CASE STUDIES ON THE MOTIVATIONS, SELECTION OF ENTRY MODES OF CERTAIN TNCS IN VIETNAM THE CASE OF HONDA MOTOR CORPORATION

FOREIGN TRADE UNIVERSITY FACULTY OF INTERNATIONAL ECONOMICS GROUP PROJECT Subject: International Investment CASE STUDIES ON THE MOTIVATIONS, SELECTION OF ENTRY MODES OF CERTAIN TNCS IN VIETNAM THE CASE OF HONDA MOTOR CORPORATION Group: 10 Class: K53CLC2 Class ID: 07 Supervisor: Pham Thi Mai Khanh Ho Chi Minh City, April 5, 2016 GROUP LIST No Student ID 1401015591 1401015597 1401015599 1401015615 1401015617 1401015621 Full name Trình Thị Thu Trâm Trần Nguyễn Minh Trân Cái Thùy Trang Phạm Thị Ngọc Trang Võ Thị Thiên Trang Lê Văn Triết Note Group leader TABLE OF CONTENT LIST OF FIGURES iii LIST OF ABBREVIATION iv INTRODUCTION CHAPTER 1: THEORETICAL FRAMEWORK .3 The OLI paradigm CHAPTER 2: MOTIVATIONS FOR HONDA FDI IN VIETNAM Ownership-specific advantages .5 1.1 Brand 1.2 High-quality products with reasonable price .5 1.3 Honda service and added in activities 1.4 Diversification of products design 1.5 Business relations and networking 1.6 ASIAN market understanding .8 1.7 Unique technology Internalization advantages Location-specific advantage 11 3.1 Economic determinants 11 3.1.1 Market-seeking: 11 3.1.2 Resource-seeking 13 3.1.3 Efficiency-seeking 16 3.2 Policy framework 17 3.3 Business facilitation .19 3.3.1 Investment Agreement 19 3.3.2 Trading and distribution rights 21 3.3.3 Inflation and exchange rate 22 3.3.4 Industry specific institution 22 COMMENTS 23 CONCLUSION .25 BIBLIOGRAPHY 26 LIST OF FIGURES Figure 1: Some of Honda’s products Figure 2: Vietnam population by Statical Publishing House 2008 12 Figure 3: Population Structure by ages in Vietnam 1979-2007 by Population and Housing Census 2007 .15 Figure 4: Workers’ average basic salary in some cities in the world .16 LIST OF ABBREVIATION AFTA Asean Free Trade Area APEC Asia-Pacific Enterprise Cooperation BTA Bilateral Trade Agreement CBU Complete Built Up CEPT Common Effective Preferential Tariff CIL Customary International Law FDI Foreign Direct Investment FIC Foreign Invested Company FTA Free Trade Agreement GATS General Agreement on Trade and Services IMF International Monetary Fund JICA Japan International Cooperation Agency MFN Most-Favored Nation MOLISA Ministry of Labour, Invalids and Social Affairs ODA Official Development Assistance OHV Overhead Value R&D Research and Development TEL Temporary Exclusion List TNC Transnational Corporation TPP Trans-Pacific Partnership TRIMS Trade Related Investment Measures TRIPS Trade Related aspect of Intellectual Property Rights VEAM Vietnam Engine and Agricultural Machinery WTO World Trade Organization INTRODUCTION Nowadays, the terms FDI – Foreign Direct Investment and TNCs – Transnational Corporations are not unfamiliar terms anymore to all of us We can easily find an Apple factory in China, Toyota in the United States, Samsung in Russia, and everywhere all over the world Pick up any newspapers or research papers in the library, it is not hard to find an article telling about the long-history success of these TNCs, which strategies they chose to win the market, how they contributed to the society However, within this research, we not mention much about that We concentrate on providing the reader about what factors lie behind the decision of FDI of TNCs, or determinants of FDI, and why they choose a country to invest in, not other countries These motivations and selection of entry mode into a certain country are of essential decisions as they affect the success of the TNCs in the long-run In this research, we choose the case of Honda Motor Company when they entered Vietnam in 1996 to analyze the motives and determinants of entering Vietnam, based on OLI paradigm (Dunning, 1993a) Honda is a Japanese transnational corporation known as a manufacturer of automobiles, motorcycles and power equipment Before Vietnam, Honda had assembly plants around the globe: China, the United States, Thailand, Malaysia, Indonesia, Since the 1960s, Honda’s products in Vietnam came mainly from imports Honda had a good reputation in Vietnam market, even when it came to motorcycles, Vietnamese often called them as “Honda motorcycles” regardless of what motorcycle brands they were In 1995, Honda decided to establish company in Vietnam, with the most important goal is to seek for market So why did they choose Vietnam? What were their competitive advantages then to enter Vietnam? Why didn’t they keep exporting motocycles to Vietnam, or licensed to an existing entity in Vietnam instead of establishing a subsidiary there? Let’s go find the answer for these questions, about the motivations and determinants of FDI of Honda in Vietnam CHAPTER 1: THEORETICAL FRAMEWORK The OLI paradigm The OLI paradigm is a widely used theory to explain FDI It states that FDI happens when these three determining factors exist simultaneously: Ownership-specific advantages: firm-specific competitive advantages compared with local firms that can compensate for the additional costs of establishing production facilities in a foreign environment and help firms overcome their disadvantages