Foreign direct

investment
(FDI)
Content

• Introduction
• Definition
• Types
• Positives and negatives
• Factors affecting selection of FDI destination
Introduction

 International trade and foreign direct investment(FDI) are the two

most important international economic activity integrating the
world economy
 FDI is the largest source of external finance for developing
countries
 Plays a crucial role in development process of host country
 FDI not only serves as a source of capital inflow into host country,
but also helps to enhance the competitiveness of domestic
economy through transferring technology ,strengthening
infrastructure, raising productivity and generating new
employment opportunities.
Recent FDI in India

Sumitomo is a comprehensive housing and wood

products corporation

Spacewood is one of India premium manufacturer of modular

kitchens and furniture offering wide range of Home and
Office Furnishings.
• India's first FDI in the furniture industry
• Spacewood has received a 26% equity stake from Japan's Sumitomo
Forestry -$14 million (Rs 91 crore)
• Through the alliance, Spacewood would increase its retail footprint
from existing 15 stores to approximately 50 stores
• As a part of this alliance, Spacewood, in association with Sumitomo
Forestry Crest Co Ltd., a 100% subsidiary of Sumitomo Forestry,
will set up a new manufacturing facility for the production of pre-
hung doors.
• The company is aiming at expanding its kitchen products and
home furniture businesses to manufacturing of wooden interior
and building materials.

• Spacewood and Sumitomo Forestry desire to contribute to the

evolution of housing and enhancement of living environments in
India through the introduction and adoption of new building
materials and technology from Japan.
• FDI has often been viewed as a threat by host countries due to the
capacity of transnational investing firms to influence economic and
political affairs
• Many developing countries often fear FDI as a modern form of
economic colonialism and exploitation
Definitions

• FDI occurs when an investor based in one country(the home

country) acquires an asset in another country(the host country)with
the intent to manage it.
• Foreign Direct Investment, or FDI, is a type of investment that
involves the injection of foreign funds into an enterprise that
operates in a different country of origin from the investor.
 why FDI consider as superior to other types of
capital flows?

• Firms entering a host country through FDI have a long term

perspective in contrast to foreign lenders and portfolio investors.
Therefore, FDI flows are less volatile and easier to sustain at the
time of economic crisis
• Debt inflows may finance consumption whereas FDI is more likely
to be used to improve productivity
• Since FDI provides more than just capital by offering access to
internationally available technologies, management know-how,
And marketing skills, it is likely to have a strong impact on
economic growth
Positives
• Access to superior technology
• Increased competition
• Increase in domestic investment
• Bridging host countries foreign exchange gaps
Negative

• Market monopoly
• Crowding – out and unemployment effects
• Technology dependence
• Profit outflow
• Corruption
• National security
FDI can be done in the following ways

• In order to participate in the management of the concerned

enterprise, the stocks of the existing foreign enterprise can be
acquired
• The existing enterprise and factories can be taken over.
• A new subsidiary with 100% ownership can be established abroad.
• It is possible to participate in a joint venture through stock holdings
• New foreign branches, offices and factories can be established
• Existing foreign branches and factories can be expanded
• Minority stock acquisition, if the objective is to participate in the
management of the enterprise
• Long term lending, particularly by a parent company to
its subsidiary, when the objective is to participate in the
management of the enterprise
 Selection of FDI destinations
• Cost of capital input
• Taxation regime
• Costs of inputs
• Wage rates
• Cost of logistics
• Market demand
 Types of FDI
FDI On the basis of direction of investment inward

outward

On the basis of types of activity horizontal

vertical

On the basis of investment objectives Resource seeking

market seeking
Efficiency seeking
On the basis of entry modes Greenfield investments

Mergers and acquisitions

On the basis of sector industrial

Non-industrial

On the basis of strategic modes Export replacement

Export platforms
Domestic substitution
On the basis of direction of investment

• Inward FDI
• Outward FDI
Inward FDI

• Foreign firms taking control over domestic assets is termed as

inward FDI
• From Indian perspective, direct investments made by foreign firms
,such as Suzuki,Honda,LG,Electrolux etc. in India are examples of
inward FDI
Outward FDI

