By Christopher Steele, COO & President N. America, Investment Consulting Associates
We live in a truly connected world. Events happening halfway around the earth impact what happens down the street, both for good and bad. Increasingly, corporations need to understand how such international trends impact their value chains, their supply chain, and the opportunities that these trends represent. 2016 saw not only the election of President Donald J. Trump, but also the Brexit vote in the UK and various nationalist or protectionist movements across Europe. Such changes were momentous from a political point of view, but are also causing companies to look at new ways of remaining an active part of the global marketplace.
What is Driving FDI, and What are the Risks?
FDI is and has commonly been driven by four major business needs:
- The need to access key resources, such as raw materials and natural resources
- The need to enter new markets to purchase and use the company's products and services
- The desire to tap into additional assets, particularly talent, key infrastructure, or economic or partner networks
- The need to gain competitive advantage through efficiency gains, cost reduction, or increased productivity
However, any step outside of the home market brings with it the risk of the unknown. This includes learning new compliance regulations, new financial and reporting policies, new workforce regulations and customs. It can also mean exposure to political, terrorism, currency, supply chain and other strategic risks.
These risks can be managed in a direct FDI setting if the rewards are great enough. Times are changing however. Much of the offshoring and FDI activity of the previous thirty years has focused on efficiency gains, cost reduction, and access to resources. Now, companies are looking at innovative ways of capitalizing on the other sides of the equation – market and asset access – and they are doing so in ways that may not look like traditional FDI. Furthermore, they are looking for new ways to do so in an increasingly protectionist world.
New Forms of FDI
Investment data shows that overall investment in FDI has remained relatively stable or even flat for the past several years. Of course, that data tends to measure direct investment by a company into a new site owned holy by the company. He pronounces of that information shows something a little different – namely that investment continues to accelerate, but that new and innovative forms of investment are becoming increasingly important.
In addition to more conventional direct FDI, companies – both inbound to the US and outbound globally – are exploring vehicles such as joint ventures and M&A as means for entering new foreign markets. In these cases the companies in question gain existing knowledge how to operate in market, may gain access to pre-existing supplier and customer networks, and generally ease the path to investment. The drawbacks include some loss of control, lack of integration, and the inability to perhaps fully bring their culture, products, and identify to the new market.
These less conventional forms of FDI may also not be as directly eligible for incentives and other inducements that can aid the investment.
Incentives Being Used to Lure FDI
It is interesting to speculate what the potential changes to the global economic environment might mean for economic development strategies. Foreign Trade Zones, which were originally a byproduct of the Smoot-Hawley tariffs of the 1930, provide a means of retaining elements of a free-trade globalist approach to economic development. Perhaps these tools will find a new life in the coming economy.
Financial and fiscal incentives are often key to inward investment strategies. Whether it is customs duty exemptions, import/export exemptions, tax holidays, tax credits or job creation grants, companies are often attracted by the incentive package that free zones offer. However, as the number of free zones around the world grows there are many similarities in the 'menu' of fiscal and
financial incentives free zones offer to attract investors. This makes many investors conclude there are really not many differences between free zones around the world or that free zones more or less all offer the same 'menu', which makes investors feel they do not have much choice in which 'restaurant' (read: free zone) they will have dinner (read: invest).
Always bear in mind the role incentives play in investment decisions. Corporate investors make investment and location decisions based on numerous factors and take into account many elements of a competitive business environment. Crucial factors are prioritized differentially per industry and value chain activity. What is similar is that incentives are often the 'cherry on top' of any investment project. Companies look at the fundamentals of a business environment within or near a free zone. As noted elsewhere, these include the availability, productivity and cost of qualified staff, infrastructure (both IT and transport connectivity), and availability of appropriate facilities (e.g. offices, warehouses etc.). Incentives can only compensate for a particular weakness in the business environment - not for the competitiveness of the entire investment climate.
It is important for any corporate investor to understand the motive behind the incentive program. These can range from attracting new industries, capital, skill and management transfer, attracting investments to economically deprived areas in a country, diversifying an economy, solving unemployment challenges, etc. All these reasons may be very legitimate and valid from a national or regional economic development policy objective, but they are not the key reason why they invest in a country or free zone.
Clarity – Many incentive policies are the result of a long and difficult policy negotiation process between many departments and ministries of a national government. In this process, many concessions have had to be made in order to finally get the approval. Although this is understandable, this difficult and challenging process must not be reflected in a difficult incentive policy framework in which the eligibility criteria and incentive application process is non-transparent and subject to multiple interpretations. Investors value simplicity and transparency and are often attracted to places where they instantly understand what types of incentives are being offered, the value of these incentives and how they can apply for them.
Tailored - Make sure the incentives are compatible with your industry and activities. Programs can often hamstring supposedly desired companies by misunderstanding the needs of those companies. Be careful that your programs don't become an anchor, rather than something that lightens your load.
Look for the soft incentive - Rather than a grant or credit, it may be in your greater interest to ease doing business or startup operations in your new location. A business environment that facilitates the speed to market can be the greatest advantage when going abroad and investing in new markets. Many free zones distinguish themselves by providing unique incentives aimed at streamlining and simplifying administrative procedures.
Any company looking to directly or indirectly enter the FDI sphere should have an explicit understanding of its goals and its tolerance for risk. Once these are known, the company will have a sound basis for understanding what form of foreign investment will work best to achieve those goals, the parameters to be used to evaluate possible location options, and the knowledge needed to evaluate any incentive program offered to sweeten the deal.
Investment Consulting Associates (ICA) is a global management advisory firm based in Amsterdam and Boston specializing in corporate location advisory, supply chain management, market entry, incentives advisory, free zone development, economic development strategies, investment promotion strategies, FDI advisory and training & seminars.