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Chapter 14 Direct Investment and Collaborative Strategies

Essay Questions

In a short essay, discuss how transportation, trade restrictions, domestic capacity, and country-oforigin effects affect companies' sales. TransportationWhen companies add the cost of transportation to product costs, some products become impractical to ship over great distances. A few of these products are newspapers, margarine, dynamite, and soft drinks. For the companies that make these products, it is necessary to produce abroad if they are to sell abroad. b. Trade restrictionsGovernments restrict imports. Thus, companies may find they must produce in a foreign country if they are to sell there. Governmental trade restrictions often favor big companies that can afford to commit large amounts of resources abroad, making foreign competitiveness more difficult for small companies that can afford only exportation as a means of serving foreign markets. c. Domestic capacityAs long as companies have sufficient domestic capacity, they are more likely to serve foreign markets through exports. However, if they need to construct additional capacity, they are likely to consider putting that capacity abroad to save on transport costs. d. Country-of-origin effectsGovernment-imposed legal measures are not the only trade barriers to otherwise competitive goods. Consumer desires also may dictate limitations. Consumers may prefer to buy goods produced in their own country rather than another. Or, they may believe that goods from a given country are superior, therefore preferring those countries' products. They may also fear that service and replacement parts for imported products will be difficult to obtain. (interpretation, pages 487488)



In a short essay, define direct investment.

Answer For direct investment to take place, control must accompany the investment. Otherwise, it is a portfolio investment. If ownership is widely dispersed, then a small percentage of the holdings may be sufficient to establish control of managerial decision-making. However, even 100 percent share does not guarantee control. If a government dictates who a foreign company can hire, what the company must sell at a specified price, and how the company must distribute its earnings, then control belongs to the government. Governments usually report direct investment by using an arbitrary figure of 10 percent or 25 percent ownership. (definition, page 489)

According to the appropriability theory and the internalization theory, why would companies want to control their foreign operations?

Chapter 14 Direct Investment and Collaborative Strategies

Answer Control is important to foreign companies because they may want to do what is best for their global operations rather than what is best for the operations of a specific country. Companies are reluctant to transfer vital resourcescapital, patents, trademarks, and management know-howto another organization that can make all its operating decisions independently. The company receiving these resources can use them to undermine the competitive position of the foreign company transferring them. The idea of denying rivals access to resources is called the appropriability theory. The control through self-handling of operations (internal to the organization) is internalization. (interpretation, page 489)

How does the interaction between a countrys market size and its import restrictions affect companies decisions to make foreign direct investments there? Answer Managers must view import barriers along with other factors, such as the market size of the country imposing the barriers. For example, import trade restrictions have been highly influential in enticing automobile producers to locate in Brazil because of its large market, but not for Central American countries that have small markets.. Removing trade restrictions among a group of countries also may attract direct investment, possibly because the expanded market may justify scale economies and possibly because the output from a new location can be feasibly exported. (interpretation, page 488)

65. In a short essay, discuss the various reasons consumers may prefer to buy goods produced in their own country. Answer NationalismIn many countries, companies have instituted promotional campaigns to persuade people to buy locally produced goods. A specific example is the campaign by the American fiber, textiles, and apparel coalitions to push "crafted with pride in the U.S.A." b. Product imageAlthough products may be identical, consumers often view their quality differently on the basis of the country of origin. c. Delivery riskMany consumers fear that service and replacement parts for foreign-made goods may be difficult to obtain from abroad. Industrial consumers often prefer to pay a higher price to a nearby producer in order to minimize the risk of nondelivery due to distance and strikes. (interpretation, page 488)

66. There are two ways companies can invest in a foreign country. They can either acquire an interest in an existing operation or construct new facilities. In a short essay, describe the advantages and disadvantages of each alternative. Answer a. Reasons for buyingThere are many reasons for seeking acquisitions. One is the difficulty of transferring some resource to a foreign operation or acquiring that resource locally for a new facility.


