5.1 Motives for FDI
9 min read•august 20, 2024
Foreign Direct Investment (FDI) is a crucial strategy for small and medium-sized enterprises looking to expand globally. Companies engage in FDI for various reasons, including market-seeking, resource-seeking, efficiency-seeking, and strategic asset-seeking motives.
Understanding these motives helps SMEs make informed decisions about international expansion. By carefully considering push and pull factors, entry modes, and short-term versus long-term objectives, companies can develop effective FDI strategies that align with their goals and resources.
Motives for market-seeking FDI
- focuses on expanding a company's customer base and increasing sales in foreign markets
- Firms engage in market-seeking FDI to tap into the growth potential of emerging economies and diversify their revenue streams
- Market-seeking FDI is particularly relevant for SMEs looking to internationalize and scale their businesses
Attracting new customers
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- Establishing a physical presence in foreign markets enables SMEs to reach new customer segments and expand their client base
- Locating closer to customers allows for better responsiveness to their needs and preferences (customized products and services)
- Engaging in local marketing and promotional activities helps build brand awareness and attract new customers (targeted advertising campaigns)
Adapting to local preferences
- Market-seeking FDI allows SMEs to tailor their offerings to the specific tastes, cultural norms, and regulatory requirements of the
- Localizing products, services, and marketing strategies enhances their appeal to local customers (menu items at fast-food chains)
- Adapting to local preferences helps SMEs gain a competitive edge over foreign rivals and build customer loyalty (language localization)
Overcoming trade barriers
- Market-seeking FDI enables SMEs to circumvent tariffs, quotas, and other trade restrictions that hinder exports
- Establishing local production facilities or distribution networks reduces the impact of trade barriers on market access (local content requirements)
- Investing directly in the host country allows SMEs to benefit from preferential treatment granted to domestic firms (government procurement contracts)
Motives for resource-seeking FDI
- aims to secure access to critical inputs, such as raw materials, labor, and specialized skills, in foreign locations
- SMEs engage in resource-seeking FDI to reduce costs, ensure a stable supply of resources, and enhance their global competitiveness
- Resource-seeking FDI is particularly relevant for SMEs in industries that rely heavily on natural resources or labor-intensive processes
Accessing raw materials
- Investing in resource-rich countries enables SMEs to secure a reliable and cost-effective supply of raw materials (minerals, agricultural commodities)
- Establishing a presence near the source of raw materials reduces transportation costs and minimizes supply chain disruptions
- Directly controlling the extraction or production of raw materials allows SMEs to ensure the quality and sustainability of their inputs (responsible sourcing practices)
Securing low-cost labor
- SMEs may engage in resource-seeking FDI to take advantage of lower labor costs in developing countries
- Outsourcing labor-intensive production processes to countries with lower wage rates helps SMEs reduce overall production costs (textile manufacturing in Southeast Asia)
- Accessing low-cost labor enables SMEs to maintain price competitiveness and improve profit margins in global markets
Leveraging specialized skills
- Resource-seeking FDI allows SMEs to tap into pools of highly skilled or specialized labor in foreign locations (software developers in India)
- Investing in countries with a strong educational system or industry-specific expertise provides access to valuable human capital
- Leveraging specialized skills from abroad enhances SMEs' innovation capabilities and helps them develop cutting-edge products and services (R&D centers)
Motives for efficiency-seeking FDI
- focuses on optimizing a company's global production network to achieve cost reductions and operational synergies
- SMEs engage in efficiency-seeking FDI to improve their competitiveness by exploiting differences in factor costs and economies of scale across countries
- Efficiency-seeking FDI is particularly relevant for SMEs operating in industries with intense global competition and pressure to reduce costs
Reducing production costs
- Investing in countries with lower factor costs, such as labor, energy, and raw materials, allows SMEs to minimize production expenses (offshoring manufacturing to China)
- Relocating production facilities to cost-effective locations helps SMEs maintain price competitiveness and improve profit margins
- Reducing production costs through efficiency-seeking FDI enables SMEs to free up resources for other strategic investments (marketing, R&D)
Optimizing global supply chains
- Efficiency-seeking FDI allows SMEs to streamline their global supply chains by locating production closer to key suppliers or markets
- Establishing a network of strategically located facilities reduces transportation costs, lead times, and inventory levels (regional distribution centers)
- Optimizing global supply chains through FDI enhances SMEs' responsiveness to changing market conditions and customer demands (just-in-time delivery)
Exploiting economies of scale
- Efficiency-seeking FDI enables SMEs to consolidate production in larger, more efficient facilities that benefit from economies of scale
- Concentrating production in fewer locations allows SMEs to spread fixed costs over a larger output volume, reducing per-unit costs (automotive assembly plants)
- Exploiting economies of scale through FDI helps SMEs achieve cost advantages and improve their competitiveness in global markets
