Development Directions and Potential for Overseas Investment - Essay Example

?Report for strategy development directions and potential for overseas investment To The Managing Director, XYZ Plc. This company under report is based in the U.K. manufacturing automobile cars and catering to the European Union market. Ever since the U.K. joined the European Union, this company has had tremendous growth with the newly emerged opportunities to market the company’s automobile cars in all the member States of the European Union ( EU) for the past more than 30 years. The company’s workforce is now 75,000 strong employed in 9 locations across the country. Since the EU market is saturated and because of the down turn in the economy for the past 2 years, the company’s management has been seriously considering strategies for stimulating growth for the company. Continuous growth is essential for company’s survival in the interest of its investors and work force. Hence, this reports addresses strategy development directions in this regard. The idea of growth should be one of the business objectives. The company needs to engage in strategy development so as to create competitive advantage over its competitors. The strategy development is important as it should be difficult for the competitors to replicate. Collaboration with business partners or the stake holders such as the company’s suppliers, distributors and customers is a guarantee creating a competitive advantage which the competitors cannot easily emulate (Campbel, Stonehouse, & Houston, 2002) Different strategies to achieve competitive advantage are 1) knowledge-based strategy, 2) generic strategy 3) hybrid strategy and 4) core competence/distinctive capability/resource-based strategy. Organizations generally will select one of the strategies and incorporate value-adding activities in support of the strategy selected. These strategies are briefly explained (Campbel, Stonehouse, & Houston, 2002). Knowledge-based strategy refers to the organizational knowledge gathered over a period through “principles, facts, skills and rules” that aid in decision making, articulate behaviour and actions (Stonehouse & Pemberton, 1999). Knowledge is available in explicit form or implicit form. Knowledge which is documented and retrieved is referred to as explicit knowledge (Campbel, Stonehouse, & Houston, 2002). Tacit knowledge is that which cannot be stored being mostly of individual experiences of experts. This is also not possible to be copied by the competitors (Demarest, 1997). There should be at least three types of knowledge available within firms. They are know-how, know-why and know-what referring to practical knowledge, theoretical knowledge and strategic knowledge respectively. All these combine to form core competencies of a firm. Generic strategies are the well known Michael Porter’s generic strategy frame work that explains the competitive advantage of a firm. (Campbel, Stonehouse, & Houston, 2002). Hybrid strategy is the combination of knowledge strategy and generic strategy. Lastly, the core competency strategy which is nothing but the essence of the firm’s vast experience in the tradional activity the firm has been engaged in. Ansoff’s matrix will also serve to give the proper direction for the company’ s future activity. In view of the saturated market in Europe, the only way out for XYZ Plc is to seek greener pastures abroad. Developing countries are the niche market for automobiles because the globalization has improved the standard of living for the people therein resulting in creation of demand for automobiles. Markets for automobiles in these countries has not yet saturated. These countries are attractive not only within the context of domestic market for automobiles but also the savings in wages by almost 65 per cent. The countries offering huge opportunities for investment are China and India, the world’s two largest populated countries. Foreign Direct Investment (FDI) These countries have benefited a lot from the inward FDI flowing in continuously. India especially has survived the economic crisis that affected all the developed countries because of its robust and conservative economic policies. China has suffered though not in large scale because of its monetary intimate connections with the U.S. Foreign Direct Investment (FDI) is a kind of investment by the residents and the firms of a source country made in a host country for acquisition of assets therein, in order to carry on business in the host country either for the manufacture, distribution of goods or services. International Monetary Fund (IMF) defines FDI as an investment of lasting interest by one country in another represented by investors from the source country operating in the economy of the host country whereby the investors have effective control over their investments in the host country. The UNCTAD 1999 World Investment Report characterizes FDI as an investment of long-term relationship featuring lasting interest and control enjoyed by the entity of the source country in the host country. The term “long-term” is used to make a distinction from portfolio investments which are of short-term character in the form of securities with high turnover. The notable features of FDI are control and controlling interest enjoyed personally by the investors on a foreign soil. The controlling interest is variable from 10 % to whatever rate of percentage permitted by the Government of the host country. It implies that an FDI cannot always be 100 % in all sectors. It can only be by entering into partnership with the entities of the host country for investments ranging from 10 % to 51 % or 49 % of stake in the ownership as dictated by the economic policies of the host country’s government. Frame work FDI determinants for China Political stability Ali and Guo (2005) have reported mixed results for political stability as a determinant for FDI. Fifty percent of respondents has ranked it as important and another fifty percent as unimportant. Four of the respondents have expressed their serious concern towards political stability in China. In the case of China, there is no doubt