Fdi Strategies in European Emerging Markets

FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies Maastricht University Faculty of Economics and Business Administration International Business, Strategy & Innovation Document: Thesis report Date: Author: Supervisor: Amsterdam, March 14th, 2009 H. W. A. Canisius (i464635) Mr. W. Swaan FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies Acknowledgement I thank my parents, family and close friends for their moral support and constructive criticism during my studies in Amsterdam and Maastricht.

I thank Marcel for letting me rent his nicely renovated and refurnished apartment while finishing my thesis. It provided a perfect work environment. I like to thank Mr. W. Swaan for supervising my thesis and his constructive criticism. The startup phase of my thesis has been quite challenging and his guidance supported me in making this thesis what it is. Last but not least, I would like to thank the interview candidates for their willingness to participate in this research and by providing the foundation for this thesis.

I hope they enjoy reading it as much as I enjoyed writing it. Hans Canisius i 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies Management summary This thesis focuses on Foreign Direct Investment (FDI) strategies of developed European market firms in European emerging markets and aims to contribute to the existing knowledge on the evolution of post-formation FDI strategies in face of host-country developments.

The literature review therefore addressed the wide variety of host-country conditions and identified institutional, network relations and competition related conditions as the most significant host-country aspects for post-formation FDI strategies. Each of these aspects has subsequently been explored in order to determine the circumstances in which certain developments can trigger the need or opportunity for FDI exit, reallocation or expansion strategies.

A case study research among developed European market firms has been conducted to provide the necessary practical insights on the selected host-country developments, yet the response rate has unfortunately been insufficient to allow for any reliable conclusions on the existing literature. The case study findings do however provide support for various aspects in the literature and thereby indicate certain vital host-country developments for consideration for post-formation FDI in European emerging markets.

Some examples of such developments are related to institutional stability and transparency, local competition and embeddedness in local network relations. This thesis furthermore identified other important considerations for post-formation FDI, like for instance the potential effect of labour market competition and the disappearance or reallocation of local markets, that were not addressed in the literature review. Besides this support for various developments addressed in the literature and other developments identified in the case study research, this thesis also resulted in three additional findings.

First, European emerging markets can be considered attractive and still are becoming more attractive for FDI as these markets continue to develop and display increasing levels of stability and prosperity. Second, the EU or potential EU integration plays a significant role in the development of European emerging markets as it stimulates a. o. FDI inflows and the development of stable and transparent institutional conditions. Finally, both the literature and research findings emphasize the importance of a thorough FDI formation phase as well as continuously monitoring ongoing development during FDI projects.

The impact of post-formation host-country development on FDI strategies is considered to diminish with increasing attention on FDI formation, yet the need to continuously monitor development during FDI project will increase under higher levels of uncertainty. Hans Canisius ii 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies Table of content 1 Introduction……………………………………………………………………………………………………………………… 1. 1 1. 2 1. 3 Focus & research questions …………………………………………………………………………………………. 2 Contribution ……………………………………………………………………………………………………………….. 4 Thesis structure ………………………………………………………………………………………………………….. 5 2 FDI and formation strategies……………………………………………………………………………………………… 2. 1 2. 2 2. 3 Firm motives for FDI ……………………………………………………………………………………………………. 6 FDI determinants ………………………………………………………………………………………………………… 8 FDI entry mode strategies ………………………………………………………………………………………….. 12 3 Host-country developments and post-formation FDI strategies…………………………………………….. 4 3. 1 FDI, institutions and emerging markets………………………………………………………………………… 14 Literature review on institutions and emerging markets ………………………………………….. 15 Challenges for post-formation FDI……………………………………………………………………….. 16 Conclusion ……………………………………………………………………………………………………….. 20 3. 1. 1 3. 1. 2 3. 1. 3 3. 2

Business relationships and networks in emerging markets …………………………………………….. 21 Literature review on network relations ………………………………………………………………….. 21 Challenges for FDI …………………………………………………………………………………………….. 23 Conclusion ……………………………………………………………………………………………………….. 26 3. 2. 1 3. 2. 2 3. 2. 3 3. 3

Competition and spillovers in emerging markets …………………………………………………………… 27 Literature review on competitor analysis and inter-firm rivalry …………………………………. 27 Literature review on FDI and spillovers in emerging markets ………………………………….. 28 Challenges for FDI …………………………………………………………………………………………….. 29 Conclusions ……………………………………………………………………………………………………… 1 3. 3. 1 3. 3. 2 3. 3. 3 3. 3. 4 4 FDI in European emerging markets ………………………………………………………………………………….. 32 4. 1 4. 2 The development of FDI in European emerging markets ……………………………………………….. 32 Country and sector selection………………………………………………………………………………………. 36 Hans Canisius iii 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies Methodology………………………………………………………………………………………………………………….. 37 5. 1 5. 2 Literature research and the research question ……………………………………………………………… 37 Research design……………………………………………………………………………………………………….. 40 Research domains …………………………………………………………………………………………….. 0 5. 2. 1 5. 3 Research strategy …………………………………………………………………………………………………….. 43 Phase 1: Firm selection ……………………………………………………………………………………… 43 Phase 2: Telephone and email contact ………………………………………………………………… 43 Phase 3: Interviews …………………………………………………………………………………………… 4 Data analysis ……………………………………………………………………………………………………. 44 5. 3. 1 5. 3. 2 5. 3. 3 5. 3. 4 6 Research findings…………………………………………………………………………………………………………… 45 6. 1 6. 2 Candidate firm selection and case introduction …………………………………………………………….. 45 Research findings……………………………………………………………………………………………………… 9 Research domain 1 and 2: Host-country institutions ………………………………………………. 49 Research domain 3 and 4: Host-country network relations……………………………………… 52 Research domain 5 and 6: Host-country competition …………………………………………….. 55 Concluding interview questions …………………………………………………………………………… 58 6. 2. 1 6. 2. 2 6. 2. 3 6. 2. 4 7 Conclusion…………………………………………………………………………………………………………………….. 0 7. 1 The research question……………………………………………………………………………………………….. 60 Host-country institutions …………………………………………………………………………………….. 60 Host-country network relation ……………………………………………………………………………… 62 Host-country competition ……………………………………………………………………………………. 4 Additional remarks …………………………………………………………………………………………….. 66 7. 1. 1 7. 1. 2 7. 1. 3 7. 1. 4 7. 2 7. 3 Managerial implications ……………………………………………………………………………………………… 66 Research limitations and suggestions for further research ……………………………………………… 68 References ………………………………………………………………………………………………………………………….. 0 Appendix A: Spillover effects as a result of foreign entry……………………………………………………………. 75 Appendix B: Questionnaire…………………………………………………………………………………………………….. 76 Appendix C: Research and interview introduction letter formats …………………………………………………. 79 Appendix D: Interview transcript A – confidential……………………………………………………………………….. 1 Appendix D: Interview transcript B – confidential……………………………………………………………………….. 87 Appendix D: Interview transcript C – confidential………………………………………………………………………. 93 Appendix D: Interview transcript D – EUNITE, Mr. M. de Bruin …………………………………………………. 100 Hans Canisius iv 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies 1 Introduction

