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Distance Influence on Foreign Direct Investment
Berry, Guillén and Zhou, 2010 Opines that FDI commonly has two general characteristics. It entails a 10 % ownership value as an ordinary matter. FDI also consists the opening transaction that liquidates investments and also the proceeding transactions done by the direct investor together with the investment company that focuses on maintenance, expansion, and reduction of the expenses. In the definition of FDI, there are three distinct features, flows of the new foreign equity, intra-enterprise debt transactions and the reinvested income.
Emerging countries are rapidly growing as primary and significant sources of foreign direct investment flow to the lead economy countries. Most enterprises from developing countries have become key, foreign investors in the international market. However, the bilateral FDI flow between countries has been affected by several factors. Part of this paper is an investigation on how various concepts of distance influence the flow of bilateral FDI between the global economies.
The different distance concepts are introduced and discussed in detail. Another concept, Liability of foreignness (LOF), is also introduced, and its impact on the trade balance highlighted as well. Lastly, the reader will find useful information on the benefits of the firm’s acquisition over a green field venture. The criteria of a business location selection are also illustrated in conclusion.
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Distance has become a hindrance to economic activities across the borders in international trade and markets. There is a dire need for any multinational enterprises to consider all concepts of distance before commencing their transactions in any country. The significant distance features to look encompass of spatial and institutional features. Geographic distance has over time been related to the costs of transport incurred in remote locations business transactions as well as the LOF.
Non-geographic distance factors have also been linked to the explanations in the respective businesses across the borders. Such features include; social, cultural, economic and normative differences. According to studies in business management, the emphasis has been laid on cultural and psychic distances that are regarded the greatest determinants in the FDIs location.
International trade research recommends that the institutional and social features be considered in the business theory so as to cab the broad range of hindrances that have been linked to geographic distance. Longer geographic distances could result in the increment of transport costs, challenges while dealing with different regulations and institutions. It is likely going to be a difficulty in understanding markets with another level of economic development (Berry et al., 2010).
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The density of distance concepts and their effects on the FDIs may be best appreciated if viewed across the regions, functions and firms. The evaluation across the region signifies a separation point from the traditional methods of analyzing location decisions of FDI. Cultural differences refer to the disparities in norms and values between the host and the home country. It is very significant since the national values among employees and countries affect how individuals act and hence have an impact on the establishment of a firm.
To understand the cultural distance as a determinant of FDI flow, it is necessary to measure it by the aid of Schwartz’s orientation of gender and culture equality. Two known orientations are embeddedness and autonomy. Embeddedness characterizes people more collectively thus social relationships with groups of people are highly regarded as individuals work towards common goals. In autonomy, people value the uniqueness of each person, and one is entitled to their feelings and ideas.
Another important aspect is the gender equality, which is not only a social factor but has an impact on the economic development of any country. Women form a significant part of the workforce in several sectors of growth. There tends to be a positive relationship between the level of human capital, other economic conditions and the women rights (Siegel, Licht and Schwartz, 2012)
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The liability of foreignness as the total of costs comprises of the unseen costs associated with the engagement with new legislatures and cultures when doing business abroad unlike home. Elango (2009) asserts in his definition of LOF that it results in a disadvantageous competition for any multinational company. Generally, according to Elango, the costs incurred by an enterprise abroad would not be incurred by a similar local company. The genesis of such costs could be cultural, geographical, economic and institutional distances that lead to an increment in costs and makes it hard to succeed abroad.
LOF majors on the social expenditures of transactions overseas. Such costs are gotten from the relational, unfamiliarity and discrimination challenges faced by the foreign companies, unlike their domestic counterparts. They are innately uncertain and may be incurred even in future. Unfamiliarity costs are a reflection of poor experience or knowledge in the foreign country hence a setback to the foreign companies as likened to the local enterprises. There is a tendency for the foreign investors to pay handsomely for what the locals acquire cheaply or at zero cost.
For instance, local banks in Germany are likely to have a sigh of relief if the Bundesbank lowers the interest rates in a day’s time but British-based banks in the country may have nothing to celebrate. Such an LOF is related to the durability of its existence in the host nation. Short-term resolutions in the foreign country result to unexpected challenges that are covered in the additional costs incurred by the multinational company to realize a similar level of host-market awareness as the domestic company.
Unfamiliarity hazards result in a rise in the average cost of the foreign company, but the production level remains constant. Such as building market awareness costs should be gotten rid of with time, although they may persist if the multinational corporation managers continue adhering to the global strategy and fail to involve themselves in the civic learning (Barnard, 2010).
