Edward Verl Fielding.

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Based on the actions considered by these four firms, one
may infer that the cost of change from national to regional
firms generally exceeds the advantages to be gained, as the
only firm considering it was pressed with the prospect of
being forced out of business.

For the two firms that were willing to regionalize a new
venture but not the present operations, one may conclude that
the business cost to change the present facilities exceeded
the expected gains, and a joint venture per se was not a pro-
hibition. The firm that had a major production facility in
a qualified mixed enterprise status but was not regionalizing
production, further implicates the business costs or lack of
benefits as an impeding factor, rather than the cost of owner-
ship change.

In addition, eleven of the twelve firms mentioned that
their fixed assets were now deployed to better serve the in-
dividual national markets rather than the regional market.
They too may be indicating that the business costs exceed the
expected benefits of regionalization.

In the evaluation of a profitable opportunity, one would
expect fixed assets and other expenses to be viewed as a sunk
cost, but for a profit center there may be a profit and loss
adjustment for write down in assets. So it would seem the
consideration may be condensed to the trade off of expected
benefits to be earned from regionalizing and the balance
sheet loss incurred in phasing out assets. This latter point


will be very important to regional centers that are evaluated
on their profit.

In the case of established firms, it may be much safer
for the firms to stay with the national units rather than
risk the instability of the regional market. This instability
problem would increase the resistance to local equity as any
decrease in profits would be very detrimental to the expected
value of an income flow of uncertain length.

It appears that stability is the key to the regional in-
vestment question, and seven of the twelve respondents spe-
cifically stated some major doubt as to the survival of the
regional union. Only two respondents mentioned the region as
being an unsatisfactory market; however, both of these respon-
dents were sales personnel, so they may have been more attuned
to that consideration.

Based on the twelve interviews one may conclude that the
slow development of investment on a regional basis within the
Andean region can be primarily attributable to the lack of
confidence in the survival of the region or in the continuity
of the regional regulations. Should this situation be recti-
fied, it still may be that the market opportunities are not
sufficient to clear the local ownership hurdle. But I do not
believe that a local ownership requirement would generally
prohibit a company from entering the market if it offered
sufficient levels of return. The exception to this may be


firms in the category of General Motors or IBM, etc. ( i.e . ,
firms whose products are more necessary to the country than
vice versa) .

Contrary to the original expectations, the interview
results, when structured in the framework of the model, do
not necessarily lead one to accept the hypothesis that the
new regional market is seen as economically preferrable to
the national markets. The data tends to indicate that the
instability or uncertainty of the continuation of the regional
association of the member countries plays an important role in
the reluctance of interviewed executives to regionalize in-
vestments. When viewed in the context of already being in
the market on a national basis, the incremental advantages of
regio.nalizing do not seem to exceed the associated costs.

The instability factor is seen as operating in several
realms. A dissolving of the regional association would pro-
bably have adverse effects on the expected income flow. In-
stability of regulations could also be seen as impacting on
various costs. As was previously mentioned the "license fee"
of divestment may become very expensive if there is no re-
gional market. Should the regulations change and some firms
be allowed to enter the regional market without the local
equity participation, then those firms that already divested
may view themselves at a competitive disadvantage. As another
example the action of competitors can adversely affect the


stability of expected benefits if one loses a monopoly

So the influence of the instability questions makes it
difficult to determine if the market is economically attrac-
tive. It seems we can conclude that for the established firm
the expected returns of the market are not sufficient to
justify the "cost".

Considering the affect of the divestment requirement on
the investment decision is also perplexing. The interview
responses indicate a difference in the willingness to enter
as a minority partner in a new joint venture and the willing-
ness to make a partial divestment of a going operation. Ten
of the twelve firms would consider entering a new joint ven-
ture, and only one of the twelve was giving consideration to
partial divestment of its present operation.

One would expect the requirement of divestment, as con-
trasted to the opportunity of a new venture, to have very
different effects on the decision makers who are rewarded on
the basis of their performance. The continuation of the
national market arrangement would be seen as less risky than
would incurring the cost of regionalization with an uncertain

The third hypothesis that the negative influence of the
divestment requirement impedes regionalization on the part of
the established firm is not a necessary conclusion of the
data. In fact the one firm that already qualified as a mixed


venture with a major production facility but was not con-
sidering regionalization tends to indicate the business costs
of regionalization exceed the expected benefits.

From this study we conclude that to effectively pursue
a regionalization program for established firms, the Andean
planners need to make regionalization more attractive or
remaining in the national mode as less attractive. At the
present time it seems less risky for the established firms
to do nothing.


Investor Outlook Prior to Decision 2k
A survey reported by Business International in their
monograph The Andean Common Market , December 1970, cites a
general optimism among U.S. businessmen. Many industries
and specific companies within those industries were excited
about the possibility of serving the new regional market.

