Difference between Organic and Inorganic Growth

Introduction

Growth Strategies enable organisation to follow an expansion route to boosts the profitability of the firm, or to develop new skills and markets. IMI decided to growth because of their high profit margins and excess cash available. There are two primary sections of growth which will be discussed in this section:

• Why do organisations grow?
• What is Organic Growth?
• Advantages and Disadvantages of Organic Growth,
• What is Inorganic Growth, and finally
• What is the difference between Organic and Inorganic Growth?

Why do organisations grow?

There are a myriad of reasons why an organisation wants to grow, and one of the primary reasons is to bring wealth to its shareholders via increased profits. Some of the other reasons why an organisation wants to grow are:

•   Maximization of Profit (maximizing profit for shareholders),
•   Providing a unique service which pertains to a ”gap” in the market,
•   Expansion into new markets due to the current market becoming saturated with their product, or too many competitors (to survive),

Growth strategies are based on market structure and current state of market

What is Organic Growth?
(Louw & Venter, 2009) Defines the term as: Internal Growth as: Organic Growth (growth from within) or intensive growth, internal growth expands sales of existing products. The primary aim of organic growth is to retain the current customer base by providing them with new products or services, and seeking new customers. (Louw & Venter, 2009, pp. 215-216)
Ansoff’s matrix identifies the following growth areas: Market Penetration, Market Development, Product Development and Diversification.
Thus organic growth can be classified as the strategies which the organisation employs to grow from within the organisation. When an organisation uses organic growth as a growth strategy then it usually re-invests profits to increase production or operations capacity, which enables them the ability to sell more products to customers

What is Inorganic Growth?(Louw & Venter, 2009) Defines the term as: through diversification (external growth), an organisation adds new businesses to its current stable. A diversified business is synonymous with a multi-business organisation operating in two or more industries. Supplying new products, venturing into new markets or franchising other companies products are examples of diversification. (Louw & Venter, 2009, pp. 217-218)
Inorganic growth is growth factors from the external environment, which the organisation can do when they merge or acquire another firm.

Inorganic Growth can be accomplished in three ways:

• Acquisitions: Acquisitions entail the purchase of assets and skills of a takeover target.
• o (Smit, et al., 2011) States “When one organisation takes over another and clearly establishes itself as the new owner, the purchase is called an acquisition. The buyer organisation ‘swallows’ the other and the buyer’s shares continue to be traded (Smit, et al., 2011, p. 119)
• Mergers: Mergers entail the pooling of resources between two or more organisations of equal size
• o (Smit, et al., 2011) States a merger takes place when two organisations – of then of about the same size- agree to operate as a single new organisation.” Example of this the merger of Daimler-Benz and Chrysler to form DaimlerChrysler  (Smit, et al., 2011, p. 119)
• Intraprises: Internally funded ventures (Intraprises) launched to exploit mew markets, products or services.

What is the difference between Organic and Inorganic Growth?

 

The primary differences between organic and inorganic growth is:

• Organic is on the basis of internal growth, while inorganic is bases on external factors(mergers, acquisitions),
• Organic especially prevalent during the early stages of a firm when new markets are built and products are being developed, while inorganic growth is usually prevalent during the later stages of the product life cycle,
• Organic Growth is usually often safer than inorganic (externally generated) growth because it can be more difficult and riskier to acquire and integrate another existing business into an existing company
• Organic Growth is usually a slower option compared to inorganic growth

Conclusion
An organisation must choose organic growth or inorganic growth for its growth strategies, based on where it is in the product life cycle. If the product is in its infancy stage then it is better to establish an organic growth strategy. But if the product is in the later part of the product life cycle then it is better to choose an inorganic growth strategy via diversification.

Bibliography
Louw, L., & Venter, P. (2009). Strategic Management - Winning in the Southern African Workplace (3rd ed.). Oxford - Southern Africa.
Smit, P. J., Cronje, G. J., Brevis, T., & Vrba, M. J. (2011). Management Principles (5th ed.). Juta.
Wilinson, N. (2005). Managerial Economics, A problem solving approach (1st ed.). Cambridge University Press.

What is international expansion strategy?

According to (Czinkota, et al., 2011) an international expansion strategy is based on the decision to diversify the market and client base to gain greater profits. The strategic decision revolves around a “greenfield investment” which entails building a firm from the ground up, or purchasing an existing firm via mergers and acquisitions. (Czinkota, et al., 2011, p. 88)

The internationalisation strategy is based on obtaining additional profits by expanding into a foreign country via Greenfields investment or via mergers and acquisitions. There are several advantages and disadvantages of these strategic decision implementations.

Diebold decided that it will focus on Acquisitions as their international expansion strategy.

Choosing a Strategy

(Hill, 2013) contents that an organisation could be faced with a situation where it cannot serve the global marketplace from a single low-cost location, producing a globally standardised product, and marketing it worldwide to attain the cost benefits associated with experience benefits. (Hill, 2013, p. 435)

Based on this (Hill, 2013) defines that there are four basic strategies to be able to be able to compete successfully internationally:

• Global Standardization Strategy
• Transnational Strategy
• International Strategy
• Localization Strategy  (Hill, 2013, p. 435)

What is Global Strategy?