The current trend of globalization and the continuous struggle for competitive advantage triggers an ever increasing competitive landscape (Estrin & Meyer 2004, p. 304). Due to these pressures and the dispersion of knowledge and resources, firms experience more and more difficulties to individually compete in increasingly international markets, which in turn results in an unprecedented growth of inter-firm partnerships (Moller & Svahn 2006, p. 985). These inter-firm partnerships can be defined as structured agreements between two or more firms and can be characterized by a. . a formal or informal structure, domestic or international and equity or non-equity based (Adobor 2006, p. 123). Furthermore, the literature describes a wide variety of motives for inter-firm partnerships, raging from access to valuable and unavailable resources and opportunities (Adobor 2006, p. 122), increase flexibility and potential lower levels of risk (Ireland, Hitt & Vaidyanath 2002, p 414), and more generally the access to knowledge, capabilities and opportunities for organizational learning (Schildt, Maula & Keil 2005).

Independent of the motives for inter-firm partnership formation, scholars recognize that the phenomena of national and international inter-firm partnerships has become an important strategic tool in order to maintain and improve a firm’s competitive advantage (Adobor, 2006 p. 122; Lajare, Lillo & Sempere 2002, p. 42; Ireland et al. 2002). As a distinctive part of this concept of inter-firm partnerships, this thesis will specifically focus on Foreign Direct Investment (FDI).

FDI can be defined as the investment in a long-term relationship reflecting the acquisition of a lasting interest and control in a firm operating in an economy other than that of the investing entity (Sohinger & Harrison 2004, p. 57; Sohinger 2005, p. 74). Incentives to initiate FDI activities are plentiful and FDI is recognized for its vital role in economic growth and development (Tarzi 2005, p. 497; Steensma, Tihanyi & Lyles 2005). As a result, an interesting field of research within the topic of FDI focuses on emerging or transition economies.

Emerging economies or markets are basically defined as markets that are in transition between a developing and developed status. In general, these emerging markets are less institutionally and economically developed and somewhat behind in terms of various technological and organizational skills, infrastructure, quality of labour and financial capital availability (Hitt, Dacin, Levitas, Arregle & Borza 2000, p. 451-53). Therefore, emerging markets are often characterized by a more volatile and instable environment, which challenges national and international businesses in their operations.

Transition economies share the same characteristics as emerging markets, but have the additional characteristic of a reform process from a planned economic system, or so-called state socialism, towards a market economic system, or socalled market capitalism (Danis & Parkhe 2002, p. 423; King 2007, p. 10). Particularly for these emerging or transition markets, FDI can provide vital resources in the form of financial capital, technological capabilities, know-how, skill development (Blomstrom & Kokko 1998, p. 1-2; Sohinger & Harrison 2004; Brada, Kutan & Yigit 2006, p. 77) and other more intangible factors (Hitt et al. 2000). In doing so, attracting FDI has become an important policy for emerging markets and a main driver for globalization and the integration of emerging markets into the global economic system (Sohinger 2005; Bitzenis & Marangos 2007). Hans Canisius 1 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies This field of research is particularly interesting due to a large number of emerging and transition economies (Danis & Parkhe 2002, p. 23) and more importantly, the efforts for the political and economical unification of the European Union (EU). Over the last decades and especially since the demise of communism, Central and Eastern Europe (CEE) and the Commonwealth of Independent States (CIS) started the process of economic transition (Kornai 2006). Since the start of this process, the EU has locked CEE in a path of development (Bohle & Greskovits 2007, p. 3) and during the last decade, many Central and Eastern European Countries (CEEC) have been gradually working towards integration with the EU (Kornai 2006).

Before CEE started its path of development, other European countries already went through a period of transition and an important example is the Spanish transition from a dictatorship to a democratic state, which triggered a period of economic development. Within this context of emerging markets and the European Unification, the involvement of foreign firms via FDI in this transition and integration process is particularly interesting. Many scholars have emphasized the importance of FDI for the economic development of emerging markets and addressed the differences in conditions that affect FDI.

In this context it is important to understand how FDI in emerging markets has evolved over time and what can be learned from it. Understanding the strategic behavior of developed European market firms (foreign firms) towards involvement in European emerging markets and with emerging market firms (local firms), is necessary to understand part of the process of strategic decision-making and the future potential of cross-European FDI strategies. Within the current literature, many scholars address aspects concerning the start of such international ventures, yet little is known about what goes on during these activities.

Aspects like performance and the dynamics of change remain important question marks. 1. 1 Focus & research questions The decision to focus on FDI is based on the fact that inter-firm partnerships can occur in many different forms, of which a formal or informal structure is only one example. These different characteristics will have a profound effect on whether partnerships are registered or not, something that will differ from country to country depending on its policies, regulations and institutional environment.

