The Concept of Divestment in Businesses - Literature review Example

Introduction Divestment is a form of retrenchment strategy employed by a business to downsize the scope of their business activities through eliminating a portion of a business that is not very profitable (Langbert, 1990). The expansion of the European Union led to the location of companies and businesses in countries in the East of the Union like Hungary and Poland. This was mainly due to the fact that these countries had lower costs of production. These companies set up factories and other production units in these new EU nations. However, as the European Union institutions grew in these countries, most of these nations have closed down their operations in these countries. This is mainly because the business environments have all changed significantly. It is quite common from businesses to divest in international business. Most businesses fold up one operation and open up another in a different country. This paper examines the concept of divestment in businesses. It examines the core concepts and ideas that influence the decisions of businesses in choosing to divest their operations and how this is carried out. The second part of the paper would include a personal reflection of the writer on the matter and it gives insights into what divestment is about and how it influences businesses. The Preamble of Foreign Direct Investment Divestment McDermott (2010) identifies that foreign direct investment is an important element and aspect of international business. “Foreign direct investment is an attempt to attain lasting investment by an entity resident in one economy in another economy through some capital investment that is meant to establish some aspect of a business in a foreign entity” (Neuhaus, 2010: p42). Foreign direct investment is seen from another angle as investment that adds up to an enterprise operating in another economy arising from another country with the view of attaining and retaining some voice in management by the company in the foreign country (Jones and Wren, 2006). This implies that foreign direct investment is about raising money in one economy and investing it in another economy. This arrangement leads to some kind of control and authority over the investment in the foreign country. Foreign direct investment is often carried out with the view of improving and increasing the profitability position of a firm (Langbert, 1990). In other words, businesses invest on other entities in other countries because they have to gain some cost or profit benefits in their operations and activities. Thus, it is typical for a business to find cheaper areas and cheaper places of siting their production wing if the conditions there are favourable and they are more likely to invest in that area in order to get the strategic and financial benefits of operating in the different nation. Multinational companies are growing in numbers throughout the world (McDermott, 2010). This is because more and more nations are relinquishing their national boundaries and limits. This means that they can do more and begin to reap more benefits through the expansion into these favourable nations and economies. The expansion of the European Union has made it possible for businesses to operate in different nations and economies without limitations. This is because the European Union removes all the barriers and limitations and make it possible for businesses to operate in different nations and communities in the EU. However, the process of divestment comes about because there are some reasons that do not really enhance the operations and activities of a given firm or entity. These issues causes a multinational firm to consider leaving one nation or community in favour of another nation or community in the world. “Corporate divestment can be defined as a firms decision to dispose of a significant portion of its assets” (Langbert, 1990). This is because divestment is some kind of retrenchment strategy that is employed by a business to downsize the scope of its activities. It involves the elimination of a portion of its operation by selling or closing it up to attain other options elsewhere. The genesis of the argument of corporate divestment is that it companies divest when the operations is not bringing enough profits as expected. “The primary assumption is that businesses want improved profitability and this is the primary factor that prompts a firms decision to divest (Langbert, 1990). This means that profitability issues are the primary factors that lead to the divestment of operations and business units. However, when one looks at things critically, it is clear that there are other factors that causes a firm or entity to divest its units in foreign countries. This is because there are some intervening factors in international business that makes it rife and appropriate for a firm to seek to divest its operations and move to another economy or nation. Boddewyn classifies the reasons for divestment into three broad categories. These categories seem to define the reasons and arguments for folding up a foreign operation in order to re-establish it somewhere. They include: 1. Conditions 2. Motivations 3. Precipitating Circumstances (Boddewyn, 1985) This classification provides the broad framework for establishing the need for the expansion of a unit of a multinational entity in a foreign country. The conditions refer to the internal factors and expectations that are pushing a firm to seek to divest. The motivations include the external factors that causes a firm to consider folding up in order to set up an operation in a foreign entity. Whilst the precipitating factors refer to the matters that occur within a nation or region which causes a business to seek to fold up its foreign operations and set up another operation elsewhere. Internal Business Conditions This section examines the variables that are within a firm which influences decisions of firms to divest from one nation and set up an operations in another nation. It would explore the important theories and concepts that defines the main internal factors that might cause a firm to choose to fold up its operations. Normally, divestment is preceded by an increased divergence in profitability between the divestment and the continuing segmentation of the divesting firm (Chen and Sang, 2007). This means that divestment is initiated when a firms unit fails to make money or meet targets This situation often leads to the further segmentation of the firm which ultimately culminates in the operation of other units with no attention given to the divested unit. Benito (1997) identifies that the size and experience of an affiliate plays a