In the chemical industry several firms planned increased
investments to expand existing facilities or build new plants
to serve the regional market. There was special interest in
the industrial chemicals in phosphate and PVC . The rising
incomes and increasing demand were seen as positive factors
for consumer demand and the need for higher farm productivity
was seen to stimulate the agricultural chemical potential.


Dow was described as taking steps to rationalize its
production of polystyrene in its Chilean and Colombian
plants, was gearing up to serve an export market and was
changing its previous strategy of the national market to the
regional market view.

The contingency considerations at this stage were the
need to achieve profitability even if the regional market did
not develop and the political problems of making sure that
the regional production rights on your products were granted
to the nations where you were located.

In the pharmaceutical industry previous operations had
been geared to the national market, but most producers were
relatively efficient anyway, due to national price controls
and a maintenance of current technology. However, there were
economies in rationalization and Pfizer is cited as moving in
that direction. Pfizer was also considering a regional pro-
duction of antibiotics behind a protective tariff.

In the glass industry, Corning expressed an interest in
beginning production in technical glass and fiberglas within
the region. Over one-fourth of Coming's Latin American
sales came from the Andean region, primarily export sales.

In the metallurgical industry, Phelps Dodge had already
begun exporting copper products from Chile to Colombia,
Bolivia and Ecuador. And in telecommunications, I.T.T. was
trying to establish joint ventures with various governments
of the region to produce communication equipment.


At the time of the survey, Decision 2^ had not been pro-
mulgated and the main problem seen was the possibility of
the regional market not being realized. In face of the
losses sustained by many investors who had expected more
rapid progress by LAFTA, such a failure of regionalization
was a real concern.

The Investors View After Decision 2U
The enactment of Decision 24 seemed to cast a chill over
the initial feeling of optimism of investors. March 22, 1971,
a letter was sent to various Andean governments by the Council
of the Americas, whose 210 corporate members represent over
85% of the U.S. private investment in Latin America, regis-
tering strong opposition to Decision 24. They noted that as
a result of Decision 24, 84 investment projects were being

held in abeyance and that the 1971 investment in Latin America

by U.S. investors would drop 57o below the 1970 level.

In a questionnaire survey of 50 MNC ' s by Pincus and
Edwards , they found Decision 24 to have very detrimental

affects on the plans for new foreign investment. Those con-
tacted saw a substantial decline; many felt the fade-out pro-
visions, profit restrictions and political uncertainty within
the region to far outweigh any potential profitability. How-
ever many respondents felt they would maintain their present
facilities but not improve nor expand them at present, as
they felt there would be some modification to Decision 24.

Other respondents felt immediate withdrawal, even at a loss,
to be the best action.

The survey by Business International reveals a great deal
of optimism and some concern about the expected stability of
the market. The survey subsequent to Decision 2^ portrays a
strong adverse reaction by U.S. businessmen. The fade-out
provisions, profit restrictions and political uncertainty
were seen as negatively affecting the profits of regionali-
zation. The proportionate weight of these factors in the
decision to reduce investment in the. region is not determined,
but once again the factor of instability plays an important
role .

The Meeker Study

In a MBA thesis exploring the acceptability of the fade-
out joint venture principle, Guy Meeker received 90 re-
sponses. Of this group, 367o indicated that a fade-out joint
venture (FOJV) may be an acceptable mode of investment under
certain conditions. The remaining 64% are not considered to
be opposed to the idea even though they did not respond favor-
ably. Meeker seems to feel a large portion of the lack of
favorable response is due to a misunderstanding of what the
FOJV involves.

He concludes that 707o of those responding to his ques-
tionnaire are potential candidates although 367o indicated
favorable cotxsideration under certain conditions. He had an


accompanying response that S7% of the firms accept joint ven-
tures as a matter of policy and S2% "accept minority positions
as a general policy." He seems to equate the willingness to
enter into a minority joint venture as tantamount to willing-
ness to accept a FOJV. He then indicates that those who ac-
cepted a minority joint venture but did not accept a fade-
out were inconsistent and did not understand the fade-out.
Therefore, the original 36% of the respondents indicating a
willingness to accept a fade-out is increased by those who
would enter into a minority joint venture, raising the pro-
portion to 10%.

This type of analysis and the way his questions were
worded tend to reduce my confidence in the conclusion he
draws as seeing the fade-out joint venture as a workable and
feasible program for foreign investors as well as for host
countries .

He concludes that the acceptability of the FOJV "is con-
ditioned by individual company policy more than anything else.

An emotive barrier such as this could be changed under com-

petitive pressure." He believes that a partial fade-out

agreement, supported by a multilateral guarantee, would at-
tain an aura of certainty and coupled with "fair" compensa-
tion would overcome any reluctance to participate in a FOJV.
Such a conclusion would seem to rely on the assumption that
the local profit criterion is the overriding concern of the
foreign investor.


