Internationalizing of Business Activities through Foreign Direct Investment - Essay Example

? Globalization #2 Introduction The advent of globalization saw the emergence and development of multinationalcorporations. These corporations engage in international business by setting up subsidiaries in foreign countries or exercising some control of firms in foreign countries. In doing so, the corporations may decide to internationalize their business activities either through foreign direct investment (FDI), exporting, licensing, or franchising. The method that the firm decided to choose has some implications on the operations of the business enterprise. This paper seeks to explore the circumstances in which firms may choose to internationalize their business activities through FDI rather than by exporting, licensing, or franchising. Discussion Many theories have emerged to explain the reasons why large firms tend to choose foreign direct investment over other options such as exporting, licensing, or franchising. These explanations center on market imperfections, transportation costs, or the argument that the company may lose its competitive advantage, especially if it shares knowledge through licensing. Dunning (1988) devised the Eclectic Paradigm, which seeks to explain why Foreign Direct Investment should be considered over the other methods (Dunning 1993, p. 156). First, a firm may choose FDI rather than exporting when it wants to regulate cost uncertainty, as well as demand uncertainty. Through FDI, the international firm will meet the shifting local demand more quickly than when the firm uses exporting; this will improve the profits of the firm. Therefore, the firm may decide to internationalize business activities through FDI rather than exporting when the cost uncertainty is lower than the demand uncertainty. Moreover, firms that engage in the production of products that may be less similar may choose foreign direct investment as an entry strategy in foreign markets than the use of exporting (Levy-Livermore 1998, p. 132). Another circumstance that may prompt a firm to use foreign direct investment rather than the other methods like exporting includes government policies. These may entail policies that discourage exports as a way of conducting international business. For example, nontariff as well as tariff barriers my discourage firms from choosing exporting as an entry mode in international business (Michael 2005, p. 55). High taxes that may be levied on the exports may compromise the profits of the business enterprise. As a result, firms may choose to make direct investments in the foreign markets with an aim of maintaining productivity and profits. Tariffs may act as barriers to international trade, especially when firms depend on exports as a mode of entry in international markets (Moosa 2002, p. 1). Another circumstance that may make a firm make a direct investment in a foreign country through FDI includes marketing concerns. This may entail the distribution, logistics, image of the firm, and responsiveness to the customers' needs. Firms that require quick and immediate feedback from the customers tend to choose FDI as the mode of entry in international markets (Markusen 2004, p. 287). Through FDI, the firm takes advantage of its presence in a foreign market to engage in widespread marketing of the products, which it produces. Thus, Foreign Direct Investment could be more favorable than exporting, licensing, and franchising in a situation where the firm wants to engage in enormous marketing of its products (Moran 2002, p. 100). Firms may also decide to internationalize their business activities through foreign direct investment where logistical considerations play an essential role in the activities of the firm. An example includes the costs attributed to internationalization through exporting (William 2004, p. 246). While firms decide to internationalize through exporting, some costs such as packaging, warehousing, distribution, and transporting costs will be incurred. Thus, in circumstances where firms want to avoid these costs, it will be more desirable to choose foreign direct investment as an entry mode rather than exporting. While using Foreign Direct Investment, such costs will be avoided since the firm will localize its activities in the foreign country. FDI, therefore, saves on the costs that the firm could incur if it chose to use exporting in its international business (Wang 2005, p. 332). A firm could also decide to use foreign direct investment as entry strategies in foreign markets, especially in circumstances when it wants to make distribution issues easy. In circumstances when the firm does not use FDI, it may be forced to hire distributors in the foreign markets. In most instances, the choice of the distributor becomes critical to the success of the firm in international business. For example, the best distributor in a foreign market could already be dealing with the products of the competitor. As a result, the firm may be compelled to hire the services of a distributor who may not be well experienced to deal with the products of the firm (Weng 2008, p 139). Consequently, the distributor may not be able to handle the products of the company exclusively since they do not possess the best experience. Thus, in such a situation, the firm may choose to use foreign direct investment. Country of origin effects could also be another circumstance that could influence the choice of a company to invest internationally using foreign direct investment. Because of nationalistic feelings, consumers may tend to prefer goods produced in their own countries rather than imports. In some instances, consumers may prefer goods from some countries due to the perception that those countries produce superior goods (Johnson & Turner 2009, p. 224). As such, firms may decide to use foreign direct investment as an entry strategy in foreign markets. In most circumstances, consumers have the confidence and trust to purchase goods produced in their countries rather than purchase imports. Therefore, firms may decide to employ foreign direct investment in internationalizing their activities when they want to gain the trust of the consumers (Wall & Rees 2004, p. 40). Foreign direct investment may also be desirable over exporting because producing in foreign markets becomes cheaper than producing in the home country and selling the products abroad. Through the use of FDI, companies can be able to control their production costs. Thus, the companies will maximize their profits by reducing the costs incurred in producing the finished product. A firm may also decide to use FDI in international business when it lacks domestic markets for the finished goods. In such a circumstance, it would be desirable for the firm to venture in foreign markets since they may prove more worthwhile than the domestic markets (Paul 