The different types of FDI
The different types of FDI
Types of Foreign Direct Investment (FDI): Foreign direct investment may be classified under various heads depending upon the criteria used.
Major types of FDI are discussed here:
(i) On the Basis of Direction of Investment:
1. Inward FDI: Foreign firms taking control over domestic assets is termed as inward FDI. From an Indian perspective, direct investments made by foreign firms, such as Suzuki, Honda, LG, Samsung, General Motors, Electrolux, etc., in India are examples of inward FDI.
2. 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). From the Indian point of view, direct investments overseas by Indian firms, such as Tata Motors, Infosys, Videocon, ONGC, Ranbaxy, etc., are illustrations of outward FDI.
(ii) On the Basis of Types of Activity:
1. Horizontal FDI: When a 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. Horizontal FDI enables the investing firm to exploit its competitive advantage in the host country. Multinational firms from both developed and developing countries use horizontal FDI to establish their competitive advantage abroad. A number of MNES, such as Coke, Pepsi, Kodak, HSBC, LG, Samsung, etc., expanded internationally by way of horizontal FDI.
2. Vertical FDI: Direct investment in industries abroad so as to either provide inputs for the firm’s domestic operations or sell its domestic outputs overseas is termed as vertical FDI. Thus, 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 the value chain from sourcing raw materials to manufacturing and to marketing. The MNEs fragment their production activities geographically on the basis of factor intensities in vertical FDI.
3. Backward vertical FDI: Direct investment overseas aimed at providing inputs for the firm’s production processes in the home country is termed as backward vertical FDI.
Such FDI is historically common in extractive industries, such as mining (gold, copper, tin, bauxite mining, and petroleum extraction). Companies like British Petroleum and Shell have expanded their international business by backward vertical FDI.
4. Forward vertical FDI: Direct investment in a foreign country aimed to sell the output of the firm’s domestic production processes is referred to as forward vertical FDI. Setting up a marketing network, assembly, or mixing operations overseas are illustrations of forward vertical FDI.
5. Conglomerate FDI: Direct investment overseas aimed at manufacturing products not manufactured by the firm in the home country is termed as conglomerate FDI.
(iii) On the Basis of Investment Objectives:
1. Resource-seeking FDI: In order to gain privileged access to resources vis-a-vis competitors, MNEs invest in countries with availability of natural resources. This ensures the MNE of stability of raw material supply at right prices.
2. 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
(iv) On the Basis of Entry Modes: On the basis of entry modes, foreign direct investment may be of the following two types: Greenfield investments: Investing in creation of new facilities or expansion of existing facilities is termed as Greenfield investment. Firms often enter international markets by way of Greenfield investments in industries where technological skills and production technology are the key.
(v) On the Basis of Sector:
1. Industrial FDI: Investment by foreign firms in the manufacturing sector is termed as industrial FDI.
2. Non-industrial FDI: Investment by a foreign firm in services sector is termed as non-industrial FDI.
(vi) On the Basis of Strategic Modes:
1. Export replacement: In response to trade barriers of the 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.
2. 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 the 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.
3. Domestic substitution: Firms invest in foreign countries so as to use firms in this kind of FDI is to obtain cheap inputs to support home production. the target as a base to serve investors home country. The basic objective of Bilateral trade agreements play an important role in FDIs to promote substitutions. Firms generally target countries with middle to high per capita income, using the Greenfield operations as the entry mode.
