Foreign Direct Investment - Case Study Example

Foreign Direct Investment UAE’s Economic Position The United Arab Emirates has a strong bilateral relationship based on a joint commitment to the security and stability of the Gulf region. The economy of the United Arab Emirates is built on the oil and gas reserves. This mineral resource places the UAE as the best economic position globally. The UAE is best located as a commercial and a business hub which holds one of the busiest man made ports, Jebel Ali (Global Investment & Business Center: USA, 2006). The Foreign Direct Investment (FDI) places the UAE at a higher position economically since it accounts for $2.3 billion 2014, in revenue based on foreign investment. Many companies around the world direct their investments in the UAE due to a significant economic growth (Global Investment & Business Center: USA, 2006). The country’s GDP stands at 1, 093 billion, where 69 % was contributed from the non oil sector (Appendix). Motive behind usage of FDI is profound. This section therefore, seeks to present theories that back the need the motive behind the consolidation of FDI by various MNE, while drawing specific examples from Dubai. Emaar Property PJSC Established in 1997, the company is a Public Joint Stock Company listed under the Dubai Financial Market. A developer in integrated master planned communities, where it has seen significant transformation of the real estate sector in Dubai. Its business strategy is aimed at replicating Dubai business model and leveraging execution capabilities and competitiveness in project management, distribution and design. Emaar Property PJSC is a global company that offers premier lifestyles. Its subsequent investment in Dubai functions with a number of subsidiaries namely; Emaar Mall Group, Emaar Investment holdings, Emaar Hotels and Resorts, Amlak Finance among others. Evidently, it has successfully launched a number of projects of projects namely Mira Oasis in Reem, Vida Residence, Boulevard Point,Samara villas in Arabian Ranches and Mulberry at Park Heights. As opposed to other oil producing countries in UAE, Dubai does not produce oil. As such, it was compelled to create preferred investment grounds such that investors could be attracted into Dubai. In this respect it offers a number of incentives for FDI companies. The country’s new Airport Free Zone and Jebel Ali free zone offer all the advantages available than any Emirati company which follows these additions; i. Renewable 15 years guarantee of no government taxation ii. 100 % foreign control and ownership iii. Flexible investment options iv. Full recruitment and administrative support v. Efficient distribution and transport facilities Its joint investment strategy took advantage of the recent buoyancy in Dubai’s real Estate market by developing new iconic projects. Evidently, it motifs to invest in Dubai is attuned to the internalisation theory, which upholds low entry modes as a preferred mode of operation in the foreign market. The preference of FDI is preferred in cases when establishing facilities overseas when the cost incurred in the licensing and exporting are higher, than the cost of internal transactions (Burgel and Murray 1998; Buckley and Casson, 1976; Ekeledo and Sivakumar, 2004). As such, Emaar Property PJSC sought to establish it regional presence so as to compete with the present local players in the real estate industry. Its investment motifs are supported by a low risk factor, as aspects of Dunnig’s eclectic paradigm. Recently, real estate uptick has been realized towards real estate, together with Emaar’s strategy in de-risking its revenue sources from a purely development to consolidate recurring revenue streams. This has reduced its estimated fair value and market value. The Eclectic theory attest that when entering the foreign market the firm could utilise its ownership advantage effectively, it could potentially attain superior market position, however its assets cannot be internationally transferrable. Emaar’s advantages in location can be realised through the cost of resources and availability that a firm can commit in a foreign market and the exposed risk and entry barriers. Dubai’s market has a high potential for investment, with low investment risk, hence attracted Emaar’s investment initiatives. It investment in Dubai has seen it gain market presence in various sectors. Given its long term investment it has created attractive programme that have significantly improved its approach to business. The Emarr Preferred Access programme is geared towards increasing investor confidence and presenting opportunities for ling term investors to be included in the company’s path breaking developments in Dubai. Theories Eclectic Theory As a further development of the internalisation theory, it was designed to the overcome the weaknesses realised with internalisation theory (Ekeledo and Sivakumar, 2004). The term eclectic ascertains Dunning’s models which incorporate of divergent theoretical