sample 107

International Management

product: 4331 | course code: c248|c348


© Centre for Financial and Management Studies, SOAS, University of London

First edition 2006, revised 2007, 2009, 2010, 2011, 2013 All rights reserved. No part of this course material may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, including photocopying and recording, or in information storage or retrieval systems, without written permission from the Centre for Financial & Management Studies, SOAS, University of London.


Course Introduction and Overview

Contents

1 Course Objectives 2

2 The Course Author 2

3 What this Course is About 2

4 An Overview of the Course 2

5 Learning Outcomes 4

6 Study Materials 4

7 Teaching and Learning Strategy 4

8 Assessment 5

Specimen Examination 9


2 University of London

1 Course Objectives Welcome to the course International Management. In a rapidly changing world, companies that operate across national boundaries are increasingly the norm: domestic businesses serving local markets tend to be smaller, less innovative, less profitable, than those that roam the world searching for favourable opportunities. On the other hand, there are bigger hazards in unfamiliar territories and intelligence is required to assess markets, capital requirements, financing methods, risk, marketing techniques, and organisa-tional forms, to enable the opportunities to be seized.

This course aims to provide frameworks, techniques and examples to help you participate successfully in the exciting and risky world of international business.

2 The Course Author Norman Flynn is Programme Director of Public Policy and Management programmes at CeFiMS. He is the author of Miracle to Meltdown in Asia (Oxford University Press) and, in addition to his role at SOAS, he has held academic positions at the London Business School and the London School of Economics, and was Chair Professor at City University of Hong Kong.

3 What this Course is About Your study of international business strategy in this course is based mainly on case studies of a wide variety of businesses – from Carrefour, a European-based retailer, to Alibaba.com, a China-based web-centred inter-mediary for manufacturers, from Amazon, an on-line retailer, to Daimler-Chrysler, a cross-border automobile manufacturer, and from Vestel, a manufacturer exporting from one location, to Dell, a computer manufacturer operating globally.

Some of the businesses you will study are successful, some have made big mistakes, others are unsure about their future success. The exposure to a variety of degrees of success will help you to assess strategic options in your own career.

The approach is not technical: you will be introduced, for example, to the reasons for and basis of currency hedging in cash management but will not go into the mathematical calculations required to implement successful hedging.

4 An Overview of the Course The course consists of eight ‘units’, each with its own core text, set readings, questions and exercises. You will also do assignments, and have the oppor-tunity to discuss the course with your fellow students through the Online Study Centre.


Centre for Financial and Management Studies 3

The Structure of the Course

Unit 1 International Investment

1.1 The Economics of International Investment

1.2 International Investment

1.3 Mergers and Acquisitions

Unit 2 Choice of Entry Strategy

2.1 Strategy Basics – Cost and Value

2.2 International Strategy

2.3 Entry Strategy

2.4 Case Studies

2.5 Feedback on Case Studies

Unit 3 International Production and Sourcing

3.1 Economic Criteria

3.2 Beyond Offshoring

3.3 Case Studies

3.4 Managing the Global Supply Chain


Unit 4 International Marketing

4.1 Marketing Mix

4.2 Global Marketing

4.3 Case Studies


Unit 5 International Organisation

5.1 Introduction

5.2 Organisational Architecture

5.3 Strategy and Architecture

5.4 Case Studies


5.6 A Successful Example – Siemens

Unit 6 Financial Management in the International Business

6.1 Investment Decisions

6.2 Financing Decisions

6.3 Money Management

6.4 Managing Foreign Exchange Risk

6.5 Case Studies

6.6 Feedback on the Case Studies

Unit 7 Assessing Country Competitiveness

7.1 Determinants of National Competitive Advantage

7.2 Company Strategy

7.3 Case Studies

7.4 Feedback on the Case Studies

Unit 8 Assessing Country Risk

8.1 Introduction



8.2 What is Political Risk?

8.3 Country Risk

8.4 A Strategic Perspective

8.5 Summary

8.6 The Examination

5 Learning Outcomes When you have completed your study of this course, you will be able to

• analyse the principles underlying decisions to invest in countries other than the home base

• discuss the basics of business strategies of cost advantage and differentiation

• explain the analysis behind decisions about where to locate production operations

• explain some of the reasons why marketing and pricing strategies can succeed or fail according to the conditions in different countries

• identify the variety of structural arrangements available to the international business

• analyse the options for dealing with currency risk in an international project or business

• analyse the elements that make a location suitable for investment projects

• list and define the types of political risk involved in establishing a business in another country.

6 Study Materials In addition to the eight units of the course guide, this course has a range of case material compiled in a two-volume collection of Case Studies. There is also a collection of articles and extracts from other sources in a Course Reader.

