INTERNATIONAL

BUSINESS

MBA SEM. 5
(G.U.)

Dr. Rajesh P Ganatra

CHAPTER 1: GLOBALIZATION AND INTERNATIONAL BUSINESS

1.1 International Business

International business can be defined as any business that crosses the national borders
of a country. It includes importing and exporting; international movement of goods,
services, employees, technology, licensing, and franchising of intellectual property
(trademarks, patents, copyright and so on). International business includes investment
in financial and immovable assets in foreign countries. Contract manufacturing or
assembly of products for local sale or for export to other countries, establishment of
foreign warehousing and distribution systems, and import of goods from one foreign
country to a second foreign country for subsequent local sale is part of international
business.

1.2 Elements of International Business

1. Legal and Regulatory Framework: This framework refers to companies
having to comply with the law of the land they operate in. Companies
involved in international business may have to comply with laws of more than
one country. This certainly poses a challenge as each country has its own set
of laws. These companies have to ascertain that their scope of business is
within the regulatory framework set by the authorities of that country.

2. Financial Management: In a domestic scenario, all the payments of a

business involve the local currency. In an international scenario, for example,
a company may pay in Chinese Yuan for sourcing its materials from China,
pay wages in Malaysian Ringgits at its production base in Malaysia, and
receive payments in Euros from its customer in Germany. Hence, a company
has to deal with multiple currencies, exchange rate mechanisms, hedging of
currencies, banking systems, fluctuating interest rates and so on.

3. Trade Barriers and Tariffs: In a domestic scenario, a company can move its
goods and services almost freely within the country. But in international trade,
companies face issues like licensing, anti-dumping laws, quota restrictions,
and tariffs for their business operations in a foreign country or region

4. Accounting and Taxation: Domestic businesses need to comply with the

accounting and taxation standards prevailing in that country. A company with
international operations has to comply with the accounting standards and tax
laws of the foreign country as well.

5. Culture: In a domestic market, a business deals with a homogenous culture

whereas a company with international business has to deal with heterogeneous
cultures in multiple countries. The company's management has to study
different cultures and get accustomed to different languages, culture,
sentiments, and traditions of the foreign country in order to conduct business
productively.

6. Market Forces: Demographics of each country have its own perceptions

about different products and services. The local, political, economic, and
technological environments differ from country to country. While these
differences are at a macro level, at the micro level we have to consider several
 other factors. They may be in terms of customer preferences, product
placement, pricing, advertising, distribution channels and so on. An
international company has to face the challenges of multiple regional
customers, each with unique requirements.

1.3 Globalization
Globalization is a process where businesses are dealt in markets around the world,
apart from the local and national markets. According to business terminologies,
globalization is defined as 'the worldwide trend of businesses expanding beyond their
domestic boundaries'. It is advantageous for the economy of countries because it
promotes prosperity in the countries that embrace globalization.

1.4 Drivers of Globalization

1. Global Market Place: International business has become easier since the
advent of internet and the emergence of e-business. A company must have a
good product, the right strategy and an appetite to take risk at the global
marketplace in order to do business internationally.

2. Emerging Markets: Compared to developed countries, developing countries

are growing at a healthy pace, thus reducing the barriers of trade. Emerging
markets provide an unexplored marketplace with unlimited potential and
scope for business. Any company with good or innovative products and
services cannot afford to ignore the opportunities provided by these emerging
markets. Foreign Direct Investment (FDI) policy of a nation lays down the
foundation for competitive and prosperous market conditions. Embracing
globalization has become a vital component of development strategy for
developing countries, and is being used as an effective instrument of economic
growth. Some countries like China, India, and Philippines also provide tax
holidays to foreign companies for setting up their business (in certain sectors)
in these countries. Such incentives make these countries an attractive
destination for companies looking for low cost production.

3. Small Domestic Market: A company, which is mature in its domestic market,

is driven to sell in more than one country because the sales volume achieved in
its own domestic market is not large enough to fully capture the manufacturing
economies of scale. For example, Nokia is an international company based in
Finland.

4. Diminishing Trade and Investment Barriers: The lowering of barrier to

trade and investments (by most countries around the world) also provides an
opportunity to companies looking for expanding their business. Expanding
into a foreign country provides access to low wage labourers, highly skilled
work force, larger market base and so on. Companies have a chance to set up
subsidiaries in low-cost countries for manufacturing their products. Easy flow
of goods and services results in the company literally designing the product in
one country, manufacturing the various components in different countries,
assembling the final product in a third country and marketing the product
across the world.
5. Technological Innovation: The advent of internet and e-commerce,
advancement of telecommunication, information technology, and
improvement in logistics have changed the dynamics of business operations.
The use of mobile telephony, wireless communications, and satellite
connectivity has reduced the time needed for decision making at an
international level. Constant innovation in technology has enhanced
information flow between geographically remote areas, thus bringing the
markets of different countries closer and paving the way for international
business.

6. Changing Demographics: Most developed countries face challenges in

sourcing workforce as the average age of the population is getting older. In the
next 10 years, most of the industrialized nations will have to depend on
sourcing its workforce from countries like India, China and other countries,
where the population is young, with abundance of skilled labour. India alone
produces close to five lakh engineers and one million English speaking
graduates and other diploma holders per year

7. Liberalization of Cross-Border Trade and Resource Movement: Over time

most governments have lowered restrictions on trade and foreign investment
in response to the expressed desires of their citizens and producers. The
primary motives for this change include giving citizens’ greater consumer
choice and lower prices, international competition making domestic producers
more efficient, and the hope that liberalization will cause other countries to
also lower trade barriers.

8. Development of Services That Support International Business: Services

provided by government, banks, transportation companies, and other
businesses greatly facilitate the conduct and reduce the risks of doing business
internationally.

9. Growing Consumer Pressures: Because of innovations in transportation and

communications technology, consumers are well-informed about and often
able to access foreign products. Thus competitors the world over have been
forced to respond to consumers’ demand for increasingly higher quality, more
cost-competitive offerings.

10. Increased Global Competition: The pressures of increased foreign

competition often persuade firms to expand internationally in order to gain
access to foreign opportunities and to improve their overall operational
flexibility and competitiveness.

11. Changing Political Situations: The transformation of the political and

economic policies of Eastern Europe, Vietnam, and China has led to vast
increases in trade between those countries and the rest of the world. In
addition, the improvements in national infrastructure and the provision of
trade-related services by governments the world over have further led to
substantial increases in foreign trade and investment levels
 12. Expanded Cross-National Cooperation: Governments have increasingly
entered into cross-national treaties and agreements in order to gain reciprocal
advantages for their own firms, to jointly attack problems that one country
cannot solve alone, and to deal with areas of concern that lie outside the
territory of all countries. Often, such cooperation occurs within the framework
of international organizations such as the International Bank for
Reconstruction and Development (World Bank).

1.5 Modes to Enter in International Business

For a company that wants to expand internationally, the most common entry options
are listed as follows:
 Export strategy.
 Licensing.
 Franchising.
 Foreign direct investment.

1. Export Strategy: This method remains the most common means of entry into
international markets. Export strategy is a very attractive option that is merely an
extension of domestic operations. It also minimizes the risk component as well as the
capital requirement. The host company's involvement in the international market is
limited to identifying customers for marketing its products.

2. Licensing: A domestic company can license foreign firms to use the company's
technology or products and distribute the company's product. By licensing, the
domestic company need not bear any costs and risks of entering foreign markets on its
own, yet it is able to generate income from royalties. The reverse of this arrangement
is the risk of providing valuable technological knowledge to foreign companies, and
thereby losing some degree of control over its use. Monitoring licenses and
safeguarding company's Intellectual Property Rights can prove to be challenging in an
international scenario. Puma adopted licensing strategy post 1999.

3. Franchising: Licensing works well for manufacturing companies but franchising is a

better option for international expansion efforts of service or retailing companies.
Franchising has the same advantages as licensing. The franchisee bears almost all the
costs and risks in establishing the foreign operations. The franchiser's contribution is
limited to providing the concept, technology and training the franchisee in the already
established model. Maintaining quality poses the biggest challenge to the franchiser.
McDonalds uses franchising model.

4. Foreign Direct Investment (FDI): FDI is the investment made by a company in a

foreign country to start its operations. Various options available for an FDI are as
follows:
I. Whole owned subsidiary - This option is viable if a company is willing to
take all the risks of all the operations pertaining to its business in a foreign
country. A subsidiary can be formed from scratch (green field investment) to
manufacture and market its products and services in a foreign country. A firm
can also export its products or services to other countries from its subsidiaries.
American Airlines is a wholly owned subsidiary of AMR Corp.
II. Joint Ventures (JV) - This is a very popular mode of entry into foreign
markets, as it minimizes business risk and investment. It is owned by one or
 more firms in proportion to their investment. If a JV is done with an existing
competitor, it could be termed as a strategic alliance. Sony Ericsson is an
example of joint venture between Sony, a Japanese company and Ericsson, a
Swedish company.

III. Merger or acquisition - A company can merge into or acquire an existing

company with established operations in a foreign country. It saves a lot of time
in construction, initial setup, and regulatory approvals and so on. In the
bargain, the acquiring company can use all the established brand names,
distribution networks and so on of the acquired company. Eg. Proctor and
Gamble

IV. Strategic investment - Any firm to a share in the profits, if any. The
shareholding can be a minority stake can purchase a stake in a foreign
company, whereby they are entitled and may be without voting rights.
Generally, the investing company does not participate in the management of
the target company.
CHAPTER 2: THE CULTURAL ENVIRONMENTS FACING BUSINESS

2.1 Culture
Culture refers to learned norms based on the values, attitudes, and beliefs of a group of
people. Often, people simultaneously belong to different groups representing different
cultures and/or subcultures. Further, every business function is subject to cultural
influences. Thus, major problems of cultural collision are likely to occur if a firm
implements practices that are less effective than intended and values and/or employees are
unable to accept or adjust to foreign customs. Thus, it is vital that firms determine which
business practices vary in a foreign country and what adjustments, if any, are necessary. At
the same time, cultural diversity can be a source of competitive advantage for global firms.

2.2 Cultural Awareness

Although people agree that cross-cultural differences do exist, they often disagree on their
impact. Are they widespread or exceptional? Are they deep-seated or superficial? Are they
easily discerned or difficult to perceive? It is vital that managers develop an acute
awareness of all those cultures in which they operate. In addition, not only are there
differences that distinguish various cultures, there is also a good deal of variation found
within cultures. Finally, because cultures are dynamic, current attitudes and behaviors may
well change in the future.

2.3 The Idea of A “Nation”: Delineating Cultures

The idea of a "nation" provides a workable definition of a "culture" because the basic
similarities among people are often both cause and effect of national boundaries. While
nations are a useful but imperfect reference for international business, language and religion
often serve as stabilizing influences on culture.

 The Nation as a Point of Reference

The nation provides a workable definition of a culture because the basic similarity among
people within countries (eg, values, language, and race) is both a cause and an effect of
national boundaries; in addition, laws apply primarily along national lines. National
identity is perpetuated through the rites and symbols of a country and a common
perception of history. At the same time, various subcultures and ethnic groups may
transcend national boundaries. In many instances, non-national similarities (such as
management vs. labour) may link groups from different nations more closely than certain
groups within a nation. While nations usually include various subcultures, ethnic groups,
races, and classes, the nation legitimizes itself by mediating the different interests.
Nations that fail in this role often dissolve.

 How Culture Forms and Changes

Culture is transmitted in a variety of ways, but psychologists believe that by age ten, most
children have their basic value systems firmly in place. Nonetheless, individual and
societal values and customs constantly evolve in response to changing economic and
social realities. Cultural change can be brought about by choice or imposition; change
that is brought about by imposition is known as cultural imperialism. The introduction of
 certain elements of an outside culture may be referred to as creolization, or cultural
diffusion.

 Language as Both a Diffuser and Stabilizer of Culture

While a common language within a country serves as a unifying force, language diversity
may undermine a firm’s ability to conduct business, to integrate workforces, and to
market products on a national level. Isolation from other groups, especially because of
language, tends to stabilize cultures. Because some countries see language as such an
integral part of their cultures, they may regulate the inclusion of foreign words and/or
mandate the use of the country’s official language for business purposes.

 Religion as a Cultural Stabilizer

Religion can be a strong shaper of values and beliefs and is a major source of both
cultural imperatives and taboos. Buddhism, Christianity, Hinduism, Islam, and Judaism
represent just some of the religions whose specific beliefs may affect business practices.
Still in all, not all nations that practice the same basic religion place identical constraints
on business. In addition, violence among religious groups can damage property and
disrupt business activities for both home and host country firms.

2.4 Behavioral Practices Affecting Business

Cultural attitudes and values affect business practices - everything from decisions about
what products to sell to decisions about organizing, financing, managing, and controlling
operations. Some of the more important aspects of culture are mentioned below.

Issues in Social Stratification

1. Ascribed and Acquired Membership

People fall into social stratification systems according to group memberships
that, in turn, determine a person’s degree of access to economic resources,
prestige, employment, social relations, and power. Ascribed group
memberships are defined at birth and are based on characteristics such gender,
family, age, caste, and ethnic, racial, or national origin. Acquired group
memberships are based on one’s choice of affiliations, such as political party,
religion, and professional organizations. Social stratification affects both
business strategy and operational practices.

2. Performance Orientation
Some nations base a person’s eligibility for jobs and promotions primarily on
competence, but in others, competence is of secondary importance. In more
egalitarian (open) societies, the less difference ascribed group membership
makes, but in more closed societies, group membership may dictate one’s
access to education and employment. Further, social obstacles and public
opinion in a firm’s home country may also affect its practices abroad.
3. Open and Closed Societies
The more egalitarian, or “open,” a society, the less importance of ascribed
membership in determining rewards. In some cases, ascribed group
membership may deny certain groups opportunities, while promoting the
interests of other groups. Opposition to certain groups may come from other
workers, customers, local stockholders, or government officials.

4. Gender-Based Groups
Strong country-specific differences exist in attitudes toward the roles of males
and females in society and the workplace, as well as the types of jobs regarded
as “male” or “female.” However, in some parts of the world, barriers to
employment based on gender are easing. In addition, as the composition of
jobs becomes less physical and more creative and/or technical, the relative
demand for female employees is also increasing.

5. Age-Based Groups
Many cultures assume that age and wisdom are correlated; thus, they often
have a seniority-based system of advancement. In others, there is an emphasis
on youth, particularly in the realm of marketing. Often there is a mandatory
retirement age in business, but not in politics. Clearly, firms must consider
reference groups when deciding whom to hire and how best to promote their
products.

6. Family-Based Groups
In some societies, family membership is more important than individual
achievement. Where there is low trust outside the family, such as in China and
southern Italy, small family-run companies are generally quite successful, but
they often have difficulty expanding beyond the family. In addition, such
allegiances may impede the economic development of a nation if large-scale
operations are necessary to complete globally.

7. Occupation
In every society certain occupations are perceived as having greater
economic value and social prestige than others. Although many such
perceptions are universal, there are significant differences in national and
cultural attitudes about the desirability of specific occupations, as well as the
willingness to accept the risks of entrepreneurship, rather than work as an
organizational employee.

8. Relationship Preferences
Within social stratification systems, not every member of a reference group is
necessarily equal. In addition, there may be strong or weak pressures for group
conformity. Such national differences in norms influence both effective
management styles and marketing behavior.
 Power Distance: Power distance describes the relationship between
superiors and subordinates. Hoftsede’s study states that when power
 distance is high, the management style is generally distant, i.e., autocratic
or paternalistic. When power distance is low, managers tend to interact
with and consult their subordinates during the decision-making process.
(Examples of countries ranking relatively high on power distance are
Brazil, France, and Malaysia; those ranking relatively low are Austria,
Japan, and the Netherlands.)

