Types of foreign direct investments are classified as horizontal FDI, vertical FDI, conglomerate FDI, and platform FDI. Countries can categorize these investments based on the relationship of the investment to the existing business of the investor and the activities of the foreign entity. Foreign direct investment (FDI) occurs when an investor from one country makes a physical investment into business interests located in another country. There are several types of FDI that companies can use to enter a foreign market. Foreign direct investment occurs when an investor establishes operations or acquires ownership of assets in a foreign country with the intent of managing and controlling the business. FDI can have significant economic impacts on both the investing country and the host nation.

Types of FDI is a frequently asked topic in the UGC-NET commerce examination and is likely to be asked in the form of a case study. Learners are requested to understand the topic in detail.

In this article, learners will be able to find out the several types of FDI and types of FDI in India exclusively along with the other related topics.

In this article, learners will learn about the following:-

• Meaning of Foreign Direct Investment (FDI)
• Types of FDI (Based on Business Relationship)
• Types of FDI (Based on Entry Strategy)
• Types of FDI in India
• How Does FDI Work?
• Recent Reforms in FDI Policy (2020–2024)
• FDI vs FPI – Key Differences

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Meaning of Foreign Direct Investment (FDI)

Foreign Direct Investment (FDI) refers to the investment made by individuals, businesses, or entities from one country into businesses or assets located in another country. FDI involves the direct ownership of assets or the acquisition of a significant stake in a foreign company, such as a subsidiary, branch, or joint venture. It is a long-term investment that can provide the investor with a degree of control or influence over the foreign business's operations and management.

FDI plays a crucial role in the global economy by facilitating the flow of capital, technology, and expertise across borders. It can take various forms, including equity investments, loans, reinvested earnings, or the establishment of new foreign enterprises. FDI is typically undertaken with the expectation of earning a return on the investment, which may come from dividends, capital appreciation, or a share of the foreign company's profits.

Foreign Direct Investment can bring several benefits to both the investing country and the host country. For the investing country, it provides opportunities for diversification, access to new markets, and potential for higher returns. For the host country, FDI can contribute to economic growth, job creation, technology transfer, and increased foreign exchange reserves. However, it also raises issues related to national sovereignty, economic dependency, and the potential for profit repatriation.

FDI is subject to regulations and policies set by both the investing and host countries, and these policies can vary widely from one nation to another. Many countries actively encourage FDI through incentives, tax breaks, and initiatives to attract foreign investors, while others may impose restrictions or conditions on foreign ownership in certain sectors to protect their national interests.

Read about India's foreign trade policy.

There is another types of segmentation done in FDI, as mentioned below.

Fig: types of fdi

Vertical FDI

Vertical FDI usually occurs when a company invests in a foreign country to either produce input to existing processes of production or to distribute its finished products. These investments aim at controlling more stages of the supply chain.

Types of Vertical FDI:

• Backward Vertical FDI: Investing in a foreign supplier of raw materials or components.
• Example: An automobile company like Ford setting up a steel plant abroad to ensure a steady supply of metal.
• Forward Vertical FDI: Investing in foreign distribution or retail channels.

Example: An electronics company establishing a foreign sales subsidiary to market its products directly.

Benefits

• Gain great control over input quality and pricing
• Increase supply chain efficiency
• Reduced transaction costs through internal sourcing
• Securing important resources, especially for highly resource-based industries

Challenges

• Highly foreign operational risk dependent
• Regulatory barriers in strategic sectors (for example, mining and energy)
• Complexity in managing multi-stage global production lines

Horizontal FDI

Horizontal FDI takes place when a company transfers an already existing business model into a foreign market. The product and production process are largely the same in both countries.

Example:A fast-food chain like McDonald's or Domino's opening outlets in another country keeping same core menu and business model.

Benefits

• Market expansion to reach new customers
• Economies of scale through operating in different markets
• Becoming local in production, reducing transportation and import costs
• Building up brand loyalty in new areas

Challenges

• Must compete head-on with local businesses
• Need a deep understanding of cultural preferences and regulations
• Possibly duplicating infrastructure and operations

Conglomerate FDI

Conglomerate FDI occurs when a firm invests in an entirely unrelated business in a foreign country-that is, there is no link whatsoever with the investing company's existing line of business.

Example:Tata Group investing in a foreign luxury hotel chain despite being widely known for automobiles, steel, and technology.