As a result, it is difficult to objectively evaluate the development of inter-firm partnerships over multiple European emerging markets. Although FDI inflows in a certain economy can also not be used as an indicator for the development in the number of partnerships between foreign and local firms, its contributing effect to economic growth and development does allow the use of FDI inflows as an indicator for the attractiveness of an economic environment (Pajunen 2008, p. 53) and the level of integration within the global system (Tarzi 2005). This thesis is therefore interested in researching the evolution of FDI in European emerging markets. Over the last decades FDI has been a popular topic among scholars and the literature, in which especially the motives, determinants and entry modes for FDI formation have been widely addressed, has drastically improved our understanding of this phenomena. Yet besides understanding why firms initiate FDI, it is vital to understand how FDI strategies evolve.

Unfortunately our understanding of what goes on during FDI activities is still limited and some questions remain partially unanswered. One Hans Canisius 2 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies example is the determinant of FDI success and FDI performance, and even today there is no clear understanding of why certain FDI’s are terminated and others are not. As a result, some authors applied the plausible assumption that ‘survival is an indicator of success’ (Tsang & Yip 2007, p. 166), while others consider success to be linked to intended or unintended exit strategies, the former due to the achievement or disappearance of the initial motive for formation and the latter due to unanticipated developments encountered during the FDI activities (Makino, Chan, Isobe & Beamish 2007, p. 11141116). Another example is the lack of understanding concerning the evolution of FDI strategies. Although the literature provides much insight into strategic aspects concerning FDI formation, little is known about the factors that trigger strategic change and result in for instance FDI exit, reallocation or investment variation decisions.

Makino et al. (2007) recognize this theoretical focus on formation aspects and stress the need to view initial formation aspects and post-formation aspects not separately, but as an integral part of corporate strategy in order to improve our understanding of the interaction between the development of international partnerships and corporate strategy. Makino et al. (2007, p. 1115-16) base their discussion on a. o. Dunning (2000, p. 183-83), who questions whether reversing the logic of initial FDI investment decisions can be used to sufficiently explain divestment decisions. In their analysis, Makino et al. 2007, p. 1119) furthermore address three distinct types of aspects which can hinder International Venture activities and trigger strategic change due to the discrepancies between initial and post-formation conditions caused by stabilizing or destabilizing forces during the activities (Yan 1998, p. 788). Categorized as changes in the inter-partner relationships, parent firm conditions and external developments in home- and host-country, Makino et al. (2007, p. 1126-1128) conclude that external developments are by far the primary cause of postformation FDI decisions for all modes of international partnerships.

In addition, the importance of hostcountry conditions received prominent attention within the literature on FDI formation decisions. Based on the emphasize on host-country conditions in formation decisions and the impact of external developments on post-formation decisions, this thesis will focus on the impact of host-country developments on post-formation FDI strategies in European emerging markets. In doing so, this thesis will furthermore focus on a selection of European emerging markets.

The foundation and central research question for this thesis will therefore be: To what extent do host-country developments encountered during FDI projects in the selected European emerging markets affect the FDI strategies of developed European market firms, and under what circumstances can these developments result in potential FDI exit, reallocation or investment fluctuation decisions? In order to answer this central research question, the literature review of this thesis will strive to answer the following sub-questions: What key host-country developments can be encountered during FDI projects in European emerging markets?

How can the identified developments result in strategic change and potential FDI exit, reallocation or investment fluctuation decisions? Hans Canisius 3 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies The research phase of this thesis will focus on the experiences of individual firms involved in FDI activities in European emerging markets and aims to nswer the following sub-questions: How do developed European market firms deal with the identified host-country developments and what effect do these developments have on FDI strategies in the selected European emerging markets? Under what circumstances will the identified host-country developments contribute to FDI exit, reallocation or investment fluctuation decisions concerning FDI projects of developed European market firms in the selected European emerging markets? The decision not to focus on inter-partner relationship and parent firm developments is based on three reasons.

First, this thesis does consider multiple forms of FDI modes and inter-partner relationship issues are especially prominent in JV’s and less in other forms of FDI like acquisitions or greenfield investments (Estrin & Meyer 2004, p. 16-17). Second, this thesis will focus on external developments effecting FDI strategies whereas parent firm developments consider internal effects on FDI strategies. Finally, external developments are generally regarded as key factors in formation as well as post-formation FDI decisions. 1. 2 Contribution As addressed in the introduction, FDI has been a popular topic among scholars and the extensive iterature on aspects concerning FDI formation has dramatically improved our understanding of this phenomena. What actually goes on during FDI projects and how certain aspects affect post-formation FDI strategies remains however open for debate, yet vital to study in order to improve our understanding of the evolution of FDI strategies. This thesis consequently strives to contribute to the current knowledge on post-formation FDI strategies and will specifically focus on the impact of hostcountry developments on post-formation strategies of developed European market firms that invest in European emerging markets.

The goal of this thesis is to provide insight into host-country circumstances in European emerging markets that can create incentives, either forced or self initiated, for FDI exit, reallocation or investment fluctuations decisions. In succeeding this goal, this thesis can inform firms on the potential constraints and opportunities provided by host-country developments during their FDI activities in European emerging markets. Hans Canisius 4 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies 1. 3 Thesis structure

The figure blow provides an overview of the structure for this thesis and briefly describes the main issues that are addressed in each chapter. Figure 1: Thesis structure. Hans Canisius 5 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies 2 FDI and formation strategies In order to obtain a comprehensive understanding of the strategic issues concerning FDI activities and the evolution of FDI strategies, it is deemed necessary to provide the reader with a brief introduction on the strategic aspects that determine FDI formation strategies.

