Decoding the Different Types of Foreign Direct Investments (FDI)

Topics Covered:

• What is FDI?
• Types of FDI
• Conclusion

What is FDI?

Before delving deeper, it is essential to understand the meaning of FDI. It is the investment made by individuals, companies, and entities of a country in foreign business interests. Investment can be made in a foreign company or a business venture. Usually, investors from foreign locations acquire ownership stakes in companies in the host country. The FDI of a country will include investments from foreign governments, companies, and individuals. The FDI of a nation represents the foreign interest and health of the economy. When inward investment is high, it represents the booming business environment of the country. Let us now discuss the different types of FDI in detail.

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Types of FDI

New investors often start venturing into foreign markets without understanding the basics. By knowing the types of FDIs first, beginners can make informed decisions. Here are the different types of FDI in detail:

Horizontal FDI

Horizontal FDI is the investment made by a domestic company into a foreign entity belonging to the same industry. For instance, a domestic company involved in fast fashion products invests in a foreign company offering the same products. You can say that the domestic company tries to replicate its existing business conditions in a foreign country through horizontal FDI. Among the types of FDIs, you might see this often in your surroundings.

Horizontal FDI usually occurs when companies open a new branch or subsidiary in a foreign location. It can be seen as an expansion of the company or entity in foreign locations. Horizontal FDI can also occur in the form of Mergers and Acquisitions. A company might merge with/or acquire a foreign entity belonging to the same industry. Horizontal FDI is profitable for businesses, as they can drive revenue from foreign locations and expand their market share.

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Vertical FDI

It occurs when a business invests in different supply chain processes in foreign locations. Investments are made across different stages of production in foreign countries. Vertical FDI can occur in two ways. The first is when a company invests in foreign countries' lower stages of the supply chain. Raw material extraction, manufacturing, and other lower stages of the supply chain are considered. It is also known as backward integration, a sub-type of vertical FDI.

On the other hand, a company or entity might invest in higher stages of the supply chain in foreign locations. For instance, a diamond distribution company can invest in a foreign company known for marketing diamond jewellery. This type of vertical FDI is referred to as forward integration. While backward integration may not be of the same industry, forward integrations usually occur within related or the same industry.

Conglomerate FDI

There might be cases when a domestic company invests in a completely unrelated foreign entity. When an investor indulges in foreign direct investments unrelated to existing businesses in the domestic company, it is called a conglomerate FDI. For example, a domestic pharma company might choose to invest in a foreign company manufacturing automobiles. In such a case, the pharma and automobile industries are not closely related.

Conglomerate FDI is not everyone’s cup of tea. An investor might find it challenging to indulge in entirely new operations in a foreign land. Most companies prefer indulging in the same industry when in a foreign land. Setting up an entirely new business or acquiring a foreign company in an unrelated industry can be challenging. Companies and investors with ample capital and experience indulge in conglomerate FDI. Among the types of FDIs, conglomerate FDI is used by companies for diversification.

Platform FDI

You might have observed large-scale companies or MNCs (Multinational Corporations) using a country as their platform/hub for global operations. A foreign country might be selected as a hub for its global operations. In such a case, the company using a foreign country as a hub for its global operations is indulging in platform FDI. Among the types of FDIs, platform FDI is a complex one. For the same rationale, MNCs and large-scale companies indulge in platform FDI.

Let us understand the concept of platform FDI with an example. Let us say that a global MNC has established its R&D (Research and Development) centre in India. The global MNC also chooses India as its hub for manufacturing, distribution, and supply chain optimisation. The Indian business landscape offers market access to all other Asian countries. In such a case, the global MNC is using India as a platform for global operations. Also, the global MNC is said to be involved in platform FDI.

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Conclusion

Investors can explore opportunities in foreign markets to diversify their portfolios. However, they must understand the types of FDIs before doing so. Understanding the different types of FDIs can help with strategic decision-making. Business owners or investors can choose the right type based on the availability of expertise, capital, and resources. Learn more about the FDI types now!