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Unit 7: Foreign Direct Investment

is granted to a licensee in return for a royalty fee. However, for both strategic and operational notes
reasons, a firm may want to retain control over these functions.

Example: A firm might want its foreign subsidiary to price and market very aggressively,
but the licensee may be unable to do this.

Third, a firm’s know-how may not be amenable to licensing. This is particularly true of
management and marketing know-how, where the kinds of skills required are difficult to codify
and cannot be written down in a simple licensing contract. They are organization wide and have
been developed over years. They are not embodied in any one individual, but instead are widely
dispersed throughout the company.
Product life cycle

The product life cycle holds that every product or line of business proceeds through four phases:
development, growth, maturity and decline. During the first two stages, sales growth is rapid
and entry is easy. As individual firms gain experience and as growth slows in the last two stages,
entry becomes difficult because of cost advantages of incumbents. In the decline phase of the
product line (as other product substitutes emerge) sales and prices decline, firms which have not
achieved a favourable position on the experience curve become unprofitable and either merge or
exit from the industry.

strategic Behaviour

Another theory to explain FDI is based on the idea that FDI flows are a reflection of strategic
rivalry between firms in the global market place. An early variant of this argument was
expounded by F. T. Knickerbocker, who looked at the relationship between FDI and rivalry in
oligopolistic industries. An oligopoly is an industry composed of a limited number of large firms
(e.g. an industry in which four firms control 80 per cent of a domestic market may be defined as
an oligopoly). A critical competitive feature of such industries is interdependence of the major
players. What one firm does can have an immediate impact on the major competitors, forcing a
response in kind.

Knickerbocker’s theory can be extended to embrace the concept of multipoint competition.
Multipoint competition arises when two or more enterprises encounter each other’s moves in
different markets to try to hold each other in check. The idea is to ensure that a rival does not
gain a commanding position in one market and then use the profits generated there to subsidize
competitive attacks in other markets. Kodak and Fuji Photo Film Co, e.g., compete against each
other around the world. If Kodak enters a particular foreign market, Fuji will not be far behind.

location advantages

The British economist John Dunning has argued that location specific advantage can help explain
the nature and direction of FDI. By location-specific advantages, Dunning means the advantages
that arise from using resource endowments or assets that are tied to a particular foreign location
and that a firm finds value to combine with its own unique assets (such as the firm’s technological,
marketing, or management know-how). Dunning accepts the internalization argument that
market failures make it difficult for a firm to license its own unique assets (know-how). Therefore
he argues that combining location-specific assets or resource endowments and the firm’s own
unique assets often requires FDI. It requires the firm to establish production facilities where these
foreign assets or resource endowments are located.

Example: An obvious example of Dunning’s arguments is natural resources, such as oil
and other minerals, which are specific to certain locations. Dunning suggests that affirm must

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