(Hill, 2013) argues that the focus for the Global Standardization strategy is to focus on increasing the profitability and profit growth by reaping the cost reductions that come from economics of scale, learning effects, and location economies. The strategic goal is to pursue a low-cost strategy on a global scale (Hill, 2013, p. 436)

Globalisation Standardisation Strategy focuses on the dividing of the organisation into several favourable locations, for example to move the production capabilities to a county with lower labour and production costs.

The organisations following the Global Standardization strategy do not favour customisation of their products, but rather focuses on the production of the same product for multiple markets to reap the maximum benefit of economics of scale.

(Hill, 2013) argues that the Global Standardization strategy are mostly used when there are strong pressures for cost reductions and demands for local responsiveness are minimal, and where there are a global requirement for the product to suit multiple markets. (Hill, 2013, p. 436)

What is multi-domestic strategy?

(Hill, 2013) argues that a multi-domestic strategy is the same as a Localization strategy. The localisation strategy focuses on the increased profitability by customizing the firm’s goods or services so that they provide a good match to tastes and preferences in different national markets. (Hill, 2013, p. 437)

(Hill, 2013) Argues that Localisation Strategy is mostly used when there are substantial differences across nations with regard to consumer tastes and preferences, and where cost pressures are not too competitive (Hill, 2013, p. 437)

The organisation can benefit from customisation of products to serve the local demand by providing kinds of products which serves the local culture and local flavour. The organisation will as well have an increase in cost of production, as the products needs to be modified for each kind of market it serves.

What is transnational strategy?

(Hill, 2013) A Transnational Strategy is used when the organisation faces both strong cost pressures and strong pressures for local responsiveness. A transnational strategy try to simultaneously achieve low costs through location economies, economics of scale, and learning effects; differentiation of their product across geographic markets to account for local differences.  (Hill, 2013, p. 437)

A Transnational Strategy enables the organisation to compete on multiple markets where local responsiveness is required. This will add additional constraints onto the organisation due the conflicting demands being placed onto the organisation, which can in turn raise the cost of production. Few organisations perfected this approach.

What is an international strategy?

(Hill, 2013) Argues that an International Strategy is taking products first produced in their domestic market and selling them in the international markets with minimal customizations (Hill, 2013, p. 438)

The base products produced would serve a wider audience, as the products are modified for use in the foreign market. These organisations usually face little competition and by using this strategy the organisations are not faced with the same cost structure challenges as Globalisation organisations.  Product development is usually centralized in one place and manufacturing and marketing operations are usually performed in each major country where they perform business.

Market Entry Modes

Entry Mode	Description
Exporting	Exporting of Goods and services to a foreign country Initial method of gaining market share Challenge: High import tariffs can cause the product to be sold at a higher premium Acceptance: Widely accepted practice
Turnkey Projects	The contractor agrees to handle every detail of the project for a foreign client, including the training of operational personnel Challenge: The firm has no long term interest into the country and may prove disadvantageous if it want to expand operations, Acceptance: Widely accepted practice
Licencing	Licencing agreement, which transfers the rights, production technologies and operating procedures to another organisation, Challenge:  High licencing costs, and production/product details unknown in target country. Support can be inefficient due to time zone differences or language barriers, Acceptance: Widely accepted practice
Franchising	A organisation which grants a secondary party the rights to perform business via its brand (this includes as well the operational guidelines to maintain business) Challenge: Franchising costs can be high, and foreign countries does not necessarily know the demographics of a secondary country, Acceptance: Widely accepted practice
Joint Venture	Sharing of ownership between multiple organisations to gain market penetration (Foreign and Local), Challenge: Loosing the original companies core brand and operating model which made them successful, Acceptance: Widely accepted practice
	Strategic Alliances Sharing of production facilities by foreign and local organisations, or to develop new products together under the local company’s umbrella
Wholly owned subsidiary	Greenfield Establishing a totally new organisation (manufacturing from scratch). This can be in the form of a new wholly owned subsidiary in a foreign country, Challenge: Huge amount of setting up costs involved and risk of brand not being accepted, Acceptance: Accepted practice
	Acquiring Existing Firm Purchasing an existing firm with an existing product and market base, Challenge: risk of new brand not being accepted, Acceptance: Widely accepted practice

Entry mode Advantages and Disadvantages

(Hill, 2013) states the following advantages and disadvantages of the Entry Modes:

