What is Foreign Direct Investment (FDI)?
Foreign direct investment (FDI) is an investment made by a firm or individual in one country into business interests located in another country. Generally, FDI takes place when an investor establishes foreign business operations or acquires foreign business assets, including establishing ownership or controlling interest in a foreign company. Foreign direct investments are distinguished from portfolio investments in which an investor merely purchases equities of foreign-based companies.
Foreign Direct Investment
Breaking Down Foreign Direct Investment
Foreign direct investments are commonly made in open economies that offer a skilled workforce and above-average growth prospects for the investor, as opposed to tightly regulated economies. Foreign direct investment frequently involves more than just a capital investment. It may include provisions of management or technology as well. The key feature of foreign direct investment is that it establishes either effective control of, or at least substantial influence over, the decision-making of a foreign business.
The Bureau of Economic Analysis (BEA), which tracks expenditures by foreign direct investors into U.S. businesses, reported total FDI into U.S. businesses of $259.7 billion in 2017, marking a 32% decrease from the prior year. As per usual, acquisitions made up the overwhelming majority of new foreign direct investments into the U.S., totaling $253.2 billion. Meanwhile, greenfield investments, a type of FDI defined by the BEA as investments to either establish a new business or to expand an existing foreign-owned business, comprised a much lighter $6.5 billion.
Methods of Foreign Direct Investment
Foreign direct investments can be made in a variety of ways, including the opening of a subsidiary or associate company in a foreign country, acquiring a controlling interest in an existing foreign company, or by means of a merger or joint venture with a foreign company.
The threshold for a foreign direct investment that establishes a controlling interest, per guidelines established by the Organisation of Economic Co-operation and Development (OECD), is a minimum 10% ownership stake in a foreign-based company. However, that definition is flexible, as there are instances where effective controlling interest in a firm can be established with less than 10% of the company's voting shares.
Types of Foreign Direct Investment
Foreign direct investments are commonly categorized as being horizontal, vertical or conglomerate. A horizontal direct investment refers to the investor establishing the same type of business operation in a foreign country as it operates in its home country, for example, a cell phone provider based in the United States opening stores in China. A vertical investment is one in which different but related business activities from the investor's main business are established or acquired in a foreign country, such as when a manufacturing company acquires an interest in a foreign company that supplies parts or raw materials required for the manufacturing company to make its products.
A conglomerate type of foreign direct investment is one where a company or individual makes a foreign investment in a business that is unrelated to its existing business in its home country. Since this type of investment involves entering an industry in which the investor has no previous experience, it often takes the form of a joint venture with a foreign company already operating in the industry.
Impact of Foreign Direct Investments
Foreign direct investments and the laws governing them can be pivotal to a company's growth strategy. In 2017, for example, U.S.-based Apple announced a $507.1 million investment to boost its research and development work in China, Apple's third-largest market behind the Americas and Europe. The announced investment relayed CEO Tim Cook's bullishness toward the Chinese market despite a 12% year-over-year decline in Apple's Greater China revenue in the quarter preceding the announcement. China's economy has been fueled by an influx of FDI targeting the nation's high-tech manufacturing and services, which according to China's Ministry of Commerce, grew 11.1% and 20.4% year over year, respectively, in the first half of 2017. Meanwhile, relaxed FDI regulation in India now allows 100% foreign direct investment in single-brand retail without government approval. The regulatory decision reportedly facilitates Apple's desire to open a physical store in the Indian market, where the firm's iPhones have thus far only been available through third-party physical and online retailers.