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A firm will prefer FDI over exporting as a strategy to break into foreign markets when transportation costs or trade barriers make exporting unattractive, the firm will also favour FDI over licensing (or franchising) when it wishes to maintain control over its technological know how, or over its operations and business strategy, or when firm’s capabilities are simply not amenable to licensing, as may often be the case.

Exporting involves producing goods at home and then shipping them to the receiving country for sale. Licensing involves granting a foreign entity (the licensee) the right to produce and sell the firm’s product in return for a royalty fee on every unit the foreign entity sells.

Limitations of Exporting. The viability of an exporting strategy is often constrained by transportation costs and trade barriers. When transportation cost is added to production cost, it becomes unprofitable to ship some products over a long distance. This is particularly true for products that have a low value-to-weight ratio and that can be produced in almost any location (eg cement, soft drinks etc).

Limitations of Licensing. A branch of economic theory known as internationalization theory seeks to explain why firms often prefer foreign direct investment over licensing as a strategy for entering foreign direct investment. According to this theory, licensing has three major drawbacks as a strategy for exploiting foreign market opportunities.

licensing may result in a firm’s giving away valuable technological know-how to a potential foreign competitor

licensing does not give a firm the tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability.

this happens particularly if the firm’s competitive advantage is based not so much on its product, but rather on the management, marketing, or manufacturing facilities that produce those products. Such capabilities are not usually amenable to licensing.

WHAT recent pattern of FDI HAVE BEEN OBSERVED?

Firms in the same industry often undertake FDI at about the same time. There also is a clear tendency for firms to direct their investment activities toward certain locations. We consider two explanations why firms in the same industry often undertake foreign direct investment simultaneously, and why some locations are favoured over others as targets for foreign direct investment:

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