Foreign direct investment used to involve a company investing in building or upgrading a factory in another country.
Today, this definition has been expanded to include the acquisition of a controlling interest in a company in another market. Under this definition, there are several ways in which companies can invest directly in foreign markets:
- Construction of facilities or investment in facilities in a foreign market (Greenfield investments)
- Mergers and acquisitions
- Investment in a joint venture located in a foreign market
However, most foreign direct investment is still made by large companies investing in the construction of facilities abroad.
Globalization has led to increased flows of inward investment between countries & created benefits for recipient countries. #TradeElite
— Lynda Arsenault (@LyndaEllenA) November 6, 2014
Reasons for foreign direct investment
Some of the many reasons why companies consider making direct investments in a foreign market are:
- Some governments prohibit or limit imports of goods produced in other countries, but a company can build a production site in the foreign market and produce locally.
- Producing goods in the target market avoids import duties and other taxes and the requirement for import permits.
- Companies can obtain the services of skilled employees in the target market or gain intelligence held by people in that market.
- In certain countries, companies can take advantage of lower costs, such as cheaper labour.
- Companies can become more competitive.
Whatever the reason for making an investment decision, it should be in the context of what the firm wants to achieve strategically.
The choice of strategy will, in most cases, determine the mode of entry.
Investment to gain access to closed markets
Investments are often made in countries as a way of gaining access to markets that are closed or limited by trade barriers, procurement practices or government regulations. For example, the defence sector in most countries usually requires local participation. In some cases, this means manufacturing the contracted equipment in the country.
Using foreign direct investment for intelligence
Companies can also make investments as a way of securing information or intelligence.
— Becky Park DeStigter (@intlentreprenr) November 6, 2014
High-tech companies can invest in research and development consortia as a way to find out what others are doing. Other companies can use investment as a window into a market, helping them gather information and intelligence on market dynamics and the operations of competitors that would not otherwise be available.
Taking advantage of lower costs
Traditionally, investment decisions were based on low factor costs, including inexpensive labour and cheap raw materials. While these continue to be important in many industries, companies today also demand innovation, access to technology and other things that give them a competitive advantage.
Factor costs are not enduring. Currency devaluation, runaway inflation and improved standards of living can all have an impact on costs. Singapore and Hong Kong were traditionally low-cost countries, but they have been overtaken by India, China and Vietnam, where costs are even lower. If factor costs are an essential element of competitiveness, the company’s strategy must be flexible enough to change locations, partners and venues to take advantage of shifting cost structures.
Foreign direct investment to enhance competitiveness
Investments can be made to enhance a competitive position or to anticipate and counter the actions of competitors.
There can be strong advantages to being the first to develop a market, such as Eastern Europe, where there is a high demand for western services and products with strong brand-name recognition. Such a strategy can yield a competitive advantage that can last for years.
— Doug Taylor (@globethoughts) November 6, 2014