Vertical FDI

As we saw in the previous section, horizontal FDI is FDI in the same industry as the home industry. Vertical FDI is FDI in associated industries in the chain of vertical integration.
Vertical integration is the expansion of a firm into a stage of the production process other than that of the original business. A company such as BHP Billiton which makes steel can integrate vertically by expanding its activities upstream, or backward, toward the source of raw materials such as iron, coal and limestone production, or by expanding downstream, or forward, toward the sale of the end product as BHP Billiton does with its subsidiary Australian Iron and Steel Co. So, in the context of FDI, BHP Billiton could have backward (upstream) FDI if it opened a new iron mine in Indonesia , or forward (downstream) FDI if it opened a subsidiary in the US to sell its steel.
As with horizontal FDI, we ask why a firm like BHP would bother with vertical FDI when it could import iron ore from Indonesia or sell its steel in the US through a local agent. As with horizontal FDI, the answer lies in more than one factor:
• market power
• market imperfections.
Market power is derived from the degree of completeness of vertical integration. Thus, BHP Billiton controls the whole process of making and selling steel because it owns the sources of raw materials, iron, coal and limestone, the manufacture of the steel at Newcastle , Port Kembla and Whyalla, and the sale of its product. BHP Billiton relies on no other company for any aspect of the process: it has complete freedom (power) to operate in the steel business, to limit competition and to control the market. We have used an Australian domestic example to illustrate the vertical integration process, but the process is similar where FDI is involved. An added bonus for vertical integration in FDI is that vertical integration enables a firm to circumvent entry barriers to another country. There is a good example of this in your textbook of Volkswagen setting up an independent dealer network in the US .