In order to expand the horizon of business, large scale businesses with strong domestic image and financial foothold try to enter new markets in other countries to reach more consumers worldwide. This investment in foreign country/ies is known as foreign direct investment (FDI). There are different ways in which a company can enter foreign market
Greenfield investment- in this the company starts its business in another country from scratch.
Mergers- in this type the company works together with another firm in the desired country. However the company going in that country does not have full control over the firm there.
Acquisition- the Company buys out another company in that country so that firm operates under the firm investing. The investing firm have complete control over the functionality of that firm.
Licencing- licencing is the agreement between two or more firms in which the firm authorizes the licensee to use the material and produce what is licenced by the licensor.
Franchising- franchising it the right granted by a firm to market their products in another country for example M.C. Donald’s.( Don Daszkowski, n.d)
All of these ways of entering foreign markets have their pros and cons for example company with little capital or mass expenditure cannot afford to start from scratch similarly some firms do not like to work with another firm so merging is out of their options. Selecting which method to use is completely dependent of the firm’s goals. Today many big firms operating in both emerged and emerging markets engage in foreign direct investment because of the potential growth that can be seen in both the markets. Foreign Direct Investments are not only beneficial for the firms overseas but also for its home and host country. Foreign Direct Investment has both advantages and disadvantages. Some of the advantages of Foreign Direct Investment are:
Brings in foreign investment which means increase in foreign reserve.
Creates employment in the country being invested in
Because of competition people can get high quality products at cheaper rates(Vinish Parikh on Feb 2, 2012)
Foreign Direct Investment also has some disadvantages:
Because the firms will bring newer technology smaller firms will be wiped out of competition
Firms have a chance to become monopoly in that country hence it can charge prices as its wishes.
Companies with newer technology will use it for producing new product which is capital intensive, which in turn will affect the jobs of employees resulting in them losing jobs..(Vinish Parikh on Feb 2, 2012)
Currently there are five countries that are most famous emerging markets in the world and their rapid market development have caught the world’s attention. These are B.R.I.C.S namely Brazil, Russia, India, China and South Africa. These countries have opened new markets for both domestic as well as international firms which are seeking opportunity to expand themselves.
Why Emerged and Emerging Markets Invest in each other
There are several reasons that explain why the firms in these two types of markets invest in each other. Firstly from the emerged market’s point of view, the firms not only want to expand their business over a wide range but also look at how much cost can be saved in doing FDI. Although there may be many reasons but some of the important reasons that make the firm invest in emerging markets are:
The public debt is less than one-third of the GDP in emerging markets and in the future is expected to drop further in the future. High debt level is a barrier to the growth of economy of a country. Also high debt level means less money in the country because most of the country’s money is used to pay back the debts hence the business cannot flourish in such countries. (Two reasons to buy emerging markets, November 9, 2012)
Demographics also play a role in favour of growth of emerging markets. Today the ratio of retirees to active workers is rising rapidly in the developed world. Within two decades, there will be as many non-workers as workers in many developed countries such as Japan and Western Europe. Meanwhile in much of the developing world, the ratio of non-workers to workers is expected to remain steady or fall over the next 20 years. Even in China, with its one-child policy, the ratio is expected to remain below 30% in the next two decades. (Two reasons to buy emerging markets, November 9, 2012)
From the above points it can be deduced that booming economy in the emerging markets means that more opportunities for international business and availability of cheap resources means high output at lower cost. Secondly the policies of governments also play a vital role in emerging markets being invested by the emerged for example China has announced to provide even better policies in order to attract more foreign investment. China has plans to improve the regulatory system governing mergers and acquisitions by foreign companies as well as the mechanism for anti-monopoly assessment of foreign investment. China also intends to implement strict policies regarding the intellectual properties right protection (China vows better environment for foreign investment, September 08, 2012). Also China is reducing its taxes on the profits that international businesses operating in China makes by 50 per cent to encourage more foreign investors to invest in China, however this policy is for those companies that are based in countries, such as the UK, that have double taxation agreements with China (Paul J Davies, July 15, 2012).
