Direct foreign investment

From CEOpedia | Management online

Direct foreign investment (DFI) is an investment made by a foreign entity into a domestic business or economy. It can take the form of a foreign company setting up a subsidiary or joint venture in the domestic country, or acquiring a controlling interest in a domestic business. DFI is a type of international investment which involves the transfer of capital, technology, management and other resources from one country to another. It is typically undertaken with the purpose of expanding a company’s operations or gaining access to new markets. The foreign investor assumes some degree of ownership and control in the domestic business, which can lead to greater economic growth and job creation.

Example of direct foreign investment

  • An example of direct foreign investment is the acquisition of a controlling interest in a domestic business by a foreign company. This could include a foreign company purchasing shares in a domestic company, setting up a joint venture with a domestic business or investing in the expansion of an existing domestic business. A famous example of this is the acquisition of German automaker Volkswagen by the Japanese company Suzuki in 2009. By doing this, Suzuki was able to gain access to the European market and expand its global presence.
  • Another example of direct foreign investment is a foreign company setting up a subsidiary or joint venture in a domestic country. This is often done for the purpose of gaining access to the domestic country's resources and markets. A famous example of this is when Chinese company Tencent Holdings set up a subsidiary in India in 2018. By doing this, Tencent was able to enter the Indian market and gain access to the country's large population.
  • Finally, a foreign company can also invest in the expansion of a domestic business. This can involve providing capital for the expansion of an existing business or providing technology and expertise to help the business grow. A famous example of this is when Apple Inc. provided capital for the expansion of Foxconn's production facility in India in 2016. By doing this, Apple was able to gain access to the Indian market and expand its global presence.

When to use direct foreign investment

Direct foreign investment is a useful tool for multinational companies who are looking for new opportunities for expansion and growth. It can be beneficial for both the foreign investor and the domestic business, providing access to new capital, technology, and markets. DFI is particularly useful in the following situations:

  • When a company is looking to expand into a new market that is geographically distant from its current operations. DFI can provide the foreign investor with a foothold in the local market, allowing it to access local resources, customers, and regulatory and legal frameworks.
  • When a company wants to gain access to new technology, processes, and management expertise. By investing in a local company, the foreign investor can gain access to these resources without having to develop them internally.
  • When a company wants to diversify its business operations. DFI can provide the foreign investor with access to new markets and industries, allowing the company to spread its risk across multiple markets and industries.
  • When a company wants to increase its market share in an industry. By acquiring a controlling interest in a domestic business, the foreign investor can gain access to a larger customer base and greater market share.
  • When a company is looking to acquire a strategic asset. Direct foreign investment can be used to acquire a local business that holds a strategic asset such as a valuable patent or brand.

Types of direct foreign investment

Direct foreign investment can take on a variety of forms. The following are some of the most common types:

  • Greenfield Investment: This type of DFI involves the foreign investor setting up a new business in the domestic country, providing capital and technology, and creating jobs in the process.
  • Mergers and Acquisitions: This type of DFI involves the foreign investor acquiring a controlling stake in an existing, domestic business. This can provide the foreign investor with access to new markets and technology and can also lead to increased efficiency and job creation.
  • Joint Ventures: Joint ventures involve two or more entities collaborating to form a new business or expand an existing one. This can provide access to new markets and technology, and can also lead to increased efficiency and job creation.
  • Portfolio Investment: Portfolio investment involves the foreign investor buying stocks, bonds and other financial instruments in the domestic country. This type of DFI can provide access to new markets and provide capital for domestic businesses.
  • Franchising: Franchising involves a foreign investor providing capital and expertise to a domestic business in exchange for a percentage of the profits. This type of DFI can provide access to new markets and technology, and can also lead to increased efficiency and job creation.

Advantages of direct foreign investment

Direct foreign investment (DFI) can bring a range of advantages to a domestic economy. These include:

  • Increased Foreign Exchange: DFI brings funds from abroad, helping to increase the foreign exchange reserves of the country. This in turn can help the domestic currency to appreciate in value, leading to increased purchasing power for the domestic population.
  • Increased Productivity: DFI can bring with it technological and managerial expertise from abroad, leading to increased efficiency and productivity. This can help to create a more competitive local environment and spur economic growth.
  • Job Creation: DFI can create new jobs in the domestic economy, leading to increased economic activity and income.
  • Increased Competition: DFI can help to create a more competitive business environment, encouraging domestic companies to become more innovative and efficient in order to compete.
  • Capital Inflow: DFI can help to attract capital from abroad, which can be used to fund domestic projects, such as infrastructure development and research and development. This can help to stimulate economic activity and growth.

Limitations of direct foreign investment

Direct foreign investment (DFI) can be a powerful tool to grow an economy, but there are certain limitations associated with it as well. These include:

  • Loss of control by the domestic business: As the foreign investor gains a controlling interest in the domestic business, the local owners may lose some control over the decision-making process. This can lead to a lack of local influence over the company’s activities.
  • Risk of market saturation: With too many foreign companies operating in the same market, competition can become intense, leading to decreased profits for the domestic businesses.
  • Political risks: Changes in the political climate can affect the foreign investor’s ability to do business in the domestic market. This could include changes in tax laws, restrictions on foreign ownership or changes in the regulatory environment.
  • Exchange rate risk: Fluctuations in the exchange rate can affect the profitability of the investment, as profits earned in the domestic currency may be worth less when they are converted back to the foreign investor’s currency.
  • Cultural differences: Different business cultures can present a challenge to foreign investors, as the expectations of the local population may differ from the foreign investor’s. This can lead to misunderstandings and conflicts.


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References

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