Chinese Outward Foreign Direct Investments Multinationals Economics Essay
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The purpose of the report is to study and understand the theories and practices applied in planning and implementation of outward foreign direct investment (FDI) of Chinese multinationals from the view of an emerging country.
The report has outlined the overview of development of outbound foreign direct investment of Chinese MNCs in three stages from the late 1970s to 2007. Since 2003, there is an impressive surge in Chinese outward FDI as a result of policy liberalization, government's support and globalization.
The report further analysed the determinants, the location and the entry strategies of Chinese MNCs in internalization process. Haier Group, the world's fourth largest white goods manufacturer was selected as illustration for the purpose of analysis.
Finally, the report pointed out the similarities and differences between MNCs from emerging countries and those from developed countries. Beside the existing literatures applied for both Chinese MNCs and developed country MNCs, there were some specific difference in planning and implementation of Chinese MNCs as an emerging outbound investor.
Overview of the Development of China's Outward Foreign Direct Investments (OFDI) and Multinational Corporations (MNCs)
Overview of Development of China's Outward FDI
China has been well known for its absorbing a huge amount of FDI since the implementation of the open-door policy in the late 1970s as the largest host country for inward FDI in the developing world since 1992 and the second largest host country for inward FDI in the world after the United States since 1993 (Yang, 2005). However, China's outward direct investment (ODI) has also experienced dramatic changes since the late 1970s, particularly in the late 1990s with strong governmental promulgation of the "going-global" strategy in order to promote international competitiveness and secure a supply of key resources (Zhang, 2009). The below Figure 1 and 2 (Zhang, 2009), respectively, illustrate the trend of China's annual ODI flows and stock from 1980 to 2007. The surge in ODI flows and stock since 2003 is the most impressive characteristic of the trend of Chinese ODI and stock in contrast to small outflows and stock in the first decade and moderate outflows and stock in the second decade. The evolution of China's ODI can be classified as three stages based on the ODI flows and stock, accompanied with the emergence of Chinese MNCs.
Figure 1: China's ODI Flows, 1980-2007 (US$ millions)
Figure 2: China's Annual Stock, 1980-2007 (US$ millions)
The first stage (1978-1991) is characterized as experimental and subject to strong state regulations as well as poor capital conditions. In its early outward-oriented investment following the open-door policy in the late 1970s, China's investment abroad was small with the restriction to the state-owned companies under the government's political considerations. In this period, Chinese MNCs were mainly large state-owned enterprises operating in monopolized industries, such as financial services, shipping, international trading, and natural resources. The CITIC Group, COSCO, China State Construction Engineering Corporation, CNPC, Sinochem, CNOOC, China Minmetals, and COFCO are examples of such MNCs emerged during this stage. The amount of investment in the entire period was insignificant, with average annual flows of US$451 million and stock value of about US$5 billion by the end of 1991 (Zhang, 2009).
The first wave of Chinese multinational corporations with a relatively large amount of overseas investment was demonstrated in the second stage (1992-2002). The average ODI flows in this period were US$2.89 billion, triple in value compared to the first stage. Stock value increased to US$37.2 billion by the end of 2002, increasing over seven times after 11 year period. The large fluctuation of ODI flows in the period was consequences of changes in domestic and international economic and political environments including Deng Xiaoping's southern tour in 1992, initiating further reforms with more liberalized ODI policy, the going-global strategy initiated in 1999, the Asian financial crisis in 1997, and the entry of China into the World Trade Organization (WTO) in 2001 (Zhang, 2009).
China has been emerged as one of the leading sources of FDI in the developing countries as well as in the world in the third stage (2002-2007) with a surge in both the growth rate and absolute volume. China's ODI flows rose nine-fold, from US$2.5 billion in 2002 to US$22.5 billion in 2007, and the ODI stock almost tripled from US$33 billion to US$96 billion during 2003-2007. Recent average annual ODI flows are US$12.85 billion, compared to US$2.89 billion in 1992-2001 and US$0.45 billion in 1980-1991. In 2007, China ranked the third-largest outward direct investor in the developing world. By the end of 2008, there were over 10,000 Chinese companies established in over 160 countries and regions. This period has also witnessed the remarkable surge in ODI in the form of mergers and acquisitions (M&As). In 2002, foreign assets acquired by Chinese companies amounted to $2.5 billion that exceeded $22.5 billion in 2007. China's ODI is higher than what would be expected in comparison to China's development level in terms of per capita income (Zhang, 2009).
