Market Entry, Entry Barriers, and Location in the Context of German Foreign Investments in China - Research Paper Example

TRADE AND THE MULTINATIONAL ENTERPRISE of Over the previous two decades, China has developed to be one of the potential countries for foreign direct investment (FDI), with countries like Germany emerging to be one of the key investors. The potential for achieving the entrepreneur’s objective renders great interest to potential investors and policy-makers. In the view of this, there are different scholarly studies that have been adopted. The research in this paper focuses on the analysis of motives and prospects within the OLI framework. The case study approach explores theoretical aspects of FDI including motives for market entry, entry barriers, ownership, and location with the context of German FDI in China. Market size and economic stability are found to be main motivations for investment. The findings provide an opportunity for justification of the study hypotheses as well as future recommendations. Introduction The case study given is the German FDI in China. China is the third leading country beneficiary of the Foreign Direct Investment. In 2003-2004, the country realized the highest investment with Germany been one the countries that invested greatly in China. Since then, the trade ties between the two countries have steadily been increasing. Currently, there are more than 1500 Germany firms that have invested in China. In point of fact, Germany is the leading European country trading partner with China. Research conducted by scholars Bernard and Jensen in 2002 showed that there were approximately $ 51.7 billion of FDI in China. In 2003, foreign investment increased up to $ 53 billion (China Statistics, 2007). The country attracted $ 61 billion in 2004. From the statistics, it can be seen that the FDI index has been increasingly drastically. Furthermore, the FDI index was ranked the top position. A study conducted by the Financial Times noted that in developing states, the Republic of China is the largest foreign direct investment beneficiary country. The research explores the OLI paradigm in the context of German FDI in China. OLI is an abbreviation for Ownership, Location, and Internalization (Agarwal, Gubitz & Nunnenkamp, 2006). The three are prime bases that underlie an enterprise’s decision to grow in a multinational company. In the context of this paper, ownership advantages help addresses the subject of why some companies go abroad and not others. Location advantages answers the question of which is the most appropriate location to establish a firm in a foreign country. Lastly, internalization focuses on the influences of a firm’s operation in an overseas country (Agarwal, Gubitz & Nunnenkamp, 2006). Notably, the research approach focuses on benefits that are realized by individual firms. In overall, the main aim of the research is to explore the main reasons for German Foreign Direct Investments in the republic of China and the prospect stance for its operations. Background study Germany Statistics shows that Germany is not only the largest economy in Europe, but also one of the leading investor countries in the world (Chung, 2001). By and large, the information technology services, the mechanical and automotive products are the main country’s export specialization. Fortuitously, these are the most sought after products in China. China For the purpose of better technologies, innovation, industrial development and overall growth in economic development, China adopted Foreign Direct Investments. Nowadays, China is a key FDI recipient country in the world (Chung, 2001). German Foreign Direct Investments in China It has scientifically been established that FDI is a better strategy in contributing to economic growth to a country than the local investment. Moreover, FDI is an excellent vehicle for improved technologies consequently contributing to the growth of an economy in large measures than local investment. China records an increased direct investment from Germany since the latter signed a memorandum of understanding (M.O.U) policy to investors. Zhang and Felmingham note that the OLI advantages of an enterprise determine its entry mode in the marketplace. Firms differ a lot in terms of their sizes and industry (Zhang & Felmingham, 2001). They also have different development stages. The table below represents the German enterprises operating in China. It also describes the entry mode of the firms and the three dimensions that steer entry decisions; resource commitment, time consumption, and risk. Nowadays, China is the leading Germany’s export and supplier market, particularly in engineering and Information Technology (IT) industry. Germany, an international direct investment, has taken the advantage of the rapidly growing rate of the local market in China. For this reason, there has been a sturdy economic bondage between the two countries. Germany has contributed immensely towards the economic growth of China, actually more than other European nations. Findings from the research conducted by the German chamber of commerce reveals a number of reasons for Germany’s production move to other nations, specifically in