Business Environment Analysis of Manufacturing FDI - Coursework Example

The study presents an attempt to explain the Foreign Direct Investment (FDI) which is a key factor of economic development and basic resource of capital cash flows. FDI is more significant than debt or equity investments for a country. The study paper examines Foreign Investment in the light of two theories, Dunnings Eclectic Paradigm and Vernons Product Life Cycle Theory. The study shows relevant and useful aspects differentiating both the theories and presents a conclusion in terms of defining the Foreign Direct Investments. These theories predict the scale and scope of multinational enterprises by looking to differences in competitive advantage, across firms or countries that might lead to the extension of corporate control across borders. INTRODUCTION Foreign Direct Investment (FDI) is defined as expenditures or investments made across border to acquire controlling of corporation and productivity. It occurs when a company directly invests in facilities and productions in a foreign country where the host country could have effective ownership and control. The productivity through FDI becomes almost triple due to which it has become a major factor of international borrowing (Alfaro, L., Chanda, Kalemli-Ozcan, & Sayek, 2004). FDI is the mechanism of countrys capital flows in economy. FDI is the key factor of economic development in many developed countries. It has significant importance for both the host country and the foreign country. For the host country, it is the attribute of growing business, exports, employment, and development of the country. It is a countrys source of capital. Both of the theories i.e. the Dunnings OLI paradigm and Vernons Product Life Cycle Theory play discusses FDI as an important factor. The question which better explains the FDI is answered in the report. Dunning theory is given for developing countries while on the other hand Vernons theory has discussed the FDI within developed countries. DUNNINGs OLI PARADIGM Dunnings OLI theory is termed as the framework used for the investigation of factors determining FDI. It is a holistic theory taking all the considered factors of international investment involving production, operation, and the growth of the business. Based on Dunnings theory FDI can be explained by three groups: 1. (O) The ownership of the firm which shows core competencies and competitive advantage of the company that will work internationally 2. (L) The location, which incorporates the decision of where a multinational will be located and perform its business activities. 3. (I) It is denoted as internalization, and explains the reason of multinational engaging with FDI (Dunning, 2001). OLI model is an attempt to develop conceptual framework for explaining the considerations of Foreign Direct Investments and Multinational Enterprises. Changes in corporate borrowing capacity and availability of internal funds may also help in explaining some firms can invest or purchase assets more cheaply than others can, even without a perceptible change in competitive advantage. Further, the Dunnings theory only studies the trade in terms of macroeconomics and the behavior of the firm in terms of microeconomics (Dunning, 2000). It is derived four types of FDI: 1. Resourcing 2. Marketing 3. Efficiency 4. Strategic asset Dunnings theory quotes its advantages including locational advantages, and the factor of internalization. The theory refers to examination of intangible assets which a firm possesses and transfers the multinational corporation on a very low cost which gives high incomes and returns. But it limits the resources, trademarks etc., which is mostly taken as an advantage. When this factor of ownership gets completed, the process of country selection should start for multinational corporations and the production. The factor of finding a location includes; quantitative and qualitative factors of production, availability of resources, the cost of transportation should be lower, also telecommunication networks, government policies, and most importantly the market size. Other factors include the distance and the travelling route of the country. Moving on the third term of Internalization, OLI defines that all the resources and advantages till the second stage should be used to generate profit by adopting some important parameters of the origin country and they should be in linked with the host country. Although the resources vary from one country to another but MNC should be formed by a win-win solution. This theory explains the distinguishing characteristics of structural and transactional failure. The failure of the structural market is termed as external which gives rise to monopolistic advantages in form of entry barriers increased by government policies. This creates discrimination between the ability of firms to gain and sustain controlling the geographic dispersed value. Transactional failure is the failure of the intermediate product market to transact goods and services at lower cost. Example of Dunnings OLI Paradigm: Chinas state owned enterprises are investing abroad. VERNONs PRODUCT LIFE CYCLE THEORY This theory was presented by Raymond Vernon in 1966. This theory is used for the analysis of the relationship between the life cycle of the product and FDI. This theory suggests and underlines that Multinational enterprises have some products and processes, skills and capabilities like marketing, managing, researching, which cannot be initially copied within the host country. In this approach, the FDI is studied in two phases i.e. the maturity phase and the diminishing or declining phase. This theory suggests that the firm should set up its production in the foreign country only for already existing products. It says that the firm should produce the product in the home country and then