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Foreign Direct Investment for Overseas Organizations

Executive Summary

Most of the advanced countries in the world involve themselves in foreign direct investment in the less developed countries with an aim of increasing their potential for investment and making appropriate use of other countries’ resources to promote development (Hill 2008). Before an organization decides on the country to invest in it must come up with proper strategies for identifying the most appropriate location in terms of economic, political, social, and other factors that make an investment viable. An organization must take into consideration the risks involved, the market situations, and the external factors that affect the operation of a business venture.

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This report creates a critical analysis of the impact of foreign direct investment in both the home country and the host countries and the factors that have to be taken into consideration while coming up with the location for foreign direct investment. The study comes up with fictitious manufacturing industry in the UK that wishes to establish industries in either India or Chad, which are both developing countries.

The introduction gives an informed explanation of the reasons why the UK wishes to establish a manufacturing industry in a developing country and not in its home country. With a choice of two countries, India and Chad, an analysis of the available investment opportunities has to be made. This is to help the managing directors of the manufacturing company to come up with the best decision on the most suitable location for the industry. The UK has for a long time invested in India and with the progress that previous investments have had, it can be argued that establishing the manufacturing industry may also result in similar success.

The report looks at the benefits and the limitations that a country like the UK may experience by investing in its manufacturing industry in India as well as in Chad. From this analysis, conclusive evidence has been identified showing that it would be better to invest in India than in Chad. Despite the major efforts that Chad is making to improve its economy, it still experiences great challenges that are likely to affect foreign investment especially in terms of production costs and market accessibility. The UK would incur fewer production costs in India than in Chad because the economy of India can more easily sustain a manufacturing company than that of Chad. On the other hand, the market structure is so rigidly structured that there is no accessibility to international markets. The local markets are also not well developed and this is made worse by the fact that the country is landlocked and poorly located.

Proper justification has also been identified of the most suitable country that the UK should invest in and this has been related to the countries’ gross domestic product and their general economic situation. On the other hand, once the UK decides to establish its industry in India, there are those management factors that must be taken into consideration in order to be successful in its operations. These factors are in respect to the cultural implications that would be encountered at the management level as well as the marketing implications that involve improving the product or creating intermediary networks to improve the market structures. The report then comes up with a conclusion of all that is required of an industry or business that is intending to promote its foreign direct investment in its host country.

Introduction

According to Abdallah (2001), UK has involved itself in investing in various countries of the world through its multinational corporations and as a result, has been able to obtain sufficient amounts of foreign direct investment. The manufacturing industry has been one of the major sectors that benefit greatly from foreign direct investment despite the fact that the sector has been experiencing a fall in its development for the last decade due to increased production and transportation costs. A decline in the manufacturing sector’s gross domestic product has not prevented the country from establishing new industries in other developing countries of the world through multinational corporations (Rugman 2003).

The two main countries that the UK has invested its manufacturing business in are India and Chad. The UK anticipates that de-industrialization in the country and in Britain, in general, will not affect the success of the multinational corporations that it has established in India and Chad, among other developing or transition countries. This study looks into the capability of the UK’s manufacturing industry is relocating to the two developing countries to obtain foreign direct investment. It focuses on the benefits derived by the country from investing in other parts of the world as well as the challenges experienced.

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Analysis of the investment opportunities

India

The UK, like most other developed nations, has invested in India from as early as the late 1990s and with the tremendous growth in India’s economic development, the investment is likely to go up for a relatively long period (Abdallah 2001). A report by the IRIS Business Services in India shows that the country receives one of the highest proportions of foreign direct investment in comparison to other developing and developed countries of the world and the UK has been one major contributor of this proportion. In the year 2002, the UK’s foreign direct investment in the country rose from 1.4billion pounds to 2.3billion at the end of the year 2006, an average of 13% increase per year. The rate of investment by the UK’s manufacturing industries in India is quite high, relatively totaling 54% of all other investments by the UK in the country. The key businesses that the country invests in are the manufacturing of chemicals, fuel products, and plastic and in food processing.

What makes India suitable for investment in FDI?

