Motives for Firms Engagement in Foreign Direct Investment (FDI)

Foreign Direct Investment (FDI) is a popular investment option adopted by firms in the contemporary business environment. This form of investment stream occurs when a firm decides to assume partial ownership of either a company stock or physical assets in a foreign country. Besides, this business manoeuvre enables a firm undertaking FDI to gain a significant measure of controlling its management systems and structures. Although portfolio management and FDI are close and interrelated terms, they are quite distinct in the sense that the former does not permit any tangible degree of securing company control.

On an international scale, the inflow in FDI is often considered to start from ten percent of ownership of stocks or assets of a foreign company. In order to accomplish FDI projects, special arrangements such as mergers and acquisitions have to be effected. Alternatively, international franchising can also be used as a channel of attaining the FDI goals. Contrary to the common perception, FDI by firms may not only flourish in economies that are in transition, but also in those economies that are emerging. For this reason, the percentage growth of firms wishing to invest in other countries has steadily grown due to such factors like highly skilled and low cost labour resources, wider marketing base compared to the domestic economy, readily available natural resources, stable political environment as well as geographical advantage. Some key motives are explained blow on why firms engage in FDI in both developed and developing host countries.

1. Resource Seeking

Empirical based research has conclusively established that the desire to seek resources is one of the driving motives why a firm would engage itself in Foreign Direct Investment. A company may be prompted to secure its investment abroad since the domestic ground is either too costly or lacks the relevant factors of production. It is vital to note that skilled and unskilled labour or advances in technology may markedly escalate the cost of production at the domestic level therefore leading to low returns. On the other hand, advances in technology or managerial capabilities may not be accounted for when seeking to invest abroad since such resources can be accessed readily at home though at a higher cost. Hence, assets that are non market in nature are of utmost importance when carrying out FDI since it is impossible to transfer them through transactions. For instance, a firm may not be in a position to import high skilled and affordable labour at will owing to economic and political barriers at hand.

On the other side, FDI undertakings that aim at seeking skilled labor may also demonstrate unique characteristics and patterns related to spill over in production. In other words, resource seeking FDI whether in terms of human labour or other natural factors of production such as land have equal implications and meaning to the firm in question. The bigger picture is to obtain relatively cheap resources that can lower production costs while maximizing returns. Although resource seeking FDI may sound quite familiar with international outsourcing or better still international trade, the two elements are indeed part and parcel of investment portfolio under FDI. In a related development, economists have used the term outsourcing with sparingly diverging meanings. In some instances, it has been used to infer to international partnerships while others have applied it to mean circumstances whereby companies resort to international markets to obtain intermediate inputs.

2. Market Seeking

Another reason why firms will undertake FDI is to seek markets for their products. A foreign market may be more appealing to a firm than the domestic one. For instance, the host country may be supplied with the needed goods and services through the process of FDI. In particular, these may be company products that are either not available at the target market or a superior substitutes to the existing products. Besides, the foreign market can also attract consumers from the adjacent countries, thereby widening the marketing portfolio further.

Nonetheless, this form of FDI is underpinned by one main challenge in the sense that the marketing points being targeted in the foreign country may not be compatible with the location where FDI is to be undertaken. In any case, both direct and indirect can be used to carry out FDI. In the first scenario, the host country is used as the ground for exploiting the available market. However, when the host country is used as a platform to seek other markets, it is referred to as indirect market seeking FDI. This characteristic way of exploiting the host country be seeking other adjacent marketing opportunities can also be classified as export-platform Foreign Direct Investment.

When seeking foreign markets in FDI, there are two important considerations that entrepreneurial firms have to bear in mind. Firstly, the prevailing economic and political factor that may affect the process of exporting goods and services from the host country especially in the case of indirect marketing is important. Secondly, the level of appropriateness in the production process is also paramount. The host country can benefit a lot from market seeking FDI in a variety of ways. For instance, the introduction of new products and services into the new market is deemed beneficial since it will narrow down the gap as far as consumer needs are concerned. In addition, the local production is bound to go through the process of modernization. Better methods of production will be realized in the host country. this can be explained from the fact the prevalence of competition among various firms producing similar products will be heightened.

Hence, each firm will endeavour to produce the best in a bid to capture and maintain market leadership. Nonetheless, fierce competition can also jeopardize a favourable marketing environment when local competitors crowd up for a single market. This will especially be inevitable if a larger share of the market is dominated by the foreign affiliates. In addition, the balance of payment for the host country may be unfavourable especially in the event the situation persists for long. This will be occasioned when funds are repatriated bearing in mind that market seeking FDI is not concerned with income generation from exports. Therefore, the impact of growth brought about by efficiency seeking Foreign Direct Investment is quite stronger than this form of FDI.

3. Non Marketable Asset Seeking

A business enterprise may also participate in FDI in order to accrue the benefits that arise from non-transferrable assets that cannot be transacted in the normal way. The characterization of such non-transferrable assets is such that they can be exploited within the target country. As a result, the firm can only benefit from this type of asset by directly investing in the host country. That is the only way through which the asset can be accessed. Firstly, this form of FD target can be put in place through the process of agglomeration. In such as case, proximity to other companies is a crucial consideration to make before setting up the project.

Thus, the localization of the FDI will largely depends on this factor. Realistically speaking, a firm will often prefer to locate where there is a cluster of other companies so that it can be in a better position to create better linkages with key payers in its production. For example, consumers and suppliers in addition to the availability of the market endowed with adequate labour as well as spill over in technology are some of the open end benefits in this type of FDI. In the case of technology, it cannot be transferred across the border without losing some value especially if it was constructed using local unique skills and competences. As consequence, a firm has to relocate some of its operations overseas in order to reap the optimum benefit of the asset whose value cannot be transferred from one location to another without losing its value.

As mentioned earlier, Foreign Direct Investment (FDI) is basically capital flow on an international level and foreign affiliates can be controlled by the mother company. With such, it implies that matters related to foreign exchange can significantly impact any FDI arrangement in place, bearing in mind the unstable nature of currency exchange rates across the globe. Perhaps, it would be pragmatic to first of all define the term. Exchange rate is the relative value of the domestic currency compared to the price of the foreign currency. At times, exchange rates can impact FDI in totality as well as the allocation of this type of investment in multiple countries. For example, currency depreciation, the movement in exchange rate can influence FDI in two major ways. To start with, it brings about wage reduction in a country alongside lowering the cost of production compared to those of its affiliates abroad. Hence, it is definite that when exchange rate depreciates, the overall return of foreign investors will improve. However, there are quite a number of considerations worth noting when discussing exchange rate level and its effect on foreign investment. It is against this backdrop that forms will opt to invest in both developed and developing countries that are experiencing continual fluctuations in currency exchange rates.

It is indeed a financial windfall to firms running FDI in countries where the exchange rate is grossly volatile since the major factors of production and other associated financial overheads will be reduced accordingly. This remains to be a very strong motive why forms will invest in overseas countries. Nonetheless, it should be noted that when currency exchange rates appreciate, the reverse effect on FDI is inevitable. Therefore, firms should always brace themselves for harder economic times or reduced returns in during such eventualities.

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