The going-global strategy has been a critical success factor in the China's ODI boom through provision of information about foreign locations, the granting of incentives and a gradual relaxation of foreign exchange controls. In order to encourage projects of natural resource exploration, exporting activities, overseas R&D centers, and M&A that can obtain foreign valuable assets such as brand names and technologies, a selective support policy has been adopted.
The leading Chinese state-owned MNCs which emerged in the first stage have maintained their continuous growth in the following decades. CITIC Group, a diversified financial and industrial conglomerate, is one of the top 100 MNCs in the world. CNPC, CNOOC, and China Minmetals have been also global players in natural resources. Beside the large state-owned MNCs, in the second and third stages, a new generation of Chinese MNCs emerged in competitive manufacturing industries, in particular in the areas of electronics and information-communication technologies. For example, Haier, Gree, and TCL are now global players in consumer electronics; Lenovo has become the third-largest personal computer (PC) manufacturer in the world following the acquisition of IBM's PC business; and Huawei and ZTE are global players in telecom equipment market.
The new generation of Chinese MNCs is also featured by the increasing number of relatively small internationalized firms diversifying in a wide range of industries and ownership structures (private ownership, local government ownership, and foreign participation).
Similar to Japanese outward FDI, the rapid accumulation of foreign reserves is expected to lead to a strong growth in China's ODI in coming years. In 2006, China's foreign currency reserves exceeded Japan's as the world's largest. By the end of 2008, the reserves rose to US$195 trillion (Zhang, 2009).
Overview of Haier Group Company
Started its operation in China in 1984 as a refrigerator manufacturer, Haier Group Company (Haier) is the world's fourth largest white goods manufacturer and one of China's top 100 electronics and information technology companies Haier operates in technology research, manufacture industry, trading and financial services. Since 2002, Haier has been ranked first among China's most valuable brands for the manufacture of white goods consisting of refrigerators/freezers, commercial air-conditioners, microwave ovens, washing machines, dishwashers, televisions, mobile phones, computers. In 2005, Haier had 240 subsidiary companies and 30 design centers, plants and trade companies and more than 50,000 employees throughout the world (Palacios, 2008). In 2006, its global revenue reached RMB107.5 billion. Its brands also ranked 86th among the world's 500 Most Influential Brands by World Brand Lab in 2006 (Haier, 2010). Haier is one of the 30 largest Chinese FDI companies ranked by outward FDI stock as of 2006 (Chaisse & Gugler, 2009).
Determinants of China's Outward Foreign Direct Investment
In line with Dunning's existing literature on outward FDI motives, Chinese MNCs' OFDI determinants can be classified into four categories, namely resource seeking, market seeking, efficiency seeking, and strategic asset seeking.
Resource Seeking FDI
The aims of resource seeking FDI is to acquire and secure resources, mainly natural resources in FDI host countries (Rajan, Kumar & Virgill, 2008). The natural resource searching is the main motivation for investment by some Chinese firms since the early 1980s, particularly state-owned enterprises (SOEs) that are largely supported by the Chinese government in internalization with the aim to secure the scare natural resources as inputs for the fast growing China economy (Palacios, 2008; Buckley et al, 2007).
One of the most important motives for MNCs to invest abroad is to seek for new markets. Market-expanding FDI is aimed to expand domestic production and sales in host and other overseas markets (Rajan, Kumar & Virgill, 2008). This determinant is also true to Chinese MNCs. For 60 percent of Chinese MNCs, the market seeking was the most strong motivation for outbound FDI (Palacios, 2008). Haier's purchase of an Italian refrigerator facility is the example. Increasingly severe competition and overcapacity are among the most important push factors that have forced China's home appliance sector firms to go abroad. Overcapacity with 30 percent excess production capacity in washing machines, 40 percent in refrigerators, 45 percent in microwave ovens and 87 percent in televisions reduces prices and encourages Chinese firms to seek sales abroad in response to sliding profit in domestic market. That is the reason for Haier to seek out new international markets through acquisitions of Meneghetti and Elba (Italy) in 2001 and 2009, respectively and bid for Maytag (United States). Such M&As can provide Haier brand name reorganization and existing distribution in European and North American markets (Palacios, 2008). Further, investment in the USA helped Haier to avoid tariff and save transportation cost. Haier achieved internationalization advantage from controlling services and marketing/distribution (Liu & Li, 2002).
The purpose of efficiency-improving FDI is to improve productivity by avoiding trading barriers and taking advantage of inexpensive productivity abroad (Rajan, Kumar & Virgill, 2008). Most of companies that consider efficiency-seeking FDI as important are Asian and in three main industries, electrical and electronic products, garments and IT services (Chaisse & Gugler, 2009). Haier's first outbound investment was joint venture in Indonesia, a developing Southeast Asia country in 1996 to achieve economies of scale from production volume and acquire international experience before entering into developed markets (Liu & Li, 2002; Palacios, 2008).
