Investment Strategies in Emerging Markets 1

1. Investment Strategies in Emerging

Markets: An Introduction to the
Research Project
Klaus E. Meyer and Saul Estrin

INTRODUCTION

Foreign Direct Investment (FDI) is widely believed to make major

contributions to the economic development of emerging markets (for
example UNCTAD 2001). At the same time, emerging markets play a pivotal
role in the global strategies of many multinational enterprises (MNEs),
notably those with ambitious growth targets. Thus MNE and local policy
makers have a common interest in encouraging foreign investment. Their
objectives vary: externalities for the local economy or profits and corporate
growth. Yet cooperation between local and foreign partners can create
beneficial outcomes for both.
This study investigates the foreign investment strategies in four emerging
markets, their determinants and their implications for the local economy and
for public policy. The outcomes of FDI in terms of both corporate and social
performance are highly dependent on how the operation is initially set-up.
Entry strategies concern the key characteristics of the foreign investment
project, including for instance entry mode, timing and location. The entry
strategy establishes where, when and how a foreign investor establishes a
new operation, setting the stage for the affiliate’s own performance and its
impact on local partners. This study uniquely incorporates business strategy
in the analytical framework and addresses both corporate and social
outcomes of FDI.
A wide range of host-country specific factors influences inward FDI into
emerging markets. Foreign investors are attracted to large and growing
markets, as well as to host countries’ endowments of natural and created
assets. In emerging markets, many investors are focused on a particular factor
as market-seeking FDI seeks large populations with rising incomes, while
resource-seeking FDI seeks labour forces at affordable costs, or specific

1
2 Investment Strategies in Emerging Markets

national resources such as mineral, or oil and gas. Moreover, the institutional
context in the location of their (potential) investment is crucial for where and
how to establish FDI, and particularly so in emerging economies. Hence, the
volume of FDI a country receives is influenced by a wide range of FDI-
specific laws and regulations (for example Guisinger et al. 1985) as well as
the overall institutional development (Henisz 2000, Bevan, Estrin and Meyer
2003, Globermann and Shapiro 2003). Equally, the institutional context
shapes the characteristics of inward FDI, notably the preferred entry mode
(for example Meyer 2001).
International business and strategic management scholars have analysed
the merits of alternative forms of international entry and their implications
for corporate performance. The literature has analysed in particular
alternative ownership arrangements (for example Anderson and Gatignon
1986, Tse et al. 1997), and the choice of acquisitions or greenfield entry (for
example Hennart and Park 1993, Kogut and Singh 1988). Most studies have
focused on project- and firm-specific aspects, such as the investor’s global
strategy, research and advertising intensity and international business
experience, using as empirical base primarily FDI between mature market
economies where the institutional context is comparatively homogeneous.
Recently, empirical studies have begun to analyse entry modes in emerging
markets such as Eastern Europe (for example Brouthers and Brouthers 2000,
Meyer 2001, Meyer and Estrin 2001) and China (for example Pan and Tse
2000, Luo 2001, Chen and Hu 2001). Other emerging markets remain under-
researched. Moreover, most studies pay only scant attention to local resource
endowment and institutional peculiarities, as few have systematically
explored the institutional variations between and within emerging markets,
and their impact on FDI.
Our study analyses the link between the host-country environment and
foreign investment strategies. We use case research to explore and refine the
concepts of entry modes, paying special attention to the concepts of resource
transfers, ownership and control, and their evolution over the first years of
operation of the project. We also use a survey to understand the determinants
of entry modes, and the relationship between FDI motivation, entry modes
and the performance of the newly established affiliate.
We also examine the benefits the host economy can gain from the
interaction with foreign investors, commonly known as spillovers. These
arise through a variety of channels, including impact on the balance of
payment, employment and investment. Probably the most important ones are
knowledge transfer and diffusion that benefit not only the affiliate of the
foreign investor, but its local business partners as well. Foreign investors
generally transfer resources to their affiliates, thus creating new operations
replicating their operations elsewhere in the case of greenfield investment,
and restructuring, upgrading and integrating existing businesses in the case of
acquisitions. This process affects not only the affiliate, but also local
 Investment Strategies in Emerging Markets 3

businesses with which they are in contact. Suppliers may be required to

achieve higher standards of quality and service, and receive support when
striving to accomplish them. Customers may receive higher quality products,
complemented with advice on how to improve their application or marketing.
Even unrelated firms may benefit from observing new business practices
applied in their local context, and learning from this ‘demonstration effect’
(Altenburg 2000, Blomström and Kokko 2002, Fan 2002). The potential of
such impact will be greater the larger the technological gap between source
and recipient economy, which makes it particularly relevant in emerging
markets.
To understand the mechanisms of spillovers, it is important to understand
processes within the investing MNE, and its interaction with the local
environment. Policy makers need to understand MNE behaviour in order to
develop policies to influence FDI. Therefore, we analyse spillovers and
corporate strategy in a comprehensive framework summarised in Figure 1.1. We
use this as the conceptual framework for the case studies in this book.