significant role in the choice of divestment. This is because a large sized entity is likely to be an entity that had attracted a heavy investment, thus, folding it up would be quite expensive. Thus, a firm would not normally want to sell it easily. However, a smaller entity with staff who have a limited experience in a given field is likely to be closed down easily. Another variable that Benito identified to be a significant element or aspect of the divestment of international business is the kind of arrangement that brought the entity to being (1997). In a case where the entity is a lose one like a joint venture, it is fairly common for the entity to be folded up. However, an entity that was meant to be long-term and entrenched in a society like a greenfield investment is likely to be kept operational over a longer period of time. An inherent factor that affects the decision to divest is the extent and scope of divestment (Li, 1995). If an arrangement is meant to have a far reaching influence on the organization, then divestment could cause a firms operations to another country. In other cases, the post-acquisition integration is a major cause of concern and it defines the effects and extent of divestment. This is because, if a firms unit was not aligned with the operations of the firm after it was opened in a foreign country, there is a natural tendency for that unit to be divested. Li (1995) states that the market orientation of a firm plays a significant role in the decision to divest. This is because when the market is oriented in a certain way or form, then the firm might have to take a decision when conditions change. This might force a firm to close down some units and some elements of its operations in order to ensure survival. Finally, the mistakes of pre-internationalisation of a firm can play a major role in the decision to divest (Elo, 2007). This is because the decisions and activities of the firm that were not in the best interest of the future of the firm would possibly cause the firm to have issues that might induce the firm to divest in order to survive and thrive (Aaker and McLoughlin, 2010). External Motivations These are factors other than the business structure which makes it convenient for a business to either move out of the country or close down the international business unit in a given country. They range from national economic to legal and cultural factors. Benito observes that one of the biggest factors in the divestment decision is the rate of market growth in a given nation (1997). Naturally, the growth of a given market or the market related to a given FDI activity is going to have an effect on whether to fold up or keep operating. This is because a business that is operating in a market with a different set of variables defining and affecting its growth would have to decide on the basis of the influence and effects of these market growth patterns. Hence the decision to continue to operate in one nation rather than another would be influenced by the market growth rate and the market growth direction. Chen (1995) goes further to state that the market focus of an economy is vital. This is because when the market conditions and the market structures of a nation is varied, the country would either become ideal to do business in or an unattractive place. Hence, the management of an international business would be influenced by such activities and patterns in their choice of whether to retain an FDI unit or not. The level of interdependency of the area that a firm operates in the wider macroeconomy counts in a decision relating to divestment (Duhaime and Grant, 2010). This is based on the fact that if an economy or nation maintains convenient factors and elements in a given nation, the country remains a good place to do business. However, if they lose all those elements and factors, the country might not be an ideal destination and hence, the investors might want to consider other options in their operations and growth. Also, the policy stability of the nation is important to the choice of whether to continue or discontinue operations (Berry, 2012). This is because if there are policies that are good and ideal for a business, it would continue operating with the economy. However, when policies destabilize a given economy and a firm notices it, it might have to cancel its FDI arrangements and look elsewhere for alternatives. Other factors like exchange rate volatility and its impact on a firms operations are likely to influence its choice of continuing operations or looking elsewhere for alternatives (Berry, 2012). Culture is an essential elements that hinders or supports divestment decisions (Boddewyn, 2011). It involves issues like cultural differences and changes in other local and cultural norms that might affect the way a business conducts its business. If culture changes significantly, it might have some production implications or some economic implications. This might in turn prompt some kind of divestment decision. An example of this circumstance is the fact that the expansion of the European Union has prompted a high degree of cultural change which is connected to the new rules of the EU. These rules relate to how workers should be treated and other pricing matters. This naturally changes the way business is done and influences the work environment for international businesses. Precipitating Circumstances. The third set of factors that influences the decision to divest in a given nation can be connected to precipitating factors or issues that come up which makes it wise to rather relocate the flow of a firms FDI than to remain in a given nation or economy. The first and most obvious precipitating factor is the industry decline (Li, 1995). This relates to a fall in some important factors which makes an industry succeed. This is because every industry has important element and fundamental features that makes it more successful. Thus, if a country has all these elements and factors, the country remains competitive. However, if another market emerges that has more important and successful competitive factors, it might not be profitable to remain in a given market. Hence, it might be more advisable to divest and consider another market in a different country. Also, the financial position of a nation must be favourable if a nation is to remain operating in it (Duhaime and Grant, 2010). The financial position relates to the cost of doing business and other related financial requirements. If a business is to remain operating a significant asset in another nation, the financial conditions need to be ideal. However, if these conditions change negatively, the firm might be forced to move out. Notable ways that