compared with local firms in foreign countries Location-specific advantages: country-specific advantages that firms can combine with their firm-specific competitive advantages by establishing production facilities in foreign countries Internalization advantages: presence of superior commercial benefits for firms resulting from the exploitation of ownership-specific and location-specific advantages by investing in foreign affiliates that they control, rather than through transactions with unrelated firms located abroad For a couple of years, the OLI model has remained the significant framework for analyzing the activities of transnational corporations (TNCs) and the economic rationale behind their international operations This model also referred to as the eclectic paradigm proposed by J.H Dunning was first postulated in 1976 It elaborates the decision and growth drivers that enable firms operate in international production (Stefanovic 2008) The paradigm which has been broadly applied in the past to explain entry mode decisions and supported by several empirical studies (Zhao 2005) is also not totally accepted, and described as limited in its accuracy to extrapolate definite methods of international operations There is a heightened consciousness that FDI operations are also determined by other factors beyond the economic advantages of the OLI framework The gravitymodel is one of the models which attempt to modify the limitations of the eclectic paradigm; it explores the process of international production and trade, inclusive of the OLI variables (Mateev 2008) Also in view is the fact that the underlying motives for production vary between regions which Dunning’s theory failed to consider A typical case to illustrate this is the fact that factors which influence foreign investment in a coal or Iron ore abundant region in Africa is likely to differ from those influencing investment by a car manufacturing company in Asia However, the OLI framework has proven to be helpful in determining the basic motives that guide the international operations of TNCs and has set a well-informed ground work for studies in international investment, business and economics It is a helpful framework for classifying a good number of recent FDI researches With the limited time to this case study, we found that OLI is an appropriate paradigm for us to achieve our research’s goal: analyze the motivations and determinants of FDI of Honda in Vietnam 13 streets, often very crowded pavements and roads, numerous small ‘on the street’ traders, low incomes and a weak management system for transportation + Due to the psychology of Vietnamese, they have tendency to use foreign goods, especially Japanese goods In their minds, all foreign goods are high quality and users of foreign goods is considered connoisseurs + Vietnamese customers wanted a flexible and easy to use form of transport that was also easily maintained through the access to components Whilst the high income levels preferred to regularly buy a new bike, the vast majority of the population would make a single purchase which they then focused on repairing themselves or at any local motorbike repair shop (Nguyen Duc Tiep, 2007; Mishima, 2005) To sustain the market for Honda bikes and to establish a dominant competitive advantage, the new Honda project needed to ensure that it not only provided the complete bike, but also provided a constant and readily accessible supply of components for repairing and maintaining all models Recognizing the huge demand for such motorcycles, in recent years many suppliers on the motorcycle market enter Vietnam The famous motorcycle manufacturers in the world such as: Honda, SYM, Suzuki, Yamaha, have conducted joint ventures with Vietnam to manufacture and supply to consumers in Vietnam In addition, during the past years, the motorcycle market has diversified even more diverse today by the Chinese bikes are imported as well as mass production in Vietnam 3.1.2 Resource-seeking It would be very costly for Honda to apply all the high-tech robot systems of their Japanese factories into another country Therefore, when entering into a country, 14 they also paid great attention to the labor force in the host country And Vietnam have excellently met this demand of Honda + Vietnamese employees are often endowed with good technical skills and are able to quickly learn the necessary assembly skills and this is also aided by the relatively simple production methods used by Honda + The Vietnamese worker still commanded only a fraction of the Japanese worker wage, ensuring that Honda company could still produce to the same high quality, but at a far lower cost radio In terms of human resources, Vietnam has 60% of the population under age 30 (table 3), one of the youngest populations in Asia, 94% of people know how to read, write, work very diligently and productivity The cost of labor in Vietnam is very low, averaging only from 55 USD to 110 USD / month (table ) 15 Figure 3: Population Structure by ages in Vietnam 1979-2007 by Population and Housing Census 2007 16 Figure 4: Workers’ average basic