approaches, including ownership advantages, Hymer’s monopolistic advantage theory, Vernon’s localisation theory, growth of the firm theory and Buckley’s transaction cost view (Buckley and Carson, 2011). This theory affirms that a firm may choose to integrate FDI activities and exert control over its resources upon fulfilling three key advantages namely location advantage, ownership advantage and internalisation advantage. Otherwise known as OLI model, it attest that ownership advantages shows how unique and firm specific resources are idealised to offer competitive or monopolistic advantages; that may help compete with local competitors in the foreign market (Buckley and Carson, 2011). The oligopoly theory contends that foreign companies would consider investing in other countries with the objectives of exercising its monopoly power they poses (Claver & Andreu, 2007). Arguably, in a bid to battle for profits and market dominance, companies involved in oligopolistic competition may shift to different market as a new strategy (Claver & Andreu, 2007). In support the OLI model advocates that a firm must poses market power that is obtained from a firm’s specific advantage (Claver & Andreu, 2007). The oligopoly theory adds to the OLI model is the relative propensity to time its entry into a specific market, against its competitors (Wilson and Baack, 2012). Confronting Dunning’s OLI model, presupposes the importance of fulfilling one of the three attributes of internalisation. He advocates that in order for a foreign firm to realise such benefits, it should poses market powers that rests on the company’s specialised knowledge. A firm that seeks to invest is such a market expects to increase its profits gains. Advantages brought by internalisation dictates whether a firm can coordinate organise their activities in order to add value in a way that can reduce coordination and transaction. These advantages are linked to the relative market efficiency in the management of information transfer. On the other hand, given that Dubai has a low contractual risk, firm will not opt to the exploit their ownership advantage (Claver & Andreu, 2007; Wilson & Baack, 2012; Pinho, 2007; Czinkota et al., 2009; Canabal & White, 2008). Based on this theory, in the case that the target market has allocation advantage then the firm would consider enforcing risk partners. A high contractual risk will compel the integration of FDI as a preferred tactic. Contrariwise, a low contractual risk will trigger the need for licensing (Sharma and Erramilli, 2004; Dunning, 1980). Although most companies have advantages of a specific market, the companies that poses the needed ownership advantage can take advantages (Nakos and Brouthers, 2002). Dunning (1980) affirms that an ownership endowment approach or location analysis cannot potentially explain the forms of investment and trade. These advantages occur when the three advantages work together. Such advantages are interlinked and dictate the firm’s decision affecting its operation in various aspects (Galán & González-Benito, 2001). More often than not FD takes place in the case when internalising firm’s specific attributes that are less likely risky for a firm as opposed to contracting its operations to other local firms. Internalisation Theory Buckley and Casson (1976) advocated the internalisation approach with respect to MNE internalisation of resources. This theory suggests that MNEs internalise their resources so as to distribute theme between the target markets and the product categories. In order to reduce any costs linked to the production phases; as such it focuses on the relative cost and collaborations regarding the type of knowledge exchanged by partners (Chen and Mujtaba, 2007). Markets are generally imperfect, based on internalisation theory. MNEs avoid market imperfections through the internalisation of their operation with respect to tacit knowledge, intermediate product, raw materials and perishable goods. The integration of this approach may reduce economies of scale that potentially lead to increased government restriction and challenges in cross border communication (Fisch, 2008). In the case, when firms consider the transaction cost to be high, then FDI would offer more efficient. Internalizing an imperfects internal market presents five advantages. i. It efficiently uses market powers facilitated through inequitable pricing in internal markets. ii. The integration of the multistage process that consolidates time delays that is devoid of future markets. iii. Elimination of disparity and the uncertainty of knowledge that exist between the sellers and the buyers iv. Reduction of tax liabilities on international transactions The theory assumes that a company can clearly present the distribution functions, realise competition from host country and differentiate ownership advantages. In this respect, companies choose their preferred entry mode by leaving out strategies resulting to higher cost and reduced profits (Decker and