Lesson 2

International Investment:
Theory and Practice

Lesson 2 International Investment

Reading:
Chap. 3, Book 1; Chap. 2 & 3, Book 2
Overview:
Foreign Indirect Investment vs. FDI
Investment vs. Speculation
Motives for Making FDI
Organizational Forms of Multinational Enterprise
Characteristics of the Multinational Enterprise
Modern Theories of FDI and Multinationals
Porters Diamond Model
Cases:
Nestls Global Drive
A Global Challenge for Kodak
Aflacs Success in Japan

2.1 The Scope of International Investment

2 types: (1) Foreign Indirect Investment (FII) or
International Portfolio Investment
Investing on international financial assets.
e.g. foreign bonds or stocks
(2) Foreign Direct Investment (FDI)
Establish joint venture or subsidiary
Note: FII can be transformed into FDI.
Under what condition?
The shareholding of a company exceeds 10% of its
stock in most cases.
2.1.1 International Portfolio Investment
Q: How do investment & speculation differ? Any
example?

Look at great investors & speculators

Find the differences between
investment & speculation

Warren Buffett
God of Stocks

George Soros
Greatest Money Manager

Q. How do Investment & speculation differ?

(1) Targets:
Mainly stable income v.s.
profiting from price changes
(2) Strategies:
Long-lasting war v.s. quick battles
(3) Tools:
Fundamental analysis v.s. technical analysis
(4) Style:
Prudent ( ) v.s. aggressive ( )

2.1.2 Foreign Direct Investment (FDI)

FDI is made to establish
(a) International ownership & control:
Establish joint venture or subsidiary
(b) Multinational Operations

Case:
Nestls Global Drive
(1) How does Nestl display basic characteristics of the
Multinational Enterprise (MNE)?
(2) Whats the motive for Nestl to invest in other
countries? Generally speaking, what are different
motives for the MNEs to make FDI? Explain.

(1) Basic characteristics of the MNE

Monopolistic advantage
It is derived from certain proprietary intangible
assets, such as superior managerial skills, patented
and unpatented innovations.
International ties of common ownership
It enables the parent and its subsidiaries to draw
on a common pool of resources such as patents,
trademarks, research facilities, information and human
capital.
Transnational intrafirm trade
More than 60% of world trade takes place within
multinational enterprises.

(2) Whats the motive for Nestl to invest in other

countries? In general, what are different motives for
the MNEs to make FDI?

Motives:
To seek
(1) market;
(2) cheap labor;
(3) raw materials;
(4) information and technology;
(5) free trade;
(6) tax reduction.

2.2 Organizational Forms of the MNE

Does MNE or MNF differ from MNC or TNC?

MNE (Multinational enterprise), MNF (Multinational firm)
MNC (Multinational Corp. ) TNC ( Transnational Corp.)
The Multinational Enterprise (MNE) can take any of the
following legal forms:
Sole Proprietorship: One owner with unlimited liability
Partnership Multiple owners with unlimited liability
Corporation Stockholders with limited liability
Operational organization in foreign countries can be:
Branch: No independent legal status.
Subsidiary: Independent legal entity entitled to
issue its own stock and bonds.
Q Is there an one-person-corporation, i.e., shareholding
company?

Caribbean
(BVI)

BVI on the Caribbean Sea

A corporation set up there
a. pay no taxes;
b. can have only one shareholder;
c. can have one board member;
d. neednt issue an annual report;
e. can use any currency for registration;
f. can use any amount for registered capital.

Case Study
Aflacs Success in Japan
Discussion Questions:
1. Based on Aflacs experience, what
conditions should a firm have to make
foreign direct investment in a foreign
country?
2. Can its success be duplicated in China?

Case: Aflac in Japan

American Family Life Insurance of Columbus founded in
1955. Now its the worlds leading seller of cancer insurance,
and one of the most successful foreign companies in Japan.
Founders: John Amos &
Tipping Point: John attended the Osaka Worlds Fair in
1970, and saw people wearing masks for fear of
getting sick. He came up with the idea of
selling cancer insurance to Japanese.
Events: In 1974, it started its business in Japan;
In 1994, it insured one in four Japanese households;
The subsidiary generated 70% of Aflacs pretax earnings;
Between 1990 and 2002, the subsidiary repatriated over $1 billion to the
parent company.

Digression: Basic FDI Theories

(1) FDI Advantage Hypothesis
Seminal analysis of the MNF by Stephen Hymer
(1960), who introduced industrial organization theory
(IOT) to the study of FDI.
IOT explains firms performance under different
market structures .
Q. Whats the basic problem of making FDI?
Foreignness
Firms proprietary asset
Firm-specific advantage
compete against local firms
make FDI

(2) Internalization Theory

Peter Buckley & Mark Casson
Q. Given the costs of foreignness, why does the
MNF choose internalization over market
transactions?
Basic views
A Internalization of proprietary assets can
best realize their full value;
B The MNF is the result of internalizing
markets across national borders.

