Chapter 7 Outline

Implications for Business

There are a number of fairly obvious implications for business in the material discussed in this chapter. For a start, a host government's attitude toward FDI should be an important variable in deciding where to locate foreign production facilities and where to make a foreign direct investment. Other things being equal, investing in countries that have permissive policies toward FDI is clearly preferable to investing in countries that restrict FDI.

Generally, however, the issue is not this straightforward. Despite the move toward a free market stance in recent years, many countries still have a rather pragmatic stance toward FDI. In such cases, a firm considering FDI usually must negotiate the specific terms of the investment with the country's government. Such negotiations center on two broad issues. If the host government is trying to attract FDI, the central issue is likely to be the kind of incentives the host government is prepared to offer to the MNE and what the firm will commit in exchange. If the host government is uncertain about the benefits of FDI and might restrict access, the central issue is likely to be the concessions that the firm must make to go forward with a proposed investment. In the remainder of this section, we will focus on negotiating with a host government.

The Nature of Negotiation

The objective of any negotiation is to reach an agreement that benefits both parties. Negotiation is both an art and a science. The science of it requires analyzing the relative bargaining strengths of each party and the different strategic options available to each party and assessing how the other party might respond to various bargaining ploys.¹⁹ The art of negotiation incorporates "interpersonal skills, the ability to convince and be convinced, the ability to employ a basketful of bargaining ploys, and the wisdom to know when and how to use them."²⁰ In the context of international business, the art of negotiation also includes understanding the influence of national norms, value systems, and culture on the approach and likely negotiating tactics of the other party as well as sensitivity to such factors in shaping a firm's approach to negotiations with a foreign government. For example, negotiating with the Japanese government for access is likely to be very different from negotiating with the British government. Consequently, it requires different interpersonal skills and bargaining ploys. We discussed the importance of national differences in society and culture in Chapter 3. It would be well to keep these differences in mind at this juncture.

The negotiation process has been characterized as occurring within the context of "the four Cs": common interests, conflicting interests, compromise, and criteria (see Figure 7.2).²¹ To explore this concept, consider the negotiation between IBM and Mexico that occurred in 1984 and 1985 when IBM tried to get permission to establish a facility to manufacture personal computers in Guadalajara, Mexico. At that time, Mexican law required foreign investors to agree to a minimum of 51 percent local ownership of any production facilities they established in Mexico (the law was repealed as part of the 1994 North American Free Trade Agreement). The rationale for this law was Mexico's desire to reduce its economic dependence on foreign-owned enterprises, thereby preserving its national sovereignty. As with many such laws, in practice it was used as a bargaining chip by the Mexican government to extract concessions from foreign firms wishing to establish production facilities in Mexico. The government was often willing to waive the 51 percent ownership requirement if a foreign firm would make concessions that increased the beneficial impact of its investment on the Mexican economy.

IBM proposed to invest about $40 million in a state-of-the-art production facility with the capacity to produce 100,000 PCs per year, 75 percent of which would be exported (primarily to the United States). IBM's objective was to take advantage of

Figure 7.2

The Context of Negotiation--the Four Cs

Mexico's low labor costs to reduce the cost of manufacturing PCs. Given the proprietary nature of the product and process technology involved in the design and manufacture of PCs, IBM wanted to maintain 100 percent ownership of the Guadalajara facility. IBM felt that if it entered into a joint venture with a Mexican firm to produce PCs, as required under Mexican law, it would risk giving away valuable technology to a potential future competitor. When presenting its case to the Mexican government, IBM stressed the benefits of the proposed investment for the Mexican economy. These included the creation of 80 direct jobs and 800 indirect ones, the transfer of high-technology job skills to Mexico, new direct investment of $7 million (the remaining $33 million required to finance the investment would be raised from the Mexican capital market), and exports of 75,000 personal computers per year. The Mexican government rejected the proposal on the grounds that IBM did not propose to use sufficient local content in the plant and would thus be importing too many parts and materials. IBM twice resubmitted its proposal. Maintaining its insistence on 100 percent ownership, IBM with each proposal increased its commitment to purchase local parts, increased the level of its direct investment, and raised its planned level of exports. The Mexican government agreed to the third proposal, which had extracted significant concessions from IBM. The final agreement required IBM to invest $91 million (up from $40 million). This money was distributed among expansion of the Guadalajara plant ($7 million), investment in local R&D ($35 million), development of local part suppliers ($20 million), expansion of its purchasing and distribution network ($13 million), contributions to a Mexican goverment-sponsored semiconductor technology center ($12 million), and various other minor investments. In addition, IBM agreed to achieve 82 percent local content by the fourth year of operation and to export 92 percent of the PCs produced in Mexico. In exchange, the Mexican government waived its 51 percent local ownership requirement and allowed IBM to maintain 100 percent control.²²

