greenfield-investment

What Is A Greenfield Investment?

Business / By / February 23, 2022

Greenfield investments are those where a company establishes a new subsidiary on foreign soil by investing in new facilities such as offices, factories, staff accommodation, and distribution hubs. They are named after the notion that a company launching a new venture from scratch starts with nothing but a green field. A greenfield investment, therefore, is a form of foreign direct investment where a company establishes operations in another country by constructing new facilities from scratch.

Green investment examples

Greenfield investments differ from brownfield investments, where the company purchases or leases existing infrastructure for the same expansionary purpose. The strategy is commonly employed by companies who desire more control over their operations and want to avoid the extra costs associated with intermediaries.

In this section, let’s take a look at some real-world examples:

Toyota Motor Corporation

In 2015, Toyota announced it would be building a new production facility in the Mexican state of Guanajuato. The factory, which would produce the Corolla mid-size sedan, was slated to cost around $1 billion.

Hyundai

South Korean auto manufacturer Hyundai made a similar commitment in 2006 when it received approval to build a factory in the Czech Republic. The factory opened three years later with an initial capacity of 200,000 vehicles per year, with the Czech government providing incentives to attract Hyundai in the hopes of lowering unemployment and stimulating economic activity in the country.

Weber

In 2021, American outdoor cooking innovation and technology company Weber opened its first manufacturing and distribution hub in southern Poland. The 50,000 square meter facility allows the company to produce high-quality barbecue products for the European market and improve its delivery and service speed in the process.

Advantages and disadvantages of greenfield investments

Advantages

  • Control – as noted earlier, greenfield investments tend to be associated with more control since the company can build its infrastructure to spec without the need to adapt or retrofit. This also the company more control over the quality of its products.
  • Brand reputation – in some cases, a company that commits to establishing a presence in another country and recruits local expertise will enjoy a superior brand reputation. It may also be able to profit from stronger local networks and partnerships.
  • Economic benefits – greenfield investments also come with several economic benefits. Companies sometimes receive incentivization from governments in the form of tax breaks and subsidies and may be able to bypass trade restrictions and import tariffs.

Disadvantages

  • Capital expenditure – greenfield investments require vast sums of money which exposes the company to more risk should the project become unviable for whatever reason. If nothing else, the capital expenditure required is a substantial barrier to entry.
  • Political risk – while a government may initially be supportive of greenfield investment, this can change after an election if a new government takes power and is less supportive of international companies operating within its jurisdiction.
  • Regulations – some countries will also require that the foreign company use domestically manufactured components or services to support their operations. Others will require that a certain percentage of the workforce be comprised of local employees. These requirements can make a greenfield investment problematic for companies that must control every aspect of the process to maintain exacting standards.

Key takeaways:

  • A greenfield investment is a form of foreign direct investment where a company establishes operations in another country by constructing new facilities from scratch.
  • Real-world examples of greenfield investment include Toyota in Mexico, Hyundai in the Czech Republic, and Weber in Poland.
  • Greenfield investments can afford the company more control over its foreign operations and grant access to various financial incentives. However, the significant capital expenditure represents a substantial barrier to entry and can make the company more vulnerable to a change in government or regulations.

Connected Business Concepts

Circle of Competence

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The circle of competence describes a person’s natural competence in an area that matches their skills and abilities. Beyond this imaginary circle are skills and abilities that a person is naturally less competent at. The concept was popularised by Warren Buffett, who argued that investors should only invest in companies they know and understand. However, the circle of competence applies to any topic and indeed any individual.

What is a Moat

moat
Economic or market moats represent the long-term business defensibility. Or how long a business can retain its competitive advantage in the marketplace over the years. Warren Buffet who popularized the term “moat” referred to it as a share of mind, opposite to market share, as such it is the characteristic that all valuable brands have.

Buffet Indicator

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The Buffet Indicator is a measure of the total value of all publicly-traded stocks in a country divided by that country’s GDP. It’s a measure and ratio to evaluate whether a market is undervalued or overvalued. It’s one of Warren Buffet’s favorite measures as a warning that financial markets might be overvalued and riskier.

Warren Buffet Companies

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Warren Buffett is an American investor, business tycoon, and philanthropist. Known as the “Oracle of Omaha”, Buffett is best known for his strict adherence to value investing and frugality despite his immense wealth. He is among the wealthiest people in the world. Most of his wealth is tied up in Berkshire-Hathaway and its 65 subsidiaries.

Price Sensitivity

price-sensitivity
Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.

Price Ceiling

price-ceiling
A price ceiling is a price control or limit on how high a price can be charged for a product, service, or commodity. Price ceilings are limits imposed on the price of a product, service, or commodity to protect consumers from prohibitively expensive items. These limits are usually imposed by the government but can also be set in the resale price maintenance (RPM) agreement between a product manufacturer and its distributors. 

Price Elasticity

price-elasticity
Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a change in its price. It can be described as elastic, where consumers are responsive to price changes, or inelastic, where consumers are less responsive to price changes. Price elasticity, therefore, is a measure of how consumers react to the price of products and services.

Economies of Scale

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In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

Diseconomies of Scale

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In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.

Network Effects

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A network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward.

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