1. What changes in Political and economic environment allowed Telefonica to expand globally?
The changes that were involved in the political and economic environment, which allowed Telefonica to start expanding globally, were privatization and deregulation. In addition economic growth, removal of many restrictions on FDI and programs that opened to foreign investors made some countries more attractive to Telefonica for expansion. Spain’s Telefonica was established in the 1920s being a state-owned national telecommunications monopoly.
Soon, the Spanish government privatized it, as well as deregulated the market for Spanish telecommunications. Due to these changes, Telefonica has a reduction in workforce, rapid adoption of new technology and began to focus on the increasing profits. Telefonica began to grow and expand globally. Hence a general shift towards democratic political institutions and free market economies encourages Telefonica to invest in different nations especially in developing nations such as countries in Latin America.
2. Why Telefonica initially focused on Latin America? Why was it slower to expand in Europe even though Spain is a member of European Union?
While changes were being made, Telefonica was looking for growth. The choice of a firm to engage in FDI occurs logically and empirically prior to the decision about where to locate. The major determinants for choosing a location for FDI are markets that have strong potential for growth, openness of recipient country to foreign trade, production cost in recipient countries, trade agreements, similarities in culture and language and the like.
The markets were growing rapidly in Latin America and Telefonica acquired many companies, which were once part of state owned telecommunication monopolies. Latin America was also experiencing a rapid change of deregulation and privatization across the region. Moreover, Telefonica focused on Latin America because of similarities in the development of the market, shared common language and deep cultural and historical ties with Spain.
Latin American markets were also increasing the adoption rate and usage, including Internet and mobile phones. Since Regional trade agreements are important determinants of FDI. Telefonica was slower to expand in Europe because there had been an implied agreement between the national telecommunications companies that they would not invade each other’s markets. By 2005, this agreement broke down when France Telecom entered Spain.
3. Telefonica used acquisition rather than greenfield ventures as its entry strategy. Why do you think this has been the case? What are the potential risks associated with this entry strategy?
Strategic alliance refers to cooperative agreement between potential or actual competitors. It may range from a short-term contractual agreement for cooperating on a particular task to formal joint ventures in which two or more firms have equity stake. This helps to circumvent entry barrier, share fixed costs of developing new product or processes and to bring together skills and assets that companies would not do separately.
However, strategic alliances or joint ventures allow competitors a low cost route to new technology and markets. In short-term strategic alliance may generate profits but in long term it hollow out firms leaving them with no competitive advantage. If firms are not careful they may end up transferring more of it knowledge and skills without receiving much benefits.
Why firms choose Acquisition instead of licensing
A company that possesses an intangible asset (e.g. proprietary technology) enjoys a potential ownership advantage over other companies in foreign markets. Under these conditions the firms may consider maximizing the benefits of its ownership advantages by licensing a foreign company to produce its goods and services.
Nevertheless, if there are high transaction costs associated with negotiation, monitoring and enforcement of contracts with foreign companies then the firm can be expected to choose FDI with its own multinational subsidiary as a superior alternative to licensing. Licensing may result in a firm’s giving away its know-how to a potential foreign competitor. Firms cannot maximize its profitability, as it does not have strong control over manufacturing, marketing and strategy in a foreign country. Benefits of acquisition
There are many benefits of acquiring current assets than undertaking greenfield investments. First mergers and acquisitions are quicker to execute. In fast evolving markets this is very important consideration. When Telefonica wanted to build a service presence in Latin America, it did so through a series of acquisitions, purchasing telecommunications companies in Brazil and Argentina. The reason was Telefonica knew that was the quickest way to establish a sizable presence in the target market.
Second reason for Telefonica preferred to acquire firms was because those firms had valuable strategic assets such as brand loyalty, customer relationships, trademarks or patents, distribution systems, production systems and so on. Hence it was easier and less risky for Telefonica to acquire those assets than to build them from ground up through a greenfield investment.
Thirdly Telefonica might have believed that they can increase the efficiency of the acquired unit by transferring capital, technology or management skills. However, there are some risks involved in merging with or acquiring the firms as companies may fail to realize their anticipated gains. Many times mergers or acquisitions fail to achieve expected revenues. Acquisitions may fail if there is clash of culture of acquiring and acquired firms. Political instability or inflation in host country may have bad impact on success after acquisition.
4. What is the value that Telefonica brings to the companies it acquires? Companies learn valuable skills and receive new technology. In addition acquisition leads to productivity, growth, product and process innovation and greater economic growth. Additional capital from acquiring company can lead to further development.
5. In Your judgment, does inward investment by Telefonica benefit a host nation? Explain your reasoning. FDI can make a positive contribution to a host economy by supplying capital, technology, and management resources that would otherwise not be available and thus boost the country’s economic growth. New technology received may result in economic development and industrialization.
Developing countries with lack of research and development rely on advanced industrialized nations for much of the technology required to stimulate economic growth and FDI can provide it. Another benefit is that FDI brings jobs to a host country that would otherwise not be created there. Effects of FDI on employment are both direct and indirect. Direct benefits arise when Telefonica employed host country citizens directly. Indirect benefits arise when jobs are created in local suppliers as a result of the investment and when jobs are created because of increased local spending by employees of Telefonica.
When FDI is in the form of acquisition the effect may be to reduce employment when the acquiring company restructure the operations to improve efficiency. But once restructuring is over the company tend to grow its employment base at a faster rate as compare to its domestic rivals. FDI results in more competition within the market that stimulates capital investment by firms in plant, equipment and R&D to gain a competitive edge over their rival. The long-term results may include increased productivity growth, product and process innovation, and greater economic growth. Hence increased competition and growth give rise to lower prices, which is beneficial for consumers.
FDI by Telefonica may not have much impact on country’s balance of payments account, as Telefonica is a service industry providing telecommunication services. For services industry there is no option for exports and the services are to be produced where it is delivered. Here the impact of FDI on competition becomes crucial for economic growth of the country.
For example under a 1997 agreement sponsored by the World Trade Organization, 68 countries accounting for more than 90 percent of world telecommunications revenues pledged to start opening their markets to foreign investment and competition and to abide by common rules for fair competition in telecommunications. Before this agreement telecommunication markets were closed to foreign competitors, and in most countries a single carrier monopolized markets, which was often a state-owned enterprise.
Hence, Inward investment by Telefonica has increased the competition and stimulated investment in modernization of telephone networks around the world, leading to better service that further resulted in lower prices. With benefits FDI also has costs for the host countries. There are possibilities that Telefonica, being a large MNE, has more economic power than local companies so it may ultimately dominate the market. In long term it may monopolize and increase prices to impact economic welfare of host nation in a negative way.
Telefonica may induce some national sovereignty and autonomy concerns within the host governments by creating a sense of economic dependence of host countries. Being a large MNE key decision made by foreign parent Telefonica may impact economy of the host country where Telefonica does not have real commitments to the host country.