The UK tech sector attracted more foreign investment during the first seven months of 2019 compared with the whole of 2018, according to research prepared for the Digital Economy Council, but greenfield investment in UK involving software and IT services is at its lowest level in nine years.
However, despite the decline in greenfield investment in UK software and IT services sector, the UK outperforms all other European countries and Israel at producing highly valued tech companies, according to the research undertaken by entrepreneurial network Tech Nation.
What is a greenfield investment?
In economics, a greenfield investment (GI) refers to a type of foreign direct investment (FDI) where a company establishes operations in a foreign country. In a greenfield investment, the company constructs new (“green”) facilities (sales office, manufacturing facility, etc.) cross-border from the ground up.
A greenfield investment is a form of market entry commonly used when a company wants to achieve the highest degree of control over its foreign activities. It can be compared to other foreign direct investments such as the purchase of foreign securities or the acquisition of a majority stake in a foreign company in which the parent company exercises little to no control over daily business operations.
Apart from potential tax breaks or subsidies in establishing a greenfield investment, the overarching goal of such an investment is to achieve a high level of control over business operations and to avoid intermediary costs.
Green field investment basics
The term “green-field investment” gets its name from the fact that the company—usually a multinational corporation (MNC)—is launching a venture from the ground up—ploughing and prepping a green field. These projects are foreign direct investments—known simply as direct investments—that provide the highest degree of control for the sponsoring company.
Another method of FDI includes foreign acquisitions or buying a controlling stake in a foreign company. However, when a business takes the acquisition route, they may face regulations or difficulties that can hinder the process.
In a green-field project, a company’s plant construction, for example, is done to its specifications, employees are trained to company standards, and fabrication processes can be tightly controlled.
This type of involvement is the opposite of indirect investment, such as the purchase of foreign securities. Companies may have little or no control in operations, quality control, sales, and training if they use indirect investment.
Splitting the distance between a green-field project and indirect investment is the brown-field (also “brownfield”) investment. With brown-field investing, a corporation leases existing facilities and land and adapts them to suit its needs. Renovation and customization usually result in relatively lower expenses and quicker turn-around than building from scratch.
Advantages of a greenfield investment
- There are numerous advantages to a greenfield investment, including the following:
- High level of control over business operations
- High level of quality control over the manufacturing and sale of products and/or services
- High control over brand image and staffing
- Economies of scale and economies of scope can be achieved in terms of marketing, research and development, and production
- Bypassing trade restrictions
- Creating jobs for the economy where the greenfield investment is taking place
Disadvantages of a greenfield investment
- There are, of course, potential disadvantages as well, such as the following:
- An extremely high-risk investment – a greenfield investment is the riskiest form of foreign direct investment
- Potentially high market entry cost (barriers to entry)
- Government regulations that may hamper foreign direct investments
- High fixed costs involved in establishing a greenfield location
Other risks and benefits of green field investments include:
Developing countries tend to attract prospective companies with offers of tax breaks, or they could receive subsidies or other incentives to set up a green-field investment. While these concessions may result in lower corporate tax revenues for the foreign community in the short run, the economic benefits and the enhancement of local human capital can deliver positive returns for the host nation over the long term.
As with any startup, green-field investments entail higher risks and higher costs associated with building new factories or manufacturing plants. Smaller risks include construction overruns, problems with permitting, difficulties in accessing resources and issues with local labour.
Companies contemplating green-field projects typically invest large sums of time and money in advance research to determine feasibility and cost-effectiveness.
- Tax breaks, financial incentives
- Everything done to specifications
- Complete control of venture
- Greater capital outlay
- More complex to plan
- Longer-term commitment
As a long-term commitment, one of the greatest risks in green field investments is the relationship with the host country—especially politically unstable one. Any circumstances or events that result in the company needing to pull out of a project at any time can be financially devastating for the business.
Real-world examples of greenfield investments
Hyundai Motor Co. in Nošovice
In 2006, Hyundai Motor Company received approval to make around one billion euros with a major greenfield investment in Nošovice in the Czech Republic. The automaker established a new manufacturing plant that employed up to 3,000 individuals in its first year of operation. The Czech Government provided tax relief and subsidies to prompt the greenfield investment, in hopes of boosting the country’s economy and lowering the unemployment rate.
The U.S. Bureau of Economic Analysis (BEA) tracks green-field investments—that is, the investment by a foreign entity to either establish a new business in the U.S. or expand an existing foreign-owned business. U.S. green-field expenditures, according to data released by the BEA in July 2018, totalled US$259.6 billion in 2017. Also, $4.1 billion went to establish new businesses. Manufacturing expenditures accounted for 40% of the total. Food and information were the most popular industries.
In April 2015, Toyota announced its first green-field project in Mexico in three years, costing US$1.5 billion for the new manufacturing plant in Guanajuato. The factory had eventual goal of hiring 3,000 employees and the capacity to produce 300,000 pickup trucks per year—the initial capacity and workforce will be a third of that number. Along with the plant, the automaker plans to build or improve urban development to provide housing for the workers, called Toyota City.
Historically, Mexico has been viewed as an attractive country for green-field investments due in large part to its low costs of labour and manufacturing, as well as its proximity to markets in the United States.