Foreign direct investment (FDI) refers to a market entry strategy where investors either expand their operations or buy other companies in foreign countries (Peng, 2008). Foreign direct investment can take various forms including horizontal FDI in which a firm expands its activities in a foreign country without changing the production stage. On the other hand, there is a vertical FDI where a firm moves into the target market but at a different value stage other than that of the resident country (Peng, 2008).
As a market entry strategy, FDI is carried out in different forms. To begin with, a firm may decide to start up a new firm in the target market or buy shares from an associated firm in the target market (Moosa, 2003). On the same note, a firm may decide to partner with another firm in the target market through a merger. Mergers are highly advisable in cases where host countries have restrictions on foreign investors, for example, China. Coca-Cola is known to enter into mergers with local bottling firms in various countries (Breitfeld, 2010).
There are several advantages that a firm gets by investing directly in foreign countries. First and foremost is the probability of taking advantage of the cheap inputs of production in the host countries, compared to their countries of origin. Besides, the firm can benefit from the tax cuts that are offered to foreign investors in various countries (Moosa, 2002). Most importantly, a firm that invests directly in a foreign country increases the market for its products and is, therefore, able to increase its profits. Moreover, the firm can be able to take advantage of economies of scale through increased operations thereby enhancing its competitive advantage.
Despite the benefits that accrue from FDI, there are some risks associated with the venture. To begin with, there is the risk of foreign exchange fluctuation which makes the earnings of a firm to vary the time and again, and sometimes loose money through the exchange process. On the same note, there is the possibility of political unrest especially in emerging markets and this will interfere with the operations of the firm. Similarly, governments can sometimes enforce unfavorable laws that may adversely affect the firm (Breitfeld, 2010).
Foreign direct investment may have its share of drawbacks, but it is a beneficial strategy for entering a new market. The favorable laws that most countries have and the availability of cheap inputs of production are just but some of the factors of attraction. Nevertheless, care should be taken always in evaluating the target market.
Breitfeld, N. (2010). Foreign Direct Investment (FDI)-Necessary Considerations of a Transnational Company. Munchen: GRIN Verlag.
Moosa, I. A. (2002). Foreign Direct Investment: Theory, Evidence and Practice. London: Palgrave Macmillan.
Peng, M. W. (2008). Global Business. Stanford: Cengage Learning.