Entry Mode	Advantages	Disadvantages
Exporting	Ability to realize location and experience curve economics	High transport costs Trade barriers Problems with marketing agents
Turnkey Projects	Ability to earn returns from process technology skills in countries where FDI is restricted	Creating efficient competitors Lack of long term market presence
Licensing	Low development costs and risks	Lack of control over technology Inability to realize location and experience curve economies Inability to coordinate global strategy coordination
Franchising	Low development costs and risks	Lack of control over quality Inability to engage in global strategic coordination
Joint Ventures	Access to local partnets knowledge Sharing development costs and risks Politically acceptable	Lack of control over technology Inability to engage in global strategic coordination Inability to realize location and experience economies
Wholly owned subsidiaries	Protection of technology Ability to engage in global strategic coordination Ability to legalize location and experience economies	High costs and Risks

(Hill, 2013, p. 499)

Some additional benefits for Mergers and Acquisitions include:

• Increased Market Share – Ability of an organisation to increase its market share by acquiring an existing firm,
• Reducing Costs – Foreign market may have lower resource costs,
• Diversification – Being able to produce new products based on the knowledge gained from the acquired firm,
• Greater Value Generation – May lead to increased value generation for the company,
• Market Penetration – Allows the firm to penetrate the market via existing relationships and customer base.
• Synergies - take advantage of each other’s core competency, and
• Acquiring Customers – Acquisition of existing customer base of acquired firm

 

Acquisitions

(Smit, et al., 2011, p. 119) states “When one organisation takes over another and clearly establishes itself as the new owner, the purchase is called an acquisition. The buyer organisation ‘swallows’ the other and the buyer’s shares continue to be traded”   Acquisitions is when a organisations purchases another country to gain control over the management and assets of the purchased company

Advantages of Acquisitions

(Hill, 2013) identifies the following Advantages of Acquisitions:

• Quick to execute – A firm can rapidly build its presence in the target foreign country
• Pre-empt their competitors – The need for pre-emption’s particularly great in markets that are rapidly globalizing, where a combination of deregulation within nations and liberalization of regulations governing cross-border FDI has made it much easier for foreign enterprises to enter the market through acquisitions
• Less Risky than Greenfields – When a firm makes an acquisition, it buys a set of assets that are producing known revenue and profit stream. In contrast the revenue and profit stream that a greenfield venture might generate is uncertain as it does not exist

(Hill, 2013, pp. 501-502)

 

Disadvantages of Acquisitions

(Hill, 2013) identifies the following disadvantages of Acquisitions:

• Erode Stakeholder Value - Often produce disappointing results of the acquired firm (acquired firm providing lower than expected profits)
• Loss of Market Share – The existing customer base may be loyal to the original brand, and by changing the brand, the market share may be eroded
• Overpaying - Acquiring firms often overpay for the assets of the acquired firm
• Clash of cultures – After a acquisition, many acquired organisations experience a high management turnover, possibly because the original firm does not like the new firms culture or way of doing business
• Failed Synergies - Attempts to realize synergies by integrating the operations of the acquired entities often run into roadblock and take much longer to forecast
• Inadequate pre-acquisition screening – many firms decide to acquire other firms without thoroughly analysing the potential benefits and costs

(Hill, 2013, pp. 501-502)

Mergers

What are mergers?

(Parkin, et al., 2005) Identifies a merger as when the assets of two or more firms are combined into a single new firm (Parkin, et al., 2005, p. 319)

(Smit, et al., 2011) States “A merger takes place when two organisations – of then of about the same size- agree to operate as a single new organisation.” Example of this the merger of Daimler-Benz and Chrysler to form DaimlerChrysler (Smit, et al., 2011, p. 119)

A Merger is a transaction whereby two companies combine to become one company or a new company is formed.

According to (Wilinson, 2005) There are several types of Mergers:

• Horizontal merger – occurs when two companies engaged in the same stage of production of the same good come together.
• Vertical merger – occurs between two firms in the same industry but engaged in different stages of the production of the good. The merger can be either forward (towards the end customer) or backward (towards the supplier of raw materials).
• Conglomerate merger – occurs between companies that operated in different markets
• Market Extension merger -> Merging of two companies/organisations selling the same kind of products in different geographical markets,
• Product-extension merger -> Merging of two companies/organisations selling related products in the same market,
• Purchase Mergers -> One company/organisations is purchased by another at a reduced rate (paid less for than its assets is worth) to expand its product base,
• Consolidation Mergers -> Two companies/organisations merge to form a total new company/organisation. (Wilinson, 2005, p. 493)

 

Some additional disadvantages for Mergers and Acquisitions include:

• Difficult to control – The acquired firm may be hard to control due to its size and different culture,
• Increased Costs – The additional operations costs of the acquired firm may add an additional burden on the host

Some additional benefits for Mergers and Acquisitions include:

• Increased Market Share – Ability of a organisation to increase its market share by acquiring a existing firm,
• Reducing Costs – Foreign market may have lower resource costs,
• Diversification – Being able to produce new products based on the knowledge gained from the acquired firm,
• Greater Value Generation – May lead to increased value generation for the company,
• Market Penetration – Allows the firm to penetrate the market via existing relationships and customer base.
• Synergies - take advantage of each other’s core competency, and
• Acquiring Customers – Acquisition of existing customer base of acquired firm
• Some additional disadvantages for Mergers and Acquisitions include:
• Difficult to control – The acquired firm may be hard to control due to its size and different culture,
• Increased Costs – The additional operations costs of the acquired firm may add a additional burden on the host

The following threats are present when companies merge:

• Competitiveness -> Due to core business focus change or loss or due to changing markets due to merger,
• Job losses -> Due to cost cutting, re-engineering of business or product focus changes,
• Cultural Differences -> Differences between Organisational Behaviour, country specific against global culture differences

Mergers can be used when both companies agree on the merging of it to gain a positive market share. Acquisitions form part of the hostile takeover of a company/organisation, when the second company/organisation does not give its consent in the acquisition.

