Why Might Firms Favour Foreign Direct Investment Rather Than Exporting, Licensing Or Franchising?

Nations in recent decades have made important forward leaps towards an inclusive environment which has contributed greatly to making global business dealings free from restrictions (i.e. trade barriers) and complexity& this culture is called Globalization which envisages an interdependent world economic system dominated by global corporations not identified with any individual country (Martin, 1998, p. 23).

For any firm to develop and grow it needs to expands its activities globally and to achieve that objective there are different market entry modes available to the firm ranging from Foreign Direct Investment (FDI), Exporting, Licensing to Franchising. This essay will explain why firms prefer to use FDI instead of the other above mentioned tools.

In the worldwide phenomenon of Globalization, foreign direct investment (FDI) is rapidly becoming an important factor in the economic growth of firms and countries. An illustration of this is the $70 BN of FDI directed towards China in 2007 vs the $2.7 BN in 1990, which has created 280,000 foreign funded enterprises (Hill, 2009, 243). In China approximately 8 to 10% of annualized gross fixed capital formation has been attributed to FDI (Hill, 2009, 243), this suggests that there is a positive correlation between FDI and economic growth.

The OECD Benchmark Definition of Foreign Direct Investment lt;/i>(OECD, 1996) defines FDI as the objective of obtaining a lasting interest by a resident entity in one economy (direct investor) in an entity resident in an economy other than that of the investor (direct investment enterprise) . In essence &FDI is a mechanism whereby a firm in one country will invest in foreign firm facilities for the intention of gaining control over the production, distribution other activities &of the acquired firm s products and services in the foreign country it is based and operates.

FDI can be divided in to two main types which are Greenfield investment and Acquisitions. Greenfield investment can be defined as the establishment of a new operation (Paul, 2008, PP.224), where as Acquisition is a cross border investment in which a foreign investor acquires an established local firm and makes the acquired local firm a subsidiary business within its global portfolio (Paul, 2008, PP 224). In recent years, Acquisition can be seen when Banco Santander a Spanish bank purchased Abbey (a British bank) in 2004 (Guardian Online, 13^th April 2010) and rebranded it to their own existing name (Santander) on Jan 2010. In summary the two forms are distinguished by how they are implemented abroad by the MNE.

According to Hill (2009, PP.428-429) MNE mostly prefer the Acquisition option due to three favourable factors which are& they fast to execute& pre-empt competitors& and less risky than Greenfield investment. However the choice for MNE to choose Greenfield investment or acquisition

depends on the situation facing them& if firms prefer to enter a market where there is already competition it will use the acquisition option to make its presence known or if there is no

Competition to be acquired it will seek the Greenfield investment. Hill (2009, PP.428-429) adds another important element that firms may have specialized knowledge or an established product that is difficult to replicate or implement for firms existing in a foreign country, so it is advantageous for MNE to enter using the Greenfield investment& example of this is Apple the American computer firm Apple which opened its first store in Europe (in London) (BBC Online, 13th April 2010).

For a firm using the market entry mode of FDI is very advantageous to due what is described as the OLI Paradigm & &(Dunning cited by OCED 2002, PP.37) which stands for ownership, location and Internationalisation advantages for FDI. Ownership refers to the assets of the MNE which enables the MNE to successfully compete against rivals in the global markets& location advantage is the low costs that a foreign country can offer an MNE such as cheap labour, cheap land like the call centres in INDIA which has seen alot of FDI from firms like BT (BBC Online, 2003). Internationalization advantage means it is cheaper for a firm exploit its ownership and location advantages to reduce costs via FDI (Dunning cited by OCED 2002, PP.37)

It is becoming very common for Governments to offer incentives for foreign firms to base their operation in their country. These incentives come in the form of tax concession, low interest loans and subsidies (Hill, 2009, PP.263) this is very advantageous for the firm as it will have financial political help in establishing it operations or outlet in the foreign country on the basis that it employs local people which contributes to the economic growth of that country.

FDI is very expensive than the other entry modes with the MNE having to spend high costs in Greenfield investments or acquisition and secondly FDI can be risky due to factors such as political instability and restriction of trade developing later.

50% of Philippines exports that are electronic goods have grown to a 14 year high reporting a increase of 53 percent to $2.07 billion in February (Business week Online, 13^th April 2010). Exporting is an economic tool where firms produce goods in their home country and distribute/selling them abroad to other foreign countries. Many firms initially started of with exporting before moving on to different entry market modes. According to Alkhafaji (1995, PP.276) there are five reasons for a firm to enter in to exporting domestic products abroad which are as follows& to access new opportunities which arise from new markets& utilize near-full domestic production capacity& overcome domestic market saturation& analyse new angles of advertising expansion& understand international involvement.

