Foreign Direct Investment Forms

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Table of Contents

Introduction
Definition
Conclusion
Works Cited

Introduction

Globalization and technology have increased the pace of foreign direct investment (FDI) across the world. This paper will discuss FDI. Specifically, the paper will discuss the various forms of FDI and it will compare FDI and other forms of penetrating foreign markets such as exporting and licensing.

Definition

FDI is a scenario where a firm in a given country invests directly in an overseas country. Under FDI, a firm can set up a new entity in the overseas country, market its products there or engage in a merger or acquisition with an existing company in the foreign country. FDI may also take the form of lending money to an overseas company (Froot 15).

Reasons why firms choose acquisition over Greenfield investments

Greenfield investment is a scenario where a firm set-ups a new business in a foreign country while acquisition involves purchasing interest in an existing business in the foreign country. There are several reasons why firms choose acquisition over Greenfield investment.

First, acquisitions are easier and faster to execute than Greenfield. The process of setting up a new production plant until it starts operations may take a long time. Besides, the firm may need to comply with a number of regulations. These difficulties make an acquisition a favorable option. Secondly, there are several risks that arise from Greenfield investment (Moran 38).

For instance, the risk of project delay or collapse is higher under Greenfield investment than acquisition. Thirdly, improving the efficiency (by providing skills and capital) of an existing business is better than setting up a new business because an existing business is already several steps ahead of a new business.

Finally, under acquisition a firm will acquire the customers of an existing business. This will enable the firm to start operations at a better level than under Greenfield investment where the company will need to attract new customers.

Reasons why FDI occurs instead of exporting or licensing

Despite the decline in the number of trade barriers over the years, FDI is still more popular than exporting or licensing. First, firms have reservations about protectionist laws that are likely to hinder export business. Secondly, implementation of democratic leadership by most countries creates a favorable environment for FDI rather than for the international trade.

Thirdly, the governments of various countries have entered into bilateral investment agreements. Such agreements aim at encouraging and shielding investment between the countries. This promotes FDI as opposed to exporting or licensing. Finally, most companies strive to increase their presence in countries across the world. This can be achieved through FDI and not exporting or licensing.

Reasons why FDIs are more profitable than the exporting or licensing

Transportation costs and trade barriers are the major drawbacks of exporting. The transport cost increases the cost of production and reduces profitability while trade barriers limit the volume and variety of commodities that can be exported. These limitations make investors prefer FDI over exporting. Also, licensing has a number of drawbacks.

First, under licensing, the firm will be compelled to give out an important technological skill to its rivals in the industry. Secondly, licensing limits the ability of the parent company to have full control over the operations of the licensed company. Some of the vital operations that the parent company may not control include manufacturing, production and strategic decisions.

The problem of licensing also arises when the success of the company is based on skills in management, production and marketing. Such skills cannot be transferred through a license. These drawbacks make companies prefer FDI over licensing (Aswathappa 256).

Conclusion

In summary, FDI is superior to other methods of penetrating into the foreign markets such as exporting and licensing. Also, it can be observed that acquisition has several advantages over Greenfield investment as a form of FDI.

Works Cited

Aswathappa, Kashlak. International Business, New York: McGraw-Hill Education, 2010. Print.

Froot, Kenneth. Foreign Direct Investment, USA: University of Chicago Press, 2008. Print.

Moran, Theodore. Foreign Direct Investment and Development: Launching a Second Generation of Policy Research – Avoiding the Mistakes of the First, Reevaluating Policies for Developed and Developing Countries, US: Peterson Institute, 2011. Print.

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