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Global Speakers Series: Farrell Promotes Foreign Direct Investment
February 2006
STANFORD GRADUATE SCHOOL OF BUSINESS—Ever wonder how much companies are really saving by outsourcing customer service operations to India, Korea, or other sites far from the American consumer?
The answer is simple: a lot.
Diana Farrell, director of the McKinsey Global Institute, told an audience at the Stanford Graduate School of Business her group studied a number of cases of foreign direct investment (FDI) and concluded that in almost every instance the practice generated large cost savings, usually accompanied by lower prices and higher quality for consumers.
Moreover, Farrell said that while corporate investment in a developing country can take many different forms, the 24/7 Indian call center had become a model for effective FDI since it took advantage of lower labor costs to produce a service that would simply not be viable in the developed world.
"You would never see 24/7 call centers in the developed world. The labor costs are just too high," said Farrell.
Farrell, who was part of the Global Speakers Series, said the McKinsey Global Institute had conducted 14 case studies of foreign direct investment by a variety of industries from automobiles to consumer electronics and banking. She said 13 of those case studies concluded that the investment had produced a "positive or very positive" impact on output and productivity."
The McKinsey research focused on foreign direct investment in major developing countries like China and India, but Farrell said anecdotal evidence indicated that more specialized investments in smaller markets like Morocco or Argentina also yielded strong returns. That said, Farrell cautioned that all foreign direct investment is not created equal. She stressed that it is not always sufficient just to set up shop in a developing country, without being aware of local regulations and political structures that might limit the success of a venture.
Tax breaks and other subsidies that governments offer to local businesses, for instance, can undermine a foreign venture if they force a Western car company to use locally made parts or simply make it too easy for low-quality manufacturers to compete.
Farrell cited the automobile sector in Brazil, which had become glutted by often low-quality parts after the government offered generous subsides to manufacturers. "It resulted in a 40 percent increase in capacity above what was required," she said.
While foreign companies often do not have the power to influence local policy-making, Farrell said businesses needed to thoroughly understand the local business politics before entering a market.
Foreign manufacturers, she said, were more likely to benefit from a local government's investment in infrastructure rather than direct subsidies to local businesses. In addition, research has shown that companies usually find it easier to set up a brand new operation in a developing country than to take over an existing one.
One of McKinsey's few case studies of FDI that did not yield such positive results involved the banking sector in Latin America, where foreign banks were challenged to win over local customers even after they had established a major presence in the region.
"It's a very sticky business and customers don't switch easily," said Farrell. "The bank has to really tick you off before you switch."
—Andrea Orr
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