• Domestic firms investing overseas and taking control over foreign

assets is known as outward FDI
• Such outward FDI is also known as Direct Investment Abroad
(DIA)
• Tata motors, Infosys, Videocon, ONGC, Ranbaxy
On the basis of types of activity

• Horizontal FDI
• Vertical FDI
• Conglomerate FDI
Horizontal FDI

• When firm invests in a foreign country in similar production

activity as carried out in home country ,it is termed as horizontal
FDI
• Thus, horizontal FDI occurs when the multinational undertakes
the same production activities in multiple countries.
• Coke, Pepsi, HSBC, Samsung etc.. Expanded internationally by
ways of horizontal FDI
Vertical FDI

• Direct investment in industries abroad so as to either provides

inputs for the firm’s domestic operations or sell its domestic
outputs overseas is termed as vertical FDI
• Vertical FDI takes place when the multinational fragments the
production process internationally ,locating each stage of
production in the country where it can be done at the least cost.
• A firm gains control over various stages of value chain from
sourcing raw materials to manufacturing and to marketing.
types of vertical FDI

Vertical FDI

Backward FDI forward FDI

Backward FDI
• Direct investment overseas aimed at providing inputs for the firm’s
production process in home country is termed as backward
vertical FDI
• Backward FDI is common in extractive industries :gold, petroleum
extraction, bauxite
• British petroleum and shell have expanded their international
business by backward FDI
• Ex: hindalco owns copper mines in Australia from 2003
• Companies that seek to enter into a backward vertical FDI typically seek
to improve to the cost of raw materials or the supply of certain key
components.
• For example, one of the major materials used for car manufacturing is
steel. An American car manufacturer would prefer that steel be as cheap
as possible, but the price of steel can fluctuate dramatically depending on
overall supply and demand. Furthermore, the foreign steel supplier
would prefer to sell steel for as high as possible in order to please its
owners or shareholders. If the car manufacturer acquires the foreign steel
supplier, the car manufacturer would no longer need to deal with the
steel supplier and its market-driven prices.
Forward vertical FDI

• Direct investment in a foreign country aimed to sell the output of

the firm’s domestic production process is referred to as forward
vertical FDI
• Setting up a marketing network ,assembly, or mixing operations
overseas are illustrations of forward vertical FDI

• the need for a forward vertical FDI stems from the problem of
finding distributors for a specific market
• For example, assume that the before-mentioned American car
manufacturer wants to sell its cars in the Japanese auto market.
Since many Japanese auto dealers do not wish to carry foreign
brand vehicles, the American car manufacturer may have a very
difficult time finding a distributor. In this case, the manufacturer
would build its own distribution network in Japan to fulfill this
niche.
Conglomerate FDI

• Direct investment overseas aimed at manufacturing products not

manufactured by the firm in home country is termed as
conglomerate FDI
On the basis of investment objectives

• Resource –seeking FDI

• Market –seeking FDI
• Efficiency –seeking FDI
Resource –seeking FDI

• In order to gain privileged access to resources with regard to

competitors, MNE invest in countries with availability of natural
resources
• This ensure the MNE of stability of raw material supply at right
prices
• The major determinants for resource seeking FDI include:
 Availability of raw materials
 Complementary factors of production
 Physical infrastructure
• when resource abundant countries lack capital and necessary
technical skills for resource extractions, such FDI is favored.
• Common in sectors like steel, copper, bauxite, agro processing….
• Morocco is an investment destination for TATA chemicals because
the country holds 60% of the world’s phosphate resources
market –seeking FDI

• MNEs invest in countries with sizable market and growth

opportunities in order to protect existing markets, counteract
competitors and to preclude rivals or potential rivals from gaining
new markets
• The major determinants of market-seeking FDI include :
 Market size
 Market growth
 Regional integration
• Market seeking FDI are often favored by MNEs in large number of
durable and non-durable consumer goods, such as automobiles,
computers, processed foods, cigarettes
Efficiency seeking FDI

• A firm may strategically opt for efficiency-seeking FDI as a part of

regional or global product rationalization and/or to gain
advantages of process specialization.
• Efficiency seeking FDI provides the investing firm not only access
to markets but also economies of scope ,geographical
diversification ,and international sourcing of inputs.
• Major determinants are :
 Productivity adjusted labour costs
 Availability of skilled labour
 Availability of business related services
 Trade policy
On the Basis of entry modes