about political stability since the Communist Party has been having an effect political control. Market Growth rate, Market size and Openness Market size ranks fourth important reason for the FDI inflow into China. The positive relationship between the market size and FDI has been confirmed by Zhang (2000) and Wei and Liu (2001). This has motivated the market-seeking firms from the U.S and Hong Kong to move their export-oriented investments towards Chinese markets. It has been proved that if the market size of a province is larger, FDI receipts will also be higher in China. Thus, China’s market size and growth have attracted sizeable FDI because large market size can provide larger economies of scale and spill over effects. FDI from EU is more committed towards Chinese domestic market than to export market generated by FDI-led production. EU Multinational Enterprise and the U.S. respondents in the study have rated China’s market size and growth as crucial to the investment decisions. GDP China’s GDP grew rapidly because of ongoing reforms after 1991. This has been the reason for more FDI inflow into the country as can be seen in the figure 4.8 below. This is an evidence of a positive relationship between GDP and FDI inflow into the country. (Daly and Zhang, 2010). The GDP growth is predicted to reach 10 % for the year 2010 as against 8.7 % for 2009. The Growth will slow down to 9 % in 2011 because of rising labor costs and lowering consumption. The growth will be around 7 % for the next three years (China Briefing, 2010). The proposition is that the GDP growth attracts FDI into China. Reverse is also true. FDI inflows into Chinese economy have resulted in the country’s economic growth mainly because of capital formation, enhanced industrial output, employment generation and increased revenue through tax collections (Zhang, 2006). Since GDP represents market size, the market size has attracted the FDIs from the U.S. and Hong Kong (Ali and Guo, 2005). Corruption Corruption is one of the factors of political risk as per the twelve sub-indices prepared by the International Country Risk Guide (Alfaro, 2003) A study by Ahlstrom et al (2003) found that foreign firms in China had been facing institutional challenges including practice of bribes and corruption interfering with law enforcement. For instance, a foreign firm in Fenggang town in Donngguan paid forty six types of various fees in the form of ‘extra budgetary’ revenue in the province for want of tax revenues. These types of extra-budgetary revenues derogate micro-economic efficiency, economic growth and give rise to corruption. Cai and Guney (n.d) 1posit that market seeking FDIs from the EU are not deterred by corruption levels in China though their general finding is that the absence of corruption and higher quality of rule of law do attract more FDIs into China. Their study cites the observation of the EU Trade Commissioner stating that European companies are confronted with market access barriers to trade and investment in China and the firms incur 21.4 billions Euros every year as missed business opportunities. Inflation Inflation is negatively related to FDI inflow (Udo and Obiora, 2006). China, for the first time in its history started attracting FDI with the setting up of four SEZs in Shenzhen, Zhuhai, Xiamen, and Shantou and fourteen coastal cities and Hainan Island during 1980s. in addition, three more zones were opened in the Yangtze River delta, the Pearl river delta and the Zhangzhou-Quanzhou-Xiamen region. But, the FDI started sliding down due to high inflation during late 1985. At that time, FDI had been concentrated in assembling and processing units in small scale sector. Since 1983, China enjoyed double digit GDP growth rate except in 1990, 1997, and 1998. Resources China has large oil reserves and its oil production is the highest in the world. But, it has to import oil because of its high consumption. It also produces coal volume of which is one third of world production. In fact, its coal industry has been experiencing over supplies and also with electricity production. In respect of other natural resources such as land, iron and minerals, they are available at competitive rates in the required quantities (OECD, 2000). China’s regional development has been varied because of the unique situation in each region. Advantages of the eastern regions are the disadvantages of the west. Western and the central regions attract foreign investment because of their economic backwardness with the resultant cheap availability of factors of production. The Eastern region has been already fully exploited and hence investors have to move towards the west for higher returns on their investments by making use of large untapped market in those regions. The western region is endowed with huge deposits of natural resources, energy and potential for agricultural production, tourism and land development. The Chinese population in that region is very diligent and work for a relatively a small pay. Cheap labour is the asset of this region (Cheng et al, 2005). Labour costs and productivity One of the factors of production cost is the wage component. In theory, lesser the labour cost, higher the FDI inflow. China’s aim is to cut down production cost by employing cheap labour. This is too simplistic. In 1980s many foreign firms were attracted to China because of cheap wage rates prevailing then and countries such as Hong Kong, Japan, Taiwan were the main sources of large scale FDI inflow during the period from 1980 to 1991 and during which period there was a positive relationship between the FDI and wage rates. From the period 1992 to 2008, FDI flow into manufacturing industries targeted high-tech industries. This needed highly skilled labour commanding a higher wage. Therefore, this period of 1992 to 2008 witnessed increased wages. Yet the FDI inflow did not decrease. In fact, during the period from 2000 to 2008 wage rates increased three fold (Daly and Zhang . 