Joint Venture

(Levi, 2005) Identifies a Joint Venture as an alternative technique for reducing the risk of expropriation is to share ownership with foreign private or official partners from the very beginning.. Joint ventures as a means of reducing expropriation risks rely on the reluctance of local partners, if private, to accept the interference of their own government. When the partner is the government itself, the disincentive to expropriate is the concern over the loss of future investments. Joint ventures with multiple participants from different countries reduce the risk of expropriation, even if there is no local participation, if the government wishes to avoid being isolated simultaneously by numerous foreign powers. (Levi, 2005, p. 388)

Joint ventures allow a foreign company to partner with a local country to perform services into the local marketplace, where the local partner carries the knowledge of the local
 

Advantages of Joint Venture

(Hill, 2013) states the following advantages of Joint Ventures:

• Knowledge - A firm benefits from a local partners knowledge of the host country’s competitive conditions, culture, language, political systems and business systems,
• Cost  Saving - When the development costs and/or risks of opening a foreign market are high, a firm might gain by sharing these costs and/or risks with a local partner,
• Political Environment - In many countries, political considerations make joint ventures the only feasible mode of entry

(Hill, 2013, p. 497)

 

Disadvantages of Joint Venture

(Hill, 2013) states the following disadvantages of Joint Ventures:

• Loss of Control - As with licensing, a firm that enters into a joint venture risks giving control of its technology to its partner
• Loss of Control of Coordination - A Joint venture does not give a firm the tight control of subsidiaries that it might need for engaging in coordinated global attacks against its rivals
• Conflict of Objectives - The shared ownership arrangement can lead to conflicts and battles for control between the investing firms if their goals and objectives change or if they take different views as to what the strategy should be (Hill, 2013, pp. 497 - 498)

 

What is a wholly owned subsidiary?

(Hill, 2013) defines a wholly owned subsidiary as: When a firm owns 100% of the stock of another firm. Establishment of the wholly owned subsidiary can be done in two ways:

• Greenfield – Setting up of a new venture, or
• Acquisition – Acquiring of an existing firm in the host country (Hill, 2013, p. 498)

 

Advantages of a wholly owned subsidiary

(Hill, 2013) states the following advantages of a wholly owned subsidiary:

• Keeping Control - When a firms competitive advantage is based on technological competence, a wholly owned subsidiary will often be preferred because it reduces the risk of losing control over that competence
• Operational Control - Gives a firm tight control over operations in different countries
• Location and experience curve economics  - May be required if a firm is trying to realize location and experience curve economics
• 100% Profit - Gives a firm 100% share in the profits generated in the foreign market (Hill, 2013, p. 498)

 

Disadvantages of a wholly owned subsidiary

(Hill, 2013) states the following disadvantages of a wholly owned subsidiary

• Costly investment - The most costly method of serving a foreign country from an investment standpoint
• Increased cultural risk - Risks associated with learning to do business in a new culture are greater (Hill, 2013, p. 499)

Bibliography

Czinkota, M. R., Ronkainen, I. A. & Moffett, M. H., 2011. International Business. 8th ed. s.l.:John Wiley & Sons, Inc..

Hill, C. W., 2013. International Business: Competing in the Global Marketplace. 9th ed. s.l.:McGraw Hill Eductions IRWIN.

Levi, M. D., 2005. International Finance. 4th ed. s.l.:Routledge.

Parkin, M., Powell, M. & Matthews, K., 2005. Economics. 6th ed. s.l.:Pearson.

Smit, P. J., Cronje, G. J., Brevis, T. & Vrba, M. J., 2011. Management Principles. 5th ed. s.l.:Juta.

Wilinson, N., 2005. Managerial Economics, A problem solving approach. 1st ed. s.l.:Cambridge University Press.

 

 

Foreign Direct Investment

What is FDI?

(Hill, 2013) States that Foreign Direct Investment occurs when the organisation invest into sources which are outside of their local country (Hill, 2013, p. 11)

According to (Rugman & Collinson, 2006) Foreign Direct Investment (FDI) can be equity funds investment in foreign countries which are executed by Multi-National Companies/Enterprises to establish footholds in foreign markets by Greenfields investment or mergers/acquisitions (Rugman & Collinson, 2006, p. 7.)