China. The reasons include; low labor costs, low exchange rate risks, low taxes and levies, and bureaucracy. In light of this, cost savings is critical for German FDI in the Republic of China. Voluminous FDI researches are guided by the OLI framework as outlined by scholar John Dunning (Brouthers & Werner, 2008).The scholar obverses that enterprise international operations are guided by a blend of theories. Basically, it can be summed up in the theory of Ownership, Location and Internalization. Ownership Advantage Obviously, there are extra costs incurred by foreign investors due to the local competitors in the home country. However, adoption of ownership advantages front a low operating cost on the FDI in the recipient (host) country. Notably, the ownership advantages can be likened to intangible resources that readily move between the host country and the investor States. Notably, German FDI in China has been successful over the years. This is particularly due to the reduced cost of operation in China (Brouthers & Werner, 2008). Moreover, there is the availability of cheap labor and low cost of manufacturing assets. In comparison to the host nation (China), Germany’s workforces are more competent. This advantage gives Germany a large share of the market domination. Location Advantages Notably, Germany takes the advantage of some factors that are readily available in China. Coincidently, these factors are in line with the core Germany’s competencies, an aspect that allows Germany gain profitable grounds in China. This is the reason that can explain why most of the regions in China accommodate about70-80% German investments (Brouthers & Werner, 2008). For example, the attractiveness of the Shanghai metropolitan region to German firms is due to the proximity of clients and great infrastructure. Secondly, the North-Eastern part of the country has abundant natural resources including ore, coal, and oil (Brouthers & Werner, 2008). These resources are a great source of attraction to foreign investors, thus expanding German FDI in China.  Internalization Advantages Germany has variant entry modes in the Republic of China. According to a research done by Cheng and Kwan, it was found that 15 % of Germany’s operation is achieved through exporting, 25 % is achieved through representative or subsidiaries offices in China (Cheng & Kwan, 2000). The rest, which is 60 %, is achieved through enterprise invest in China as a WFOV or JV (Cheng & Kwan, 2000). Professionalism and technological known how exists as the core factors that have influenced Germany’s success in investing in China. Problem Statement Objectives The main objectives of the research are; I. To establish the factors, that attracts German firms to invest in China. II. To study the future outlook and conditions needed for the expansion of German FDI in China. III. To examine obstacles to German FDI in China. Literature Review A wide range of theoretical approaches has been adopted to explain the pattern and levels of FDI enterprise activities. These theoretical approaches range from internalization models theories, eclectic models, to the mainstream paradigm.Hale and Long observed that the general motives for foreign direct investment can be summed up in taxonomy (Hale & Long, 2012). The taxonomy structure classifies multinational enterprise into four types; the marketplace seekers, resource seekers, efficiency and competence seekers, and the capability or strategic seekers. Notably, the marketplace seekers comprise of firms that seek to exploit the new market. Generally, they are motivated by the prospect of growth and development in new markets. Also, they seek to counteract actions by competitors (Schüler-Zhou, 2013). The resource seekers tend to be motivated by their aspirations for cheap resources which include technological, human, physical, and organizational. On the other hand, the main intent of efficiency and competence seekers is to take the advantage of the different economic systems, policies, and market structures (Schüler-Zhou, 2013). One distinguishing feature of efficiency and competence seekers is to concentrate on maximum productivity in a limited geographical location. Finally, the strategic seekers intention is to engage in FDI as the key means for enhancing international competitiveness. Sanyal and Guvenli observe that OLI framework structure is the best model to analyze the activities of international firms and the economic rationale behind the firm’s operations (Sanyal, R. N., & Guvenli). The OLI model was postulated in year 1976 and was first proposed by J.Dunning (Schüler-Zhou, 2013). The OLI model elaborates on the factors that enable a firm to thrive in foreign countries. The paradigm is used to explain the entry mode decisions of firms in foreign countries. Furthermore, it is widely accepted in extrapolating the variants definite methods of multinational firm operations. There is a heightened believe that FDI activities are also influenced by other factors other than those in within the OLI framework (Fu, 2000). Scholars have come up with models that criticize the OLI models. For instance, the gravity model is used to disparage the limitations of the OLI models. It