 Individualism versus Collectivism: Hoftsede’s study defines

individualism as a person’s desire for personal freedom, time, and
challenge. His/her dependence on the organization is low, and self-
actualization is a prime motivator. On the other hand, collectivism indicates
a person’s dependence on and allegiance to the organization, as well as
his/her desire for training, collaboration, and shared rewards. A prime
motivator is a safe physical and emotional environment. Examples of
countries ranking high on individualism are Australia, Britain, and the
United States; those ranking high on collectivism are China, Mexico, and
Japan. It should also be noted that in many instances, an individual’s
preference for individualism vs. collectivism will be more important than
the national norm relating to the same preferences.

9. Risk-Taking Behavior
Nationalities differ in their attitudes toward risk-taking, i.e., how willingly
people accept things the way they are and how great their need for control of
their destinies.
 Uncertainty Avoidance: Hofstede’s study describes uncertainty
avoidance as one’s tolerance of risk. When the score is high, workers
need precise directions and the prospect of long-term employment, while
consumers are wary about trying new products. When the score is low,
workers are willing to be creative and to move to new jobs, while
consumers accept the risk of being the first to try new products. Examples
of countries ranking high on uncertainty avoidance are Belgium and
Portugal; those ranking low are Britain and Denmark.

 Trust: Trust represents one’s belief in the reliability and honesty of

another. Where trust is high, there tends to be a lower cost of doing
business because managers devote less time to investigation and oversight
and more to innovation and investment. While Norwegians tend to exhibit
a high degree of trust, Brazilians tend to be skeptical.

 Future Orientation: Individuals who tend to live for the present as

opposed for the future see risks in delaying gratification and investing for
the future. Where future orientation is higher, workers will more likely be
motivated by types of delayed compensation, such as retirement programs.
While a future orientation tends to be higher in Canada, the Netherlands,
and Switzerland, it tends to be lower in Italy, Poland, and Russia.
  Fatalism: Fatalism represents the belief that life is predestined, that every
event is inevitable, that occurrences represent “the will of God.” Unlike
those who believe strongly in self-determination and basic cause-and-
effect relationships, fatalists (e.g., Muslims and other fundamentalist
groups) are not likely to plan for contingencies or take responsibility for
performance. Thus they are less swayed by persuasive logic than by
personal relationships.

10. Information and Task Processing

People from different cultures obtain, perceive, and process information in different
ways; thus, they may also reach different conclusions.
 Perception of Cues: People perceive cues selectively. They identify
things by means of their senses (sight, smell, touch, taste, sound) and in
various ways within each sense. The particular cues used will vary both
for physiological and cultural reasons e.g., differences in eye pigmentation
enable some to distinguish colors better than others; the richer and more
precise a language, the better one’s ability to express subtleties.

 Obtaining Information: Low-Context versus High-Context Cultures.

Language represents a culture’s primary means of communication. In a
low-context culture, people rely on explicit, first-hand information that
bears directly on a decision or situation; people say what they mean and
mean what they say. In a high-context culture, people rely on implicit,
peripheral information and infer meaning from things communicated
indirectly; relationships are very important; e.g., while the United States
and most of Northern Europe are considered to be low-context cultures;
most countries in Southern Europe and Saudi Arabia are considered to be
high-context cultures.

 Information Processing: All cultures categorize, plan, and quantify, but

the ordering and classification systems used often vary. In monochronic
cultures (e.g., northern Europeans) people prefer to work sequentially, but
in polychronic cultures (e.g., southern Europeans) people are more
comfortable working on multiple tasks at one time. Likewise, in some
cultures people focus first on the whole and then on the parts; similarly,
some cultures will determine principles before they try to resolve small
issues (idealism), whereas other cultures will focus more on details rather
than principles (pragmatism).

11. Communication
Communication problems may arise when moving from one country to another,
even though both countries share the same official language. Of course, problems
also arise when moving from one language to another.
 Spoken and Written Language. Translating one language into another
can be very difficult because (a) some words do not have a precise
translation, (b) the common meaning of words is constantly evolving, (c)
 words may mean different things in different contexts, and (d) a slight
misuse of vocabulary or word placement may change meanings
substantially. Further, while jokes and laughter have universal appeal,
much humor does not. Therefore, words must be chosen very carefully,
because poor translations may have tragic consequences.

 Silent Language: Silent language incorporates the wide variety of

nonverbal cues through which messages are sent—intentionally or
unintentionally. Color associations, the distance between people during
conversations, the perception of time and punctuality, a person’s perceived
prestige, and kinesics or body language, are all very significant.
Misunderstandings in any of these areas can be serious.

2.5 Dealing with Cultural Differences

Once a company identifies cultural differences in the foreign countries in which it operates,
must it alter its customary practices? Can individuals overcome adjustment problems when
working abroad?
1. Accommodation
If products and operations do not run counter to deep-seated attitudes, or if the host
country is willing to accept foreign customs as a trade-off for other advantages,
significant adjustments may not be required.

2. Cultural Distance
Cultural distance represents the degree of similarity between two societies. Countries
may be relatively similar to one another because they share the same language,
religion, geographical location, ethnicity, and/or level of economic development.
Generally, a firm should have to make fewer adjustments when moving within a
culturally similar cluster than when it moves from one distinct cultural cluster to
another. Nonetheless, a manager must not assume that seemingly similar countries are
more alike than they really are and be lulled into a complacency that overlooks
critical subtleties.

3. Culture Shock
Culture shock represents the trauma one experiences in a new and different culture
because of having to learn to cope with a vast array of new cues and expectations.
Reverse culture shock occurs when people return home, having accepted the culture
encountered abroad and discovering that things at home have changed during their
absence.

4. Company and Management Orientations

Whether and to what extent a firm and its managers adapt to foreign cultures depends
not only on the conditions within those cultures but also on the policies of the
company and the attitudes of its managers.
 Polycentrism: Polycentrism represents a managerial approach in which foreign
operations are granted a significant degree of autonomy, in order to be
responsive to the uniqueness of local cultures and other conditions.
  Ethnocentrism: Ethnocentrism represents a belief that one’s own culture is
superior to others, and that what works at home should work abroad. Excessive
ethnocentrism may lead to costly business failures.

 Geocentrism: Geocentrism represents a managerial approach in which foreign

operations are based on an informed knowledge of both home and host country
needs, capabilities, and constraints.

2.6 Strategies for Instituting Change

Companies may need to transfer new products and/or operating methods from one country
to another in order to gain a competitive advantage. To maximize the potential benefits of
their foreign presence, they need to treat learning as a two-way process and transfer
knowledge from home countries abroad and from host countries back home.

1. Value systems: The more that change upsets important values, the more resistance
it will encounter. Accommodation is much more likely when changes do not
interfere with deep-seated customs.

2. Cost Benefit of Change: Some adjustments to foreign cultures are costly to

undertake, but their benefits are only marginal. The expected cost-benefit of any
change must be carefully considered.

3. Resistance to Too Much Change: Resistance to change may be reduced if only a

few demands are made at one time; others may be phased in incrementally.

4. Participation: A proposed change should be discussed with stakeholders in

advance in order to ease their fears of adverse consequences—and perhaps gain
their support.

5. Reward Sharing: A company may choose to provide benefits for all the
stakeholders affected by a proposed change in order to gain support for it.

6. Opinion Leaders: Characteristics of opinion leaders often vary by country. By

discovering the local channels of influence, an international firm may seek the
support of opinion leaders to help speed the acceptance of change.

7. Timing: Many good business changes fail because they are ill-timed. Attitudes and
needs change slowly, but a crisis may stimulate the acceptance of change.

8. Learning Abroad: The essence for undertaking transnational practices is to

capitalize on diverse capabilities by transferring learning among all the countries in
which a firm operates.
CHAPTER 3: POLITICAL AND LEGAL ENVIRONMENT FACING INTERNATIONAL BUSINESS

3.1 The Political Environment

For a multinational enterprise to succeed in countries with different political and legal environments, it must
carefully analyze the fit between its corporate policies and the political and legal conditions of each particular
nation in which it operates.

3.2 The Political System

A political system is the complete set of institutions, political organizations, and interest groups, the
relationships among those institutions, and the political norms and rules that govern their activities. Thus, it
integrates the various parts of a society into a viable, functioning entity. It also influences the extent to which
government intervenes in business and the way in which business is conducted both domestically and
internationally. The ultimate test of any political system is its ability to hold a society together.

3.3 Individualism versus Collectivism

It is useful to profile the similarities and differences among political systems according to the general within a
society about the primacy of the rights and role of the individual versus that of the larger community. Under an
individualistic paradigm (e.g., the United States), political officials and agencies play a limited role in society.
The relationship between government and business tends to be adversarial; government may intervene in the
economy to deal with market defects, but generally it promotes marketplace competition. Under a collectivist
paradigm, the government defines economic needs and priorities, and it partners with business in major ways.
Government is highly connected to and interdependent with business; the relationship is cooperative.

3.4 Political Ideology

A political ideology is the body of goals, theories, and aims that constitute a sociopolitical program (e.g.,
liberalism or conservatism). Pluralism indicates the coexistence of a variety of ideologies within a particular
society. Although shared ideologies create bonds within and between countries, differing ideologies tend to
split societies apart. The two extremes on the political spectrum are democracy and totalitarianism.

3.5 Democracy
A democracy represents a political system in which citizens participate in the decision-making and governance
process, either directly or through elected representatives. Contemporary democracies share the following
characteristics: freedom of opinion, expression, press, religion, association and access to information; freedom
to organize; free elections; an independent and fair court system; a nonpolitical bureaucracy and defense
infrastructure; and citizen access to the decision-making process. In decentralized democracies, e.g., Canada
and the United States, companies may face different and sometimes even conflicting laws from one state or
province to another. The defining characteristic of democracy is freedom. Measures of political rights and
civil liberties have been developed to assess levels of freedom; a country may be rated as free, partly free, or
not free.

3.6 Totalitarianism
Totalitarianism represents a political system in which citizens seldom, if ever, participate in the decision-
making and governance process; power is monopolized by a single agent and opposition is neither recognized
nor tolerated. In theocratic totalitarianism, religious leaders are also the political leaders. In secular
totalitarianism, the government maintains power through the authority of the state. Other variants of
totalitarianism include authoritarianism and fascism.

3.7 Trends in Political Systems

Several factors have powered the democratization of the world. First, many totalitarian regimes failed to
improve the economic lives of their citizens, who eventually challenged the right of the state to govern.
 Second, vastly improved communications technology weakened the ability of regimes to control people’s
access to information. Third, many people who champion democracy truly believe that greater political
freedom leads to economic freedom and higher standards of living. Although the world is experiencing
general movements towards democracy and more open economies, this does not necessarily indicate an
increasing homogenization of political systems. Not all nations embrace the concept of "democracy" as
defined by Western standards. China and Russia are two examples of countries with different views of
democratic governance.

3.8 Political Risk.

Political risk is the possibility that political decisions, events, or conditions will affect a country's business
environment in ways that will cost investors some or all of the value of their investment or force them to
accept lower than projected rates of return. Leading sources of political risk are: expropriation or
nationalization, international war or civil strife, unilateral breach of contract, destructive government actions,
harmful actions against people, restrictions on the repatriation of profits, differing points of view, and
discriminatory taxation policies.

The following types of political risk range from the least to the most destructive.

1. Systemic Political Risk.

Systemic political risk creates risks that affect all firms because of a change in public policy. However,
such changes do not necessarily reduce potential profits.

2. Procedural Political Risk.

Procedural political risk reflects the costs of getting things done because of such problems as government
corruption, labor disputes, and/or a partisan judicial system.

3. Distributive Political Risk.

Distributive political risk reflects revisions in such items as tax codes, regulatory structure, and monetary
policy imposed by governments in order to capture greater benefits from the activities of foreign firms.

4. Catastrophic Political Risk.

Catastrophic political risk includes those random political developments that adversely affect the operations
of all firms in a country.

3.9 LEGAL ISSUES IN INTERNATIONAL BUSINESS

Two major areas of concern to international business concerning legal issues are operational concerns and
strategic matters.

3.9.1 Operational Concerns

Efforts to start a business, to enter and enforce contracts, to hire and fire employees, and to close a business are
all affected by national laws and regulations. While there appears to be an inverse relationship between a
country’s per capita income and its tendency to regulate business, the legal systems of the more highly
developed countries tend to regulate the major operational features of business activity more consistently than
do the less developed nations. Further, those countries that make it easy to start a business also tend to impose
fewer and simpler regulations to hire and fire workers and impose less regulation in their courts and
bankruptcy systems.

3.9.2 Strategic Concerns

Many legal issues affect the process of value creation. The following legal contingencies often shape an
international competitor’s strategic plans.
1. Product Safety and Liability. Often products must be customized in order to comply with local
standards, which may be higher than those found in a firm’s home market. While product liability laws
are very stringent in markets such as the United States, they are spotty, absent, and at times even
arbitrary in many less developed countries.

2. Marketplace Behavior. National laws determine permissible practices in pricing, distribution,

advertising, and the promotion of products, and they vary widely from one country to another.

3. Product Origin and Local Content. Local content is important to all nations, and most countries
push foreign firms to add value locally. In addition, product origin determines applicable fees and may
be subject to quantitative restrictions as well.

4. Legal Jurisdiction. Every country specifies which law should apply and where litigation should occur
when agents are involved—whether they are legal residents of the same or different countries.

5. Arbitration. Most arbitration is governed by the New York Convention, a protocol specified in 1958
that allows parties to choose their own mediators and resolve disputes on neutral ground.
CHAPTER 4: THE ECONOMIC ENVIRONMENT

4.1 Economic Environment

Company managers study economic environments to estimate how trends affect their performance. A country’s
economic policies are a leading indicator of government’s goals and its planned use of economic tools and
market reforms. Economic development directly impacts citizens, managers, policymakers, and institutions.
The economic environment refers to the economic conditions under which a business operates and takes into
account all factors that have affected it. It includes prime interest rates, legislation concerning employment of
foreigners, return of profits, safety of country, political stability and so on.

4.2 Various Aspects of Economic Environment

National Economic Policies: National economic policies depend on a country's socio-economic and cultural
background. All governments aspire to achieve four major economic objectives:
I. Full employment.
II. A high economic growth rate.
III. A low rate of inflation.
IV. Absence of deficit in the country's balance of payments.
The basic problem is that the first two objectives work against the last two. Measures such as low interest rates,
tax cuts and increase in public spending creates jobs and stimulates growth but also causes inflation, increase in
wage, and higher imports. Due to increased consumer expenditure the country's balance of trade worsens.

Economic Structure
The structure of a nation's economy is determined by
I. the size and rate of its population growth,
II. income levels
III. distribution of income,
IV. natural resources,
V. agricultural,
VI. Manufacturing and services sector.
VII. Economic infrastructure

Economic Infrastructure
It is the sum of all the external facilities and services that support the work of firms including
i. communication,
ii. transportation,
iii. electricity supply,
iv. banking and financial services.

Industry Structure
The structure of an industry is determined by factors such as:
i. Entry and exit barriers.
ii. Number of competing firms.
iii. Market share among firms in that sector.
iv. Average size of competing units.

Market Growth
It is measured in terms of local currency and adjusted for inflation. Local currency is used because conversions
into other currencies are affected by exchange rate fluctuations.

Income Level
It is taken as the GDP per capita and GDP is directly proportional to the productivity of the country. Net
income is another important variable and is without tax payments from individual gross incomes.
Openness of the Economy
The ratio of a country's imports and exports to its Gross National Product (GNP) indicates its vulnerability to
fluctuations in international trade. A nation with a high foreign trade or GNP depends heavily on the economic
well-being of the nations it exports to. Conversely, closed economies have a high degree of control over the
economy.

