When a multinational company acquires an operation that acts as a supplier or distributor, it is called vertical foreign direct investment. On the other hand, when a company initiates a similar procedure or business model in another country, it is referred to as horizontal FDI. Companies that engage in vertical FDI aim to lower the cost of raw materials or gain better control of their supply chain.
Basics
Foreign direct investment (FDI) involves investments by companies or individuals in foreign businesses, either through establishing operations or acquiring assets abroad.
Horizontal FDI occurs when a company replicates its domestic business operations in a foreign country. For instance, Toyota manufactures cars in both the United States and China. On the other hand, vertical FDI occurs when a multinational enterprise acquires or establishes operations to serve as either suppliers (backward vertical FDI) or distributors (forward vertical FDI). Companies pursuing backward vertical FDI aim to enhance their access to raw materials or essential components. An example would be a Japanese car manufacturer acquiring a tire production company.
Conglomerate FDI represents the third category, wherein a company invests in unrelated businesses in foreign countries. This strategy presents two primary challenges: entering foreign markets and venturing into unfamiliar industries.
Exploring Vertical Foreign Direct Investment
Imagine an American automobile manufacturer. Steel, a crucial material for car production, is subject to price fluctuations due to supply and demand shifts. The manufacturer desires lower steel costs, while the foreign steel supplier aims for higher profits. By acquiring the foreign supplier, the car manufacturer eliminates reliance on market-driven steel prices.
Horizontal FDI predominates over vertical FDI. Developed countries prioritize market access over cost reduction in FDI motives.
Companies pursuing forward vertical FDI may encounter difficulties in finding distributors in specific markets. For instance, American car manufacturers seeking entry into the Japanese auto market may face resistance from Japanese dealers favoring domestic brands. To address this, the manufacturer may undertake vertical FDI, establishing its distribution network in Japan to fill the gap.
Facilitating Cross-Border Financing: FDI's Role in Economic Growth
Foreign Direct Investment serves as a vital avenue for nations and enterprises with constrained capital resources to secure financial support from more affluent countries. China's remarkable economic expansion can be attributed, in part, to its robust export activity and inflow of FDI. According to the World Bank, FDI is valuable for nurturing the private sector within lower-income economies and combating poverty.
Conclusion
Foreign direct investment encompasses horizontal and vertical strategies, with horizontal FDI replicating domestic operations abroad and vertical FDI optimizing supply chains through supplier or distributor acquisitions. While horizontal FDI is common, forward vertical FDI aids in overcoming distribution challenges in foreign markets.