4.3 Horizontal FDI
Horizontal FDI is FDI in the same industry abroad as that in which a firm operates at home, but why should a firm choose FDI rather than the options of exporting and licensing?
FDI is both expensive and risky compared with either exporting or licensing. It is expensive because the firm is literally starting from scratch to build a new enterprise in a foreign country, unless of course it has bought a going concern. It is risky because of the problems likely to arise in a different culture (which we discussed in Chapter 2) and because of distance and communication problems. The reasons FDI is often chosen in preference to the other two options are complex and are concerned with five factors:
- transportation costs
- market imperfections
- competition
- the product life-cycle
- location-specific advantages.
Transportation costs vary greatly with the type of product. When transportation costs are added to production costs it becomes unprofitable to ship low value-to-weight products such as cement and beverages over long distances. That makes exporting far less attractive than licensing or FDI. On the other hand, high value-to-weight products such as computer hardware and software, and medical equipment have little impact on the relative attractiveness of exporting, licensing, or FDI.
We will consider the other four factors listed above in the next section under 'Theories of horizontal FDI'. The reason for this is that in your textbook, Hill (2005) uses the word 'theory' with some elasticity. Thus 'transportation costs' are a 'factor', but 'market imperfections' rates it using the term 'theory'. Also, competitors are discussed under the rubric of Knickerbocker's theory and the product life-cycle theory (also discussed in Chapter 3), both of which are of course legitimately theories.
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