A Foreign Direct Investment, or FDI, is a “category of international investment made by a resident entity in one economy (direct investor) with the objective of establishing a lasting interest in an enterprise resident in an economy rather than that of the investor (direct investment enterprise)”, according to the OECD (1999). The difference between FDI and Portfolio management is that FDI implies a “lasting interest”, which often indicates a long term relationship and an influence on the way of management on the “direct investment company” by the “direct investor company”.
According to the literature, there are several reasons why companies engage in FDI instead of portfolio management. Most of them highlight the long term partnership between the companies and the benefits brought by the direct investor company to the direct investment company. But is that all? Do you really believe that multinational companies like Tesco or Apple are just investing in FDI in foreign countries because they want to help local populations to develop? I certainly don’t!... Those companies invest in FDI because it will be better for them at some point whether it is for cutting production costs or using cheaper call centre. Is it too cynical to just say that like that?
Indeed, companies invest in FDI principally in Asia at the moment. Whether it is China, or India, their labour cost is cheaper than in west countries, even considering transportation costs.
However, it is not all bad for the direct investment company. Since the two companies are in a long term partnership, the companies “exchange” their knowledge. I see that more like that: the direct investor company offer its knowledge and experience to the direct investment company, and in return, the last one offers a way to enter a new market to the first one. But what’s next? What will happen when all the knowledge will have been transferred and the market will be mature?
Considering FDI, the direct investor company has to think through different risks occurring when investing in a foreign country. According to Moffett, Stonehill and Eitman (2012) there are three major risks: transaction risk, translation risk and economic risk. Let’s take the example of Tesco. The company is investing in FDI in America under the brand “fresh and easy”. They want to open 40 stores by then end of 2014, and already have 26. In this case, Tesco will have to consider:
Ø The transaction risk: this could affect profits the company is making when they are sent back to the UK as well as the investment the company will have to make to keep the FDI going. However, this risk could be diminished by “netting”.
Ø The translation risk: this could affect the value of the company’s asset or at least their value in the balance sheet. This could therefore affect shareholder value or at least the perception of it…
Ø The economic risk: this could affect the long term competitiveness. The perfect example of this risk could be what happened with the “Shwinn” company, creating two of its major competitors by sharing too much of their knowledge.
In conclusion, I think that FDI is a solution for now, but could be a problem in the future.
Hi Aurelie,
ReplyDeleteI agree in the fact that FDI could be a problem in the future and that companies like Apple or Tesco are looking for new profits and markets.
But you mention that FDI is a solution for now and not in the future. According to you, why FDI are a solution now ?
You don't think that it's risky to invest so much in all those countries in the sense that they could reverse the situation in the future ?
Thank you,
PY
Hello PY,
ReplyDeleteI think indeed that investing in other countries which could at some point reverse the situation and our current vision of the "business world" is risky.
However, considering the current economic situation in numbers of western countries, I think that if companies want to survive this periode, they have to take some risks. And this implies investing in other countries. FDI will give advantages to companies investing like for example allowing them to have access to new markets.
On the other side, if it gives them an advantage they need now, it could be a problem in the future when/if they want to "break the deal" and go their own way. Indeed, once the direct investment company will have learnt everything they have to learn from their partner, there will be a risk that they will want to go their own way, which could be a disastre for the direct investor company.
As a conclusion, i think FDI, as all business decision, must be taken aware of all the risks that could happen.