Economic factors

According to Hill (2008), since the country dropped its socialist-based policies, it was able to move from a period of under-development towards a developing economy. The country’s economy was initially characterized by protectionism, public ownership of property, and rigid regulations which resulted in high levels of corruption and slow economic growth. The socialist-based policies have since 1990 been replaced by a market-based system that has promoted economic liberalization and hence economic growth (Luff, 2006). With agriculture being the major activity in the country, raw materials for the manufacturing sector are readily available. UK’s multinational corporations that deal with the manufacture of chemical products can obtain the raw materials more easily and at low costs hence reducing the high transportation expenses that would be incurred in obtaining the raw materials from the home country. On the other hand, the food processing industries that have been established by the UK are able to obtain the agricultural products as their raw materials and have ready markets for the finished products.

Market dominance

The industrial sector in the country constitutes only 12% of the country’s total economy. This implies that by investing in the manufacturing sector, UK will be able to dominate the market more easily and hence promote greater demand for its products (Nayal 2003). The per capita income of India is approximately $1043, which is high compared to other developing countries. This means that the people’s purchasing power is also relatively high thus promoting the market for manufactured goods. This makes the country a suitable location for most multinational corporations and UK has taken the opportunity to develop new manufacturing industries since 2006. Another factor that shows an increase in people’s purchasing power is the average economic growth that is 7.5% per year, determined in 2008 and which implies that the level of unemployment has gone down significantly.

Market accessibility

According to Rugman (2003), India successfully participates in the global market, with its local trade also showing tremendous growth after the year 2000. According to the World Trade Organization statistics, the country accounts for 1.5% from the year 2007. In 2006, the country’s total imports and exports were valued at $437billion in both goods and services. This implies that it had wide coverage in the global market, thus creating greater market access for the multinational corporations that are established.

Political factors

The Indian government is encouraging foreign investors to invest in the country’s economy. The government advocates for investment into the country so long as 50% of the company’s equity shall be owned by Indians. This has encouraged the UK to set up manufacturing and food processing industries in the country, with a clear understanding of what entails a foreign holding in a local Indian company. With the strict restrictions on foreign investment having been modified to encourage investors, UK is likely to make a success from its foreign direct investment. The government aims at reviving the domestic markets and through liberalization efforts that it has implemented the country will be a suitable location for foreign investors (Dunning 1998).

Financial incentives

Nayal (2003) argues that, with the country’s high economic growth rate, there is the possibility that the country will develop its financial instruments to promote the growth of foreign and domestic investments. The presence of financial structures like the futures markets shows that there is high potential for economic growth which will, in turn, enable the investment companies to increase their activities. The development of banking systems has made it possible to provide credit facilities to the key economic sectors like agriculture, small-scale enterprises, and other small industries thus attracting foreign investments.

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Limitations of investing in India through FDI

Despite the benefits, the UK derives from investing in its manufacturing industries in India, there are challenges that it is likely to experience as a result of the various economic and other political and social barriers. This is likely to lead to the UK involving itself in risks as it establishes the corporations in India. The fact that India has had a significant economic growth rate, it has a wide disparity in terms of economic inequality (Rugman 2003). Wage differentials are a major barrier to most foreign and domestic investments and the rising levels of poverty lower the availability of skilled and competent labor, as almost a third of the total population suffer from what has been termed as chronic energy deficiency. This is a major challenge to the upcoming foreign investments, which will have to obtain labor from the home country or import from other foreign countries in order to enhance profitability. This may mean that the investments will be incurring greater costs in the host country than when it would have invested in its home country (Rugman 2003).

Luff (2006) notes that Infrastructural facilities in India are also poorly developed and investing in the country would imply that the UK first develops the facilities in the location where it intends to establish its industries. Inadequate infrastructural services are a barrier to development and foreign investments would incur greater expenses establishing or improving the infrastructure in India.

The country is also not sufficient in its technology and most of it has to be imported from outside. The manufacturing sector in the UK had been declining as a result of increased costs of production and transportation and such a situation is likely to recur in India especially because of the poor technology and infrastructure. Despite steady economic growth in India, the country has not developed the key areas that will promote foreign investment, having not spent much on power, transportation, telecommunication, and other infrastructural facilities. In 2002, the country spent only 6% of its gross domestic product on infrastructure and the Indian government has been made to open up more infrastructures in the private sector in order to promote foreign investment (Hill 2008).

