Analyzing the Reasons for Investing Abroad - Literature review Example

Analyzing the Reasons for Investing Abroad Introduction Every company that thinks of investing abroad should thoroughly conduct a cost-benefit analysis. There are a number of factors to take into account at first with regard to the reasons companies must invest abroad, and several broad aspects can be associated with the general degree of risk a specific host country has for a multinational company (MNC) planning to or attempting to invest abroad. Such aspects include the country’s recent history, the form of external and internal demands and/or problems confronted by the government, the disintegration or solidarity of the local community on the aspect of religion and culture, the extent of public order or disorder, the existing political structure, and the mindset of the government of the host country (Peng 2010, 181-183). This essay critically analyzes and discusses the reasons why a firm chooses to invest abroad. Investing Abroad Firms decide to invest abroad for various reasons. Even so, companies that choose to invest overseas largely strive to strengthen their global competitiveness. Numerous global companies choose to invest abroad to penetrate bigger overseas markets. In order to sustain growth, a company should boost its sales or profits, which could be unattainable in the local market. In general, according to Cohen (2007), local markets are restricted to a specific growth rate and size and are highly exposed to competition from other local markets with comparable production, marketing, and product capacities. In this setting, investing abroad is a rational decision for a firm planning to penetrate a bigger market. Aside from the profitability of an additional, bigger market, foreign markets usually provide further competitive gains to the company (Ajami & Goddard 2006, 221). Such markets, for instance, may not have organizational capabilities that are comparable with or of similar level as those of a company investing abroad and the level foreign market competition may not be as heavy as competition in local markets (p. 221). At times companies should do business abroad to penetrate global markets because government regulations of host countries mandate that the products of the company be produced locally. These regulations are commonly enforced to heighten the growth of the national economy, employment, and overall domestic production (Carbaugh 2010, 12). Hence, the firm that plans to penetrate a foreign market has to spend for foreign facilities that are supervised by local managers, in domestic subsidiaries, or by means of several other mechanisms. A company penetrating a foreign market may prefer to do business there if it realizes that it is more cost-effective to produce products locally, instead of producing them at home and selling them abroad. Production economies may take place via other dynamics if the local market is huge and the demand is sustainable to give good reason for investment in the facility and tools required to establish a production system. For instance, the marketing and delivery costs could be cheaper than those of processes at home, the sources of needed raw materials could be nearer to the facility abroad, and the labor costs could be cheaper abroad (Frishberg 2010, 139). Another major aspect is the company’s location. A facility located overseas could also be a lot more productive for a developing market. Generally, companies do business in direct competition with other global and local companies. This form of competition is especially strong in markets where only a small number of major companies dominate. In this setting, the strategies of a particular company are swiftly imitated and rivaled by the others. As a result, if a company invests overseas, its rivals carry out the same tactic (Ajami & Goddard 2006, 222). One apparent reason for investing overseas is to be on a par with the established company in new markets and total sales/profit. Another reason is the necessity of rivaling competitors’ overseas tactic; otherwise, the competition may gain further competitive advantages from its business overseas, which may be transferred to the local market, as well. Competition usually takes place between companies of various countries who lead portions of the same market. If a firm penetrates the local industry of another country, it is highly possible that the competitor will be pushed to even the score by penetrating the local market of its competitor (Ajami & Goddard 2006, 222). A case in point is the one that took place more than two decades ago, when Kodak made a decision to penetrate the market of Japan to counteract the market share leverage of Fuji in the United States (p. 223). On the other hand, numerous companies believe that if they authorize the use of their technology to a firm abroad, their technology could be disclosed to competitors. In reality, numerous firms, particularly in highly specialized or technological industries, rigidly protect their technology and knowledge that they refuse to franchise them. The tradition of keeping hold of know-how within the firm is commonly called ‘internalization’ (Froot 1993, 40). A number of firms believe that franchising their technology could lead to the franchisee delivering a substandard product, which could harm the brand or image of the product. In order to prevent these risks, firms choose to establish their own foreign production facilities. Setting up their own production facilities also grants several firms better guarantee of prompt after-sales services for their goods and/or services, quality maintenance, sustainable survival, and stable supply (Froot 1993, 40-41), which are fundamental to sustaining customer loyalty in a very competitive global market. In addition, numerous companies depend on raw materials brought in from other countries, a dependence that can develop from cost, availability, and supply concerns. The raw materials might be lacking at home, or, instead, it could be more cost-effective to get raw materials from other countries than locally if the differences in prices go above the extra costs of transportation (Brigham & Houston 2011, 500). If a company chooses to depend on raw materials abroad, it usually becomes reliant on a stable supply at expected and constant prices. Nevertheless, in certain instances firms are hesitant to accept the risk of the inconsistencies of the supplier and choose to invest in resource extraction operations abroad. At times these investments are encouraged by the belief that the needed technology or expertise is lacking in the source country and hence should be supplied by the company planning to dig up the resources (Ajami & Goddard 2006, 223). Generally, consent from the governments of resource-rich countries is focused on the form of technology the foreign company is capable of providing for the resource extraction operations. Additionally, numerous firms want to get rid of middlemen from their transactions and forward integrate the