Motives for strategic asset-seeking FDI
- aims to acquire valuable resources, capabilities, or competencies that are not available in the
- SMEs engage in strategic asset-seeking FDI to enhance their competitive position by accessing advanced technologies, know-how, and intellectual property
- Strategic asset-seeking FDI is particularly relevant for SMEs looking to upgrade their capabilities and enter high-value-added industries
Acquiring cutting-edge technologies
- Investing in technologically advanced countries enables SMEs to access state-of-the-art technologies and production processes
- Acquiring cutting-edge technologies through FDI helps SMEs improve product quality, reduce costs, and shorten time-to-market (semiconductor industry)
- Accessing advanced technologies allows SMEs to differentiate their offerings and gain a competitive edge in global markets
Enhancing innovation capabilities
- Strategic asset-seeking FDI enables SMEs to tap into foreign innovation ecosystems and collaborate with leading research institutions
- Establishing R&D facilities in innovation hubs provides access to skilled researchers, advanced infrastructure, and knowledge spillovers (Silicon Valley)
- Enhancing innovation capabilities through FDI helps SMEs develop new products, services, and business models that drive growth and competitiveness
Gaining valuable intellectual property
- Acquiring companies with valuable patents, trademarks, or copyrights allows SMEs to gain control over key intellectual property assets
- Gaining access to proprietary technologies, brands, or content through FDI strengthens SMEs' market position and creates barriers to entry (pharmaceutical patents)
- Leveraging acquired intellectual property enables SMEs to expand into new markets, develop new products, and generate licensing revenues
Defensive vs offensive FDI motives
- Defensive FDI motives focus on protecting a company's existing market position and competitive advantages in the face of external threats
- Offensive FDI motives aim to proactively expand a company's market presence and capture new growth opportunities in foreign markets
- Understanding the distinction between defensive and offensive FDI motives is crucial for SMEs in formulating their internationalization strategies
Protecting existing markets
- SMEs may engage in defensive FDI to safeguard their market share in key foreign markets threatened by local competitors or changing regulations
- Establishing a local presence through FDI helps SMEs better monitor market developments and respond quickly to competitive threats (local production facilities)
- Defensive FDI enables SMEs to maintain customer relationships, secure distribution channels, and protect their brand reputation in critical markets
Proactively expanding market share
- Offensive FDI motives drive SMEs to aggressively pursue new market opportunities and gain a first-mover advantage in high-potential countries
- Investing early in emerging markets with strong growth prospects allows SMEs to establish a strong market position and capture market share (China's consumer market)
- Proactively expanding market presence through FDI enables SMEs to build brand awareness, develop local partnerships, and adapt to local preferences ahead of competitors
Push vs pull factors in FDI decisions
- Push factors are conditions in the home country that encourage or pressure companies to invest abroad
- Pull factors are attractive features of the host country that draw foreign investors to establish operations there
- Analyzing the interplay of push and pull factors is essential for SMEs in selecting appropriate FDI destinations and strategies
Home country conditions
- Unfavorable home country conditions, such as high costs, limited growth opportunities, or strict regulations, may push SMEs to invest abroad (high corporate tax rates)
- Saturation of the domestic market or intense competition may compel SMEs to seek new markets and diversify their operations through FDI
- Government policies that encourage outward FDI, such as tax incentives or support programs, can act as push factors for SME internationalization (export promotion agencies)
Host country attractiveness
- Favorable host country conditions, such as large market size, high growth potential, or abundant resources, act as pull factors for FDI (growing middle class in emerging markets)
- Attractive investment incentives, such as tax breaks, subsidies, or preferential treatment, can draw SMEs to invest in specific host countries (special economic zones)
- Stable political and economic environments, well-developed infrastructure, and a skilled workforce are pull factors that attract FDI from SMEs (Singapore's business-friendly environment)
Greenfield investment vs cross-border M&As
- Greenfield investment involves establishing a new venture from scratch in a foreign country, while cross-border M&As entail acquiring an existing company abroad
- The choice between greenfield investment and cross-border M&As depends on factors such as the SME's resources, market entry objectives, and target industry characteristics
- Understanding the pros and cons of each entry mode is crucial for SMEs in designing their FDI strategies and allocating resources effectively
Establishing new operations
- Greenfield investment allows SMEs to build a new facility tailored to their specific needs and requirements (customized production lines)
- Setting up new operations from scratch enables SMEs to maintain full control over their foreign subsidiaries and implement their corporate culture
- Greenfield projects often involve higher initial costs and longer time horizons compared to cross-border M&As (construction expenses, regulatory approvals)
Acquiring existing firms
- Cross-border M&As provide SMEs with a faster and less risky way to enter foreign markets by acquiring an established local player