In this example, the common interest of both IBM and Mexico is establishing a new enterprise in Mexico. Conflicting interests arise from such issues as the proportion of component parts that will be procured locally rather than imported, the total amount of investment, the total number of jobs created, and the proportion of output that will be exported. Compromise involves reaching a decision that brings benefits to both parties, even though neither will get all of what it wants. IBM's criteria or objectives are to achieve satisfactory profits and to maintain 100 percent ownership. Mexico's criteria are to achieve satisfactory net benefits from the resource-transfer, employment, and balance-of-payments effects of the investment.

Bargaining Power

The outcome of any negotiated agreement depends on the relative bargaining power of both parties. Each side's bargaining power depends on three factors (see Table 7.3):

• The value each side places on what the other has to offer.

• he number of comparable alternatives available to each side.

• Each party's time horizon

From the perspective of a firm negotiating the terms of an investment with a host government, the firm's bargaining power is high when the host government places a high value on what the firm has to offer, the number of comparable alternatives open to the firm is great, and the firm has a long time in which to complete the negotiations. The converse also holds. The firm's bargaining power is low when the host government places a low value on what the firm has to offer, few comparable alternatives are open to the firm, and the firm has a short time in which to complete the negotiations.

To see how this plays out in practice, consider again the case of IBM and Mexico. IBM was in a fairly strong bargaining position, primarily because Mexico was suffering from a flight of capital out of the country at the time (1985 and 86), which made the government eager to attract new foreign investment. But IBM's bargaining power was moderated somewhat by three things. First, despite its symbolic importance, the size of the proposed investment was unlikely to have more than a marginal impact on the Mexican economy, so the economic value placed by Mexico on the investment was not that great. Second, IBM was looking for a low-labor-cost, politically stable location close to the United States. Mexico was obviously the most desirable location given these criteria. Greater distance and higher transportation costs made alternative low-labor-cost locations, such as Taiwan or Singapore, relatively less attractive, while other potential locations in Central America were ruled out by political instability. Third, given the profusion of low-cost competitors moving into the US personal computer market during the mid-1980s, IBM probably felt it needed to move quickly to establish its own low-cost production facilities. But there was no compelling reason for Mexico to close a deal quickly. Due to all these factors, the Mexican government also held some bargaining power in the negotiations and was able to extract some concessions from IBM. On the other hand, IBM's strong position allowed it to insist that it maintain 100 percent ownership of its Mexican subsidiary. This represented a significant concession from the Mexican government; IBM was the first major company for which Mexico waived its prohibition of majority ownership.

In a similar case during the 1960s, IBM was one of the few firms to get the Japanese government to waive the restriction on FDI that would allow it to establish a wholly owned subsidiary in Japan. IBM was able to do this because it was the only major source of mainframe computer technology at the time, and numerous Japanese companies needed that technology for data processing. The lack of comparable alternatives available to the Japanese enabled IBM to pry open the Japanese market. Similarly, during the 1980s, Toyota extracted significant concessions from the state of Kentucky in the form of tax breaks, low-interest loans, and grants, and Honda received similar concessions from the state of Ohio. At that time, both states were suffering from high unemployment, and the proposed auto assembly plants promised to have a substantial impact on employment. Also, both companies had a number of states from which to choose. Thus, the high value placed by state governments on the proposed investment and the number of comparable alternatives open to each company considerably strengthened the bargaining power of both companies relative to that of the state governments.

Table 7.3

Determinants of Bargaining Power

		Bargaining Power of Firm
		High	Low
	Firm's time horizon	Long	Short
	Comparable alternatives open to firm	Many	Few
	Value placed by host government on investment	High	Low