Why Did Honda Choose the In-production Facilities Rather than Contracting the US Auto Company - Case Study Example

Why Honda chose the In-production facilities rather than contracting the US Auto Company. Introduction Any company needs to achieve its objectives in the market. Thus it is mandatory to look for strategies that it can employ in its operations. For instance, foreign investment is one of the strategies that Companies use to secure a wider market, hence, attaining their goal. For example, in the 1980s Japanese Automobile Companies decided to invest in Northern American based plant[Aso15]. Some of the automobile Companies who invested are Honda, Toyota, Mazda and Nissan. In addition, Honda also invested in an engine plant that was used to supply assembly plants. The investment in a foreign market is favored by some of the factors that are explained in the theories of Foreign Direct Investment. The following is a discussion that explains why the Honda decided to invest in production facilities. Discussion Market imperfections are the connections that exists between exchange rates and foreign direct investment. These imperfections are experienced where the world integrates the capital markets. Thus they are subjected to information limitations. In this situation, there is a domestic currency depreciation that can eventually lead to the acquisition of assets from foreign countries. This leads to international capital flow. In Honda’s case, the decrease in the dollar value leads to the increase in the foreign direct investment[Agm15]. This chance brought an opportunity for Honda to invest in the US. Since the dollar was weaker to some extent, Honda found it easier for it to invest in the US. This was because the assets were cheap for Honda, since it had a different currency. The modern theory of FDI occurs because of the domestic assets worth more under foreign control. Honda was able to manage its plant in US than its counterpart. It accessed the same capital market with the US hence was very easy for it to penetrate. Honda took advantage of the dollar when it depreciated and then invested in United States. It is because, United States becomes a cheaper place to invest when the dollar decreases in value, and thus, it was easy for Honda to produce in United States. It is noted that the depreciation of a dollar does not affect the opportunities of the foreigners to invest in the United States. Therefore, it was a good chance for Honda to invest in the United States of America since its opportunity to produce there was not affected by the decrease in the value of the dollar[Asm14]. Due to the exchange rates, the United States contributed 75% of the final cost of the Honda car, and the imported parts paid the 25% cost. This favored Honda to build some assembly companies in the United States. After Honda realized the opportunity, it also built a production plant in the United States. These plants were very profitable to Honda hence making it continue its production activities in the country. The reduction of the value of United States dollar led to Honda gaining a lot in terms of profitability since there was a capital flow that was very advantageous to the foreign investors than the home country investors. The market imperfections approach to FDI contributed a lot to Honda’s decision of investing in the production facilities than contracting with the United States. Honda could not contract with the United States plants since the depreciation of the dollar affected the home plants[Cav15]. Therefore, if Honda had contracted with any United States plant, it could have been affected by the effects of dollar depreciation. Therefore, Honda found it easy for it to invest in production activities on its own than contracting with any plant in the United States. Investing on its own had more benefits than contracting with any plant in the United States. Honda had an advantage in terms of bidding. This is explained by the relationship that exists between the exchange rates and the FDI. Honda had a Japanese currency that favored it to have an added advantage in terms of bidding for building and assets in the United States. This was due to the reduction in the value of the American dollar. Therefore, Honda had that advantage since it was using a non-dollar currency that made it have an upper hand in terms of purchasing power as compared to the United States plants. Therefore, it was wise for Honda to invest on its own than contracting with an established United States auto company. Honda decided to invest in the United States since the Japanese yen against the United States dollar. This situation led to the increase in the exporting costs. The increase of the exporting cost of finished automobiles and parts to the United States made it expensive for Honda. Therefore, Honda considered it cheaper to invest the United States due to the exchange rates that was available in the market. The appreciation of the value of the Japanese yen than the American dollar led to this decision[Cav15]. The FDI theory in explaining Honda’s FDI into the US. FDI contributes a lot to the economic progress of any country in the world. There are different theories that explain FDI determinants and motivations. The theories include macro-level, micro-level, and the development theories. The macro-level theory focuses on the motivations that motivate the investors to invest in foreign countries. On the other side, micro-level FDI theories explain why subsidiaries can be opened abroad instead of exporting them. The third theory, the development theory is used to analyze the product life, and FDI flows. The development explains best on Honda’s FDI into the US. The development theories that include, Life cycle theory, Japanese FDI theories, and five stage theories try to explain why a company can prefer to invest in a foreign market. By the help of this theories, we get to understand the factors that led to Honda investing in US in production activities and not contracting