Chad

Chad’s economy has been boosted by the major foreign direct investments that establish projects in the oil sector. The UK, among other major countries, has established a manufacturing industry that deals with oil and petroleum products. Chad is known as one of the largest African countries that are still under-developed and foreign investment would imply that capital will more easily flow from the rich and more developed countries to the poor country. Chad has made dramatic efforts to create incentives for foreign direct investment, mainly through exploiting its natural resources and promoting political stability hence reducing the level of poverty (African Research Bulletin, 1999).

Advantages of investing in FDI in Chad

With major efforts being made to develop the industrial sector in Chad, UK has made its establishments in the sector to ensure that the natural resources exploited do not result in the decline of the country’s economy, a situation that was experienced by Nigeria and the Netherlands. The country’s political system is promoting foreign investment and the government has provided incentives that will enable the country’s economy to benefit from the FDIs. The recently developed political stability measures by the president have enabled Chad to begin exporting its oil reserves to approximately a 1.5billion barrels in the year 2000 alone (Trends in Developing Economies 2006).

In the investment code provided by the government in 1987, incentives for foreign direct investments were established on the condition that the investments will benefit the local people and the local raw materials will be fully utilized (African Research Bulletin, 1999).

In 2002, the country experienced growth in its agricultural sector and this accounted for 35.8% of the gross domestic product which was relatively significant and which worked well to promoting foreign investment. Other sectors that contributed to the country’s GDP in 2002 included industry, at 17.7%, and trade, at 24%. It implied that the country was developing and there was a great chance for the foreign investments to thrive and more so with the support of the government.

The major incentive for UK’s foreign direct incentive in Chad is the oil discoveries that have been used by the manufacturing industries to provide raw materials for the oil products which they process. In 2002, Chad had become the African major performer in attracting foreign direct investment, with the previous year having received no FDI at all. The country benefited in over $900million in 2002 and this also promoted the country’s exports to neighboring Cameroon and also to other countries like Germany and France (Rugman 2003).

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Barriers to and disadvantages of investing in Chad

Despite the efforts made to promote the country’s economy, there is still great risk involved in foreign direct investment. The country continues to experience political instability with warfare that continues to hinder development. The political hardships have brought with it many economic challenges including the loss of currency value. Even with finances being obtained from the World Bank, the country lacks proper financing strategies, and hence developing the local structures like the development of the Doba oil structures proved a challenge (African Research Bulletin, 1999).

Most of the country’s economic activities are carried out informally and it is, therefore, difficult to determine the areas that show development. The UK may not be able to get accurate data that will help it make the right decision whether to set up a multinational corporation or not since there are hardly sufficient economic statistics (Trends in Developing Economies 2006). For instance, the country involves itself in the export of livestock, agricultural products, and camels to the neighboring countries but since this is mainly informal, a multinational corporation in the country may not know the nature of the markets in terms of accessibility.

Summary of the analysis

By looking at each of the two countries, it is possible to identify the most suitable country to invest in. Both countries have made efforts to encourage foreign investors and even with their conditions, the FDIs still find it difficult to invest in the countries. This is especially so with Chad, where, as a result of the civil war which was experienced in the 1970s, foreign investors are yet to regain their confidence in the country. The UK had not invested in the country earlier and its recent interest must also require proper management decisions so that the FDIs may be profitable.

The Porters Diamond theory shows the competitive advantage of nations and it emphasizes those factors that a foreign investor would take into consideration to be able to know which country would be most suitable to invest in. These include the availability and efficiency of the countries’ factors of production, the prevailing demand situations, available related industries and the prevailing nature of domestic rivalry. These are used to determine the country that has competitive advantage over the other countries that are in the list of selection. For instance, if the UK management uses the Porters theory, it will easily be able to determine which of the two countries, India and Chad, is most appropriate (House 2004).

