What is a Foreign Direct Investment?

Foreign direct investment (FDI) refers to a company from one country making an investment in another country. This investment can be a physical investment, such as building a factory, purchasing land, or mining. Purchasing a controlling interest in an existing foreign company is also considered a foreign direct investment.

Joint ventures and reciprocal trade agreements are other types of FDIs. A joint venture includes two or more companies financing and managing the investment in the foreign country. In a reciprocal trade agreement, two companies that produce similar goods agree to act as distributor for each other in their home countries. When a company licenses its products, and they are produced in a foreign country by another company, this is also a form of FDI.

When a company makes this type of FDI to expand its business in another country, this is called a horizontal foreign direct investment. A Japanese car maker building a factory in the United States, or purchasing a controlling interest in an American car maker, are examples of horizontal FDI. Companies can also make vertical FDIs to increase sales and grow the business.

Vertical FDI occurs when a company takes on the role of either supplier or distributor for its finished products. When a Japanese car maker builds an auto parts plant in the United States or buys a car dealer to sell its cars, the Japanese company has made a vertical FDI. Taking on the role of supplier refers to backward vertical FDI. Companies that become the distributor of their products in another country are practicing forward vertical foreign direct investment.

All types of foreign direct investments can benefit the company. FDIs can increase goodwill in the foreign country by creating jobs. The cost of the finished product may also be lowered since the goods do not have to be imported. This can, in turn, reduce pressure from local governments to supply locally produced products. FDI can also help significantly increase production and lower production costs.

A company that wants to make a foreign direct investment must consider several factors when making such an investment to access new markets. The company must take stock of its internal resources to ensure it has the manpower and financial strength to support the new venture. It must also analyze the sales potential for its product in the new market. This includes determining its competitiveness against companies already producing similar products in the new target market.