Zhao, 2004; Casson, 1998). Based on Hirsch (1976) economic model, companies should choose a preferred location for their marketing, operations and R& D activities. Buckley and Hashai (2005) contend that the internalisation necessitates straight investment that means low variable cost and fixed cost. Knowledge transfer is witnessed through knowledge complexity, firm boundaries and the geographic distance. Monopolistic Advantage Theory Hymer (1960) presupposes that in the case that a firm is typified by firm specific attributes that cannot be easily copied, it could realise high rents and recover the higher cost of investing (Burgel and Murray, 1998). He asserts that firms with increased market advantage, in a relatively imperfect, market could favour the use of FDI. FDI’s direction is dependent upon easiness of entry into the new target. Evidently, market imperfections such as economies of scale, as well as , diversification and knowledge advantages are key factors that allow a company to use its monopolistic power to gain entry into the market (Claver and Quer, 2005; Buckley, 2006). Accordingly, Hymer suggests that the FDI inflows are not linked to country-level attribute, such as high interests rates (Rowthorn, 2006; Buckley, 2006). Arguably he presupposes that the cross FDI occurs concurrently and mostly in similar industries; whereas other absorb more FDI flows (Treece, 2006; Buckley, 2006). He presupposes a company’s nationality as an influential aspect through the following attributes; the firm’s stakeholder’s, its managers and the company itself. Hymer (1968) advocates FDI as an important factor for cross border expansion for two important reasons. The first motive rests on the firm’s intra firm transfer of technological and organisational advantage that is realised in the firm’s home country. In order to realise full returns from such returns, firms have to establish the foreign operation in order to compete with firms both at their homes and in divergent host market (Claver and Quer, 2005; Claver and Andreu, 2007). The second driving force is the relative propensity to remove conflict business activities while in the foreign market. In this respect, it forces the company to make more investment in the target country that what is important to create a preferred portfolio. The monopolistic advantage theory was viewed as a linkage to Bain’s IO theory; where the role of Ricardian rents was eminent (Sharma and Erramilli, 2004). Implications from Emaar Property PJSC Resources –Transfer Effect An investment through FDI could positively impact a host economy through the integration of supplying technology, management resource and capital resources that would have otherwise not be available. Gaining such resources are imperative in the stimulating the country’s economy (Claver and Andreu, 2007). Capital With respect to capital, companies, mostly invest in long term projects that consolidate risk taking and the profits repatriations in the case when the investment gains profits. Arguably, Fisch, (2008) advocate that FDI can make significant contribution not only through offering foreign capital , but also, by crowding in domestic investment; its therefore increases the whole value of the FDI. Investment from Emaar Property PJSC has seen its net profits at AED 861 million sin FNY 2014. Its quarterly revenue has been registered at AED 2.76 billion a year, offering significant cash flow for the country. It tentative project management initiative for Burj khalifa has significantly boosted the tourism sector Advantages linked to unrestricted cash flow are; i. International capital flows reduced risks through a consequent diversification ii. The spread of best practices of corporate governance, legal tradition and accounting rules, can be realised through global integration. iii. Increased global mobility of capital limits inhibits the host country from pursuing unsound policies. Technology Technological advancement can potentially stimulate a country’s economic growth by taking two invaluable forms. Technology can be integrated in the production process or in a product (Hussein, 2009 p. 364). Evidently, Emaar Property PJSC has brought tremendous improvement in technology, given its years in the real estate industry. The marvelled engineering development of Burj Khalifa has brought new technological designs that are eco-friendly and beating all engineering odds. Management The transfer of knowledge enhances the existing knowledge in the host country through the transfer of competent skills, labour training and new managerial practices. An important spin off effects is realised when the local personnel that are trained to occupy financial and managerial post. Contrariwise, superior managerial skills can potentially stimulate suppliers; distributor and competitors’ to improve their approach to management, given the need for efficiency in construction business. Through implicit and explicit training new skills can be gained. Training through Emaar is beneficial