UNIT 2 FOREIGN DIRECT INVESTMENT
PART 1. READING SECTION
1. Lead-in: Work in groups: What are the advantages and disadvantages of FDI?
2. Read the text
FOREIGN DIRECT INVESTMENT
The decision to invest outside the whole country is a major one that requires careful
analysis. Investments overseas can be portfolio investments, where investors buy shares
and debentures (long-term obligations) that can be liquidated at market value anytime.
These Investments can be made without leaving the home country through an
international investment broker or a banking institution. Foreign direct investments are
quite different. They usually involve the establishment of plants or distribution networks
abroad. Investors may acquire part or all of the equity of an exciting foreign company
with the objective of controlling or sharing control over production, research and
development, and sales. Contrary to portfolio investments, foreign direct investments
mean a long-term commitment where capital funds will be tied up for a long time.
Multinational corporations usually take a strategic approach that is to locate or create
markets for its present and future markets. Markets for products are no longer national in
today's world. The technological and cultural changes of the 20th century and particularly
in the three decades after World War II, have created fairly uniform world markets, with
increasingly similar economic and social needs. All countries in the world strike to full
technological growth and the highest possible standards of living, of their present stage of
development. Consequently, MNCs of all types and nationalities, large and small have
expanded with great vitality abroad, often overshadowing their market shares at home.
Such is the case, for example, of the Swiss drug companies and the leading German,
Japanese and American automobile manufacturers.
The typical MNC pools all its resources to achieve the highest possible efficiency and
obtain the maximum return on investments. Research and development, raw
materials, investment capital, and managerial skills are utilized for the benefit of many
world markets. For example, of an automobile originally designed in Japan is later
sold, assembled or manufactured, with minor changes in the United States, Canada,
Western Europe and so on. The basis development costs, like research and design, can be
expected to be amortized on sales in many markets. Research may be carried out in one
country, parts made in another, then assembled and sold in a third country.
Most American multinationals, already technologically advanced, do not have to invest
overseas to seek ‘know- how’. Many European and Japanese companies, however, come
to the United States to do just that. Their primary aim is to benefit from American
Technology. For example, the British company, Plessy, made a $190 million bid to take
over American Alloys Unlimited, before the bid. Plessey believed that it would be less
costly to pay a higher price for technical ‘know-how’ than to do research and
development in the alloy field over a period of time.
Financial considerations are also the most important and sometimes decisive factors.
What is the expected return on an investment? What are the sources of working capital?
What are interest rates? What is the cash flow projection? -i.e. the amount of cash that
remains after a company has paid taxes and other cash expenses. Only when reliable
access to outside financing is available can a project for foreign direct investment be
termed viable. A non-viable project is one where the expected rate of return or profits
realized on assets employed is likely to be lower than from a comparable investment in
the host country.
Local regulations or legislation is another factor that must be studied before an
investment is made. When Thomson, the French electronics, set up a company to
produce military electronic devices in Chicago, it found out about the buy American Act
only after the acquisition. This act prohibits the United States government from
purchasing foreign-made military equipment with the exception of components.
Subsequently, Thompson withdrew from the company at the substantial loss. United
States antitrust legislation prohibits corporations from dominating or monopolizing an
industry. When British Oxygen bought 35% of Airco, a major United States producer of
industrial gases, it was sued by the US federal government for violating antitrust lower
labor laws. Labor laws are still another important legislative factor. Before an investment
is made, it is important to consider right-to-work laws in the existence of absence of
labor unions. The likelihood of government interference has to be studied. Despite
France’s efforts to attract foreign investment in the past companies to divest themselves
of their French subsidiaries. In 1976 International Telephone and Telegraph (ITT) sold
its interest in Le Matériel Téléphonique (producer of telephone equipment) to Thomson,
a French company, as a result of government pressure.
Investment incentives are still another consideration. These incentives are usually of a
monetary nature, such as cash grants, lower taxes, accelerated depreciation, training
allowances, research subsidiaries, and interest rebates on loans. Incentives differ from
country to country and region to region and are always highest in a depressed area. In
Belgium, where many coal mines have shut down, certain regions experienced long
periods of unemployment. These regions are likely to offer incentives to foreign
investors.
Prior to making a foreign investment, a corporation has usually had some form of trade
with the foreign nation. When a corporation starts to export for the first time, it will
usually engage distributors, who receive a commission on products sold. Distributors are
called exclusive if they are under contract to sell only the exporters’ products. Otherwise,
they are called multiple, representing other manufacturers as well.
