GLOBAL BUSINESS TECHNOLOGY AND KNOWLEDGE SHARING

Greenfield Investment on Technology

Development
By Rakesh Singh Shekhawat (2016D2TS0986P)

What is a Greenfield Investment?

In economics, a greenfield investment (GI) refers to a type of foreign direct investment (FDI)
where a company establishes operations in a foreign country. In a greenfield investment, the
company constructs new facilities (sales office, manufacturing facility, etc.) cross-border from
the ground up.
According to the Bureau of Economic Analysis (BEA), a greenfield investment is a project
“where foreign investors establish a new business or expand an existing business on U.S. soil.”
A greenfield investment is a form of market entry commonly used when a company wants to
achieve the highest degree of control over foreign activities. It can be compared to other foreign
direct investments such as the purchase of foreign securities or the acquisition of a majority
stake in a foreign company in which the parent company exercises little to no control over daily
business operations.
Apart from potential tax breaks or subsidies in establishing a greenfield investment, the
overarching goal of such an investment is to achieve a high level of control over business
operations and to avoid intermediary costs.
The reasons that drive a company to pursue investment opportunities in foreign
countries;

Cutting costs.
Most western countries have high wages relative to their Asian, African and South American
counterparts. They also have cheaper resources for use in the manufacturing process. The
cheaper resources enable the company to realize low per unit costs which can be passed on to
the consumers. Mercedes Benz had this strategy when it entered the Indian market. Importing
finished units from the nearest production facility would result in higher prices that could delay
market uptake. The high import taxes would also result even higher process compared to other
brands competing in the same category. Cheaper Indian labour, lower taxes and lower cost of
main raw materials led to the decision to embark on the investment.

Expanding the product base

Entry into the foreign market offers chances of expanding the product base. To make the
company’s products appeal to the local clientele, the products must be tailored to meet the
specifications of the local market. the result is an extended and diversified product base. For
instance, VW acquisition of Skoda led to the addition of another product to sell alongside the
VW brands. Skoda, whose motherland was in the Czech Republic, closely resembles VW in
both quality and reliability. VW offered the Skoda brands for sale most of Asia, Africa and
South America.

Expand revenue base

Mature markets in the developed world offer limited prospects for growth. With the rising
incomes of emerging markets, firms are keen to exploit their potential. For instance, Mercedes
Benz entry into the Indian market followed successes of its rivals in the same market category
(Audi and BMW). The rising incomes in these emerging markets and the countries surrounding
them make for a very attractive offer for the investing firms to ignore. This contrasts with most
western markets where high gas prices and a contracting economy have forced customers to
opt for economy car models.

Competition in the domestic market

Competition is stiff in most developed markets. Customers are also discriminative and with
little switching costs, they can opt for competing brands. Often, price-based competition thins
margins making companies realize very low profitability despite low volumes. For these
reasons, firms look for options out of their domestic fronts to escape the cutting throat
competition. The best option is to venture in far flung markets surging with demand and where
competition is not based on pricing.

Underutilized capacity
Massive investment in plant and equipment leads to incurrence of very high fixed costs. To
break even, firms have to move large volumes. This implied demand cannot come from their
domestic markets and thus they venture in foreign markets to move large documents to meet
their operational expenses.

Rigid policies in the domestic market

Domestic restrictions in the local market constrict the firm’s ability to wring out profits. these
range from safety to environmental regulations that severely limit the firm’s ability to operate
profitably. Emerging markets promise fewer restrictions as they seek to attract capital into their
economies to provide employment for their surging populations. This makes these destinations
fertile grounds to acquire related firms or establish Greenfield investment.

Monopolistic advantages
Most investing firms possess operative advantage relative to the local firms. Due to their
superior investment in research and development, they have amassed a number of patents and
manufacturing skills that rivals that of domestic firms. They also have access to a lot of capital
from their home markets owing to their track record and operational relationships with major
world financiers. Therefore, these forms are able to invest in huge plants or acquire extensive
operations in foreign markets. This affords them economies of scale that is passed on to the
consumers as reduced price. foreign firms are also able to develop superior product
differentiation. The marginal cost of transferring their superior knowledge and experience in
foreign markets is lower than that of local firms that have to invest full cost to realize such
experience and knowledge advantage.
On the contrary, local firms lack financial muscle to invest in research and development. They
cannot also invest in large buyouts due to limited resources at their disposal. As a result, they
develop weak supply chains, have fewer patents and have very low economies of scale leading
to higher per unit costs.