exhaustively explores the process of international trades and production. Another concern of the OLI model that is criticized by economists is the lack of clear distinction between the vertical and horizontal motives when locating production facilities in foreign countries. Moreover, the model does not explain the distinction between the Merger firms, Greenfields, and Acquisitions modes in FDI (Fu, 2000). Also, Dunning theory on OLI model failed to consider the underlying motives for the variation in production between different regions (Brouthers & Werner, 2008). A typical example to exemplify this is the reality that factors that influence investment in Iron or Coal ore abundant in Africa is different from those influencing the foreign investment of car manufacturing in United States. However, the OLI model is critical in determining the factors that influence international operations. Consequently, this has set basis for studies in international business, economics, and management. Moreover, the OLI framework is important especially when recent studies in FDI. Economists have made improvements on the OLI model. In particular, Dunning observes that market failure, competitive advantages, environment variables, and association should be incorporated in the OLI model to guide firm production decisions (Brouthers & Werner, 2008). Chung supported this model to explain foreign firm’s entry decisions in translation economy like in Eastern and Central Europe (Chung, 2001). However, despite the improved measures, Wei and Liuargues that the OLI framework is an inert one (Wei & Liu, 2001). This is because the model fails to do due to the negligence of strategic factors, competition and the situational contingency involved in decision-making. Wei and Liu obverses that the model fails to cover all factors that influence entry mode decisions by firms (Wei & Liu, 2001). METHODOLOGY Approaches to the study of FDI There are three approaches used in the study of FDI; case study approach, summative econometric analyzes, and micro-oriented studies approach. However, the research objectives are the determinant factors that influence upon the best approach for the study. In the context of this study, the summative econometric analysis is not applicable since the main aim is to study the market sector and not one specific aggregate objective (Voss, Tsikriktsis, & Frohlich, 2001). In the view of this, the most suitable approach to the study seems to be case study approach since it offers the most advantage with respect to achieving the study objectives. Furthermore, the approach is the most applicable since it is easy to gather in-depth data from foreign firms from Germany that have invested in China. Also, there is in-depth understanding of FDI in China. As noted earlier, the aim of the research is to examine issues of OLI models through investigations of Germany FDI in China. Primary data was collected through personal interviews and questionnaires. Eight German firms investing in China were considered. The ideal number firms to be considered in the research depend on the study objectives and often vary from one research case to another (Voss, Tsikriktsis, & Frohlich, 2001). Voss et al recommends a sample of five to ten cases. Critical in the study was the improvement of data validity, quality, and reliability. The propositions taken included observing whether the findings concurred with the results of other studies. The questionnaire and interview questions related to the OLI model were open- ended in nature. This was imperative as it encouraged interactive discussion. The two methods of data collection ensure that ten data gathered is reliable. Besides, the interviewees were encouraged to discuss about their firm’s experience. In analyzing the gathered data, the initial step was, to summarize, the statements from the respondents on the issues under study. Following, the different cases were compared to reveal patterns, similarities, and variations. The cross-case analyzes are imperative since it increases the validity and reliability of the research findings. For further refinement of the findings, provisional study findings were sent to the respondents who made additional comments. This is critical as it helps guard against research predisposition and biasness. Data findings and analysis of the case studies All the firms selected for the contribution of the research have an established presence in the Republic of China. The data collected represented the main characteristics of firms that participated in the research. Besides the use of interviews and questionnaires, secondary sources of data collection such as business press, and annual reports were used. Factors that attracts German firms to invest in China There are myriads factors that make China a perfect location for German FDI. First, China has a large market size that makes it an apt location for foreign investment. For instance, the total population in 2001 was 76 million. The total population is by far more than that of Germany. The population has increased steadily over the recent years. Secondly, China is a member of the World Trade Organization hence opening business opportunities to potential investors. In