You will read parts of a textbook written by Charles Hill, who is Professor of International Business at the University of Washington, and has worked extensively as a consultant to international firms:

Charles Hill (2011) International Business: Competing in the Global Marketplace, Eighth Edition, New York: McGraw-Hill International.

Where there are gaps in the textbook coverage, these will be supplemented by articles reprinted in the Course Reader.

7 Teaching and Learning Strategy As indicated earlier, this course provides frameworks, techniques and examples to help you participate successfully in the world of international business. The major objective of our teaching strategy in this course is to expose you to a wide range of experiences of firms that have competed



successfully on the global stage, and some that have not, and to provide the analytical ideas and applied skills you need to contextualise and evaluate those experiences. After completing this course, you should be able to test the utility of the various frameworks and strategies in the light of several experiences of business internationalisation, in terms of the lessons they offer, both positive and negative.

To facilitate your learning, there are many Review Questions and Exercises in the units. You will get feedback and advice on your progress with the course in the comments on your assignments, and to help you prepare for the final examination there is a Specimen Examination Paper.

8 Assessment Your performance on each course is assessed through two written assignments and one examination. The assignments are written after week four and eight of the course session and the examination is written at a local examination centre in October.

The assignment questions contain fairly detailed guidance about what is required. All assignment answers are limited to 2,500 words and are marked using marking guidelines. When you receive your grade it is accompanied by comments on your paper, including advice about how you might im-prove, and any clarifications about matters you may not have understood. These comments are designed to help you master the subject and to improve your skills as you progress through your programme.

The written examinations are ‘unseen’ (you will only see the paper in the exam centre) and written by hand, over a three hour period. We advise that you practice writing exams in these conditions as part of your examination preparation, as it is not something you would normally do.

You are not allowed to take books or notes into the exam room. This means that you need to revise thoroughly in preparation for each exam. This is especially important if you have completed the course in the early part of the year, or in a previous year.

Preparing for Assignments and Exams

There is good advice on preparing for assignments and exams and writing them in Sections 8.2 and 8.3 of Studying at a Distance by Talbot. We recom-mend that you follow this advice.

The examinations you will sit are designed to evaluate your knowledge and skills in the subjects you have studied: they are not designed to trick you. If you have studied the course thoroughly, you will pass the exam.

Understanding assessment questions

Examination and assignment questions are set to test different knowledge and skills. Sometimes a question will contain more than one part, each part testing a different aspect of your skills and knowledge. You need to spot the key words to know what is being asked of you. Here we categorise the types of things that are asked for in assignments and exams, and the words used.



All the examples are from CeFiMS examination papers and assignment questions.

Definitions

Some questions mainly require you to show that you have learned some concepts, by setting out their precise meaning. Such questions are likely to be preliminary and be supplemented by more analytical questions. Generally ‘Pass marks’ are awarded if the answer only contains definitions. They will contain words such as:

Describe Define Examine Distinguish between Compare Contrast Write notes on Outline What is meant by List

Reasoning

Other questions are designed to test your reasoning, by explaining cause and effect. Convincing explanations generally carry additional marks to basic definitions. They will include words such as:

Interpret Explain What conditions influence What are the consequences of What are the implications of

Judgment

Others ask you to make a judgment, perhaps of a policy or of a course of action. They will include words like:

Evaluate Critically examine Assess Do you agree that To what extent does

Calculation

Sometimes, you are asked to make a calculation, using a specified technique, where the question begins:

Use indifference curve analysis to Using any economic model you know Calculate the standard deviation Test whether

It is most likely that questions that ask you to make a calculation will also ask for an application of the result, or an interpretation.

Advice

Other questions ask you to provide advice in a particular situation. This applies to law questions and to policy papers where advice is asked in relation to a policy problem. Your advice should be based on relevant law, principles, evidence of what actions are likely to be effective.

Advise



Provide advice on Explain how you would advise

Critique

In many cases the question will include the word ‘critically’. This means that you are expected to look at the question from at least two points of view, offering a critique of each view and your judgment. You are expected to be critical of what you have read.

The questions may begin Critically analyse Critically consider Critically assess Critically discuss the argument that

Examine by argument

Questions that begin with ‘discuss’ are similar – they ask you to examine by argument, to debate and give reasons for and against a variety of options, for example

Discuss the advantages and disadvantages of Discuss this statement Discuss the view that Discuss the arguments and debates concerning

The grading scheme

Details of the general definitions of what is expected in order to obtain a particular grade are shown below. Remember: examiners will take account of the fact that examination conditions are less conducive to polished work than the conditions in which you write your assignments. These criteria are used in grading all assignments and examinations. Note that as the criteria of each grade rises, it accumulates the elements of the grade below. Assignments awarded better marks will therefore have become comprehen-sive in both their depth of core skills and advanced skills.

