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OLI Model Explained

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Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of UK Essays.

Published: Fri, 21 Jul 2017

The OLI theory stated that entry mode decisions are determined by the composition of three sets of advantages as perceived by enterprises:

– ownership advantages – advantages that are specific to the nationality and nature of the company-owner;

– location advantages – advantages arising from the fact that various locations can provide different resources, institutions and regulations related to the revenue and production costs;

– internalization advantages – advantages associated with the transfer of ownership advantages across national boundaries within own organization.

These firm specific advantages (FSA) or ownership advantages are usually intangible and often can be transferred within the MNEs at low cost, for example brand name, technology, benefits of economies of scale. These advantages either lead to higher revenues and/or lower costs that can offset the costs of operating abroad. According to the results of interviews, both companies, Chevron and BG Group, possess these advantages, including brand name, developed technology, which allowed them to gain higher revenues and sometimes lower costs.

During the interview there were defined that international companies, which entered oil sector of Kazakhstan, faced additional costs – ” costs of foreignness'”. These costs could be specified as follows: language, cultural, institutional and legal diversities, lack of knowledge about local market and business, costs of operating and communicating at a distance. Of course, both companies realized the presence of such additional costs, and also realized that these costs are easy to overcome and eventually everything will be repaid with interest. Consequently, if a foreign company is to be successful in foreign country, it must have some kind of advantage that overcomes the costs of operating abroad. MNE should have specific advantage against their competitors, if it needs to be profitable abroad.

There are three basic types of firm specific advantages (or ownership advantages), which MNE can possess:

– monopolistic advantages. Multinational Enterprises can possess these advantages in the form of privileged access to input and output markets through ownership of patent rights, licenses, rare and unique natural recourses and etc;

– technology, knowledge that in a broad sense include all forms of innovation activities;

– economies of large size or advantages of common governance. These advantages include economies of scale and scope, learning economies, advantages from international diversification of risks and assets, wider access to financial capital across the MNE.

According to the results of research, Chevron and BG Group broadly possessed practically all of the advantages described above. Both companies entered Kazakh oil market already being experienced and successful, with its own way of business, brand name, fame, international management, technology, patents and innovations.

It is important to mention that foreign investors not only possess all these firm specific advantages, but also provide and share it to the host country, which promotes growth of the economy of Kazakhstan, improvement of its legal and institutional framework, development of its infrastructure and workforce professionalism.

The company should use some foreign factors in connection with its ownership advantages (Firm Specific Advantages) in order to earn benefits of these advantages. Consequently, the location advantages of different countries are major in determining which will become host countries for the MNE. The country specific advantages (CSAs) can be classified into three groups:

– economic advantages (E), includes quality and quantity of such factors as size and scope of the market, production costs, transport costs, telecommunication costs and etc;

– political advantages (P) include the specific and general policies of the government that affect the inflow of Foreign Direct Investment and international production.

– social advantages (S), advantages include “mental distance” between home and host country, cultural and language differences, overall attitude towards foreigners and the general position towards free enterprise.

Considering Kazakhstan and its location specific advantages it is possible to point out that the key attracting economic advantage is huge capability of natural resources, specifically oil and natural gas. Taking into account the fact that on the territory of Kazakhstan there are famous worldwide “Karachganak” and “Kashagan” oil fields, it is easy to understand such intense interest by large oil companies. Chevron and BG Group have really rich experience of operating internationally and in an uncertain environment. Also both interviewed companies mentioned that Kazakhstan’s fast development and economic growth were determinant factors as well. Such factor as availability of skilled labor and its costs, the acceptance of foreign capital, risk rating of the country also played significant roles.

As for political advantages, which were attractive for interviewed foreign investors is political stability of the Kazakhstan. Since gaining independence country had the same president, during this period Kazakhstan developed stable government, with stable laws and rules that noticeably reduced investment risks. Comparing to other countries Kazakhstan has very low tax regime, it is stable, only 12.5% and not dependant on the revenue of oil production.