FDI is a particular form of an inter-firm partnership and has become an activity that outgrows any other form of international transaction (Blonigen 2005, p383). Like any other form of inter-firm partnership, the ultimate goal of FDI is to gain access to resources, capabilities and potential business opportunities in order to build, maintain or improve a firm’s competitive advantage. Although FDI can flow from developed to developing economies and visa versa (Tsang & Yip 2007), the activities more likely originate from more developed economies due to a better availability of financial capital and skilled labour markets (Bloningen 2005, p. 85). The attractiveness of emerging markets for FDI activities originate out the fact that these economies may offer attractive and growing markets, cheap labour costs and access to resources (Estrin & Meyer 2004, p. 3). This chapter aims to briefly recap the existing knowledge on FDI formation strategies. First, the motives for FDI will be discussed after which an overview of FDI determinants will be provided. Finally, this chapter will address the different FDI entry mode strategies. 2. 1

Firm motives for FDI Due to the wide variety of firm characteristics in combination with different industries and market conditions, there is no universally applicable motive for FDI. Motives for FDI are influenced by a variety of factors depending on firm-specific characteristics as well as environmental conditions in the homeand host-country. As a result, scholars have come up with different classifications for FDI motives, of which Dunning’s classification is generally applied in the strategic literature.

Dunning (1998, p. 53; 2000, p. 164-162) describes four types of FDI motives: First, market-seeking FDI concerns the desire to gain access to previously inaccessible foreign markets and exploit opportunities provided by proximity to consumer markets, market size, market growth and future potential (Galego, Vieira & Vieira 2004, p. 79; Baniak, Cukrowski & Herczynski 2005, p. 10). Second, resource-seeking FDI concerns the desire to gain access to valuable and critical natural resources (Tarzi 2005, p. 505).

Third, efficiency-seeking FDI concerns the desire to exploit cost advantages in order to lower factor costs of production, capture economies of scale and rationalize operations (Galego, Vieira & Vieira 2004, p. 79; Tarzi 2005, p. 502-505; Baniak, Cukrowski & Herczynski 2005, p. 10) Finally, strategic asset-seeking FDI concerns the acquisition of new and valuable assets in order to strengthen a firm’s competitive advantages in terms of its resource endowment. Hans Canisius 6 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies

In contrast to the above presented classifications, Tsang & Yip (2007, p. 1156-57) adopt a resource exploitation versus exploration theory. Tsang & Yip place a prominent focus on developed as well as developing markets, whereas other scholars mainly focus on FDI flows originating from more developed markets. Within the exploitation versus exploration theory, exploitation represents the use of available information to improve current performance, whereas exploration represents the search and acquisition of new information to improve future performance.

In the context of FDI, this theory provides two distinct perspectives. FDI from an exploitation perspective concerns transferring firm resources and capabilities to other markets, while FDI from an exploration perspective concerns the acquisition of strategic assets. Tsang & Yip argue that economic distance between the home- and host-country is an important aspect that determines an exploitation or exploration motive for FDI. Economically less-developed markets are generally behind in term of managerial and technological expertise, and display lower factor costs.

Thus providing the opportunity for firms from a moredeveloped market to exploit certain firm-specific advantages that enable it to obtain a competitive advantage. Firms that invest in more-developed markets do not have this exploitation opportunity, but are, via ownerships advantages as a result of FDI, provided with the opportunity to explore and learn from a local firm’s asset portfolio and increase its own strategic assets. In summary, exploitation opportunities are provided by initiating FDI in less-developed markets and exploration opportunities are provide by FDI activities in more-developed markets. Tsang & Yip 2007) To conclude, motives for FDI are subject to a firm’s initial intention and the opportunities provided by investing in more- or less-developed markets. Figure 1 summarizes the above identified classifications and provides a clear overview of the main FDI motives. Figure 2: FDI motives (based on Dunning 1998; Dunning 2000; Tsang & Yip 2007). Hans Canisius 7 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies 2. 2 FDI determinants

Equal to the variety in FDI motives, the determinants for FDI are subject to various factors originating from firm-specific, environmental and economic conditions. Besides a clear understanding of the possible motives for FDI, it is equally important to understand which and how certain factors determine FDI decisions. Empirical evidence on these determinants is fairly young and statistically fragile (Blonigen 2005, p. 398), but even though scholars use different perspectives, there is general agreement on a number of FDI determinants.

One of the most commonly used classifications of FDI determinants is the OLI-model by Dunning. The model is based on the necessity of three determining factors that need to be present in order to initiate FDI and for FDI to be successful (Tarzi 2005, p. 506-09). These factors are ownership advantages, location advantages and internalization ability. Ownership advantages concern a firm’s property rights and intangible assets that enable it to obtain a competitive advantage and typically arise from firm-specific characteristics.

Furthermore, a firm needs to have the ability to internalize activities in order to reduce uncertainty and transaction costs. Internalization can be defined as the ability to learn and make certain aspects an integral part of an organization. Finally, a host-country needs to offer certain location advantages. These advantages indicate the attractiveness of an investment climate and can arise from for instance a stable political and economic environment, skilled, cheap and flexible labour markets, attractive markets and sustainable economic growth (Tarzi 2005).

In considering these three factors it is clear that only location advantages are affected by a host-country environment and that firms either do or do not poses the necessary ownership advantages and ability to internalize (Tarzi 2005, p. 506-09; Baniak et al. 2005, p. 9-11). This implies that especially location advantages are a critical factor in determining FDI strategies. Table 1 (page 9 11) provides an overview of FDI determinants categorized according to the OLI-model. In understanding the process of FDI strategies, it is important to consider the relation between host-country conditions and investment incentives.

These host-country conditions will create an invest climate that is either favorable or unfavorable for FDI activities. As mentioned in the introduction, this thesis will focus on the development of these host-country conditions and the affect on post-formation strategy. Hans Canisius 8 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies Table 1: An overview of the FDI Determinants based on the OLI-model Category Firm-specific advantages: – Strategic direction. – Determines the motive for FDI (efficiency-, resource-, market- or strategic assetseeking).