- Acquiring existing firms enables SMEs to gain immediate access to local market knowledge, distribution networks, and customer relationships (instant market share)
- Cross-border M&As allow SMEs to acquire valuable assets, such as brands, technologies, or human capital, that would be difficult to develop internally (acquiring a local brand)
Short-term vs long-term FDI objectives
- Short-term FDI objectives focus on achieving immediate gains, such as quick market entry, cost savings, or access to specific resources
- Long-term FDI objectives prioritize sustainable growth, competitive advantages, and strategic positioning in foreign markets over time
- Balancing short-term and long-term objectives is essential for SMEs in developing a coherent and effective FDI strategy
Quick market entry strategies
- SMEs with short-term FDI objectives may prioritize speed of entry over other considerations to capitalize on time-sensitive opportunities (first-mover advantage)
- Acquiring an existing local company or forming a joint venture with a local partner can facilitate rapid market entry and access to established networks
- Focusing on quick wins, such as securing key customers or contracts, can help SMEs generate early revenues and establish a foothold in the market (pilot projects)
Sustainable competitive advantages
- SMEs with long-term FDI objectives prioritize building sustainable competitive advantages that can support their growth and profitability over time
- Investing in the development of unique capabilities, such as R&D, brand equity, or human capital, can create lasting value and differentiate the SME from competitors (proprietary technologies)
- Establishing a strong local presence and deep market understanding enables SMEs to adapt to evolving customer needs and stay ahead of the competition (localized product development)
Economic vs non-economic FDI motives
- Economic FDI motives are driven by the pursuit of financial gains, such as higher profits, cost savings, or increased market share
- Non-economic FDI motives are influenced by factors beyond financial considerations, such as corporate social responsibility, political objectives, or personal ties
- Recognizing the interplay between economic and non-economic motives is crucial for SMEs in aligning their FDI strategies with their overall corporate goals and values
Profit maximization goals
- SMEs with strong economic FDI motives prioritize investments that offer the highest potential returns and contribute to the bottom line (high-margin products)
- Seeking cost efficiencies, economies of scale, and new revenue streams are common economic motives driving FDI decisions (outsourcing to low-cost countries)
- Evaluating FDI opportunities based on financial metrics, such as ROI, NPV, or payback period, helps SMEs allocate resources to the most promising projects (financial projections)
Corporate social responsibility considerations
- Non-economic FDI motives, such as corporate social responsibility (CSR), may drive SMEs to invest in projects that generate social or environmental benefits (renewable energy investments)
- Engaging in FDI activities that promote sustainable development, community welfare, or ethical business practices can enhance SMEs' reputation and stakeholder relationships (fair trade initiatives)
- Balancing profit maximization with CSR considerations enables SMEs to create shared value and contribute positively to the host country's development (job creation, skills transfer)
Key Terms to Review (20)
Bilateral Investment Treaties: Bilateral Investment Treaties (BITs) are agreements between two countries that establish the terms and conditions for private investment by nationals and companies of one country in the other country. These treaties aim to protect foreign investments by providing legal guarantees, such as fair treatment and protection against expropriation, which encourages foreign direct investment (FDI) by reducing risks for investors.
Eclectic Paradigm: The eclectic paradigm is a theory that explains the reasons why companies choose to engage in foreign direct investment (FDI) based on three main factors: ownership, location, and internalization advantages. This framework helps businesses understand how these factors interact to create a competitive advantage when investing abroad, emphasizing that firms weigh various motives for FDI such as market access, resource acquisition, and efficiency gains.
Efficiency-seeking fdi: Efficiency-seeking foreign direct investment (FDI) refers to the investment made by companies in foreign markets to enhance their operational efficiency and reduce production costs. This type of FDI is motivated by the desire to optimize resource allocation, leverage economies of scale, and access specialized skills or technologies that are not available in the home country, thus improving overall competitiveness.
Employment generation: Employment generation refers to the process of creating new job opportunities in an economy, which can occur through various means such as the establishment of new businesses, expansion of existing enterprises, and foreign direct investment (FDI). This concept is crucial because it directly influences economic growth, reduces unemployment, and enhances the overall standard of living within a region. It also plays a key role in addressing social challenges by providing livelihoods and improving community welfare.
Exchange rate risk: Exchange rate risk refers to the potential for financial losses due to fluctuations in the exchange rate between two currencies. This risk is especially relevant for businesses engaged in international trade or investment, as changes in currency value can impact profits, costs, and overall financial stability. Companies often face this risk when making foreign direct investments (FDI), as currency depreciation or appreciation can significantly affect their expected returns.