International Debt
An outstanding loan that one country owes to another country or institutions within that country. Foreign debt
also includes due payments to international organisations. Foreign exchange reserves should not be less than
outstanding short-term foreign debts. On the other hand, a high foreign debt servicing requirement maybe a
positive indicator, suggesting that a country has borrowed heavily to invest in its future.

Degree of urbanization
This is an important factor because there are major differences in incomes and lifestyles between urban and
rural areas in most countries such as:
I. Shopping patterns - shopping frequency, average purchase value.
II. Nature of goods bought.
III. Expectations in quality and technical sophistication.
IV. Education levels.
V. Ease of distribution.

4.3 Elements of Economic Environment

Gross National Income

Gross national income (GNI) measures the income generated both by total domestic production plus the
international production activities of national firms. It is the market value of all final goods and services newly
produced by a country’s domestically-owned firms plus the net flows of factor income (i.e., rents, profits, and
labor income) in a given year.

Gross Domestic Product

Gross domestic product (GDP) measures the value of production generated by both domestic and foreign-
owned firms within a nation’s borders in a given year.

Gross National Income Per Capita

GNI per capita is the value of all goods and services produced in the economy divided by the population. In
2005 high-income countries accounted for less than 15 percent of the world’s population but nearly 75 percent
of the world’s GNI

Purchasing Power Parity

While exchange rates define the number of units of one currency that are required to purchase one unit of
another currency, they do not determine what a unit of currency can buy in its home country, i.e., exchange
rates do not incorporate differences in the cost of living. Purchasing power parity (PPP) represents the number
of units of a country’s currency required to buy the same amount of goods and services in the domestic market
that one unit of income would buy in another country. PPP is estimated by calculating the value of a universal
“basket” of goods that can be purchased with one unit of a country’s currency

Human Development Index

The Human Development Index (HDI) measures longevity, knowledge (primarily the adult literacy rate), and
standard of living and is designed to capture long-term progress rather than short-term changes in the given
country.
4.4 Features of Economy to Be Considered While Evaluating Economic Environment of Any Country

4.4.1 Inflation

 Inflation is the pervasive and sustained rise in the aggregate level of prices as measured by a cost of
living index. When aggregate demand grows faster than aggregate supply, i.e., when prices rise faster
than incomes, the effects can be dramatic.

 Inflation and the Cost of Living. Rising prices make it more difficult for consumers to buy products
unless their incomes rise at the same or faster pace. In addition, historically chronic inflation erodes
confidence in a country's currency and spurs people to search for other ways to store value.

 Implications of Chronic Inflation. Among other things, high inflation results in governments’ setting
higher interest rates, installing wage and price controls, and imposing protectionist trade policies and
currency controls.

 Price Indexes and Problems in Measuring Inflation. The Consumer Price Index (CPI) measures the
average change in consumer prices over time in a fixed market basket of goods and services

4.4.2 Unemployment

The unemployment rate represents the number of unemployed workers divided by the total civilian labor force
in a given country.

 The Working Age Population. At present, the wealthier countries of the world are watching their
working-age populations shrink, while the poorer countries of world are seeing their working age
populations’ rise.

 Labour Regulation. Emerging economies also face challenges from excessive labor restrictions,
making companies reluctant to hire new workers for fear of not being able to fire them if needed.

 Problems in Measuring Unemployment. Given the wide differences in social policies and institutional
frameworks, the meaning of the unemployment rate varies from one country to another. Often, the true
degree of joblessness and the productivity of those who work are distorted.

4.4.3 Debt

It is the sum total of a government’s financial obligations; its measures the state’s borrowing from its
population, from foreign organizations, from foreign governments, and from international institutions. Internal
debt results when a government spends more than it collects in revenues; the subsequent pressure to revise
government policies often lead to economic uncertainty. External debt results when a government borrows
money from foreign lenders. The Heavily Indebted Poor Countries initiative is designed to alleviate the severe
external debt burdens of less developed countries, much of which was amassed during the oil shocks of the
l970s and the 1980s. More recently, transition economies have also seen their rates of economic development
slowed because of high external debt burdens.

4.4.4 Income Distribution

Income distribution describes what share of a country’s incomes goes to various segments of the population.

 Income Distribution among Wealthy Nations. Uneven income distribution is not a problem for poorer
nations.
  Urban versus Rural Income Distribution. There is a particularly strong relationship in skewed income
distributions and growth in per capita income between those who live in urban settings, where growth is
accelerating, and those who live in rural settings, where growth is nearly stagnant.

 A Note on Income Inequality. Income inequality is now the highest it has been at any time in the
world's history, according to Jeffery Sachs. The main reason is that 200 years ago everyone was poor.
Increasing income inequality isn't just an issue of social justice, but also one of economic efficiency.

4.4.5 Poverty

Poverty is a condition in which a person or community is deprived of, or lacks the essentials for a minimum
standard of well-being and life. According to the World Bank, globally, the world is about 78 percent poor, 11
percent middle income, and 11 percent rich. In poverty-stricken countries, economic infrastructure and progress
are minimal. Poverty impacts economic development and the way businesses do business. International
companies must deal with issues such as the lack of market systems, infrastructure deficiencies, criminal
behavior, and bad government.

4.4.6 Labour Costs

Companies continually scrutinize where it makes most sense to locate particular activities. Companies scan the
world, looking for the best deal on labor costs. With current projections indicating the average wage rate in the
U.S. moving up to a bit over $25 an hour, China with an average rate of $1.30 and Indonesia with $0.70 will
attract additional jobs from overseas.

4.4.7 Productivity

Companies refine their interpretation of labor costs by considering productivity – the amount of output created
per unit of input. In terms of labor, productivity is the quantity produced per person per labor hour. Beginning
with the first half of the 1990s, emerging markets have accelerated global productivity. Productivity, worldwide
has benefited from an unprecedented combination of technological progress, open markets, and better economic
policies. Technology is expected to continue to aid in productivity gains.

4.4.8 Balance of Payments

 These Balance of Payment accounts attempt to identify the reasons behind various categories of
international receipts and payments, making it possible to establish the values of payments by domestic
residents to foreigners, and vice versa, for purchase of imports, use of services, lending, or direct foreign
investment.

 The account is divided into categories for long and short term financial transactions, which is initiated
by the national monetary body, and involves goods and services. Balance of payments is a record of all
economic transactions that occur between residents of a country and foreigners over a specific period of
time.

 The balance is shown monthly, quarterly or annually. The accounts show the structure of the external
trade, net position as a lender or borrower and trends in economic relationships with the world.

 The balance of payments is a good overall indicator of a country's economic health; the likelihood of the
country's government imposing forex controls, import restrictions and policies such as tax increments
and interest rate hikes.

 Current account deficit records physical imports and exports along with international transactions in
invisibles, that is non-physical items such as residents' pensions, interest and royalties from abroad,
domestic firm's fees for the movement of goods in other countries, and so on. The balance of trade
within the current account is the balance on physical (visible) imports and exports.
  The other major grouping is the capital account which shows the balance of transactions in financial
assets, including direct investments in foreign financial instruments, movements in short-term assets,
inter-governmental loans and changes in the country's gold and forex reserves.

 Reserves will decline if there is, for example, a current account deficit which in turn affects the currency
rate. To prevent the local currency from depreciating too much, some foreign currency reserves will be
sold, but since it is limited, this is only a temporary measure.

4.5 Types of Economic Systems

An economic system is the set of structures and processes that guides the allocation of scarce resources and
shapes the conduct of business activities in a nation. The spectrum of systems is anchored on one end by
capitalism and on the other by communism.
Free-market (capitalistic) economies are built upon the private ownership and control of the factors of
production.

4.5.1 Market Economy

A market economy describes the system where individuals, rather than government, make the majority of
economic decisions. Key factors include consumer sovereignty, the freedom of market entry and exit, and the
determination of prices according to the laws of supply and demand. Credited to Adam Smith, the laissez-faire
principle, i.e., nonintervention by government in a country’s economic activity, states that producers are driven
by the profit motive, while consumers determine the relationship between price and quantity demanded. Thus,
scarce resources are allocated efficiently and effectively.

4.5.2 Command Economy

It is also known as centrally-planned economy. Command economies are built upon the government
ownership and control of the factors of production. Central planning authorities determine what products will
be produced in what quantities and the prices at which they will be sold. Most often, the totalitarian aims of
communism gave the highest priority to industrial investments and military spending at enormous expense to
the consumer sector.

4.5.3 Mixed Economy

Mixed economies fall between the extremes of market and command economies. While economic decisions
are largely market-driven and ownership is largely private, government nonetheless intervenes in many
economic decisions. The extent and nature of such intervention may take the form of government ownership of
certain factors of production, the granting of subsidies, the taxation of certain economic activities, and/or the
redistribution of income and wealth.
CHAPTER 5: GLOBALIZATION AND SOCIETY

5.1 Evaluating the Impact of FDI

 Multinational enterprises (MNEs) have their greatest impact on countries when they
engage in foreign direct investment (FDI). Although not all MNEs are huge, the sheer
size of some troubles their critics. Further, their global orientation causes many to
believe that MNEs are insensitive to national (local) concerns. Depending upon their
particular perspectives, pressure groups in both home and host countries continue to urge
their governments to devise policies that either encourage or restrict MNE activities.

 FDI has come to be seen as a major contributor to economic growth and development by
bringing capital, technology, management expertise, jobs, and wealth to host countries
However, FDI is not without controversy. Over time the structure of FDI has shifted
toward services and away from many extractive and other industries. Many countries
that opened their markets have experienced economic and social disruptions as MNE
investments have constrained or eliminated domestic competitors. At the same time
many firms made large foreign investments that have seriously underperformed. As
MNEs continue to allocate resources across a variety of countries in their quests to
optimize performance, governments will, in turn, enact policies that reflect their own
interpretations of the relative benefits and costs of FDI. Countries react differently to
FDI. Some countries view FDI with suspicion, some oppose it, and others encourage it.
The reasons for these different viewpoints can be traced to various factors.

5.2 Reasons for FDI

To get a better understanding of the relationship between MNEs and governments, three areas
are of particular interest: stakeholder trade-offs, cause-and-effect relationships, and individual
and aggregate effects.

5.2.1 Stakeholder Trade-offs

To survive and prosper, companies must satisfy a variety of stakeholders, i.e., shareholders,
employees, customers, suppliers, and society. Depending upon the objectives of different
constituencies, FDI can result in win-win, win-lose, or lose-lose (positive, neutral, negative)
outcomes. At any given time, it is necessary to give the various stakeholders unequal attention.
The management of stakeholder relationships requires that the MNE make necessary trade-offs.

5.2.2 The Question of Cause-and-Effect Relationships

Just because two factors (such an in increase in both FDI and unemployment) move in similar
directions, it does not necessarily mean that they are causally related and interdependent.
Inequitable income distribution, political corruption, environmental debasement, and social
deprivation are just some of the many intervening variables that can distort the analysis of cause
and effect.

5.2.3 Individual and Aggregate Effects

Evaluating MNEs and their activities on an individual basis can be both time-consuming and
costly. On the other hand, applying the same policies and control mechanisms to one and all is a
far from perfect approach, especially if policies are based on exceptions, and not the general rule.
5.3 The Economic Impact of the Mne

The investments and operations of MNEs may affect national balance-of-payments,

economic growth, and employment objectives in ways that are positive or negative for both
home and host countries.

5.3.1 Balance-of-Payments Effects

Although foreign direct investment involves both capital and earnings inflows and outflows,
many people fear (irrationally) that the net balance-of-payments effects may be negative.

 Effect of Individual FDI: The effect on the host country of a single foreign direct
investment may be positive or negative. When FDI results in import substitution,
i.e., when products that were formerly imported by a country are subsequently
produced within that country, its foreign exchange reserves should increase.
Generally, FDI is initially favorable to the host country and unfavorable to the
home country, but this effect may reverse over time if aggregate repatriated profits
exceed the value of the initial investment. Thus, governments must learn to
maximize the benefits while minimizing the long-term adverse effects of FDI flows.

The formula for calculating the balance-of-payments effects is:

B = (m – m1) + (x – x1) + (c – c1)

Where
B = balance-of-payments effect
m = import displacement
m1 = import stimulus
x = export stimulus
x1 = export reduction
c = capital inflow for other than import and export payments
c1 = capital outflow for other than import and export payments

 Calculating Net Import Effect: Although the equation is straightforward,

determining the value of each variable I difficult because the data used must be
estimated and are subject to assumptions. The net import effect (m – m1) is positive
for the host country if the FDI results in the substitution of local production for
imported products and is negative if it results in an increase in imports to supply the
new productive capacity. (The marginal propensity to import reflects the fraction of
a change in imports due to a change in income, i.e., the portion of increased income
spent on imports.)

 Calculating the Net Export Effect: The net export effect (x – x1) is particularly
controversial because underlying assumptions are widely debated. That said, the
effect is positive for the host country if the FDI results in the generation of exports
but negative if it results in a decline. (FDI may also stimulate home country exports
of complementary products to the host country.)
  Calculating the Net capital flows: The Net capital flows (c – c1) are difficult to
assess because of the time lag between an outward flow of investment funds and the
subsequent inward flow of remitted earnings from that investment. Although initial
capital flows to the host country are positive, they may be negative in the long run if
capital outflows eventually exceed the value of the investment. Finally, indirect
effects such as those derived from the transfer of technology and managerial skills
are difficult to measure but may be critical to the development of the economic
efficiency of the host country.

5.3.2 Growth and Employment Effects

In contrast to the balance-of-payments effects, the effects of FDI on economic growth and
employment should not be a zero-sum game because MNEs may use resources that were
either underemployed or unemployed. The argument that both home and host countries can
gain from FDI rests on two assumptions: (i) resources are not necessarily fully employed
and (ii) capital and technology cannot be easily transferred from one industry to another.

 Home-Country Losses: As manufacturers seek lower-cost foreign production sites,

home countries claim that FDI outflows create jobs abroad at the expense of jobs in
the home country.

 Host-Country Gains: Host countries gain through the transfer of capital and
technology; through the import of technology and managerial ability, new jobs may
also be created.

 Host-Country Losses: Critics argue that FDI inflows often displace domestic
investment and drive up local labor costs. They claim that MNEs have access to
lower-cost funds than local competitors do and that MNEs can spend more on
promotion activities. In addition, while it is true that MNEs often source inputs
locally, critics claim that they also destroy local entrepreneurship. Further, as MNEs
gain valuable knowledge in their foreign operations that can be shared across their
entire organizations, critics fear that local firms subsequently suffer a competitive
disadvantage. Pro-NME analysts claim that the presence of MNEs may actually
increase the number of local companies operating in host-country markets by
serving as role models for local talent to emulate.

5.4 The Foundations of Ethical Behavior

Whether they engage in trade, licensing, or foreign direct investment, MNEs must act
responsibly. However, because ethical behavior is rooted in both cultural and legal traditions
that vary from one country to another, dilemmas often arise.

5.4.1 Why Do Companies Care about Ethical Behavior?

There are cultural and legal reasons for companies to behave ethically, and individuals have high
ethical standards. In addition, ethical behavior can help achieve a competitive advantage and
avoid the perception of being irresponsible.
5.4.1.1 The Cultural Foundations for Ethical Behavior

 Relativism versus Normativism

Beliefs may vary because of different family and religious teachings, different laws and
social pressures, different observations, experiences, and perceptions, and even different
economic circumstances. Within a country an individual’s values may differ from his/her
employer’s policies, which may differ from prevalent societal norms or laws. At the
international level, cultural complexity increases geometrically. While many actions elicit
universal agreement on what is clearly right and wrong, others are less clear.
Relativism holds that ethical truths depend upon the groups subscribing to them; thus,
intervention in local issues and traditions by outsiders is clearly unethical.
On the other hand, normativism holds that there are universal standards of behavior that
everyone should follow; thus, nonintervention in local violations of global standards is
clearly unethical.