FDI IN EMERGING MARKETS

Over the past decade, emerging markets have become major recipients of
FDI as multinational enterprises have expanded their global strategies to take
advantage of business opportunities. Emerging economies are attractive for
business because of their sometimes large and often fast growing markets,
and because they provide access to resources, notably raw materials and
labour not available at the same cost, in mature market economies. Total FDI
flows worldwide had grown from US$ 200 billion in 1990 to US$ 1,500
billion in 2000, before falling back to US$ 735 billion in 2001. Of this,
developing nations and transition economies account for US$ 206 billion (28
per cent) in 2001. However, FDI in emerging economies is distributed very
unequally, with China receiving the largest share (US$ 47 billion), followed
by Mexico, Brazil and Hong Kong with over US$ 20 billion each in 2001.
The poorest economies of Africa or Latin America, in contrast, receive only
negligible sums (all data from UNCTAD 2002).
Despite their attractions, emerging markets pose particular challenges to
investors because of the weaknesses in the institutional environment.
The legal framework concerning business law tends to be less developed with
respect to, inter alia, competition policy, regulatory policy, corporate
taxation, and definition and enforcement of property rights (not just
intellectual property). Moreover, even where the necessary laws are in place,
their implementation and enforcement may be inhibited by, among other
causes, lack of qualified accountants, bureaucrats and lawyers. Intermediaries
and information systems, such as audited corporate accounts and business
4

Host Economy
Environment

Institutional & legal

framework
Performance of
Mode of MNE affiliate
Resource Endowment
Entry
= Local Firms
= Human Capital
= Infrastructure
Greenfield
Acquisitions
Joint Ventures
Partial acquisitions Spillovers
Multinational Firm

Firm-specific resources
Global strategy and
organizational structure
Objective of FDI

Figure 1.1 Conceptual framework of the study

 Investment Strategies in Emerging Markets 5

directories, may also be lacking, and the laws may be subject to frequent
changes, which creates considerable uncertainty for businesses.
In addition informal institutions can differ greatly from those of Western
market economies. For instance, traditional value systems are more
widespread, including collectivist, particularist, and family-oriented values,
as well as religion. Relationship-based interactions with business partners are
more common, in part due to low trust in both governments and outsiders to
the society. Markets - especially for capital and skilled labour - may be thin
or illiquid and inhibited by numerous market failures. These “institutional
voids” (Khanna and Palepu 1999) can cause high transaction costs in
markets, such that investing firms may prefer to ‘internalise’ business
transactions in situations, where they would use market-transactions in
mature economies. At the same time, few local firms match international
standards in technology and management. This means that firms following
entry strategies in emerging markets face special problems that may require
unique solutions.
For this study we have selected four emerging economies that despite
significant cultural, geographical and economic differences are quite similar
with respect to FDI. Each has substantially increased their FDI receipts in the
mid to late 1990s although they are still not among the top recipients: India,
South Africa, Egypt and Vietnam (Table 1.1).1 All four countries were
relatively closed economies with a large extent of state involvement, but each
had gone through substantial liberalisation in the 1990s.
By the end of the 1990s they had achieved macroeconomic stability and
economic growth prospects were considered to be favourable. Also, these
countries were ranked similarly by the Human Development Report 2002
with positions between 107th and 124th worldwide (Table 1.2). India has
operated for many years as a mixed socialist-capitalist economy, but has
embarked on major, though gradual, liberalisation of both the domestic
economy and its FDI regime since 1991. Egypt formally abandoned the ideas
of central planning in 1971, but the process of liberalisation has been very
slow and only accelerated in the 1990s; many FDI restrictions have been
removed in the 1990s, though others remain in place. Vietnam belonged to
the socialist block since the 1970s, but embarked on gradual reform from
1986, along a similar path to China. South Africa’s economy was severely
constrained by the international embargo of the apartheid regime, but the
regime change in 1994 led to a more open economic system with new
business opportunities. Table 1.2 provides an overview of economic and
social indicators in each country.2 The institutional change affecting FDI in
each country is presented in greater detail at the outset of each of the country
sections of this book.
Table 1.1 Foreign Direct Investment in emerging markets

Year 1982– 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
1989
South Africa 49 -5 -8 -42 -19 380 1241 818 3817 561 1502 888 6789 754

India 113 236 155 233 574 973 2144 2525 3619 2633 2168 2319 3404 3449

Egypt 926 734 352 459 493 1256 598 636 887 1065 2919 1235 510 647

Vietnam* 5 16 32 385 523 1936 2336 1803 2587 1700 1484 1289 1300 1200

Notes: Annual Average

In million US$
We use the latest available revision of the data, i.e. WIR 2002 for data for 1996 onwards.
In the case of Vietnam, this involves a considerable downward adjustment of the data from 1996 onwards, compared to the data reported in UNCTAD
2001.

Source: UNCTAD 1994 to 2003

 Investment Strategies in Emerging Markets 7

Market-seeking foreign investors are first and foremost interested in large

and fast growing economies. At a time when mature markets in Europe,
Japan and (to a lesser extent) North America offer little growth potential,
many firms seek business opportunities by serving the growing demand in
emerging markets. India is a large economy, with an annual GDP of US$ 447
billion courtesy of its large population and despite its low average per capita
income. Although ahead of Vietnam, India is a low-income economy with
per capita GDP of US$ 460 at current exchange rates, thus lagging
considerably behind Egypt (US$ 1,490) and South Africa (US$ 3,020).
Vietnam has achieved very high economic growth in recent years with 7 per
cent growth in the second half of the 1990s, ahead of both India and Egypt.
On this score, South Africa performs poorly as its growth rate in recent years
is more comparable to that in mature market economies.
All four countries have substantially reduced their inflation rate over the
decade to reach single-digit inflation in 2000, and trade has grown, increasing
the interdependence with the international economy. However, the trade data
show some interesting variations: South Africa is the only country with a
trade surplus, with substantive exports of the mining industry and, by the end
of the decade, of basic processed goods. In Egypt, the falling price of oil has
slowed trade, which thus fell from 52.9 per cent in 1990 to 19.2 per cent of
GDP in 2000, while imports exceed exports by over 50 per cent in both years.
The volume of trade is largest relative to the country’s GDP in Vietnam (96.1
per cent). Turning to social development indicators, Vietnam is performing
as well, if not better than the other countries, despite its much lower GDP.
Thus, Vietnam is ranked 109th in the Human Development Index developed
by the UN, only two ranks behind South Africa (rank 107), and ahead of both
Egypt (rank 115) and India (rank 124). The socialist emphasis on education
and health care is reflected in a remarkable adult literacy rate of 93.1 per cent
and a life expectancy at birth of 69 years. Life expectancy has increased since
the 1970s in Vietnam (by 19 years), Egypt (15 years), and India (13 years),
while it has in recent years fallen back on 1970’s levels in South Africa,
mainly due to the AIDS crisis.
However, other indicators of industrial and economic development show
South Africa ahead of the other countries, which is indicative of its dual
economy: some aspects of the economy resemble a mature market economy,
while large parts of the society live under conditions more typical for
developing countries. This is reflected in an unusually high Gini-coefficient
of 59, high urbanization of 56.9 per cent, higher tertiary (university)
enrolment rate of 18.9 per cent (second to Egypt with 20.2 per cent), and a
high share of the service sector in GDP (64 per cent). Also,
Table 1.2 Key economic and social data in Egypt, India, South Africa and Vietnam

