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What are non-equity modes of investment (NEMs)?
Greenfield and brownfield investments require substantial upfront costs and commitment, which might prove not suitable for investors in their early stages of market expansion. As an alternative solution, FDI investors are increasingly turning their attention towards new forms of market entry which offer a higher degree of flexibility.
Instead of contributing capital to start a new business in Vietnam, foreign investors instead have the option to enter “contractual agreements” to do business with local partners. This form of market entry is referred to as the “non-equity modes (NEMs)”, which is already stipulated in the Law on Investment 2020. Accordingly, Clause 14 of Article 3 articulates: “Business Cooperation Contract (BCC) is a type of contract signed between investors for business cooperation, profit sharing, and product co-distribution in accordance with the provisions of the law without the need to establish a business entity.”
Under NEMs, foreign investors can enter the market with ease and trigger a new cross-border FDI project. According to Vietnamplus, “this approach allows multinational corporations to coordinate activities in the global value chain through supporting domestic suppliers, thereby strengthening the linkage among Vietnamese suppliers in the value chain. With the new form, investments will be made through trade contract mechanisms between foreign investors and domestic enterprises, and they are often provisions of brands, intellectual property rights and business know-how, technologies, skills, or business processes.”
Examples and Advantages of NEMs
Several types of contractual agreements exist and are allowed in prevalent practice under Vietnamese legislations:
Contract manufacturing or Service outsourcing is a contractual arrangement in which a MNC contracts out to a host-country firm some production, services or processing elements in its global value chain.
Contracting allows foreign investors to leverage economic arbitrages from more cost-effective local workforces and economies of scale. The investor also saves the costs of setting up a new factory and purchasing equipment, which can prove to be costly.
Licensing is a contractual agreement in which the licensor (i.e. the foreign investor with a proprietary technology, product, or brand) provides their products, services, brand and/or technology to a licensee in the host country via a contractual agreement.
This form grants the licensor affordable and low-risk entry to a new market while the licensee can tap into the competitive advantages and unique assets of a foreign firm without having to invest heavily in R&D cost. Licensing also helps the licensor to promote their brand in a new market, increasing the value and sustainable growth of the brand.
Franchising is a contractual relationship in which the right to operate a pre-existing business model is granted by a foreign investor (the franchisor) to a local business partner (the franchisee). Differing from licensing, under franchising agreements, the franchisee must pay franchise fees to the franchisor in exchange for a standardised and globally well-known brand and system that have been proven to generate profits. A popular example of this form would be global fast-food chain KFC.
Under the form of Franchising, foreign investors will always have a stable and continuous stream of profits because the terms of franchising contracts often last many years. With the profits from Franchising activities, investors can strengthen the main activities of the company or develop policies to expand and develop the business further in the future. Furthermore, Franchising also helps investors to expand the market and attract more consumers all over the world. This not only helps the investor's brand maintain a high share in the market, but also accelerate the company’s growth.
Apart from Contracting, Licensing, and Franchising, which are the three most common NEMs, others also exist for more specific business arrangements, including:
Contract farming is a contractual relationship between an international buyer and (associations of) host-country farmers or relevant intermediaries, which establishes conditions for the farming, harvesting, and marketing of agricultural products.
Management contract is a contractual relationship in which operational control of an asset in a host country is vested to an international firm, the contractor, which manages the asset in return for a fee. This structure is widely used in the hospitality industry.
Concession is a higher form of a management contract, in which the managing firm shall manage the asset in exchange for an entitlement to the profits generated by the asset. Concessions are rather complex, such as build-own-transfer (BOT) arrangements in which the foreign partner shall play the role of investor and own the asset for a period before transferring its management to the local partner. Concessions are widely used in public-private partnerships (PPPs).
Strategic alliance is a relationship between multiple firms to pursue a joint business objective which does not require the creation of a new legal entity.
Benefits of NEMs for the host country
NEMs are capable of generating significant economic and social benefits for the host country, including:
Creating a large number of jobs in developed countries: According to the UNCTAD report, it is estimated that 18-21 million people worldwide work in NEMs, mostly in the form of Contract manufacturing, Services outsourcing and Franchising. For instance, in Mozambique, contract farming has empowered more than 400,000 local small merchants to participate in the global value chain.
Generating substantial export profits: Modes such as Contract Manufacturing, Services Outsourcing or Contract Farming generate significant export value overseas and earned large foreign currency. Because the products will be produced in the country and then exported to foreign countries and domestic enterprises earn a huge profit (foreign currency).
Knowledge Transfer: Through forms such as Franchising or Licensing, small and medium-sized enterprises will have access to high-level science and technology, famous brands or even organisational structure and business secrets of manufacturers. invest. Thereby, they will learn from experience and develop their abilities more.
Helping countries participate in global value chains (GVCs): NEMs strengthen the local foundation of jobs, GDP, exports and technological development, which enables the local economy to participate more deeply and effectively in global value chains.