 Walking the Fine Line Between Relativism and Normativism. Many argue that
managers the world over must exhibit ordinary decency, i.e., principles of honesty and
fairness. In addition, they argue that MNEs are obligated to set good examples that can
serve as the standards for responsible behavior. From a competitive standpoint, it is
argued that responsible acts create strategic and financial success because they lead to
trust, which in turn leads to commitment. In addition, many multilateral agreements exist
that can aid in ethical decision-making; they deal primarily with employment practices,
consumer and environmental protection, political activity, and human rights in the
workplace. Still, no set of workable corporate guidelines is universally accepted and
observed.

5.4.1.2 The Legal Foundations for Ethical Behavior

Ethics teaches that people have a responsibility to do what is right and to avoid doing what is
wrong.
 Legal Justification: Pro and Con. The appropriateness of behavior can be measured in
the sense that individuals and organizations must seek justification for their behavior, and
that justification is a function of both cultural values (many of which are universal) and
legal principles. However, opponents of legal justification feel that ethical behavior is
not sufficient because: (i) everything that is legal is not necessarily ethical, (ii) the law is
slow to develop in emerging areas of concern, (iii) the law is often based on moral
concepts that cannot be separated from legal concepts, (iv) the law may need to be tested
by the courts, and (v) the law is not efficient in terms of achieving ethical behavior at a
minimum cost. Nonetheless, the law does serve as a useful basis for examining ethical
behavior because it embodies cultural values. Proponents of the legal-justification
standard state the there are several good reasons for complying with it: (i)the law
provides a basic guide for proper conduct, (ii) the law provides a clearly defined set of
rules, and when followed they establish a good precedent, (iii) the law contains
enforceable rules that apply to everyone, and (iv) the law reflects careful and wide-
ranging discussions.

 Extraterritoriality. In addition to the fact that laws vary among countries, strong home-
country governments may attempt to extend their legal influence to foreign countries.
Extraterritoriality refers to the extension by a government of the application of its laws
 to the foreign operations of its domestic firms. In cases of health and safety regulations,
differences may not be insurmountable, but in other instances, home- and host-country
laws clearly conflict.

5.5 Ethics And Corporate Bribery

The law is a good place to start when studying ethical behavior. In addition, managers encounter
certain externalities (byproducts of activities) that must be solved in the public arena. Some of
the key ethical issues companies face when doing business internationally are discussed below.

5.5.1 Corruption and Bribery

Bribery consists of payments, or promises to pay cash or something else of value, to public
officials and/or other people of influence. It affects the performance of countries and companies
alike. Anecdotal information indicates that in recent decades, questionable payments by MNEs
to government officials have been prevalent in both industrial and developing countries.

5.5.2 The Consequences of Corruption

High levels of corruption tend to correlate with lower rates of economic growth as well as lower
levels of per capita income. Corruption may also erode the legitimacy of a government. Both
the legal definition of a bribe and the likelihood of paying brides abroad vary by nationality.

5.5.3What’s Being Done About Corruption?

The U.S. Foreign Corrupt Practices Act outlaws the payment of bribes by U.S. firms to foreign
officials, political parties, party officials, or party candidates; applies to firms registered in the
United States and to any foreign firms that are quoted on any U.S. stock exchange; and was
extended to include bribery by foreign firms operating in U.S. territory in 1998. (While the law
seems to be a useful deterrent, an apparent inconsistency permits payments to foreign officials to
expedite otherwise legitimate transactions, but not to other officials.) Federal government
guidelines for establishing an effective antibribery compliance program involve setting high
standards, communicating those standards to relevant employees, educating employees regarding
their expected behavior, and monitoring compliance.

Multilateral efforts to confront bribery are numerous. They include: Transparency International’s
Business Principles for Countering Bribery (2003); the OECD Convention on Combating
Bribery of Foreign Public Officials in International Business Transactions (1997); the antibribery
provisions of the revised OECD Guidelines for Multinationals; and the International Chamber of
Commerce (ICC) Rules of Combat to Combat Extortion and Bribery (1999).

In addition, Transparency International assists citizens in setting up national chapters to fight

local corruption. It also regularly compiles an international Corruption Perceptions Index (CPI)
based on surveys of business people, risk analysts, journalists, and the general public. Further,
the Partnering Against Corruption Initiative brought together nearly fifty construction- and
natural resource-based multinational enterprises at the 2005 World Economic Forum to sign a
zero-tolerance pact against corruption.
5.6 Ethical Behaviour And Environmental Issues

Environmental damage can occur from the extraction of resources, some of which are renewable
and some of which are not, and the contamination of the environment via production processes
and the use of pollution-causing products.

5.6.1 What Is “Sustainability”?

Sustainability means meeting the needs of the present without compromising the ability of future
generations to meet their own needs, while taking into account what is best for society and for the
environment.

5.6.2 Global Warming and the Kyoto Protocol

The issue of global warming, the Kyoto Protocol, and the potential impact of the Protocol on
corporate behavior all serve to illustrate the challenges associated with responsible societal
behavior. Global warming results from the release of greenhouse gases that trap heat in the
atmosphere, rather than allowing the heat to escape.

The Kyoto Protocol. At the heart of the international treaty known as the Kyoto Protocol,
signed in 1997, is the theory that if global warming is not controlled and reduced, the rising
temperature of the earth will result in catastrophic events. The Protocol, which is an extension of
the UN Framework Convention on Climate Change, obligates signatory countries to reduce their
greenhouse gas emissions to 5.2 percent below 1990 levels between 2008 and 2012. While the
European Union has made the decision to set a target of an 8 percent reduction below 1990
emission levels (and countries such as Germany have established even higher goals), the United
States, China, and India are not parties to the agreement, even though they generate a significant
portion of the world’s greenhouse gases.

Foreign firms operating in countries that have adopted the Kyoto Protocol are required to meet or
exceed the same standards as local companies, regardless of the standards of their home
countries. (Firms that are not in compliance with local standards may be able to buy credits from
companies whose emissions are actually below the target levels.) While the legal approach to
responsible behavior says that firms can operate according to local laws, the ethical approach
says that firms should do whatever is necessary and economically feasible to reduce greenhouse
gas emissions to the lowest possible levels.

5.7 Ethical Dilemmas And Business Practices

Sometimes ethical are industry specific, such as the pharmaceutical industry. Other times the
dilemmas are not exactly industry specific but deal with issues that cross industries, such as with
labor conditions in developing countries.

5.7.1 Ethical Dilemmas and the Pharmaceutical Industry

How can pharmaceutical MNEs such as GlaxoSmithKline generate sufficient revenues to create
new products, their major source of competitive advantage, while being responsive to the very
real health problems of developing countries? Most research-based pharmaceutical firms sell
products at high prices so long as those products are covered by patents.
Tiered Pricing and Other Price-Related Issues. Many firms also used tiered pricing schemes
whereby consumers in industrial countries pay market prices for products, but consumers in
developing countries pay lower (subsidized) prices. Legal generic products comply with patents
while allowing for the purchase of drugs at lower costs; unauthorized (illegal) generic drugs may
or may not be reliable.

Taking TRIPS for What It’s Worth. The WTO Agreement on Trade-Related Aspects of
Intellectual Property (TRIPS) provides a mechanism for poor countries facing health crises (such
as AIDS in Africa) to either produce or import generic products.

R&D and the Bottom Line. Governments and private foundations enable countries to issues
bonds to generate the funds needed to purchase vaccines via the International Finance Facility
for Immunization. In addition, governments are pressured to reduce tariffs and other barriers that
disadvantage their own people.

5.7.2 Ethical Dimensions of Labour Conditions

A major challenge facing MNEs is the globalization of the supply chain and the working
conditions of laborers. Pressures from external stakeholders to adopt responsible employment
practices in overseas operations are extensive. Some of the many international labor issues that
companies, governments, trade unions, and nongovernmental organizations must deal with
include: fair wages, child labor, working conditions, working hours, and freedom of association.
These issues are especially critical in the retail, clothing, footwear, and agricultural industries,
where so many MNEs outsource production to independent firms in foreign countries The
Ethical Trading Initiative base code focuses upon the employment practices of MNEs by getting
them to first adopt ethical employment policies and then monitor compliance with their foreign
suppliers.

The use of child labor is a particularly sensitive issue. According to the UN’s International
Labor Organization (ILO), more than 250 million children between the ages of 5 and 17 are
working worldwide; nearly 180 million of those are young children or are working in ways that
endanger their health or well-being because of hazards, sexual exploitation, trafficking, and/or
debt bondage. Those who argue in favor of child labor claim that in many instances, children are
better suited to perform certain tasks than adults, and that if the children were not employed, they
would in fact be worse off. While some firms simply avoid operating in countries where child
labor is used, others try to establish responsible operating policies in those locales. Often,
however, it is difficult for MNEs to hire and/or retain local workers; even though the working
conditions and wages that MNEs offer may be higher, the number of hours they allow their
employees to work may be lower.

5.8 How a company should behave?

A corporate code of ethics can aid in the consistency of behavior.

 Motivations for Corporate Responsibility

Firms need to act responsibly for at least four reasons. First, unethical and/or
irresponsible behavior could result in legal headaches, especially in the areas of financial
mismanagement and product safety. Second, such behavior could also result in consumer
action (eg, boycotts), even though the effectiveness of such actions is unclear. Third,
 unethical behavior can lower employee morale. Fourth, the cost to firms of bad publicity
can be enormous.

 Developing a Code of Conduct

A major component of a company’s strategy to realize ethical and socially responsible
behavior across the entirety of its organization is a corporate code of conduct. External
codes provide guidelines, recommendations, and rules that are issued by entities within
society in order to enhance corporate responsibility, but they are somewhat inconsistent
across organizations. In creating its own code of corporate ethics a firm should: set global
policies that must be complied with wherever the company operates; communicate the
code to all employees within the organization and to all suppliers, subcontractors, and
customers; ensure that its policies are carried out in all instances; and report results to its
stakeholders. Generally, codes of conduct address such areas as employment practices,
human rights, standards of ethical conduct, and care of the environment. In addition to
the efforts made by firms themselves to ensure compliance, they may also choose to use
NGOs such as the Fair Labor Association or global audit firms, such as KPMG, to help
monitor their practices
CHAPTER 6: INTERNATIONAL TRADE THEORIES AND ITS APPLICATIONS

6.1 Introduction
From ancient civilizations, world history is essentially a story of wars and trade. Major wars
were primarily fought mainly for economic reasons rather than conflict of political, cultural
or social ideas. For example, Britons set up their colonies world over for trade, U.S. invaded
Iraq and Libya mainly for economic reasons. Africa was colonised for trade and commerce
and so was the story of Latin America. Historians, world over, generally agree that most wars
are fought for trade-related reasons. Theories of international trade and their application help
us understand the motives and reasons behind such wars explaining trade pattern and the
benefits that flow from trade. An understanding of international trade theory helps us as
investors or consumers/buyers or sellers/companies and governments to determine how to act
for their own benefit within the global trading system.

6.2 Why do nations trade?

Fundamental question that International Trade Theories help us understand is – why do
countries trade? Why a strong economy like the US does not produce all goods and services
at home rather than importing them from countries such as China and India? Why do
countries specialize in trade, for example, a strong economy like Japan imports wheat, corn,
chemical products, aircraft, manufactured goods, and informational services from other
countries. International trade theories attempt to solve the above questions with the help of
the diagram given below:
6.3 Theories of International Trade

International trade, as discussed in the first chapter, involves cross-border exchange of goods,
services and ideas. International trade may be affected by factors like tariff barriers, non-
tariff barriers like restrictions, embargoes, nationalisation, sanitary-phyto-sanitary barriers,
technical barriers to trade. International trade may also become a costly affair due to factors
such as time costs, transactional cost, logistical cost, documentation costs and costs related
with legal systems.

A comparison between the nations that import and export will show that, the factors of
production assume a crucial significance. The mobility of factors of production is less in case
of international trade, but their contribution to total revenue of trade is much higher when
compared with its share in revenue in domestic markets.

The international trade theories attempt to analyze the pattern of international trade and help
government and policy makers to understand the ways to maximize the gains from trade.
These reasons make international trade theory a preferred field of research not only for
economists but also for anybody interested in doing business successfully both domestically
and internationally as domestic markets are also open for foreign competition in liberalized
and globalised era.

6.3.1 Mercantilism
Mercantilism theory of international trade has its origin in England in the middle of
16th century. Mercantilism theory is based on the principle assertion that government
control of foreign trade is of paramount importance for ensuring the prosperity and
military security of the state. The main tenet of this theory was that gold and silver were
the mainstays of national wealth and government should endeavour to increase the
inflow of gold and silver. This is to be achieved by exporting more and importing less,
thus having a surplus balance of trade.

Profounder of mercantilism theory argued that national wealth and prosperity will
increase with more and more inflow of gold and silver which were the main currency of
trade at that point of time. An English mercantilist writer Thomas Mun writes on
mercantilism in 1630. “State should focus on increasing export and controlling imports,
thus to increase our wealth and treasure, by accumulation of gold and silver. We must
sell more to strangers yearly than what we consume of theirs in value yearly’.

Between mid-16th century and 18th century, government’s world over that had
consistent belief in mercantilism, advocated and executed policy interventions to
achieve a surplus in the balance of trade. The mercantilists have a belief that it is not
important to increase the volume of foreign trade but to maximize exports and
minimize imports. Mercantilist advocated policy interventions such as tariffs and
quotas on imports and subsidies for exports. Thus, mercantilism becomes ‘zero sum
game’ whereby economic growth/prosperity of a country is dependent on the cost of
other economies.
 Mercantilism theory suffered from many flaws and inconsistencies which were rightly
pointed out by the classical economist David Hume in 1752. Hume propounded that if
England had a favourable balance of trade with France (i. e, if it exported more than
what it imported), the resultant inflow of gold and silver would enhance the flow of
money into the domestic system. This in turn will generate inflation as people of
England would have more purchasing power. Alternatively, people in France would
buy less as their purchasing power will decrease with the outflow of gold and silver to
England. Thus, prices of commodities will go up in England and will go down in
France due to lack in demand and monetary contraction. People of France would be
able to buy less English goods, because firstly they have less purchasing power and
secondly, English goods are expensive. English trade will be affected till there is
equilibrium in trade. Hume’s arguments were sound.

Noted classical economist like Adam Smith and David Ricardo also argued that trade is
‘positive sum game’ and not a ‘zero sum game’ as mercantilists argued. Trade benefits
everyone due to variety of reasons such as cost competitiveness, comparative
advantages, absolute advantages, PLC cycle, factor endowments etc. and mercantilism
theory is by all means considered ‘dead’ or ‘irrelevant’ in contemporary trade
environment.

6.3.2 Theory of Absolute Advantage

In one of the most notable book ’Wealth of Nations‘in 1776, Adam Smith attacked the
mercantilism and argued that countries differ in their ability to produce goods and
services efficiently due to variety of reasons. At that time, England, by virtue of their
superior manufacturing processes, were the world’s most efficient textile manufacturers
of the world. This was due to combination of several factors such as favourable climate,
good soils, skilled manpower and accumulated experience and expertise in textile
production. On the other hand, the French had one of the most efficient wine industries
of the world. Thus, England had an absolute advantage in the manufacturing of textiles
and France had an absolute advantage in the production of wine. Adam Smith argued
that a country has an absolute advantage if it has one of the most efficient and cost
effective product in comparison to any other country producing it.