 Benefits

• It diversifies risk entering into unrelated industries
• Gives the firm an opportunity to leverage surplus capital
• Opens up avenues for new revenue streams and entry into high-growth sectors

Challenges

• Lack of industry-specific knowledge or expertise
• Higher risk due to the limited synergy
• Complex management and allocation of resources

Platform FDI

Investments made in a foreign country with the intent of exporting the goods or services to a third country are Platform FDIs. The host country acts as a production hub and not as the final market.

Example:Nike invests in Vietnam for production not to sell in Vietnam, but export the products to Europe and the US.

Strategic Purpose

• Leverage cost advantages (cheap labor, infrastructure)
• Take advantage of trade treaties (e.g. ASEAN, EU-GSP)
• Maximize logistical benefits for regional exports

Benefits

• Low production cost coupled with access to global markets
• Flexibility in managing global supply chains
• Minimization of tariffs and duties due to preferential trade agreements

Challenges

• Geopolitical changes or shifts in trade policies
• Could incur resentment from either the foreign governments or workers
• Limited contribution to the development of the local market

Know about Costs and benefits of FDI to home and host countries.

Types of FDI (Based on Entry Strategy)

The types of FDI has been mentioned below.

• Greenfield Investment: An investor establishes a new operation in the host country from the ground up. The investor builds new productive assets like factories, offices or R&D centers.
• Mergers and Acquisitions: An investor acquires partial or full ownership of an existing company in the host country through purchase of shares or assets. This is often the quickest way to enter a market.
• Joint Ventures: Two or more companies come together to form a new business entity in the host country. Each partner contributes resources and shares ownership, control, profits and losses.
• Licensing and Franchising: An investor obtains rights to use intangible assets like trademarks, patents, trade secrets or business models in the host country in exchange for fees or royalties.
• Contract Production: An investor contracts a firm in the host country to produce goods and services according to specifications without acquiring ownership.
• Privatization: Governments sell part or all of state-owned enterprises to foreign investors to raise funds and improve efficiency.
• Brownfield Investment: An investor purchases existing operational assets like factories, real estate or mines in the host country. Less risk than greenfield investments.

Also know about EU Trade Agreements.

Types of FDI in India

Types of FDI in Indian context has been explained below.

• Greenfield Investment: Many major global companies have set up new manufacturing facilities in India through greenfield investments. Examples include car makers like Volkswagen, Hyundai and Renault Nissan. Tech firms like Samsung, Apple and Nokia have also established new R&D and production centers.
• Mergers and Acquisitions: Foreign acquisitions of Indian companies have been common. Major deals include Hindustan Unilever acquiring Hindustan Lever, ArcelorMittal acquiring Essar Steel, and Vodafone acquiring Hutchison Essar. Many foreign private equity firms have also invested in Indian companies.
• Joint Ventures: Several India-focused joint ventures have been formed, particularly in the automotive industry. Examples include Maruti Suzuki between Suzuki and the Government of India, Tata Motors JV with Fiat, and Ford JV with Mahindra & Mahindra. Many pharmaceutical companies also have JVs in India.
• Licensing and Franchising: Numerous global brands have entered India through licensing and franchising agreements. This includes fast food chains like McDonald's, KFC and Pizza Hut. Retailers like Marks & Spencer, Sephora and IKEA also operate franchises in India.
• Contract Production: Several global companies outsource manufacturing and services to Indian firms under contract. This includes technology services, call centers, generic drug manufacturing and automobile components.
• Privatization: The Indian government privatized many state-owned enterprises in the 1990s and 2000s, attracting significant FDI. Companies like Vodafone, British Telecom and Hindalco acquired stakes in telecom and mineral firms.

Find about Trends in FDI.

How Does FDI Work?

Foreign Direct Investment (FDI) constitutes an important factor for the economic development of a country, particularly in the case of developing countries. In general, FDI is understood as direct investment made by an investor or firm in the production or business operations of another country. FDI is characterized by a long-term interest in the investment made in the target company, along with a degree of control or influence on the target firm. Generally, FDI proceeds through a series of activities that highlight specific stages, each of which is crucial for granting smooth access for operation and compliance in the host country.

The Investment Decision

At the FDI initiation point, a foreign investor considers a potentially lucrative venture in a host country. This decision is driven by considerations such as market potential, cost advantages, tax and other incentives, availability of skilled labor, and access to resources. Manufacturing, services, infrastructure, and technology are the major sectors that attract their attention. The risks, government controls, and expected return on investment are assessed by the investor before taking further steps.