Egypt India S. Africa Vietnam

1990 2000 1990 2000 1990 2000 1990 2000
Population, million 52 64 835 1.016 34 43 66 79
GDP, US$ billion 48 95 315 471 113 129 5 31
GDP per capita, US$ 926 1.490 377 460 3.325 3.020 78 390
GDP per capita, at PPP int $ 2.640 3.690 1.449 2.390 8.524 9.180 n/a 2.030
Average annual GDP growth (%), * 3.8 5.4 5.4 5.7 0.7 2.6 7.7 7.0
Consumer price inflation 14.0 4.3 10.5 7.6 11.3 6.7 n/a 3.7
Exchange rates, Local currency per
US$, av. 2.00 3.70 18.10 46.80 2.60 7.60 8.13 14.51
Exports, US$ bn 9.6 4.7 22.5 42.4 28.0 30.0 1.4 14.3
Imports, US$ bn 15.8 13.6 26.9 28.8 21.1 29.7 1.8 15.2
Ratio of trade to GDP (%) 52.9 19.2 15.7 19.4 43.4 46.3 62.0 96.1
Household consumption, % of GDP 72 72 68 68 63 64 90 70
Government consumption, % of GDP 11 10 12 11 20 18 8 7
Gross Fixed Capital Formation, % of
GDP 27 24 23 25 19 15 13 25
Life expectancy at birth ** 52.1 66.9 50.3 62.9 53.7 53.9 50.3 67.8
Adult literacy rate 55.3 57.2 85.3 93.4
HDI index 0.574 0.642 0.511 0.577 0.714 0.695 0.605 0.688
HDI rank na 115 na 124 na 107 na 109
Gini index *** na 28.7 na 37.8 na 59.3 na 36.1
Tertiary enrolment rates, % **** 15.8 20.2 6.1 6.6 13.2 18.9 1.9 4.1
Urban population, % of total ** 43.5 42.7 21.3 27.7 48.0 56.9 18.8 24.1
Agriculture % of GDP 19 17 31 28 5 4 37 26
Industry % of GDP 29 33 27 25 40 32 23 33
of which: manufacturing 24 27 17 16 24 19 19 n/a
Services % of GDP 52 50 42 46 55 64 40 42
Value Added of SOE (% of GDP) 30.0 13.4 14.7 n/a
Phone lines (# per 1000 people) 30 86 6 32 93 114 1 32
Mobile phones (# per 1000 people) na 21 na 4 na 190 na 10
R&D expenditures as % of GNP na 1.9 na 0.6 na 0.6 na Na
Scientists and engineers in R&D per
million people na 493 na 158 na 992 na 274
Net FDI inflows, % GDP 1.7 1.3 0.1 0.5 -0.1 0.8 0.2 4.1
Stock market capitalisation, US$ bn 1.8 32.8 38.6 184.6 137.5 262.5 0 0
Listed domestic companies 573 1.032 2.435 5.863 732 668 0 0
Av. price of traded company, US$ mn 3 32 16 31 188 393 n/a n/a

Notes: * averages over the 1990-1995 and 1996-2000, ** data refer to 1975 and 1999, *** Gini coefficient refers to different years between
1993 and 1998, **** data refer to 1990 and 1995.

Sources: IMF: International Financial Statistics; World Bank: World Development Report, Competitiveness Indicators; UN: Human
Development Report, various years.
 Investment Strategies in Emerging Markets 11

telecommunications in terms of fixed phone lines or mobile phones are far

better developed than in the other three countries. Natural resource industries
that provide an important basis for economic development include mining in
South Africa, oil exploration in Egypt and agricultural products in Vietnam
India and Vietnam are far less urbanised (28.1 per cent and 19.7 per cent,
respectively), and agriculture continues to account for a very large share of
GDP (28 per cent and 24 per cent). University education is still an exception,
and less than two per cent have a phone line, while the number of Internet
hosts is negligible. Yet, since Internet cafés are more common than private
connections, many people do have access to the worldwide web. These
indicators are of interest to investors because they illustrate the resource
endowment, and indicate a growing middle class, which may be demanding
Western-style consumer goods. Even in a relatively poor country like India,
the large numbers in the urban middle class have purchasing power meriting
investment in serving them (Dawar and Chattopadhay 2002).
The last rows in Table 1.2 report data of special interest to financial
investors. South Africa has the largest capital market in terms of market
capitalisation, which makes it attractive for foreign portfolio investors.
However, both India and Egypt have more listed domestic companies, which
suggest an active local equity market. In socialist Vietnam no stock
exchanges had yet been established. Foreign direct investment, which Table
1.1 shows to be of similar magnitude in the four countries, has quite a
different impact relative to the size of the host economy: in Vietnam, it
amounts to 4.1 per cent of GDP, while it is only 0.5 per cent in India.

