Categorising FDIs

Understanding Foreign Direct Investments (FDI)

Foreign Direct Investments (FDI) are investments made by a firm or individual in one country into business interests in another country, typically by establishing business operations or acquiring business assets in the foreign country. FDI can take various forms depending on the degree of ownership a firm has abroad, which can mean full ownership through acquisitions or shared ownership through joint ventures or strategic alliances. A prime example of a joint venture can be seen in the collaborative efforts between the University of Nottingham in the UK and the Chinese educational group Bindly to establish a new educational institution in China.

Types of FDIs: Joint Ventures and Strategic Alliances

While joint ventures specifically involve two or more parties sharing ownership to create a new entity, the term "strategic alliance" encompasses a broader range of collaborations. A strategic alliance may include equity-based collaborations, where company investments are shared, non-equity-based arrangements, or a blend of both methods. Firms that decide against shared ownership may pursue a total acquisition of a firm abroad to gain complete control. In cases where suitable businesses for acquisition are unavailable, companies may opt for a greenfield investment, entailing the establishment of a new business entity from scratch in the target country.

Navigating FDI Terminology

To better understand FDI, it's important to familiarize oneself with terms that describe the directional aspects of investments—upstream, backward, inward, and forward FDI. Backward or upstream FDI refers to investments made in activities such as sourcing raw materials or designing products in foreign locations. Conversely, forward or downstream FDI refers to investments in distribution and sales operations abroad. Additionally, horizontal FDI involves firms replicating the same activities in different geographic regions—such as manufacturing in multiple countries without diversifying into other areas of the value chain.

Inward vs. Outward FDI and FDI Flow

Understanding inward and outward FDI is equally crucial. Inward FDI tracks investments flowing into a specific country from abroad, while outward FDI monitors investments made by local firms in foreign countries. FDI flow is thus a metric of the annual investment capital transferred between countries. For instance, inward FDI might measure the funds a subsidiary in Country A receives from a multinational firm based in Country B, whereas outward FDI would measure the investments from a local firm in Country A to its subsidiary established in Country B.

The Risks and Advantages of FDI

The transformation into a multinational enterprise through FDI, while appealing, comes with substantial risks. According to Professor John Dunning, three primary conditions should be met for a firm to consider entering into FDI: ownership advantages, location advantages, and internalization advantages.

1. Ownership Advantages: These can include resources or inherent capabilities, such as advanced technologies or superior organization strategies, that a company possesses in its home country and can exploit in foreign markets.
2. Location Advantages: These are benefits that specific geographic areas offer, which might include growing consumer demand in emerging markets or natural resources available in less developed countries, thus providing a strong incentive for foreign investment.
3. Internalization Advantages: Firms should have the capacity to manage operations effectively internally to avoid high transaction costs associated with outsourcing activities like quality control or logistics.

This framework of ownership, location, and internalization advantages is referred to as the OLI paradigm or eclectic theory, which is integral to understanding international business dynamics. Students are encouraged to engage in further readings and practical exercises to deepen their understanding of these concepts and their interconnections in FDI.