should move out to the whole world. The process of the production will start in the home country and the product in parts will be delivered to different countries where they will get assembled in the subsidiaries of the host country. Thus this strategy will be helpful in maintaining the low cost of production. This theory also supports the innovation of the product, products produced as an export delivered as well as an import and becomes exported product. The key factors involved in this theory are innovation, advancement in technology and the market expansion. The theory suggests that the production of already existing products in the new markets. The theory presents four types of production cycles: 1. Innovation 2. Growth 3. Maturity 4. Decline Discussing briefly, the first cycle involves production of new and innovative products which will be used locally. The surplus gained should be exported to serve the foreign markets. It involves the advantage of technology against the competitors. However, the products will gain popularity and it will encourage the competitors in the market leading to come up with new product or imitate the products. The best strategy should be to follow the production and selling of a product which is exported from another country to maintain the market share position (Glass, & Saggi, 2002). This theory is more relevant for the manufacturing industries, performing initial entries in the foreign markets and in future moving for multinational corporations and Foreign Direct Investment firms. It has been identified that many MNCs are now able to develop new products and achieving the product life cycle approach. In the new production phase, the product is concentrated in the market keeping the cost of production low. When the product reaches to its growth level, at this stage the producer has the advantage of investments to be placed abroad. Theory suggests that the manufacturer should first invest in the country where the export sales are high in the industry supporting economies of scale in the local productions. When the product growth reaches to maturity, manufacturer should shift the productivity from initial FDI country towards the lower cost countries. This strategy will sustain the production of old product and also new production can take place and the overall production can increase. Further the location advantages of a host country are its comparative advantages for Foreign Direct Investments in relation to other countries (Morgan, & Katsikeas, 1997). Example of Vernons Theory: Proctor and Gamble employed more than 8,000 scientists and researchers in 2000 in 18 technical centers in nine countries. Many products were developed in health and beauty care segments, in these offshore research centers and were market in US and other foreign countries. Another example is of Otis Elevator. Otis Elevator is a wholly owned subsidiary of United Technologies Corp., and the company offers its products in more than 200 countries and maintains major manufacturing facilities in Europe, Asia, and the Americas. Despite being headquartered in the United States, 80% of Otis’s 2005 revenues of $9.6 billion were generated from other countries. Most of Otis’s new elevators, escalators, moving walkways, and shuttle systems were first developed in the United States and then transferred to and manufactured by its foreign subsidiaries in the target overseas markets, although the company increasingly engages in development work abroad. CONCLUSION It is concluded that overall, Eclectic OLI Paradigm is a more comprehensive view for explaining the FDI than the Product Life Cycle Theory. This theory combines the specifications of the country, ownership, and internalization factors in explaining the logic and benefits of foreign productions. Although the theory emerged two decades ago which is totally different from present market aspects and behavior, but still the ability and skills of the OLI Paradigm theory are significant enough to explain Foreign Direct Investment and formation of Multinational Enterprises. This theory does not directly explain the behavior of multinationals ownerships, it first clarify the advantages. This kind of distinctive theory possesses resourceful information for the present industries. Industries understanding and adopting these resources are working efficiently. The only drawback of this theory is that it does not involve yield high returns for multinational enterprises. Also, it does not involve the process of international production. Foreign investments are a dynamic platform which incorporates resource commitment, production, investment approaches over time. Coming towards the Product Life Cycle Theory, falls near, explaining the dynamic process of FDI. The product life-cycle theory adequately describes how a new MNE develops a new product and then engages in FDI. However, it fails to describe the actions of existing multinational corporations with substantial FDI that may skip steps in the model or even reverse the process. References Alfaro, L., Chanda, A., Kalemli-Ozcan, S., & Sayek, S. (2004). FDI and economic growth: the role of local financial markets. Journal of international economics, 64(1), 89-112. Dunning, J. H. (2000). The eclectic paradigm as an envelope for economic and business theories of MNE activity. International business review, 9(2), 163-190. Dunning, J. H. (2001). The eclectic (OLI) paradigm of international production: past, present and future. International journal of the economics of business,8(2), 173-190. Glass, A. J., & Saggi, K. (2002). Intellectual property rights and foreign direct investment. Journal of International economics, 56(2), 387-410. Morgan, R. E., & Katsikeas, C. S. (1997). Theories of international trade, foreign direct investment and firm internationalization: a critique. Management decision, 35(1), 68-78. Read More