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LIBRARY

OF THE

MASSACHUSETTS INSTITUTE
OF TECHNOLOGY



No. 711-7^ Cancelled



JUL 10 197^



Wi»^ INST.
JUN 24 "74



es



WORKING PAPER
ALFRED P. SLOAN SCHOOL OF MANAGEMENT



SOME STRATEGIC OWNERSHIP CONSIDERATIONS FOR FOREIGN
INVESTORS IN THE ANDEAN PACT REGION

Edward Verl Fielding



June 1974



712-74



MASSACHUSETTS

INSTITUTE OF TECHNOLOGY

50 MEMORIAL DRIVE

CAMBRIDGE, MASSACHUSETTS 02139



MASS. INST. TECH.



SOME STRATEGIC OWNERSHIP CONSIDERATIONS FOR FOREIGN
INVESTORS IN THE ANDEAN PACT REGION

Edward Verl Fielding



June 1974



712-74



Edward V. Fielding, June 1974






RECEIVED
JUL 1 1974
VI. I. T. LlbKMKItS



SOME STRATEGIC OWNERSHIP CONSIDERATIONS FOR FOREIGN
INVESTORS IN THE ANDEAN PACT REGION

by
Edward Verl Fielding

ABSTRACT



Within the broad area of U. S. investment in developing
countries, this study is limited to the countries of the
Andean region - Bolivia, Chile, Colombia, Ecuador, Peru and
Venezuela. The investment opportunities considered are those
available to U. S. firms which had facilities within the
region prior to July 1, 1971, and now have the option of
continuing to serve the national market or expanding to a
regional mode.

This study investigates the reluctance of established
firms to change from serving the national market to a regional
approach. The initial postulate is that the reluctance on
the part of the U. S. investors to regionalize is associated
with an aversion to entering into the required partial divest-
ment to local participants.

In-depth interviews were conducted with executive officers
responsible for investment in the Andean region. The firms
contacted were selected from a list of firms that had invest-
ments in more than one of the Andean countries.

As a result of the interviews, new factors are seen as
having an important impact on the reluctance to change from
the national to regional mode. For many reasons, the benefits
flowing from the new regional market are not seen to offset
the costs of change. So contrary to the initial hypothesis,
U. S. investors do not view the regional market favorably.
Such findings would imply the need for a new strategy for
Andean regional planners. Changing the unfavorable evaluation
of the regional opportunity would require the granting of
benefits to firms that regionalize and/or penalizing firms
that do not change from the national mode.

The implications for Andean planners and the distinctions
made between minority participation in new joint ventures and
the fade-out partial divestment of existing ventures may be
some of the more useful concepts developed in this study.



07211B3



ACKNOWLEDGMENTS

The stimulating suggestions and time of Professor
Richard D. Robinson and Dr. Donald R. Lessard are
especially appreciated.

The financial assistance provided by a grant under
the direction of the Center For International Studies
enabled me to interview the executives in the Miami Latin
American headquarters. I very much appreciate this
assistance and the opportunity it provided to work with
Dr. Lessard on a project to develop detailed information
about U.S. investors' perceptions of the new Andean
regional market.

The candid observations of the executives inter-
viewed provided many insights and made an important
contribution to this project. Their time and assistance
provided a useful perspective.



ACKNOWLEDGMENTS

The stimulating suggestions and time of Professor
Richard D. Robinson and Dr. Donald R. Lessard are
especially appreciated.

The financial assistance provided by a grant under
the direction of the Center For International Studies
enabled me to interview the executives in the Miami Latin
American headquarters. I very much appreciate this
assistance and the opportunity it provided to work with
Dr. Lessard on a project to develop detailed information
about U.S. investors' perceptions of the new Andean
regional market.

The candid observations of the executives inter-
viewed provided many insights and made an important
contribution to this project. Their time and assistance
provided a useful perspective.