Meeker does foresee that the adoption of the FOJV prin-
ciple by a host government would impede the flow of foreign
investment, but it would soon resume if the policy was con-
sistent. He sees the FOJV as helping to assuage nationalistic
fervor and also developing nations to "channel foreign pri-
vate investment according to the priorities of a predetermined

development plan, rather than adjust domestic policies to the

dictates of foreign capitalists."

It seems the Meeker data could be given to another inter-
pretation. Willingness to enter into a minority joint venture
does not necessarily imply a willingness to partial divest-
ment in a FOJV. Entering into a new venture may be seen as
an opportunity while the FOJV is a sharing of what one already
has. This is not intended as a judgmental statement regarding
foreign ownership or nationalistic pressures, but is an at-
tempt to clarify the attitude that may be held by the execu-
tive as he approaches one of these situations.

In the new venture the prospective minority partner has
many freedoms, including the freedom to select the technology,
financing and other scarce resources to be committed to the
project. In other words there is the opportunity to be sel-
ective of what assets are brought to the partnership and what
benefits are to be received.

Another conclusion that may be disputed is that the im-
peded flow of foreign investment would resume once there was
a perception of consistency in the FOJV requirement. It may


be that the reduction in the expected stream of profits,
resulting from the joint equity requirement, has raised the
level of earnings required and so changed the evaluation of
the market potential. Perhaps a joint venture that required
the same level of scarce resources as a wholly owned opera-
tion, but did not yield the same return would not appear as
attractive as the wholly owned operation.

Ferguson Study - Strategic Problems of the FOJV

In a thesis exploring the strategic business implications


of the FOJV, Terry Ferguson has pointed out three major pro-
blems for the foreign investor. He foresees difficulty in
the location of local capital under conditions which would
permit a satisfactory negotiation and sale. The limitations
on the freedom to choose the correct timing for the negotia-
tion would reduce the assurance of a fair exchange. And of
course, the difficulty in establishing a fair way to evaluate
the equity for divestment is a major problem.

Ferguson sees the initial problem of limited local capi-
tal in developing countries to be adversely influenced by the
high degree of perceived risk due to inflation, currency de-
valuation, political instability and the volatility of eco-
nomic activity. An investor confronted with a high level of
perceived risk requires a high rate of return and so would
not be willing to pay as much for a stream of income as a
foreign investor might.


From his interviews he concludes that companies are
learning to live with the fade-out requirements in the Phili-
ppines and the Mexican restrictions.

Reasons for this are given by Ferguson as follows:

1. misunderstanding of what the phase-out
requirement really means ( i.e .. a lessening
of equity position and not necessarily a
100% divestiture) ;

2. it apparently is possible to negotiate an
acceptable agreement in some cases;

3. there are many advantages to having a local
partner, once the entrepreneur is satisfied
that his local partner is very competent and
is doing a better job than he could under
the circumstances, it may become more ac-g
ceptable to take a minor equity position.

Ferguson indicates that the FOJV requirement is not an
absolute prohibition preventing the firm from considering the
investment opportunities of the market. The implications of
this report and Ferguson's conclusions are seen as compatible
as the reluctance to enter into a FOJV may be seen as a matter
of degree, highly influenced by the perceived benefits of the
market, the stability of the flow of benefits and the action
of competitors. However, the FOJV and a minority joint ven-
ture are not being equated, as some firms will not share cer-
tain proprietary technology.

Franko - Is the Joint Venture Workable?
Lawrence Franko reports that his study dealt with the

broader question of the success and failure of joint ven-
tures between U.S. investors and host country nations. He


concludes that success or failure of the arrangement is
heavily influenced by the type of management organization of
the U.S. firm. If the U.S. firm has decided to meet overseas
price competition by concentrating on a limited product line
abroad then it will tend to develop inflexible, centralized
decision making organization which does not have room for
consideration of the minority or local interest. Contrari-
wise, firms choosing the strategy of foreign product diversi-
fication do not tend to centralize their decision making, so
the local national owner can be readily tolerated.

While this study and the Franko survey investigate two
very different aspects of joint venture relationships, it may
be that the data from the Franko study could be structured in
the models presented and shed further light on the proprie-
tary knowledge and technology question.


From the interview data one may conclude that the new
Andean regional market is not seen as having sufficient in-
cremental advantage, as compared to the continuation of the
national market mode, to merit a change. The model indicates
and the data confirms that the uncertainty of the continuity
of benefits gained or costs incurred in regionalization tends
to make it less risky to do nothing than to change existing
national operations to a regional operation.


