Increasing Agricultural Productivity:

Encouraging Foreign Direct Investments in the COMCEC Region

2. General Benefits, Risks and Costs of FDI in Agricultural

Sector

In order to better understand the firm-level perspectives towards risks in agricultural FDI in the

COMCEC Member Countries it is necessary to first explore the literature that focuses on the

motives of firms undertaking FDI, and how those firms manage their foreign operations and

mitigate the risks that are associated with this process. From a different perspective, for

governmental agencies, involved in investment promotion and international trade facilitation, it

is important to understand the business drivers behind internationalization. These insights

allow for an evaluation of their current business climates measured against critical location

requirements by private investors and opens the discussion to possibly compensate private

investors by means of business incentives. In the next few sections a more exhaustive

framework as to how and why companies engage in FDI is outlined. There is one section

dedicated to the role of incentives and how this influences the location decision making by

private investors.

2.1

FDI Decisions in the Agricultural Sector: A Firm Perspective

Firms have a variety of different management strategies at their disposal to operate

internationally. It is important to understand that FDI is typically the most effective mechanism

to operate internationally, but it also entails the highest level of risk. Firms export, license or

engage sales agents in foreign markets; however, FDI in the form of a cross border M&A or

greenfield investment is a strategy that involves a long term commitment to a foreign market

through a significant capital investment and therefore entails higher risks than arm’s length

modes (i.e. through third parties) of international expansion. Figure 8 shows this evolution:

When export sales take off the company may consider moving to the next level of involvement; a

common way to deal with the increasing complexities of a growing export business is to engage

with external export and sales agents or to set up a dedicated sales and marketing

representative office. In this case the local office will take care of the administrative side and

further promote the product or service offering in the foreign market. This requires investment

in staff, accommodation and equipment. Risks relate to increasing overhead, but local disruptive

matters can be controlled more easily.

If volumes justify it, significant (supply chain) savings can be realized when value added

activities such as logistics, packaging and assembly are relocated to the foreign market.

Companies tend to start with ‘routine’ activities to learn how to do business and set up an

organization in their foreign markets. There are different ways to accomplish this. Companies

can form a joint venture with a local partner, or seek contract manufacturers. In a contract

manufacturing business model, the hiring firm approaches the contract manufacturer with a

design or formula. The contract manufacturer (CM) will quote the parts based on processes,

labour, tooling, and material costs, and after price negotiations, act as the hiring firm's factory,

producing and shipping units of the design on behalf of the hiring firm. Starting small helps keep

learning costs, ramp-up difficulties and initial low productivity at manageable levels. By this

stage the complexity (i.e. quality control, stable output and supplies, logistics, etc.) is increasing

and the substance and mandate in the foreign country is growing.

Figure 8: Modes of Internationalization