Multi-national companies of emerging market countries such as China invest in emerged or developed markets because in some cases firms prefer to produce products which are capital and technology intensive, sometimes the technology required to produce the product is not available in the country that is economically emerging that’s why the firms choose to go to developed markets such as United States, UK and Japan since these countries are technologically more advanced than emerging so the availability of high-end technology is mostly available. Location advantages are also a factor that MNC’s in developing countries need to consider when investing. Advantages of location can be divided into three categories economic, social and political. Economic advantages refer to the country’s factor endowment for example capital, labour, managerial skills, technology and resources as well as transportation and communication and infrastructure. Social or non-economic advantages (or disadvantages) include the language, ethnicity, business customs and culture of different countries. Finally, political advantages include the government’s attitude towards MNCs and certain policies, such as trade barriers and investment regulations that may affect FDI. Location-Specific determinants of FDI are classified into two categories Hierarchical-related advantages and Network-related advantages. Hierarchical-related advantages include distribution of natural and artificial resource endowments such as labour, energy, materials, components and semi-finished goods, international transport and communication costs, investment incentives and disincentives (including performance requirements, etc.) and artificial barriers. Network-related advantages arise essentially from the presence of a portfolio of immobile local complementary assets, which, when organized within a framework of alliances and networks, produce a stimulating and productive industrial atmosphere. Location-specific determinants of FDI can also be classified into supply-demand category where main variables of supply are capital, labour and resources, on the other hand the variable of demand are the market size and also the growth rate of that market. (Piteli, Eleni E.N, Feb 2009)
Difference of reasons and entry strategies between firms of Emerging and Emerged Markets
Firms of emerging and emerged markets may enter each other’s markets in a different pattern for example a Chinese firm intending to enter U.K markets might prefer for instance merging with a UK based firm rather than choosing Greenfield investment or acquisition. On the other hand a UK based firm may enter Chinese markets by choosing to start from scratch i.e. prefer Greenfield investment over other means of market entry. The factors that play a role in deciding the mode of entry are availability and cost of resources for example the UK firm with large capital can find cheap labour and resources for operating and because of its huge capital the firm can choose greenfield investment over other modes or it can acquire a small to medium size firm operating in China. On the other hand the Chinese firm which wishes to enter UK’s market need to see how much expensive the labour and resources are because the labour and resources in UK are much more expensive than the resources in China hence it needs to revise its income and expenditure to see how much it can afford. However if the Chinese firm is a large MNC with a large stock of capital then it can choose to either merge with the firm based in UK or acquire it. But for firms of medium size it is impossible to start from scratch in UK because of lack of capital hence it may prefer merging or licensing over acquisition or Greenfield. Government tax and other restriction policies is also one of the factor that leads to different entry modes for example government in UK may favour small sized businesses to establish well more than medium or large businesses in that case for a Chinese firm investing in UK it is more desirable to enter its markets as a small firm to take advantage of the policies until it becomes a well-established firm in the given market. In China the government policies are not dependent on the size of the firm for example tax rates does not depend on how big or how small the firm is rather is universal and applies to all the firms equally. In that case the US firms going to China have a variety of options available from Greenfield to Franchising and the mode it choose will depend on its purpose of investment i.e. if it chooses Greenfield it will create a new market but will face intense competition from big fishes. When investing into a foreign country a multi-national company does not only have to keep in view the economic and political factor but also social factor. The company needs to know the language spoken there, the culture and traditions and ethical rules followed in that country for example Mc. Donald does not sell beef in India because it’s a culture or a tradition but people do not eat beef there rather vegetables are mostly in their menu. Hence Mc. Donald is still in business in India because it is following the Indian culture. Knowing the culture is as important as knowing the economic and political situation of the country in which the investor intends to invests. By knowing the culture the firm can then create demands accordingly in the new market. Because of the economic, political and cultural differences that exist in the developed and developing countries, the firms within each type of market has different thoughts when it comes to foreign investment because all the firms want to establish well in the new market at the minimum cost.
Emerging markets have become the centre of foreign direct investments over the couple of years. Firms from the developed markets are now concentrating on expanding their businesses in emerging countries such as Brazil, Russia, India, China and South Africa because of their booming economies and relaxation in government policies have been seen as an invitation to foreign firms from the emerging countries. Foreign Direct Investment (FDI) has benefits for both the international firm as well as the host country. Emerging countries also emphasis more on FDI because it creates more job opportunities for host countries it is one of the way of tackling the unemployment problems and bringing its rate down as much as possible. Foreign direct investment also brings in foreign currency so the foreign reserve of the country grows. Foreign direct investment is necessary for any country to grow internationally economically, the more the foreign direct investment the more strong the country will be economically. Due to the volatile political situation in emerging markets it is always difficult to attract more FDI because of the risk factor, however B.R.I.C.S countries have relatively more stable political and economic situation as compared to other emerging markets. Today however China’s situation has become debatable because it is now seen as a threat to the economy of US, which analyst deduce will exceed US’s economy over the years to come. The importance of Foreign Direct Investment is so much that all the countries regardless of whether they are developed or developing are dependent on it very much. FDI can be described as a bridge connecting the home and the host country.