70% and above: Distinction – As for the (60–69%) below plus: • shows clear evidence of wide and relevant reading and an engagement

with the conceptual issues • develops a sophisticated and intelligent argument • shows a rigorous use and a sophisticated understanding of relevant

source materials, balancing appropriately between factual detail and key theoretical issues. Materials are evaluated directly and their assumptions and arguments challenged and/or appraised

• shows original thinking and a willingness to take risks

60–69%: Merit – As for the (50–59%) below plus: • shows strong evidence of critical insight and critical thinking • shows a detailed understanding of the major factual and/or

theoretical issues and directly engages with the relevant literature on the topic

• develops a focussed and clear argument and articulates clearly and convincingly a sustained train of logical thought

• shows clear evidence of planning and appropriate choice of sources and methodology



50–59%: Pass below Merit (50% = pass mark) • shows a reasonable understanding of the major factual and/or

theoretical issues involved • shows evidence of planning and selection from appropriate sources, • demonstrates some knowledge of the literature • the text shows, in places, examples of a clear train of thought or

argument • the text is introduced and concludes appropriately

45–49%: Marginal Failure • shows some awareness and understanding of the factual or theoretical

issues, but with little development • misunderstandings are evident • shows some evidence of planning, although irrelevant/unrelated

material or arguments are included

0–44%: Clear Failure • fails to answer the question or to develop an argument that relates to

the question set • does not engage with the relevant literature or demonstrate a

knowledge of the key issues • contains clear conceptual or factual errors or misunderstandings

[approved by Faculty Learning and Teaching Committee November 2006]

Specimen exam paper

Your final examination will be very similar to the Specimen Exam Paper that appears at the end of this introduction. It will have the same structure and style as the actual exam, and the range of question will be comparable.

CeFiMS does not provide past papers or model answers to papers. Our courses are continuously updated, and past papers will not be a reliable guide to current and future examinations. The specimen exam paper is designed to be relevant to reflect the exam that will be set on the current edition of the course

Further information

The OSC will have documentation and information on each year’s examination registration and administration process. If you still have questions, both academics and administrators are available to answer queries.

The Regulations are available at www.cefims.ac.uk/regulations.shtml, setting out the rules by which exams are governed.



UNIVERSITY OF LONDON

Centre for Financial and Management Studies

MSc Examination

Postgraduate Diploma Examination

for External Students 91DFMC248

INTERNATIONAL MANAGEMENT (CHINA)


Specimen Examination

The examination must be completed in THREE hours.

Answer THREE questions, selecting at least ONE question from EACH section. The examiners give equal weight to each question; therefore, you are advised to distribute your time approximately equally between three questions.

DO NOT REMOVE THIS PAPER FROM THE EXAMINATION ROOM. IT MUST BE ATTACHED TO YOUR ANSWER BOOK AT THE END OF THE

EXAMINATION.

© University of London, 2012 PLEASE TURN OVER



Answer THREE questions; at least ONE from EACH section.

Section A (Answer at least ONE question from this section)

1 What are the main ways in which you can answer the question: ‘what business is this company in?’

Illustrate your answer with examples.

2 What are the main issues involved when a company chooses how to enter a new country market? Illustrate your answer with exam-ples of successful and unsuccessful entry strategies.

3 Does ‘mass customisation’ mean that competitive strategy no longer requires a choice between competing on cost and compet-ing on product differentiation? Elaborate your answer with reference to relevant management theories and case materials.

4 Write notes on the following and how the terms are used in inter-national business?

a Market segments

b Price discrimination

c Intermediaries

d Viral marketing

Section B (Answer at least ONE question from this section)

5 Why was Carrefour’s entry into Japan a failure, while its entry into other Asian markets was successful?

6 Did reorganisation make Sony successful from 2000s onwards?

7 Discuss the reasons for the approaches to exchange rate risk of two companies you have studied.

8 Why did Ireland and Singapore been successful economies in the 1990’s?

[END OF EXAMINATION]



Contents

1.1 The Economics of International Investment 3

1.2 International Investment 5

1.3 Mergers and Acquisitions 8

1.4 Conclusions 12

References and Websites 14



Unit Content In this unit you will be presented with two of the fundamental questions about international business:

• Why do individuals and companies invest in other countries? • What forms can that investment take?