Table 1.3 Country Risk Indices

Egypt India S. Africa Vietnam

Overall country risk 3.0 3.1 2.4 3.1
Political risk 3.0 3.5 2.5 3.0
Economic risk 3.0 3.0 2.5 3.5
Legal risk 3.5 3.0 2.0 3.0
Tax risk 3.0 2.5 1.5 3.0
Operational risk 3.0 3.0 2.0 3.5
Security risk 2.5 3.5 3.5 2.0

Note: Risk ratings, with 1=little risk, for 2002

Source: World Markets Research Centre, Country Analysis Report, 2002.

12 Investment Strategies in Emerging Markets

Table 1.3 reports country risk indicators by a risk consultancy agency for
the four countries for different aspects of risk. Overall, South Africa is
evaluated somewhat less risky for investors, except for security risk, which is
high because of the high crime rate. As the EIU (2002) puts it, “The high
level of crime is perceived to be one of the obstacles to economic growth,
however, studies of foreign investors’ attitudes to crime present a mixed
picture.” It can be seen that the other three countries appear rather similar
through the lenses of financial risk analysts.

STRATEGIC MANAGEMENT ISSUES

Companies investing abroad have to take many strategic decisions on how to
enter a foreign country. This includes, inter alia, entry mode, timing, and
within-country location, which are often interdependent with operational
strategic issues concerning marketing, logistics or human resource
management. International business and strategic management scholars have
analysed the merits of alternative forms of international entry and their
implications for corporate performance. The choice of mode concerns both
the resources to be employed in the new affiliate and the ownership and
control over these resources. Separate lines of research have analysed
alternative ownership arrangements (for example Anderson and Gatignon
1986, Buckley and Casson 1998, Tse et al. 1997), and acquisitions versus
greenfield decisions (for example Barkema and Vermeulen 1998, Hennart
and Park 1993, Kogut and Singh 1988). Although in practice the decisions
are often intertwined, different issues have to be considered.
Our analysis takes the framework in Meyer and Estrin (2001) and the
literature on entry mode choice as starting point, but also draws upon
literature in international business strategy concerning post-acquisition
management (Buono and Bowditch 1989, Haspeslagh and Jemison 1991,
Jemison and Sitkin 1986, Birkinshaw et al. 2000), the role of subsidiaries
within MNEs (for example Birkinshaw 2000), and the impact of institutions
on corporate strategies (Oliver 1997, Peng 2000, Meyer 2001). Our main
focus is on how foreign investors adapt their business to a specific context.
Since imperfect institutional frameworks and weak resource bases exist
throughout emerging economies, investors have to accommodate these
challenges by developing appropriate entry modes.

Entry Modes in Emerging Markets

Foreign investors’ entry modes are commonly classified in three types,

greenfield (start-up), acquisition and joint venture (JV).3 A greenfield project
entails building a subsidiary from bottom up to enable foreign sale and/or
production. Real estate is purchased locally and employees are hired and
 Investment Strategies in Emerging Markets 13

trained using the investor’s management, technology, know-how and capital.

Acquisitions are ‘purchase of stock in an already existing company in an
amount sufficient to confer control’ (Kogut and Singh 1988, p.412). The new
affiliate is integrated into the investing company as a going concern that
normally possesses production facilities, sales force, and market share. Cross-
country acquisitions have become a dominant feature of FDI worldwide, and
they are also increasing as a share of inward FDI in emerging markets (for
example UNCTAD 2000). In the 1990s, acquisitions in emerging markets
were sometimes related to privatisation, especially in Central and Eastern
Europe (for example Antal-Mokos 1998, Meyer 2002, Uhlenbruck and De
Castro 2000).
An important distinction in the analysis of entry mode is the origin of the
resources employed in the new operation (Meyer and Estrin 2001, Anand and
Delios 2002). Whereas a greenfield uses the resources of the investor and
combines them with assets acquired on local markets, an acquisition uses
assets of a local firm and combines them with the investor’s resources,
notably managerial capabilities. A greenfield project gives the investor the
opportunity to create an entirely new organisation specified to its own
requirements, but usually implies a gradual market entry. In contrast, an
acquisition facilitates speedy entry and immediate access to local resources,
including access to local networks and business licenses that help the investor
to reduce transaction costs of operating in the emerging market context.
However, an acquired company may require deep restructuring to overcome
a lack of fit between the two organisations. In some acquisitions in emerging
markets, this restructuring is so extensive that the new operation almost
resembles a greenfield investment, which Meyer and Estrin (2001) call
‘brownfield’. The paucity of firms and the underdeveloped nature of capital
markets may also limit the possibility for acquisitions in emerging markets.
The third major mode of entry is a joint venture, which implies creation
of a new organisation with resource contributions from two or more parent
firms. The parents share strategic and operational control of the firm. A joint
venture is created as a new legal entity like a greenfield, but jointly by two or
more firms that both contribute resources. Like an acquisition, a JV provides
the foreign investor with access to resources of a local firm, whereas a
greenfield does not. Joint ventures are designed in a variety of different ways
depending on the resource availability, concerns for control, and bargaining
power. Last but not least, partial acquisitions share some characteristics with
both acquisitions and joint ventures. The investor becomes involved with an
existing firm rather than a newly created one, but control is shared with other
shareholders.
 q`= f`=

Resources held by
local firms Acquisition

Resources Resources held by

required the investor

Resources available Greenfield

on markets

q`= f`=

Figure 1.2 A Model of Entry Mode Choice

Notes: TC = Transaction costs of the relevant markets, IC = Costs of adapting and integrating resources.

Source: Meyer and Estrin 2001.

