Page 149 - DMGT545_INTERNATIONAL_BUSINESS

International Business

notes l z Impediments to the sale of know-how explain why firms prefer horizontal FDI to
licensing These impediments arise when (a) a firm has valuable know-how that cannot be
adequately protected by a licensing contract, (b) a firm needs tight control over a foreign
entity to maximize its market share and earnings in that country, and (c) a firm’s skills and
know-how are not amenable to licensing.
l z Knickerbocker’s theory suggests that much FDI is explained by imitative strategic behaviour
by rival firms in an oligopolistic industry.

l z Vermon’s product life cycle theory suggests that firm’s undertake FDI at particular stages
in the life cycle of products they have pioneered.
l z Dunning has argued that location-specific advantages are of considerable importance in
explaining the nature and direction of FDI. According to Dunning, firms undertake FDI to
exploit resource endowments or assets that are location-specific.

l z Backward vertical FDI may be explained as an attempt to create barriers to entry by gaining
control over the source of material inputs into the down stream stage of a production
process. Forward vertical FDI may be seen as an attempt to circumvent entry barriers and
gain access to national market.
l z The market imperfections approach suggests that vertical FDI is a way of reducing a firm’s
exposure to the risks that arise from investments in specialized assets.

l z From a business prescriptive, the most useful theory is probably the market imperfections
approach, because it identifies how the relative profit rates associated with horizontal FDI,
exporting, and licensing vary with circumstances.

l z The benefits of FDI to a host country arise from resource-transfer effects, employment
effects, balance of payments effects, and its ability to promote competition.
l z The costs of FDI to a host country include adverse effects on competition and balance of
payments and a perceived loss of national sovereignty.

l z The benefits of FDI to the home (source) country include improvement in the balance of
payments as a result of the inward flow of foreign earnings, positive employment effects
when the foreign subsidiary creates demand for home country exports and benefits from a
reverse resource-transfer effect. A reverse resource-transfer effect arises when the foreign
subsidiary learns valuable skills abroad that can be transferred back to the home country.

l z The costs of FDI to the home country include adverse balance-of-payments effects that
arise from the initial capital outflow and from the export substitution effects of FDI. Costs
also arise when FDI exports jobs abroad.

7.8 keywords

Backward Vertical FDI: It is an attempt to create barriers to entry by gaining control over the
source of material inputs into the down stream stage of a production process.
Foreign Direct Investment (FDI): Direct investment in business operations in foreign country.
Forward Vertical FDI: It is an attempt to circumvent entry barriers and gain access to national
market.
Horizontal Foreign Direct Investment: Foreign direct investment in the same industry abroad as
a firm operates in at home.
Market Imperfections: These are factors that restrain markets from working perfectly.
Vertical Foreign Direct Investment: Foreign direct investment in an industry abroad that provides
input into a firm’s domestic operations, or foreign direct investment into an industry abroad that
sells the outputs of a firm’s domestic operations.

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