Recommendation and justification of the most suitable country for investment

With the analysis of the two countries, it is clear that Chad is still experiencing great economic hardships and this may be a challenge to UK when it establishes its manufacturing industry. Therefore the most suitable country to invest in would be India. Chad is a landlocked country and this makes the country under-developed as it has little access to development. It is geographically remote, having been located at the heart of Africa. The country relies heavily on agriculture but productivity is greatly affected by poor environmental conditions, characterized by drought (Trends in Developing Economies 2006). This means that the contribution to agriculture on the gross domestic product is very low and since it is a major economic activity, the country’s GDP is still very low. While agriculture in India contributed 17.7% to GDP, Chad’s agricultural production only contributed 1% in the year 2007. This in turn led to a decline in the total GDP in Chad by over 40%. This shows that as a result of the unfavorable climatic conditions, the country’s economy remains unstable while that of India continues to show consistent growth because it does not rely solely on agriculture.

According to Nayal (2003), the economic liberalization of India has made the country consist of a market-based economic system and this enhances the market structure hence providing greater access to both the domestic and global markets. Chad, on the other hand, is landlocked and does not have access to the global markets. It mainly exports its goods to Cameroon and Libya and this means that investment by UK into the country would make it look for its own ways of establishing new markets. This will lead to the country incurring greater costs in the distribution of its products. A country that has a well established market structure is the most efficient and therefore India has competitive advantage over Chad with its market structure.

UK involves itself in the manufacture of chemical products and in food processing services. In India, the local industries deal mainly with household manufacturing services and this creates an effective supply chain with the foreign investors. The privatization of some of the major public sectors led to the increased production of the highly marketable consumer goods and this will help the UK’s industries to take advantage of this favorable markets. Chad, on the other hand, mainly relies on foreign aid and has not much established its local industries. Apart from the oil sector that is slowly taking root in the country’s economy, most of the other local industries are not developed. This would mean that UK’s investment in Chad would make UK to develop new infrastructures that will enable the development of the manufacturing sector. Chad is under-developed in its industrial sector and hence greater capital will be incurred in investing in a sector that has not been locally developed (Abdallah 2001).

The growth of the business sector mainly information technology has enabled specialization in labor and well skilled workers (Dunning 1998). This implies that through this growth, UK would not need to obtain labor from external sources and this will minimize the labor costs. Hence, the supply of skilled labor in India is more sufficient to cater for the upcoming manufacturing industries than in Chad, where most of the population is poor and there are lower levels of skilled labor. Information technology is likely to enable UK’s manufacturing industries’ technology to adapt to the existing economic conditions in India. This means that UK will not have to incur large amounts of expenses in implementing their technology in the foreign investments in India. In Chad, oil production is the major activity in the industrial sector. The technology is still not developed and the country mostly relies on foreign donors for the production of oil and this means that the country has not been able to develop its own technology. Investing in the country would mean that UK imports technology from its home country or from the other developed countries and this would result in the industries have higher production costs.

Hence, with these factors, the Porter Diamond’s theory may be used to show that India has competitive advantage over Chad and UK would more suitably invest in India than in Chad. The most appropriate form of investment in India would be through joint ventures. Since the country has already established its own local industries, the way to successfully invest in the economy would be to join the already existing manufacturing industries and exploit the country’s resources together (House 2004). The government of India also requires that a foreign company has to be owned by Indians by at least 50% and this way the company would be considered to be Indian equity (Dunning 1998). This makes joint ventures to be most appropriate. Joint ventures with the local companies will also enable the foreign company to have full access to the country’s resources in terms of labor, raw materials and the financial incentives.

Key strategic issues the MD needs to be aware of in respect of the investment in India

Cultural differences and implications of the FDI

The management of the foreign direct investment in UK must be able to identify the host country’s requirements in respect to investing in a joint venture. The India government is making great efforts to promote liberalization and it is through this that it is encouraging more foreign investors into the country. A simplification and liberalization of the norms of foreign direct investment will help revive the domestic industries and in turn promote the total country’s growth. Easing the entry restrictions for the foreign direct investors has, however, brought with it challenges that are likely to affect their success and which has also resulted in various cultural implications. The director of the UK foreign direct investments in India must be able to understand clearly these implications and make efforts to ensure that the investments have operated accorded to the expectations of the host country while at the same time achieving their desired goals (House 2004).