 Investment Strategies in Emerging Markets 15

Acquisition versus Greenfield

From a strategic management perspective, the choice between greenfield and

acquisition is foremost a decision over the origins of the resources for the
new venture (Meyer and Estrin 2001, Anand and Delios 2002, Danis and
Parkhe 2002). A greenfield uses resources of the investor and combines them
with local assets, whereas an acquisition uses primarily assets of a local firm
and combines them with the investor’s. The preferred entry mode thus
depends first on the resources needed, which in turn depends on the strategic
objectives of the project, and second on the resources that are found (i) within
the entering multinational enterprise, (ii) in unbundled form on local markets,
and (iii) in bundled form in local firms (see Figure 1.2). Resources are here
defined broadly, including for instance network capital in form of
relationships with other businesses or authorities.
= Entry modes are influenced by transaction costs in the pertinent markets,
which in turn are shaped by institutions, such as competition policy, profit
repatriation rules, protection of property rights, taxation and other aspect of
government intervention. Moreover, costs of restructuring and integrating
acquired firms affect acquisitions, which in turn depend on, for instance, the
strategic, cultural and technological fit. The capability to manage this process
is built through prior experiences (for example Buono and Bowditch 1989,
Haspeslagh and Jemison 1991), the strategic and organisational fit between
the acquired firm and the acquirer organisations (Kogut and Singh 1988,
Birkinshaw et al. 2000), and the cultural distance between the two firms (for
example Barkema et al. 1996).
In this study, we draw on both the resource-based view and transaction
cost analysis in analysing mode choice. Transaction costs in emerging
markets are high due to incomplete and evolving institutional frameworks
governing market relationships (for example Peng 2000, Meyer 2001).
Acquisitions internalise certain markets and bring together complementary
resources, but these resources need to be integrated effectively (for example
Haspeslagh and Jemison 1991). Resource acquisition and absorption is of
crucial importance for transformation of enterprises unable to cope with the
consequences of liberalisation and privatisation (for example Kogut 1996,
Uhlenbruck and De Castro 2000, Uhlenbruck, Meyer and Hitt 2003).
Following the framework of Figure 1.2, the first aspect to be investigated
concerns the strategic intent underlying the entry. The key distinction is
between market-seeking and resource-seeking entry (Dunning 1993). For
instance market-seeking FDI pursuing first-mover advantages may seek a
local partner to provide market intelligence or access to distribution
networks, brand names and market share. Resource-seeking investment may
aim to utilise the local human capital to strengthen the global R&D of the
investor. Our research thus reassesses how strategic objectives relate to
investor’s preferred entry mode in the emerging market institutional context.
16 Investment Strategies in Emerging Markets

Greenfield is preferred by investors competing with resources that can be

transferred internally and can constitute core competences of the new
business unit. This includes managerial resources (Penrose 1959), financial
resources (Chatterjee 1990), and capabilities with firm-specific public good
properties (Caves 1971). On the other hand, resources of local firms can
attract acquisition entry, for instance technological assets or market share in
the target markets. Finally, local markets provide assets required in greenfield
ventures, such as real estate, business licenses, local blue-collar workers, and
supplies of intermediate goods. Our research thus analyses the role of
resources in the host economy, in particular, what kinds of resources
controlled by local firms induce foreign investors to pursue a JV or an
acquisition entry.
Bringing together resources previously held by different businesses incurs
transaction costs either in the market for corporate control, or on local
markets for complementary assets. Markets for corporate control are highly
imperfect in emerging markets, which raises transaction costs of foreign
acquisitions. In emerging markets, the transaction costs in equity markets can
be a major constraint on foreign acquisitions. Neither can the markets for
complementary resources be presumed to be efficient in emerging markets.
Hence, we consider how institutions of the host economy such as
infrastructure, the legal system, and regulation of FDI, affect the choice of
entry strategy.
The investment is not complete with the acquisition of resources; they
have to be amalgamated to create an efficient new business unit within the
investors’ network. Mode choice therefore has to reflect the costs and time
lags required for integration and adaptation. A firms’ capability to manage
the post-entry integration process thus feeds back into their choice of entry
strategy. Greenfield investors avoid the costs of integration, but are more
sensitive to relocation costs associated with the international transfer of
resources. Thus we explore how factors specific to the investing firm and its
potential local target, such as emerging market expertise and psychic
distance, affect the entry mode choice.
Generally, our expectation is that less developed local institutions are
associated with more joint ventures, while weak local firms would lead
investors to favour greenfield entry. This is in addition to investor firm-
specific influences on mode choice.

Joint Ventures

A joint venture (JV) with a local partner provides access to selected resources
contributed by the partner, without the responsibilities that arise from taking
over an existing organisation. A new entity is created under joint ownership
of two or more parent firms that all contribute in various ways to the
organisation. While providing access to selected resources, a JV requires
 Investment Strategies in Emerging Markets 17