TABLE OF CONTENTS

ABSTRACT 2

ACKNOWLEDGMENTS 3

TABLE OF CONTENTS k

LIST OF TABLES 5

LIST OF FIGURES 6

CHAPTER 1 - FOREIGN INVESTMENT CONSIDERATIONS FOR THE

ANDEAN REGION 8

1. Introduction 8

2. Plan of Study 10

3. Incremental Nature of Regionalization 11

4. A Priori Assumptions 19

5. Methodology 21

6. Hypothesis 23

CHAPTER 2 - THE REACTIONS OF SOME U. S. BUSINESSMEN. . . 32

1. Interview Results 32

2. Implications Drawn From The Model 35

3. Information From Other Studies ^1

^. Conclusions ^9

CHAPTER 3 - CONCLUSIONS 53

1. Prospects For Regionalization of Existing
Facilities 53

2. Implications For Andean Planners 55

3. Suggestions For Further Study 57

BIBLIOGRAPHY 68



LIST OF TABLES

Table 1 - U. S. Direct Investment in ANCOM 25

Table 2 - International Monetary Transactions 28

Table 3 - Impact of Export Items on GNP, 1971 60

Table ^ - Basic Data on the Andean Countries and

Other Latin American Republics, 1969 61



6

LIST OF FIGURES



Figure I - Map of Andean Countries 7



Figure 2 - Decision Factors For Firms Regionalizing

Existing Facilities 15



Figure 3 - Decision Factors For Firms Beginning New

Ventures on Regional Basis 17



Figure k - Interview Data 36



La Gualra
Caracas
Barranqullla /t^\sf ^

VENEZUELA



Buenaventura

Quity :

ECUADOR
Guayaquil




Valparaiso



Figure 1-THE ANDEAN GROUP COUl^TRIES



8

Chapter 1
FOREIGN INVESTMENT CONSIDERATIONS FOR THE ANDEAN REGION

INTRODUCTION

Many nations have begun imposing restrictions on foreign
investors as a method to increase indigenous control over the
economy. Mexico, Brazil, Chile, Peru, Indonesia, India,
Ceylon, Philippines, and Japan have all at some time had
restrictions on the portion of a national enterprise that may
be owned by foreigners.

Recently the member countries of the Cartagena Agreement
(Bolivia, Ecuador, Chile, Colombia, Peru and Venezuela) codi-
fied common regional treatment for all foreign capital.
Decision 2^4, a statute of the Cartagena Agreement, adopted
July 1, 1971 (January 1, 197^ in Venezuela), sets forth rather
specific guidelines for the treatment of established and for
new foreign owned firms. "It was the first common policy

toward foreign investment ever adopted by a group of nations

1
and the first major test of a policy of forced divestment."

The Cartagena Agreement is the underlying document ini-
tiating a customs union among its signatories. Decision 2k
flows out of the creation of this regional market and is
designed to prevent foreign investors from reaping all the
economic benefits of regionalization.

Decision 2k restricts the benefits of lower intraregional
tariff barriers to those firms which may be classified as



mixed or national enterprises. In this classification a mixed
enterprise requires at least 5l7o local private ownership or
30% government ownership and the national enterprise requires
at least 807o local ownership.

Firms established within the region before the enactment
of Decision 2U may elect to retain 100% foreign ownership;
however, they will not benefit from the lower intraregional
tariffs. Decision m also requires any new firm ( i.e . , one
entering the region after June 30, 1971) to comply with the
divestment requirements of at least qualifying as a mixed
company. In this case, the firm would also qualify for certi-
ficates of origin and would benefit from lower intraregional
tariffs.

The reaction of the foreign investor to Decision 2k is
important to the member countries of the region. As we see
in Table 2, new foreign investment plays an important role in
the balancing of the foreign exchange flow. From Tables 1
and 2 we see that there has not been a growth of new U.S. in-
vestment in this area since the implementation of Decision 2U .
This reduction in investment raises many interesting questions;
however, this paper will be primarily limited to considering:

1. What is the evaluation of the new regional market by
U.S. businessmen?

2. What is the feeling of U.S. businessmen toward the
local ownership requirements of Decision 24?



10



3. How does the reaction to Decision 2^ affect
the decision made with regard to the regional
market opportunities?

These questions are considered for firms which already
had facilities in the market prior to Decision 2^; but of
course they also have the option of investing in new faci-
lities.



PLAN OF STUDY

This study investigates the cost/benefit evaluations
made by U. S. businessmen considering the change from a posi-
tion of serving the national markets to serving the Andean
regional market. A decision model is used to analyze the
incremental nature of the move to regionalization and to
draw conclusions from the interview data.

Chapter 2 is a discussion of the reactions of U. S.
businessmen towards the new regional market. The data from
this interview survey is reported and previous surveys are
cited. The other surveys discussed primarily deal with the
specific evaluation of the Andean regional market or attitudes
towards minority joint ventures.

The conclusions in the final chapter state that the
reluctance for firms to regionalize existing operations is
associated with an unfavorable evaluation of the market



11



opportunities and not just an aversion to the partial divest-
ment requirements.

INCREMENTAL NATURE OF REGIONALIZATION

As a generalization, the "established" firm that wishes
to take advantage of the lower intraregional tariff benefits
is faced with two differing requirements. First the firm
must agree to an acceptable divestment program which would
lead to qualifying the firm as a mixed enterprise. The next
step would be the implementation of the business decision of
servicing the regional market rather than just the national
market. In most instances, this would require an increase in
investment to expand production, to increase the supply and
marketing coordination, and physically to move goods into
new markets.