There are two key advantages to exporting for a firm first of which is simply that the expensive cost of setting up operations abroad is avoided and secondly the firm achieves experience curve and location economies (Hill, 2009, 419). & Experience curve indicates a firms overheads reducing in production over the life of a product when output doubles& this is usually bought about due to factors ranging from efficiency in production to learning from rival firms on their business strategies to economies of scale. &A location economy is when a firm bases its value activities in countries where factors such as economic, political, technological are conducive for the activity to be successful (Aswathappa, 2005, PP.295).

According to Hill (2009. PP 420) there are many disadvantages for exporting, a firm may not be situated in the best county for that particular aspect of the production and could be therefore restricted to the cost disadvantages of the current location. Volatile fluctuation of transportation costs in that country of activity location could make it very expensive and uneconomical& exposure to a foreign market will likely involve government regulations which could be trade barriers and quotas. &Also, an exporting firm may deal with middle men who are not necessarily loyal to one brand.

Franchising can be defined as an agreement & one lasting for a definite or indefinite period of time in which the owner of a protected trademark grants to another person or firm for some consideration the right to operate under this trademark for the purpose of producing or distributing a product or service (Thompson cited by Cave Murphy, 1976, PP. 572). In summary firms that opt for franchising sells brand name to the franchisee (firm) but make the rule that the franchisee will agree to follow the principles by which the business is originally run and based on. A successful example of a franchisee is McDonalds which has in the region of 1190 restaurants around the world of which 51% is a franchise (McDonalds UK, 13^th April 2010).

Franchising offers advantages to both the franchisor and the franchisee. Advantages to the Franchisor are that it will not incur the high costs which are involved in construction, setting up a new business premise and operating it& the franchisee assumes the costs and takes full responsibility for the implementation (Reference for Business, 13^th April 2010). This allows the franchisor to save money to expand production and advertisement. The Franchisee is able to start up the firm with business advice experience from the franchisor. The franchisee can also establish relationships with his local community and businesses (Pride et al.,2009, PP.156-156)

Despite the advantages of Franchising for firms there still exist disadvantages which again affect both franchisor and franchisee. The franchisor &is putting the brand name of the company at risk by allowing individuals who may not fulfill the quality and excellence associated with the brand name& quality control is difficult when & geographical distances (especially international ) are taken in to consideration (Business Link, 13^th April 2010). & For example a customer purchasing a drink in a Starbucks (franchisee) in London could be disappointed if the quality is poor, they draw conclusion that all Starbuck outlets have the same standard, hence affecting brand name of Starbucks for which the ramifications are high. Drawbacks for the franchisee is that they need to provide the large costs involved in setting up a outlet of the company and also paying management and franchisee and other fees on an annual basis which could reduce the actual return (or profit of the franchisee ) (Federal Trade Commission, 13^th April 2010). Another major disadvantage for the franchisee is the limitations of the franchisee contract which limited yours activities, even though you may have ideas which could enhance the quality of your service or product& in the USA there has many law suits due to contract disputes (Pride et al.,2009, PP.156-156)

Finally the other market entry mode for firms is licensing when a firm (licensor) sells the right to intangible property to another firm (licensee) for a limited period for which the licensor is paid a fee for this agreement (Hill, PP.421). Licensing seems similar to franchising however there is a subtle difference which is that licensing allows the firm to use the brand name, technology or knowledge in a way suited to their own business needs& an illustration of this is Disney which was the top firm in 2008 for licensing that generated majority of Disney £26 BN (Global License Online, 13^th Aprl 2010).Major advantage for a firm to enter a foreign market using licensing is that they are using an established and reputed brand or technology to enhance it s own product , to increase sells. For the licensor there is no cost of setting up the costs and risks of setting up an outlet or operation. (Hill, 2009, PP.421). A firm wanting to use Licensing as a market entry mode will face disadvantages in that its own technology could be enhanced and used by the licensee to enter the licensor market and put it out of business which happened which was seen with the RCA licensing colour technology to Sony who went on to improve the technology and take over the Global TV market (Hill, 2009, PP.422). Another major disadvantage is given by (Walter and Tracey, 1988, PP.12-13) in that though the licensor has quality control over the licensed product, name or technology they do not control the licensee s production supply or advertising something that the licensor (firm) would be interested in.In Conclusion this essay has shown that though there are many economic benefits from exporting, franchising and licensing however the advantages are not as strong as for Foreign Direct Investment strategy for firms. FDI is not limited to terms set by other entities such as a licensor or franchisor& it can change its business activities or strategies without restrictions. Government incentives are a big benefit as it can help with financial costs and potentially help business activities and sales thrive. FDI is more holistic approach for the firm and the Country as shown it stimulates economic growth. & The firm will do well to make use of FDI however huge costs are involved.