Product life cycle

Vermon (1971) came up with this theory to explain the gradual shift tat firms experience to
foreign direct investment from exporting. At the start, firms come up with an innovative
product and enjoy monopolistic advantage at home. It therefore specializes in the production
of the innovative product and exports. It soon standardizes its production and invests abroad to
exploit its monopolistic advantages. It soon attracts competition and soon looks to venture into
other foreign markets to exploit its monopolistic powers.

Advantages of a Greenfield Investment

There are numerous advantages of a greenfield investment, including:
• High level of control over business operations
• High quality control over the manufacturing and sale of products and/or services
• High control over brand image and staffing
• Economies of scale and economies of scope can be achieved in terms of marketing,
research and development, and production
• Bypassing trade restrictions
• Creating jobs for the economy where the greenfield investment is taking place

Disadvantages of a Greenfield Investment

There are numerous disadvantages of a greenfield investment, including:
• An extremely high-risk investment – a greenfield investment is the riskiest form of
foreign direct investments
• Potentially high market entry cost (barriers to entry)
• Government regulations that may prevent foreign direct investments
• High fixed costs involved in establishing a greenfield location
Political risks that a firm may experience
Strength and stability of government
Political risks depend on a variety of factors the most important factor being the stability of
central government. The government is crucial in maintaining law and order, observing rule of
law and enforcing contracts. Without a central strong central government, it is not possible to
maintain lawful operations in the country. Secondly, the attitudes of labour unions pose
political risks. *** cite that the government is the single most important determinant of foreign
direct investment that a country holds due to its enactment of policies supportive of business.

Labour unrest
The attitude of labour unions poses enormous risks to the investing firms. Labour unions that
have extensive membership can cripple operations of a firm in their quest for higher pay for
their members. They can increase the cost of doing business and can initiate litigation leading
to enormous cost to the organization. They can also initiate wage increases that can render the
investment uncompetitive.

Government takeover of investment

There is a possibility of the government taking over the investment that a company has
established. It may be a partial or total takeover of the firm or even a forced sale of shareholding
to the local investors keen to divert policies of the company in annual general meetings through
their voting power. This is most prevalent in mining sectors. In most cases, government urges
renegotiation of contracts that had earlier been signed. This leads to incurrence of loss or lower
profits.

Political unrests
Political unrest refers to the violence that breaks out as a result of fallout of the political
processes. The general population feels that it cannot pursue political settlement due to the
weak institutions in the country and resorts violence. Violence leads to stoppage of economic
activities as looting and theft takes centre stage. Capital flows out of the country and local
people’s purchasing power erodes. Resolution process takes long even the firm’s commitment
fall due. The firm has to meet its maturing obligations from its capital as production cannot
take place.

Operational restrictions
These are restrictions that arise after establishing the operations. For instance, the regulatory
authorities can insist that the supervisory activities must be held by locals. They can also change
operational rules restricting say the opening and closing hours of business. Further, they can
also impose restrictions on repatriation of capital despite the investment from the parent
company coming from abroad. That means that foreign firms wanting to put in additional
investment to boost their operations hesitate as they have doubts as to whether they will
repatriate their investment. These add to operational risks of the firm and reduce a firm’s
competitiveness.
Mitigating measures that a firm should take to safeguard itself against
political risk
Given the risk that a firm is exposed to, it is important to take measures to safeguard it against
losses arising from the crystallization of political risk. The most common measure is to seek a
foreign investment guarantee from OPIC (Overseas Private Investment Corporation). OPIC
provides coverage against losses occurring from expropriation, war or civil disorder and non-
convertibility of profits for repatriation.
The other method entails striking harmonious chord with the local population. This means
avoiding behaviour that stirs trouble with the local government or its people. Investing firms
should engage in social responsibility initiatives and fight the impression that they have come
to exploit their natural resources.