Concepts of Foreign Direct Investment and Its Significance in Multinational Companies - Case Study Example

Research Paper on a Selected Multinational Company and Its Foreign Direct Investment of the Table of Contents Background 3 Foreign Direct Investment (FDI) 3 Multinational Companies (MNCs) and FDI 4 Significance and Barriers of FDI 4 Wal-Mart 5 Wal-Mart and FDI 6 Direction and Form of FDI 7 Findings 9 Conclusion 10 1.References 12 Background Foreign Direct Investment (FDI) Investments made by a company based in a country, to a different country means investing directly into a foreign country. Foreign direct investment (FDI) is different from indirect flow of investments because in case of indirect investments, either companies need to form a joint venture or have to tie-up with any domestic or local company of the target country in which the company wants to invest. However, FDI simply means getting the rights to conduct business or make investments straightforwardly even without getting into a joint venture with the domestic companies. The companies making direct investments have ample control and influence over the company in which the investment is made. Countries foster open economies in order to utilize the resource of skilled workforce and explore growth prospects by attracting foreign investors, so FDI becomes an obvious choice for developing countries for economic growth and development (Gilroy, Gries, & Naudé, 2004, p. 50-55). According to International Monetary Fund (IMF), FDI facilitates companies to make investments with the expectation of establishing lasting relationships with the target countries. FDI was considered to be one of the major drivers of continuous growth and globalization, before the financial crisis. However, as revealed by UNCTAD in the World Investment Report of 2009, about 85 percent of the Transnational Corporations got affected by financial crisis in 2008-09. USA tops the list of FDI inflow, but many other countries have joined this list (Breitfeld, 2010, p. 1). Multinational Companies (MNCs) and FDI Nowadays, we stay in one global country. This is said because there are trade and commerce taking place among all the countries. People staying in any country can make use products of different countries. From this very concept the term global marketing has come up. Now, when we say that the world has become one market, we can also say that the economies of individual countries also affect the global economy, especially the international trade. There is a lot of capital involved in international trade and commerce. Products and services costing billions of money are traded everyday among nations in the world market. So the price of currency exchange and fluctuations also significantly affect the profit and income of the marketers (Baker, Epstein, & Pollin, 1998, p. 117-120). Multinational corporations (MNCs) and FDI are complex expression that illustrates two separate but correlated concept. The MNCs or multinational enterprises (MNEs) manage their production, organization, and deliver products and services in the different countries primarily through FDI. FDI acts as an entry mode for the MNCs in other countries. There are various types of entry modes that are available for the MNCs, but FDI being the easiest and the most productive one, is generally chosen by the MNCs. FDI assists the MNCs in acquiring durable participants through mergers and acquisition or by establishing foreign branches, which implies that the firm would have a certain level of involvement and control on the management. Significance and Barriers of FDI Developing countries witnessed a rapid growth of population across the globe since 1950. However, this growth did not match the increasing per capital income. It has been seen that when FDI is skillfully applied, it has proved to be one of the fastest mode of development and investment for the MNCs. It comes with diverse benefits for both the host countries and investing firms. Development and growth can be seen in leaps and best practices are applied in order to compete in the world market. Various new practices are being planned in order to make FDI beneficial and more assured for the host countries as well as for the investing companies. The effects of FDI on the domestic firms in the developing countries have been identified through a meta-analysis. This has revealed that FDI assists in increasing the investments robustly, and improves local productivity of the host country as well (Jensen, Rutherford, & Tarr, 2004, p. 10-15). On the other hand, FDI is also a controversial or complex phenomenon because it might create difficulty for the growth and development of local small scale industry in the host countries. Many countries, especially in the Asian countries, FDI was not readily acceptable in order to provide protection to their domestic manufacturers. This means that FDI depends on the policies and regulation of the countries where investment is ought to be made (Hoekman, Mattoo, & English, 2002, p. 247-251). Wal-Mart Wal-Mart Stores Inc. is an American company which was established in the year 1962 in Arkansas, USA. The company deals with supermarket retailing, and is reported to be the third largest public corporation in the world according the Fortune Global 500 list of 2012. Wal-Mart is also considered to be the largest retailer globally. The company was founded by Sam Walton, and it got listed on the New York Stock Exchange in the year 1972. The company owns around 8970 stores in 15 different countries. Wal-Mart operates in different formats such as grocery stores, supermarkets, discount stores, supercenters, hypermarkets, clubs, warehouses, etc (Yahoo Finance, 2013). The merchandise offered by Wal-Mart are mainly, grocery items, meat, dairy products, , baby