Foreign Entry Modes - Essay Example

Foreign Entry modes: Evaluate the use of a Greenfield site compared to an acquisition for entry to a foreign country April,2009 TABLE OF CONTENTS 1.0Introduction 1.1Green Field Site Entry Strategy into a Foreign Country 1.2 Acquisition Mode Entry into a Foreign Country 2.0 Conclusion and Recommendation 1.0 Introduction Research on Foreign Direct Investment (FDI) in the past has attracted much attention from the field of international finance and international marketing. FDI refers to a situation where, a firm invests directly in facilities to produce or market product in another country (Hill 2007:238, Sumulong et al., 2003, Buckley 2004, Shen et al., 2006). Once a corporation or firm undertakes a foreign direct investment, it becomes a Multinational Enterprise (MNE). Examples of foreign direct investment initiatives include: CEMEX a Mexican corporation operating in more than fifty countries; British petroleum, Texaco, ASDA, TESCO (Hill 2007). Hill (2007) contends that FDI takes on two main forms: Greenfield investment, mergers and acquisitions. Hill (2007) went further and argue that, in a Greenfield investment, the firm in question establishes a new operation in a foreign country while the later involves acquiring or merging with an existing firm in the country. Acquisition however is usually hostile, because this is usually done against the wish of management (e.g. CEMEX's acquisition of RMC of Britain and Southland in the United States (Hill 2007, Buckley 2004). In the years that follow after the Second World War, trade and investment have become increasingly intertwined. Within the first few decades after the war, most countries from Asia and Africa viewed Foreign Direct Investment (FDI) with suspicion, and wariness and the flow of FDI towards these areas has been relatively slower (Buckley 2004, Sumelong et al., 2003). To most of these countries, the presence of Multinational Enterprises (MNEs) was seen as an impeachment to their national sovereignty. The situation was further aggravated with previous colonial experience and the fact that to some, FDI was a modern form of economic colonialism (Sumulong, Fan & Brooks 2003). According to the World Trade Organisation (WTO), the flow of FDI has substantially changed the international economic landscape. From1980 it has been argued by a handful of researchers (e.g. Hill 2007, Sumelong et al 2003, Buckley 2004, and Reis & Head 2005) that FDI outflow has overtaken the growth of world exports. The expansion in FDI became relatively pronounced during the period 1985-2000, a period characterized with scores of mergers and acquisitions, the Asian financial crises, the oil boom and privatization programs in Latin America (Hill 2007, Sumelong et al., 2003). In the year 2000, FDI outflow stood at $1.4 trillion (Hill 2007, Sumelong et al., 2003). Figure 1 below gives a summary of FDI and export growth between 1980-2000. Sources: Exports: IMF 2003; FDI Outflows: UNCTAD 2002 Having said this, in the remaining part of the paper I will be comparing Greenfield investment to acquisition as an entry mode strategy. The second section of the paper discusses Green field investment, while the last section provides the conclusion and recommendations. 1.1Green Field Site Entry Strategy into a Foreign Country Where a firm chooses to invest through the setting up of new operations in a foreign country often refered to as Greenfield venture. On the other hand, where the company acquires 100% ownership of an existing business to promote it activities is refered to as acquisition (Hill 2007). Ownership advantages resulting from Multinational Enterprise operations MNE can be looked upon from two directions. That is in a situation where full ownership prevails and a situation where ownership is shared with local partners. Tseng Hui-Chuing (2007) argued that MNEs equipped with capabilities to attain assets seeking objectives are more likely to choose an internationalization of foreign operations than a shared ownership mode. That, is Greenfield investment and acquisition. In this direction, diversification of institutional power is reduced, corporate identity is preserved, and opportunistic behaviour resulting from shared ownership minimize. The researcher went further to argue that, MNEs will prefer full ownership mostly in situation where the short term benefits in collaborating in assets exploration tend to be more than the long term cost of full ownership (White & Lui 2005). Entering into join venture is only possible option when assets seeking multinationals lack capabilities to duplicate or acquire needed assets or where the pros of sharing assets outweighs the cons of ownership (White & Lui 2005). By entering into a join venture ownership structure, the partnership will provide an advantage to easily gain access to resources that are costly or prohibitive to be reproduced or transfer outside of