In essence, Foreign Direct Investment occurs when the organisation invests directly into new or existing products or services to produce or sell goods or services in a new market.

Why international business is complex and risky

According to (Hill, 2013) there are several risks in doing business in international markets: Cost of setting up production facilities in foreign market can be high, Political and Economic environments may be different,  Culture and language differences, additional administrative burdens may be placed on the multinational organisation. (Hill, 2013, p. 402)

Factors that explain preference for FDI

According to (Czinkota, et al., 2011) the theme of FDI is a global business environment that attempts to satisfy increasingly sophisticated consumer demands, while the means of production, resources, skills, and technology needed become more complex and competitive. The theory of FDI is eclectic representing a collection of forces and drivers.  (Czinkota, et al., 2011, p. 88)

According to (Czinkota, et al., 2011) there are three types of firms, and each type seek to explain the different types of factors to explain the preference of FDI: (Czinkota, et al., 2011, pp. 88-90)

Firms as Seekers

According to (Czinkota, et al., 2011) a firm that expands across borders may be seeking any of a number of specific sources of profit or opportunity

• Seeking Resources – firms seeking unique and valuable natural resources for their products
• Seeking Factor Advantages – Seeking production saving resources, for example – low cost labour. As noted by Vernon’s product cycle, the same firms may move their own production to locations of factor advantages as the products and markets mature.
• Seeking Knowledge – Firms may attempt to acquire other firms in other countries for the technical or competitive skills they possess
• Seeking Security – Firms continue to move internationally as they seek political stability or security
• Seeking Markets - the ability to gain and maintain access to markets is of paramount importance to multinational firms (Czinkota, et al., 2011, pp. 88-90)

Firms as Exploiters of Imperfections

According to (Czinkota, et al., 2011) many of the policies of governments create imperfections. These market imperfections cover the entire range of supply and demand of the market: trade policy (tariffs and quotas), tax policies and incentives, preferential purchasing arrangements established by governments themselves, and financial restrictions on the access of foreign firms to domestic capital markets

• Imperfections in access - Many of the world’s developing countries have long sought to create domestic industry by restricting imports of competitive products in order to allow smaller, less competitive domestic firms to grow and prosper. Multinational firms have sought to maintain their access to these markets by establishing their own productive presence within the country, effectively bypassing the tariff restriction
• Imperfections in factor mobility - Other multinational firms have exploited the same sources of comparative advantage —the low-cost resources or factors often located in less-developed countries or countries with restrictions on the mobility of labour and capital.
• Imperfections in management - The ability of multinational firms to successfully exploit or at least manage these imperfections still relies on their ability to gain an ‘‘advantage.’’ Market advantages or powers are seen in international markets as in domestic markets: cost advantages, economies of scale and scope, product differentiation  managerial or marketing technique and knowledge, financial resources and strength (Czinkota, et al., 2011, pp. 88-90)

Firms as Internalizers

According to (Czinkota, et al., 2011) the research of Buckley and Casson and Dunning has attempted to answer these questions by focusing on non-transferable sources of competitive advantage—proprietary information possessed by the firm and its people. Many advantages firms possess centre around their hands-on knowledge of producing a good or providing a service. By establishing their own multinational operations they can internalize the production, thus keeping confidential the information that is at the core of the firm’s competitiveness. Internalization is preferable to the use of arms-length arrangements such as management contracts or licensing agreements. They either do not allow the effective transmission of the knowledge or represent too serious a threat to the loss of the knowledge to allow the firm to successfully achieve the hoped-for benefits of international investment.  (Czinkota, et al., 2011, pp. 88-90)

Some of the primary reasons why Firms prefer FDI to exporting and licencing is:

• Transportation Costs – Foreign countries product costs are affected by high shipping costs and it can become unprofitable to transport the products over long distances.
• Market Imperfections - According to the market imperfections approach, the organisation needs to determine need to find some sort of imperfection to justify how its competitive advantage can be justified against the additional cost of the complexities of international investment. Based on the approach of imperfections and the organisation can gain a competitive advantage in the new market. The Market imperfections approach explains why FDI is preferred over licensing or exporting.
• Strategic Behaviour - Knickerbocker’s theory is based on the strategic rivalry between firms in the global market place, and the imitative behaviour between firms and the oligopolistic nature of the relationship between firms. This theory does not explain why FDI is preferred over licensing or exporting
• Location Specific Advantages – The Eclectic paradigm of Dunning specifies that firms chase location specific advantages in combination with specific industry and product knowledge
• Product Life Cycle Theory - Vernon’s theory of Product Life Cycle argued that firms undertake Foreign Direct Investment during particular stages in the life cycle of the product they have pioneered. The will then start with investment in other advanced countries when the local demand grown to such to the extent that they can expand operations in to other markets. Thus his theory is based on the method of investing in a foreign country based on cost pressures, and does not explain why FDI is preferred over licensing or exporting.  (Czinkota, et al., 2011, pp. 88-90)

Market Imperfections Approach

(Hill, 2013) indicates that the internalization theory is also known as the market imperfections approach. The internalization theory seeks to explain why firms often prefer FDI to licensing as a strategy for entering foreign markets. (Hill, 2013, p. 258) According to (Czinkota, et al., 2011) market imperfections are created by Government policies. These market imperfections cover the entire range of supply and demand of the market: trade policy (tariffs and quotas), tax policies and incentives, preferential purchasing arrangements established by governments themselves, and financial restrictions on the access of foreign firms to domestic capital markets

The organisation needs to determine need to find some sort of imperfection to justify how its competitive advantage can be justified against the additional cost of the complexities of international investment.