The unit then moves on to the major form of investment – merger and acquisition (M and A) – and introduces the strategic reasons for and options in M and A activity. These three issues will form the foundation for much of the rest of the course.

Learning Outcomes When you have completed your study of this unit and its readings, you will be able to

• analyse the principles underlying decisions to invest in countries other than the home base

• judge the relevance of each method of international investment – foreign direct investment and portfolio investment

• discuss the fundamentals of merger and acquisition strategy, including investment for market growth, synergy and diversification.

Reading for Unit 1

Course Reader

Hendrik Van den Berg (2002) sections from Chapter 5 ‘International Trade and Economic Growth’, and Chapter 10 ‘The Economics of International Investment’ from International Economics, New York: McGraw-Hill/Irwin.

Patrick A Gaughan (2002) ‘Merger Strategy’, from Mergers, Acquisitions and Corporate Restructuring, Third edition, New York: Wiley.

As the course progresses you will also analyse case studies; this unit is concerned with some fundamentals and the readings here will be restricted to textbook accounts of the subject.



1.1 The Economics of International Investment In this section you will study the basic principles of investment, and interna-tional investment flows. We start with some fundamentals about investment, or the acquisition of assets.

1.1.1 Investment

It is conventional to define international investment as the purchase of real and financial assets in a country other that that of the investor. It is also usual to define investment as an ‘intertemporal transaction’ – that is, a payment made in one period for an expected return in some future period. The only difference between a domestic and an overseas investment is the degree of risk and uncertainty involved.

Your first reading is from a textbook, International Economics, by Hendrik Van den Berg. In this reading, the author develops a two-period model of consumption and investment, explaining that an equilibrium point balan-cing consumption and investment occurs, which reflects the economy as a whole’s preference for consumption now against consumption in the future.

He then goes on to show that if there are better investment opportunities in another economy, investors will transfer some of their asset purchases there. This investment is financed in period 1 through a trade surplus, and in period 2 a trade deficit. This simple equilibrium model shows the relation-ship between investment and trade. It also demonstrates that savings levels vary across countries and over time, therefore the funds available for in-vestment, at the economy level, vary between countries.

Van den Berg then develops a partial equilibrium model for savings be-tween two countries. What this model shows is that if there is no restriction on the flow of savings, differences in returns will be eliminated by the flow of loanable funds to the country where interest rates are highest, producing a gain for those whose funds were previously lent in the lower-interest country and a loss for those whose funds were previously invested in a higher-interest country, but that overall there is a net gain in welfare. As a simple summary, this is the argument for a free flow of funds among count-ries, together with an explanation for the resistance to the free flow of funds from those who own financial assets in the higher-interest countries.

Reading

Now, please read Van den Berg, Chapter 10, sections 10.2 ‘A General Equilibrium Model of Inernational Investment’, and 10.3, ‘A Partial Equilibrium Model of International Savings’, making notes as you read on the main points raised in the section above.

Then you should read section 10.4, ‘Risk Reduction through International Diversification’, where the argument is simply that international investment allows investors to gain the rewards from investing in the places where returns are highest and that building a portfolio of investments in many countries allows them to smooth the risks.

Hendrik Van den Berg (2002) International Economics, sections from Chapter 10, ‘The Economics of International Investment’, reprinted in the Course Reader.



So far, you have been studying, mainly, a two-period model, which would predict that international investment, given the free flow of funds, would equalise the return on assets throughout the world, as funds flowed to where they could get the best returns. In countries where capital is rela-tively scarce and therefore returns high, investors would buy assets until a global equilibrium return is reached. In such a world, corporate as well as individual investment strategies would be relatively simple: find those investment opportunities where equilibrium has not yet been reached and returns will be higher than those investment opportunities where there is equilibrium.

1.1.2 Investment flows

The question raised in this section is:

• Why does investment not all flow to countries where capital is scarcest, and returns highest?

The simple process of adding more investment to an economy will not produce economic growth because, as investments depreciate, an increasing level of savings is required to replace the stock of capital, and returns to investment will diminish. If this were not the case, economies could not have grown as fast as they manifestly have. The solution to this economists’ problem is technological change: each round of investment does not replace the old stock of machines but rather a new, improved, set.

In a later section of this reading, Van den Berg uses Solow’s model to argue that international investment is a vehicle for generating technological change in the recipient countries. This was a major contribution, which led economic analysis away from static treatment of technology and from the assumption that all units of capital are substitutes for each other towards the more real-world case in which technology matters and rates of return on investments depend on more than the simple volume of investment in an economy. Not all investments in countries with small supplies of capital will be successful. Therefore, investment flows will depend not just on the existence of different average rates of return in different economies.