this may occur is when the cost of doing business goes extremely high or some other costs are introduced into the system which makes it very expensive to do business. This induces a divestment decision which causes a business to move out of a given economy. In the case being reviewed, it can be argued that most businesses moved into Hungary and Poland after the European Union admitted them because they had a good financial position. However, after they changed their financial outlooks, it was not profitable to continue to remain in those nations. Thus, others folded up their FDI assets in these two countries and moved further east to get the benefit of a better financial and trading position. Geographical market growth differences are important and vital factors in the decision of whether to remain in a nation or not (Berry, 2012). This is because when an economy remains relatively lower and more attractive to conduct business in them, the nation would be a good place to do business. However, when another economy opens up with a much better prospect, a business might be forced to take a divestment decision which could lead to the collapse of the business activity in one country. Conclusion Divestment decisions are mainly connected to profitability. They are decisions that are taken with the view of helping a business to increase its profitability position and circumstances. The main elements that prompt divestment decisions are size and experience of a firm in a foreign country. Also, the scope of the internationalization of the business and the alignment of the FDI asset with the other operations of the business. Other matters relate to the economy. The market growth and its patterns play a role in deciding whether to continue in one economy or the other. The position of allied industries and the policy of the government are important pointers that influence divestment decisions. Also, culture and changes in culture provide a strong grounds for divestment decisions. Finally, the issues that come up might either make or unmake a given firm in its FDI quest. This is because these activities can either cause a decline or growth in an activity or economy. The collapse of a given industry or a given sector could prompt an FDI divestment decision. Also sharp financial changes in the economy could make a divestment decision necessary in a short period of time. Finally, the relative market growth of a rival economy could cause a firm to divest. References Aaker, D. H. and McLoughlin, D. (2010) Strategic Market Management: Global Perspectives Hoboken, NJ: John Wiley and Sons Publishing. Benito, G. R. G. (1997). Divestment of foreign production operations. Applied Economics, 29(10), 1365-1378. Berry, H. (2012) “When Do Firms Divest Foreign Operations?” Organization Science Journal 2012 15(2) pp481 – 492 Boddewyn, J. J. (1985) “Theories of Foreign Direct Investment and Investment: A Classificatory Note” Management International Review 25 (1) pp51 – 65 Boddewyn, J. (1979). Divestment: Local vs. foreign, and U.S. vs.european approaches. Management International Review, 19(1), Chen, S. J. and Wu. G. C. (1996) “Determinants of Divestment of Foreign Direct Investment in Taiwan” Welwirtschliftlicles Arvhiv 136 pp 172 – 184 Chen, P. F and Zeng, G. (2007) “Segment Profitability, Misvaluation and Divestment” The Accounting Review Vol 82 (1) pp11 – 26 Duhaime, I. M and Grant, J. H. (2010) “Factors Influencing Divestment Decision Making: Evidence from a Field Study” Bureau of Economic and Business Research Working Paper. Elo, K. Z. (2007) The Effects of Capital Controls on Foreign Direct Investment Decisions New York: IMF Publications. Gabriel R. G. Benito. (2005). Divestment and international business strategy. Journal of Economic Geography, 5(2), 235-251. Jones, J. and Wren, C. (2006) Foreign Direct Investment and the Regional Economy London: Ashgate Publishing. Langbert, M. (1990). Multinationals: Foreign divestment and disclosure Palgrave Macmillan Journals. Li, J. T. (1995) “Foreign Entry and Survival: Effects of Strategy Choices on Experience in International Markets” Strategic Management Journal 16 pp348 – 462 McDermott, M. C. (2010). Foreign divestment: The neglected area of international business” International Studies of Management & Organization, 40(4), 37-53. Neuhaus, M. (2010) The Impact of FDI on Economic Growth London: Springer. Singer, A. E. (2010) Integrated Ethics with Strategy New York: World Scientific Part 2: Reflective Essay Personally, this essay has been a very educative essay and has taught me how to view the decisions and opinions about foreign direct investments. One notices that foreign direct investment is not as far-fetched as it appeared to be two or three decades ago. This is because the national boundaries and limitations are fast disappearing. Hence, it is now very easy for a company to open up a major production unit in a foreign country with very little restrictions and limitations. Thus, as an international business student, I realize that it is important for a business to take timely decisions about how to move into a given nation and how to fold up. This paper shows me the factors that must prompt these activities and decisions. In notice that profitability, strategic positioning and competitive advantage are the main elements that prompt the move of FDI into a given nation. However, this also influences the decision to move out of the economy. Thus, a firm would have to examine itself critically along these lines before launching into a different country to begin operations there. Profitability is a major metric and a major standard for the decision to either remain in a given economy or to go into another economy to operate in it. Hence, the firm must ensure that it captures strategic advantages in the quest to expand into another economy. If these factors are not really present, a business must re-examine its position and view of expanding to another country. Once a firm establishes a unit in a foreign country, it would have to ensure that the unit attains the objective for which it was established. This can be done by monitoring important factors continuously to ascertain whether they are relevant and/or vital in helping the firm to meet its objectives and needs. The first thing that a firm needs to examine are the internal factors. A firm would have to examine its internal structures and ensure that they are still in sync with the foreign direct investments they have made. A firm must consistently ask itself whether the FDI is living up to its expectations or not. The level of connection that the FDI makes to the companys vision must be evaluated and examined from time to time for a decision to be made on whether