in provisioning higher quality given that only productive firms are involved with the trade. These benefits can be summaries as; i. Managerial efficiency ii. Externalities that arise from on-job training iii. Entrepreneurial capability Employment benefits Benefits realised through an association of FDI are both indirect and direct. Creation of employment opportunities can be beneficial to the labour force. Such benefits are attuned to UAE’s attainment of emiritisation, where the country hopes to create large employment opportunities. All Emaar’s projects necessitate human labour since most development projects are labour intensive. Such acquisition suggests the need to acquire, human capital at various sites. Disadvantage Increased Competition Buckley and Carson (2011) affirm that the presence of a foreign enterprise in a host country increases its economic development by augmenting domestic competition, resulting to higher productivity, efficient resource allocation and lower prices. A tentative increase in competition tends to catalyse Emaar’s capital investment in R & D and plant equipment in order to increase its competitive advantage in the market. Evidently, they stimulate growth through effective production approach and lowering their prices through an increased competitive avenue. Spill Over Effect Fisch, (2008) advocates that vertical spillover is eminent when local firms become more productive due to the presence of MCS through reverse engineering, demonstration effects and increased competition. As such, it enhances backward of forward linkages in this respect. Through forwards linkage the domestic firms can improve their productivity, since the involvement of MNE in the domestic market offer intermediate input that integrates new technologies or processes. With over ten development projects, Emaar Property PJSC entrance and the operation in Dubai has generated profound spill over effects to the rest of the economy, implying that there has been considerable transfer of new capabilities to local firms. The empirical studies presented by spillover effects of FDI are in line with the idea that MNE have a greater advantage in architectural and organisational techniques, as opposed to domestic firms (Hymer, 1976). Hymer presupposes that the transfer of knowledge is realised through divergent means such as trade, FDI, strategic alliance and subcontracting. As a preferred mode of technology transfer therefore, FDI can potentially integrate superior technological improvements at reduced cost. From a neo-classical point of view since technology is typified by the characteristic good, some parts of the technology is realised in the MNE subsidiaries to additional domestic firms (Canabal & White, 2008). From Das’ price-leadership model, he affirms that domestic firms can learn from MNE and increasingly become efficient in its operations (Treece, 2006; Wilson & Baack, 2012; Hymer, 1976). An entry by MNE can present conflicting effects on the level of backwards linkages in Dubai’s industry. Firstly, such entry reduces the degree of the backward linkage since local firm’s output level essentially shrinks, with respect to autarky. These result from the competition from the multinational company, in this case Emaar. Contrariwise, Emaar may source the intermediate company locally, hence generating the additional demand for the intermediate product. References Buckley, P. J. (2011) The theory of international business pre-Hymer. Journal of World Business, 46 (1): 61-73. Buckley, P. 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Journal of International Marketing, 20 (2): 96-115. APPENDIX Dubai’s GDP GDP by Sector from 2008 to 2009 Sectors 2010 2009 2008 Non- Financial Corporation Sector 1,012,939 915, 611 1,083,467 Mining and Quarry 345, 366 288, 582 427, 104 Whole Sale, Repairing and Retail 138, 948 133, 544 146, 700 Real Estate 108, 412 106, 670 124,000 Government Service Sector Financial Corporation Sector 74, 319 71, 841 73, 500 Dubai’s Interests Risks Comparison of UAE’s index against different countries Source: A.T. Kearny Analysis Shareholder’s Value 2012 2011 Book Value Fair value Book Value Fair value Trade and other receivables 3558 3559 Development Properties 26,998 43, 181 26, 611 37, 720 Cash and bank balances 3611 3612 2765 2765 Securities and Loans Associates 4300 4334 4012 4010 Fixed Assets 8109 10, 518 8300 10, 261 Investment in Associates 6429 6350 6683 6388 Goodwill 47 46 44 44 Total Assets 61, 050 87, 846 60, 053 79320 Total Liabilities 28, 616 29220 28, 741 29, 120 Emaar Regional Business Highlights Projects Completed Underway Projects 2011 2012 2013 2014 Downtown Commercial Spaces 2,860,476 - 2560,476 300,000 - - Downtown Development 9880 2,485 7, 853 1, 278 749 - Dubai Marina 4,450 - 4,450 - - - Emaar Towers 168 - 168 - - - Umm Al Quwain 277 - 277 - - - Arabian Ranches 4, 177 786 14, 146 - - 224 Dubai’s Mall Average Quarterly Strong Record of Execution Emaar Property PJSC delivered 32, 902 residential units in UAE Read More