Finally, you will study in this reading Van den Berg’s discussion of why investment does not flow as freely as the simple model might suggest.

Reading

Please turn to the Reader and study Van den Berg’s Section 5.3 setting out the Solow Growth Model, Section 10.5 on his use of Solow’s model and Section 10.7, where Van den Berg turns to the reasons why investment does not flow as freely as the simple model might suggest.

Make notes on the important issues raised in each section, and list the reasons given for the impediments to investment flows.

Briefly, Van den Berg’s barriers to international investment, which you should have detailed in your notes, are these:

Hendrik Van den Berg (2002) International Economics, Section 5.3 ‘The Solow Growth Model’, and Sections 10.5 ‘International Investment and Economic Growth’, and 10.7 ‘The Barriers to International Investment’, reprinted in the Course Reader.



• government policies to restrict investment • risk • asymmetric information • exchange rate risk • the relative underdevelopment of international institutions.

These issues are dealt with in an introductory way, and we will come back to them in subsequent units.

To make sure you have understood this chapter, look at the summary at the end of it. This course is designed from the perspective of business decision-making, so not all of the elements of the chapter, especially those that argue for the welfare-maximising effects of international investment, will be relevant to you. It is not the purpose of this course to justify or criticise the investment behaviours of corporations or individuals.

1.2 International Investment Before examining mergers and acquisitions, we will consider investment further – foreign direct investment (FDI) and portfolio investment.

1.2.1 Foreign direct investment and portfolio investment

Individuals and companies can make investments in other countries in different ways.

The difference between foreign direct investment and portfolio investment can be defined in terms of whether the investment gives the purchaser any control over the use of the asset. So, a small minority shareholding gives no control, but a large block of shares might give some control. The absolute level of investment under each definition is not specified, although Van den Berg suggests that a 10%+ holding begins to give some control to the stock-holder. For a company, the important thing is the purpose of the investment – FDI implies that they want some control over the company in which the investment is to be made.

We can also distinguish between vertical and horizontal FDI – the former being made to establish a supply chain in more than one country, the latter designed to replicate similar facilities in more than one country. About 18% of US investment in poor countries results in products being exported to the US. Rich-country-to-rich-country investment tends to be horizontal. We will look in more detail at global supply chains in Unit 4. The advantage that less developed countries have generally concerns labour costs, regulation strictness and taxation levels.

There are many reasons why companies develop into multinational enterprises (MNE). One theory about what determines the boundary of the firm is the impact of transaction costs on a company as it purchases the goods and services to produce its products: where transaction costs are expensive, at some point it becomes more efficient to internalise the production of those goods and services rather than buy them. If by so doing the firm has to acquire the supplier companies or set up new ones



and those companies are in another country, the logic of minimising transaction costs results in an MNE.

A counter tendency is the going practice of outsourcing functions, especially manufacturing functions, to companies in another country. Here, the deci-sion to outsource, usually for reasons of minimising costs, has the opposite effect – the main company stays a single-country enterprise.

Another important reason for becoming an MNE is the impact of economies of scale. Some industries have very large ‘minimum efficient plant sizes’, especially in industries that have high research and development costs. In these cases, a single R and D operation and a spread of manufacturing plants close to markets makes the best economic sense.

Some foreign investment is the result of restrictions on trade: for example, overseas investment in the European Union is a direct result of companies wishing to sell in Europe, but being at a disadvantage because of tariffs and non-tariff barriers to exporting. Similarly, companies may wish to avoid taxation and regulation by locating in another country.

Portfolio investment is defined as the acquisition of securities in quantities that do not give the purchasers control over the enterprise invested in.

For an indication of the scale of the flows of FDI, look at the global summary of FDI inflows in Table 1.1 below. Consider these points about the flow of FDI:

• twice as much FDI flows to developed as to developing economies

• the European Union has seven times the FDI inflow of China and over five times as much as the USA

• FDI was on an upward trajectory by 2005 • the rate of growth of FDI in developed economies is faster

than in developing economies.

You should also note that the 2005 data for the United Kingdom are dis-torted by a single, large, investment by Royal Dutch Shell.

The table includes a note that World FDI inflows are projected as the basis of 96 economies for which data are available for part of 2006, as of January 2006. Data are estimated by annualising their available data, in most cases first quarter of data. The proportion of inflows to these economies in total inflows to their respective regions or sub-regions in 2004 is used to extrapo-late the 2005 data.

Exercise

Now that you have seen the direction of flows, can you note what are the possible explanations for these trends?

One explanation for the large flows to the European Union and the USA is the desire by companies to get over tariffs and other protectionist trade restrictions.