Chapter 14 Direct Investment and Collaborative Strategies

Personnel are a resource that foreign companies find it difficult to hire, especially if local unemployment is low. Instead of paying higher compensation than competitors do to entice employees away from their old jobs, a company can buy an existing company, which gives the buyer not only labor and management but also an existing organizational structure. Through acquisitions, a company may also gain the goodwill and brand identification important to the marketing of mass consumer products, especially if the cost and risk of breaking in a new brand are high. Further, a company that depends substantially on local financing rather than on the transfer of capital may find it easier to gain access to local capital through an acquisition. Local capital suppliers may be more familiar with an ongoing operation than with the foreign enterprise. In addition, a foreign company may acquire an existing company through an exchange of stock, which circumvents home country exchange controls. b. Reasons for buildingAlthough acquisitions offer advantages, a potential investor will not necessarily be able to realize them. Companies frequently make foreign investments where there is little or no competition, so finding a company to buy may be difficult. In addition, local governments may prevent acquisitions because they want more competitors in the market and fear market dominance by foreign enterprises. Even if acquisitions are available, they are less likely to succeed than start-up operations. The acquired companies might have substantial problems. Further, the managers in the acquiring and acquired companies may not work well together. Finally, a foreign company may find local financing easier to obtain if it builds facilities, particularly if it plans to tap development banks for part of its financial requirements. (interpretation, pages 490491) 67. In a short essay, describe the general motives for collaborative arrangements. Answer General motives for collaborative arrangements include all of the following: a. Spread and reduce costsTo produce or sell abroad, a company must incur certain fixed costs. A company may have excess production or sales capacity that it can use to produce or sell for another company. The company handling the production or sales may lower its average costs by covering its fixed costs more fully. Likewise, the company contracting out its production or sales will not have to incur fixed costs that may have to be charged to a small amount of production or sales. b. Specialize in competenciesA company may seek to improve its performance by concentrating on those activities that best fit its competencies, depending on other firms to supply it with products, services, or support activities for which it has lesser competency. Large, diversified companies are constantly realigning their product lines to focus on their major strengths. This realigning may leave them with products, assets, or technologies that they do not wish to exploit themselves, but that may be profitably transferred to other companies. c. Avoid competitionCompanies may band together so as not to compete. Companies also may combine certain resources to combat larger and more powerful competitors. d. Secure vertical and horizontal linksThere are potential cost savings and supply assurances from vertical integration. Horizontal links may provide finished products or components. For finished products, there may be economies of scope in distribution, such as by having a full line of products to sell, thereby increasing the sales per fixed cost of a visit to potential customers.


Chapter 14 Direct Investment and Collaborative Strategies

Gain knowledgeMany companies pursue collaborative arrangements to learn about a partner's technology, operating methods, or home market so that their own competencies will broaden or deepen, making them more competitive in the future. (interpretation, pages 492493)

68. In a short essay, describe the international motives for collaborative arrangements. Answer International motives for collaborative arrangements include all of the following: a. Gain location-specific assetsCultural, political, competitive, and economic differences among countries create barriers for companies that want to operate abroad. When they feel ill-equipped to handle these differences, they may seek collaboration with local companies who will help local operations. In other countries, foreign companies may team with local companies to gain operational assets. b. Overcome legal constraintsCollaboration can be a means of protecting an asset. Many countries provide little de facto protection for foreign property rights such as trademarks, patents, and copyrights unless authorities are prodded consistently. To prevent pirating of these proprietary assets, companies have sometimes made collaborative agreements with local companies, which then monitor that no one else uses the asset locally. c. Diversify geographicallyBy operating in a variety of countries, a company can smooth its sales and earnings because business cycles occur at different times within the different countries. Collaborative arrangements offer a faster initial means of entering multiple markets. Moreover, if product conditions favor a diversification rather than a concentration strategy, there are more compelling reasons to establish foreign collaborative arrangement. d. Minimize exposure in risky environmentsOne way to minimize loss from foreign political occurrences is to minimize the base of assets located abroador share them. A government may be less willing to move against a shared operation for fear of encountering opposition from more than one company, especially if they are from different countries and can potentially elicit support from their home governments. Another way to spread risk is to place operations in a number of different countries. (interpretation, pages 493494)


Chapter 14 Direct Investment and Collaborative Strategies

99. How/why might companies have to accept a trade-off among their objectives when choosing their form of operations abroad? Answer A decision to take no ownership in foreign production, such as through licensing it to a foreign company, may reduce exposure to political risk. However, learning about that environment will be slow, delaying reaping the full profits from producing the product abroad. When a company has a desired, unique, difficult-to-duplicate resource, it is in a good position to choose the operating form it would most like to use. The preferred form may be exporting, selling from a wholly owned direct investment, or participating in a collaborative arrangement. However, when it lacks this bargaining strength, it faces the possibility of competition. It may have to settle on a form that is lower on its priority list; otherwise, a competitor may preempt the market. (interpretation, pages 494495) 100. How do companies' desire for control and their international experience influence their choice of operating from abroad? Answer The more a company depends on collaborative arrangements, the more likely it is to lose control over decisions, including those regarding quality, new product directions, and where to expand output. This is because each collaborative partner has a say in these decisions, and the global performance of each may be improved differently. External arrangements also imply the sharing of revenues, a serious consideration for undertakings with high potential profits because a company may want to keep them all for itself. When a company already has operations in place in a foreign country, some of the advantages of contracting with another company to handle production or sales are no longer as prevalent. The company knows how to operate within the foreign country and may have excess capacity it can use for new production or sales. (interpretation, page 495) 101. In a short essay, discuss the issue of key sector control.