Asset-seeking FDI aims to access localized knowledge and technology (Rajan, Kumar & Virgill, 2008). The strategic asset seeking is the increasingly dominant driving force for Chinese MNCs going abroad because of the tremendous competitive pressure on Chinese firms in domestic markets that has forced top Chinese firms to go abroad to acquire complementary assets such as established brand names, advanced technology, and a reputation from their presence in advanced economies. Outward FDI is a response to FDI inflows to China and is used as a vehicle for the acquisition of advanced technology abroad (Palacios, 2008). Forming internalization technological alliances with major multinationals such as Mitsubishi, ESS, Lucent, Metz and Phillip as well as M&As of Italian and USA firms are the strategy for Haier to seek its strategic assets. The philosophy of Zhang Ruimin, Haier's CEO that "Entering a difficult advanced market first, then go to easy, underdeveloped markets" has boosted Haier's reputation domestically and internationally (Kumar, John & Warrier, 2008). The success in the USA market helped Haier be confident and experienced in acquire Meneghetti, an Italian company in 2001 that would produce Haier refrigerators based on designs provided by French and Dutch engineers (Liu & Li, 2002). The acquisition was driven by the market-seeking and strategic asset motivations. Since Haier Europe head quarter is located in Varese, a home of large white goods manufacturers such as Phillips and Whirlpool and many firms specilised in components and intermediary phases, these agglomeration advantages can help Haier to access to specialized knowledge on markets and technologies when white good manufactures heavily depend on its internal resources (Pietrobelli, Rabelloti & Sanfilippo, 2010).
Chinese Government's Determination and Policy Liberalization
The Chinese government plays a crucial role in going abroad policy of Chinese MNCs. The policy liberalization, particular Deng Xiaoping's visit to southern provinces in 1992 remarking more liberalized ODI policy and the going-global strategy in 1999 has boosted Chinese firms to outbound invest (Buckley et al, 2007). Being a large SOE, with the strong encourage and support from Chinese government, Haier gained some special conditions that other companies could not obtain. For example, Haier was approved to establish a financial company, to be the majority shareholder of a regional commercial bank, and to form a joint venture with an American insurance company. These incentives from the government have a positive effect on Haier's internalization motives (Liu & Li, 2002).
Location of China's OFDI
Cultural proximity has become a prominent factor in selecting locations to Chinese MNCs. Although Chinese firms invest in nearly every country, they have concentrated in the neighbouring Asian economies including Mongolia, Central Asian countries, Indonesia, South Korea, Singapore, Vietnam, Iran and Hong Kong (particularly Hong Kong with 56 percent of total ODI stock) and tax havens (especially the Cayman Islands and the Virgin Islands with 25 percent of total ODI stock) (Zhang, 2009; Chaisse & Gugler, 2009). Hong Kong is one of the largest recipients of ODI from mainland China because of being one of global financial marketplace (Chaisse & Gugler, 2009) and the ethnic and guanxi (relationship) networks with mainland China (Buckley et al, 2007). The ethnic and family guanxi networks create a firm-specific advantage for Chinese MNCs due to reducing the business risk and transaction costs associated with business opportunities in foreign markets. Hence, Chinese firms tend to invest in countries with a large resident population of ethnic Chinese that are mostly in Asia, constituting 88% of all ethnic Chinese living outside China (Buckley et al, 2007).
However, there are some changes in China's ODI destinations. Although Asia (mainly Hong Kong) and Latin America (mainly Cayman and Virgin Islands) have a dominant share in both ODI stock and flows, the shares in Africa, Europe, and North America have increased significantly. The dominant position of Hong Kong has been decreasing in both ODI flows and stock, surpassed by Latin America in 2006, as shown in Figure 3 (Zhang, 2009).