Of course, there can be different kinds of market imperfections which can influence the location decisions of international companies. In our case interviewed companies mentioned:

– insufficient infrastructure. Kazakhstan is a large country, which is located in the middle of Asia and doesn’t have access to the open sea; consequently, investing oil companies cannot export extracted oil as far as they want. Also there is a lack of pipelines in the country, as Kazakhstan had only one way pipelines. Nowadays all these imperfections can be overcome and eliminated. For example, Kazakhstan has such influential neighbors as Russian Federation and China, and export of the extracted oil to those countries is not a problem. Moreover, Chevron, BG Group and other joint ventures are working on pipelines projects, which can allow them to increase export, among them is CPC Caspian Consortium Pipelines project going to the west side.

– lack of experienced labor. According to the interview both international companies decided that this particular problem is insurmountable. Nowadays companies provide special trainings and courses for the local employees that help them to grow.

– challenge in bringing business culture in accordance to the business rules of Kazakhstan. This problem is general for foreign companies, it is important to adapt to local regulations.

– corruption. From year to year government of Kazakhstan attempts to eradicate this specific problem.

It is important to note, that relative attractiveness of different locations can change over some period of time that is why a host country should, to some extent, engineer its competitive advantage as a location for foreign direct investment.

Internalization advantage derives from the difficulties that can arise in writing controllable and enforceable contracts with potential partners that create an income which approximates the real worth of marketed advantage. “I” advantages are benefits arising from producing internally to the company, since they allow it to come over external markets and transaction costs. The internationalization process of international companies is usually characterized as an incremental process from a domestic base to high international market involvement due to limited resources and local knowledge (Johansson and Vahlne, 1977). It has been suggested that international companies are also more likely to take lower control entry modes due to investment risks at the initial stage of internationalization (Palenzuela and Bobillo, 1999).

According to the interview results, both companies formed joint ventures with local partners in Kazakhstan. The main reason of this is the fact that foreign companies did not have enough experience and knowledge of operating in oil industry of Kazakhstan. It is always easier to work with partners, who can be useful to overcome such difficulties as: language barrier, culture barriers, reduce risks. Companies needed guidance at the initial levels, and therefore, started operating together with local partners because of common interests, possible opportunities to avoid competition with Kazakhstan’s home firms or other international enterprises. But not only foreign companies had benefits from forming joint ventures; it is possible to say that there was mutual advantage as for investing companies and for Kazakhstan.

The OLI model by Dunning was widely applied in this research, and it is important to admit that it helped to identify determinants and motivations of FDI and helped to observe the modifications and its affects on economy of Kazakhstan and country as a whole. Since the first approach of OLI model was published in 1980, till now it was strongly criticizes by various authors, but the fact that this model was applied for this research and gained satisfactory results and analysis are proving that this model is still applicable for identifying the determinant factors of FDI and has great explaining power.

6.2 FUTURE PERSPECTIVES OF FDI IN KAZAKHSTAN

In October 2010 there was an enlarged meeting of the “Nur Otan “- National Democratic Party (NDP) fraction of Kazakhstan. On this meeting Karim Masimov, the Prime Minister of Kazakhstan, announced that there were reached agreements with foreign partners concerning attraction of additional investments for the realization of joint projects in the amounts of: $ 13 billion from China, $ 5 billion from Korea, $ 3 billion from Russia, more than $ 2 billion from France. Karim Masimov stressed out that these are not only abstract investment numbers, behind them are quite specific and well-designed projects. During the first six months of this year Kazakhstan attracted foreign direct investment (FDI) only a third of this amount. Many countries faced this problem due to the global economic crisis, which has led to reduction of opportunities to attract funding and complicated the practice of refinancing loans. In 2008, growth was observed only in the volume of foreign direct investment – their share in the financing structure has grown to 73%. Similar trends are observed in Kazakhstan. In 2008, the volume of foreign portfolio investment decreased and increased volume of FDI. Meanwhile, FDI are very important for our country, because in the last pre-crisis year (2007) FDI stock in our economy was $ 70 billion, while domestic investors invested around $ 80 billion. It means that FDI account for almost half of all investment in Kazakhstan.

In the next few years, international financial markets will be hard-to reach for developing economies, including Kazakhstan, therefore attraction of FDI should be a key source of financing for the country’s development in the coming years

Kazakhstan and its government are trying to change diversification of FDI, for example, crude oil and natural gas extraction was 35% in the structure of FDI in period from 2003 to 2007, while in 2008 this figure was fixed at 13 %. Geological exploration and research reached 50-53 % of the total FDI in 2005-2006, comparing to 36-38% in 2007-2008. The proportion of foreign investments in the manufacturing industry and financial sector of Kazakhstan increased significantly during last years. Although there was a decline in the growth of FDI in Kazakhstan, in general, in 2008 there was established an absolute record in terms of foreign direct investments – 20.1 billion of dollars.

