Foreign direct investments and INTERNATIONALIZATION issues Foreign direct investment (FDI) plays an extraordinary and growing role

in global business. It can provide a firm with new markets and marketing channels, cheaper production facilities, access to new technology, products, skills and financing. For a host country or the foreign firm which receives the investment, it can provide a source of new technologies, capital, processes, products, organizational technologies and management skills, and as such can provide a strong impetus to economic development. Foreign direct investment, in its classic definition, is defined as a company from one country making a physical investment into building a factory in another country. The direct investment in buildings, machinery and equipment is in contrast with making a portfolio investment, which is considered an indirect investment. In recent years, given rapid growth and change in global investment patterns, the definition has been broadened to include the acquisition of a lasting management interest in a company or enterprise outside the investing firms home country. As such, it may take many forms, such as a direct acquisition of a foreign firm, construction of a facility, or investment in a joint venture or strategic alliance with a local firm with attendant input of technology, licensing of intellectual property. In the past decade, FDI has come to play a major role in the internationalization of business. Reacting to changes in technology, growing liberalization of the national regulatory framework governing investment in enterprises, and changes in capital markets profound changes have occurred in the size, scope and methods of FDI. New information technology systems, decline in global communication costs have made management of foreign investments far easier than in the past. The sea change in trade and investment policies and the regulatory environment globally in the past decade, including trade policy and tariff liberalization, easing of restrictions on foreign investment and acquisition in many nations, and the deregulation and privatization of many industries, has probably been the most significant catalyst for FDIs expanded role.

Driven by mergers and acquisitions and internationalization of production in a range of industries, FDI into developed countries last year rose to $636 billion, from $481 billion in 1998.
In many cases, large companies still play a dominant role in investment activities in small, high tech oriented companies. However, unlike in the past, these larger companies are not necessarily acquiring smaller companies outright. There are several reasons for this, but the most important one is most likely the risk associated with such high tech ventures. In the case of mature industries, the products are well defined. The manufacturer usually wants to get closer to its foreign market or wants to circumvent some trade barrier by making a direct foreign investment. The major risk here is that you do not sell enough of the product that you manufactured. However, you have added additional capacity and in the case of multinational corporations this capacity can be used in a variety of ways.

High tech ventures tend to have longer incubation periods. That is, the product tends to require significant development time. In the case of software and other intellectual property type products, the product is constantly changing even before it hits the marketplace. This makes the investment decision more complicated. When you invest in fixtures and machinery, you know what the real and book value of your investment will be. When you invest in a high tech venture, there is always an element of uncertainty. Unfortunately, the recent spate of dot.com failures is quite illustrative of this point.
Therefore, the expanded role of technology and intellectual property has changed the foreign direct investment playing field. Companies are still motivated to make foreign investments, but because of the vagaries of technology investments, they are now finding new vehicles to accomplish their goals. Consider the following:

Licensing and technology transfer. Licensing and tech transfer have been essential in promoting collaboration between the academic and business communities. Ever since legal hurdles were removed that allowed universities to hold title to research and development done in their labs, licensing agreements have helped turned raw technology into finished products that are viable in competitive marketplaces. With some help from a variety of government agencies in the form of grants for R&D as well as other financial assistance for such things as incubator programs, once timid college researchers are now stepping out and becoming cutting edge entrepreneurs. These strategic alliances have had a serious impact in several high tech industries, including but not limited to: medical and agricultural biotechnology, computer software engineering, telecommunications, advanced materials processing, ceramics, thin materials processing, photonics, digital multimedia production and publishing, optics and imaging and robotics and automation. Industry clusters are now growing up around the university labs where their derivative technologies were first discovered and nurtured. Licensing agreements allow companies to take full advantage of new and exciting technologies while limiting their overall risk to royalty payments until a particular technology is fully developed and thus ready to put new products into the manufacturing pipeline. Reciprocal distribution agreements. Actually, this type of strategic alliance is more trade-based, but in a very real sense it does in fact represent a type of direct investment. Basically, two companies, usually within the same or affiliated industries, agree to act as a national distributor for each others products. The classical example is to be found in the furniture industry. A U.S.-based manufacturer of tables signs a reciprocal distribution agreement with a Spanish-based manufacturer of chairs. Both companies gain direct access to the others distribution network without having to pay distributor support payments and other related expenses found within the distribution channel and neither company can hurt the others market for its products. Without such an agreement in place, the Spanish manufacturer might very well have to invest in a national sales office to coordinate its distributor network, manage warehousing, inventory and shipping as well as to handle administrative tasks such as accounting, public relations and advertising.

