Foreign Direct Investment (FDI) refers to an investment made by a foreign entity, that is, by an individual or a company, into a business based out of another country. FDI can be characterized by a notion of direct control and cannot be classified as simply a means of monetary fund transfer.
There are several ways of making a foreign direct investment into a business and the investors can expand their business in any other country. They are also eligible to acquire voting stocks along with equity in a business based in another country.
Here are a few ways for investors to penetrate a foreign market-
- Mergers & Acquisitions
- Joint ventures with business based outside their country
- Getting voting stocks in a business based overseas
- Starting a subsidiary of a domestic company in a foreign country
In this blog, you will learn about different Types of Foreign Direct Investments along with other important details about FDI. Let’s have a look.
Types of Foreign Direct Investment
There are four types of FDI available. Let’s have a closer look.
Being the most common type of FDI, Horizontal FDI, revolves around investing monetary funds into a business overseas but belonging to the same or similar sector as that owned or operated by the foreign investor.
A business is eligible to invest in another business based out of another country, but producing same or similar kinds of products and services and the core activities remaining the same.
For example, Zara, which is a Spain-based apparel country, invested in a clothing brand in India, called Fab India, which sells similar products as Zara. While both companies are from the same sector of merchandise, this kind of investment will be called Horizontal FDI.
Another example is of McDonald’s, which believed in investing in Asian countries, in order to expand their number of stores in the region.
A Vertical Investment is made within a typical supply chain in any business, which might or might not belong to a same or similar industry of goods & services. To invest as a Vertical FD investor, a business based outside their country dealing with supplying or selling of goods is their main focus.
They can also be categorized as backward or forward vertical integrations to strengthen a part of the supply chain without changing the business in any way.
For example, Costa Coffee might invest in coffee plantations in countries like Brazil, Columbia, Vietnam by purchasing a supplier in the supply chain. This can be referred to backward vertical integration.
Forward vertical integration will occur when a business in a foreign business ranked higher in the supply chain, for example, a coffee brand from the United States might wish to invest in a UK-based grocery brand.
Conglomerate Foreign Direct Investment occurs when a foreign investor invests his/her monetary funds into a business which is overseas dealing with an entirely different industry and producing completely different products or services.
FDI is not directly linked to the investor’s personal business. The main focus of this kind of investment is to add more business niches and start new journeys of business in other countries.
For example, a consumer beverage brand called Starbucks in the United States, making an investment in Titan which is a renowned watch making brand and a joint venture between the Tata Group and TIDCO all over the world.
The last but not the least, is Platform Foreign Direct Investment in which a business expands into a foreign country, but the products produced are exported to another, third country. Platform FDI is seen in free-trade zones of FDI hungry countries.
For example, almost all electronic equipment and appliances are produced in countries like China and Thailand but are sold to other countries like USA, India or France.
Another example is of the famous French perfume brand Chanel, which is produced at a manufacturing plant in the United States, and exported all over the world, to countries in Asia, America, and parts of Europe.
Advantages of Foreign Direct Investment
- Develops Investor Portfolio
Investors through FDI can achieve greater portfolio efficiency, as it enables the investor to diversify their holdings outside of a specific country, industry or a political system. A broader base of investments will enhance the overall portfolio and build strong long-term returns.
- Enhances Technology in Developing Countries
Through best management practices and excellent accounting and legal guidance by investors, foreign companies can adopt latest technology, operational practices and financing tools. It helps in enhancing the lifestyle of the employees, therefore, improving the standard of living for the people of the respective country. It also helps in reducing the influence of local governments over them.
- Provides Financing to Developing Countries
As the overseas country benefits through the foreign invest and is able to raise their standard of living, it also enables them to pay higher taxes and unfortunately, some countries offer tax incentives to attract FDI.
- Enables Long-Term Lending Relationship
While short-term investors believe in investing their “hot-money” to create an asset bubble, that is, by investing huge amounts of funds all at once and then selling them just as fast. This kind of short-term investment creates a boom-bust cycle ruining economy. On the other hand, FDI takes a longer time to set-up and has a more permanent footprint in a country.
Disadvantages of Foreign Direct Investment
- Unsuitable for Strategic Industries
According to the IMF report, countries allowing foreign ownership of companies in strategically important industries could lower the comparative advantage of the country.
- Low Moral Attachment
Foreign investors have lower moral attachment because they could strip the business without adding any value by selling unprofitable portions of the company to local and inexperienced investors.
- Illegal Access to Local Markets
Foreign investors can use the businesses collateral to acquire low-cost and local loans. They do not tend to reinvest in the business, but lend the funds back to the parent company.
To become a foreign investor, it is important to understand the different types of Foreign Direct Investments. With such investments, you are allowed to invest in any new business in a foreign country or invest in an already existing business in an overseas country.