Figure 3: Geographic Distribution of Chinese ODI Flows, 2003 - 2006 (%)
Source: Zhang (2009)
Location selection is one of the most important strategies in internalization. Haier's strategy for international investment expansion is the key to its success (Liu & Li, 2002). Similar to other Chinese MNCs that concentrate on the neighbouring Asian countries, particularly developing countries with cultural proximity, Haier, in its early stage of internalization, also invested in neighboring developing Asian countries such as Indonesia (1996), Philippines (1992), Malaysia (1998), Iran (1999) (refer to Figure 5). However, unlike other Chinese MNCs, Haier then moved to the USA in 1999 by establishing a design center in New York, and a manufacturing center in South Carolina with a total investment of US$30 million, the largest FDI from China in the USA (Liu & Li, 2002). The strategy "first difficult, then easy" by entering into advanced economies to gain international reputation that then helps Haier easily access to developing countries as well as other developed countries. For instance, thanks to its success in the US market, Haier succeeded in acquiring Meneghetti (2001) and then Elba (2009). The location in Italy has a strategic position for Haier because of its specialization of white goods industry. Haier Europe was established in Varese (Italy) to coordinate the sales and marketing of its products across 13 European countries. These M&As not only help Haier to overcome EU tariff barriers but also help it to improve the capacity to design , develop and manufacture products suitable for European markets and for the high end of the Chinese import market (Liu & Li, 2002).
Figure 4: Foreign Direct Investment by Haier Group
Source: Liu & Li (2002)
Figure 5: Paths of Haier's International Expansion
Source: Liu & Li (2002)
Also unlike other traditional Chinese MNCs that set up their own marketing in every country, Haier uses its local distributors to take advantage of its numerous mature distributors for each product with developed marketing channels who are familiar with local marketing practices and environment and have no language and cultural barriers (Liu & Li, 2002).
Chinese MNCs' Entry Strategies
The internationalization phase for Chinese multinationals is summarized as Figure 7.
Figure 6: Chinese Multinationals' Evolutionary Pattern and Practice
In its early stage of internationalization, learning phase, focusing on the attraction and absorption of existing technology and know-how, Chinese firms usually employ the forms of collaboration, joint ventures or licensing agreements with foreign companies (Teagarden & Cai, 2009). Greenfield investment that is, by establishing solely funded subsidiaries or joint ventures with local partners, particularly has been a major format of Chinese MNCs in the fields of home electrical appliances, electronics, and textile industries (Palacios, 2008). For instance, Haier had licensing agreements and alliances with respected global competitors such as Leibherr Group and Merloni (Teagarden & Cai, 2009).
The build-up phase requires mastering the application and localization of knowledge acquired in the learning phase. Developing and reinforcing operational effectiveness in the choice and development of capabilities enabling growth and value-chain expansion are the key in this phase. Haier developed quality assurance capabilities by incorporating the 6-S quality concept named from the initials of five Japanese words-seiri (discard the unnecessary), seiton (arrange tools in the order of use), seisoh (keep the worksite clean), seiketsu (keep yourself clean), and shitsuke (follow workshop disciplines) and the English word "safety" (Teagarden & Cai, 2009).
Desires to seek higher margin markets and utilize increasingly world-class capabilities are the most important motives in the international phase that begins with regional expansion to the similar or nearby market then moves to the developed markets. In this phase, the company focuses on building brand, localization of products and services for new markets and differentiating products to have a higher margin in its corporate strategy. Similar to other China's top home electrical appliance makers such as TCL and Gree, Haier has set up production lines outside China and R&D center overseas in developed countries such as USA and Europe to support the internationalization objective (Palacios, 2008).
In the globalization phase, the corporate strategies focus on diversifying products and geographically, building global brands to achieve dominant position in its markets. For instance, Haier continues its philosophy "roll the ball up the slope", moving from the low end to the high end of the value chain.
Comparison between Chinese MNCs and Developed Countries' MNCs
Motivations of Outward FDI
The classical motivations of market-seeking, resource-seeking, and strategic asset-seeking play the key role in boosting Chinese MNCs go global. However, apart from these characteristics that are originally developed in a Western context and for Western companies, there are other specific motivations for Chinese MNCs' OFDI, including the latecomer perspective and catch-up strategies, institutional analysis in connection to the role of Chinese government, the excess foreign currencies reserves (Chaisse & Gugler, 2009).
Further, while developed countries' MNCs possess an ownership advantage before investing abroad, some Chinese MNCs use OFDI as a vehicle to obtain ownership advantage, particularly foreign technology and management skills. Thus, while OFDI by MNCs of developed countries are driven by asset exploitation, Chinese MNCs are motivated by asset-seeking and innovation-enhancing interest, for example, Lenovo gained IBM's brand name through acquisition of IBM's PC business (Zhang, 2009). This motivation may help explain the surge of FDI inflows into the United States and other developed countries from many developing countries (Rajan, Kumar & Virgill, 2008).
State-Owned Enterprises (SOEs) Versus Private Enterprises
Chinese private companies were not allowed to invest abroad until 2003. And after that, there is still limit to private companies for outbound investments in some specific sectors such as mining. The largest Chinese FDI players are usually the most profitable SOEs who are backed up with an officially sanctioned monopoly in their industry such as natural resources, telecommunications or infrastructure while the private sector firms usually invest in small-scale projects (Chaisse & Gugler, 2009).
