Page 127 - DMGT545_INTERNATIONAL_BUSINESS

International Business

notes exporting or licensing because of the following factors that alter the relative attractiveness of
exporting, licensing, and FDI:
1. Transportation costs,
2. Market imperfections,
3. Following competitors,
4. Strategic behaviour, and

5. Location advantages.
transportation costs

When transportation costs are added to production costs, it becomes unprofitable to ship some
products a long distance specially products that have a low value-to weight ratio and can be
produced in almost any location (e.g. cement, soft drinks etc). For such products, relative to either
FDI or licensing, the attractiveness of exporting decreases. Thus transportation costs alone can
explain why Cemex, the largest cement manufacturer of Mexico has undertaken FDI rather than
exporting. For products with a high value-to-weight ratio, transport costs are normally a very
minor component of total landed cost (e.g. electronic components, personal computers, medical
equipment, computer software etc.). In such cases, transportation costs have little impact on the
relative attractiveness of exporting, licensing, and FDI.

!
Caution Products having low value-weigh ratio acquire higher transportation cost resulting
in unprofitable transactions.
market imperfections

Market imperfections are factors that restrain markets from working perfectly. In the international
business literature, the marketing imperfection approach to FDI is typically referred to as
Internationalization theory. With reference to horizontal FDI, market imperfections arise in two
circumstances: when there are impediments to the sale of know-how (licensing is a mechanism
for selling know-how). Impediments to the free-flow of products between nations decrease the
probability of exporting, relative to FDI and licensing. Impediments to the sale of know-how
increase the profitability of FDI relative to licensing. Thus, the market imperfections explanation
predicts that FDI will be preferred whenever there are impediments that make both exporting
and the sale of know how difficult and/or expensive.

Impediments to Exporting: Governments are the main source of impediments to the free flow of
products between nations. By placing tariffs on imported goods, government increases the cost
of exporting relative to FDI and licensing. Similarly, by limiting imports through the imposition
of quotas, governments increase the attractiveness of FDI and licensing. For example, the flow
of FDI by Japanese auto companies in the United States during the 1980s was partly driven by
protectionists threats from Congress and by quotas on the import of Japanese cars. For Japanese
auto companies, these factors have decreased the profitability of exporting and increased the
profitability of FDI.
Impediments to sale of know-how: According to economic theory, there are three reasons that
the market does no always work well as a mechanism for selling know-how, or why licensing
is not attractive as it initially appears. First, licensing may result in a firm’s giving away its’
know-how to a potential foreign competitor. Second, licensing does not give a firm tight control
over production, marketing, and in a foreign country that may be required to profitably exploit
its advantage in know-how. With licensing, control over production, marketing and strategy

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