the firm that controls the resources (Oliver 1990). Makino & Neupert(2000) went further to substantiate that a wholly owned structure has an advantage a greater discretion or latitude to leverage the resources when compared to join venture. Tseng Hui- Chuing (2007) elaborated and strengthened location and ownership advantages existing to MNEs using a set of hypothesis to connect, local technological advantages, natural resource advantages, cheap labour, technological advantages with firm specific advantages (Marketing and firm size advantage). Tseng Hui Chuing (2007) however, postulated that in situation where the advantages and capabilities that MNEs embrace, is location specific (labour, technology, natural resources, expertise etc), or difficult to be redeployed or rebuilt in a new market, then Join ownership should not be given a second thought. This tie with Dunning (1993) findings that there are four generic location specific advantages for MNEs. Natural resource seeking advantage Market seeking advantage Strategic assets seeking advantage In finance, it is a common practice to view mergers and acquisitions as manifestations of the market for corporate control. Much of foreign direct investments usually take the form of mergers and acquisition and according to Reis & Head (2005), two-third of FDI that took place between the periods of 1987-2001 was in the form of mergers and acquisition. With their relative advantage of capital, technology, and managerial resources that would otherwise not be available to the host country or other domestic firms, FDIs are often seen as monopoly because of their economic, technology and managerial advantage they posses. Subsequently, host countries enjoy these benefits and costs that otherwise is unavailable to domestic firm. This is because of the monopolistic position enjoyed by FDIs (MNEs) with respect to these resources (Weigel &Miller 1972, Hill 2007, Sumelong et al., 2003). These monopolistic advantages come from, superior knowledge; production capabilities not accessible to other local firms; technological advancement and superiority not open to other firms (Hill 2007, Sumelong et al., 2003, Aitken & Harrison 1997). These benefits to host countries include: flow of resources, employment, Balance of Payment, economies of scale and scope, technological and managerial transfer. The above benefits accrue to the host country because of the imbalance of resources between local firms and the FDIs or advantages enjoyed by FDIs or not available to local firms at the same costs within the host countries. According to Aitken & Harrison (1997), a Foreign Direct Investment is often seen as a monopoly because, FDI only operates in situation where they are monopoly in host countries or hold some supremacy over similar companies in countries of interest. The monopolistic position results from the foreign company ownership of some resources, patents that are unavailable at the same price or terms to the local companies (Hill 2007, Wigel & Miller 1972, Sumelong et al 2003). Some other important benefits of FDI to the host country are the transfer of capital, technology, managerial skills, and economies of scale. These benefits come as a result of the monopolistic position of MNEs. Multinational companies by virtue of their large size and financial strength have access to financial resources not available to host country firms (Hill 2007). These funds might be available from internal company sources, or because of their goodwill they may find it easier to borrow, or acquire recent and modern technology. Local firms on their part because of the size of their activities and unknown reputation cannot access these same resources. Thus MNEs become monopolies within the host countries as these resources are open just to MNEs and the competitive table is tilted in their favour. The resulting benefits to host country (e.g. Capital, technology transfer, managerial skills, jobs that would otherwise not be created) are as a result of the monopolistic position of FDIs relative to local firms. Hill (2007), however argues that, establishing wholly owned subsidiary is generally the most costly method of serving a foreign market. Fir, doing this must be prepared to bear the cost and risks of setting up overseas operations. In this dimension, Hill (2007) stipulates that, the risk associated in doing business in a foreign culture will be less if and acquisition is used. 1.2 Acquisition Mode Entry into a Foreign Country On the other hand, the coming together of companies to gain synergistic effects has been seen in recent times as the most profitable way of investment. We often hear of this or that company merging with another or taking over another. It is common knowledge as it prominent portion of broadcasted news and columns in business papers have of late been dedicated to mergers and acquisitions as they are the most important forms of investment