Entry Route Selection

In India, there are two main routes for foreign investment: the Automatic Route and the Government Route.

• Automatic Route allows them to invest without prior government approval, requiring only post-investment intimation to the Reserve Bank of India (RBI). This route is preferred for its easy and quick operations and includes manufacturing, e-commerce (B2B), and renewable energy sectors.
• On the other hand, the Government Route requires prior approval from the concerned ministry or department and the Department for Promotion of Industry and Internal Trade (DPIIT). This is for sectors that are considered sensitive, such as defense, telecom (over and above prescribed limits), media, and pharmaceuticals.

Investment Execution

The investor then implements the investment according to the selected way of entry. There are three basic alternatives for foreign investors available for making investments in India:

• Greenfield Investment, which requires the setup of an entirely new operation from the ground level including land acquisition, building of infrastructure, and hiring of the workforce.
• Brownfield Investment consists of the acquisition or merger into an existing Indian company.

• Joint Ventures imply working with a local partner by combining foreign capital and expertise with local market knowledge and regulatory insight. The choice has several strategic advantages depending on the intentions of the investor. 

Capital Inflow & Operations

After the mode of entry is finalized, funds are routed to the host country through banking channels permitted by the appropriate authorities. These funds would then be used in business activities such as buying equipment, hiring personnel, and commencing production or service delivery modes. Along with capital, FDI may also bring in the latest technological upgrades, skilled manpower management practices, and appropriate global standards. This is, however, beneficial for not just the investor’s business but also for adding strength to the environment of the host country.

Monitoring & Compliance

FDI operations must comply with various regulatory requirements consistently. Companies must adhere to local legislation on labor issues, taxation, environmental standards, and corporate governance. Subsequently, the interests of financial disclosures are audited, and other reports are submitted periodically. The Reserve Bank of India, DPIIT, and other pertinent authorities check these investments to maintain transparency, accountability, and conformity with national interests.

Recent Reforms in FDI Policy (2020–2024)

The Government of India has introduced various critical changes for encouraging foreign investment that is viewed as transparent and safe and is sector-related in recent years. Such reforms signify the government's sovereign concern in balancing openness vis-a-vis national interest and ease of doing business.

100% FDI Allowed in Insurance Intermediaries

• To foster growth and bring in international insurance players:
• FDI in insurance intermediaries (brokers, agents, and TPA services) has been raised to 100% through the automatic route.
• This step was mainly intended to attract capital, enhance technical collaboration, and improve insurance penetration in India.
• There were also provisions to ensure that Indian ownership and control continued to be with respect to the core insurance business.

Stricter FDI Norms for Bordering Countries (Especially China)

• In April 2020, Government revised its FDI policy to protect against opportunistic takeovers during the economic distress (like COVID 19):
• Any FDI from countries that share a land border with India (like China, Pakistan, Nepal, Bangladesh, Bhutan, Myanmar, Afghanistan) shall require a government approval.
• Even indirect acquisition through a third country will be covered under this.
• The main aim is to protect strategic sectors as well as startups from hostile acquisitions or unregulated takeovers.

Introduction of National Single Window System (NSWS)

• To simplify and fasten the FDI approval process and compliance:
• The National Single Window System (NSWS) was launched as a digital one-stop portal for investors.
• It integrates over 30 central departments and 20+ state governments on a unified digital interface.

Investors can:

• Seek clearances, licenses, and registrations.
• Track application status in real-time.
• Avoiding double submission by allowing submission of documents only once (central repository).
• The NSWS aims to increase transparency, decrease red tape, and allow ease of doing business, particularly for Greenfield investment and new players.

FDI vs FPI

Understanding the difference between Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) is essential for UGC-NET and other competitive exams.

Conclusion

The various types of FDI represent different strategic options for companies to enter foreign markets and integrate internationally. Each type involves trade-offs between control, risk, costs and speed of market entry. Companies choose the type that best matches their objectives, capabilities and circumstances. Overall, FDI plays an important role in driving international trade, competition and economic growth.

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Read about India and search relations.

Types of FDI Previous Year UGC NET Question

Which of the following is not a type of Foreign Direct Investment (FDI)?

1. Horizontal FDI
   B. Vertical FDI
   C. Conglomerate FDI
   D. Portfolio Investment

Correct Answer: D. Portfolio Investment