The firm characteristics that determine the motive for FDI, its preferred structure and location are its size, the type of industry of operations, its international orientation, the level of international experience and the firm’s strategic direction. – Dunning 1998; Dunning 2000; Tarzi 2005 Determinants Explanation of the determinant Sources – Tangible and intangible resources and – A strong resources endowment will increase firm-specific advantages. Firms from capabilities. developed markets tend to have a stronger resource endowment compared to emerging market firms. – Propriety technology. – Social legitimacy. Firm-specific preferences concerning partner characteristics. – Valuable propriety technology will increase firm-specific advantages. – A high level of social legitimacy will increase firm-specific advantages. – Hitt et al. 2000, p. 450-452; Tarzi 2005, p. 506 – Tarzi 2005, p. 506 – Tarzi 2005, p. 506; Lu & Xu 2006 – In partner selection, firms from both emerging and develop markets will search for – Hitt et al. 2000 a suitable partner with certain tangible and intangible assets. Particularly the differences between emerging and developed markets provide an interesting setting for firm-specific references used in partner selection in order to gain access to opportunities for organizational learning and resources in order to enhance firm-specific capabilities. – Due to uncertainty and high transaction costs, internalization can be more cost effective compared to market coordination. With the ability to internalize an activity, a firm can reduce these factors of uncertainty and transaction costs. – By internalizing certain activities, firms can overcome market imperfections with regards to knowledge development or information costs and operational efficiency. Institutions provide the rules that structure interaction in a society. A well developed institution setting will result in lower levels of transaction costs and information costs by reducing uncertainty, thereby providing a stable structure which facilitates interaction and creates a favorable business environment for local and foreign firms. – Institutional voids will trigger environmental uncertainty and high transaction costs. As a result, local markets do not function effectively and costs for market coordination will increase, creating a less favorable business environment. Legal stability is crucial in attracting FDI. Well functioning regulatory institution and thus legal stability, increase transparency and reduce uncertainty. Transaction costs will decrease and create an environment attractive for FDI, due to lowering the overall costs for investments. – Tarzi 2005, p. 506; Baniak et al. 2005, p. 9-10 Internalization ability: – The ability for internalization to exploit market imperfections in order to reduce uncertainty and transaction costs. – The ability for internalization to exploit market imperfections in order to increase knowledge and efficiency.

Location-specific advantages: Formal institutions – Level of institutional development. – a. o. Hoskisson et al. 2000; Meyer 2001; Estrin & Meyer 2004; Meyer 2004; Meyer & Nguyen 2005; Blonigen 2005; Baniak et al. 2005 – a. o. Meyer 2001; Estrin & Meyer 2004; Blonigen 2005 – Sohinger & Harrison 2004, p. 73; Baniak et al. 2005, p. 8-23; Sohinger 2005, p. 92 – Tarzi 2005, p. 506; Baniak et al. 2005, p. 9-10 – Transaction costs and market coordination. – Regulatory institutions and legal stability. Hans Canisius 9 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies

Formal institutions – Property right protection. – Well structured property right regulations will increase investments in intellectual property, due to lower levels of risks regarding the chance of expropriation by other firms. – Corruption hinders FDI by creating uncertainty, transaction costs and distortion effects. In addition, the impact of corruption can be different depending on the FDI motive. In for instance market-seeking FDI, the costs of corruption may be passed on to consumer prices, whereas resource-seeking FDI will not have the ability to overcome these addition costs. Host-country governments can create entry barriers in order to reduce FDI inflows. On the other hand, these governments can also stimulate FDI inflows by lowering entry barriers via decreasing regulatory burdens, flexible labour market regulations, favorable foreign ownership, taxation and repatriation policies, and especially the stimulation of the free capital flows. – Host-country labour markets that are characterized by one or more of de following conditions: a skilled labour force, cheap labour costs and flexible labour market regulations, can offer an attractive environment for FDI. Large local markets that display sufficient growth levels and potential will also create an attractive environment for FDI. – Host-country capital markets characterized by a free flow of capital will likely result in a higher level of integration within the world economy, consequently creating a favorable business environment. – Political stability is deemed crucial in order to reduce uncertainty and create a stable environment attractive for FDI. – Political rights and civil liberties are basic factors of democracy and tend to increase FDI.

Especially in CEEC, this factor of political right and civil liberties is important contributing factor for FDI inflows. – Blonigen 2005, p. 390; Pajunen 2008, p. 666 – Habib & Zurawicki 2002; Robertson & Watson 2004; Pajunen 2008, p. 666; Brouthers et al. 2008 – Tarzi 2005, p. 500-510; Galego et al. 2004, p. 87; Trevino & Mixon 2004, p. 233; Meyer & Nguyen 2005, p. 68; Khanna et al. 2005, p. 66-67 – Dunning 1998, p. 53; Meyer, 2004, p. 270; Tarzi 2005, p. 504-505 – Dunning 1998, p. 53; Galego et al. 2004, p. 87; Tarzi 2005, p. 507 – Tarzi 2005, p. 509-510 – Corruption. FDI regime or trade openness (barriers to entry). – Labour markets (quality, costs and flexibility). – Host-country markets (size and growth rate). – Host-country capital markets (free flow of capital). – Political stability. – Tarzi 2005, p. 507; Brada et al. 2006, p. 658; Pajunen 2008, 665-666 – Pajunen 2008, p. 666 – Political right and civil liberties. – Infrastructure and infrastructural development. – The level of economic reform and privatization policies in emerging or transition economies. – Institutional voids lead to an insufficient infrastructure. Infrastructural development – Tarzi 2005, p. 07; Blonigen will reduce transportation, communication and production costs, thus creating an 2005, p390; Baniak et al. attractive business environment. 2005, p. 23 – The level of economic reform and more specifically the method and schedule of – Mallin & Jelic 2000; privatization are important determinants for FDI. By bringing financial capital, Rondinelli & Black 2000, technological development and organizational skill development, privatization can p. 88-91; Galego et al. 2004, contribute to economic reform and the integration of these economies within the p. 1; Sohinger 2005; global system. Bitzenis & Marangos 2007 – Firms (foreign and local) can benefit from locating within the vicinity of industry clusters and existing FDI firms. Consequently, agglomeration can positively affect infrastructural development, the level of industrialization and the level of FDI. – Dunning 1998, p. 51; Meyer & Nguyen 2005, p. 71 – Agglomeration effects and FDI zones. Hans Canisius 10 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies

Informal institutions – Host-country culture (behaviors, customs and values). – Informal institutions are much less transparent compared to formal institutions – Meyer & Nguyen 2005 and concern certain behaviors, customs and values embedded in culture. Due to the lack of transparency, these aspects are a source of uncertainty and can therefore hinder FDI, especially when the differences between these aspects vary considerably between home- and host-country. – The aspect of business ethics has become an important issue regarding international business.