For the new firm the marginal nature of regional ization
is not entirely clear. It seems that Decision 24 explicitly
requires all new firms to be established as mixed enterprises,
but there is some confusion as to the specific requirements
imposed by Colombia and Venezuela.

Decision 2k requires that a foreign owned firm qualify
as a mixed enterprise or have agreed to an acceptable program



12



to attain this status before it can benefit from the lower
intraregional tariffs. There is no prohibition against a
totally foreign owned firm shipping its goods within the
region, but in such a case it is subject to national tariff
barriers.

From an incremental view, the decision of the established
firm becomes more complex. It would seem that the first con-
sideration would be the evaluation of the regional marketing
opportunities as contrasted to the present situation ( i.e . ,
what savings can be achieved and what will the costs be?) .
The established firm has certain fixed assets, sources of
supply, management systems, marketing systems and trained
employees. It is important to consider what changes need
to be made in order to benefit from the regional market.

It would seem that the established firm would consider
at least three questions in regard to the new regional op-
portunity.

_1. What can be achieved in the regional market

not achieved by the present arrangement? Here
the concern is for the benefits which may accrue
to the firm when going from servicing the indi-
vidual national markets to treating the region as



13



a whole. What are the particular economies of scale
that the company may realize? In terms of competition,
one may consider what the firm will gain if it region-
alizes production, and competition does not, and what
the firm would lose if competition regionalizes and the
firm does not. The competition question is seen by
managers as being very important.

2^. What will be the cost to the firm of changing from
serving national markets to serving the market on a
regional basis? This question would probably be con-
sidered in terms of the required changes within the
business system (production, supply, marketing, manage-
ment, employees) and the effect of the change in owner-
ship to include local equity. The cost of the change in
the business system is somewhat easier to evaluate, as
many of the elements can be quantified. However, some
of the costs involve people - by redefining jobs,
changing management hierarchies, transferring employees,
perhaps training new employees, and establishing new
sources of supply and new market outlets. So it is not
clear cut that business costs can in fact be quantified.

The requirement of local equity participation is
even more difficult to evaluate. In considering whether
or not to change from its present ownership arrangement
the parent company may weigh the following:



1^

1) its past experiences in joint venture arrangements;

2) its impression of ability and integrity of local busi-
nessmen; 3) problems of subsequent transfer of ownership
by local partners; 4) conflict of interest among the
parent firm, the foreign partners, the joint venture and
host government; 5) financial problems of local partners;

and 6) costs and benefits attributable to the joint

3
venture strategy. Here again, there is no simple answer.

3^. What are the prospects for continuity of the regional
market, i.e . , how stable is the amalgamation of nations?
There will be a concern regarding the expected period of
time over which the cost of changing the organization to
a regional basis can be amortized, and how long the re-
gional benefits may be realized. Should the region dis-
solve, then it is likely that the firm would be in a much
worse position than had it remained as producers for the
individual national markets. It may be that the firm
would now be faced with much higher levels of breakeven
production which would require the exporting of products
across tariff barriers. The same may be true if the step
toward regionalization had involved rationalization of
production.
A hierarchy of the decision chain of an established firm

may be depicted as a flow of factors considered in a cost/

benefit analysis. See Figure 1.



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Ostensibly the decision chain for the new investor would
be less complex, as he would not be concerned with the cost
of change. In its place he would be concerned with the cost
of entering into a venture as a minority partner and start-up
business costs. This decision chain is depicted in Figure 2.

It may be helpful in the evaluation to describe more
fully some of the elements of the models. In the model for
the established firm the "cost of making ownership change"
would include the effort made to locate a suitable partner,
various conflicts that would arise, the possibility of losing
proprietary knowledge, a sharing of scarce resources, a
reduction in profits, etc. The "business costs" would in-
volve such things as building new facilities, developing new
markets, training new people, assimilating the national
groups into a regional group, establishing new sources of
supply, coordinating production and distribution, etc. One
can see possible interactive effects of these two costs
which would increase the total cost.

Some less certain factors which will impact on the cost/
benefit analysis include: the action of competitors, con-
tinuity of the denouements or complex outcomes, and the per-
ceived stability of the region. If one result of regionali-
zation was the gaining of a monopoly position, one might be
encouraged to make the move; but the action of competitors
and the expected continuity of the monopoly position would
influence the cost/benefit evaluation. It may be that the



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Online LibraryEdward Verl FieldingSome strategic ownership considerations for foreign investors in the Andean pact region → online text (page 1 of 5)