Joint venture and other hybrid strategic alliances. The more traditional joint venture is bi-lateral, that is it involves two parties who are within the same industry who are partnering for some strategic advantage. Typical reasons might include a need for access to proprietary technology that might tip the competitive edge in another competitors favor, desire to gain access to intellectual capital in the form of ultra-expensive human resources, access to heretofore closed channels of distribution in key regions of the world. One very good reason why many joint ventures only involve two parties is the difficulty in integrating different corporate cultures. With two domestic companies from the same country, it would still be very difficult. However, with two companies from different cultures, it is almost impossible at times. This is probably why pure joint ventures have a fairly high failure rate only five years after inception. Joint ventures involving three or more parties are usually called syndicates and are most often formed for specific projects such as large construction or public works projects that might involve a wide variety of expertise and resources for successful completion. In some cases, syndicates are actually easier to manage because the project itself sets certain limits on each party and close cooperation is not always a prerequisite for ultimate success of the endeavor. Portfolio investment. For most of the latter part of the 20th century when FDI became an issue, a companys portfolio investments were not considered a direct investment if the amount of stock and/or capital was not enough to garner a significant voting interest amongst shareholders or owners. However, two or three companies with "soft" investments in another company could find some mutual interests and use their shareholder power effectively for management control. This is another form of strategic alliance, sometimes called "shadow alliances". So, while most company portfolio investments do not strictly qualify as a direct foreign investment, there are instances within a certain context that they are in fact a real direct investment.

Why is FDI important for any consideration of going global?

The simple answer is that making a direct foreign investment allows companies to accomplish several tasks:

Avoiding foreign government pressure for local production. Circumventing trade barriers, hidden and otherwise. Making the move from domestic export sales to a locally-based national sales office. Capability to increase total production capacity. Opportunities for co-production, joint ventures with local partners, joint marketing arrangements, licensing, etc

Theories of international businessSome of the most important theories of international business are given below-

The

absolute

advantage

theory

The absolute advantage theory was given by Adam Smith in 1776; according to the absolute advantage theory each country always finds some absolute advantage over another country in the production of a particular good or service. Simply because some countries have natural advantage of cheap labour, skilled labour, mineral resources, fertile land etc. these countries are able to produce some specific type of commodities at cheaper prices as compared to others. So, each country specializes in the production of a particular commodity. For example, India finds absolute advantage in the production of the silk saris due to the availability of skilled workers in the field, so India can easily export silk saris to the other nations and import those goods in which other countries find absolute advantages. But this theory is not able to justify all aspects of international business. This theory leaves no scope of international business for those countries that are having absolute advantage in all fields or for those countries that are having no absolute advantage in any field.

The

comparative

cost

theory

After 40 years of absolute advantage theory, in order to provide the full justification of international business David Richardo presented the Richardian modelcomparative cost theory. According to the comparative cost theory, two countries should do business with each other if one country is having an advantage in the

ability of producing one good relative to another good as compared to some other countrys relative ability of producing same goods. It can be well understood by taking an illustrationIf USA could produce 25 bottles of wine and 50 pounds of beef by using all of its production resources and France could yield 150 bottles of wine and 60 pounds of beef by using the same resources, then according to absolute advantage theory France finds clear advantage over USA in the production of both beef and wine. So, there should not be any business activity between the two countries. But this is not the case according to the comparative cost theory. Comparative cost theory suggests relative comparing of the beef and wine production. In relative comparing we can find that France sacrifices 2.5 bottles of wine for producing each pound of beef (150/60) and USA sacrifices 0.5 bottles of wine for producing each pound of beef (25/50). So, we can see that production of beef is more expensive in France as compared to USA. Comparative cost theory suggests USA to import wine from France instead of producing it and in similar manner theory suggests France to import beef from USA instead of producing it.

In this way, comparative cost theory well explains the driving forces behind international business. Opportunity cost theory

The opportunity cost theory was proposed by Gottfried Haberler in 1959. The opportunity cost is the value of alternatives which have to be forgone in order to obtain a particular thing. For example, Rs. 1,000 is invested in the equity of Rama News Limited and earned a dividend of six per cent in 1999, the opportunity cost of this investment is 10 per cent interest had this amount been deposited in a commercial bank for one year term. Another example is that, India produces textile garments by utilizing its human resources worth of Rs. 1 billion and exports to the US in 1999. The opportunity cost of this project is, had India developed software packages by utilizing the same human resources and exported the same to USA in 1999, the worth of the exports would have been Rs. 10 billion. Opportunity cost approach specifies the cost in terms of the value of the alternatives which have to be foregone in order to fulfill a specific art. Thus, this theory provides the basis for international business in terms of exporting a particular product rather than other products. The previous example suggests that it would be profitable for India to develop and export software packages rather than textile garments to the USA.

The

vent

for

surplus

theory

International trade absorbs the output of unemployed factors. If the countries produce more than the domestic requirements, they have to export the surplus to other countries. Otherwise, a part of the productive labor of the country must cease and the value of its annual produce diminishes. Thus, in the absence of foreign trade, they would be surplus productive capacity in the country. The surplus productive capacity is taken by another country and in turn gives the benefit under international trade. According to this theory, the factors of production of developing countries are fully utilized. The unemployed labor of the developing countries is profitably employed when the surplus is exported.