The following imperfections can exist:

1. Imperfections in access: Some smaller developing countries have policies to promote production of local content, Multinational firms have sought to maintain their access to these markets by establishing their own productive presence within the country, effectively bypassing the tariff restriction
2. Imperfections in factor mobility: combining the mobility of capital with the immobility of low-cost labour has characterized much of the foreign direct investment seen throughout the developing world
3. Imperfections in Management: The ability of multinational firms to successfully exploit or at least manage these imperfections still relies on their ability to gain an ‘‘advantage.’’ Market advantages or powers are seen in international markets as in domestic markets: cost advantages, economies of scale and scope, product differentiation, managerial or marketing technique and knowledge, financial resources and strength. (Czinkota, et al., 2011, p. 89)

Vernon’s Product Life Cycle Theory

(Czinkota, et al., 2011)  States the Product Life Cycle Theory as a theory that a product passes through four stages: Introduction, Growth, Maturity and decline. The production of the products location moves from industrialized to low-cost developing countries. (Czinkota, et al., 2011, p. 77)

According to (Hill, 2013) argued that often the same firms that pioneer a product in their home markets undertake FDI to produce a product  for consumption in foreign markets. Vernon argued that firms undertake Foreign Direct Investment during particular stages in the life cycle of the product they have pioneered. The will then start with investment in other advanced countries when the local demand grown to such to the extent that they can expand operations in to other markets. They can as well shift production to developing countries where the production costs will be lower due to saving costs due to increasing market and price competition.

The product life cycle consists of the following stages:

• Developing the new product – Building a new product from innovative ideas, designing the product and initially manufactured locally.
• Maturing of the product - As the product matures; production costs needs to be reduced, as well as how to maintain the products market share. Vernon argues that the firm faces a critical decision at this stage, either to lose market share to foreign-based manufacturers using lower-cost labour or to invest abroad to maintain its market share by exploiting the comparative advantages of factor costs in other countries
• Standardized Product – In the final stage the product is standardized in its manufacturing capabilities and continuous cost saving measures are put in place to optimize profits. According to Vernon. As knowledge and technology continually change, so does the country of that product’s comparative advantage.  (Hill, 2013, p. 260)
• Developing the new product – Building a new product from innovative ideas, designing the product and initially manufactured locally.
• Maturing of the product - As the product matures; production costs needs to be reduced, as well as how to maintain the products market share. Vernon argues that the firm faces a critical decision at this stage, either to lose market share to foreign-based manufacturers using lower-cost labour or to invest abroad to maintain its market share by exploiting the comparative advantages of factor costs in other countries
• Standardized Product – In the final stage the product is standardized in its manufacturing capabilities and continuous cost saving measures are put in place to optimize profits. According to Vernon. As knowledge and technology continually change, so does the country of that product’s comparative advantage.  (Hill, 2013, p. 260)
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Knickerbocker’s Theory of FDI

According to (Hill, 2013) Knickerbocker introduced the concept of multipoint competition which arises when two or more enterprises encounter each other in different regional markets, national markets, or industries. These firms will then mimic each other and try to keep each other in check, and so ensuring that its competitors does not obtain a commanding position in the market.  (Hill, 2013, p. 260)

There is a great interdependence between these organisations (imitative behaviour), and if one of these firms produces a new product then all these other oligopolistic firms must respond. For Example if one of the firms in the oligopoly lowers its prices then it can have an immediate impact on its major competitors and so can take away market share away from its competitors, and so forcing its competitors to lower prices as well. Organisations in an oligopoly tend to imitate each other’s Foreign Direct Investment strategies.

Which theory offers the best explanation of the historical pattern of horizontal FDI?

Vernon’s theory of Product Life Cycle argued that firms undertake Foreign Direct Investment during particular stages in the life cycle of the product they have pioneered. The will then start with investment in other advanced countries when the local demand grown to such to the extent that they can expand operations in to other markets. Thus his theory is based on the method of investing in a foreign country based on cost pressures, and does not explain why FDI is preferred over licensing or exporting.

Knickerbocker’s theory is based on the strategic rivalry between firms in the global market place, and the imitative behaviour between firms and the oligopolistic nature of the relationship between firms. This theory does not explain why FDI is preferred over licensing or exporting.