products, beverages, frozen foods, bakery products electronic goods, household items, and many more. Currently the operations of Wal-Mart are segregated into three subdivisions, namely, Wal-Mart International segment, Wal-Mart US segment, and Sams Club. Different format stores are run by Wal-Mart in 50 states of USA. Apart from this, the company also manages its retail operations online through walmart.com. The international segment of Wal-Mart has its presence in around 26 countries. The business model of Wal-Mart is based on selling an array of products to the customers at a low price, so that the offerings of Wal-Mart are affordable for all (Wal-Mart, 2010). Wal-Mart and FDI Wal-Mart progressed globally with their corporate strategy of controlling the retail industry, by offering lowest possible priced products to the customers and maintaining the sustainability of the company. The supermarket concept in present scenario forms the basis of Wal-Mart’s business strategy both in US as well as internationally. Wal-Mart forecasted the opportunities that it can explore in countries like South Africa, China, Brazil, and India and entered those markets where the culture and concept of supermarkets was still at their developing stage. In places where FDI was not prevalent, Wal-Mart entered into a joint venture with a domestic firm in the country (Paul, 2010, p. 360-362). For example, in China Wal-Mart entered through joint venture, though it also owns numerous majority-owned subsidiaries in China too. Trade barriers prevailed in China up till 2005, but after that stringent rules were not imposed on the supermarkets and they were easily granted rights of distribution too. In Mexico, Wal-Mart also owns many majority-owned subsidiaries with the name Walmex, while in Japan it wholly owns Seiya since 2008. So these are the FDI initiatives taken by Wal-Mart across different countries. However, the countries where trade restrictions are still prevailing, Wal-Mart functions and operate in a partnership or joint venture with local companies (Peng, 2008, p. 159-161). Countries like Pakistan, India still have much restriction in terms of allowing FDI. In India, Wal-Mart formed a joint venture with Bharti Enterprises for penetrating in the country. It functioned through franchising and managed the wholesale division, and the stores were named Bharti Wal-Mart. The government of India has approved 51 percent of FDI on the multi-retail brands, which is further subjected to support or approval by the head of different states. However, FDI is actively prevalent in European countries such as UK, Germany, France, or Italy. Similarly Wal-Mart is actively present in American countries too. Wal-Mart Chose FDI over licensing or franchising in these countries because it offers high level of direct control and management power, which also reduces the company’s risk associated with capabilities or resources (Roberts, & Berg, 2012), p. 163) Direction and Form of FDI FDI is generally directed towards the development and growth of the nation and world economy as well. USA is the most preferred target in case of FDI inflows, while the European market is also gaining preference rapidly along with the Latin American countries. The trend reveals that the direction of FDI has always been towards the developed nations only. According to the world investment report in the year 2002, the developed nations hold 70 percent of the world FDI inflows, while the developing nations have around 28 percent. USA attracts about $281 billion FDI inflow alone, so it is obvious that companies like Wal-Mart, get benefits of being an US based company. The retail grocery and apparel segment gets benefited mostly due to the FDI inflows. Large local retailers segment are growing in developing countries as the foreign retailers can form joint ventures with the local companies and sell products to the mass. Wal-Mart’s strategy has been to invest in the countries where resources like logistics was ready available, raw materials was obtainable at reasonable price, global supply chain was accessible, the size of the market is large enough and middle-class customer segment is enthusiastic and ready to buy variety of products. So in order to direct the flow of FDI for their benefit, Wal-Mart has preferred to open its stores in the towns, rural areas, of the developing countries, which are generally ignored by the other retailers. Even in developed countries Wal-Mart was preferred by the people. Another initiative of Wal-Mart is to acquire raw materials from the farmers directly in the country where investment is done. This eliminated the middlemen, and improved the economic condition of the farmers. Apart from this, Wal-Mart has also acquired many existing supermarkets in the different countries and used this brand proposition to do business. For example it acquired Asda in UK, and did not change its name to retain all the old and loyal customers of Asda. Asda generates about 42.7 percent of Wal-Mart’s business in the Wal-Mart International segment. In other countries such as in Japan and Mexico too, Wal-Mart operates with the name of the acquired supermarket chain to gain quick market share. This is the strategy which Wal-Mart applies to take quick advantage of the FDI. However, in case of countries like India, Pakistan, or China, Wal-Mart has to face difficulty because of trade barriers. In India, Wal-Mart has still not received full fledged opportunity to utilize the most accessible mode of market entry because India still has trade barriers for protecting their domestic industry, while in China Wal-Mart faced initial barriers due to the procurement of fresh raw material such as sea fish, etc, which were later resolved and Wal-Mart has been successful in doing business in