with it (Taylor, Robert). The life cycle theory is usually used to analyze the relationship that exists between a life cycle and possible FDI flows. The theory focuses on a firm setting production activities in the foreign market for the products that are already standardized and has already matured in the home market. Honda chose to invest in US since it had already products that had standardized and had matured in the Japanese market. Despite the fact that there was fear that to invest in Northern America may lead to high labor costs and poor productivity which would have led to Honda’s automobile production unprofitable. To deal with this problem, the theory explains that a cycle where a product is produced in the home country and their subsidiaries produce the product in other parts at a lower cost. Honda realized later that, the assumptions about poor productivity had n basis thus went ahead to construct its Company there. The experience in the market and the maturity of Honda products in the Home market was the main factor that favored Honda. Honda’s technological innovations also contributed a lot to its penetration in the US market. Due to this innovations, new products are created and, therefore, the size of the market and its structure increases thus influencing the extent and the type of international trade. The second theory is the Japanese FDI theories. The theory has three phases where the phases explain how a company can invest in the foreign market. The first phase explains about the underdeveloped countries which are targeted by foreign Companies that uses the potentiality of cheap labor (Taylor, Robert). In the second phase, there will be more FDI inflows thus increase in labor costs and the living standards of the country’s people. In the third phase, there are many innovations and the FDI is motivated by market and technological factors. The case of Honda, it was favored by the third phase where it had the innovations and technologies that enabled it to penetrate the US market. The last theory is the five theories of John Dunning[Rod14]. The theory explains that a country tend to pass through five stages development. The first stage is where the country is unable to attract FDI inward since it only possesses the natural resources (Taylor, Robert). At this stage, the per capita income is low hence the level of demand is very low. The second stage stipulates that the inward FDI begins to raise, and the outward remains low. In this stage, the domestic markets grow in purchasing power therefore making productions by the foreign firms. In the third stage, there are huge inwards investments leading to high technological capabilities and standardized products. This favored Honda since it had high technological abilities and standardized products in the market[Tay14]. Other aspects of Honda’s investment in the US that are not included in the theories of FDI. Apart of the imperfections to FDI and the FDI theories that were used to explain Honda’s FDI to the US, there are other aspects that explain why Honda made it in the foreign market. First, the threat of protectionist. Many Japanese Companies invested in the foreign market due to the trade protectionist legislation [Cav151]. This was seen real due to the increase in Japanese automobile exports. It is because of this reason that made Honda take a decision on investing in United States. This aspect contributed a lot since Honda wanted to circumvent the threat of protectionist that was available during that time. Secondly, the long-term corporate strategy of Honda made it invest in the United States. Due to the stiff competition that Honda faced in Japan by the other established companies, it decided to look for market abroad. This was Honda’s strategy that helped it to survive in the market. Since Toyota and Nissan were already established in Japan, Honda wanted to make its way in the United States ahead of its competitors. Honda had a belief in customizing products to suit the needs of the local markets available. This became a success to Honda since it became the second largest company in the United States as compared to Japan where it was the fourth company [Tom15]. Lastly, the other aspect that led to Honda’s invest in the United States was the availability of other plants that would provide spare parts to Honda. Conclusion. In conclusion, Honda’s investment in the US was contributed by various factors. First the imperfection approach to FDI. This is where the depreciation of the US dollar and the increase in the value of the Japanese yen led to the penetration of Honda in the US market. This situation led to the increase in the exporting costs. The increase of the exporting cost of finished automobiles and parts to the United States made it expensive for Honda. Therefore, Honda considered it cheaper to invest the United States due to the exchange rates that was available in the market. The appreciation of the value of the Japanese yen than the American dollar led to this decision. The FDI theories explain Honda’s success in the US market. The most applicable theory is the development theory. This theory consists of Life cycle theory, Japanese FDI theories, and five stage theories. These theories try to explain why Honda took that decision of investing in the US rather than contracting with the US plants. Lastly, there are other factors that explain the penetration of Honda to the US market. First, the threat of protectionist. Many Japanese Companies invested in the foreign due to the trade protectionist legislation. Secondly, the long-term corporate strategy of Honda made it invest in the United States. Due to the stiff competition that Honda faced in Japan by the other established companies, it decided to look for market abroad. Works Cited Aso15: , (Asongu 5), Agm15: , (Agmon 3), Asm14: , (Asmussen 50), Cav15: , (Cavusgil 34), Cav15: , (S. T. Cavusgil 5), Rod14: , (Rode 8), Tay14: , (Taylor 145), Cav151: , (S. T. Cavusgil 32), Tom15: , (Tomi 5), Read More