Page 129 - DMGT545_INTERNATIONAL_BUSINESS

International Business

notes undertake FDI to exploit such foreign resources. This explains the FDI undertaken by many of the
world’s oil companies, which have to invest where oil is located to combine their technological
and managerial knowledge with this valuable location-specific resource. Another example is
valuable human resources, such as low-cost highly skilled labour. The cost and skill of labour
varies from country to country. Since labour is not internationally mobile, according to Dunning
it makes sense for a firm to locate production facilities where the cost and skills of local labour are
most suited to its particular production process.

7.2.2 vertical fDi

Vertical FDI takes two forms, there is backward vertical FDI into an industry abroad that provides
inputs for a firm’s domestic production processes. Historically, most backward vertical FDI has
been in extractive industries

Example: Oil extraction, bauxite mining, tin mining, and copper mining.
The objective has been to provide inputs into a firm’s downstream operations.

Example: Oil refining, aluminium smelting and fabrication, tin smelting and
fabrication.
Firms such as Royal Dutch/Shell, British Petroleum (BP), RTZ, and Consolidated Gold Field are
among the classic examples of such vertically integrated multinationals.
A second form of vertical FDI is forward vertical FDI in which an industry abroad sells the
outputs of a firm’s domestic production processes. Forward vertical FDI is less common than
backward vertical FDI.

Example: Volkswagen entered the US market, it acquired a large number of dealers
rather than distribute its cars through independent US dealers.
The question may arise that why firms go to all the trouble and expense of setting up operations
in a foreign country. There are two basic answers–the first is a strategic behaviour argument and
the second draws on the market imperfections approach.

Did u know? Vertical FDI has two forms, backward and forward.

strategic Behaviour argument

According to economic theory, 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. Such
strategic behaviour involves vertical FDI if the raw material is found abroad.
Another stand of the strategic behaviour explanation of vertical FDI sees such investment not as
an attempt to build entry barriers, but as an attempt to circumvent the barriers established by
firms already doing business in a country. This may explain Volkswagen’s decision to establish
its own dealer network when it entered the North American auto market.

market imperfections approach

The market imperfections approach offers two explanations for vertical FDI. The first explanation
revolves around the idea that there are impediments to the sale of know-how through the market
mechanism. The second explanation is based on the idea that investments in specialized assets
expose the investing firm to hazards that can be reduced only through vertical FDI.

124 lovely Professional university