When the foreign country becomes familiar with the products, the company might not
renew the contract with the distributors but rather will set up its own sales organization. It
will acquire its own network of dealers throughout the country, probably supervised by
various regional sales offices. Again, dealers can be exclusive or multiple.
Building up a dealer network is complicated and expensive. The exporter may refer to a
license as a foreign manufacturer. The latter is then authorized to manufacture the
product under license, using the original manufacturers’ brand name. In return, the
exporter will receive royalty payments. A drawback of licensing, as well as of
authorizing foreign distribution, is that the original manufacturer gives up control over
the product. If the licensed product lacks quality, the exporter’s reputation will suffer. It
may be very difficult to correct a distributor’s marketing mistakes if the exporter
eventually decided to handle the distribution.
Therefore, licensing and distributing are almost always of a temporary nature. Sooner or
later, the exporter will be faced with the foreign direct investment question. The basis
decision is whether to set up a manufacturing plant or make an acquisition of an existing
one. Then there is the question of whether to create a joint venture or to go it alone. A
joint venture is a subsidiary formed by two or more corporations. This form is chosen
when companies want to share capital outlay and ‘know-how’. In the long run, it is often
an unsatisfactory relationship, as the respective partners find it increasingly difficult to
share control. However, in some countries, such as Japan and Spain, a foreign investor
cannot own more than 50 percent of a corporation; that is, local interests in the foreign
venture must equal at least 50 percent.
In many countries, especially in parts of the Third World, there is resistance to foreign
direct consequences of criticism of multinational corporations. In the industrialized
nations, such as France and the United States, opposition is also growing. Even in some
quarters in the United States, foreign investment is seen as a threat. The critics forget,
however, that their countrymen invested six times as much overseas in 1976 as did
foreigners in the United States.
Some strategic industries (such as food, computers, nuclear reactors and energy) will
find it increasingly difficult to expand abroad. Foreign investment will be dependent on
the power struggle between governments and multinational corporations. But direct
investment is likely to continue its adventurous course in many areas. The economic
integration of the United States, Europe and Japan will stimulate its development.
PART 3: SPEAKING SECTION
Useful language
Asking for opinions Agreeing Making suggestions
How do you feel about... ? That’s true. I think we should...
What do you think? I agree. How about... ?
What’s your opinion? Absolutely / Exactly. Why don’t we... ?
What’s your view? I think so too. Maybe / Perhaps we
could ...
Giving opinions Disagreeing
I think... /I don’t think... I see / know what you
In my opinion ... mean, but...
I’m afraid I can’t agree.
Maybe, but
Role-play: Jonson, a large department store in Chicago, USA, is losing money. Its main
product areas are food, clothing and household furniture. Seventy percent of its revenue
comes from clothing, twenty-two percent from food and eight percent from furniture.
Three directors of the company meet to discuss the company’s problems and how to
solve.
Student A
In your opinion, Jonson has a problem with its brand image.
• People consider their clothes to be boring, old-fashioned, over-priced and
unexciting. They used to think they were well-made, value for money, durable and
reasonably priced.
• Nowadays, the store sells clothes aimed at: different age groups - young, middle-
aged and old.
• People do not enjoy visiting the store because it needs redecorating in brighter
colours.
• Staff uniforms do not help the company’s brand image.
You think Jonson should focus on one segment of the clothing market. You are
not sure which segment would be best, so you want to spend a lot of money on
market research.
Student B
In your opinion, the brand image of Jonson is excellent. People think that Jonson’s
products are high quality and durable. But they are aiming at too many segments of the
market.
• They should focus on the 30-50-year-old segment of the clothing market.
• They should not compete in the 15-30-year-old segment and should reduce floor space
for these products.
• They should use the additional space to sell more food.
• They need to spend more money on advertising and promoting their clothes.
Student C
In your opinion, Jonson’s problem is that it is selling the wrong clothes at the wrong
price.
• It doesn’t have enough top-selling products at low prices.
• The products are not stylish or colourful.
• The store is dull. It needs to be redecorated in bright colours.
• It needs to improve the display of the clothes.
You think Jonson should focus on the young segment of the market (the 15-30 age
group). It should recruit a fashion expert with an international reputation - someone
who knows what to buy and when to buy.