China. On the other hand the retail chain failed in Germany and in South Korea. Though Wal-Mart made huge investments in Germany, but there is oligopoly form of market in the country, so the concept of low priced product was common, and the competition was high. Apart from this, the corporate culture of Wal-Mart was not accepted by the employees in Germany, so the investment of Wal-Mart was a total collapse. As far as forms of FDI are concerned, there are generally two types of FDI; they are vertical FDI, and horizontal FDI. The horizontal FDI happens when companies copy or follows the home based activities or functions for the host countries with the help of FDI. In this case the companies usually invest in the same industry as that of the home country. Wal-Mart has also chosen horizontal FDI, as it operates in the same industry around the world. Vertical FDI arises when the companies move downstream or upstream in the value chain and makes alterations according to the requirement of the host country. In case of forward or upward vertical FDI, the company invests in such facilities that would be consuming the product of the mother company. These involve grants, tax holidays, interest loans, etc. In case of backward or downward vertical FDI, company provides the raw material to the mother company. Apart from these general forms, the most of the FDIs includes cross-border investment activities such as mergers and acquisitions. Wal-Mart has acquired several supermarkets in host countries to penetrate in international markets, such as Asda in UK. Acquisition has always been one of the most attractive form of FDI for Wal-Mart because they could quickly execute their investment plans assumed to be less risky for them compared to joint ventures. Moreove,r control of the business remains in the hands of Wal-Mart in case of acquisition. However in India Wal-Mart entered with a joint venture with Bharti Enterprise and initiated business through franchising. Findings Though economists have always remained skeptical over the positive externalities of FDI, but many countries have invested large amount of money to attract the foreign investors. Though countries like Latvia or Czech Republic have referred that FDI or entry of MNCs affect the development of domestic enterprises in similar industry, yet penetration of MNCs through FDI is increasing rapidly. The net sales of Wal-Mart International were $125.9 billion in 2012, which indicates a 15.2 percent increase as compared to the previous year. The company has opened up 612 new stores in different countries, and has acquired 1094 stores around the world by 2012. Wal-Mart operates in the same industry and deals in similar products around the world, which reveals a horizontal form of FDI (Wal-Mart, 2012). However, merger and acquisition is also seen in case of FDI. Wal-Mart’s strategy has always been aggressive growth in the international market through FDI and acquisition. In this process Wal-Mart has also acquired largest market share in the supermarket industry of different countries other than USA, such as in Brazil, it has acquired the supermarket chain called Bompreco, then again in 2005, it took control of the operations of Sonae Distribution Group, and many other super market chain which made Wal-Mart the third largest chain of supermarkets in Brazil. Conclusion This research study aims at identifying the concepts of FDI and its significance in MNCs, and how FDI helped Wal-Mart to formulate its expansion strategies. Wal-Mart is one of the largest retailers around the world, and manages its operations and business in almost every country, so the study is initiated with a background which portrays the basic concepts associated with FDI and its effect on the MNCs. Further the operations of Wal-Mart as an MNC has been discussed to focus on its FDI strategies, its approach towards merger and acquisition and the form of FDI it has chosen mostly to conduct business internationally. The strategies that Wal-Mart has formulated to grab maximum market share and direct the FDI inflows towards its home country has been evaluated in order to understand the reason being the popularity of US in case of FDI inflows. Wal-Mart can be considered as one of best example of MNCs, who have utilized the phenomenon of FDI effectively. 1. References Baker, D., Epstein, G., & Pollin, R. (1998). Globalization and progressive economic policy. Cambridge: Cambridge University Press. Breitfeld, N. (2010). Foreign direct investment (FDI) - Necessary considerations of a transnational company. Berlin: GRIN Verlag. Gilroy, B. M., Gries, T., & Naudé, W. A. (2004). Multinational enterprises, foreign direct investment and growth in Africa: South African perspectives. Berlin: Springer Hoekman, B. M., Mattoo, A., & English, P. (2002). Development, trade, and the WTO: A handbook, part 1. Washington D. C.: World Bank Publications. Jensen, J., Rutherford, T. F., & Tarr, D. G. (2004). The impact of liberalizing barriers to foreign direct investment in services: The case of Russian accession to the World Trade Organization. Washington D. C.: World Bank Publications. Paul, J. (2010). Business environment. (3rd ed.). New Delhi: Tata McGraw-Hill Education. Peng, M. W. (2008). Global business. Connecticut: Cengage Learning. Roberts, B., & Berg, N. (2012). Walmart: Key insights and practical lessons from the worlds largest retailer. London: Kogan Page Publishers. Wal-Mart. (2010). Annual report 2010. Retrieved from: http://cdn.walmartstores.com/sites/AnnualReport/2010/PDF/WMT_2010AR_FINAL.pdf. Wal-Mart. (2012). Annual report 2012. Retrieved from: http://www.walmartstores.com/sites/annual-report/2012/. Yahoo Finance. (2013). Wal-Mart stores inc. (WMT): Profile. Retrieved from: http://finance.yahoo.com/q/pr?s=WMT+Profile. Read More