Geert Hofstede in his Cultural Dimensions model argues that there is noting like universal management theory and different nations all over the world have different understanding of the term management. According to this model, management is not a concept that can be isolated from other activities that are taking place in a given society. Management instead is interactive; it interacts with all that is taking place among communities, in politics and the government and also interacts with the various aspects of religion and scientific beliefs (Kassem 1976).

In this aspect, the UK investment in India will imply that it incorporates the activities of the country with its management operations. The UK’s manufacturing industries in India have formed joint ventures with the local industries and through this they have to put into consideration proper management skills to cater for the needs of the local community while also achieving the business’s goals. To understand the management of India, the MD should a clear knowledge and empathy for the entire community of India. The MD while dealing with the management strategies needs to understand that other people’s needs in other regions are as important as their own experiences even when they are completely different (House 2004).

The major cultural implications to put into consideration, according to Geert Hofstede (1976) are in respect to understanding:

  1. The extent to which people take economic inequality as being normal. This will help the mergers be able to set its goals without having to go through a lot of pressure in keeping the economy of a country developed.
  2. The individualism and collectivism of people interacting with the venture. This will enable the management to be able to employ the most effective strategies of handling its employees and the local community.
  3. The long term and short term values of the society: This is in respect to setting management goals that the venture would take as short term and those that would be regarded as long term.

Marketing implications

With the advancement in information technology in the business sector, the joint ventures formed are likely to improve their activities and benefit from this advancement (Hill 2008). However, the FDI regulations in India require that the foreign investors must exploit the country’s resources to its benefit. In this aspect, even when the UK’s foreign direct investment market their products, they must make maximum use of the country’s local markets and enhance the market conditions.

This is however not difficult due to the easing of the FDI regulations. The joint ventures through government approvals have been able to improve their products by making the best use of the local and foreign technology (restrictions on technology transfer has been eased as well) and they are also able to successfully market their products to the local and international markets more effectively. According to Hill (2008), the joint ventures form networks with other business sectors to promote the distribution of products through the advanced information technology.

Conclusion

In conclusion, it can be noted that foreign direct investment requires critical analysis of the choice of countries that the investor has. One must look into consideration the benefits as well as the limitations of investing in a different country and not in the home country. Since there are a number of countries where FDIs can be established, a foreign investor is sometimes required to implement an appropriate model like the Porter Diamond’s model of competitive advantage so that a proper analysis is made and the best final decision made on the location of the investment. The managing director will also be required to clearly identify the cultural implications that come with establishing an investment in a certain country. Hence, foreign direct investments involve much more than simply coming up with a venture in a particular location.

Bibliography

Abdallah, W, 2001. Managing Multinationals in the Middle East: Accounting and Tax Issues: Greenwood Publishing Group, UK.

Africa Research Bulletin, 1999: Africa Research Ltd.

Dunning, J and Narula, R, 1998. Foreign Direct Investment and Governments: Catalysts For Economic Restructuring: Taylor & Francis, India.

Hendel, A. et.al, 2008. Rightshore!: Successfully Industrialize SAP Projects Offshore: Springer, New York.

Hill, C, 2008. International Business: Competing in the Global Marketplace: London: McGraw-Hill.

Hofstede, G and Kassem, S, 1976. European Contributions to Organization Theory: Van Gorcum, USA.

House, R, 2004. Culture, Leadership, and Organizations: The GLOBE Study Of 62 Societies: SAGE, UK.

Jain, S, 1993. Market Evolution in Developing Countries: The Unfolding of the Indian Market: Haworth Press, UK.

Luff, P, 2006. Trade and Investment Opportunities with India: Third Report of Session 2005-06: Stationery Office, Britain.

Molyneux, P, 2004. Multinational Corporate Strategy and Finance: University of California, USA.

Nayak, S, 2003. Globalization and the Indian Economy: Roadmap to a Convertible Rupee: Routledge, UK.

Rugman, A and Hodgetts, R, 2003. International Business: Financial Times/ Prentice Hall.

Trends in Developing Economies, 2006: World Bank Publications.

Wall, S. and Rees, B. 2004. International Business: Financial Times/ Prentice Hall.

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