• Greenfield investments
• Mergers and acquisitions
Greenfield investments

• Investing in creation of new facilities or expansion of existing

facilities is termed as greenfield investment.
• A form of foreign direct investment where a parent company starts
a new venture in a foreign country by constructing new operational
facilities from the ground up. In addition to building new facilities,
most parent companies also create new long-term jobs in the
foreign country by hiring new employees.
• Coca-Cola, McDonald’s and Starbucks
Advantages of a greenfield investment

• You will achieve economies of scale and scope in production, marketing,

finance, research and development, transportation and purchasing.
• You will have greater control of all aspects of the business.
• You will be able to implement the best long-term strategy.
• Commitment to the market will be solid.
• Vendor financing is often available.
• You can work with the relevant authorities from the beginning.
• You will have control over your brand.
• You will have control over your staff.
• There will be press opportunities.
Against the greenfield approach

• It is likely to cost more.

• Competition will be difficult to overcome.
• The entry process may take years.
• The barriers to entry can be costly.
• Governmental regulations may put multinational enterprises at a
disadvantage in the short term.
Mergers and acquisitions

• For establishing overseas production facilities, mergers and

acquisitions are crucial tools for a firm’s internationalization
strategy
• A merger is a legal consolidation of two companies into one entity
• An acquisition occurs when one company takes over another and
completely establishes itself as the new owner. Such purchase may
be of 100%, or nearly 100%, of the assets or ownership equity of the
acquired entity
• The distinction between a "merger" and an "acquisition" has
become increasingly blurred in various respectsalthough it has not
completely disappeared in all situations
Heinz and Kraft Foods: $62.6B

• The biggest completed deal of 2015 so far, this merger between the
two food and beverage giants was valued at $62.6 billion. The
newly created Kraft Heinz Company is the third-largest food
company in the U.S. and fifth-largest in the world, measured by
annual sales.
Dell to Buy EMC in Deal Worth About $67 Billion

• Dell is buying EMC, a $50 billion publicly traded IT giant for

around $67 billion in one of the tech industry's biggest mergers
ever
• The major foreign MNE acquiring indian firms duiring 2005- 2007:
Vodafone- Hutchison essar, maxis& Apollo hospitals – Aircel,
• Major acquisition by Indian firms are :
Jsw steels- Jindal united steel, suzlon energy – RE power
On the basis of sector

• Industrial FDI
• Non-industrial FDI
Industrial FDI

• Investment by foreign firms in manufacturing sector is termed as

industrial FDI
Factors:
 To achieve cost efficiencies by way of taking advantage of
availability of raw material inputs and manpower at cheaper costs.
 To bypass trade barriers such as high import tariffs and other
import restrictions
 To be closer to the markets and serve them more efficiency
 To have physical presence due to strategic reasons
Non-industrial FDI

• Investment by a foreign firm in services sector is termed as non-

industrial sector.
On the basis of strategic modes

• Export replacement
• Export platforms
• Domestic substitution
Export replacement

• In response to trade barriers of host country,such as import

restrictions and prohibitive tariff structure,FDI is made a substitute
for exports.
• it is aimed to serve the target market and its surroundings
effectively.
• Entry mode for such types of FDI is typically through M&As.
• Countries with high per capita income are generally targeted for
export replacement FDI
Export platforms

• In order to minimize a firm’s cost of production and distribution,

FDI is made so as to utilize the target country to serve the global
markets.
• The competitive advantage and incentives offered by the host
country plays a crucial role in attracting such FDI
• Greenfield investment is often the mode of entry in such target
markets as these have relatively low per capita income
Domestic substitution

• Firms invest in foreign countries so as to serve investors home

country
• The basic objective of firms in this kind of FDI is to obtain cheap
inputs to support home substitutions.
• Firms generally target countries with middle to high per capital
income, using the greenfield operations as the entry mode
Reference
1.Times of India
2. International business - Rakesh Mohan Joshi
3.International business – Justin Paul
4.International business –Vishal Kumar
5. bgr.in
6. economictimes.indiatimes.com
7. fdiintelligence.com
8. scribd.com