Government agencies: Government agencies are organizations established by a government to implement and enforce specific laws, regulations, and policies. These agencies play a crucial role in economic development, public safety, and welfare, often influencing foreign direct investment, responding to natural disasters, and engaging with various stakeholders to achieve their objectives.
Home country: The home country refers to the nation where a multinational corporation or foreign investor originates. This term is essential in understanding how businesses engage in foreign direct investment (FDI) as companies often invest in other countries to expand their operations or access new markets while leveraging resources and advantages from their home country.
Horizontal integration: Horizontal integration is a business strategy where a company acquires or merges with other companies at the same level of the supply chain, often in the same industry, to increase market share, reduce competition, and enhance efficiency. This approach allows firms to grow by consolidating their position in a specific market, leveraging economies of scale, and maximizing resources for better profitability.
Host country: A host country is a nation where foreign companies or investors establish operations, production facilities, or branches. This term is crucial in understanding the dynamics of foreign direct investment (FDI), as it outlines the environment and conditions under which international businesses operate and contribute to the local economy.
Internalization theory: Internalization theory is a concept in international business that explains why firms prefer to establish foreign production or operations through Foreign Direct Investment (FDI) rather than through licensing or exporting. It suggests that companies internalize their operations to retain control over their proprietary assets, minimize transaction costs, and enhance their competitive advantage in foreign markets.
Labor cost: Labor cost refers to the total expenses incurred by a business for employing workers, including wages, salaries, benefits, and payroll taxes. This concept is crucial for companies considering foreign direct investment (FDI) as it impacts operational expenses, pricing strategies, and overall competitiveness in the global market.
Market-seeking fdi: Market-seeking foreign direct investment (FDI) occurs when companies invest in a foreign market to establish a presence and access local customers. This type of investment aims to tap into new markets, grow sales, and increase market share by producing goods or services close to the target market, thereby reducing transportation costs and adapting to local preferences.
Multinational corporations: Multinational corporations (MNCs) are large companies that operate in multiple countries, managing production or delivering services in more than one nation. These firms leverage their global presence to maximize profits, optimize supply chains, and access new markets, which ties into the decision-making processes surrounding foreign direct investment (FDI) and influences how they interact with foreign exchange markets to manage currency risks.
Political Risk: Political risk refers to the potential for losses or adverse impacts on businesses and investments due to political decisions, instability, or changes in government policies in a given country. This type of risk can significantly influence foreign direct investments, as investors must assess the likelihood of government actions that could affect their operations, such as expropriation, changes in regulations, or civil unrest. Understanding political risk is essential for companies considering establishing new operations or expanding into foreign markets.
Political stability: Political stability refers to the durability and integrity of a government system, characterized by the absence of violent conflict or significant political upheaval. It ensures that the political environment remains predictable and orderly, which is crucial for fostering economic growth and attracting foreign investment, particularly in the context of international business activities.
Resource-seeking FDI: Resource-seeking foreign direct investment (FDI) refers to investments made by companies in foreign countries to acquire natural resources, such as minerals, oil, or agricultural products. This type of FDI is driven by the need for firms to secure essential materials that are either unavailable or more expensive in their home country, thereby reducing production costs and enhancing competitiveness.
Strategic asset-seeking fdi: Strategic asset-seeking foreign direct investment (FDI) refers to the investment approach where companies invest in foreign markets to acquire resources and capabilities that are critical for enhancing their competitive advantage. This type of FDI is often aimed at gaining access to advanced technology, skilled labor, or valuable brands that are not easily available in the investor's home country. Companies engaging in strategic asset-seeking FDI look to strengthen their long-term position in the global market by securing assets that can drive innovation and growth.
Technology transfer: Technology transfer is the process of sharing or disseminating technological knowledge, innovations, or skills from one organization, individual, or country to another. This transfer can take various forms, such as through licensing agreements, joint ventures, or foreign direct investment. It plays a critical role in enhancing productivity, fostering innovation, and promoting economic development in host countries by facilitating access to advanced technologies and expertise.
Trade Agreements: Trade agreements are treaties between countries that outline the terms of trade between them, aimed at reducing or eliminating barriers such as tariffs and quotas to encourage free trade. They can also address issues such as labor standards, environmental protections, and intellectual property rights, creating a framework for economic cooperation and integration. By establishing clearer rules for trade, these agreements can influence competition, investment decisions, and the overall flow of goods and services across borders.
Vertical Integration: Vertical integration is a business strategy where a company expands its operations by acquiring or merging with other companies in its supply chain, either at the upstream (suppliers) or downstream (distributors and retailers) levels. This strategy helps firms gain control over their production processes, reduce costs, and improve efficiency by streamlining operations and minimizing reliance on external suppliers or distributors.