fact, its membership is a key motivation factor for German FDI. The organization is critical to the success of global trade especially due to the expedited tax rate and cheap labor. There was a universal consensus among the respondents that the geographical distance between urban centers is a major key motivation factor for German FDI in China. China exports and imports goods in volumes and the trend is continuous. Due to the large population, there is a need for quick transport for consumable goods to the different centers. This assertion is also provided by studies done by (Voss, Tsikriktsis, & Frohlich, 2001). It is also evident that manufacturing and ICT sectors induce high demand for foreign investment. Future outlook for German FDI in China Despite the prevailing problems facing Germany firms operating in China, enterprises are more hopeful than ever. In future, the majority of the German enterprises project an increasing growth in the market size. Moreover, China will be central in serving as an export hub to other neighboring markets based on the evaluation of current resources. The Chinese market will remain to be the chief attraction for most of the German foreign enterprises. However, the firms face the challenge of increased competition. For this reason, Germany firms operating in the Chinese market need to hone their competitive edge so as to lengthen their investment. However, the cost for professionals is expected to rise. As a result, there will be an increase in operational and production costs in China including transport costs, energy costs, and local resources. Nevertheless, this may be averted if the Industries shortage of skilled labor, particularly ICT, manufacturing, and engineering industries can train local people. Currently, on average, it is estimated that one license is issued on a daily basis for a new German enterprise. If the trend continues, it is projected that there will be the establishment of more German business whilst the existing ones continues to expand. Obstacles to German FDI in China Undoubtedly, the Chinese market has offered a vast number of German firms within a short time. However, these firms are faced with numerous challenges in the market environment. The German Chamber of Commerce (GIC) describes the Chinese market as a double sword with numerous opportunities and myriad obstacles. Some of these challenges are dynamic whereas others are fixed. There are poor trade policies and regulations. Foreign investors encounter difficulties when gathering useful information about suppliers and customers. In general, there is porosity in legal laws governing trade activities in China. Secondly, there is breach of contract terms and is mostly influenced by the government. This is unfair, and it discourages entrepreneurs from investing. Also, there is differentiation in the market size; this makes it difficult to provide services to the customers. Finally, the WTO been implemented slowly, this leaves most of the German investors unhappy and dissatisfied. Recommendations There are number of suggestions in relation to China attracting foreign firms in its market niche. A general recommendation is to encourage the China to put a concerted effort towards abolishing of margins that may be in the path of foreign firms. Investment in ICT and manufacturing industry will improve the production and processing thus significantly attracting other potential investors in transport and logistics sectors. The government needs to encourage FDI through the open door policies and regulations. Also, there is a need for reduced tax rate and provision of trade incentives. In addition, the ICT and manufacturing industry would welcome a more transparent legal system. The government should do away with retrospective and hasty legislation. Conclusion The study has sought to demonstrate the factors that have influenced German FDI in China using the OLI model. The model was proposed by Dunning, and it is very helpful in assessing economic rationale of foreign investments. It seems from the research that the attractiveness and market potential in China prevail over the challenges facing German investors. Nonetheless, attention should be given so as to solve these problems currently facing foreign investments in the Republic of China. One prospect for Germany FDI in China that the cost for professionals is expected to rise, and this will lead to a rise in operational and production costs. A general recommendation is to encourage the China to put a concerted effort towards abolishing of restrictions that may be in the path of foreign firms. References Agarwal, J. P., Gubitz, A., & Nunnenkamp, P. (2006). Foreign direct investment in developing countries: The case of Germany. Tübingen: Mohr. Brouthers, K.D & Werner, S (2008). Is Dunnings Eclectic Framework Descriptive or Normative?  Journal of International Business Studies Vol. 30, No. 4, pp. 831-844 Cheng, L. K., & Kwan, Y. K. (2000). What are the determinants of the location of foreign direct investment? The Chinese experience. Journal of International Economics, 51, 379-400. China Statistics (2000) A Statistical Survey of China. 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