Smith argued that countries should specialize in production and manufacturing of goods
and services in which they have an absolute advantage. Such cost effective and efficient
products can be traded with goods from other countries in which that country has an
absolute advantage. According to Smith, England should specialize in the production of
textiles and France should specialize in the production of wine. Both countries should
exchange such products of absolute advantage with each other, i.e. England should sell
textiles to France and France should sell wine to England.

The crux of Smith’s absolute advantage theory is that a country should not produce
goods at home in which it does not have cost advantage; instead it should import from
other countries. Absolute advantage theory was based on ‘positive sum game’ where
countries benefit from trade unlike mercantilism theory which was based on ‘zero
game’.
 6.3.3 Comparative Advantage Theory
David Ricardo, in his notable book ‘Principles of Political Economy’ published in 1817
came up with an improvement on Adam Smith’s ‘absolute advantage theory’. Ricardo
argued what might happen if one country has an absolute advantage in the production
of all goods.

Adam Smith’s theory suggests that such a country might not have benefitted from
international trade as trade is positive sum game and countries prosper only if they
exchange the goods in which they have absolute advantage.

Ricardo argued that it was not the case and showed that countries should trade goods
with each other where they have comparative cost advantage. For a sustainable
economic system, Ricardo argued that a country should specialize in the production of
those goods that it can produce most efficiently and import the goods which it produces
less efficiently even if it has absolute cost advantage in the production of those goods.

6.3.4 Theories of Specialization: Assumptions and Limitations

The theories of absolute and comparative advantage are based upon the economic gains
from specialization, i.e., concentration on the production of a limited number of products.
Each holds that specialization will maximize output and that countries will be best off by
trading the output from their own specialization for the output from other countries’
specialization. However, both theories make certain assumptions that may not always be
valid.
1. Full Employment: Both theories (absolute and comparative advantage) assume
that resources are fully employed. When countries have many unemployed or
underemployed resources, they may seek to restrict imports in order to employ or
use idle resources.
2. Economic Efficiency: Individuals and countries often pursue objectives other than
economic efficiency. Individuals may prefer activities and/or occupations that are
economically less productive, and nations may choose to avoid overspecialization
because of the vulnerability created by potential changes in technology and price
fluctuations.
3. Division of Gains: Although specialization does maximize output, it is not always
clear how those gains will be divided. If one country believes that a trading partner
is receiving too large a share of the benefits, it may choose to forego its relatively
smaller gains in order to prevent the partner country from receiving larger gains.
4. Two Countries, Two Commodities: Absolute and comparative advantage theories
use the example of two countries and two commodities, or products, to explain
trade gains. The analysis becomes more complex when 200 countries trading
thousands of products are presented.
5. Transport Costs: If it costs more to deliver products than can be saved via
specialization, then the gains from trade are negated.
6. Statics and Dynamics: Although the theories of absolute and comparative
advantage consider gains at a given time (a static view), the relative conditions that
surround a country’s particular advantage or disadvantages are dynamic
 (constantly changing). Thus, one cannot assume that future advantages will remain
constant. (This idea will also be relevant to the discussion of the dynamics of the
location of production and export sources.)
7. Services: Although the theories of absolute and comparative advantage were
developed from the perspective of trade in commodities, much of the same
reasoning can be applied to trade in services.
8. Production Networks: While both theories deal with the trading of one product for
another, increasingly there are divisions by components and function as well as
within a company’s value chain network. The firm’s value chain can include a
number of countries; however, the argument for specialization still remains valid.
9. Mobility: Neither the assumption that resources can move domestically from the
production of one good to another at no cost, nor the assumption that resources
cannot move internationally, is entirely valid. Nonetheless, domestic mobility is
greater than the international mobility of resources. Clearly, the movement of
resources such as capital and labor is a very real alternative to trade.

6.3.5 The Heckscher-Ohlin Trade Theory

The Heckscher-Ohlin (H-O) theory further improvises on the absolute cost advantage and
comparative cost advantage theory. It tries to explain the crucial question of why countries
trade goods and services with each other. The theory is based on the hypotheses that
countries trade with each other as they differ with respect to the availability of the factors
of production i.e. land, labour and capital.
H-O theory explains that a country will specialise in the production of goods and services
that it is particularly endowed with and are suited for production in that country.
Countries that have abundant capital but are scarce in labour force therefore specialise in
production of goods and services that, in particular, require more capital. H-O theory
propounds that specialisation in production and trade among countries generates higher
economies of scale and scope and ensures higher standard of living for the countries
involved
EXAMPLE
US is a capital rich country hence its exports basket will be dominated by capital
intensive products like, aeroplanes, submarines, tanks, space system, nuclear plants, super
computer, high-end servers etc. Whereas India has labour abundance, so its export basket
is dominated by product with labour contents like gems and jewellery, textiles,
handicrafts, sports toys, handlooms, apparel, electronics and information technology
services.
Assumptions
1. Countries worldwide are endowed with different factors of production, i.e. land,
labour and capital may not be in equal proportion in all countries. Some are abundant
with land, some capital and some with labour.
2. Production of goods either requires relatively more capital or land or labour.
3. Factors of production do not move between two countries.
4. Theory has assumption that there is no transport cost for trade between two
countries.
5. The consumers and users in two trading countries may have the same needs.
6.3.6 Product Life Cycle Theory
This theory was proposed by Raymond Vernon in the mid-1960s. It was based on the
observation that in the 20th century, a very large proportion of the world’s new products
were developed by American firms and sold there first. He argued that the wealth and
size of the market gave American firms a strong incentive to develop new consumer
products and in addition, the high cost of labour was an incentive to develop cost-saving
innovations. He did not agree with earlier theories and emphasised on information, risk,
and economies of scale, rather than on cost. He focused on the lifecycle of the product
and came up with his theory which identified three distinct stages:

STAGES

New product stage – The need for a new product in the domestic market is identified
and it is developed, manufactured and marketed in limited numbers. It is not exported in
sizeable quantities, since it is primarily for the national market.

Maturing product stage – Once the product has become popular in the domestic market,
foreign demand increases and manufacturing facilities abroad may be set up to meet
demand there. After success in the foreign markets and towards the end of the product
maturity stage, the manufacturers try and produce it in the developing countries.

Standardised product stage – In the last stage of the life-cycle theory, the product
becomes a commodity, the price becomes optimised and the makers look for countries
where it can be made with the least production costs. One of the results of this is the
product being imported into the firm’s home country. Dell manufactures hardware in
Asia, which is then transported to the US, its country of origin. Hence a product which
started as export commodity of a country may end up becoming an import product.

6.3.7 Porters Diamond Model

In 1990, Michael Porter analysed the reason behind some nations’ success and others’
failure in international competition. His thesis outlined four broad attributes that shape
the environment in which local firms compete and these attributes promote the creation
of competitive advantage. They are explained as follows:

Factor endowments – Characteristics of production were analysed in detail. There are

basic factors like natural resources, climate, and location and so on and advanced factors
like communications infrastructure, research facilities.

Demand conditions – The role of home demand in improving competitive advantage is

emphasised since firms are most sensitive about the needs of their closest customers. For
example, the Japanese camera industry which caters to a sophisticated and
knowledgeable local market.

Relating and supporting industries – The presence of suppliers or related industries is

advantageous since the benefits of investment in advanced factors of production spill
 over to these supporting industries. Successful industries within a country tend to be
grouped into clusters of related industries. For example Silicon Valley.

Firm strategy, structure and rivalry – Domestic rivalry creates pressure to

innovate, improve quality, and reduce costs which in turn helps create world-class
competitors.

He said that these four attributes constituted the diamond and he argued that firms are most
likely to succeed in industries where the diamond is most favourable. He also stated that the
diamond is a mutually reinforcing system and the effect of one attribute depends on the state
of others. For example, favourable demand conditions will not result in a competitive
advantage unless the state of rivalry is enough to elicit a response from the firms.
 CHAPTER SEVEN

GOVERNMENTAL INFLUENCE ON TRADE

I. INTRODUCTION
In principle, no country permits a totally unregulated flow of goods and services
across its borders. Likewise, governments may choose to enable the global
competetiveness of their own domestic firms. Protectionism refers to those
government restrictions and incentives that are specifically designed to help a
county’s domestic firms compete with foreign competitors at home and abroad. The
rationale for such policies can be economic or noneconomic in nature. Whenever
governments choose to impede the flow of imports and/or encourage the flow of
exports, they simultaneously provide direct and/or indirect subsidies for their
domestic firms.

II. CONFLICTING RESULTS OF TRADE POLICIES

While governments intervene in trade in order to attain economic, social, and/or
political objectives, they also pursue political rationality when they do so. Officials
enact those trade policies they feel will best protect their nations and citizens—and
perhaps their personal political longevity. However, aiding struggling constituencies
without penalizing those who are well off is often impossible.
The Role of Stakeholders
Proposals for trade regulation reform often spark fierce debate among competing
parties, also known as stakeholders.
The Role of Consumers. Consumers generally purchase products with little thought
as to where the product was produced. Import barrier costs are often spread out so
that the effect is not noticed by the consumer.

III. ECONOMIC RATIONALES FOR GOVERNMENTAL INTERVENTION

Governmental intervention in the trade process may be either economic or
noneconomic in nature.
Fighting Unemployment Displaced workers often do not find jobs that provide
comparable compensation. Often unemployment benefits must be spent on living
expenses instead of job skill training for a new job.
What’s Wrong with Full Employment as an Economic Objective? Persistent
unemployment pushes many groups to call for protectionism; one of the most
effective is organized labor. By limiting imports, local jobs are retained as firms and
consumers are forced to purchase domestically produced goods and services.
However, unless the protectionist country is relatively small, such measures usually
do little to limit unemployment. On the other hand, they may result in a decline in
export-related jobs because of (i) price increases for components or (ii) lower
incomes abroad. Further, such measures are likely to lead to retaliation unless either
the protectionist or the affected country is relatively small. Thus, governments must
carefully balance the costs of higher prices with the costs of unemployment and the
displaced production that would result from freer trade when enacting such
measures.
Protecting “Infant Industries”
First presented by Alexander Hamilton in 1792, the infant-industry argument holds
that a government should temporarily shield emerging industries in which the
country may ultimately possess a comparative advantage from international
competition until its firms are able to effectively compete in world markets.
1. Underlying Assumptions. The infant-industry argument presumes that the
initial output costs for a small-scale industry in a given country may be so
high as to make its output noncompetitive in world markets. Eventual
competitiveness will result from movement along the learning curve plus the
efficiency gains from achieving the economies of large-scale production.
2. Risks in Designating Industries. Although it’s reasonable to expect
production costs to decrease over time, there is a risk that costs will never
fall enough to create internationally competitive products. Two basic
problems associated with this argument are the assumptions that (i)
governments can in fact identify those industries that have a high probability
of success and (ii) firms within those industries should receive government
assistance. Infant-industry protection requires some segment of the
economy (typically local consumers) to incur the initial higher cost of
inefficient local production. Ultimately, the validity of the argument rests
on the expectation that the future benefits of an internationally competitive
industry will exceed the costs of the associated protectionist measures.
Developing an Industrial Base
Many of today’s emerging economies emulate historical practices and use
protectionism to spur local industrialization. They operate under the assumptions
outlined below.
1. Surplus Workers. The industrialization argument purports that the
development of national industrial output (and hence economic growth)
should be supported, even though domestic prices may not be competitive
on the world market. Surplus workers can more easily be used to increase
manufacturing output than agricultural output. Shifting people out of
agriculture, however, can create at least three problems: 10 worker
expectation of industrial jobs may not be met, 2) improved agriculture
practices may be a better means of achieving economic success, and 3)
shifting people from rural to urban areas may lead to reduced food output..
2. Investment Inflows. Import restrictions encourage foreign direct
investment by foreign firms that want to avoid the loss of a lucrative or
potential market. FDI inflows in turn lead to increased local employment,
an attractive outcome for policy makers.
3. Diversification. Price variations can wreak havoc on economies that rely
on just a few commodities for job creation and export earnings. Contrary to
expectations, however, unless a country’s industrial base is truly expanded,
a move into manufacturing may simply shift that dependence from a
reliance on the basic commodities to the downstream manufactured goods
produced from them.
 4. Growth in Manufactured Goods. Terms of trade refers to the quantity of
imports that a given quantity of a country’s exports can buy. Many
emerging nations have experienced declining terms of trade because the
demand for and prices of raw materials and agricultural commodities have
not risen as fast as the demand for and prices of finished goods. In addition,
changes in technology have reduced the need for many raw materials. Cost
savings realized from manufactured products go mainly to higher profits
and wages, thus fueling the industrialization process.
5. Import Substitution and Export-Led Development. Import substitution
represents an economic development strategy that relies on the stimulation
of domestic production for local consumption by erecting barriers to
imported goods. If the protected industries do not become globally
competitive, however, local customers will continually be penalized by high
prices or higher taxes. On the other hand, export-led development
encourages economic development by harnessing a country-specific
advantage (e.g., low labor costs) and building a vibrant manufacturing sector
through the stimulation of exports. In reality, when effectively crafted,
import substitution policies eventually lead to the possibility of export
promotion as well.
6. Nation Building. The industrialization process helps countries build
infrastructure, advance rural development, and boost the skills of the
workforce.
B. Economic Relationships with Other Countries
Countries track their own performance as compared to other nations to
determine whether to impose trade restrictions as a means of improving their
competitive positions. The four primary motivations for doing so are outlined
below.
1. Balance-of-Trade Adjustments. The trade account (the current account)
is a major part of the balance of payments for most countries. If balance-of-
payments difficulties persist, a government may restrict imports and/or
encourage exports in order to balance its trade account. It has two options
that affect its competitive position broadly: (i) depreciate or devalue its
currency, an action that makes all of its products cheaper in relation to
foreign products, or (ii) rely on fiscal and monetary policy to bring about
lower price increases in general than those in other countries.
2. Comparable Access or “Fairness.” The comparable access argument
promotes the idea that a country’s firms are entitled to the same access to
foreign markets as foreign firms have to its market. Economic theory
reasons that producers operating in industries where increased production
leads to economies of scale but which lack equal access to foreign
competitors’ markets will struggle to become cost-competitive. However,
restricting trade, even on the grounds of “fairness,” may lead to higher
prices for domestic customers. There are at least two reasons for rejecting
the idea of fairness. First, tit-for-tat market access can lead to restrictions
that may deny one's own consumers lower prices. And second, governments
would find it impractical to negotiate and monitor separate agreements for
 each of the many thousands of different products and services that might be
traded.
3. Restrictions as a Bargaining Tool. Import restrictions may be levied as a
means to try to persuade other countries to lower their import barriers. The
danger, however, is that each country will, in turn, retaliate by escalating its
own restrictions. To successfully use restrictions as a bargaining tool
requires that they be (i) believable and (ii) important to the targeted parties.
4. Price-Control Objectives. Countries may withhold products from
international markets in an effort to raise world prices and thus improve
export earnings and/or favor domestic customers. (Organization of
Petroleum Exporting Companies [OPEC] is a case in point.) The practice
of pricing exports below cost, or below their home-country prices, i.e.,
below their “fair market value,” is known as dumping. Most countries
prohibit imports of “dumped” products, but enforcement usually occurs
only if the product disrupts domestic production. The optimum-tariff
theory claims that a foreign producer will lower its prices if the destination
country places a tariff on its products. So long as the foreign producer
reduces its price by any amount, some shift in revenue goes to the importing
country, and the tariff is deemed an optimum one.

