Chapter 17

Foreign Direct
Investment and
Political Risk

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Key Focus Areas

Competitive Advantage

When does a firm start

considering investing abroad?

Modes of Foreign
Investment

How to invest abroad and the

pros and cons of each option?

Political Risks

We look into the different

types of political risks:
Firm- Specific, CountrySpecific and Global-Specific

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Sustaining and Transferring Competitive Advantage

Key question to answer before a firm decides to invest abroad is
Whether it has a sustainable Competitive Advantage
Yes

Firm-specific: Difficult for other firms

to replicate

No

Need to consider whether

to invest abroad

Transferable: The firm should be

able to transfer the competitive
advantage in new markets

Powerful: enough to compensate the

firm for the potential disadvantages
of operating abroad

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Sustaining and Transferring Competitive Advantage

Economies of Scale and Scope

Can be developed in production,

marketing, finance, research and
development, transportation, and
purchasing
Large size is a major contributing factor
(due to international and/or domestic
operations)
Managerial and marketing expertise

Includes skill in managing large industrial

organizations (human capital and
technology)
Also encompasses knowledge of modern
analytical techniques and their
application in functional areas of
business
Highly differentiated marketing strategy
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Largest automobile manufacturer

by output

As an important part of Japans economy,

Toyota had access to emergency loans from
state lenders during 2009 totalling approx.
US$ 3 billion

Offer a small number of products

and focus on high end
Create a halo effect that makes people crave
for new Apple products
Maintain customer touch-points and
provide a unique experience by selling
products through their own Apple stores in
various countries
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Sustaining and Transferring Competitive Advantage

Advanced technology

Includes both scientific and engineering

skills
Includes any patented technology/
intellectual property that the company
may have

Leading Oil & gas company in terms of

patents
Technology edge acquired by
investments in R&D result in them being
a leader globally for Oil & Gas
exploration

Financial strength

Demonstrated financial strength by

achieving and maintaining a global cost
and availability of capital
This is a critical competitive cost variable
that enables them to fund FDI and other
foreign activities

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Global revenue in 2014 was US$ 485 billion

Uses its financial prowess to develop
supply chain in all the countries that it
establishes its base

Sustaining and Transferring Competitive Advantage

Differentiated products and services

Firms create their own firm-specific

advantages by producing and marketing
differentiated products
Such products originate from researchbased innovations or heavy marketing
expenditures to gain brand identification

Most successful electric car

manufacturer globally

The speed of innovation launching new

products and services have ensured they
are way ahead of competition
Superior battery characteristics and
establishing supercharging network

Competitiveness of the home market

A strongly competitive home market can

sharpen a firms competitive advantage
relative to firms located in less
competitive ones
This phenomenon is known as the
competitive advantage of nations and
has four components as shown in Exhibit
17.1
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Japanese car manufacturers operate in a

domestic market which is highly
competitive

When these firms operate in foreign

markets they implement the best practices
acquired in their local markets
6

Exhibit 17.1 Determinants of National Competitive Advantage:

Porters Diamond

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How to Invest Abroad: Modes of Foreign Involvement

Exporting Versus Production Abroad
Example

Manufactured in
UK and exported

Exporting has none of the unique risks

facing FDI, joint ventures, strategic
alliances and licensing with minimal
political risks

The amount of front-end investment is

typically lower than other modes of
foreign involvement
Agency costs such as monitoring and
evaluating foreign units are also
avoided
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Majority of the markets

Toyota manufactures/
assembles locally

The firm is not able to internalize and

exploit the results of its R&D effectively
as if it is invested directly
Some disadvantages include the risks of
losing markets to imitators and global
competitors

11

How to Invest Abroad: Modes of Foreign Involvement

Licensing and Management Contracts Versus Control of Assets Abroad
Example

Operates in Malaysia
through a licensing
agreement with local
company Naza

Licensing is a popular method for

domestic firms to profit from foreign
markets without a large commitment of
funds
Since the foreign producer is typically
wholly owned locally political risk is
minimized

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The foreign company can gain from the

connections of the local player and the
local player gains the managerial and
technological expertize

Operates in Slovakia
through a 100% owned
subsidiary manufacturing
.3 million cars every year

License fees are lower than FDI profits

Possible loss of quality control
Establishing possible competitors
Technological improvements by the
licensee which then enter your home
market
Possible loss of FDI opportunity at a
later date
Risk that technology will be stolen
High agency costs
12

How to Invest Abroad: Modes of Foreign Involvement

Joint Venture Versus Wholly Owned Subsidiary
Example

Operates in Malaysia
through a JV
agreement with UMW

A joint venture is here defined as shared

ownership in a foreign business
Better understanding of local customs,
mores and institutions of government
Providing for capable mid-level
management
Some countries do not allow 100%
foreign ownership
Local partners have their own contacts
and reputation
Local partners may possess key
technology
Public image may be enhanced by
partnering with a local company
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Operates in US through
a 100% wholly owned
subsidiary

However, JVs are not as common as 100%owned foreign subsidiaries as a result of:
Increased political risk if the wrong
partner is chosen
Divergent views about the need for cash
dividends, or the best source of funds
for growth (new financing versus
internally generated funds)
Transfer pricing issues
Control of financing
Difficulties in the ability to rationalize
production on a worldwide basis
Issues with increased financial
disclosure
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Political Risk and Classification

In addition to business and foreign exchange risks FDI faces political risks
In order for an MNE to identify, measure and manage its political risks, it
needs to define and classify these risks as below:

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14

Management Strategies for Country-Specific Risks

Country specific risks affect all firms, domestic and foreign in a host country

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18

Global-Specific Risks and Various Management Strategies

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Executive Summary
Foreign Direct Investment and Political Risk
Key Conclusions

Competitive
Advantage

Modes of
Foreign
Investment

Political
Risks

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Companies should start considering foreign investment if they have a

distinct competitive advantage which is unique to the firm, is transferable
and can compensate for the challenges faced by investing abroad
Companies have different options of foreign investment such as
licensing, joint venture, wholly owned subsidiary, the level of foreign
presence and foreign investment increasing in the above sequence
In addition to business and foreign exchange risks FDI faces political
risks which an MNE needs to identify, measure and manage, such
risks are classified as firm specific, country specific and global risk

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UNCTD - Source

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