Answer Closely related to the extraterritoriality issue is the fear that if foreign ownership dominates key industries, then decisions made outside of the country may have extremely adverse effects on the local economy or may exert an influence on politics in the host country. MNEs' home country headquarters often decide on what, where, and how their foreign subsidiaries will produce and sell. These decisions might cause different rates of expansion in different countries and possible plant closings with subsequent employment disruption in some of them. Further, by withholding resources or allowing strikes, the MNE also may affect other local industries adversely. Aside from establishing policies that generally restrict the entry of foreign investment, countries have selectively prevented foreign domination of so-called key industries, which affect a large segment of the economy or population by virtue of their size or influence. (interpretation, pages 495497) 102. Define licensing, cross-licensing, exclusive licensing, and nonexclusive licensing.


Chapter 14 Direct Investment and Collaborative Strategies

Answer Under a licensing agreement, a company (the licensor) grants rights to intangible property to another company (the licensee) to use in a specified geographic area for a specified period. In exchange, the licensee ordinarily pays a royalty to the licensor. The rights may be exclusive (the licensor can give rights to no other company) or nonexclusive (it can give away rights). For industries in which technological changes are frequent and affect many products, companies in various countries often exchange technology rather than compete with each other on every product in every market. Such an arrangement is known as cross-licensing. (definition, page 497) 103. Why are there international licensing agreements between a parent company and a company abroad in which it owns in whole or in part? Answer Many licenses are given to companies owned in whole or part by the licensor. A license may be necessary to transfer technology abroad because operations in a foreign country, even if 100 percent owned by the parent, usually are subsidiaries, which are separate companies from a legal standpoint. When a company owns less than 100 percent, a separate licensing arrangement may be a means of compensating the licensor for contributions beyond the mere investment in capital and managerial resources. (interpretation, page 498) 104. Explain how franchising agreements differ from licensing agreements? Answer Franchising is a specialized form of licensing in which the franchisor not only sells an independent franchisee the use of the intangible property (usually a trademark) essential to the franchisee's business, but also operationally assists the business on a continuing basis, such as through sales promotion and training. In a sense, a franchisor and a franchisee act almost like a vertically integrated company because the parties are interdependent and each produces part of the product or service that ultimately reaches the consumer. (definition, page 498) 105. What is the major dilemma that franchisors face in their international operations? Answer A dilemma for successful domestic franchisors is that their success comes from three factors: product and service standardization, high identification through promotion, and effective cost controls. When entering many foreign countries, franchisors may encounter difficulties in transferring these success factors. At the same time, the more adjustments made to the host country's different conditions, the less a franchisor has to offer a potential franchisee. (interpretation, page 499) 106. What is a management contract, and what are the possible advantages to both parties in the contract?


Chapter 14 Direct Investment and Collaborative Strategies

Answer One of the most important assets a company may have at its disposal is management talent, which it can transfer internationally, primarily to its own foreign investments. Management contracts are means by which a company may transfer such talentby using part of its management personnel to assist a foreign company for a specified period for a fee. The company may gain income with little capital outlay. Contracts usually cover three to five years, and fixed fees or fees based on volume rather than profits are most common. A company usually pursues management contracts when it believes that a foreign company can manage its existing or new operation more efficiently than it can. With management contracts, the host country gets the assistance it wants without needing direct investment. In turn, the management company receives income without having to make a capital outlay. A management contract may also allow the supplier to gain foreign experience, increasing its capacity to internationalize. (definition, page 500) 107. What is a turnkey operation? What features generally make turnkey operations different from other collaborative arrangements? Answer Turnkey operations are a type of collaborative arrangement in which one company contracts another to build complete, ready-to-operate facilities. Companies building turnkey operations are frequently industrial-equipment manufacturers and construction companies. The customer for a turnkey operation is often a governmental agency. One characteristic that sets the turnkey business apart from most other international business operations is the size of the contracts. Most contracts are for hundreds of millions of dollars, and many are for billions. Smaller firms often serve as subcontractors for primary turnkey suppliers. However, large companies are vulnerable to economic downturns when governments cancel big contracts. Payment for a turnkey operation usually occurs in stages, as a project develops. Because of the long time frame between conception and completion, the company performing turnkey operations can encounter currency fluctuations and should cover itself through escalation clauses or cost-plus contracts. (definition, pages 500501) 108. What type of ownership sharing can exist in joint ventures? Answer A type of ownership sharing popular among international companies is the joint venture, in which more than one organization owns a company. Joint ventures are sometimes thought of as 50/50 companies, but often more than two organizations participate in the ownershipage. Further, one organization frequently controls more than 50 percent of the venture. The type of legal organization may be a partnership, corporation, or some other form permitted in the country of operation. When more than two organizations participate, the joint venture is sometimes called a consortium. The more companies in the joint venture, the more complex the management of the arrangement will be. Certain types of companies favor joint ventures more than others do. (definition, pages 501502) 109. What are equity alliances, and why would companies form them?