IV. NONECONOMIC RATIONALES FOR GOVERMENT INTERVENTION

Governments may choose to intervene in the trade process for noneconomic reasons
such as the maintenance of essential industries, the prevention of shipments to
unfriendly nations, the maintenance or extension of spheres of influences, and/or the
protection of national identity.
A. Maintaining Essential Industries
The essential industry argument states that a government applies restrictions
to protect essential domestic industries during peacetime so that the country is
not dependent on foreign sources of supply during war. Protecting an inefficient
industry, however, will lead to higher costs and possibly political consequences
as well.
B. Preventing Shipments to “Unfriendly” Countries
Groups concerned about security use national defense arguments to prevent the
export, even to friendly countries, of strategic goods that might fall into the
hands of potential enemies or that might be in short supply domestically. Trade
controls on non-defense goods may also be used as a foreign policy weapon to
try to prevent another country from meetings its political objectives. However,
retaliation often renders such protectionist measures ineffective.
C. Maintaining or Extending Spheres of Influence
To maintain their spheres of influence, governments may give aid and credits to
and encourage imports from countries that join a political alliance or vote a
preferred way within international bodies. Further, trade restrictions may coerce
governments to take certain political actions or punish firms whose governments
do not comply.
 D. Preserving National Identity
Countries are partially held together though a unifying sense of cultural and
national distinctiveness. To sustain this collective identity, governments may
limit the presence of foreign products in certain sectors.

V. INSTRUMENTS OF TRADE CONTROL

Governments use many rationales and seek a range of outcomes when they try to
influence the international trade process. The choice of instrument(s) is crucial
because each type of control may incite different responses from both domestic and
foreign groups. While some instruments directly limit the amount that can be traded,
others indirectly affect the amount traded by directly influencing prices, i.e., while
tariff barriers directly affect prices and subsequently the quantity demanded,
nontariff barriers may directly affect price and/or quantity.
A. Tariffs
A tariff (also called a duty) is a tax levied on (internationally) traded products.
Export tariffs are levied by the country of origin on exported products; a
transit tariff is levied by a country through which goods pass en route to their
final destination; import tariffs are levied by the country of destination on
imported products. A tariff increases the delivered price of a product, and, at the
higher price, the quantity demanded will be less.
1. Import Tariffs. Unless they are optimum tariffs, import tariffs raise the
price of imported goods by placing a tax on them that is not placed on
domestic goods, thereby giving domestically produced goods a relative price
advantage. Tariffs may also serve as a major source of revenue in
developing countries. A specific duty is a tariff that is assessed on a per unit
basis; an ad valorem tariff is assessed as a percentage of the value of an
item. If both a specific duty and an ad valorem tariff are assessed on the
same product, it is known as a compound duty. A tariff controversy
concerns the treatment of manufactured exports to industrialized nations.
While raw materials frequently enter industrial countries tariff-free, when an
ad valorem tariff is applied to manufactured goods, it is generally applied to
the total value of the product. Critics argue that the effective tariff on the
manufactured portion, i.e., the value-added portion, is higher than the
published tariff.
B. Nontariff Barriers: Direct Price Influences
Nontariff barriers (NTBs) represent administrative regulations, policies, and
procedures, i.e., quantitative and qualitative barriers that directly or indirectly
impede international trade.
1. Subsidies. Subsidies consist of direct or indirect financial assistance from
governments to their domestic firms to help them overcome market
imperfections and thus make them more competitive in the marketplace.
One of the most popular forms of government subsidy can be seen in the
agriculture industry. From the standpoint of market efficiency, subsidies are
more justifiable than tariffs because they seek to overcome, rather than
create, market imperfections. However, many international frictions result
from disagreements about the definition of a subsidy.
 2. Aid and Loans. Governments may give aid and loans to other countries
but require that the recipient spend the funds in the donor country; this is
known as tied aid or tied loans. In this way some donor products that
might otherwise be noncompetitive may find limited international markets.
However, there is growing skepticism about the value of tied aid because it
can slow down the development of local suppliers in developing countries
and shield suppliers in the donor countries from competition.
3. Customs Valuation. Because of the temptation to declare a low invoice
price in order to pay a lower ad valorem tariff, it is sometimes difficult to
determine the true value of traded products. Due to the many different
products traded and the differences being minute in some cases, it is easy to
misclassify a product and receive a lower tariff. First, customs officials
should use the declared invoice price. If there is none, or if the authenticity
of the value is in doubt, then customs agents may assess the shipment on the
basis of the value of identical (preferable) or similar (acceptable) goods
arriving at about the same time. Further, because countries often impose
different import barriers on products sourced from different countries,
customs officials must also determine a product’s true origin.
4. Other Direct Price Influences. Other means that countries may use to
affect prices include establishing special fees for consular and customs
clearance and documentation, requirements that customs deposits be made
in advance of shipment, and minimum price levels at which products can be
sold after they receive customs clearance.
C. Nontariff Barriers: Quantity Controls
Governments use a variety of nontariff barriers to directly affect the quantity of
imports and exports. When the quantity of imports is limited, the resulting shift
in the supply curve means that the equilibrium price will then be higher.
1. Quotas. A quota represents a numerical limit on the quantity of a product
that may be imported or exported in a given period of time. (Because of the
increase in the equilibrium price, quotas may increase per unit revenues for
firms that participate in the market.) Voluntary export restraints (VERs)
are negotiated limitations of exports from one country to another and, as in
the case of a quota, may result in higher prices to customers. An embargo
represents an outright ban on imports from or exports to a particular
country.
2. “Buy Local” Legislation. Buy local legislation represents laws that are
intended to favor the purchase of domestically sourced products over
imported products, particularly with respect to government procurement.
Local content requirements, i.e., costs incurred within the local country
(usually measured as a percentage of total costs), fall within this category.
3. Standards and Labels. The professed purpose of standards is to protect
the safety or health of the domestic population. However, countries may
also devise classification, labeling, and testing standards that facilitate the
sale of domestic products but obstruct the sale of foreign-sourced products
4. Specific Permission Requirements. An import (or export) license
requires that firms secure permission from government authorities before
 conducting trade transactions. Such procedures directly restrict trade when
permission is denied and indirectly restrict trade because of the cost, time,
and uncertainty involved in the process. A foreign exchange control
requires an importer of a given product to apply to a government agency to
secure the foreign currency to pay for the product.
5. Administrative Delays. Intentional administrative delays create
uncertainty and increase the cost of carrying inventory. However,
competitive pressures can motivate countries to improve inefficient
administrative systems.
6. Reciprocal Requirements. Governments may require that foreign
suppliers accept products in lieu of money. Offsets and countertrade (see
Chapter 13) are reciprocal requirements that are made between countries
with ample access to foreign currency that want to secure jobs or
technology as part of the transaction.
7. Restrictions on Services. Countries restrict trade in services such as
transportation, insurance, advertising, consulting, and banking for reasons
of essentiality, standards, and immigration.
a. Essentiality. Countries consider certain services industries to be
essential because they serve strategic purposes or provide social
assistance to citizens. Private companies of any sort may be prohibited,
and in other cases, price controls may be imposed by the government;
government-owned operations are often subsidized.
b. Not-for-Profit Services. Mail, education, and hospital health services
are often not-for-profit services and governments may preclude foreign
firms from competing in these areas.
c. Standards. Governments may limit foreign entry into particular
service professions in order to assure that practitioners are qualified.
Licensing standards vary by country and extend to a wide variety of
occupations. Prerequisites for taking certification examinations may be
lengthy.
d. Immigration. Government regulations often require that an
organization, whether domestic or foreign, demonstrate that the skills
needed for a particular job are not available locally before hiring a
foreigner.

VI. DEALING WITH GOVERNMENTAL TRADE INFLUENCES

Although there are risks and costs associated with each option, firms can deal with
trade restrictions by (a) moving operations to a lower-cost country, (b) concentrating
on market niches that attract less international competition, (c) adopting internal
innovations that lead to greater efficiency or superior products, or (d) trying to get
government protection.
A. Tactics for Dealing with Import Competition When the options of moving
operations abroad, concentrating on niches, and innovation fail or are not
practical, companies may turn to the government to restrict imports or open
export markets.
o Locating Decision Makers. Companies may want to find government
officials who are supportive of their case. Generally Congress is sensitive
to the employment effects of trade, especially in their jurisdictions.
o Involving Industry and Stakeholders. There is strength in numbers and
companies may want to join forces within the industry to gain more
political clout. Outside groups such as activists and the general public may
be of help in promoting the case for favorable trade policies for the firm.
o Preparing for Changes in the Competitive Environment. Companies can
take different approaches to deal with changes in the international
competition environment. Frequently these different approaches are based
on their strategies and abilities.
 CHAPTER EIGHT
CROSS-NATIONAL COOPERATION AND AGREEMENTS

I. INTRODUCTION
Trading groups are a significant influence on the strategies of MNEs because they define the
size of regional markets and the rules by which companies must operate. Economic
integration is the political and economic agreements among countries that give preference to
member countries in the agreement. Approaches to economic integration include global
integration via the World Trade Organization, bilateral integration via cooperation between
two countries, and regional integration via cooperation between countries in the same
geographic proximity.

II. THE WORLD TRADE ORGANIZATION (WTO)

The World Trade Organization has become the primary multilateral forum through which
governments conclude trade agreements and settle associated disputes.
A. GATT: The Predecessor to the WTO
The General Agreement on Tariffs and Trade (GATT) was established in 1947 by
twenty-three nations as a multilateral agreement whose objective was to abolish quotas
and reduce tariffs.
1. Trade without Discrimination. The fundamental principle of “trade without
discrimination” was embedded in the most-favored-nation (MFN) clause, i.e., the
principle that each member nation must open its markets equally to every other
member nation. Several major rounds of negotiations from 1947 to 1993 led to a
wide variety of multilateral reductions in both tariff and nontariff barriers. At the
conclusion of the Uruguay Round in 1994, the World Trade Organization was
created in 1995 for the purpose of institutionalizing the GATT.
B. What Does the WTO Do?
The World Trade Organization (WTO) was founded in 1995 as a permanent world
trade body for the purposes of (i) facilitating reciprocal trade negotiations and (ii)
enforcing trade agreements between or among member nations. The WTO adopted the
principles and agreements reached under the auspices of the GATT, but it expanded its
mission to include trade in services, investment, intellectual property, sanitary
measures, plant health, agriculture, textiles, and technical barriers to trade. Currently the
150 member countries of the WTO collectively account for more than 97 percent of the
value of world trade. Major decision-making units include: the Ministerial Conference,
the General Council, the Council for Trade in Goods, the Council for Trade in Services,
and the Council for Trade-Related Intellectual Property Rights (TRIPS).
1. Normal Trade Relations. The WTO replaced the GATT’s most-favored-nation
(MFN) clause with the concept of normal trade relations, which prohibits any sort
of trade discrimination. With the following exceptions, it restricts this privilege to
official members:
• Developing countries’ manufactured products have been given preferential
treatment over those from industrial countries.
• Concessions granted to members within a regional trading alliance, such as the
EU, have not been extended to countries outside the alliance.
Exceptions can be made in times of war or international tension.
 2. Dispute Settlement. Under the WTO there is now a clearly defined mechanism
for the settlement of disputes. Countries may bring charges of unfair trade practices
to a WTO panel; accused countries may appeal; WTO rulings are binding. If an
offending country fails to comply with a judgment, the rights to compensation and
countervailing sanctions will follow. The Doha Round began in Doha, Qatar in
2001 to address disputes between developed and developing nations. Issues
surrounding agricultural subsidies have been particularly difficult.

III. THE RISE OF BILATERAL AGREEMENTS

Currently, bilateral agreements, also known as preferential trade agreements (PTAs) (and
also referred to by some as free trade agreements (FTAs)) are sometimes negotiated by
partner nations as a way to circumvent the multilateral trading system and meet their mutual
trading objectives.

IV. REGIONAL ECONOMIC INTEGRATION

Regional trade agreements or RTAs involve multiple countries engaged in the process of
economic integration. Neighboring countries tend to ally with one another because of their
proximity, their somewhat similar tastes, the relative ease of establishing channels of
distribution, and a willingness to cooperate with one another for the greater benefit of the
allied parties. The two basic types of regional economic integration that address barriers to
trade are:
• Free Trade Agreements, in which all barriers to trade, i.e., tariff and nontariff barriers,
are abolished among member nations, but each member determines its own external
trade barriers with non-FTA countries.
• Customs Unions, in which all barriers to trade, i.e., tariff and nontariff barriers, are
abolished among member nations, and common external barriers are levied against non-
member countries.
1. Common Market. When moving beyond the reduction of tariff and nontariff
barriers, a common market may be created, allowing for the free flow of capital and
labor. It may go even further by harmonizing commercial, monetary, and fiscal
policies and establishing a common currency, plus a supranational political structure
dedicated to dealing with common economic issues.
A. The Effects of Integration
Regional economic integration can affect member countries in social, cultural,
economic, and/or political ways. (MNEs are, or course, particularly interested in the
economic effects.)
1. Static and Dynamic Effects. Static effects represent the shifting of resources from
inefficient to efficient firms as trade barriers fall. Dynamic effects represent the gains
from overall market growth, the expansion of production, the realization of greater
economies of scale and scope, and the increasingly competitive nature of the market.
Static effects may occur when either of two conditions occurs:
a. Trade creation. Trade creation occurs when production shifts from less
efficient domestic producers to more efficient regional producers for reasons of
absolute or comparative advantage.
b. Trade diversion. Trade diversion occurs when, as a result of the imposition of
common external barriers, trade shifts from more efficient external sources to
less efficient suppliers within the group. (When lower cost, externally-sourced
products are suddenly confronted by trade barriers, the effective delivered cost
of those products increases; thus, the quantity that can be purchased for a given
 amount of money is reduced.) Dynamic effects of integration occur when trade
barriers come down and the size of the market increases. Because of the larger
size of the market, competitors are able to reduce their unit costs by capturing
economies of scale. As a result, customers gain access to a wider variety of
lower cost, higher quality products. Another important effect of the FTA is the
increase in efficiency due to increased competition.

V. MAJOR REGIONAL TRADING GROUPS

Trading groups can be organized by type and/or location. Firms are interested in regional
trading groups because they can serve as potential markets, sources of raw materials, and
production locations.
A. The European Union
The European Union (EU) represents the most advanced regional trade and investment group
in the world today.
1. Predecessors. The EU evolved from the European Economic Community (EEC) to
the European Community (EC) to the European Union (EU). The European Free
Trade Association (EFTA) consists of Iceland, Liechtenstein, Norway, and
Switzerland; all but Switzerland are linked to the EU via a customs union.