Further, most of the large-scale investment projects have been executed by Chinese SOEs. The share of FDI flows of SOEs under the Central Government has increased from 73.5% in 2003 to 82.3% in 2004 and 83.2% in 2005. Even Lenovo, mostly privatised today, was largely owned by the state at the time of its acquisition of IBM's personal computer business. Hence, the Chinese Government plays the important role at various levels in large Chinese FDI projects (Chaisse & Gugler, 2009).
Most importantly, Chinese FDI no matter what executed by either SOEs or private sector firms must be initially approved and yearly reviewed by Chinese authorities. Hence, the Chinese government can use these instruments to put investment activities in line with government policies. That also affects the motivations and strategies of Chinese MNCs going global.
Rajan, Kumar & Virgill (2008) argued that MNCs from developing countries see the same basic advantages of ownership, location, and internationalization as those from developed countries, but they are derived from different sources. For example, while the developed countries gain ownership advantage for FDI from sophisticated technology and management, the developing countries gain the ownership advantage from technology and management expertise which are suitable or adaptable to local conditions in other developing countries. Hence, developing countries should choose countries with economic and cultural similarities and geographic proximity as destinations to overcome various disadvantages from host countries in order to gain international experience to move on to a relatively large scale in more developed and geographically distant countries (Rajan, Kumar & Virgill, 2008).
Ownership and Control
There is a typical difference in ownership and control between MNCs from emerging countries and those from developed countries. Most emerging MNCs establish joint ventures with local partners in the host country rather than establishing wholly-owned subsidiaries there so that they can gain knowledge of local distribution channels and local economic and political environments. They also have lower equity participation than developed country MNCs partially because of their lower bargaining power. Further, MNCs of developed countries usually have anxiety of monopolizing the relatively advanced technology they introduced whereas emerging MNCs are not as anxious to obtain complete control as developed country MNCs because of little fear of losing control over standardized technology. However, nowadays emerging MNCs tend to invest abroad through M&As to gain majority or complete control because technology mobility and capital mobility make it easier for them to compete in host countries than it has been in the past (Palacios, 2008).
Emerging MNCs differ from developed country MNCs in geographical distribution. Developed country MNCs tend to establish subsidiaries worldwide while LDC MNC usually operate in their own region to best exploit their advantages in other developing countries or exploitation of increasing regional economic cooperation and integration in the region. Chinese MNCs now have the more diverse path of outbound investment. Many of them choose to invest in developing countries outside their region or even, some emerging MNCs may invest substantially in developed countries at earlier stage of their development as the case with Haier in China (Palacios, 2008).
Chinese OFDI has been dramatically increasing. China's outbound FDI is expected to rise to a tremendous US$60 billion by 2010. Chinese investors are increasingly exploring opportunities overseas in a wide range of industries (Chaisse & Gugler, 2009). Dunning's literature on outward FDI motives is still applicable in explaining motivations of outbound investment of Chinese MNCs. That is, resource seeking, market seeking, efficiency seeking, and strategic asset seeking. The resource seeking and market seeking are the most two important motivations to force Chinese MNCs to go global. However, the strategic asset seeking is increasingly important to Chinese MNCs in the effort to gain advanced knowledge and management skills. Apart from traditional approach on motivations, Chinese government's financial backup and policy liberalization are the crucial important push factors to Chinese outward FDI. Cultural proximity is a prominent factor for Chinese MNCs in determining locations because of its similarities and ethnic and family networks that give MNCs advantages in internalization. Although Asia is still being the largest FDI recipient area, Latin America, Africa, Europe, and North America are increasingly important investment regions to Chinese MNCs. In order to success in internationalization, Chinese MNCs follows the evolutionary pattern, that consists of five steps, that is learning phase, build-up phase, internationalization phase, globalization phase and globalization dominance phase. The MNCs should have appropriate corporate strategies in corresponding phase to gain their competitive advantages in going global. Finally, although the existing literature on motivation is applicable to explain the outward FDI of emerging MNCs, specifically Chinese MNCs, there are some other specific motivatives for Chinese MNCs to go abroad such as the latecomer perspective and catch-up strategies, the excess foreign currencies reserves and more importantly, the role of Chinese government. Different from developed country MNCs, large Chinese MNCs are usually SOEs that are backed up by the Chinese Government who plays the important role at various levels in large Chinese FDI projects. There are also differences in ownership, control and geographic distribution between Chinese MNCs and developed country MNCs. However, Chinese MNCs now are gradually going to the same trend with the developed countries.
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