Foreign Direct Investment, which is often referred to simply as FDI, is what occurs when a company physically invests assets into a foreign country. It may also occur when an investment is made through alliances or joint ventures internationally so local foreign markets can be accessed. With more than $1 trillion in FDI having been made since 2000, there is no doubt that there has been a dramatic impact on the global economy thanks to those who have made FDI a priority.
By weighing the pros and cons of foreign direct investment directly, each organization can decide if it is the right way to enter into a new local market. Here are some of the key points to consider before finalizing that decision.
The Pros of Foreign Direct Investment
1. It’s an easy way to develop local resources through international investments.
The costs of importing and exporting tangible goods can be enormous. These costs aren’t absorbed by companies. They’re passed along to consumers. By building physical assets internationally, such as Toyota building a car manufacturing plant in the United States instead of Tokyo, the local economy is stimulated in both regions because of the increased output while market access becomes easier and cheaper.
2. It allows for more domestic development.
As corporations focus their resources toward international development, a service gap invariably develops in the domestic economy where that corporation is located. This gives local businesses and entrepreneurs the opportunity to step in and fill that gap, creating the chance to develop their own opportunities for profit in the process.
3. It keeps prices low for consumers.
If it costs $10 in labor to create a product in the United States, but the same labor can be performed internationally for $4, then an organization has just created a difference of $6. If that difference is split 50% so the customer gets a portion and the organization gets a portion, then the cost of the product goes down $3 and the company experiences $3 in cost savings with every item created. Both parties win.
4. There is the possibility of a huge return.
Many investments wind up being stock when it comes to a business-to-business transaction. This is done because it limits the risks that an organization is exposed to in another company’s operations. A direct investment gives a business the opportunity to earn a share of all potential returns, which means there is always the possibility of a huge return that can be achieved.
5. Even in business-to-business transactions, there is more control received by the investor.
Investors have the chance to be involved in the direction of local economies or foreign company decisions with their foreign direct investment with the right role being negotiated. Although this increases the liabilities that are assumed, especially to fees and fines, there is still an ability to actively continue participation in the business. A limited partnership even removes personal assets from liability in most circumstances.
6. It reduces the cost to profit ratio.
When there are local assets in place in foreign countries, it costs less to produce the needed number of products. This means it takes fewer sales to create a profit. With a reduction of the cost to profit ratio, long-term profits can be achieved with continued investments into the FDI infrastructure because each investment has the potential to lower the costs even further.
The Cons of Foreign Direct Investment
1. It changes the market dynamics for local businesses.
Although there is a clear benefit to the international business in establishing local resources, this comes at a disadvantage to local businesses that are already in place. A local economy only has a finite amount of resources available to it and FDI takes those resources away from those who are local so the international corporation can find more success.
2. It develops a strong pricing competition that isn’t always beneficial.
One of the issues of FDI is that it creates circumstances where prices are lower, but they can wind up being too low sometimes. Competition is healthy for consumers because it keeps prices fair, but when one company is attempting to undercut another in the same industry with price cuts, it doesn’t help. Eventually each company undercuts each other to the point where the price structure is not sustainable. Consumers might initially benefit, but eventually the quality of the product suffers, organizations go out of business, and then prices go up anyway.
3.It creates a form of dependence on the corporation for local economy stimulation.
As FDI develops internationally, local economies begin to depend upon it more and more. An unhealthy relationship begins to form because the corporation can begin making greater demands of the local economy to “make them stay” in that location. This ultimately means that some products wind up being at a lower cost at the expense of others who are paying a high personal cost to keep their own benefits.
4. Politics can make or break a foreign direct investment.
The situation in Greece is a prime example of how a foreign direct investment has a unique set of risks. The government may decide that they have a right to take over the investment and nationalize it for the “greater good” of everyone. Sometimes assets may be seized in order to manage debt from other poor investment strategies. When this occurs, the entire investment is at risk and this is a risk that always exists.
5. It can become a black hole of labor.
Many businesses seek foreign investors because they’re on their last legs. They want someone to come in and save them. Without proper due diligence, a company may make an investment only to find out that they’ve got to increase their own workloads to save their investment. The goal of an investment is to make life easier, not more difficult, which is why FDI is not always the best solution in every single circumstance.
6. A company may find itself competing with itself for a market share.
The goal of a foreign investment is to enter into a new market, but thanks to the internet, even small businesses today can have an international presence. A direct investment may create better overall local brand recognition, but it may also mean that a company begins competing with itself, especially when the investment is made into a foreign business instead of physical assets.
The pros and cons of foreign direct investment show that it can be incredibly beneficial or a large disaster that lurks in the shadows. It is all dependent on the amount of research that takes place before the FDI takes place. By performing your due diligence and evaluating this pros and cons, it will become possible to find and make that best investment possible.