From the model, one can see three areas of action that
may lead to firms moving from the national to regional mode.
An increase in perceived stability of the benefits gained or
costs incurred may raise the expected value of income flows
or losses incurred. At present it seems less risky to do
nothing, so some incentive to change to regionalization or
some penalty for remaining as a national firm may be effec-
tive. The action of competitors also influences investment
decisions, so some program of encouraging defensive invest-
ment may be useful.

It is difficult to generalize about the partial divest-
ment program or fade-out joint venture FOJV) . However, there
are some firms that refuse to participate in any type of joint
arrangement in production of the firm's primary products. It
may be (and was confirmed in the interviews) that a firm with
such a policy may be willing to be a minority partner in some
venture not involving proprietary knowledge.

The data does seem to support the conclusion that the
fade-out joint venture is perceived to be very different from
the opportunity to enter a new venture as a minority partner.
The acceptability of a fade-out joint venture arrangement
seems to be influenced by expected benefits of the market and
actions of competitors.

The reluctance of firms to regionalize their present
national operations seems to be more associated with the in-
stability of the region and uncertainty of the denouement


stream than with the local equity requirement. However, the
regionalization decision may be a hierarchical evaluation
with instability one of the early considerations, and the
ownership question at a higher level.



Chapter 2

1. Guy B. Meeker, "Fade-Out Joint Venture: Can It Work For

Latin America?," Inter-American Economic Affairs ,
(Spring 1971).

2. Joseph Pincus and Donald E. Edwards, "The Outlook for

United States Foreign Direct Investment in the
Andean Pact Countries in the Seventies," Journal of
International Business Studies , (Spring 1972) , p. 59.

• 3. Ibid .

it. Meeker, (Spring 1971).

5. Ibid .

6. Ibid .

7. Terry Douglas Ferguson, Corporate Strategy Considerations

of the Phase-Out Joint Venture As a Form of "Direct
Foreign Private Investment , (S.M. Thesis, M.I.T.,
June 1972).

8. Ibid . , p. 66.

9. Lawrence Franko, Strategy Ch oice and Multinational Corpo -

rate Tolerance f or J oint Ve n t u res With Foreign Partners ,
(DBA Dissertation, Harvard University Graduate School
of Business Administration, 1969).


Chapter 3



The interview data structured within the framework of
the model in Chapter 1 leads one to believe that under the
presently perceived conditions of uncertainty, there will be
little regionalization of existing U.S. -owned facilities.
One element of risk to the businessman is uncertainty, and
in this situation the consequences of doing nothing appar-
ently seem less risky than the prospects of regionalization.

The cost of changing from servicing the national market
to regionalization is segmented into two broad categories -
the business cost, and the cost of the change in ownership
structure. Chapter 1 provides some ideas of what considera-
tions may fall within each.

The interview data suggest that the unfavorable com-
parison of business cost with the expected advantages (the
term is used in the anticipatory and probabilistic senses')
of regionalization constitute a major factor impeding some
firms from regionalizing. So the hypothesis that the
regional market is favorably evaluated would be rejected.

The influence of the cost of change in ownership struc-
ture is also important; in fact for some firms it is pro-
hibitive. In this latter case it was suggested that


proprietary technology and the sharing of scarce resources
were important considerations. These elements also offer
strong logical support for there being a difference in the
willingness of a firm to enter into a new venture as a
minority partner and its willingness to partially divest
its current holdings to gain the right to share in an un-
certain income stream. The ownership requirements are
restrictive in some cases but not in others; so hypothesis
two is not universally true. The reluctance to act is
influenced by the evaluation of the market opportunity and
to some extent, by the partial divestment requirements; so
hypothesis three was incomplete.

As an additional consideration, the executive officers
interviewed expressed a different attitudinal view of the
FOJV and the opportunity of the new venture. A profit cen-
ter with an allocation of assets is evaluated against the
earnings of those assets. So a situation of continuity
may seem much less risky than an uncertain income stream
that requires significant organizational change, i.e . ,
doing nothing may be less uncertain than partial divestment
The anticipated earnings flow from change would need to be
quite favorable to overcome the adjustment of uncertainty.
Hence, a FOJV is seen as an uncertainty, while a minority
interest in a new venture is seen as an opportunity.



From a Machiavellian perspective, some incentive is
required to get the established firms to change from ser-
ving the national market to regionalization, or some penalty
imposed on those which remain in the national mode. In the
latter case the imposition of taxes or other unfavorable
treatment of the firms in the single nation mode would make
a change to regionalization seem more beneficial. However,
such penalties may have unfavorable long run implications
and complex interactions.

On the positive side, granting tax advantages, income
stabilization behind "guaranteed" tariff barriers, a per-

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Online LibraryEdward Verl FieldingSome strategic ownership considerations for foreign investors in the Andean pact region → online text (page 3 of 5)