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A green field venture means starting off an enterprise from scratch, which is from a green field (Klimek, 2011). Acquiring an existing company as opposed to Greenfield venture has several merits. Firstly, it is faster. If the investor wanted the company to take a shorter time for their presence to be noted as well as compete well at entry level in the market, then this would be the best option. Greenfield ventures demand a longer period of physical construction and developing the company. The acquisition is one of the cost-effective means for the investment to realize a competitive mileage in technology, brand name, distribution and logistical advantages as it gets rid of the local competitor.
International political, economic and foreign exchange state may cause imperfections in the market thus causing the target companies to be underestimated. Several MNEs in Asia have been targeted in the recent past due to the economic crisis in the region that consequently impacts on their financial wellbeing. This has left many companies in a state of desperation for capital injections to survive competitively. The acquisition is the best strategy to solve such challenges as maneuvering through the local distribution channels, recruitment of the local employees, and it also creates a platform with a readily established market with a customer base.
Such factors shorten the time needed for the venture to break even. On the other hand, cross-border acquisitions have their shortcomings that the investor needs to consider before making the bold step. The costs of acquisition and financing are relatively too high. It can be difficult to mesh diverse corporate cultures. It may force the management to consider slimming down in order to up the economies of scale. The outcomes of such a step may not be productive to the firm since there is a tendency for individuals to try saving their jobs.
Other difficulties may emanate from the host nation’s interference with financing, pricing, market segmentation; employment guarantees favoritism and overall nationalism. An investor may decide on acquiring a joint venture. In such a form the investor accesses the local partner’s experience and skills, the government contacts and the knowledge about the local market. A joint venture is thus regarded the best way of investment (Becker & Fuest, 2011).
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The business location is critical for any venture to realize growth as well as experience successful operations. Choosing a business location requires precision in market research and planning. It is imperative to put into consideration several factors when making a choice for the company’s location. Several aspects are involved such as assessment of the supply chain, observation of the demographics, understanding state legislature, staying on budget and scoping the competition.
Some other factors to focus on in the research include; the company needs, employees, customers, the equipment required to deliver services among others. Talking of the company needs, most enterprises make a location choice that gives them accessibility to their customers. On this note, it is vital to consider the brand image and ask whether the location is going to be consistent with the intended brand. Establish whether the companies around are complementing or competing for the venture.
It is very necessary mostly where shopping comparisons are common. If the competitor is likely to make the environment tougher then it is advisable to shift the location. There is a need to find out whether the target area has potential employees and the rates of labor. If the business has a prospect of growth, then one should look for a building that offers room for expansion.
The business should also be located at a place where suppliers can quickly find you. One has to think also of safety too, thus, questions about the crime rate in the select area need be asked. Zoning regulations; these help determine whether one may conduct their type of venture in a given building or location. This may be found out through holding the local planning agencies (Cavusgil et al., 2014).
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The business location should be consistent with one’s style of operation. There is a need to determine whether the intended operation is going to be formal or informal. In cases where the customer base is local one is required to find out whether the population matches the customer profile for the business support. Find out whether the community has a stable economy for the company’s well-being.
It is vital to be cautious with a community that solely dependent on a particular company for their economy since this could lead to a downturn that is not healthy for any business. Having the knowledge about the legislature on businesses in a given location is very essential. Look into hidden costs because not many spaces are business ready thus requiring a lot of initial work be done before start-up. Determine also whether the select location qualifies you to access the government economic incentives (Hair Jr et al., 2015).
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References
Barnard, H., 2010. Overcoming the liability of foreignness without strong firm capabilities—the value of market-based resources. Journal of International Management, 16(2), pp.165-176.
Becker, J. and Fuest, C., 2011. Tax competition—Greenfield investment versus mergers and acquisitions. Regional Science and Urban Economics, 41(5), pp.476-486.
Berry, H., Guillén, M.F. and Zhou, N., 2010. An institutional approach to cross-national distance. Journal of International Business Studies, 41(9), pp.1460-1480.
Cavusgil, S.T., Knight, G., Riesenberger, J.R., Rammal, H.G. and Rose, E.L., 2014. International business. Pearson Australia.
Elango, B., 2009. Minimizing effects of ‘liability of foreignness’: Response strategies of foreign firms in the United States. Journal of World Business, 44(1), pp.51-62.
Hair Jr, J.F., Wolfinbarger, M., Money, A.H., Samouel, P. and Page, M.J., 2015. Essentials of business research methods. Routledge.
Klimek, A., 2011. Greenfield foreign direct investment versus cross-border mergers and acquisitions: the evidence of multinational firms from emerging countries. Eastern European Economics, 49(6), pp.60-73.
Siegel, J.I., Licht, A.N. and Schwartz, S.H., 2012. Egalitarianism, cultural distance, and FDI: A new approach. Organization Science, Forthcoming.
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