(3) OLI Advantages Theory

According to John H. Dunning, The MNC must
have three advantages:
(i) Ownership advantage: a proprietary asset to
give it firm-specific advantage
(ii) Location advantage: favorable investment
conditions as country-specific advantage
(iii) Internalization advantage: Internalization of
the proprietary asset across national borders
can best realize its full value.

Case: Aflac
Q. 1. Based on Aflacs experience, what conditions
should a firm have to make FDI?
Answer:
1. (1) Ownership Advantage:
The firm possesses proprietary knowledge
(2) Location Advantage:
Japan is a well-developed economy. Income and
purchasing power are high. Besides, in-house sales
subsidiaries in Japanese corporations can be set up to
handle insurance sales.
(3) Internalization Advantage
Aflac cannot realize full value of its proprietary asset
through market transactions like franchising.

2. Succeed in China?
Application: Porters Diamond Model
Government

Firm Structure, Strategy

& Rivalry

Factor Conditions

Related & Supported

Industry

Demand Conditions

Chance

Porters Diamond Model Applicable to China

Government

Firm Structure & Rivalry

in-house sales subsidiaries,
allowed,efficient foreign
insurers, intense competition

Factor Conditions
plenty human resources,
low cost, good infra.
modern communication

Demand Conditions
more civilian-run firms, rising
income, medical system reform
credible foreign insurance

Related & Supported Industry

fast-developing financial industry,
more investment channels, rapid
expansion of foreign banks

Chance

Case: Aflac
Q (ii) Can its success be duplicated in China?
Compare:
Factor conditions:
+
Firm structure & rivalry
0
Demand:
+
Supporting industries:
+
Government:
Chance:
+
On the whole, there are location advantages.
In addition, Aflac has a proven business model. Thus,
success is very likely.

Theoretical Issue:
FDI as a Currency Area Phenomenon
According to Aliber, a financial economist:
Foreign direct investment is a currency
area phenomenon.
Firms in countries with strong currencies
have a currency-area advantage. They can
acquire foreign firms and production facilities
at low costs in countries with weak currencies.

Q. In 1950s and 1960s the dollar was quite

strong, and U.S. made substantial FDI in
Europe and other countries. During the 1970s
and early 1980s, German mark and Japanese
yen were appreciating, and there were
extensive German and Japanese outward
investments and the invasion of the U.S. by
European MNFs. Given this development,
Alibers theory seems to explain well the
direction of MNFs investment in the postwar world. But Alibers theory has never
been widely accepted, why?

Why not widely accepted?

Its drawbacks:
(1) FDI is a long-term strategic commitment
while current currency value is a short-term
phenomenon. Relying on the short-term
market bias to account for the long-term
decision making is not logically convincing.
2 It is inadequate to explain crossinvestment between currency areas.

Case A Global Challenge for Kodak

(p12, Book 1) Kodaks crisis:
In early 80s, Fuji had control over 70% of domestic
film market, and started an aggressive expansion into
north America and European markets, which threatened
Kodaks dominant position there. Worse yet, Fuji
undercut prices, and captured large market share,
Kodaks profit sagged.
(1) What mode of entry did Kodak use for Japanese market
prior to 1980s? Why?
(2) What strategy did Kodak adopt to counterattack Fujis
aggressive expansion into North America markets?
Why?
(3) How can Kodak thrive in the new era of digital
cameras?

(1) Licensing. Kodak underestimated Japanese rivals

(2) From licensing to export + joint venture strategy
Set up joint venture with a Japanese distributor,
establish its distribution and marketing channel, and
spend heavily on promotion.
Reasons for the Strategic Change
a. Exports + FDI can bring in more profits than
licensing
b. Offense is the best defense.
Outcome:
Kodak had great success in Japan. In 1990, its sales in
Japan reached $1.3 billion. Fuji had to defend its home
market, and withdrew a group of best senior executives
from abroad.
(3) Be a leader in digital cameras, or diversify its biz?

Recapitulation:
International Portfolio Investment differs from FDI;
Investment and speculation have different characteristics;
MNE can take various legal organization forms;
Main motivations for FDI are seeking resources, markets,
and efficiency;
Mode of entry into a foreign market is an important
strategic decision (Kodak);
OLI advantages theory offers a guideline for making FDI
decision;
Porters diamond model provides a useful framework for
evaluating location advantages.

Reminder:
After the class discussion of the case, you
can receive bonus points if a short report is
submitted. It should compare analyses of the
professor and others with yours. New ideas may
also be provided. This report is not required, but
you are encouraged to do so.
If you want to do the report, it should be
submitted at the beginning of the next class. An
electronic copy should also be sent to TA and
my e-mail box before the next class.
Note:
Learning is an exciting journey of new
discoveries!

Preparation for the Next Class

Topic: International Trade: Theory & Practice
Reading:
Chap. 4 & 5, Book 1; Chap. 3 & 17, Book 2
Content:
Rationale of International Trade
International Trade Terms
Remittance & Collection
Letters of Credit
Case Study: An Exchange between Tom & Huck
Can Lee & Wang Help Each Other?
An unexpected development
What type of L/C is it?
Note:
Knowledge acquisition vs. skill acquisition
There are tricks of trade!