Why Do Companies Engage in Foreign Direct Investment?

Foreign direct investment is an important corporate strategy for companies that wish to operate on a global basis. While companies may gain a certain degree of international exposure through indirect financial investment, trade or technology transfer, they can better level resources both at home and abroad by directly investing in local production facilities and marketing campaigns. Foreign direct investment is often encouraged by hosting countries that may impose various trade barriers on imports.

Even as free trade has become more prevalent, national protectionism can still surface from time to time. Countries tend to impose trade barriers as they don't think that importing alone would benefit their economies in terms of increasing producing capacity and improving technology uses. Moreover, buying foreign exports may lead to more and easier consumptions, as well as use up foreign currency reserves. Thus, companies may find it ineffective to focus solely on trade when expanding to foreign markets. Foreign direct investment offers an alternative of producing goods where they are sold.

Increasingly, companies engage in foreign direct investment to reduce production costs. While companies can import low-cost raw materials, they cannot take advantage of cheaper labors in another country if companies produce from their home countries. Meanwhile, directly investing in overseas production facilities where raw materials are supplied saves additional costs on transportation when importing the materials is no longer needed. In some cases, companies can still save money even when they plan to ship back final products to sell in their home markets.

Aside from concerns of trade barriers and production costs, producing locally through foreign direct investment helps companies put their finger on the pulse of local market trends. Facing a gradually saturated domestic market, many companies wish to expand to new markets oversees. But producing away from where customers are often reduces response time in terms of following customers' changing demands. Foreign direct investment brings together production personnel and marketing crew to provide the right products for the new market channels.

To attract foreign direct investment, hosting countries often provide various incentives from lower taxes, streamlined application procedures to government-backed financing and greater access to local resources. Companies with only local sales offices or some form of strategic alliance with local businesses are not qualified as having made foreign direct investment. Companies may not benefit from many of the local governments' giveaways unless they commit their capital locally in buildings, machineries and equipment. Companies that do make physical investments into setting up factories and other services facilities can find themselves easily embraced by the hosting countries.