Table 1.1 Foreign Direct Investment, by host region and host economy 2003–2005 (in billions of dollars)

Host region/economy 2003a 2004a 2005b Growth rate % World 637.8 695.0 896.7 29 Developed Countries 441.7 414.7 573.2 38 Europe 3 258.2 449.2 74

European Union (25) 349.1 259.1 446.3 72 EU–15 327.6 231.4 407.7 76 France 42.5 24.3 48.5 99 Germany 27.3 –38.6 4.9 NA Italy 16.4 16.8 13.0 –23 Luxembourg 83.8 67.2 13.4 –80 United Kingdom 27.4 77.6 219.1 182

New 10 European states 12.5 27.8 37.7 36 Czech Republic 2.1 4.5 12.5 181 Hungary 2.1 4.6 6.0 30 Poland 4.6 12.6 8.7 –31

United States 56.8 96.9 106.0 11 Japan 6.3 7.8 9.4 21

Developing Economies 172.1 243.1 373.5 13 Africa 17.2 13.7 28.9 55

Egypt 0.2 1.3 4.1 226 Morocco 2.3 0.9 1.2 38 South Africa 0.7 0.8 7.2 803 Sudan 1.3 1.5 2.1 40

Latin America and the Caribbean 48.0 68.9 72.0 5 Argentina 1.7 4.1 4.2 3 Brazil 10.1 18.2 15.5 –15 Chile 4.4 7.6 7.0 –8 Colombia 1.8 3.1 4.5 48 Mexico 12.8 17.9 17.2 –4

Asia and Oceania 106.9 155.5 172.7 11 West Asia 11.9 17.6 26.5 51 Turkey 1.8 2.7 4.8 77

South, East and South East Asia 94.7 137.8 146.2 6 China 53.5 60.6 60.3 0 Hong Kong, China 13.6 34.0 39.7 17 India 4.3 5.3 6.0 12 Indonesia –0.6 1.0 3.5 242 Korea, Republic of 3.8 7.7 4.5 –42 Malaysia 2.5 4.6 4.2 –9 Singapore 9.3 16.1 15.9 –1 Thailand 1.9 1.4 3.7 159

South East Europe & Common-wealth of Independent States

24.0

37.2

49.9

34

Russian Federation 8.0 12.6 26.1 109 Romania 2.2 6.4 5.2 –19 Kazakhstan 2.2 5.4 5.4 0

a Revised data. Source: UNCTAD b Preliminary estimates.



For a detailed discussion of FDI flows, see World Investment Report: www.unctad.org/wir.

It is also likely that companies want to locate their production close to these markets, and the difference in labour costs between these and other loca-tions is less important than those considerations. Clearly, if labour costs were the dominant criterion, there would be a higher proportion of FDI flowing to low-wage economies.

1.3 Mergers and Acquisitions By now you should have an overview of some of the economic rationale for transnational investment, and a summary of the reasons that companies invest in countries other than their country of origin. One option for making an overseas investment is to take a stake in a company operating in the target country, whether a minority or majority stake. We now turn to the question of merger and acquisition strategy, or the reasons for and forms of investment in other companies, as a central element of international strategy.

1.3.1 M and A trends

Merger and acquisition activity occurs in waves, as conditions for agglomer-ation and the fashion for company management to use acquisition as a growth strategy comes and goes. The first wave of mergers in the USA (where this sort of activity started) dates back to 1879–1904 as US corpora-tions attempted to establish monopoly positions in all the major industries. This was followed by the ‘anti-trust’ laws that still form the basis of US competition policy. The two subsequent waves of M and A activity occurred within the anti-trust laws and were designed for different purposes, whether the establishment of oligopolies (a small number of competitors in an industry) or other business strategies.

‘Modern’ M and A began with the fourth wave, 1981–1989. Here the mergers were of very high value and large companies were involved. Investment banks became involved, offering advice and collecting fees; take-over and defence strategies were developed in great intricacy and there was much greater use of debt to finance take-overs. During this wave, the first signifi-cant multi-national merger and acquisition activity also took place – for example, the acquisition of Standard Oil by British Petroleum in 1987.

The fifth wave began in 1992. The features of the fifth wave were an increas-ing use of equity rather than debt to pay for the acquisitions; there was a period of consolidation as ‘roll-up’ deals picked up the smaller companies in an industry and amalgamated them with the larger. This was aided by the ability of specialised investment banks to offer, often complex, financing solutions to finance acquisitions. International acquisitions also took off during the fifth phase, with European deals almost matching US deals by 1999, at around US$1,500 million in value. Asian deals also took off, mostly based in Japan.