Firms commit themselves to certain ethics and have to comply with these ethics in order to protect their social legitimacy. Because business ethics vary between cultures, firms need and will consider the aspect of business ethics in making strategic decisions. – Economic stability is vital in order to reduce uncertainty and create a stable environment. An unstable economic environment discourages FDI and may only be attractive for short-term investments. – Exchange rate uncertainty can, depending on a firm’s risk averseness, delay investment decisions. Exchange rate volatility can make investments either more or less attractive.

Host-country currency depreciation will lower an asset’s price, whereas currency appreciation will increase an asset’s price. – Although a general assumption is that higher host-country taxes discourage FDI, the actual impact of taxes is more complex. Income and profit out of FDI activities will be subject to host- and home-country tax policies, indirect taxes and international bilateral treaties. Yet besides the complexity of taxation, favorable taxation polices can encourage FDI and the Global Competitiveness Report labels taxation policies as a possible problematic issue in doing business in a host-country. Trade protection can function as a barrier to entry and can therefore discourage FDI by limiting a foreign firm’s ability for host-country production and export. – The impact of GDP on FDI incentives is positive. – Meyer 2004, p. 271-273 – Business ethics. Macro-economy – Economic stability. – Sohinger & Harrison 2004, p. 73; Baniak et al. 2005, p. 8-22; Tarzi 2005, p. 507 – Blonigen 2005, p. 385-387 – Exchange rate. – Taxation policies. – Blonigen 2005, p. 387-390; Tarzi 2005, p. 500; Pajunen 2008, p. 666; Global Competitiveness Report, The most problematic factors for doing business – Blonigen 2005, p. 90-391; Tarzi 2005, p. 515 – Galego et al. 2004, p. 79 – Tsang & Yip 2007 – Trade protection. – Gross Domestic Product (GDP). – Economic distance / level of economic – With increasing economic similarity in terms of development, FDI becomes less development. attractive due to an increasing hazard rate of failure. Furthermore, similar economies are more competitive and offer less attractive opportunities for foreign firms to exploit certain advantages over local firms. Natural environment – Physical distance / geographic location. – The effect of distance on FDI can be both a positive and negative.

On the positive – Galego et al. 2004, p. 79-80 site, FDI can be a substitute for export and thereby reduce costs. On the negative site, with increasing distance comes increasing costs of managing the activities. Yet even though FDI over large distances can be positive, the effect of distance on FDI is negative in general. Consequently, firms will have to carefully outweigh the costs and benefits. – A host-country environment can offer foreign firms certain natural resources that are unavailable in the foreign firm’s home-country and therefore increase FDI incentives. Dunning 1998, p. 53; Dunning 2000; Tarzi 2005, p. 504-505 – Natural resources. Hans Canisius 11 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies 2. 3 FDI entry mode strategies So far, this chapter elaborated on the motives and determinants for FDI strategies. Yet, the issue of FDI entry modes remains to be discussed. Obviously the motive and determinants for FDI affect this decision, but there are two additional variables that need to be considered.

These variables concern the resources that will be employed by the entity and the control over these critical resources. The structure of an FDI subsidiary can be organized in different modes, commonly classified as greenfield, acquisitions and joint ventures (JV’s) (Meyer 2004, p. 265). A greenfield investment represents an entirely new entity, in which the foreign firm’s management, know-how, technology and capital are used to set up the entity. A greenfield investment is furthermore based on the application of foreign firm resources in combination with ‘freely available’ host-country resources.

These ‘freely available’ resources enable a foreign firm to obtain access without the necessity of cooperating with local firms. Acquisitions, on the other hand, are based on the application of locally controlled resources in combination with foreign firm resources. In this case, foreign firms need to cooperate with local firms to obtain access to these resources. In order to do this, an acquisition entails the purchase of a stock in an already existing firm or SOE. Whether or not the acquired local firm is reorganized or remains operating as it did before the acquisition, depends on the intention of the investor.

Some private firms and SOE’s might require extensive restructuring in order to become sustainable businesses (Rondinelli & Black 2000, p. 86). Unlike acquisition, greenfield investment is a gradual process towards market access and does not provide immediate access to local resources and market. Finally, a JV represents the creation of new entity between two or more firms and provides access to preferred resources without the responsibilities that come with an acquisition. Partners in a JV share their own resources and in return obtain access to the resources shared by the other partners (Meyer 2004, p. 65). An apparent disadvantage of JV’s is that they are subject to conflict, especially when partner-firms are pursuing conflicting objectives (Estrin & Meyer 2004; Brouthers & Bamossy 2006). On the other hand, JV’s provide the opportunity for mutual learning and knowledge transfer between the partners (Meyer 2004, p. 265). The structure of a JV enables a firm to establish a foreign business operation without the necessity of full ownership, either due to unfeasibility or insufficient financial capital for acquisition.

Especially, in environments that display high transaction costs and inhibit foreign firms to internalize certain activities, a JV provides a viable entry mode option. As a result, JV’s are often used as a starting point for FDI activities under turbulent and uncertain conditions, which can later on be expanded towards other mode of FDI subsidiaries under less risky conditions. (Estrin & Meyer 2004) Although it is clear that the different entry modes apply for different situations concerning the employed resources. The next obvious question concerns the desired level of control.