sharing of control, which many MNEs prefer to avoid. Market transactions or

internal organisation provide clear governance structures, whereas JVs are
subject to possible conflicts between the two parent firms that may pursue
objectives that are not entirely complementary. Strategic flexibility may be
greatly reduced if strategic decisions need to be cleared by all parents.
A joint venture may therefore easily conflict with other objectives of the
entry. If the marketing, logistics and human resource practices have to be
negotiated with a local partner, this poses severe constraints on an MNEs’
ability to integrate the new operation with its global structures and processes.
On the other hand, JVs are a means to accelerate entry and to gain access to
crucial complementary assets more quickly than if these resources have to be
acquired and built by the foreign firm internally. Hence, if timing is urgent,
then market-seeking investors may prefer a JV, at least initially.
Transaction cost economists looking at alternative organisational forms,
analyse why firms would prefer a JV despite the apparent disadvantages of
shared control (Buckley and Casson 1976, 1998, Hennart 1988). JVs offer the
opportunity to establish a business operation in a foreign country when
establishment of a wholly owned affiliate is not feasible, or is too expensive. As
an intermediate form between market and intra-firm coordination, a JV reduces
transaction costs of the market, at the expense of coordination costs between the
parents. Multinational firms often consider JVs as a second best mode of entry
for emerging markets because they provide only a limited degree of control,
which greatly reduces the investor’s flexibility. As we have seen, shared control
can lead to coordination conflicts between the partners, especially if their
objectives are not compatible or cultural barriers inhibit communication. Hence,
transaction cost economists argue that JVs are only used if specific conditions
apply:
• The project depends on resource contributions from two or more
partners;
• The markets for the contributions from the parents are subject to
market failure, that is transaction costs are high;
• It is not feasible to internalise the whole operation with one partner
taking over the other(s). This would apply for instance when the
project is small relative to the parents, or if one of the parents is
state-owned.
Anderson and Gatignon (1986) apply transaction costs in a different but
complementary way, outlining the conditions when firms would prefer a high
control mode, that is a JV rather than a contract, or a wholly owned affiliate
rather than a JV:
• If markets fail due to high asset specificity or information
asymmetry, and the partner could take advantage of this. This
applies even more if the business environment is highly
uncertain. Hence environmental uncertainty has a moderating
18 Investment Strategies in Emerging Markets

effect on the primary causes of transaction costs, asset

specificity and information asymmetry.
• If the firms face major obstacles to communication, or to
observe and monitor independent local agents. This could for
instance arise due to cultural distance.
• If the local partner could free-ride on the investor’s reputation,
for example use the brand name without adhering to the quality
standards associated with the brand.
In emerging markets, JVs are sometimes a response to legal
requirements. For example, India had placed an upper limit on the maximum
share of equity that foreigners were allowed to hold in many industries,
which was gradually removed over the 1990’s. In the case of larger projects,
ownership constraints may have to be negotiated with government
authorities. The decision to set up a joint venture thus involves adaptation to
local institutions, minimization of transaction costs, optimising control, and
access to resources.

Mode Dynamics

Entry strategy decisions are about more than selecting between prototypical
organisational forms. The broad classifications of ‘acquisition’, ‘greenfield’,
and ‘joint venture’ disguise a wide variety of organisational forms. Many
entries can be described as hybrids of different modes, including ‘brownfield’
(Meyer and Estrin 1999, 2001) and partial acquisition. Moreover, initial
organisational arrangements may be temporary, and from the outset, the
foreign investor may prepare to replace resources, thus developing a
brownfield, or to eventually fully take over a JV or a partial acquisition.
Some projects that are formally classified as acquisition in fact resemble
greenfield projects. The foreign investor may initially acquire a local firm,
but almost completely replace plant and equipment, labour and product line.
The new operation is built primarily with resources provided by the investor.
After only a short transformation period, often less than two years, the
acquired local firm has gone through deep restructuring, and both its tangible
assets, such as physical equipment, and its intangibles such as brand names
and organisational culture have been reduced to a supplementary role. Meyer
and Estrin (2001) thus propose to distinguish such entries from conventional
acquisitions by defining it as follows: a brownfield is a foreign acquisition
undertaken as part of the establishment of a local operation. From the outset,
its resources and capabilities are primarily provided by the investor, replacing
most resources and capabilities of the acquired firm.
This research aims to establish the broader relevance and the performance
implication of brownfield entry strategies beyond European transition
economies. The existence of brownfield FDI in other emerging markets, its
underlying motives and strategies, as well as its implications are important
 Investment Strategies in Emerging Markets 19

research questions. Thus we explore how prevalent the brownfield

phenomenon is across different emerging markets, and under which
circumstance it emerges.
The initial ownership set-up of an FDI may change quickly. Control
arrangements are known to be unstable, especially in ‘staggered acquisitions’
(frequently observed in privatisation) or in “foreigners’ fade-out”
arrangements. JV may be time-limited from the outset, or unexpected
changes in the local firm or in the foreign parent’s global strategy may induce
amendments of the ownership and control arrangements. Acquisitions may be
implemented with stepwise ownership transfer, especially in the context of
privatisation of SOE (Meyer 2002). This study aims at refining the typology
of entry modes to incorporate the post-entry dynamics and thus re-examines
typologies of entry modes, giving particular attention to the dimensions of
resource transfer, control, and time.

From Entry Mode Choice to Affiliate Performance

Foreign investors establish their foreign operations using the mode that most
suits their needs, and one would expect that the less they have to compromise
on their optimal mode, the better the performance of the operation. Managers
themselves generally argue that full control would be preferred in most cases,
and that joint ventures risk too many conflicts. However, this sentiment is not
necessarily supported by prior empirical literature. On the other hand,
acquisitions are reportedly often failing to meet their original objectives, not
only in emerging markets but also in a mature market context. This has been
attributed to a variety of causes, including managers underestimating the
effort required to restructure and integrate the acquired firm. Given the
distance of organisational cultures between the emerging markets in this
study and the countries of origin of many of the investors, this issue is likely
to be of particular concern.
= The theoretical considerations suggest that corporate performance will be
best when firms have freely chosen their entry mode in accordance with
resource and transaction cost considerations, while changes in strategy to
accommodate regulatory requirements, for instance a maximum foreign share
in equity, would worsen corporate performance. However the study of
performance implications of mode choice is complicated by the endogeneity
of entry mode choice; in other words the environmental factors influencing
performance also influence the selection of entry modes.
=
=
IMPACT ON HOST ECONOMIES
FDI influences the host economy in a variety of ways, including technology
transfer, technology spillovers, R&D, employment quantity and quality,
20 Investment Strategies in Emerging Markets

