Greenfield Investments: The Benefits and Risks

The advantages of greenfield investments include increased investor control relative to investing in an existing local business, as well as the opportunity to form marketing partnerships and avoid intermediary costs.

Greenfield projects are just one way to make foreign direct investments (FDI) and are often used to expand into emerging markets. They typically involve a parent firm establishing a subsidiary in the foreign country. Coca-Cola and Starbucks are examples of multinational companies that have made numerous greenfield investments worldwide.

When Greenfield Investments Matter

Greenfield investment is an alternative to foreign portfolio investment, where an individual or company merely buys the stocks or bonds of an existing company. It is also an alternative to brownfield investing, in which an investor buys an existing business or production facility.

Businesses undertake greenfield projects when there are no acquisition opportunities in the target market, or when market research shows that there is little local competition in a particular line of business.

A Means of Greater Control

A greenfield enterprise provides the investor with control over the business in several ways that he probably wouldn't have if simply investing in an existing local company. One is in establishing an overall strategy by, say, determining what sort of product or services it will sell, and then setting rates of production and the pace of expansion in the target market.

For example, the investor can decide whether it wants to begin operations on a small scale and gradually increase its presence or prepare for a large-scale roll-out of its products. It wouldn't usually have such freedom of action if it were to invest in an existing local business.

Greenfield investments enable easier and more effective adaptation to the foreign market. The investor can adapt both products and pricing to local conditions and has greater control over assuring product quality. Having complete ownership of a subsidiary allows the investor to extend offers to customers or potential customers, such as discounts, rebates or warranties, as market circumstances dictate.

Other Benefits

An on-site presence can also facilitate the tailoring of advertising and marketing efforts to the local market environment, and the formation of partnerships with native businesses to increase market penetration.

It also allows the investor to avoid almost entirely the cost of using intermediaries such as lenders or other investors. Depending on the country's economic policies, companies can also profit from government tax incentives aimed at attracting foreign investment.

The Downside

Greenfield investments are one of the riskier forms of FDI. Some countries ban FDI altogether in certain politically sensitive industries.

But even where it's allowed, there can be high barriers to entry, such as "local-content requirements" that require foreign firms to use domestically manufactured components or domestically supplied services in order to do business.

Greenfield projects usually come with high fixed costs, because they often involve building facilities from the ground up (hence the term).

They are also more vulnerable to political risk because it's harder to divest from a wholly owned production facility, for instance, than it is to sell a passive portfolio investment in a local business.