various phases followed in their production and delivery processes (Ajami & Goddard 2006, 223-224). For instance, a company may be manufacturing plastics and selling it to a domestic merchant abroad that turns it into plastic wares and afterward sells it overseas. The earnings from the returns produced from the sales of the plastic wares would be distributed by the firm manufacturing the plastic and the domestic merchant. If the firm selling the plastic had its own manufacturing facility for plastic wares abroad, it would be capable of regulating and managing the whole operation and do away with sharing its earnings with the mediating entity. This incentive could encourage the firm producing the plastic to establish its own plastic ware production abroad. MNCs usually invest abroad to acquire new technologies and knowledge that are lacking in the home country. New technologies are widely desired by the total acquisition of new companies having such know-how. New technologies and knowledge are often aimed at global integration (Peng 2010, 196). Generally, the firm that gains access to a new technology by means of a foreign acquisition establishes overseas plant, which improves the current operations by integrating the technological, financial, and management capabilities of the main firm. It is quite expected of a highly profitable or thriving company to invest abroad. In fact, alongside productivity or efficiency, growth is commonly a benchmark for determining success among companies in a market. Major growths in local market share seldom emerge without a certain extent of geographic growth, initially of service and sales activities, eventually of manufacturing plants (Peng 2010, 196-198). Nevertheless, it is the early success that motivates investment abroad, namely, “both through lower costs associated with the learning curve and through increased access to and thus lower cost of financial capital” (Froot 1993, 38). Eventually, the process of expansion leaks out into overseas markets. Basically, both foreign direct investment (FDI) and trade are merely features of competition among major companies. Trade theory presents a rationally consistent justification for postwar transformations in the production pattern across the globe and, hence, for the related developments in trade patterns (Cohen 2007, 222). Wide-ranging patterns in the global production system can be associated with the identified ‘changes in relative factor abundance worldwide’ (Froot 1993, 39). However, the traditional neoclassical model does not have much to argue about the major companies that perform a great deal of global production and trade, nor about the continuous market penetration and exit processes that typifies almost all global markets (p. 39-40). Foreign direct investment does not belong in a rigidly neoclassical perspective. Within ‘perfect’ competition, small companies gain uniform access to markets and technology, without any factors powerful enough to affect output or input prices (Froot 1993, 40). The expansion of a company’s production outside a single facility’s minimum productive size needs a justification, for coordination of operations in various sites entails added costs (Froot 1993, 40). The related gains should be bigger if the various locations cover a number of countries, as this requires greater coordination expenditures. Recommendations and Conclusions Companies having a competitive advantage like well-organized product distribution channels, recognized product quality, managerial knowledge, advanced technology can take advantage of that leverage in various ways, as well as but not restricted to formation of overseas subordinates. According to Cohen (2007), the most observable preference is by means of trade, with every market sourced from local production. Almost all production-based companies at least start with this model (p. 222-224). Direct investment will be preferred rather than, or as an add-on to, trade alone to the degree that the site itself provides significant gains to the firm. Such advantages could emanate from the common components of comparative leverage as manifested in lesser production expenditure (Carbaugh 2010, 316). Import barriers or other policy incentives in the host country also contribute to the identification of the most beneficial or profitable site for manufacturing (p. 263). Because investing abroad implies greater management costs, profitable location is not sufficient to justify the formation of foreign subordinates. Except if MNCs have leverage over domestic companies enough to counterbalance the global coordination costs, the advantages of location will be seized instead by local companies. In the latter situation, the leverage of the overseas firm could be allocated to local companies in the favored location via franchising/licensing or other forms of continuous agreements (Cohen 2007, 224). How a particular corporate leverage is taken advantage of hence relies on the balance, for all possible approaches, between the advantages to be obtained and the costs to be sustained. In comparison to direct investment, franchising or exports will normally produce a smaller number of gains but require lesser costs. Nevertheless, costs of coordination differ across companies; firms already leading in the home country manifest a company-specific leverage of intra-company organization (Bora 2002, 110). Bigger firms discover internalization, such as formation of manufacturing subsidiaries, cost-effective whereas small technological companies prefer licensing or trade contracts to take advantage of innovations. Therefore, theory indicates that in order to successfully invest abroad, a company should have a certain extent of firm-specific resources in marketing, management, technological, and professional capacities. A company possessing such resources benefits from numerous potential ways to acquire the fees or charges that they will generate in overseas markets, such as marketing agreements, management agreements, licensing, merging, and subsidiary manufacturing. In summary, firms decide to invest abroad for several reasons, such as productivity goals, strategic resource objectives, access to needed raw materials and new markets. References Ajami, R. & Goddard, J. (2006). International Business: Theory and Practice. New York: M.E. Sharpe. Bora, B. (2002). Foreign Direct Investment: Research Issues. London: Routledge. Brigham, E. & Houston, J. (2011). Fundamentals of Financial Management. Mason, OH: Cengage Learning. Carbaugh, R. (2010). International Economics. Mason, OH: Cengage Learning. Cohen, S. (2007). Multinational Corporations and Foreign Direct Investment: Avoiding Simplicity, Embracing Complexity. Oxford, England: Oxford University Press. Frishberg, D. (2010). Investing Without Borders: How Six Billion Investors Can Find Profits in the Global Economy. Hoboken, NJ: John Wiley & Sons. Froot, K. (1993). Foreign Direct Investment. Chicago: University of Chicago Press. Peng, M. (2010). Global Business. Mason, OH: Cengage Learning. Read More