Foreign Direct Investment

1. Foreign Direct Investment Chapter 7 Instructor Shan A. Garib, Winter 2013

2. Foreign Direct Investment Objectives • FDI creates a new company by two or more existing companies • One company gives up a lot of control • Companies can ALSO invest directly in a foreign market without partnering with a local company • Greenfield – riskiest but avoid entry barriers, retain control and make substantial profits • Acquisitions - This chapter is about the rationale behind FDI and why it might be risky! M&A’s are discussed and considerations before any choice to enter Types of JV are discussed and why use them

3. Foreign Direct Investment Foreign Direct Investment • Involves investing in company or building in another country • Involved acquisition of controlling interest in foreign market • Ways to invest: • Construction of facilitates eg Greenfield • M&A • Investment in JV Reasons for FDI • Prohibition or limits of imports produced in other countries but can build a production in that country • Producing goods in target market eliminates import duties and taxes or permits • Can get skilled local labour in target market often cheaper cost • Can become more competitive

4. Foreign Direct Investment Foreign Direct Investment Reasons for FDI Investment to gain access to closed markets • Key issues to consider: • How important is the market? • How much and what type must be made to gain access • What are the ownership requirements for competing successfully Investment for Intelligence • Mostly high-tech companies • Ask these questions: • Where are the new areas of opportunity • How is business done? • Who should the company get to know? • What is the competition doing?

5. Foreign Direct Investment Foreign Direct Investment Reasons for FDI Taking advantage of lower costs • Low cost labour and raw materials • Seek expertise and innovation for competitive advantage • Key questions to consider: • How important are factor costs • How important is an educated work force • Can company get cost advantages through automation? Investment to enhance competitiveness • Eg first to develop a market • Key issues to consider: • Will the company be first in the market and get comp advantage? • Will entering the market force competitiors to react? • Can company capture market share? • Will your actions to enter take profits away from competition • Can company get preferred distribution?

6. Foreign Direct Investment Common Investment Vehicles • The reason to enter will determine Investment vehicles

7. Foreign Direct Investment Greenfield Investments • Investing in the development of manufacturing facility, office or retail site in foreign markets • Ownership is usually held by parent company as wholly owned subsidies Reasons for making greenfield Investment • Need to construct a specific plant to meet business requirements • Need to avoid environmental liability of an existing plant\ • Avoid expensive retro-fitting of existing plant • Absence of suitable and available partners in a target market • Presence of legal impediments Advantages of Greenfield Investment

8. Foreign Direct Investment Greenfield Investments Advantages of Greenfield Investment • Built to meet exact needs and can accommodate latest tech • Can build corp culture by hiring right ppl and training them • Have 100% control over what it does • Reduced risk of liabilities • Adjust strategies easily Drawbacks of Greenfield Investments • Strategy is complex, expensive and risky • A lot to invest in, plant and equip, dist, hiring etc… • Accusations of being controlled from abroad • Takes time to establish plant and equipment/office, hire • Hard to leave, lots of commitment

9. Foreign Direct Investment Greenfield Investments

10. Foreign Direct Investment Greenfield Investments

11. Foreign Direct Investment Mergers and Acquisitions • Purchase assets and majority ownership of another country • Two businesses are combined • Most successful when two businesses have developed a business relationship- mutual trust and respect • Without this, its is called a hostile takeover • 60-70% acquisitions fail and 90% lose market share Acquisition Considerations • Foreign acquisitions or difficult b/c: Capital • Usually done in cash • Accounting practices may vary • Hard to get valuation info

12. Foreign Direct Investment Mergers and Acquisitions Acquisition Considerations • Foreign acquisitions or difficult b/c: Time • Slow to set up b/c have to find the right company • Locating an acquisition can take 2-5 years • Too long to take advantage of evolving market Legal Restrictions Cultural Considerations • Understand differences Company Background • Know it through research (history, financial situation, reputation, competitiveness) Environmental risks • Make sure there are unknown enviro risks or liabilities

13. Foreign Direct Investment Mergers and Acquisitions Acquisition Considerations • Foreign acquisitions or difficult b/c: Fact Checking • Ensure all facts/figures are correct Developing a relationship • Develop joint objectives Pricing • Rational for pricing must be understood Taxation • Tax planning can max value of an acquisition • Foreign companies not treated the same, not have tax-free offers

14. Foreign Direct Investment Mergers and Acquisitions

15. Foreign Direct Investment Joint Ventures • Tightly coupled form of SA • Two companies make a legal agreement to design. Mfg, manage, market, distribute Reasons for JV: • Get local experts • Access new tech • Get reciprocal access • Fulfil a legal requirement for foreing owned corporations • Share skills Forms of JV: • Unincorporated – legal partnership only, no separate entity, partners maintain ownership in own assests • Incorporated – creation of separate business, shareholders are partners • -no rights to assets but share profits

16. Foreign Direct Investment Joint Ventures

17. Foreign Direct Investment Joint Ventures • Difference between unincorporated JV and standard partnership: • Partners in JV put in financial or skill based assets • Have separate interests in the assists • Operate separate businesses • In partnership, businesses of partners are run together with common goal • Partners in an unincorporated VJ share in profits but not liable for other party losses Deciding what to chose: • Level of risk – with an Incorporate JV a partner is liable for venture company's losses limited to amount of invested in shares • Level of privacy – b/c unincorporated JV is a private agreement it is protected form public scrutiny

18. Foreign Direct Investment Joint Ventures Deciding what to chose: • Accounting – with UNINC. JV partners can retain separate accounts • Legislation – UNINC JV allow flexibility in company legislation • Financing – getting loans is easier with INCORP. JV JV Considerations • Control • Majority control advantages avoid decision deadlocks, prevent leaks of proprietary info • Foreign partner might resent partner • Hard to find local ppl for venture

19. Foreign Direct Investment Joint Ventures JV Considerations • Valuations • Each partner contributes to JV • Value assessed at beginning • Autonomy • JV be independent of two founding partners, with own staff etc • Flexibility and compromise • Common goals make things easy • Continuity • Changes in personnel, policies and boards should be minimized • Exit Strategy • Must set terms for separation

20. Foreign Direct Investment Joint Ventures JV Considerations • Record Keeping • Have a detailed legal agreement • Policies and procedures should cover: • Accounting practices • Budgeting approvals • Capital investment guidelines and restrictions • Sourcing of raw materials • Transfer pricing • Reinvestment or dividend payout • Legal counsel • Partners’ liability insurance • Roles of BOD

21. Foreign Direct Investment Joint Ventures JV Considerations • Record Keeping • Have a detailed legal agreement • Policies and procedures should cover: • Health and safety • Environmental guidelines • HR practices • PR • Conflict resolutions • Confidentiality • Non compete • Exit provisions eg buy-sell agreements

22. Foreign Direct Investment Joint Ventures Advantages of JV • Tap into partners knowledge • Use pre-existing distribution networks • Permit greater flexibility in market entry • Extend knowledge of both partners • Foster complimentary skills Disadvantages of a JV • Choice of personnel from partner might follow how important the JV is to the partner • Local partner often hires local staff • Reputations are tied • JV carries more legal and financial obligations • Exit costs maybe high