Technical Compatibility and the Mode of Foreign Entry under Network Externalities

This paper examines the preferences of a foreign firm and awelfare-maximizing host country government over two modes of foreigndirect investment (FDI): de novo entry by the foreign firm andacquisition of the domestic incumbent. Two crucial features of the modelare the presence of network externalities and (endogenously determined)partial incompatibility between the technology of the domestic incumbentand that introduced by the foreign firm. The relative impact of themodes of entry on local welfare is determined by the degree ofcompetition (more intense under de novo entry) and the magnitude of thepositive network externality (greater under acquisition). The clashbetween the foreign firm's equilibrium choice and the local government'sranking of the two modes of entry might be a potential motivation forpolicy restrictions that limit the degree of foreign ownership.