Naturally firms prefer full control, especially because structures based on partial and unequal ownership are subject to possible conflict. Each entry mode option provides certain control aspects. Greenfield investments provide full ownership, thus control, and JV’s only provide partial ownership. The level of control within acquisitions will be determined by the acquired percentage of stocks and can thus range between full and partial ownership. Under conditions of high information asymmetries, asset specificity, possible Hans Canisius 12 14-03-2009

FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies communication obstacles and the chance of opportunistic behavior, firms will prefer acquisitions or greenfield investments over JV’s (Estrin & Meyer 2004). An important notion with regards to entry mode strategies is that the classification of the three discussed entry modes does not recognize the wide variety and hybrid forms of FDI structures caused by different demands and contextual idiosyncrasies (Estrin & Meyer 2004, p. 8). Estrin & Meyer (2004, p. 300) stress that the design of the agreement might be more important that the entry mode itself, especially because firms seldom face such clearly defined options. By creatively configuring the FDI strategy and entry mode, and by continuously monitoring project-specific and environmental conditions, a firm will be able to remain flexible and overcome certain obstacles that would otherwise result in selecting the second best alternative entry mode. Estrin & Meyer 2004, p. 320-321) Hans Canisius 13 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies 3 Host-country developments and post-formation FDI strategies After the brief discussion of the strategic considerations for FDI formation strategies in the previous chapter, this chapter will focus on host-country developments that can affect post-formation FDI strategies. Supported by the finding of a. o. Makino et al. 2007), the extensive literature on FDI determinants and the Global Competitiveness Report, this thesis argues that host-country conditions are a primary aspect of concern with regards to FDI strategies and that developments in these conditions can thus have a significant impact on the evolution of post-formation FDI strategies. Consequently, this chapter will focus on a selection of host-country developments, classified under institutional, network relations and host-country competition developments. Chapter 5 will subsequently formulate each of these host-country developments into specific research domains. . 1 FDI, institutions and emerging markets The importance of institutions for corporate strategy has been recognized by many scholars (a. o. Hitt et al. 2004, p. 182-183; Meyer 2004, p. 271). As discussed in section 2. 2 on FDI determinants, the aspect of institutions is crucial in FDI formation decisions, especially concerning markets characterized by a less developed institutional setting (Meyer & Nguyen 2005, p. 66; Blonigen 2005, p. 390). Consequently, institutional development has received prominent attention and is deemed vital in attracting FDI for emerging markets (Meyer & Nguyen 2005; Pajunen 2008).

But the significance of institutions does not end there. As a country’s environment is subject to continuous change, its institutions will also change (Meyer & Nguyen, 2005, p. 66) and therefore remain a critical issue for corporate strategy after FDI formation. The Global Competitiveness Report emphasizes the continuous significance of institutions by identifying critical issues, all directly linked to a country’s institutional setting, for doing business in a certain country.

Yet, although the aspect of institutions is crucial for corporate strategy throughout a firm’s activities, it is important to distinguish between institutional determinants for FDI formation and institutional developments that affect FDI postformation strategies. The section on FDI determinants provided a number of institutional factors that influence FDI formation strategies and although these factors will remain important after formation, some factors will likely become more significant during post-formation FDI. Consider for instance the factor of political stability and FDI in European emerging markets.

During FDI formation, developed European market firms will search for a politically stable environment and can, for instance, select an EU member in order the have some sort of certainty regarding political stability. Although this factor of political stability will remain important, its significance for post-formation strategies will likely be less compared to other institutional factors. Therefore, this thesis argues that certain institutional factors will be more significant for post-formation strategies than others and that foreign firms can encounter ertain institutional developments that either provide opportunities or hinder foreign firms in operating effectively and consequently lead to strategic change. Hans Canisius 14 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies This section will focus on host-country institutional developments that are considered to have a significant effect on post-formation FDI strategies. Eventually, this thesis will research how developed European market firms assess the significance of these developments for the strategic change of these FDI strategies. . 1. 1 Literature review on institutions and emerging markets Institutions refer to the formal and informal structures and mechanisms that govern the behavior and interaction of individuals and organizations within a society (North 1990, p. 3-6). Formal institutions concern for instance a country’s regulatory framework, political climate, educational system and labour markets, whereas informal institutions are much less transparent and concern certain behaviors, ethics and values influenced by a country’s culture (Meyer & Nguyen 2005).

The role of institutions is to lower transaction costs by reducing environmental uncertainty and provide a stable environment which facilitates interaction and creates a favorable business environment (Hoskisson et al. 2000, p. 252-253; Meyer 2001, p. 358). Ultimately, institutions will affect the level of environmental uncertainty and stability within a country and a well developed institutional environment will limit uncertainty, whereas a poorly developed institutional setting causes an instable and volatile environment, increasing environmental uncertainty and transaction costs. Particularly in emerging arkets, institutions are often poorly developed (Steensma et al. 2005, p. 215). Such a less-developed institutional setting can pose sufficient challenges for FDI due to: 1) an insufficient regulatory framework and therefore poor protection of valuable firm-specific assets, 2) an insufficient institutional quality, which is vital for well-functioning markets and therefore has a negative impact on transaction costs, and 3) with a less-developed infrastructure as a result (Blonigen, 2005, p. 390). Emerging markets can consequently be characterized as more economical, political and regulatory volatile compared to more developed markets.

Therefore, emerging markets on one hand provide the problem of managing the risks that are inherent to these volatile environments and on the other hand provide the opportunity to exploit market imperfections and gain access to new markets, resources or efficiency opportunities (Baniak et al. , 2005, p. 12). Yet, due to this volatile environment and less developed institutions (Hitt et al. 2000, p. 451), these markets are instable and can pose significant challenges for businesses (Hoskisson et al. 2000; Meyer, 2001, p. 357), causing an unfavorable environment for FDI (Estrin & Meyer 2004, p. 3).

