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Foreign direct investment (FDI) as an attractive option for companies

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MIMS, Mumbai

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  1. Introduction
  2. Market imperfections
  3. Market internalisation
    1. Coase's view
    2. Buckley and Casson's view
  4. Location specific advantages
    1. Labor costs
    2. Marketing factors
    3. Trade barriers
    4. Government policy
  5. The product life cycle theory
  6. The eclectic theory
  7. Conclusion

Companies choose to venture into international markets since they want to maximize returns for their shareholders. Entry in foreign markets could prove to be a risky proposition. Foreign direct investment has many benefits. It enables the parent company to establish its operations in foreign country either through a subsidiary or forming the joint venture with a local partner.

What influences the companies to invest their capital in a foreign country? The production could be exported which is far less risky and it does not involve the trouble or expense of setting up and managing operations in a foreign country. If transportation costs are too high then the firm could license it products or sell technology and/or brands to an overseas firm which knows the territory well. As Root (1978) observes any theory of FDI must answer the question as to why firms invest directly and can they then compete successfully with local firms and why do they enter the market through FDI and not through licensing or exporting.

[...] Buckley and Casson (1976) developed this into an explanation of multinational activity, arguing that the influence of market imperfections as a causative factor for leading to internalisation. The incentive to internalise depends on four key groups of factors: Industry specific factors, for example, economies of scale and external market structure. Region specific factors, for example, geographical distance and cultural differences. Nation specific factors, such as political and fiscal conditions. If the multinational internalises then it may realise valuable cost savings and Giddy (1976b) says that such economies might arise through bypassing: imperfect markets for the firm's resources, outputs and government barriers to entry. [...]

[...] Overall, it is necessary for the multinational to have at least one some firm-specific advantage the source of market imperfection giving it an edge over domestic producers. Michalet and Chevalier (1985) cited over thirty reasons given by French multinationals for undertaking FDI, however most of the reasons cited related to some form of market imperfection. The firm must also be able to transfer any advantages it has in the market over borders and into foreign countries so that it can exploit them. [...]

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