exports and imports, and competition. This makes it of interest to policy

makers in emerging markets, and has triggered considerable research,
reviewed by Altenburg (2000) and Blomström and Kokko (2002). This
literature has mostly been concerned with testing the hypothesis that FDI has
a positive effect on local firms in the industry or in vertically related
industries. It finds horizontal spillovers in the same industries hard to
establish, except in transition economies (Haddad and Harrison 1993, Aitken
and Harrison 1999, Sinani and Meyer 2002).4 However, there is strong
evidence in favour of vertical spillovers (for example Smarzynska 2002).
Moreover, the local industry’s own technological capabilities and the
‘absorptive capacity’ (Cohen and Levinthal 1990) are found to be crucial for
their ability to benefit from inward FDI (for example Kokko et al. 1996).
This research is largely conducted using official statistical data that do not
contain information on many of the constructs that are relevant from a
theoretical perspective. For instance, more information is required on the
knowledge and resource transfers within the multinational firm, a
precondition for technology spillovers to occur. To provide policy advice, it
would be necessary to both know whether spillovers occur at an aggregate
level, and what would increase them. Hence, conditions prevailing in the
local economy need to be incorporated in the analysis, notably the absorptive
capacity and the institutional context. Moreover, this literature rarely
differentiates FDI projects when assessing its impact on local firms. The
literature on FDI and spillovers thus raises many questions, some of which
we address in this research, notably concerning the dynamics of resource
transfers and the role of entry modes.
Entry strategies profoundly affect the ways in which foreign investors
interact with the local economy, and may thus be generating beneficial
spillovers. Empirical studies have addressed some of these issues in OECD
countries, but no systematic evidence exist for less advanced economies. The
World Investment Report 2000 (UNCTAD 2000) reviews the available
literature and infers that the long-term impact of FDI, established by different
entry modes, would not differ systematically by most criteria. However, due
to path dependency of networks and competence development, acquisitions
tend to retain and develop existing supplier links and, as a consequence,
continue to share technology with local partners.
In the short term, a number of impact parameters may differ considerably
across investment projects. Greenfield investors create new businesses and
have positive direct effects on employment and gross domestic investment.
They may increase competitive pressures on local competitors, which induce
them to improve their efficiency, or be forced to exit the market. Investors
typically set up new production facilities with their own management and
technology, and import machinery from their own home country. While
greenfield projects require more technology and other know-how transfers,
the investor is better able to control the diffusion of specialist know-how
 Investment Strategies in Emerging Markets 21

beyond the affiliate. For example, production with low-cost labour for
worldwide markets uses greenfield operations, especially in specifically
designed economic zones. Greenfield projects tend to have their strongest
economic links with their parent and other affiliated companies, rather than
with the local economy.
Greenfield moreover contributes to local capital formation, and thus to
gross domestic investment possibly beyond the sum of the FDI reported in
balance of payment statistics if additional local sources of funds are
mobilised. However, locally raised funds can also crowd out local
investment. Greenfield FDI also has direct positive effects on employment
levels, since all jobs in a project are newly created. Crowding out effects of
local firms that use traditional labour intensive methods of production are
however possible.
Acquisitions, on the other hand, are at the time of entry existing
enterprises, integrated in the host economy. They may have indigenous R&D
operations, local brands, and a local supplier network, and are thus well
positioned to act as relatively autonomous affiliates within a diversified
MNE. Following the acquisition, traditional business relationships may or
may not be continued by the new owners. Yet, even if some acquisitions
discontinue local R&D, local sourcing or local brands, on average acquired
affiliates would be more local in these respects that greenfield operations.
Evidence on this comes for example from Belderbos et al. (2001) who find a
higher share of local content in acquired affiliates of Japanese MNE, and to a
lesser extent in their joint ventures, compared to greenfield FDI. However,
crucial for an assessment of the impact is the counterfactual “what would
have happened to the firm without the acquisition?” (for example Zhan and
Ozawa 2001). Investors do not necessarily have both options, greenfield and
acquisition, to choose between. And, for the local firm the alternative to
being acquired may not be prosperity as an independent firm.
From a theoretical perspective, the impact of acquisitions or greenfield
investment differs between advanced and transition economies due to, among
other factors, the technological gap, quality of resources in local firm, and
development of the regulatory and institutional framework. Hence empirical
research is required, as inferences from empirical studies elsewhere are only
to a limited extent transferable. Table 1.4 presents a preliminary assessment
based on the literature, especially UNCTAD (2000). Greenfield investments
are more predictable in their development path, while post-acquisition
restructuring can proceed in very different ways, dependent on the investor’s
strategic intent and the envisaged role of the new affiliate within the
multinational network. In general, the dominant views in the literature can be
summarised as follows:
• In the short term, FDI in the form of acquisitions or greenfield
projects differs in its impact on the transfer of financial resources,
investment, technology transfer, technology diffusion, original
 Table 1.4 Impact of FDI by different modes

Short-term Impact Long-term Impact

Transfer of financial Acquisitions require the immediate transfer of financial Considering subsequent investment and investment in
resources resources, whereas transfers for greenfield are more restructuring, both modes may lead to transfer of
likely to be stretched over time. financial resources to similar extent.

Investment in capital Greenfield ads directly to productive capital stock, Subsequent investment in acquisitions may exceed that
stock while acquisitions would only do so through of greenfield projects. Both modes may have an indirect
subsequent restructuring investment, notably in cases negative effect through crowding out local firms.
of brownfield.

Transfer of Greenfield normally requires transfer of technology or Technological upgrading of affiliates is driven by the
knowledge to the marketing knowledge (depending on purpose of the same strategic considerations and thus unlikely to differ.
affiliate FDI), but only what is needed for the specific
operation. The knowledge transferred to acquired firms
may vary considerably.