salary in some cities in the world 3.1.3 Efficiency-seeking Low labour costs and the quality of the human resources are still an indispensable factor in the attraction of FDI, coupled with the need for a system that allows easy recruitment of that labour and the opportunity to improve the technical skills of the labour force (Bui Anh Tuan, 1991) TNCs are attracted by countries that concentrate on development their human resources This has become a high priority issue in Vietnam where the skills levels and productivity of the labour force need a lot of improvement Nevertheless, the Government is trying to overcome these problems For example, a MOLISA policy document (Paper No.18MOLISA- ‘Labour and Social Issues Emerging from Vietnam WTO Entry) notes how FDI Law has consistently developed to encourage a favourable labour market climate for investors 17 3.2 Policy framework Vietnam political stability creates security for investors when doing business in Vietnam - Motorcycle industry affected by the tax, commercial law, business law - Motorcycles CBU imported from abroad must bear the tax rate of 30-40%, the imported components are assembled in the country also suffered a 20-25% tax rate, the clear, localized cars will have significant advantages in terms of price competition, especially in moderately priced cars - Vietnam's law provisions at least 18 years old to use the motor as age restrictions on use of motorcycles The two basic pillars of the policy on foreign direct investment in Vietnam are to protect and to encourage the foreign investors * For the first pillar: - After 1986, adopting economic innovation policies, Vietnam opened its door to global investors, and the National Assembly enacted the ‘Law on Foreign Investment’ to encourage multinationals investing capitals and technologies in Vietnam, guaranteeing the ownership and rights of foreign investors in jure In the following years, a series of revised policies including tax and tariff, monetary, land, etc, have been put in place to improve the investment environment - All of the assets of foreign investors have been strictly protected in Vietnamese territory 18 + The Vietnamese government is committed to never nationalize the assets of the foreign investors and behave towards both domestic and foreign investors on an equal basis (NAV, 2005j) + The foreign investors have the right to transfer their lawful capital and assets abroad after completion of all financial rights for the Vietnamese government + Law has been supplemented and amended several times, the main direction of these amendments is to create the attractive environment for foreign investors and to enhance the competitiveness of investment environment in Vietnam with the other regional countries + The Vietnam-Japan Co-operation Initiative has also provided Honda the opportunities to expand their market due to a commitment for long term development of both sides The regulations on protection of intellectual property of foreign investors have been addressed seriously and every effort made to execute it successfully * For the second pillar: + The foreign investors have been allowed to take many incentives from investment policies for their investment in Vietnam in terms of land clearance, tax refunds and exemptions The Law on Foreign Investment in Vietnam stipulated the highest level of corporate income tax at 25 per cent and then to increase this to 28 per cent in the following years, in order to harmonise with the tax levied on the domestic enterprises of 30 per cent (Pham Duy Nghia, 2006) However, from 2007, the tax was again decreased to the 25 per cent level (‘Tax reform’ Vietnam News, Dec 2007) The withholding tax levied on foreign invested enterprises for their 19 profit transfer out of Vietnam to home countries has been reduced from the per cent level to zero + The foreign investors have been also treated as the same to that of domestic investors in accordance with WTO principles Advantages from a friendly relationship between Vietnamese and Japanese governments, especially as Japan is the main donor of ODA for Vietnam In fact, the majority of ODA of Japan provided to Vietnam flows in the improvement of infrastructure for smooth circulation of the transportation and means it thus directly impacts on the future prosperity of Honda motorbikes The strategic economic partnership built by highranking officers of Vietnam and Japan is a politically favorable environment for long- term investment of Honda in Vietnam (Ohno, 2003) + The institutional environment for Honda Vietnam Company has also been surrounded by comprehensive interactions of several supranational Japanese agencies such as JICA, JBIC and other intelligent economic units of the motorbike manufacturers These agencies become the ‘antennas’ to provide Honda ‘just-intime’ and all-around sources of information in the motorbike market, thus enabling Honda to remain ahead of the competition 3.3 Business facilitation 3.3.1 Investment Agreement After that Doi Moi policy in 1986, immediately in 1991, Congress had stated their intention to "diversify" and "multilateralisation" of