2. Organizational Structure: The European Commission provides the EU’s political

leadership and direction; it consists of commissioners appointed by member
countries for five-year renewable terms. The commission is responsible for
proposing EU legislation, implementing EU legislation, and monitoring compliance
with EU laws by member nations. The European Council is composed of
representatives from the government of each member country. The Council is
responsible for passing laws and making and enacting major policies. Composed of
785 members (allocated on the basis of country population) elected every five years,
the European Parliament has three major responsibilities: legislative power, control
over the budget, and supervision of executive decisions. Parliament considers
legislation presented by the European Commission; if the legislation is approved, it
is then submitted to the European Council for final adoption. The European Court of
Justice ensures consistent interpretation and application of EU treaties. Dealing
mostly with economic matters, it serves as an appeals court for individuals, firms,
and organizations fined by the commission for infringing upon Treaty Law.
3. The Single European Act. The EU has been moving toward a single market ever
since the passage of the Single European Act. It is designed to eliminate any
remaining nontariff barriers to trade in Europe.
4. Monetary Union: The Euro. The Treaty of Maastricht, signed in 1992, sought to
foster both political and monetary union within the EU. While the move toward a
common currency has partially eliminated different currencies as a barrier to trade,
not all members have adopted the euro. (Members adopting the euro at the time of its
launch on January 1, 1999, were Austria, Belgium, Germany, Finland, France,
Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain; Greece followed
suit on January 1, 2001. Slovenia adopted the euro on January 1, 2007. Of the 15
members of the EU prior to the expansion in 2004, only the UK, Denmark, and
Sweden elected not to adopt the euro.) Now one of the most widely traded currencies
in the world, the euro facilitates price transparency for customers and eases pricing
decisions and transaction reconciliations for firms.
 5. Expansion. The EU expanded from 15 to 25 countries in 2004 by admitting countries
primarily from central and eastern Europe. Although this expansion increased the
EU’s population and added to its economic output, the integration of such disparate
countries will not be easy. Most are poor, agriculturally-based, newly democratized
economies which, when taken together, will seriously strain the EU’s financial
resources. Another challenge is the issue of governance, because economically large
members of the EU fear that the addition of so many new countries will weaken their
control and influence. In 2007, the EU increased its membership by two additional
countries – Romania and Bulgaria, bringing the total number of member states to
twenty seven.
6. Bilateral Agreements. The European Union has signed numerous bilateral trade
agreements with other countries outside Europe. In addition, the EU has entered into
an agreement with the European Free Trade Association (with the exception of
Switzerland) to form the European Economic Area (EEA).
7. How to do Business with the EU: Implications for Corporate Strategy. There are
at least three ways in which the competitive strategies of foreign firms that choose to
do business within the EU are affected. First, they must determine their production
site location(s) on the basis of total costs that include labor, transportation, and other
strategic factors. Second, foreign firms must decide upon an entry strategy, i.e., new
investments, expanding existing investments, or joint ventures and mergers. Third,
firms must be sensitive to essential national differences, particularly in areas such as
economic growth rates and cultural traditions. In addition, the trade-offs between the
advantages of pan-European strategies and more localized strategies must be
continually examined.
B. North American Free Trade Agreement (NAFTA)
Effective as of January 1, 1994, the North American Free Trade Agreement
(NAFTA) incorporates Canada, Mexico, and the United States into a regional trade
bloc of countries of quite different sizes and sources of national wealth.
1. Why Nafta? More than a mere free trade agreement and claiming a total GNI
greater than that of the 27-member EU, NAFTA calls for the elimination of tariff
and nontariff barriers, the harmonization of trade rules, the liberalization of
restrictions on services and foreign investment, the enforcement of intellectual
property rights, and a dispute settlement process. NAFTA makes logical sense in
terms of geographical location and trading importance. Two-way trade between the
United States and Canada is the largest in the world. NAFTA extends its
cooperation beyond tariff reductions to include provisions for services,
investments, and intellectual property. NAFTA has provided both static and
dynamic effects. Canada and the U.S. benefit from the lower-cost agricultural
products from Mexico and U.S. producers benefit from the growing Mexican
market. NAFTA is a good example of trade diversion in which Canadian and U.S.
companies have shifted some production facilities to Mexico from Asia due to the
benefits of the trade agreement.
2. Rules of Origin and Regional Content. NAFTA’s rules of origin require that at
least 50 percent of the net cost of most products originate within the region if those
products are to be eligible for the more liberal tariff conditions within the bloc.
3. Special Provisions. NAFTA is a unique sort of trade agreement in that it also
addresses two side issues: (i) regional labor laws and standards and (ii)
strengthened environmental standards.
 4. The Impact of NAFTA. Due to low wages in Mexico, U.S. companies invested
significantly in the country. FDI from the U.S. accounts for about 62% of all
foreign direct investment in Mexico. While trade and investment amongst the
NAFTA members has increased significantly, the employment picture is less clear.
Although some investment funds have been flowing out of Mexico since the
maquiladora plants were stripped of their duty-free status in 2001, other investment
funds have been flowing into Mexico from companies such as Wal-Mart, which is
now the largest employer in Mexico. Further, illegal immigration continues to be a
problem in the United States. It is estimated that 1.3 million farm jobs were
eliminated in Mexico due to competition from American farmers. It is proposed
that many of these displaced Mexican workers illegally cross the border in their
search for work in the United States.
5. How to Do Business with NAFTA: Implications for Corporate Strategy.
Although NAFTA has not expanded beyond the original three countries due to
political obstacles, each member of NAFTA has entered into bilateral agreements
with other countries. The existence of NAFTA is causing firms from all three
member countries to re-examine their trade and investment strategies. A number of
industries (e.g., automotive products and electronics) already view the region as
one large market and have rationalized their production processes, products, and
financing accordingly. Although much low-end manufacturing has moved south to
Mexico, more sophisticated manufacturing and services operations are increasing in
the United States. In addition, Canadian firms along the U.S.-Canadian border are
generating more competition for U.S. firms along their mutual border than are
Mexican firms along the U.S.-Mexican border. Further, as Mexican incomes have
continued to rise, Mexican demand for Canadian- and U.S.-sourced products has
increased as well.
C. Regional Economic Integration in the Americas
Although there are six major regional economic groups in the Americas regional
integration in Latin America has not been particularly successful, because many
countries rely more on the United States for trade than on members of their own groups.
The Caribbean Community and Common Market (CARICOM) and the Central
American Common Market (CACM) are both found in Central America. Five Central
American countries and the Dominican Republic now have a free trade agreement with
the United States (CAFTA-DR) as discussed below in the Point-Counterpoint segment.
The two major groups in South America are the Andean Community (CAN) and the
Southern Common Market (MERCOSUR). In addition, there is the proposed South
American Community of Nations. The primary reason for each of these groups entering
into collaboration is market size.
1. CARICOM: Benchmarking the EU Model. The Caribbean Community is working
hard to establish an EU-style form of collaboration, one that would mirror the EU, but
on a smaller scale.
2. MERCOSUR. The major trade group in South America is MERCOSUR, comprised
of Brazil, Argentina, Paraguay, and Uruguay. Venezuela recently joined the group,
however, full membership of Venezuela is still pending approval of Brazil and
Paraguay. Chile, Bolivia, Ecuador, and Peru are associate members of
MERCOSUR, meaning they have duty free access to MERCOSUR markets without
getting involved in the negotiations to complete the customs union phase.
 3. Andean Community (CAN). Stated in 1969, CAN is the second most important
regional group in South America. Since its beginning, CAN has shifted its focus from
one of isolation to being open to foreign trade and investment.
4. South American Community of Nations (CSN). In 2004 the members of the Andean
Community (CAN), MERCOSUR, and other South American countries attempted
to launch the 12-nation South American Community of Nations (CSN). The goals
of CSN are to liberalize trade and eventually have a common currency, parliament,
and passport. However, its prospects for success are questionable as the
participation of several countries is at best lukewarm.
D. Regional Economic Integration in Asia
Regional economic integration has not been as successful in Asia as in the EU or the
NAFTA region because most Asian countries have relied on U.S. and European markets
for their exports.
1. Association of Southeast Asian Nations (ASEAN). The Association of Southeast
Asian Nations (ASEAN) was first organized in 1967. On January 1, 1993, it
officially formed the ASEAN Free Trade Area (AFTA) for the purpose of cutting
tariffs on interzonal trade to a maximum of 5% by 2008. Comprised of Brunei,
Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore,
Thailand, and Vietnam, ASEAN holds great promise for market and investment
opportunities because of its large market size.
2. Asia Pacific Economic Cooperation (APEC). The Asia Pacific Economic
Cooperation (APEC) community was founded in 1989 to promote multilateral
economic cooperation in trade and investment in the Pacific Rim. Comprised of 21
countries that border the Pacific on both the east and the west, APEC leaders have
committed themselves to achieving free and open trade in the region by 2010 for
the industrial nations and by 2020 for the remaining member countries. However,
progress toward free trade is hampered by the number of members, the geographic
distances between nations, and the lack of a binding treaty. Nonetheless, because
APEC includes 41% of the world’s population, 56% of world GDP, and about 49%
of world trade, it has enormous potential to become a significant economic bloc.
APEC is trying to establish open regionalism whereby individual member countries
can determine whether to apply trade liberalization to non-APEC countries on an
unconditional, most-favored-nation basis or a reciprocal, free trade agreement basis.
E. Regional Economic Integration in Africa
There are several regional trade groups in Africa that are registered with the WTO,
including the Southern Africa Development Community (SADC), the Common Market
for Eastern and Southern Africa (COMESA), the Economic and Monetary Community
of Central Africa, and the West African Economic and Monetary Union (WAEMU).
[See Map 8.5] The problem with these groups is that they rely more on their former
colonial powers and other developed markets for trade than they do on each other.
1. The African Union. Created in 2002 by 53 African nations, the African Union took
the place of the Organization of African Unity (OAU), which focused its energy
and resources on political issues in Africa (notably colonialism and racism). The
new AU is modeled loosely on the EU, although this type of integration may prove
difficult in Africa.
F. Other Forms of International Cooperation
1. The United Nations.
The UN was established in 1945 to promote international peace and security and to
help with global issues such as economic development, antiterrorism, and
 humanitarian relief. There are 192 member states in the UN General Assembly. The
UN Conference on Trade and Development (UNCTAD) was established to tackle
problems of the developing world concerning trade issues.
2. Non-Government Organizations (NGOs)
Non-government, non-profit volunteer organizations such as the Red Cross are
private institutions that can be involved in transnational activities. Several NGOs
have a focus on the rights of workers in less developed countries.

VI. COMMODITY AGREEMENTS

A commodity agreement is designed to stabilize the price and supply of a primary
commodity such as petroleum, natural gas, copper, coffee, cocoa, tea, or sugar because both
long-term trends and short-term fluctuations in their prices have important consequences for
the world economy.
A. Commodities and the World Economy
On the demand side, commodity markets play an important role in industrial countries,
transmitting business cycle disturbances to the rest of the economy and affecting the
rate of growth of prices. On the supply side, primary products account for about half of
developing countries' export earnings.
B. Consumers and Producers
For many years, countries tried to ban together as product alliances or joint producers to
help stabilize commodity prices. However, these efforts, with the exception of OPEC
have not been very successful.
C. The Organization of Petroleum Exporting Countries (OPEC)
The Organization of Petroleum Exporting Countries (OPEC) represents a producer
cartel, i.e., a group a commodity-producing countries with significant control over
output and price. Member countries include Algeria, Iran, Iraq, Kuwait, Libya, Nigeria,
Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela.
1. Price Controls and Politics. OPEC controls prices by establishing production quotas
on member countries. Because of the importance of commodities to the production
process, it is critical that managers understand the factors that influence their prices.
Politics plays an important role in OPEC deliberations as countries with larger
populations are tempted to exceed their quotas to generate more revenue.
2. Output and Exports. Currently OPEC’s oil exports represent about 51 percent of the
oil traded internationally. Therefore, OPEC can have a strong influence on the oil
market, especially if it decides to reduce or increase its level of production. Events
beyond OPEC’s control can also influence prices.
3. The Downside of High Prices. Keeping prices high has a downside for OPEC.
Higher prices encourage exploration outside of OPEC member countries and can
cause a global economic slowdown, thus lowering the overall demand for oil.
 CHAPTER NINE
GLOBAL FOREIGN-EXCHANGE MARKETS

What is Foreign Exchange?

Foreign exchange is money denominated in the currency of another nation or group of nations, i.e.,
it is a financial instrument issued by countries other than one’s own. An exchange rate is the price
of one currency expressed in terms of another, i.e., the number of units of one currency needed to
buy a unit of another.
Players on the Foreign-Exchange Market
The foreign exchange market is made up of several players. The Bank of International Settlements
(BIS), a Swiss-based central banking institution divides the market into three major players:
reporting dealers, other financial institutions, and non-financial institutions. Who Are the Players?
Reporting dealers are also known as money center banks and include large banks such as Deutsche
Bank and HSBC. Other financial institutions include commercial banks other than money center
banks (local and regional banks), hedge funds, pension funds, money market funds, currency funds,
mutual funds, and specialized foreign exchange trading companies.
Whom Do the Players Serve? Non-financial customers include governments and companies.
What Do Players Do? Players, at whatever level can trade currencies to generate a profit, or they
can provide a wide range of foreign-exchange services for their customers.

Some Aspects of the Foreign-Exchange Market

The foreign-exchange market is comprised of two major segments. The over-the-counter market
(OTC) includes commercial banks, investment banks, and other financial institutions—this is where
most foreign-exchange activity occurs. The exchange-traded market includes certain securities
exchanges (e.g., the Chicago Mercantile Exchange and the Philadelphia Stock Exchange) where
particular types of foreign-exchange instruments (such as futures and options) are traded.
Some Traditional Foreign-Exchange Instruments. Several types of foreign exchange instruments
are available for trading. In addition, several types of transactions may occur. Spot transactions
involve the exchange of currency “on the spot,” or technically, transactions that are settled within
two business days after the date of agreement to trade. The spot rate is the exchange rate quoted for
transactions that require the immediate delivery of foreign currency, i.e., within two business days.
Outright forward transactions involve the exchange of currencies beyond two days following the
date of agreement at a set rate known as the forward rate. In an FX swap (a simultaneous spot and
forward transaction), one currency is swapped for another on one date and then swapped back on a
future date. In fact, the same currency is bought and sold simultaneously, but delivery occurs at two
different times.
Derivatives. In addition to the traditional instruments, several other ways now exist with which to
participate in the foreign-exchange market, known as derivatives. Currency swaps deal with
interest-bearing financial instruments (such as bonds) and involve the exchange of principal and
interest payments. An option is a foreign-exchange instrument that guarantees the purchaser the right
(but does not impose an obligation) to buy or sell a certain amount of foreign currency at a set
exchange rate within a specified amount of time. A futures contract is a foreign-exchange
instrument that specifies an exchange rate, an amount, and a maturity date in advance of the
exchange of the currencies, i.e., it is an agreement to buy or sell a particular currency at a particular
price on a particular future date.
Size, Composition and Location of the Foreign-Exchange Market. The Bank for International
Settlements (BIS) estimated in 2007 that $3.2 trillion in foreign exchange was traded each day. This
increase more than reversed the decline seen from 1998 to 2001. This reversal is likely due to the
growing importance of foreign exchange as an alternative asset and the larger emphasis on hedge
fund (a fund, usually used by wealthy individuals and institutions, which is allowed to use aggressive
trading strategies unavailable to mutual funds).
Using the U.S. Dollar on the Foreign-Exchange Market. The U.S. dollar remains the most
important currency in the foreign-exchange market comprising one side (buy or sell) of 86.3 percent
of all foreign currency transactions worldwide in 2007. This is because the dollar: is an investment
currency in many capital markets, is held as a reserve currency by many central banks, is a
transaction currency in many international commodity markets, serves as an invoice currency in
many contracts, is often used as an intervention currency when foreign monetary authorities wish to
influence their own exchange rates.
Frequently Traded Currency Pairs. Nonetheless, the largest foreign exchange market is in the
United Kingdom, which is strategically situated between Asia and the Americas, followed by the
United States, Japan and Singapore. Four of the most commonly traded currency pairs involve the
U.S. dollar, with the top to pairs being euro/dollar (EUR/USD) and the dollar/yen (USD/JPY).

MAJOR FOREIGN-EXCHANGE MARKETS

The Spot Market
The spot market consists of players who conduct those foreign-exchange transactions that occur “on
the spot,” or technically, within two business days following the date of agreement to trade.
Foreign-exchange traders always quote a bid (buy) and offer (sell) rate. The bid is the rate at which
traders buy foreign exchange; the offer is the rate at which traders sell foreign exchange. The
spread is the difference between the bid and offer rates, i.e., it is the profit margin of the trade.
Direct and Indirect Quotes. Exchanges can be quoted in American terms, i.e., a direct quote that
gives the value in dollars of a unit of foreign currency, or European terms, i.e., an indirect quote
that gives the value in foreign currency of one U.S. dollar. The base currency, or the denominator,
is the quoted, underlying, or fixed currency; the terms currency is the numerator. Most large
newspapers quote exchange rates daily, listing both spot and forward rates. The spot rates listed are
usually the selling rates for interbank transactions (transactions between banks) of $1 million or
more.