In the first half of 2009 there was observed the decline of foreign direct investment. So, if in the first half of 2008, FDI amounted $ 9.4 billion, over the same period in 2009 – 7.7 billion, primarily due to the decline of FDI in manufacturing, financial sectors, ferrous and nonferrous metallurgy, oil and natural gas exploration. Continued their growth investments in geology exploration and research, therefore, structure of investment partly redeployed to the back side of the extractive sector.

According to Madiyar Kengebulat, the senior expert at the Center for Macroeconomic Analysis and Forecasting Institute of Economic Research, Madiyar Kenzhebulat, despite the crisis, there is no catastrophic decline of FDI flows in Kazakhstan; investment attraction continues to be good. Leaders of FDI in Kazakhstan are still countries, on territory of which there are popular offshore zones, for example: the Netherlands, the United States, Virgin Islands, United Kingdom, etc. Most of this foreign investors can be considered as such only with great indulgence. It is important to note, that except investments from US, the income from other specified countries has fallen in the first half of 2009, which determined the overall decline in FDI. [1] 

It is very important that Kazakhstan seeks to diversify FDI in the country in order to eliminate oil-dependence, the Government’s role in changing the structure of FDI in the coming years will be decisive, work started in the right direction, and often visits of our delegations to neighboring countries lead to the signing of memorandums and agreements. Therefore, investment projects in different areas arise all the time, but according to the FDI attraction statistics, the share of other areas investments considerably inferior to investments in the oil sector and exploration.

Kenneth Mack, the president of the American Chamber of Commerce in Kazakhstan, on the “round table” in Astana concerning measures to prevent corruption in Kazakhstan said that the investing companies from China, Europe or the U.S. will go away as soon as the oil runs out, so Kazakhstan needs to create something right now that will make them stay on the market. Although there are project in different areas, nowadays mostly services providing companies enter Kazakhstan’s market.

Experts that participated in the development of the “Concept of accelerated industrial-innovative development of Kazakhstan for 2010-2014, with a view to 2030”, believe that a small population with a high proportion of village residents, low involvement of the Kazakhstan’s economy in the world trade relations, low level of transport and logistics infrastructure development, difficulty of foreign investors access to plots of land; all these aspects hinder foreign investments inflow in non-extractive sectors of country’s economy. Moreover, the image of Kazakhstan as a country with administrative arbitrariness and corruption is widely spread abroad. What is more in Kazakhstan is very difficult situation with the qualifications of employees and retention of existing talents. [2] 

In opinion of leading specialist, in the next two years, the structure of FDI will not change. The main volume of FDI, as in previous years, will be in geological exploration and crude oil and natural gas extraction fields. This is so due to the fact that the greatest rate of return and short payback period for FDI in recent years have been recorded in mining industry. While fishing and provision of community, social and personal services are lagging behind. These important factors are determinants for the structure of FDI. The volume of FDI is expecting to increase in the coming years, mainly due to the beginning of commercial oil production at Kashagan field.

It is important to improve banking sector to increase the inflow of FDI. In addition to this, government should establish a fully fledged industrial and innovation infrastructure, which will contribute flow of investment, transfer of technology, improvement of managerial skills.

Kazakhstan has significant number of competitors in attracting foreign direct investors, for example, Latin and Central America, Africa, Central Asia. It is obvious that these countries, including Kazakhstan, have serious problems to solve: slow growth of per capita income, reduced productivity, weak credit frameworks, cumbersome bureaucracy, high level of corruption, executive and legislative authorities not properly executed, deficient public institutions. It is important to examine what country should do to improve its ability to compete in the global economy.

