diversity (e.g. through the export of Hollywood and Bollywood movies). However, the imported culture can easily supplant the local culture, causing reduction in diversity through hybridization or even assimilation. The most prominent form of this is Westernization.
Greater international travel and tourism
Greater immigration
Spread of local consumer products (e.g. food) to other countries (often adapted to their culture)
World-wide fads and pop culture such as Pokémon, Sudoku, Numa Numa, Origami, Idol series, YouTube, Orkut, Facebook, and MySpace.
World-wide sporting events such as FIFA World Cup and the Olympic Games.
Formation or development of a set of universal values
Development of a global telecommunications infrastructure and greater transborder data flow, using such technologies as the Internet, communication satellites, submarine fiber optic cable, and wireless telephones
Increase in the number of standards applied globally; e.g. copyright laws, patents and world trade agreements
Critics argue the dark side of globalization stems from Multinational Corporation’s violation of human rights in factories at their host country (mostly developing nations) and use their economic importance to their host country as a political leverage. And more recently, it’s widens the gap between rich and poor nations. Well, quite frankly, globalization is not meant to level the playing field and remove poor nations out of poverty. Globalization is the beacon of spreading knowledge, technology, cultures, religion in a world that’s ever becoming much smaller to live in.
The bad side about globalization is that it adversely affects those who are less endowed. Hence, we have the common grudge about competition from Foreign Talents in Singapore. Even corporate which are less endowed such as our SME would complain about foreign competition.
The complex issue is that competition actually makes us improve, develop and evolve. But the “divide” between the rich and poor aggravates and the income gap widens.
The world today is more dangerous and less orderly than it was supposed to be. Ten or 15 years ago, the naive expectations were that the “end of history” was near. The reality has been the opposite. The world has more international terrorism and more nuclear proliferation.
MNCs seem to capitalize a lot of cheap labor and hence cut down on costs, however with this they seem to be operating on malpractices such as workers exploitation and other business malpractices.
For instance Nike opened up a manufacturing outlet in to capitalize in the cheap labor but this has led to so many human rights activists calling for a reform in practices stating that these outlets were actually workshops where employee’s age start from 13 yrs old and earn about $1 a day in harsh working condition and working with harmful chemicals like the glue that is used for the production with the shoe.
Nike has stepped up to the amount of pressure from the activist groups and the media by stating that the Nike Corporation did not run the outlet but the outlet subcontracted by locals who run the outlet on Nike’s behalf.
Another example of business malpractice can be assessed with Coca Cola’s strategy in India. Coca Cola was accused of ill-treatment of harmful chemicals, they were accused of dumping of harmful chemical waste into lakes which is used by people for their daily rituals and irrigation. Studies also have shown that harmful pesticides were present in the bottle which led to an uproar from activists calling for a ban from Coca Cola.
Globalization is like a two-edged sword. On one hand it might actually benefit those who live in third-world countries by opening up a new source of low-paying jobs. On the other, it results in the loss of industrial jobs in developed countries, converting them into service economies. Trade liberalization agreements have given companies the option of picking up and moving their manufacturing operations out of country in search of cheap labor this may lead to a prosperous move in the terms of the company but doesn’t always make it worthwhile for the country.
Conclusion
MNCs all over the world would have to take a lot into consideration before thinking whether to go to a country through a Joint Venture or through an FDI.
FDI does pose a lot of incentives which are provided by the government of the host country such as breaking down trade barriers for the company also tax free holidays and grants. There all seem appealing but the investment made into moving into a country can seem a lot, the company would not only have to put into a lot of initial capital to start up a business but they would need to put up money needed on the long run for training and developing skills of the employees, understanding the language, norms and culture of the host country may be daunting and could prove to be detrimental if got wrong to the company. For example, a washing powder company opened up a store in the middle east and continued to go through the same print add that has led them to be successful in the rest of the world but the saw a dramatic drop in sales which they found out was because of the lack of understanding of the conditions and the country. They used the same add that goes from left to right showing pictures from dirty clothes and after using the washing powder it would be come clean but unfortunately for them the Middle East read from right to left and didn’t paint a pretty picture in their minds.
So there is a lot of factors to be taken into consider when dealing with investing in another country and companies would have to make up a PESTLE analysis which looks at the Political, Economic, Social, Technological, Legal and Environment factors that need to be into consideration before make such a huge investment.
Joint Venture or a strategic alliance is another attractive strategy to enter a market with a partnership with another company. This is used in order to gain an insight into a country before making a successful transition into opening a company in the country. Joint Ventures is another way of understanding the country but also the company your sharing the risk with, which might lead to the a risk in losing intellectual property and the risk of losing control over the joint venture due to clash in personalities.
Once these methods have been taken in consideration , the company in turn would be a globalized company where the base company is in one country and providing and manufacturing products also in other countries. Globalization on one hand it might actually benefit those who live in third-world countries by opening up a new source of low-paying jobs but on the other it could lead to exploitation and leading to human rights violations. This may lead to a prosperous move in the terms of the company but doesn’t always make it worthwhile for the country.
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