it must continue or not. Where it is not possible that an FDI would continue to add up to the vision of the company, there might be the need to divest and the management would have to do further analysis and take appropriate action. In analysing the internal factors of a foreign direct investment, here is the need to examine the experience and the size of the affiliate and see if the affiliate is really doing what it has to do. In cases where the affiliate is not being very productive and supportive of a firms goals, there might be the need for divestment. If this is established, there is the need to examine the realities of folding up. This is done through the examination of the kind of legal arrangement between the company and the partner in the foreign country and how easy it might be to dispose of the operations amongst other things. It is also prudent for a firm to examine the market conditions and its implication to the need for divestment. This is because the closure of a given unit of a business could have some serious impact on the company. So a firm needs to examine the implication of a given closure of an FDI on its operations. In doing this, the business would have to look at the global markets and how the firms ability to operate on the global market would be modified if it goes ahead with the closure. This would help the business to decide the actual implications of a divestment on the internal structures of the firm and how these structures would be affected if the divestment goes ahead. I also learn that it is important for a business to learn from every business decision that might have resulted in some kind of divestment. This is because most of these divestment decisions are borne out of the fact that a firm makes serious and significant mistakes in its operations and activities. Hence, the firm might have to document its failures and ensure that they integrate it in any future decision they make about the growth and expansion of the business. The research indicated that host country factors are significant in the decision about whether to open up a branch in a foreign country or not. This is because the conditions in a host country play a significant role in defining whether to continue operating an FDI in it or closing it down in order to support a firm to survive in international business. It is evident from the research that the market growth rate provides a strong guideline on how appealing a given international market is. This is because the international markets open up different market avenues. And if a business is to operate and succeed on the international market, it would need to compare growth in a nation it operates in with that of other nations. To this end, a given firm would be able to identify the right markets and the related markets and work hard to operate in a way that would make it appealing and appropriate. Thus, the market needs to be monitored carefully. If there is a significant change in the market focus or the macroeconomic structures, an international business would need to review its FDI in that country and where necessary, make changes in order to cut down on costs in its international operations. Additionally, changes in the pattern of the market and its focus is really important. Where market conditions and government policy is changed in a way and manner that it goes against the competitive and profitability position of an international business, it might have to vary its activities and actions and divest. This divestment might be a way of saving the firm a lot of losses and a lot of financial burdens in the future. Other softer elements of a nations economy might affect the desire and the approach to dealing with divestment decisions. One of these elements is the culture of the nation that the firm operates within. Although this changes gradually, it goes a long way to determine whether a given nation is appropriate for FDI to continue flowing into it or there is the need for the company to vary its tactics. Culture causes a firm to decide whether to continue operating in the same nation or move to another nation. Also, government policy stability is an issue that a firm needs to be sensitive to. The frequency of change and the implication of change goes to define the kind of terrain that exists. This would play a significant role in defining whether a firm would have to fold up or continue operating in a given nation or economy. It is also evident from the research that in reality, a lot of factors that prompt discussions on the need to divest relate to emergent issues, particularly serious issues. This is because emergent issues can come up with in a short time which could make a given nation an undesirable location to conduct business. For instance, if the conditions in a given nation changes significantly over a short period of time, the managers of a company with an FDI in it would have to act and act quickly. Thus for instance, if a nation goes through significant financial activities that shapes its future and features, a nation with an FDI in it would have to make a quick and decisive decision on whether to continue operating in it or not. For example, the financial crisis in Cyprus seem to be so threatening that international businesses with FDI units in Cyprus might gave to take divestment decisions. This is because these firms have been pushed to act significantly to avert the implications of losing more of their resources and investments. Thus, they would have to act and act in a quick and decisive manner to ensure that they do not get engulfed into a situation that might not be desirable. In dealing with a nation going through financial crisis, divestment decisions often involve the identification of a better market to set up operations in order to attain optimum benefits. This is because as one nation gets bad and things get very negative, other nations emerge as alternative investment destinations. Thus, a firm might have a motivation to expand into any of these new nations or economies in order to gain the best results and the best competitive strengths in international businesses and global business. In conclusion, the international business terrain is very competitive. It is moved by profitability and a firm would naturally want to move to another market if profitability is guaranteed. In doing this, most firms would first examine their internal competencies and arrangements and align it to a given nation in order to get FDI to move into it. However, once FDI goes into a given country, conditions like internal alignment issues might force a firm to divest. Also, macroeconomic conditions and other emergent issues might prompt the need for relocation. Read More