Knowledge diffusion Acquired firms with strong local links are likely to Path dependency of networks and competence
retain them, which facilitates spillovers. If local development suggests that differences are likely to
partners were weak before acquisition, linkages may be persist.
discontinued. Greenfield typically has stronger linkages
with MNE, less with local firms.
Technology Unless there are strong specific R&D capabilities In the long-term, location of R&D is likely to follow
generation locally, greenfield investors are unlikely to establish availability of R&D resources in the environment. Yet, a
local R&D beyond adaptation of products. If an path dependency effect is likely, that is acquired firms
acquired firm has very strong R&D capabilities, these retain R&D, and an early decision of upgrading or
may be strengthened (‘asset-seeking FDI’), else discontinuation of R&D may have long-term effects.
discontinuation and centralisation of R&D is likely.

Employment In a greenfield, every job is created new. Acquisitions Crowding out effects may arise from both acquisition
(quantity) may lead to reduction of employment if motivation is and greenfield. Else, no systematic differences between
‘efficiency seeking’ or ‘short-term financial gains’, or modes expected.
if the acquired firm has overcapacity. However, this
may be ‘employment saving’ depending on the
counterfactual.

Employment quality Greenfield may establish a new and thus more modern No systematic differences between modes expected.
work environment, which facilitates higher quality
employment, in terms of wages, work conditions, etc.
Early unionisation may be less likely. Acquisitions may
face inertia as older norms may persist.

Skills, Training of Acquisitions face possible initial inertia to skill No systematic differences between modes expected.
workforce transfer, possible brain drain by moving people abroad.
Greenfield has to recruit top people, often from local
firms. Either way, no major differences to be expected.
Exports Acquisitions typically continue to serve the existing No systematic differences between modes expected.
local markets. Greenfield is often established either to
use factor cost advantages for global markets, or to
serve the local market.

Imports Acquisitions build on local supplier linkages if these Path dependency of networks and competence
are good quality. Greenfield rely to a larger extent on development suggests that differences are likely to
imports (e.g. Belderbos et al. 2001). persist.

Market structure A greenfield entry as such reduces concentration, and International mergers may join foreign affiliates and
enhances competition. The impact of acquisition or thus reduce competition, thus acquisition entails a risk
brownfield entry crucially depends on the market of negative impact on competition. Else, the dynamics
position of the acquiring firm prior to the acquisition. of competition in the local market may lead to crowding
out effects or subsequent entry independent of how the
foreign firm entered.

Competitive Not expected to vary by mode. Not expected to vary by mode.

behaviour

Source: UNCTAD 2000, and own extensions

 Investment Strategies in Emerging Markets 25

R&D, employment quantity and quality, employee training, exports,

imports and competition, and institutional development.
In the long term, differential impact effects of acquisition and greenfield
investment diminish, leaving no substantial and systematic differences, yet with
specific exceptions. Path dependency of networks and competence development
lead to persistence of differences in the use of local suppliers, technology
sharing with local suppliers, and local R&D.

RESEARCH APPROACH AND OUTLINE OF THIS BOOK

We aim at gaining a comprehensive perspective on the issues and thus use
multiple complementary research methods. In each of the four countries of
this study, we have conducted three case studies, and a questionnaire survey
with at least 150 received responses for each. Moreover background papers
review the pertinent institutional and economic environment as well as trends
of FDI and their entry modes. Researchers affiliated with leading local
institutions, have conducted this research in close coordination with the
research team at London Business School.
The case studies were conducted on the basis of a common framework
that has been developed jointly, and modified on the basis of initial reports on
cases of FDI. This framework established key issues that the field research
teams were to consider for each case, including the multinational investor,
the local partners, the entry motives and modes, the institutional
environment, post-entry restructuring processes, as well as corporate
performance and spillovers. In each country, the cases include two
manufacturing cases and, except for Vietnam, one service company (Figure
1.3). The case studies consider both local and foreign perspectives and, being
prepared by local partners, avoid the common bias of FDI research, focusing
on the perspective and information provided by the foreign investor only.
The survey has been conducted with a common research instrument that
has been translated to local languages where appropriate. In all countries the
sample includes all FDI established over a ten-year period 1990-2000, that
have at least 10 employees and foreign equity participation of 10 per cent. To
coordinate the research, to discuss the research questions and to design the
common research instruments, the research teams met four times between
November 2000 and March 2003, including a field research workshop in
Cairo that concentrated on local perspectives and information provided by
foreign investors.
This book presents the research following the following structure: The
next chapter summarises and interprets the data obtained in the survey study
in a comparative perspective, and thus sets the stage for discussing patterns
for the individual country analyses. Chapters 3 to 10 present the results for

1
26 Investment Strategies in Emerging Markets

each of the countries, following a common structure. Each country is

introduced with an overview of key contextual issues that may influence FDI,
and a summary of key findings from the survey in that country. The second
chapter for each country presents three in-depth case studies of foreign
investors. The book concludes with two chapters that draw inferences and
practical implications respectively for managers in multinational firms and
their local partners, and for policy makers at the national and multinational
level.

Egypt India South Vietnam

Africa
Services ECMS ABN ABN Amro ---
(telecom) Amro (banking)
(banking)
Food & Heinz Bacardi- --- SEAB /
beverages (ketchup) Martini Carlsberg
(spirits) (brewing)
Manufacturing, --- Packaging NGK / ABB
intermediate (packagin Behr (Electrical
products g) (automotive components)
suppliers)
Manufacturing, GlaxoSmith- --- EST Honda
final products Kline (electrical (motorcycles)
(pharmaceuti equipment)
cals)

Figure 1.3 Case studies