NOTE: THIS CASE IS OUTDATED! THIS PAGE IS IN NO WAY ASSOCIATED WITH Falconbridge Dominicana.
FALCONDO
The Falcondo case demonstrates the potential political problems that may confront multinational corporations. These political issues may, if not properly managed, escalate to the point of no return in negotiations, further leading to domestication or shut-down of operations. Naturally, the preferred solution to many of these problems that may arise between host nations and multinational entities should be mutually beneficial to both partners and result in a "win-win" solution. In practice, however, such a solution is extremely difficult to find, and often even more difficult to enforce properly. The recommendations in this case are aimed at finding such a solution to the Falcondo- Dominican Republic (DR) conflict.
BACKGROUND
The strategic importance of nickel is demonstrated by its physical strength and the wide range of products in which the product is used. However, substitutes such as Plastics and aluminum are effective and readily available, but expensive. Before 1984, the demand for nickel was low and overproduction flooded the market causing prices to decrease. In order to reduce large inventory levels, demand was higher than production. Suddenly, in 1987, there was a world wide deficit in the commodity and prices increased. Falconbridge is predicting a future long-term annual growth rate of 2 percent in the worldwide demand of nickel.
Falcondo was the largest industrial project undertaken in DR. With its poor economy and high unemployment rate, Falcondo was seen an excellent opportunity and an effective Foreign Direct investment aimed at increasing exports, reducing unemployment and increasing technical competence (refer appendix 3). Due to favorable interest concessions granted by the DR, the project was to a large degree funded by debt and Falconbridge, together with US based Armco Steel owned 90 percent of the equity. The debt was raised from three large American insurance companies. Such a debt structure would ensure US-support by diversifying risk to American based companies and high interest expenses would decrease taxable income in DR (tax rate is 33%). Furthermore, Falcondo did not have to pay import and export taxes and revenue from operations would be placed in New York in order to avoid foreign exchange risks.
Primarily, due to high energy costs of producing nickel out of Laterite ores, the oil-shocks of the 1970's and a decrease in worldwide demand, Falcondo operated at a loss until 1987. Due to tax loss carry-forwards, Falcondo only paid $13 million (1972-1987) in taxes on exports valued at $ 1 billion since 1982. The worsening state of the DR economy in 1987 and the desperate need of financial resources, President Balaguer imposed export taxes on nickel. This move was justified by that the nation had received few benefits from Falconbridge in return for its natural resources and environmental degradation. In 1987, the DR mine employed 1500 employees, 12 expatriates and 150 local engineers. Laterite reserves in DR would last approximately 19 years at current production rates. Refer appendix 2 for a PESTE analysis of DR.
THE CONFLICT.
The dispute centers on a newly imposed export duly on minerals and sugar that at current exchange rates would amount to about 25 percent of the value of material shipped. Falconbridge refused to pay the duty, calling it prohibitive, and sought to make payments to the government through some other type of tax. Rapid changes of people in DR's political agencies and the absence of a Canadian embassy further increased the complexity of negotiations. In March 1988, the partners were far from an agreement and negotiations halted. Due to the global importance of Nickel and financial commitment from US financing firms, the dispute between DR and Falcondo quickly escalated to indirectly involve the USA. At the same time, the DR was actively seeking Foreign Direct Investment (FDI) to improve economy. The essence of the conflict lays in the fact that DR wants more of the profit cake in return for its natural resources, and Falcondo, facing profitability uncertainties and thus finding it difficult to comply to major negative tax changes. Refer appendix 4 for host government cost/benefit perceptions of FDI.
BARGAINING POWER RELATIONSHIPS.
Clearly, as indicated in Appendix 1, the bargaining power of the two conflicting partners is well balanced. That supports the high degree of complexity of the conflict. Beamish et al. note that "the political cost for very high-profile firms tries to affect the political as well as the economic costs of intervention" (1994: 192).
Falconbridge faces high political and economic costs if it decides to shut-down operations in DR. The firm holds the majority of the debt financing of the plant and considerable investments will be lost if operations are ceased. More importantly, a potential future source of revenue might be lost to a competitor. Furthermore, the fifteen expatriate personnel would have to be relocated at considerable costs. Furthermore, there are potential political consequences such as a possible negative image perceived by the world community. The company will also lose its market bargaining position by no longer being the World's second largest nickel producer. Knowledge, access to international markets and capital represent the main sources bargaining leverage. Its bargaining power is directly related to international commodity prices of oil and nickel, which in turn determine the profitability of operations. Furthermore, Falconbridge is not ready to give-up its subsidiary. Especially not now when profits can compensate for the heavy losses accumulated in earlier years.
