The benefits of FDI
It is important to understand why a firm takes a decision to invest in foreign countries when low-risk alternatives to cater to foreign markets, such as exporting and licensing, are already available. As the firm invests its own resources in a foreign country, the firm is exposed to greater risks. Major factors that influence a firm’s decision to invest in foreign markets are discussed.
Cost of transportation: Higher costs of transportation between the production facilities and geographically distant markets make it economically unviable for firms to compete or enter such markets. Substantial costs of transportation have to be incurred for marketing products in countries located at larger geographical distances.
For a product with low unit value, i.e., value to weight ratio, such as steel, fast food, cement, etc., the cost of transportation has much larger impact on its competitiveness in foreign markets compared to a high-unit value product, such as watches, jewellery, computer processors, hard-disks, etc.
Therefore, for low-unit value products, it becomes more attractive to manufacture the products in the foreign country itself either by way of licensing or FDI.
Liability of foreignness: A firm’s unfamiliarity with the host country and lack of adaptation of business practices in a foreign country often result in a competitive disadvantage vis-a-vis indigenous firms. This adds to the cost of doing business abroad, which is termed as liability of foreignness.
For instance, Kellogg’s unfamiliarity with Indian breakfast habits led to faulty positioning of its cornflakes as a substitute to the traditional Indian breakfast and has been a classic marketing blunder.
It took several years for Kellogg’s to understand the centrality of its traditional food in India’s lifestyle before repositioning its cornflakes as a complementary rather than a substitute to the Indian breakfast. In another instance, Disneyland failed miserably in its French venture primarily due to lack of product adaptation in view of significant differences in customers’ preferences in Europe vis-a-vis the US market.
It has to arrive at a trade-off between scale benefits from concentrating production at a single location and exporting or benefits of FDI, such as proximity of production locations, higher level of control, and gaining better access to the market.
Benefits of FDI
Potential benefits of FDI to host countries include the following
1. Access to superior technology: Foreign firms bring superior technology to the host countries while investing. The extent of benefits depends upon the technology spill-over to other firms based in the host country.
2. Increased competition: The investing foreign firm increases industry output, resulting in overall reduction in domestic prices, improved product or services quality, and greater availability. This intensifies competition in host economies, resulting in net improvement in consumer welfare.
3. Increase in domestic investment: It is found that capital inflows in the form of FDI increase domestic investment so as to survive and effectively respond to the increased competition.
4. Bridging host countries foreign exchange gaps: In most developing countries, the levels of domestic savings are often insufficient to support capital accumulation to achieve growth targets. Besides, the level of foreign exchange may be insufficient to purchase imported inputs. Under such situations, the FDI helps in making available foreign exchange for imports.