2011, p. 234). In international business, licensing entails an arrangement whereby a firm sells its intellectual property rights to another company. The firm that buys the intellectual property (known as the licensee) agrees to pay a certain fee to the firm that sold the rights (licensor). Some circumstances may discourage firms to use licensing in international business. For instance, firms that operate in countries with weak protection of intellectual property should not use licensing. If a firm engages in international licensing in such circumstance, it may risk losing its investment (Jones & Colins 2006, p. 42). Firms may also choose foreign direct investment over licensing in order to gain opportunities in the market. This stems from the fact that licensing tends to limit market opportunities for the licensor as well as the licensee. In a circumstance where the licensor wants to overcome the mutual dependence with the licensee, it would be advisable for a firm to choose FDI rather than licensing. Firms may also choose to internationalize their activities through foreign direct investment when they want to avoid costly litigation, which may be involved in resolving disputes between the two parties (Johnson & Turner 2003, p. 117). Moreover, firms may decide to internationalize their business activities via FDI rather than licensing in circumstances where uncertainty prevails whether the licensee will comply with the license agreement fully. A firm may have the uncertainty that the licensee will not be able to handle problems that may accrue; this will affect the reputation of the product. For instance, in licensing, the licensee may not have the required skills and knowledge to deal with the products. In such a circumstance, the firm would choose to market the product itself in order to avoid uncertainties that may arise in the market (Jonny 2008, p. 41). In licensing, the burdens of overseeing the foreign operations, as well as the burden of finances for foreign operations go to the licensee. In addition, the transfer of these burdens is accompanied with the transfer of control to the licensee. Thus, a firm may choose to use foreign direct investment when it wants to regain control since it will own the means of distribution and production through FDI. As a result, foreign operations can be changed incase problems arise, and it would be much easier to safeguard the reputation of the firm and its products. Consequently, the company gets the opportunity to impose strict oversight regarding foreign operations since it owns them (Feenstra 1989, p. 58). An international franchising agreement gives an independent entrepreneur or organization, known as the franchisee, an opportunity to carry out business for another entity known as the franchisor. In return, the franchisee receives a certain fee for carrying out the business activities on behalf of the franchisor. In the world of international business, franchising has become one of the forms of international business that grows at a high rate. A firm may favor foreign direct investment than franchising when it wants to have ultimate control of its operations (Cohen 2007, p. 97). Through franchising, the franchiser may lose some considerable control over the franchise operations of the firm. A company may decide to choose foreign direct investment as an internationalization strategy rather than international franchising to counter this loss of control. In franchising, there is no guarantee that the franchisee will carry out the operations of the firm in the same way and with the same standards as established in the operations of the franchiser. As a result, the firm may lose its popularity and influence in international business. In such a circumstance, it would be advisable for the firm to choose foreign direct investment over franchising. When the firm controls the assets that relate to operation and production, it will control the standards relating to product quality and customer service (Ajami & Goddard 2006, p. 13). Consequently, the company will not worry about monitoring the activities of the franchisees. Therefore, a firm may choose direct investment and direct ownership when it wants to have control over assets and maintain the brand name. Another circumstance that may prompt a firm to use FDI over franchising could be the desire to maintain profitability of the firm. This is because, in franchising, the franchisor and the franchisee share the profits made by the firm. Moreover, firms may try to avoid the complex nature of international franchising and opt to use foreign direct investment as an entry strategy in international markets. The management of the operations of franchises can prove to be expensive than when the firm decides to use foreign direct investment. As a result, the firm may decide to choose direct investment as a strategy for international business rather than use of international franchising (Hill 2007, p. 193). The insecurity associated with franchising may also make firms choose foreign direct investment over international franchising. For example, there is a high likelihood that the franchises will go out of business. In order to overcome this uncertainty, firms may choose foreign direct investment over franchising as an entry strategy in the international markets (Froot 1993, p. 88). Conclusion Globalization has precipitated international business; as a result, large firms have engaged in numerous investments, especially in foreign markets. There are circumstances, which may make firms internationalize their business activities through foreign direct investment rather than exporting, licensing, or franchising. In exporting, the firm may incur costs of distribution, transportation, and storage of the products. Therefore, the firm may choose foreign direct investment over exporting in international business. The uncertainty associated with licensing and international franchising may also make the firm choose FDI over these methods. Thus, firms tend to favor foreign direct investment over exporting, franchising, and licensing due to the numerous benefits associated with FDI. References List Ajami, R. A. & Goddard, J. G. (2006). International Business: Theory and Practice, New York, M.E Sharpe. pp. 12-15. Cohen, S. D. (2007). Multinational Corporations and Foreign Direct Investment: Avoiding Simplicity, Embracing Complexity, Oxford, Oxford University Press. pp. 95-105. Dunning, J. H. (1993). The Globalization of Business: The Challenge of the 1990s, London, Routledge. pp. 155-158. Hill, C. W. (2007). Global Business Today, New York, McGraw-Hill. p. 193. Johnson, D. & Turner, C. (2003). International Business, London, Routledge. pp. 100-120. Jonny, J. K. (2008). Global Marketing: Foreign Entry, Local Marketing, and Global Management, New York, McGraw-Hill Irwin. pp. 40-48. 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