The DR would also encounter severe political and economic consequences if a solution cannot be found. First, the nation has to improve its economy. FDI is an effective means for a developing nation to acquire valuable foreign exchange throughout export enhancement programs, provide employment and knowledge, and increase access to overseas markets. If Falcondo is forced to leave through domestication measures, it will be very difficult for the DR to attract future valuable FDI. Political instability is already a potential obstacle to the promotion of the nation. There is also the potential for further political or military involvement from the USA. Economic side-effects include the loss of export markets, increase in unemployment, and the loss in tax revenue. Even if there are 150 local engineers employed, Falcondo has bargaining leverage in its knowledge base and international networks. It is likely that DR will not be able to effectively run the mine without the support from its Canadian partners. DR has significant bargaining power of natural resources, regulations and labor but it is tied-up in using it due to the strategic importance of the industry. However, it is possible for the DR to block regular exports from the Falcondo plant. Its bargaining base can be further enhanced by the opening of another Nickel producing facility, reducing dependency on Falcondo as the sole operator.
As demonstrated above, there is no direct benefiting partner if Falcondo closes operations. Falcondo is profitable under present economic conditions and Worldwide market prices of nickel and oil. Thus, recommendations will focus on a strategy that will more fairly share the profits from operations and ensure the future existence of Falcondo in DR. At this point in time, both partners are loosing and unreliable deliveries upset potential customers.
RECOMMENDATIONS.
The DR clearly expected Falcondo to bring in the discussed side effects of FDI and Falcondo's main objective was profit maximization. An ultimate solution to the problem is one that incorporates expectations into a commonly accepted strategy. The very first and fundamental strategy component is to formulate an effective team of negotiators. The host government in particular has to ensure that negotiating partners of its behalf are not transferred elsewhere during the process. Having a team of effective and professional liaisons is crucial. It is very difficult to negotiate with different people all the time and also impossible to reach a consensus. Furthermore, as the negotiating staff at Falcondo already anticipated, the operating contract from 1969 has to be re-negotiated.
The possibility of establishing an arbitrator committee consisting of neutral partners leading the way in negotiation should only be explored if there is a solid dead-lock in negotiations. Presently, none of the partners are interested in such a committee and rather prefer to solve the conflict amongst themselves. With this attitude, it is highly questionable whether the partners will adhere to the rulings of such an arbitration committee.
The equity composition of Falcondo is one-sided. After acquiring shares from Armco Steel, Falconbridge had approximately 90 percent of all equity. In order to increase the partnership atmosphere, substituting the present forced dependency on each other, a new equity sharing plan is proposed. Taxes which are historically owed to DR should be paid in equity and in local managerial control. This will facilitate a common negotiating platform on which common objectives can replace adverse ones.
Together with equity sharing, increasing the competitiveness of Falcondo is in the interest of both partners. The uniform export taxes, linked to the Peso will not strengthen its competitive position. Instead of such export duties, tax rates should be tied to market prices for nickel rather than overall corporate earnings (based on the London Metal Exchange). This will decrease the dependence on the highly unstable Peso and further increase the influx of much needed foreign exchange to the nation. Strong market prices will therefore increase DR's tax revenue on the expense of Falcondo's profits.
In addition, Falcondo should ensure stable employment, even throughout poor market conditions. If the plant has to be temporary closed again due to high inventory levels and low sales, employees should be kept on the payroll. This is representing an excellent way for Falcondo to show some goodwill for a low price. Also, environmental concerns raised by the population have to be taken seriously.
The profitability potential of Falcondo is largely dependent on international commodity prices on oil and nickel. If prices on oil increase dramatically and prices on nickel decrease, it is very difficult to justify the future existence of Falcondo's operations in DR. Such macro-economic factors together with host government intervention can justify a possible shut-down of the subsidiary from both associates.
CONCLUSION.
Due to the well balanced bargaining position between the DR and Falconbridge, a shut down of Falcondo would be negative for both partners. However, market trends together with increasing costs of production and high interest payments make Falcondo an extremely profit sensitive operation. The proposed recommendations will produce an effective negotiating committee responsible for amending the operating contract form 1969, increase the Partnership relationship between the DR and Falcondo by equity redistribution, introduce a new export-tax based upon the market price of nickel, and finally, build-up nation level confidence via several goodwill measures. To maintain Falcondo profitable is after all in the good interest of all stakeholders. However, decreasing nickel prices and threats of substitute products are perhaps more detrimental to the existence of the subsidiary than the conflict itself.
APPENDIX 2
PESTE- POLITICAL, ECONOMIC, SOCIAL, TECHNOLOGICAL and ECOLOGICAL ANALYSIS OF THE DOMINICAN REPUBLIC.
POLITICAL
Moderately Unstable
Single Party Rule (Dictator)
International Involvement in Domestic Politics (US)
ECONOMIC
Poor economic performance, poor economic growth
High unemployment
Low level of development
Focus on primary industry
High foreign debt
Declining value of the Peso
Low per Capita income levels
SOCIAL
Unequal income distribution
Low life expectancy (57 years)
Predominately one ethnic group
TECHNOLOGICAL
Low technological base
Foreign dependency upon technology
ECOLOGICAL
Potential for mining exists
Rising concerns over environmental issues amongst the population
Small island nation with a large population (high population density)