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Greenfield Investment Strategy: Meaning, Advantages, Disadvantages, Examples and More

Greenfield Investment Strategy: Meaning

A greenfield project is where the entire project has to start from scratch. And everything from planning to implementation is new. In international trade and investments, there are certain limitations and restrictions while entering foreign markets. Hence, to overcome such entry barriers, Greenfield Investment Strategy (GIS) is used by big firms to get access to the potential foreign markets. Therefore, Greenfield Investment Strategy is a getting/investing Foreign Direct Investment (FDI) in the target country. Under this, the investing company establishes a new operating facility or expands its existing facility in a foreign country. Here the word Green resembles an altogether ‘New’ investment.  This strategy helps in entering foreign markets. Moreover, this strategy allows the investing company to involve and control day to day operating activities. And the investing company not only puts money in a foreign country but also extends a complete business help.

In this strategy, the parent company is opening a wholly-owned subsidiary in cross-border economies. Sometimes the whole setup, including the production line and distribution channel, is created from the scratch level. Greenfields investment strategy, many times, also extends management and technical assistance, along with capital investment. It is like establishing a completely new venture.

This type of FDI investment takes place when the parent company is unable to find prospective acquisition targets. The center focus of this type of investment is generally developing countries. The acquiring company generally focuses on the Net Present Value (NPV) & Internal Rate of Return (IRR) of the project as the target of the investing company is to get returns on the investments.

Greenfield Investment: FDI or FPI?

There are majorly two ways to enter a foreign market, i.e., Foreign Direct Investment (FDI) or Foreign Portfolio Investment (FPI). Under FPIs, the investors only extend monetary investments. They are not allowed to interfere in day to day operating activities or even in important decisions. FPI investors are only concerned with their profit shares.

On the other FDI investors not only invest money into the businesses but also are actively involved in day-to-day operations. FDI investors make investments in all assets, unlike FPIs, who only invest in financial securities. Thus FDIs are direct investment while FPIs are an indirect investment. FDI investors are strategic investors, while FPI investors are financial investors.

Thus Greenfield Investments are under FDI investment because investors invest in the whole business and not just financial security. Greenfield investors stay for the long term and focus on the growth of the company, along with its profitability.

Greenfield Investment Strategy

Greenfield Vs. Brownfield

Both Greenfield and Brownfield investments are part of Foreign Direct Investment (FDI) but often are confused with being the same. The main difference is that Greenfield invests and sets up the whole business afresh. On the other hand, Brownfield leases the entire business and makes lessee work according to its requirements. Or it is a further development of an existing structure or unit.   As a result, Greenfield is costlier than the Brownfield investment strategy. Greenfield requires a lot of investment in establishing and running the business. As a result, it is more risky and expensive than Brownfield.

One of the significant differences is that Greenfield investment can be a new investment or expansion. On the other hand, Brownfield investment compulsorily takes place on the existing facilities.

Greenfield Investment Vs. Mergers and Acquisitions

In Mergers and Acquisitions (M&A), a takeover of existing business takes place, while in Greenfield investment, an establishment of new business takes place. Merger and acquisition can be partially-owned or fully-owned, while Greenfield is always fully-owned.

Advantages

  • The Investor has complete control over the operations of the subsidiary entity / new unit.
  • The subsidiary unit /new unit gets extensive help from the parent company.
  • The brand image of the parent company expands in international markets.
  • This setup creates domestic employment opportunities.
  • It follows the ‘High-Risk High Return’ principle. Greenfield investors earn more than Brownfield investors.
  • Developing countries encourages this type of FDI by giving subsidies and tax benefits.
  • It allows the investing company to be flexible according to its requirement. Existing acquisition forces the acquiring company to adjust according to the current setup. Greenfields allows being super flexible.
  • The maintenance cost of the new plant is comparatively lower than the maintenance cost of the existing plant.
  • An intermediary entity for running the international operation is not required in this type of FDI. The subsidiary is a wholly-owned subsidiary.
  • It also creates positive sentiments amongst customers and investors.
  • It helps in augmenting the benefits of Economies of Scale and Scope in all areas of businesses.
  • The parent company can install modern equipment and manufacturing techniques.
  • It boosts the earning capabilities of the parent company

Disadvantages

  • It often becomes a very costly affair. There exists a high fixed cost.
  • Planning of this FDI is very complicated. As a result, special skills become necessary.
  • As it is a strategic investment, it is a long term commitment. The Investor needs to stay for a long to get its Return on Investment back.
  • At times political instability in the international market creates issues.
  • There are high levels of entry and exit barriers for the investing company.
  • If a debt is the source of finance, the interest burden increases in such a situation.
  • These investments consume a lot of time for the parent company.

Real-Life Examples Greenfield Investments

  • Hyundai Motors, in 2006 has made Greenfield investment by establishing a new manufacturing unit in the Czech Republic. The Czech Republic government has provided subsidies and tax benefits.
  • In 2007, Mercedes Benz entered the Indian market by purchasing 100 acres of land in Pune, Maharashtra, for establishing its altogether new manufacturing unit.
  • Similarly, In 2015, Toyota Motors had decided to set up its new plant in Mexico under Greenfield Investment. The total cost of establishing the facility was around $ 1.5 billion.

The above examples are not exhaustive & are provided just for reference.

Conclusion

Greenfield Investment strategy is one of the most preferred Foreign Direct Investment (FDI). Hence, this strategy is adopted by the countries to channelize investments in specific areas. And it fulfills the need for the technology as well as funding. Moreover, this strategy gives an easy entry to the business in a potential foreign market, where otherwise access would be difficult. However, it has its pros and cons. This strategy can be successful if proper planning & long term investments are made. And it is the best strategy available when there is no target company for acquisition available in the target market. By strategically staying for the long term, the limitation of high cost can be overcome easily.

Reference Links

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=636612

https://openknowledge.worldbank.org/handle/10986/13941

https://www.unescwa.org/greenfield-investment

https://www.emerald.com/insight/content/doi/10.1108/EUM0000000005350/full/html

https://www.investopedia.com/ask/answers/071315/what-are-benefits-company-investing-greenfield-investment.asp

https://www.igi-global.com/dictionary/greenfield-investment/47278

Last updated on : September 30th, 2020
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