Direct investments in foreign countries

Table of content

1 Introduction
1.1 The topic
1.2 Procedure

2 The reasons of companies to invest abroad
2.1 New customers
2.2 Cost reductions

3 Difficulties in foreign countries
3.1 Economic sector
3.2 Legal-political sector
3.3 Sociocultural sector

4 Development programmes
4.1 Investment insurance through the companies of the Berne Union
4.2 Investment support offered by countries to encourage overseas investors

5 Summary

References

1 Introduction

1.1 The topic

In the 20th century, global competition and entering in foreign markets are not only opportunities for companies which want to improve their business position. As an example one study indentified 136 U.S. Industries – including automobiles, accounting services, entertainment, consumer electronics, and publishing – that will have to compete on a global basis or disappear.^[1] There are different ways in which to enter in a foreign market: Exporting, licensing, franchising, entering into a joint venture with a host country company, and setting up a wholly owned subsidary in the host country.^[2] This term paper will concentrate on the last two ways, which are called direct investments, which means that the company is involved in managing the productive assets, which distinguishes it from other entry strategies that permit less managerial control^[3].

It seems to be clear that, in general, competing in foreign markets where there are significiant cross-country variations in cultural, demographic, and market conditions, poses a much bigger strategy-making challenge than just competing at home.^[4] But where exactly are the main difficulties and how to solve at least the biggest problems?

It sounds funny when we hear some mistakes of big companies like Wal-Mart, which has encountered difficulties in translating the warehouse club concept to Hong Kong. As a young accountant eyed a 4-pound jar of peanut butter, he said. “The price is right, but where should I put it?”. Or when Coors Beer tried to translate a slogan with the phrase “Turn It Loose” into Spanish and it came out as “Drink Coors and Get Diarrhea”. Although these examples may seem humorous, these kind of problems are serious for managers trying to operate in a competitive global environment. The different problems companies have when they make direct investments abroad and how to solve them will be theme of this term paper.

1.2 Procedure

After the introduction the main reasons why companies expand into foreign markets (which can be seen in new (potential) customers like for example China´s increasing demand for cars and in cost reductions like using low-priced labor in Asia) will be shown.

The theme of the third chapter and the main point of this term paper will be the different difficulties for companies which want to direct invest abroad. When they are comparing one country with another, the economic, legal-political and sociocultural sectors presents the greatest difficulties.^[5]

Afterwards some possibilities will be shown for first how to solve at least some problems through investment guaranties and second which different kinds of development programmes are offered by countries to attract foreign direct-investors.

In the last part of this term paper the gained results will be summarized.

2 The reasons of companies to invest abroad

Location economies are those that arise from performing a value creation activity in the optimal location for that activity, wherever in the world that might be (transportation costs and trade barriers permitting). Location as a value creation activity in the optimal location for that activity can have one of two effects. It can (1) enable a company to differentitate its product offering and charge a premium price or (2) lower the costs of value creation, helping the company achieve a low-cost position.^[6] In this chapter, these two kinds of reasons to (direct) invest abroad will be shown.

2.1 New customers

Global companies like Wal-Mart, Federal Express or Nike recognized that business is becoming a unifield global field as trade barriers fall, communication becomes faster and cheaper, and consumer tastes in everything from clothing to cellular phones converge^[7], so to gain access to new customers is one of the main reasons of (direct) investing abroad. Expanding into the markets of foreign countries offers potential for increased revenues, profits, and long-term growth and becomes an especially attractive option when a company´s home markets are mature. Especially the companies, which are racing for global leadership in their respective industries, like the above mentioned and for example Cisco Systems, Intel, Sony, Nokia, and Toyota, must move rapidly and aggressively to extend their market reach into all corners of the world.^[8]

In emerging markets like India, China, Brazil, and Malaysia, market growth potential is far higher than in the more mature economies of Britain, France, Canada and Japan. In India there are efficient, well-developed national channels for distributing trucks, scooters, farm equipment, groceries, personal care items, and other packaged products to the country´s 3 million retailers. Wheras in China distribution is primarily local and provincial and there is no national network for distributing most products^[9], so China is supposed to be a country with a lot of opportunities for direct-investors when the infrastructural problems are solved.