According to the market imperfections approach, the organisation needs to determine need to find some sort of imperfection to justify how its competitive advantage can be justified against the additional cost of the complexities of international investment. Based on the approach of imperfections and the organisation can gain a competitive advantage in the new market.

The Market imperfections approach explains why FDI is preferred over licensing or exporting.

(Hill, 2013) specifies the reasons why the market imperfections approach is the best way of explaining the historical pattern of FDI is:

• The Market imperfections approach addresses the components of Knickerbocker’s and Product Life Cycle theories,
• Vertical FDI enables the firm to reduce its risk into the new market and ensure its exposure is minimized when moving into an imperfect market,
• Market imperfections approach shows how the firm are driven to establish its competitive advantage and exploit imperfections in the market to drive the profits of the organisation, (Hill, 2013, p. 258)

What is inward FDI?

(Hill, 2013) argues that governments offer many incentives for foreign countries to invest in their countries. Inward Foreign Direct Investment is when local Government promotes investment from Foreign Countries and Foreign Firms to invest in their country. Foreign Direct Investment policies are usually to support the Governments development objectives which include infrastructure development, growth and job creation. (Hill, 2013, p. 273)

What Determines a countries FDI Strategy?

(Hill, 2013) Defines the following components of countries Foreign Direct Investment Strategy:

• A Countries Development Objectives, and
• the degree of policy intervention and factor endowments (Hill, 2013, p. 273)

A Countries Development Objectives and policies in conjunction with the local market conditions, determine the country’s Foreign Direct Investment Strategy.

Why do Governments promote inward Foreign Direct Investment?

According to (Czinkota, et al., 2011) the multiple countries implement policy measures to attract Foreign Direct Investment.  The reasons why governments want to attract Foreign Direct Investment include the needs of poorer countries to attract additional foreign capital to fuel economic growth without taking out more loans that call for fixed schedules of repayment. One of the reasons why industrialized nations undertake in these efforts is that they are under pressure to provide jobs for their citizens and have come to recognize that foreign direct investment can serve as a major means to increase employment and income.

Governments can initiate policies to promote Foreign Direct Investment, and most investment promotion can be an area for hot competition between countries. (Czinkota, et al., 2011, pp. 55-57)

What Kind of incentives can Governments undertake to promote inward FDI?

According to (Czinkota, et al., 2011) policymakers can facilitate investments into the country by the following three types:

• Fiscal – Includes specific tax measures, designed to attract foreign investors. These measures includes special depreciation allowances, tax credits or rebates, special deductions for capital expenditures, tax holidays, and the reduction of tax burdens on the investor
• Financial - offer special funding for the investor by providing, for example, land or buildings, loans, and loan guarantees – these are several types of financial incentives for foreign countries to promote inward FDI
• Nonfinancial - can consist of guaranteed government purchases; special protection from competition through tariffs, import quotas, and local content requirements; and investments in infrastructure facilities, enhancement of infrastructure, streamlining of processes of production, investment into education, Political, economic and legal stability

The aim of inward FDI and these incentives is motivated by the desire for the local country to gain resources-transfer and employment opportunities, which affects the FDI and to capture the FDI potential from host countries. Successful incentives can attract investors to the country, but if proper market conditions do not exist then investors will turn away from the country as well. The local countries can gain from the employment and resource transfers gained by inward FDI
According to (Hill, 2013) Governments can employ an array of possible Foreign Direct Investment Policies to influence Foreign Direct Investment which includes Locational advantages often refer to such static concepts as access to natural resources. These include Skills, Infrastructure, and Local Supply Services etc. (Hill, 2013, p. 273)

FDI Types

According to (Wang, 2009) there are three major modes of foreign exchange market entry as well as doing business in a foreign country:

• Exporting – Exporting is the marketing and sales for locally produced goods and services to a foreign country. This is the traditional form of developing new markets for the selling of locally produced goods and services in the global market. There is no production in the foreign country, and the organisation need to have knowledge around the foreign country’s local customs and culture.
• Licencing – Permits a firm (licensee) in the foreign country the use of intellectual property of the licensor. These can include intangible assets for example patents and production techniques. Licencing usually yield high returns, but manufacturing and marketing activities may be lost.
• Foreign Direct Investment – Foreign direct investment entails the merger, acquisition or Greenfields investment into the foreign country to establish production capabilities in the foreign market. (Wang, 2009, p. 404)

Two Main Forms of FDI

(Hill, 2013) States that there are two forms of Foreign Direct Investment:

• Greenfield Investment – Establishing new operations in a foreign country, and

• Acquisition or merging – Acquisition or Merging with a existing firm  (Hill, 2013, p. 248)

Greenfield Investment or Acquisition/Merging allows the organisation to gain access to the foreign country’s markets with existing products. Foreign Direct Investment is not foreign portfolio investment, where organisations or people invest in foreign countries, but is it rather the direct involvement into a new or existing organisation in a foreign country.