The large amounts of external funding required for sustaining the repeated waves of M and A activity made it particularly susceptible to upsets in the



global economy, such as the dot-com crash and the financial crisis of 2007–08. To see the effect of this, please now study Figure 1.1, which shows the value of M and A deals, by value and by region, from 2000 to 2008.

When studying the data the following points are worth noting:

• the growth in the proportion of transnational deals over the period

• the increasing location of M and A activity in the European and Asian-Pacific regions

• the effect of the financial crisis: leveraged buy-outs have by and large witnessed the biggest decline, while government activities such as government investments in financial institutions, investment by gov-ernment-controlled corporate and sovereign wealth funds are less affected.

Figure 1.1 Share of global M&A by geography of target (%)

Asia-Pacific

Europe

Americas

2000 2001 2002 2003 2004 2005 2006 2007 20081

2

3

4

5

Total value ($US trillion)

9 12 13 19 18 19 15 18 19

33 32 33 40 37 38 39 41

58 56 49 45 47 46 46 42 40

23 25 25 28 29 29 29 41 35

Year

Share of cross-border flows %

39

Source: Dealogics McKinsey analysis

At the end of this section you might like to consider whether the above points signal the end of the most recent wave of M and A activity; or are we about the see the beginning of a new wave, involving new investors, often state-led, and from different regions?

1.3.2 Merger strategy

While not all mergers are transnational, M and A are an important element of international business strategy. Here we turn to the issue of merger strategy: why and how do companies merge?



Reading

Turn now to the Reading ‘Merger Strategy’, a chapter from a textbook by Patrick Gaughan. In it, the author explains the main reasons and strategies for mergers.

As you read the chapter, you should make notes covering the main issues involved.

The first reason for merger is to achieve growth in a slow-growing industry. Company managements are always under pressure to grow their turnover, and building increased market share in a slow market is a long-term process. Acquisition of other companies is a faster route to growth. The danger, though, is that the increase in sales thus acquired may not result in increased profits. Managers’ pursuit of turnover growth might not be compatible with owners’ pursuit of increased profits.

Synergy

A concept often used in merger strategy is ‘synergy’. Gaughan defines three types of synergy that can result from a merger. The first is the ‘increase in value of the newly combined company’, above the combined value of the prior-to-merger companies, less any merger expenses:

Net Acquisition Value = [VAB – (VA + VB)] – (P + E)

Where VAB = the combined value of the two companies

VB = the market value of B

VA = A’s measure of its own value

P = the premium paid for B, over its share price

E = the expenses of acquisition.

The term in square brackets is the synergistic effect of the merger.

The second type of synergy is ‘operating synergy’, through which the merged companies can either gain greater revenues together than apart (for example, by combined marketing), or achieve reduced costs (through economies of scale, for example). Gaughan is keen to remind you that the achievement of operating synergies of both types requires a great deal of management effort and strategic thinking.

The third type of synergy is ‘financial’, where the cash flows of the merged companies are uncorrelated and the combined business has a less volatile cash flow. To this could be added the automatic currency hedge implied by a merger between companies operating in different currencies.

Diversification

A second motive for merger is diversification. Diversification can produce ‘conglomerates’, which consist of a portfolio of unrelated businesses. Many fourth-wave mergers were of this type, and they were followed by a period of ‘deglomerisation’, where buyers could add value by demerging unrelated businesses from their conglomerate parents, because the conglomerate management could not be successful in a range of unrelated activities.

Patrick A Gaughan (2002) Chapter 4 ‘Merger Strategy’, reprinted in the Course Reader from Mergers, Acquisitions and Corporate Restructurings.



Diversification may be pursued to enable the company to move from less to more profitable activities. One of the most successful conglomerates devel-oped through acquisitions was the US company General Electric (GE). In recent years, the company has added organic growth at 8% per annum to its history of growth through acquisition.1

A famous recent, unsuccessful, example involved the French water utility company, known at the time as Vivendi, whose CEO took the company into television production, films and music industries in the belief that these activities would be more profitable (and interesting) than supplying water. The new group made losses of 23.6 billions in 2002, the largest recorded loss by a French corporation. More usual is a move from a mature industry where growth is slow into faster-growing sectors. However, Gaughan’s summary of the evidence on diversification is that it tends to reduce rather than enhance company value after the mergers.

Economic motives

Mergers enable integration, either horizontal (between companies doing similar things) or vertical (among companies at different stages in the supply chain). Horizontal mergers are generally pursued to gain market share and market power. Vertical integration offers the chance to

• gain control over supplies (for example, the acquisition of oil and gas rights)

• gain cost advantages by internalising a supplier • reduce transaction costs • acquire specialist inputs previously bought in the market.