It is obvious that due to strong competition the government of Kazakhstan should increase the foreign investors trust and confidence. For this aim achievement it is necessary to strengthen the financial markets by:

– improving the institutional capacity of the Services of the Financial Authority (SFA), the main responsibilities of which is monitoring and resolving problems of financial institutions, i.e. strengthening of the inspection department for insurances, banks, portfolio management;

– designing an adequate regulatory and legal frameworks for prudential supervision in order to ensure the stability and solvency of financial institutions in a high competitive environment;

– improving control procedures, including on-site assessment, monitoring and analysis of banking institutions, designing credit limit systems and training methodologies for assessing financial institutions, rules and procedures for evaluating different types of loans;

– development of adequate supervision for non-banks and facilitation of the banking and capital markets integration;

– continuing to apply accounting and auditing standards and requirements, which are internationally accepted for the disclosure of financial institutions’ information. Nowadays there is no real transparency in many institutions of Kazakhstan, including banks, companies, pension funds and insurance companies balance sheets;

– developing and implementing, really, the rules and regulations applicable to transactions on the capital market;

– promoting transparency of capital markets, including the improvement of accounting, auditing, and information;

– standards of disclosure;

– critical necessity for market regulators professional training.

Strengthening financial markets leads to an increase in credit availability and reducing of transaction costs by promoting more accountable and even stronger institutions, supporting the lengthening of terms of investment, promoting lending, as well as dissemination of know-how and best practices to major market players.

As for legal and institutional framework, in order to facilitate the realization or the management of the FDI projects, following suggestions can be realized:

– provide resources in order to strengthen the institutional capacity of tax authorities and enable them to better enforce regulations and laws;

– promote alternative conflict resolution mechanisms and strengthen the judicial system;

– support the modernization of justice administration through the development and application of reforms that could generate more efficient system;

– restructure judiciary institutions with qualified and trained professionals.

Macroeconomic stability and improvement, stronger institutions and open trade policies have a noticeable impact on the investment climate through promoting a stable foundation against which business and economic cycles are not sharp or extremely unstable, and consequently, capital, goods and services can move freely. The accession of the Republic of Kazakhstan to the World Trade Organization (WTO) will promote the implementation of projects aimed to support trade openness, and the government should:

– invest in the strengthening and modernization of customs administration (corruptive);

– improve the reform of the foreign trade regulatory framework and capacity building for international trade negotiations;

– promote international standards and transparency in the tendering process for granting concessions;

– directly finance the strengthening of supervisory and regulatory authorities;

– need for logistic bonded modern warehouses near the international airports, free industrial zones and major cities, industrial and trade centers for IT, biotechnical products, pharmaceuticals, etc. [3] 

Although there are some local disadvantages and needs in improvements, nowadays Kazakhstan is very successive in attracting FDI in the economy of the country, and what is more, it is obvious, that it has all real potential factors for continuing increase inflow of FDI in the future. Among them are good economic performance, improvement of internal and external policies, accession to the WTO, significant number of international universities and schools, improving financial sector up to international standards, acceptable ratio of corruption and criminality, increasing number of industrial, financial and economic free zones. Kazakhstan will continue to be an attractive destination for Foreign Direct Investment.

6.3 FUTURE RESEARCH IMPLICATIONS

According to the gained results and conclusions of the study, Kazakhstan is quite a new participant in the rivalry to attract foreign investment, nowadays country offering foreign investors many potential advantages and its oil market is still very attractive destination for FDI. During the research process factors influencing the position of Kazakhstan in the eyes of foreign investors were determined through OLI model by Dunning, which proved its sustainability.

For future research it could be beneficial to identify and analyze determinants of FDI using other, different from used in this study, research methodologies in order to address this issue more deeply and comprehensively, from various sides. For example, instead of using applying OLI model, it would be interesting to apply econometric model. Also it would be cognitive to examine FDI in other countries, and compare obtained research results with those of Kazakhstan’s. For example, it is possible to take several CIS (not necessarily) countries and make comparison analysis concerning its FDI.

For myself, I found interesting to consider Foreign Direct Investment in Kazakhstan in terms of implications for Policy-Making in Kazakhstan. The following study could examine deeper the investment climate in Kazakhstan and more precisely major barriers for foreign investors entering the Kazakhstan’s market, moreover, it could be possible to define strategic problems in the investment policy and make recommendations for the future improvements of investment strategy of FDI policy by government to attract foreign investors.

There is a great platform for future researches and noticeable opportunity to extend further the international business research in this specific field.


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