today (Randeniya and Roivas, 2004). Generally speaking, the motives for mergers and acquisitions can be broadly divided into two, viz, the financial and non-value maximizing reasons. The financial reason: This deals with the financial value of the firm as a whole and looks at aspects such as increasing overall performance and creating shareholder value. (Risberg, 2006). This is due to the gains of synergy and overcoming of information asymmetry which might have been existing in the stand alone firms. (Risberg, 2006). Also, the firm's inability to fund certain marginally profitable projects as stand alone institutions is a motivating financial factor behind mergers. There is also the non-value-maximising marginally based motive behind mergers. This arises mainly due to the manager's desires to increase power, sales or growth. This reason is also known as personal or strategic reasons. (Risberg, 2006). In a merger, the newly formed firm has a completely new name while in an acquisition, the absorbed firm may retain its name, though management is handled by the acquiring firm. (Randeniya and Roivas, 2004). Other remote reasons for mergers of acquisitions are psychological motives which is mainly fear. Thus, we find a situation where firms come together or acquire others or due to the fear of being acquired by other larger more efficient firms. (Risberg, 2006). Again, as firms grow old, they become rigid and more bureaucratic in their procedures. This makes individual initiative and spontaneity difficult and barring the way to long term survival, hence the need for new blood to be injected in the form of a merger or acquisition. (Risberg, 2006). An acquisition on the other hand is a union of two firms in one of them survives while the other goes out of existence. (Gustafsson and Hukkanen, 2002). In certain occasions, the absorbed company may retain its individual identity if it is an important strategic element, for example, when Ford acquired Volvo, Volvo was still allowed to keep its brand name.(Randeniya and Roivas, 2004). In an acquisition, the surviving firm usually has greater power, and can thereby rule the integration process on its own, usually usurps the weaker firm, acquiring its assets and liabilities. (Gustafsson and Hukkanen, 2002; Karin and Elisabet, 2006). Acquisition unlike Greenfield investment are quick to execute, through acquisition, Hill (2007) argues that a firm can easily build its presence in the target foreign market. An example of this is the German automaker who had to acquired the number three United States automaker as a means to increase it presence and market share rapidly. In most situations, acquisition is used today as a means to preempt competitors (Hill 2007). Acquisitions are seen as being planned and executed so as to dominate the market. (Georgio, 2002). This is particularly true with horizontal integration and conglomeration. (Georgio, 2002; Almqvist and Johansson, 2005; Risberg, 2006). There are always inherent diviation of the expected outcome of an acquisition and the actual experience of the key stake holders such as customers, employees, share holders and suppliers. (Buono, 2003). There are a lot of forces, some positive, some negative that act on acquisition to influence their outcomes, which need to be meticulously handled. Positive forces include managerial vision, transitional expansion, financial analysis, duplication elimination etc while negative forces include synergy trap, market sanctions, cultural clash/employee resistance, integration costs etc. (Randeniya and Roivas, 2004). The positive factors go a long way to give the firm added value that is geared towards achieving the aims of the acquisition. The negative factors, especially cultural clash/employee resistance can very negatively affect the firm and slow down, if not, make the intentions of the acquisition fail completely. Careful address and handling of these issues is thus the preoccupation of management to make the best out of whatever situation. Most managers handle this by first taking on cultural integration before bring in structural integration of the firms. (Gustafsson and Hukkanen, 2002). Acquisitions are considered less risky than Greenfield investment by managers. 2.0Conclusion This paper looks at two alternative entry mode, Greenfield investment and acquisition. It can be argued from our findings that, acquisition is easier, faster and less risky and this account for the increase use of acquisition as an entry mode for foreign direct investment. Greenfield investment risk the problem of cultural crash and in most cases, the firms risk the problems of finding its own suppliers. References Almqvist, J., Johansson, C. (2005) What did you say - A study of communication with links to anxiety during a merger. Department of Management and Economics, Linkping University Aitken, B., Hanson, G. 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