2010). Economic freedom Foreman and Vibah (2007) report that China’s net receipts of FDI during 1990-98 were $ $244,327m. The authors’ investigation involved economic freedom and its impact on FDI in three developing countries including China. They found economic freedom did not have much impact on the FDI inflow when aggregate measures of economic freedom were employed in the regressions. On the other hand, on disaggregation of measures the results showed that enhanced economic freedom resulted in increased FDI inflows. China, therefore needs to give more protection to the intellectual property rights, reduce governmental intervention and lower tariff barriers to attract more FDIs. Booth (2006) attributes China’s law score on economic freedom to market distortions. Public sector does not respond to market pressures for improving efficiency. Energy subsidies prevent energy efficiency and do not promote the use of coal instead. Absence of protection for intellectual property rights prevents multinational companies bringing in high-class technology. Isolating FDIs in specific zones prevents diffusion of technology through the domestic economy. The EU is yet to recognise China as a market economy, an evidence to show there are market imperfections prevailing in the Chinese economy. The World Bank has prepared a comparative chart of indicator of obstacles for the countries of China, Russia, Indonesia and Philippines. Indicator for China is extracted in the following table 4.2 (Krug and Hendrischke, 2009, p 55 Indicator Value Economic and regulatory policy uncertainty (%) 31.54 Macroeconomic instability (%) 28.06 Business licensing and permits (%) 18.81 Consistency of officials’ interpretations of regulations 68.43 Senior management time spent dealing with the requirement of regulations (%) 20.24 Unofficial payments from firms to get things done (% of sales) 1.99 Gifts requested by government officials 100.00 Time firms spent in meeting with tax officials (days) 14.55 Firms expected to give gifts in meetings with tax inspectors (%) 45.93 Value of gifts expected to secure government contract (% of contract ) 2.31 Confidence in the industry system (%) 82.87 (Source: World Bank 2005). (Krug and Hendrischke, 2009, p 55) Table Obstacles indicator for FDI in China These obstacles are self-explanatory. In spite of these obstacles with values ranging from 1.99 to 100, China has been experiencing sustained FDI inflows because of the vast market size and still untapped business potential. Infrastructure Infrastructure is one of the four main determinants of FDI, others being market size, economic development and labour market. China has improved its infrastructural facilities over the years particularly in terms of transportation and communication. This has become a major attraction as a location for FDI (Krug and Hendrischke, 2009) External Economies The FDI inflow is capable of creating external economies by increased employment, productivity of labour and wages or by building of production clusters and agglomeration effects. Infrastructure, specific industrial output required as inputs through forward and backward production linkages and industrial outputs giving rise to market expansion are responsible for creation of external economies such as reduced production costs. To create external economies there have to be infrastructure in manufacturing, and services (Kyrkilis, Valentzas, Pantelidis and Dells. 2008). Corporate Tax It is a general theory that taxation has a negative effect on FDI inflows. But, it depends on the purpose for which FDI inflows are seeking to enter the country. Thus, if there are other compelling reasons, corporate tax alone cannot be a dampening factor. Wei (2008) reports that despite the increase in the income tax on foreign investors, India India is equally attractive in respect of the above FDI determinants and added attraction is that it is a democratic country. Conclusion In view of the foregoing, it would in the interest of XYZ Plc to lose no time in making FDI in any one of the above two countries for manufacture of automobiles in Cars segment where the firm enjoys core competency. Partnership with local firms is highly recommended for the obvious advantages of knowledge of local market and dealing with local chap labour. References Ali Shaukat and Guo Wei (2005) Determinants of FDI in China Journal of Global Business and Technology, 1 (2). Booth Phillip (2006) Towards a liberal utopia London, Continuum International Publishing Group 2ed Cai Huifen and Guney Yilmaz (n.d) European Union Foreign Direct Investment in China: Evidence from a Panel Study of EU Manufacturing Firms, 1998-2007 Accessed 30 March 2011 < www.ifm.eng.cam.ac.uk/cim/symposium2010/proceedings/27_cai.pdf > Campbel, D., Stonehouse, G., & Houston, B. (2002). Business Strategy. Oxford: Butterworth-Heinemann. Daly, Kevin; Zhang, Xiaoxi (2010). The Determinants of Foreign Direct Investment in China (Report) Journal of International Finance and Economics, International Academy of Business and Economics. . High Beam Research. Accessed 24 March 2011 . Demarest, M. (1997). Understanding knowledge management. Long Range Planning , 30 (3), 374-384 in Campbell David, Stonehouse George, Houston Bill (1999) Business Strategy. Oxford; Butterworth-Heinmann. Foreman Kapuria and Vibha (2007) Economic Freedom And Foreign Direct Investment In Developing Countries. Journal of Developing Areas, The, Fall 2007. Accessed 29 March 2011 Krug Barbara and Hendrischke Hans (2009) The Chinese Economy in the 21st Century: Enterprise and Business Behaviour Glos, U K. Edward Elgar Publishing, Kyrkilis Dimitrios, K Velentzas , Pantelidis ostas Pantelis , Delis Taxiarchis (2008) What Causes Inflows of Foreign Direct Investment to China: Some Empirical Evidence accessed 29 March 2011. Stonehouse, G. H., & Pemberton, J. (1999). Learning and knowledge management in the intelligent organsiation. Particpation and Empowerment: An International Journal , 7 (5), 131-144 in Campbell David, Stonehouse George, Houston Bill (1999) Business Strategy. Oxford; Butterworth-Heinmann. Wei, Y. and Liu, X. (2001), Foreign Direct Investment in China: Determinants and Impact, Edward Elgar, UK.in Ali Shaukat and Guo Wei (2005) Determinants of FDI in China Journal of Global Business and Technology, 1 (2). Read More