The institutional voids present in emerging markets (Khanna et al. 2005) cause high transaction costs and increase incentives for internalization, whereas market coordination would be preferable in the presence of well developed institutions (Estrin & Meyer 2004, p. 5). Ultimately, the quality of host-country institutions will not just be vital for FDI formation strategies, but will remain vital throughout a firm’s activities within a certain country. Hans Canisius 15 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies 3. 1. 2

Challenges for post-formation FDI As indicated in the literature review on institutions and the section on FDI determinants, hostcountry institutions play a crucial role in FDI strategies. This section will focus on regulatory institutions, corruption, labour market institutions, infrastructure and taxation policies as key institutional variables that can cause strategic change in post-formation FDI strategies. The selection of these five factors is based on a priority analysis of the Global Competitiveness Report’s most problematic factors for doing business in the emerging markets researched in this thesis.

Regulatory institutions and property rights protection: The significance of a well structured and stable regulatory framework has received strong support in the literature on FDI (Baniak et al. 2005; Sohinger 2005). Again, the key concern regarding these institutions is to reduce environmental uncertainty by providing a transparent and fair system of laws and regulations. As a result, countries with well developed regulatory institutions will attract more FDI, because the level of uncertainty and thus the risks for investment decrease (Baniak et al. 2005, p. 23). An important example of this regulatory framework is property rights protection.

The aspect of property rights protection is vital in order to protect a firm’s valuable assets against opportunistic behavior (Pajunen 2008) and is regarded as an important prerequisite for certain investment incentives (Blonigen 2005, p. 390). Pajunen (2008, p. 666) concluded that regulatory institutions as well as property rights protection are especially significant for FDI attractiveness of CEEC. In considering port-formation FDI strategies, increasing regulatory transparency, stability and fairness will likely trigger a favorable environment for FDI expansion strategies.

Especially, when foreign firms initially entered an emerging market with a certain level of reticence regarding investments of valuable assets, positive developments in regulatory institutions can stimulate foreign firms to expand their activities and increasing investments in valuable assets. On the other hand, a lack of development regarding regulatory institutions will hinder these investment patterns. Even when the quality of other institutional factors does increase, a lack of regulatory development and property rights rotection will likely have a deterring effect on FDI, because uncertainty and high transaction costs remain. It is therefore expected that developments in the transparency, stability and fairness of regulatory institutions can increase FDI investments of valuable assets and the intensity of a foreign firm’s activities in an emerging market. On the other hand, independent of other institutions, a lack of regulatory development is expected to deter FDI incentives and result in FDI exit, due to the increasing attractiveness of other investment climates. Hans Canisius 16 14-03-2009

FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies Corruption In addition to regulatory developments, insufficient regulatory institutions increase the chance of opportunistic behavior, rent shifting and corruption (Hoskisson et al. 2000; Getz & Volkema 2001, p. 23). Habib & Zurawicki (2002, p. 293) also stipulate that poorly developed institutions (a. o. intransparent regulations and political instability) and a lack of economic development will enhance the opportunities for corruption. Yet Pajunen (2008, p. 54) stresses that even though corruption has traditionally been associated with emerging markets, corruption is also present in some developed countries and has therefore been an important research topic. Getz & Volkema (2001, p. 9) define corruption as ‘the abuse of public role and resources for private benefits or the misuse of office for nonofficial ends’, a rather politically orientated definition. Other scholars have used a more abstract definition of corruption and define it as illegal and improper or unethical behavior in the form of bribery, extortion or embezzlement (Habib & Zurawicki 2002, p. 92; Pajunen 2008, p. 654). The problem with corruption lies in the fact that it results in additional costs, higher uncertainty levels and creates distortion (Habib & Zurawicki 2002, p. 292). Consequently, the risks of investments will increase, causing corruption to have disincentive impact of FDI (Getz & Volkema 2001; Habib & Zurawicki 2002, p. 303; Pajunen 2008, p. 666). Besides the costs and uncertainty aspects, firms will also avoid corruption because it is viewed as morally wrong and difficult to manage (Habib & Zurawicki 2002, p. 303).

In this context, exposure to home-country corruption provides a learning experience to deal with corruption abroad and Habib & Zurawicki found evidence suggesting that greater absolute differences in corruption levels between a home- and host-country deters FDI. Furthermore, the impact of corruption differs depending in motive for investment. Although the overall impact of corruption on FDI is still considered to be negative, some FDI motives may provide the opportunity to partially overcome the constraints posed by corruption (Brouthers, Gao & McNicol 2008).

In considering market-seeking FDI, firms can have the opportunity to pass on the additional costs of corruption onto consumer prices. Yet, this increase in costs will lower overall market attractiveness, because consumer prices increase (Getz & Volkema 2001, p. 21), thereby reducing market demand to those willing to pay the higher price and thus reduce the firm’s ability for market penetration (Brouthers et al. 2008, p. 674). This implies that even though the impact of corruption is negative, highly attractive markets mitigate this impact and could still offer a favorable environment for FDI.

The opportunity to overcome the additional costs of corruption will not be available for resourceseeking FDI motives. The uncertainty and costs of corruption will increase overall costs, thus undermining the goal of resource-seeking FDI, namely access to reliable and cheap resources. As a result, resource-seeking firms will prefer more stable environments which display lower costs and accessibility to raw materials and labour (Brouthers et al. 2008, p. 675). This implies that increasing attractiveness does not mitigate the negative impact of corruption on resource-seeking FDI.

By combining the aspects of poorly developed institutions and the motive for FDI, we can point out that firms need to carefully consider corruption in their assessment of an emerging market’s attractiveness for investment. In some cases, the assessment of corruption might even be more important compared to other institutional developments (Robertson & Watson 2004). The question for Hans Canisius 17 14-03-2009 FDI strategies in European emerging markets The impact of host-country developments on post-formation FDI strategies his research will however focus on the effect of corruption on the evolution of post-formation FDI strategies. Labour markets institutions and quality: As for any sort of business ac