economic relations with other countries, creating favorable environment to attract foreign investment, participation in organizations, other international associations as necessary and conditional 20 Vietnam became an official member of ASEAN since 1995 Vietnam participated Common Effective Preferential Tariff (CEPT) under the framework of ASEAN AFTA Vietnam in 1996 But the only real tariff cuts since 1999 when the first group of items from the temporary exclusion list (TEL) was transferred to the tariff reductions under the CEPT Under the provisions of the CEPT Agreement, Vietnam's items are divided into two main groups: Group items of reduce and eliminate tariffs and sensitive agricultural products group These government policy create the opportunity for Honda entry to Vietnam market easier, especially after two countries establish FTA relationship from 2003 and sign the FTA agreement in 2006 These Vietnamese government ‘s actions lead to expectation of more open policy for foreigner in the future In fact, Vietnam’s entry into APEC, AFTA, WTO and numerous bilateral commercial agreements indicates the government’s commitment to development of investment policies after joining in ASEAN Vietnam became a member of the WTO in January 2007 It is a signatory to the General Agreement on Trade and Services (GATS), WTO’s Trade-Related Aspects of Intellectual Property Rights (TRIPS) and Trade-Related Investment Measures (TRIMS) agreements Vietnam did not sign up to WTO’s optional Agreement on Government Procurement Under the WTO rules, Vietnam must extend national treatment to the projects of investors from WTO member countries This means that Vietnamese and foreign invested projects like projects from Japan should be treated equally In fact, this 21 principle has been reflected in the CIL and the Government is reviewing a range of legislation to ensure that national treatment extends to all business regulations Vietnam has bilateral investment agreements with Japan In 2016, negotiations of a Trans-Pacific Partnership trade agreement (TPP), in which the both the Japan and Vietnam participate, address investment issues With TPP, tax will be completely eliminated The tax on remittances of investment-earned profits abroad was decreased until eliminated in 2004 3.3.2 Trading and distribution rights The Vietnamese Commercial Law (2005) has been significantly amended, establishing a new legal framework for foreign participation in the import and distribution sector While previously foreign investors could only conduct commercial activities from representative offices and branches, the new Commercial Law allows foreign invested enterprises to independently conduct commercial activities (NAV, 2005c) In accordance with market access commitments contained in international treaties to which Vietnam is a signatory, the Decree No 23/2007/ND- CP dated 12 February 2007 of the Government provides the legal basis for foreign-invested companies (FICs) to engage in trading and distribution activities (NAV, 2007a) This bring more advantage for Honda to conduct their own commercial activities Vietnam also gives MFN status to investors from Japan However, before enjoying BTA trading and distribution rights, an existing manufacturer must first amend its license through application subject to government approval Thus, Japanese enterprises would not automatically enjoy trading rights and distribution rights 22 under BTA without going through further legal mechanisms of approval (Kurtz, 2004; Seow and Ching, 2008 p.1-30) 3.3.3 Inflation and exchange rate Government launches policies reducing inflation rate to create an investment environment with less risk Exchange Rate: A relative depreciation of the host country’s currency results in increasing FDI inflow to Vietnam Depreciation of exchange rate strengthens host market’s competitiveness due to lower cost of manufacturing assets and natural source, and therefore more FDI are injected into Vietnam market It is also supported by Vietnam’s frequent going-down exchange rate regulation in practice, annual depreciation rate of 426%, from 166.73 to 17065.1 VND against USD during the last 25 years 3.3.4 Industry specific institution In the case of Vietnam automotive represents a positive influence of industrial policy In fact, the automotive policy may have been absolutely critical for the establishment of export-oriented automotive components industry A key element of this policy has been a tariff regime for imports of cars and components based on local contents with import-export complementation Local content is measured on a “net foreign exchange usage” basis, which allows export revenues to be deducted from the value of imports on which tariffs were to be paid Local content requirements have encouraged the development of local supplier network serving Honda’s motorcycle manufacture in Vietnam, where Japanese foreign investors have established some key suppliers.