Useful Notes on FDI-Related Entry Modes (Branch Office, Joint Venture, Wholly Subsidiary and Umbrella Holding Company)

One goes in for FDI related mode only as part of grand strategy, hence takes a keen interest. FDI- related entry modes are – Branch office, joint venture, wholly owned subsidiary, and umbrella holding company.

The Branch Office:

“A branch office is a foreign entity in a host country in which it is not incorporated that exists as an extension of the parent and is legally constituted as a branch.” In many countries the corporate law allows such branch offices to engage into production and operating activities. However, a representative office is not allowed to engage into profit-making business activities. Representative offices can undertake liaison work with government or its agencies, market research, and consulting activities.

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Most of the foreign banks (Standard Chartered Bank, Bank of America, HSBC, etc.), and consulting firms and accounting firms (Earnest & Young, KPMG, PWC, etc) opt for the branch office status. In case of any damage claim, it is the parent company which shall be liable, since branch has no legal-person status.

The Joint Venture:

A joint venture may take any of the following shapes- i) a corporate entity formed by an international company with local entrepreneurs, ii) a corporate entity formed by two foreign entities, to undertake business in third country, a iii) corporate entity formed by an international firm in collaboration with a government agency in the host country, or iv) a cooperative undertaking formed by two firms for a limited period of time (till the project is completed).

Joint ventures are not new to international firms. In case of joint venture, the investing firms keep their identities intact. Shenkar and Luo (2008) have categorised the joint ventures as the cooperative (contractual) joint venture and the equity joint venture. According to them most of the cooperative joint ventures do not involve constructing and building a new legally and physically independent entity.

Thus cooperative joint ventures take the form of a document, i.e., cooperative agreement. This type of joint venture is in use for joint exploration, research & development, co-production, co- marketing, and co-management. Whereas, the equity joint ventures take the form of a new entity.

Most of the foreign insurance companies entering in India have formed joint ventures with the local companies – Bajaj (Indian) Allianz (Germany), IFFCO (Indian) Tokyo (Japan), Maruti (Govt, of India) and Suzuki Motors (Japan), etc. Sectors which are heavily regulated like insurance, the reason d’etre for JV is particularly strong.

Wholly Owned Subsidiary Company:

Most of the foreign corporates while entering a new nation for business, given a choice, prefer to have a wholly owned subsidiary company. There are many reasons behind this preference – parent company can have tight control over its subsidiary, parent firm can exercise tight control over all the subsidiaries across the globe for global integration, and the risk of sabotaging the technological expertise is eliminated.

However, this mode is not free from limitations – it can be a complex, costly, and lengthy process; and wholly owned subsidiaries are viewed, particularly among the developing nations, as contributing little in terms of technology transfer and local skill development.

A foreign company preferring to have a outright wholly owned subsidiary may go in for any one or more of the following ways – i) Greenfield investment ( starting from scratch by establishing a new plant, ii) acquisition of a going concern, and iii) purchase of existing distributor (and build production facility later on).

Umbrella Holding Company:

“The umbrella holding company is an investment company that unites the firm’s existing investment such as branch offices, joint ventures, and wholly owned subsidiaries under one umbrella to combine sales, procurement, manufacturing, training, and maintenance.” This becomes necessary when a large company’s different divisions have different forms of businesses in one country, often working at crossroads with the organisational objective.

Du Pont of the US, in 1989, established Du Pont China Ltd., as an umbrella holding company, so as to unite and integrate investments made by different divisions of the company. Some countries have prescribed certain conditions for allowing any company to establish holding company.

Choice of FDI and the Decision Framework. Once a foreign investor has decided to pursue an FDI related project, the other decisions will depend upon many considerations which are country-, industry-, firm-, and project specific.

Country specific considerations include host government’s FDI policies (the quantum of equity participation and local arrangement allowed), shape of infrastructure, intellectual property regime, host country risk scenario, and cultural closeness.

Industry specific considerations include entry barriers, uncertainty and complexity (as in the retail sector in India), and availability and favourability of supply and distribution chains. The firm specific considerations include availability of resources, chances of leakage of technology, strategic goals of the foreign company, and the host country experience. Project specific considerations include size of the project (bigger it is, joint venture is the choice), project orientation (import substitution / local market oriented / technology oriented / infrastructure oriented, and availability of a suitable local partner.

To close the discussion on going global, a few important observations are worth noting. The level of internationalisation will depend on the commitment of managers and the resources availability. Since the resources availability changes over time, the firms always do not go global at the same pace. While it is true that firms go for internationalisation in a sequence, the same is not followed in terms of each market.

“As a firm gets experience in foreign markets it is possible that in subsequent markets a firm will move to an advances stage of the model without going through the early stages.” It has also been observed that firms normally go to a foreign land nearby to its present location. This factor of internationalisation is becoming less important with the advent of improved transport and communications.

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