Positive Impact of FDI

(Czinkota, et al., 2011) States the following positive impact of Foreign Direct Investment:

1. Capital formation
2. Technology and management skills transfer
3. Regional and sectorial development
4. Internal competition and entrepreneurship
5. Favourable effect on balance of payments
6. Increased employment (Czinkota, et al., 2011, p. 52)

According to (Wang, 2009) there are three major advantages of FDI:

• • The ownership advantage - business can be performed better within the firm than being negotiated between business partners with short-term financial interests.
• (a) the potential of technology may be better exploited and cost saving in production and marketing processes may be better achieved when the activities are co-ordinated within the firm;
• (b) management and organisation skills of the parent firm may be readily transferred to the subsidiary to raise the efficiency in the subsidiary;
• (c) the good practice in the subsidiary may be transferred back to the parent firm or transferred to other subsidiaries, which has become increasingly important and imminent in recent years;
• (d) absorption of local knowledge is made easier under the same management team;
• (e) easy shifts of production between different sites or plants in response to changes in economic conditions, such as appreciation of the local currency in one of the host countries; and
• (f) Institutional and cultural differences can be dealt with in a co-ordinated manner and the differences and diversities may serve as a propeller rather than an obstacle to the growth of the firm.
• The Location advantage - there exist some benefits for the product to be made locally in the host country, including
• (a) lower factor prices such as labour costs and easy access to local finances; (b) higher transportation costs deterring trade and in favour of local production;
• (c) import restraints in the host country and other barriers to trade making exporting impossible or financially unfeasible;
• (d) easy access to the host country’s natural resources that are scarce in the home country; and (e) easy access to customers
• Internationalisation advantage - is derived to a certain extent from the ownership advantage. Market failure or market imperfections are one of the reasons to internalise business activities. The benefits of internalisation include
• (a) avoiding higher external transaction costs;
• (b) saving resources from writing excessively detailed contracts for every task and activity;
• (c) co-ordination activities in production and marketing can be effectively performed;
• (d) enforcement of various measures can be easily monitored; and
• (e) Production lines can be rationally integrated. (Wang, 2009, pp. 404-405)

Negative Impact of FDI

(Czinkota, et al., 2011) States the following negative impact of Foreign Direct Investment:

1. Industrial dominance

2. Technological dependence

3. Disturbance of economic plans

4. Cultural change

5. Interference by home government of Multinational Corporation   (Czinkota, et al., 2011, p. 52)

Several Activities which a Multi-National Company can perform FDI

According to (Rugman & Collinson, 2006) there are several activities in which a Multi-National Company can perform FDI:

• Backward Integration – the ownership of equity assets used earlier in the production cycle

• Forward Integration - the purchase of assets or facilities that move the company closer to the customer (such as a computer manufacturer that acquires a retail chain that specializes in computer sales)

• Horizontal Integration - is the acquisition of firms in the same line of business (such as a computer chip manufacturer that buys a competitor), (Rugman & Collinson, 2006, p. 281)

Cost of inward FDI

(Hill, 2013) Argues that there are several costs for promoting inward Foreign Direct Investment:

1. Adverse effects of FDI on competition within the host nation

 subsidiaries of foreign MNEs may have greater economic power than indigenous competitors because they may be part of a larger international organization

2. Adverse effects on the balance of payments

 when a foreign subsidiary imports a substantial number of its inputs from abroad, there is a debit on the current account of the host country’s balance of payments

3. Perceived loss of national sovereignty and autonomy

 decisions that affect the host country will be made by a foreign parent that has no real commitment to the host country, and over which the host country’s government has no real control (Hill, 2013, p. 273)

Some of the negative impact of promotion of Foreign Direct Investment can be:

• Several countries can provide the same incentives, and a slight change in incentive policies can have a little or no impact on investors decision to invest in the local country, and
• Local firms can be at a disadvantage if the governments favour foreign investors and do not support the local organisations(Czinkota, et al., 2011, pp. 55-57)

Conclusion

There are several reasons why firms seek to invest in foreign markets, these reasons includes:  Firms as Seekers, Firms as Exploiters of Imperfections, Firms as Internalizers. But the primary goal as seen in each of these section is to develop the market and to maximize its profits.

Few Governments identifies the need to ensure that there are appropriate policies to promote Inward Foreign Direct Investment to support their developmental needs. Governments can implement the Fiscal, Financial and Nonfinancial policies to promote inward FDI into their countries to promote and fund their developmental and growth needs. But it must always be mindful and aware of the costs associated with attracting inward FDI.

Bibliography

Czinkota, M. R., Ronkainen, I. A. & Moffett, M. H., 2011. International Business. 8th ed. s.l.:John Wiley & Sons, Inc..

Hill, C. W., 2013. International Business: Competing in the Global Marketplace. 9th ed. s.l.:McGraw Hill Eductions IRWIN.

Rugman, A. M. & Collinson, S., 2006. International Business. 4th ed. s.l.:Prentice Hall.

Wang, P., 2009. The Economics of Foreign Exchange and Global Finance. 2nd ed. s.l.:Springer.