[Sau04] 23 COMMENTS Another approach to explain Honda FDI in Vietnam is using the Product Life-Cycle Theory International product life-cycle theory provides a theoretical explanation for both trade and FDI The theory, developed by Raymond Vernon, explains why U.S manufacturers shift from exporting to FDI The manufacturers initially gain a monopolistic export advantage from product innovations developed for the U.S market In the new product stage, production continues to be concentrated in the United States even though production costs in some foreign countries may be lower When the product becomes standardized in its growth product stage, the U.S manufacturer has an incentive to invest abroad to exploit lower manufacturing costs and to prevent the loss of the export market to local producers The U.S manufacturer’s first investment will be made in another industrial country where export sales are large enough to support economies of scale in local production In the mature product stage, cost competition among all producers, including imitating foreign firms, intensifies At this stage, the U.S manufacturer may also shift production from the country of the initial FDI to a lower-cost country, sustaining the old subsidiary with new products The first complete motorcycle, with both the frame and engine made by Honda, was the 1949 D-Type, the first Honda to go by the name Dream Over the next few decades, Honda worked to expand its product line and expanded operations and exports to numerous countries around the world This is Honda’s initial stage according to the production life-cycle theory Honda Motor Company grew in a 24 short time to become the world's largest manufacturer of motorcycles After the standardization of products in the growth stage, Honda started to conduct local motorcycles production through many joint-ventures or wholly owned subsidiaries in the United States (1959), Thailand (1965), Canada (1969), Philippines (1976), India (1995), China (1996), and Vietnam (1996) was also among this trend of Honda Honda had exported Honda Cub, Honda Dream to Vietnam since its initial stage of life-cycle since 1960s However, until its growth stage, Honda decided to establish company in Vietnam in 1996 as Vietnam motorcycle market at that time was still new, Vietnamese people were in high demand of motorcycles then and there was not a lot competitors in the market In fact, prior to Vietnam, Honda had exploited all the potential emerging markets from North America to Asia, and the timing of entry into Vietnam was relatively late compared with other Honda’s entries However, so as to make a decision whether to enter Vietnam or not, Honda still had to consider many motivations and determinants of FDI as presented in detailed in the previous part, which follows the eclectic theory of Dunning On undertaking FDI in Vietnam, Honda faces a lot of problem from the government policies, the market, the competitors, However, Honda has been successful in dealing with those obstacles to have the biggest market share of Vietnam motorcycle industry with 65 percent, and 640 authorized resellers (HEAD), produces 2.5 million motorcycles per year, and has factories after 20 years in Vietnam 25 CONCLUSION This case study has demonstrated the reasons why Honda choose to undertake FDI in Vietnam, based on some theories of foreign direct investment On doing this research about the case of Honda, our group has the opportunity to understand more about FDI, the FDI theories and about TNCs, what are their motivations and what factors affect their decision when choosing to go abroad and invest in a country Moreover, we notice that our country – Vietnam has a lot of location advantages that need to be developed more to increase our global competitiveness in attracting FDI 26 BIBLIOGRAPHY Amy Kazmin, Honda’s sweet success, [http://www.usvtc.org/httpdocs %202/News/2002/Sep%2002/Honda's%20Sweet%20Success%20Goes%20Sour%20in %20VN.htm] Bui Tuan Anh (2011), Determinants of Foreign Direct Investment in VietNam, Greenwich University, LonDon Du, J (2011), What are the Determinants of FDI to Vietnam, Tilburg University 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27 Timothy M Laseter, Balanced Sourcing the Honda Way, Booz and Company, [http://www.strategy-business.com/article/13515?gko=ce6a5] Tran Ngoc Ca (2002), Learning technological capability for Vietnam's industrial upgrading: chalenges of the globalization, National Institute for Science and Technology Policy And Strategy Studies (NISTPASS) Hanoi, Vietnam WTO Center VCCI, (2015), Hỏi đáp Hiệp định Thương mại Tự (FTA), [http://www.trungtamwto.vn/tin-tuc/hoi-dap-ve-cac-hiep-dinh-thuong-mai-tu-do-fta] ... motivations and selection of entry mode into a certain country are of essential decisions as they affect the success of the TNCs in the long-run In this research, we choose the case of Honda Motor. .. efficiency-seeking Among these factors, as mentioned in introduction part, the most important motivation as well as the target of Honda is market-seeking 3.1.1 Market-seeking: The entry of Honda into Vietnam. .. of years, the OLI model has remained the significant framework for analyzing the activities of transnational corporations (TNCs) and the economic rationale behind their international operations