A good example for a developing market is the automobile market in China. China´s automobile market has a lot to catch up on and the potential for development is immense: Never before were so many cars sold in China like in September 2003. As the halb-public institut Automotive Resources Asia communicated in a press release at the beginng of October, for the first time there were more than 200,000 cars sold in September 2003. This means an increase of 56% compared with September one year earlier. The sales for the whole year is 1.45 billion cars, 69% higher than the year before.^[10] The following figure shows the enormous opportunities for automobile companies in China:

illustration not visible in this excerpt

Figure 1: Car density in China compared with Germany and USA^[11]

An instance of an open-minded company for new markets is the German firm Volkswagen with settlements all over the world. The Group operates 4 production plants in eleven European countries and seven countries in the Americas, Asia and Africa. Around the world more than 320,000 employees produce over 21,500 vehicles or are involved in vehicle-related services on every working day. The Volkswagen Group sells its vehicles in more than 150 countries.^[12]

illustration not visible in this excerpt

Figure 2: Market share of VW Group in 2002.^[13]

When China opened its doors to the world in 1978, Volkswagen followed the call for Sino-Western cooperation and friendship. As early as 1978, negotiations with the Chinese Government and partners took place, eventually leading to establishing the joint ventures SHANGHAI VOLKSWAGEN in 1984, and FAW-VOLKSWAGEN in 1990.

With these joint ventures Volkswagen produces cars suitable to Chinese consumers. Together with its Chinese partners Volkswagen has become the undisputed market leader in the automobile industry in China with an impressive market share of more than 50%. More than 1.6 million locally manufactured cars have come to the road since Volkswagen's beginning in China.
To ensure the future success of its joint ventures in China, Volkswagen intends to maintain its leading market position in China while expanding its operations. The key to reaching this goal is to work closely with its Chinese partners in developing the joint ventures into companies that can compete in the international marketplace on their own.^[14]

2.2 Cost reductions

Other reasons for companies to direct invest abroad are the lowered costs. Various costs – including labor, materials, transportation and financing- may be lower outside the home country.^[15]

Differences in wage rates, worker productivity, inflation rates, energy costs, tax rates, government regulations, and the like, create sizable variations in manufacturing costs from country to country. Plants in some countries have major manufacturing cost advantages because of lower input costs (especially labor), relaxed government regulations, or unique natural resources. In such cases, the low-cost countries become principal production sites, with most of the output being exported to markets in other parts of the world. Companies with production facilities in low-cost countries have a competitive advantage over rivals with plants in countries where costs are higher. The competitive role of low manufacturing costs is most evident in low-wage countries like Taiwan, South Korea, China, Singapore, Malaysia, Vietnam, Mexico and Brazil, which have become production havens for goods with high labor content. Likewise, concerns about short delivery times and low shipping costs make some countries better locations than others for establishing distribution center facilities.^[16]

Most of the markets have pressures for cost reductions. These kind of pressures have been intense in the global tyre industry in recent years. Tyres are essentially a commodity product for which differentiation is difficult and price is the main competitive weapon. The major buyers of tires, automobile companies, are powerful and face low switching costs, so they have been playing tyre companies off against each other in an attempt to get lower prices. Furthermore, the decline in global demand for automobiles in the early 1990s has created a world capacity standing idle. The result has been a worldwide price war, with almost all tyre companies suffering heavy losses in the early 1990s. In response to the cost pressures, most tyre companies are now trying to rationalize their operations in a way consistent with the attainment of a low-cost position.^[17]

An example for a company of another market, which use the advantages of direct investments in foreign countries, is Swan Optical, a U.S.-based manufacturer and distributer of eyewear. With sales revenues only in the $20 million to $30 million range, Swan is hardly a giant, yet it manufactures its eyewear in low-cost factories in Hong Kong and China that it jointly owns with a Hong Kong-based partner. Swan also has a minority stake in eyewear design houses in Japan, France, and Italy. What we see in the Swan Optical story is a company that has dispersed its manufacturing and design processes to different locations around the world to take advantage of the favorable skill base and cost structure found in outher countries. Investments in Hong Kong and subsequently China have helped Swan to lower its cost structure, while investments in Japan, France, and Italy have helped it to produce differentiated designer eyewear for which it can charge a premium price. The critical point is that by dispersing its manufacturing and design activities in this manner, Swan has been able to establish a competitive advantage for itself in the global market-place for eyewear.^[18]

[...]

^[1] Daft 2000, 74.

^[2] Hill/Jones 1998, 260.

^[3] Daft 2000, 120.

^[4] Thompson/Strickland 2001, 201.

^[5] Daft 2000, 108.

^[6] Hill/Jones 1998, 247.

^[7] Daft 2000, 105.

^[8] Thompson/Strickland 2001, 200.

^[9] Thompson/Strickland 2001, 201.

^[10] Netzeitung 2003.

^[11] Volkswagen 2003a.

^[12] Volkswagen 2003b.

^[13] Volkswagen 2003c.

^[14] Volkswagen 2003d.

^[15] Punnett/Ricks 1992, 249,quotet in Pearce/Robinson 2000, 124.

^[16] Thompson/Strickland 2001, 202.

^[17] Hill/Jones 1998, 251.

^[18] Hill/Jones 1998, 247 f..