Gaughan also covers a variety of other motives, including the desire to improve the quality of management by acquisition, improve research and development capabilities, distribution networks and tax advantages.

You should now have a grasp of the basics of merger strategies. In general, you should remember that mergers do not automatically result in improved profitability because

• the premium paid may be too high • the managers may have overstated the case for the merger and the

value of the merged entity (the ‘hubris hypothesis’) • the management skill required to make the new company work may

be lost after the merger as managers leave the target company • synergies are not realised.

Gaughan wrote another book after the one you have been reading from, called Mergers: What Can Go Wrong and How to Prevent It2, based on analysis the fifth-wave mergers. In that book he advocates joint ventures as a less risky strategy, especially when the purpose of the merger is to acquire a market presence in an overseas territory. We will return to the question of

1 See an interview with GE’s CEO at: http://www.ge.com/files/usa/company/investor/

downloads/harvard_business_review_ge.pdf 2 Gaughan (2005)



the best entry strategy in Unit 2 and to the reasons for success and failure of mergers when we look at the case of DaimlerChrysler, in Unit 5.

1.4 Conclusions In this unit you have been introduced to some of the economic analysis underlying the question of why companies decide to acquire assets in another country. You have also seen that stark economic calculations of costs and returns are not the sole explanation for the decisions to acquire foreign assets, and that institutional factors and trade and other rules and regula-tions also affect the decision.

You have also seen that M and A, one of the main ways in which companies can acquire assets in another country, has a wave pattern but is in trend growth and has spread from the USA to the rest of the world. However, the effects of M and A on a company’s profitability are not guaranteed to be positive. In many cases the combined value of the new company is less than the separate values of the old ones.

In the next unit we turn to the question:

• What strategies must managers adopt to ensure that the international expansion of their company is profitable?

Unit 2, then, is concerned with the choice of entry strategy. The unit after that considers practical questions about production and sourcing in count-ries other than the home base.

Review Questions

To help you to review this unit, make sure that you are able to answer the following ten questions, based on the readings.

1. Why do people and businesses acquire assets in other countries?

2. Why do interest rates differ between countries?

3. With no restriction on international investment, what would you expect to happen to rates of return in different countries?

4. What does the Solow model offer as an explanation for the fact that returns to investment do not always decrease?

5. Why is international investment smaller than it should be, if the equilibrium model was correct?

6. Why do companies pursue (a) vertical, and (b) horizontal integration?

7. What are the main reasons for the growth of Multinational Enterprises?

8. Why is the volume of Foreign Direct Investment higher in developed than in developing economies?

9. What are the main types of ‘synergy’ that can result from mergers and acquisitions?

10. What are the obstacles to achieving synergy after a merger?

In summary, the main points covered by this unit are:



• Investment decisions are not a simple matter of choosing to invest where returns seem to be highest. Government policies, asymmetric information, exchange rate and other risks, the development of institutions all have an influence on where companies invest.

• Investments may be made in two basic ways – by directly buying or creating an asset, or by buying stock in already existing assets. Direct investment may be vertical or horizontal – investments that move capital from one rich country to another tend to be horizontal; investments from richer to poorer countries tend to be vertical.

• The main motivations behind direct investment to create a multi-national enterprise are:

• internalising transaction costs • keeping control over proprietary knowledge • realising economies of scale • maintaining or improving reputation • getting over trade restrictions across boundaries • avoiding taxes • hedging exchange rate risk from exporting • substituting for poor or missing financial markets • anticipating favourable business conditions in the new location • finding low-cost locations for all or part of the value chain.

• Mergers and acquisitions occur in waves, some waves involving debt financing and others equity. Different waves have had different motivations. M and A activity also has different motivations:

• to achieve growth in a slow-growing industry • managers’ desire to increase turnover by acquiring other

companies • ‘synergy’ – merged organisations able to achieve greater sales

or profits than unmerged entities • diversification • to gain market share • to gain control over the value chain.



References and Websites Gaughan Patrick A (2005) Mergers: What Can Go Wrong and How to Prevent It, Fourth edition, Hoboken NJ: Wiley.

Gaughan Patrick A (2002) Mergers, Acquisitions and Corporate Restructuring, Third edition, New York: Wiley.

General Electric: Interview with GE Chief Executive Officer available at http://www.ge.com/files/usa/company/investor/downloads/harvard_business_review_ge.pdf

UNCTAD: www.unctad.org

Van den Berg Hendrik (2004) International Economics, New York: McGraw-Hill/Irwin.

World Investment Report: available at http://www.unctad.org/wir.

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