Chapter 14 Direct Investment and Collaborative Strategies

Answer An equity alliance is a collaborative arrangement in which at least one of the collaborating companies takes an ownership position in the other. In some cases, each party takes an ownership, such as buying part of each other's shares or by swapping shares with each other. The purpose of the equity ownership is to solidify a collaborating contract, such as a supplier-buyer contract, so that it is more difficult to breakparticularly if the ownership is large enough to secure a board membership for the investing company. The airline industry epitomizes the use of equity alliances. (definition, page 503) 110. What are the alternative ways that joint ventures dissolve? Answer Joint venture divorce and divorce from other collaborative arrangements can be planned or unplanned, friendly or unfriendly, mutual or nonmutual. The major strains on collaborative arrangements are due to five factors: the importance to the partners, differing objectives, control problems, comparative contributions and appropriations, and differences in culture. (interpretation, page 503) 111. In a short essay, discuss the various problems of collaborative arrangements. Answer The major strains on collaborative arrangements are due to five factors: a. Collaboration's importance to partnersOne partner may give more management attention to a collaborative arrangement than the other does. If things go wrong, the active partner blames the less-active partner for its lack of attention, and the less-active partner blames the more active partner for making poor decisions. The difference in attention may be due to the different sizes of partners. b. Differing objectivesAlthough companies enter into collaborative arrangements because they have complementary capabilities, their objectives may evolve differently over time. For instance, one partner may want to reinvest earnings for growth and the other may want to receive dividends. One partner may want to expand the product line and sales territory, and the other may see this as competition with its wholly owned operations. A partner may wish to sell or buy from the venture, and the other partner may disagree with the prices. c. Control problemsBy sharing the assets with another company, one company may lose some control of the extent or quality of the assets' use. When no single company has control of a collaborative arrangement, the operation may lack direction. Studies show that when two or more partners attempt to share in an operation's management, failure is much more likely than when one partner dominates. However, the dominating partner must consider the other company's interests. For this reason, studies also show that joint ventures with an even split in ownership are likely to succeed because the financial ownership ensures that management will consider both partners' interests. d. Partners' contributions and appropriationsOne partner's capability of contributing technology, capital, or some other asset may diminish compared to its partner's capability over time. In almost all collaborative arrangements, there is a danger that one partner will use the other partner's contributed assets, enabling it to become a competitor.


Chapter 14 Direct Investment and Collaborative Strategies

Differences in cultureCompanies with different cultures differ in how they evaluate the success of their operations. In addition to national culture, differences in corporate cultures may also create problems within joint ventures. For example, one company may be accustomed to promoting managers from within the organization, whereas the other opens its search to outsiders. One may use a participatory management style, and the other an authoritarian style. For this reason, many companies will develop joint ventures only after they have had long-term positive experiences with the other company through distributorship, licensing, or other contractual arrangements. (interpretation, pages 504505)

112. Explain how companies can manage international collaborative arrangements effectively. Answer As companies enter into more collaborative arrangements, they enjoy better performance. In essence, they may choose partners more wisely and learn how better to have synergy between their partners and their own operations. A company can seek out a partner for its foreign operations, or it can react to a proposal from another company to collaborate with it. In either case, it is necessary to evaluate the potential partner not only for the resources it can supply but also for its motivation and willingness to work with the other company. Contracts should be spelled out in detail, but if courts must rule on disagreements both parties may lose something in the settlement. Management also should estimate potential sales, determine whether the arrangement is meeting quality standards, and assess servicing requirements to check whether the other company is doing an adequate job. Mutual goals should be set so that both parties understand what is expected, and the expectations should be spelled out in the contract. (interpretation, pages 505508)