The Forward Market

The forward market consists of those players who conduct foreign-exchange transactions that occur
at a set rate beyond two business days following the date of agreement to trade. The forward rate is
the rate quoted today for the future delivery of a foreign currency. A forward contract is entered into
whereby the customer agrees to buy (or sell) over the counter a specified amount of a specific
currency at a specified price on a specific date in the future.
Forward Discounts and Premiums. The difference between the spot and forward rates is either the
forward discount (the forward rate, i.e., the future delivery price, is lower than the spot rate) or the
forward premium (the forward rate is higher than the spot rate).
Options: An option is a foreign-exchange instrument that guarantees the right, but does not impose
an obligation, to buy or sell a foreign currency within a certain time period or on a specific date at a
specific exchange rate (called the strike price). Options can be purchased over the counter from a
commercial or investment bank or on an exchange. The writer of the option will charge a fee, known
as the premium. An option is more flexible, but also more expensive, than a forward contract.
Futures: A foreign currency future resembles a forward contract because it specifies an exchange
rate sometime in advance of the actual exchange of the currency. However, a future is traded on an
exchange, not OTC. While a forward contract is tailored to the amount and time frame the customer
needs, futures contracts have preset amounts and maturity dates. The futures contract is less valuable
to a firm than a forward contract, but it may be useful for small transactions or speculation.

THE FOREIGN-EXCHANGE TRADING PROCESS

When a firm needs foreign exchange, it typically goes to its commercial bank. If the bank is large
enough, it may have its own foreign-exchange traders. A smaller bank, dealing either on its own
account or for a client, can trade foreign exchange directly with another bank or through a foreign
exchange broker, who matches the best bid and offer quotes of interbank traders.
Banks and Exchanges
At one time, only big money center banks could deal directly in foreign exchange. Now, with the
advent of electronic trading, smaller regional banks can hook up to Reuters or Bloomberg and deal
directly in the interbank market. In spite of these developments, the greatest volume of foreign-
exchange activity still takes place with the big money center banks.
Top Foreign-Exchange Dealers. Top banks in the interbank market are so ranked because of their
abilities to: trade in specific market locations, engage in major currencies and cross-trades, deal in
specific currencies, handle derivatives (forwards, options, futures, and swaps), conduct key market
research. A large firm may use more than one bank to conduct its foreign-exchange dealings, given
their particular strategic capabilities. In addition to the OTC market, there are a number of
exchanges where particular types of foreign-exchange instruments (such as futures and options) are
traded.
CME Group. The Chicago Mercantile Exchange (CME) offers futures and options contracts in
numerous foreign currencies. In 2005, CME entered into an agreement with Reuters to have its
futures contracts quoted; they teamed up again in 2007 to launch FXMarketSpace, the world’s first
centrally cleared global foreign-exchange platform.
Philadelphia Stock Exchange. The Philadelphia Stock Exchange (PHLX) was one of the
pioneers in trading currency options. It lists six dollar-based standardized currency options contracts
and futures in British pounds and the euro.
London International Futures and Options Exchange The London International Futures and
Options Exchange still trades the U.S. dollar/euro and euro/U.S. dollar options contract, even
though it was purchased by Euronext, which merged with the NYSE.

HOW COMPANIES USE FOREIGN EXCHANGE

Companies enter the foreign-exchange market to facilitate their regular business transactions and/or
to speculate.
Business Purposes (I): Cash Flow Aspects of Imports and Exports
When a company must move money to pay for purchases or receives money for sales, it has an
option on the documents it can use, the currency of denomination, and the degree of protection it can
ask for.
Commercial Bills of Exchange. In order for these transactions to take place, a number of documents
are needed including a draft and a letter of credit. A draft or commercial bill of exchange is an
instrument in which one party directs another to make a payment. If the exporter demands payment
to be made immediately, the draft is called a sight draft. If the payment is to be made later it is called
a time draft.
Letters of Credit. With a bill of exchange, it is always possible the importer will not be able to
make the payment to the exporter. A letter of credit (L/C) [See Fig 9.7] obligates the buyer’s bank
to honor the draft. Letters of credit can be either revocable or irrevocable. A revocable letter of
credit can be changed by any of the parties and an irrevocable letter of credit cannot be changed
without the consent of all parties to the transaction. A letter of credit may also be confirmed by
another bank and is called a confirmed letter of credit.

Business Purposes (II): Other Financial Flows

Companies also deal in foreign exchange for other transactions, such as the receipt or payment of
dividends or the receipt or payment of loans and interest.
Speculation involves buying (or selling) a currency based on the expectation it will gain (or lose) in
strength against other currencies. Although speculation offers the chance to profit, it also contains an
element of risk. Profit-seekers may engage in arbitrage, i.e., they may purchase foreign currency on
one market for immediate resale on another market (in a different country) in order to profit from a
price discrepancy. Interest arbitrage involves investing in debt instruments (such as bonds) in
different countries in order to maximize profits by capturing interest-rate and exchange-rate
differentials.
 CHAPTER TEN
THE DETERMINATION OF EXCHANGE RATES

I. INTRODUCTION
An exchange rate represents the number of units of one currency needed to acquire one
unit of another currency. Managers must understand how governments set exchange
rates and what causes them to change so they can make decisions that anticipate and take
those changes into account.

II. THE INTERNATIONAL MONETARY FUND

In 1944, the major allied governments met in Bretton Woods, NH, to discuss post-war
economic needs. One of the results was the establishment of the International
Monetary Fund (IMF).
A. Origin and Objectives
Twenty-nine countries initially signed the IMF agreement, and there were 185
member countries at the beginning of 2007. The IMF has three major objectives:
 To promote international monetary cooperation, exchange stability, and
orderly exchange arrangements
 To foster economic growth and high levels of employment
 To provide temporary financial assistance to countries to help ease balance-
of-payments adjustment
1. Bretton Woods and the Principle of Par Value. The Bretton Woods
Agreement established a system of fixed exchange rates under which each IMF
member country set a par value (benchmark) for its currency based on gold and
the U.S. dollar. Par values were later done away with when the IMF moved
toward greater exchange-rate flexibility.
B. The IMF Today
1. The Quota System. When a country joins the IMF, it contributes a certain sum
of money, called a quota, relating to its national income, monetary reserves,
trade balance, and other economic indicators. The quota then becomes part of a
pool of money the IMF can draw on to lend to member countries. At the end of
March 2007, the total quota held by the IMF was SDR 217 billion (U.S. $327
billion). It also forms the basis for the voting power of each country, as well as
the allocation of its special drawing rights.
2. Assistance Programs. When a member country experiences economic
difficulties, the IMF will negotiate loan criteria designed to help stabilize its
economy. Funds are released in phases, allowing the IMF to monitor progress
before releasing all of the funds.
3. Special Drawing Rights (SDRs). The help increase international reserves, the
IMF created special drawing right (SDR), an international reserve asset
designed to supplement members‟ existing reserves of gold and foreign
exchange. The SDR is used as the IMF‟s unit of account (the unit in which the
IMF keeps its records) and for IMF transactions and operations. The value of
 the SDR is based on the weighted average of four currencies. At the beginning
of 2007 those weights were: the U.S. dollar 44%, the euro 34%, the Japanese
yen 11%, and the British pound 11%. Unless the executive board decides
otherwise, the weights of each currency in the valuation basket changes every 5
years.
C. Evolution to Floating Exchange Rate
The IMF‟s original system was one of fixed exchange rates; the U.S. dollar
remained constant with respect to the value of gold and other currencies operated
within narrow bands of value relative to the dollar.
1. The Smithsonian Agreement. Following President Nixon‟s suspension of the
dollar‟s convertibility to gold in 1971, the international monetary system was
restructured via the Smithsonian Agreement, which permitted an 8%
devaluation of the U.S. dollar, a revaluation of other currencies, and a widening
of the exchange-rate flexibility bands.
2. The Jamaica Agreement. These measures proved insufficient, however, and in
1976 the Jamaica Agreement eliminated the use of par values by abandoning
gold as a reserve asset and permitting greater exchange-rate flexibility.

III. EXCHANGE-RATE ARRANGEMENTS

The IMF surveillance and consultation programs are designed to monitor the exchange-
rate policies of member nations to be sure they act openly and responsibly with respect
to their exchange-rate policies. Member countries are permitted to select and maintain
their exchange-rate regimes, but they must communicate those choices to the IMF. Some
countries that use a fixed or pegged exchange rate use an exchange-rate anchor for their
monetary policy, which means that they buy or sell foreign exchange at given rates to
maintain the value of the currency. In addition, countries can adopt a monetary policy
that uses growth in the money supply, called the monetary aggregate anchor, a targeted
rate of inflation, or something else that they feel is important.
A. Fixed versus Flexible Currencies One can say that currencies are either fixed,
meaning their value is locked into something and doesn't change, or flexible and move
in value by the forces of supply and demand.
B. Exchange Agreements with No Separate Legal Tender
1. Dollarization. Replacing a country's currency with the U.S. dollar.
C. Currency Board Arrangements An organization in a country that is responsible
for issuing currency and usually anchors the currency to a foreign currency.
D. Conventional Fixed-Peg Arrangements
In a conventional fixed-peg arrangement, a country pegs the rate for one currency to
that of another (or to a basket of currencies) under a very narrow range of
fluctuations in value.
E. Pegged Exchange Rates within Horizontal Bands
The next category, pegged exchange rates within horizontal bands, is characterized
by a broader band of fluctuations than the first three, and contains only a few
countries.
F. More Flexible Arrangements
1. Crawling Pegs.
 2. Managed Float.
3. Independent Floating.
G. Exchange Rates: The Bottom Line The world can be divided into countries
that basically let their currencies float and those that have significant Central Bank
intervention. Additionally, people involved in international business should
understand how exchange rates of countries in which they do business are determined as
it influences many functional aspects of their business operations.
H. The Euro The currency of the European Monetary System.
1. The European Monetary System and the European Monetary Union. The
creation of the euro had its roots in the European Monetary System (EMS),
begun in 1979. The EMS was set up as a means of creating exchange-rate
stability within the European Community. Members‟ currencies were linked
through a parity grid. As the fluctuations in exchange rates narrowed, the EMS
was replaced with the Exchange Rate Mechanism (ERM). In 1999, the
European Monetary Union (EMU) came into being, creating the euro as the
common currency of all EMU member nations. The euro is administered by
the European Central Bank (ECB). Having a common currency eliminates
exchange rate risk among member nations and greatly reduces the cost of cross
border transactions. Despite these advantages, three of the original 15
members of the European Union have opted not to join the euro zone. New
applicants to the euro zone, consisting of 10 new European Union members,
must meet the following criteria to be accepted to the EMU:
• Annual government deficit must not exceed 3 percent of GDP.
• Total outstanding government debt must not exceed 60 percent of GDP.
• Rate of inflation must remain within 1.5 percent of the three best
performing EU countries.
• Average nominal long-term interest rate must be within 2 percent of the
average rate in the three countries with the lowest inflation rates.
• Exchange rate stability must be maintained, meaning that for at least two
years, the country concerned has kept within the „normal” fluctuation
margins of the European Exchange Rate Mechanism.
As of 2007, 13 of the 27 member states of the EU were using the euro.
2. Pluses and Minuses of the Conversion. While the move to the euro has been
smoother than predicted, the largest currency conversion of all times has both
pluses and minuses. Many companies believe the euro increases price
transparency and eliminates foreign exchange risk, however, not all member
states use the currency, especially the newer member states.

IV. DETERMINING EXCHANGE RATES

Exchange-rate regimes are either fixed or floating, with fixed rates varying in terms of
just how fixed they are and floating rates varying with respect to just how much they are
allowed to float.
A. Non intervention: Currency in a Floating-Rate World
Floating-rate regimes are those whose currencies respond to the conditions of
supply and demand. Technically, an independent floating currency is one that floats
 freely, unhampered by any form of government intervention. Equilibrium exchange
rates are achieved when supply equals demand
B. Intervention: Currency in a Fixed-Rate or Managed-Rate World
In a managed fixed exchange-rate system, a nation‟s central bank intervenes in the
foreign exchange market in order to influence the currency‟s relative price. To buy
foreign currencies, it must have sufficient reserves on hand. When economic
policies and market intervention don‟t work, a country may be forced to either
revalue or devalue its currency.
C. The Role of Central Banks
Each country has a central bank responsible for the policies affecting the value of
its currency. The central bank in the United States is the Federal Reserve System,
i.e., the Fed, a system of 12 regional banks. The New York Fed, representing both
the Fed and the U.S. Treasury, is responsible for intervening in foreign-exchange
markets to achieve dollar exchange-rate policy objectives. The New York Fed also
acts as the primary contact with other foreign central banks. The euro is
administered by the European Central Bank which, although independent of all EU
institutions and governments, works with the governors of Europe‟s various central
banks to establish monetary policy and manage the exchange-rate system.
1. Central Bank Reserve Assets. Central bank reserve assets are kept in
three forms: gold, foreign-exchange reserves, and IMF-related assets. Central
banks are primarily concerned with liquidity, in order to ensure they have the
cash and flexibility needed to protect their countries‟ currencies.
2. How Central Banks Intervene in the Market. Selling U.S. dollars for
foreign currency puts downward pressure on the dollar‟s value; buying U.S.
dollars for foreign currency puts upward pressure on the dollar‟s value.
Depending on market conditions, a central bank may:
• coordinate its actions with other central banks or go it alone
• aggressively enter the market to change attitudes about its views and
policies
• call for reassuring action to calm markets
• intervene to reverse, resist, or support a market trend
• be very visible or very discrete
• operate openly or indirectly through brokers.
Case: The U.S. Dollar and the Japanese Yen. The Federal Reserve could
intervene in the foreign exchange market in order to affect the price of the
Japanese yen, relative to the U.S. dollar by using foreign reserves.
Different Approaches to Intervention. Government policies change over
time, depending on economic conditions and the attitude of the prevailing
administration concerning intervention in the foreign exchange market.
U.S. Attitude towards Intervention. In general, the United States disapproves
of foreign currency intervention, based on the belief that it is very difficult, if
not impossible for intervention to have a lasting impact on the currency's
value.
The Bank for International Settlements (BIS) in Basel, Switzerland, acts as
the central bankers‟ central bank and serves as a gathering place where central
 bankers meet to discuss monetary cooperation. Although just 55 central banks
are shareholders in the BIS, it regularly deals with some 140 central banks
worldwide.
D. Black Markets
The less flexible a country‟s exchange-rate system, the more likely there will be a
black market, i.e., a foreign exchange market that lies outside the official market.
Black markets are underground markets where prices are based on supply and
demand; the adoption of floating rates eliminates the need for their existence.
E. Foreign Exchange Convertibility and Controls
Some countries with fixed exchange rates control access to their currencies. Fully
convertible currencies are those that the government allows both residents and
nonresidents to purchase in unlimited amounts. Hard currencies are currencies that
are fully convertible. Soft (or weak) currencies are not fully convertible and tend
to be the currencies of developing nations. Most countries today have nonresident,
or external, convertibility, meaning that foreigners can convert their currency into
the local currency and can convert back into their currency as well.
1. Controlling Convertibility. Governments sometimes place restrictions on
currencies such as licenses that are required of importers and exporters that fix
exchange rates at an official price. Some countries employ multiple exchange
rates, where different exchange rates are set for different types of transactions,
and others use advance import deposits which require a deposit with the
central bank for as long as one year interest-free. Governments may also limit
the amount of exchange through quality controls, which limit the amount of
foreign currency that can be used in a specific transaction.
F. Exchange Rates and Purchasing Power Parity
The theory of purchasing-power parity (PPP) states that the prices of tradable
goods, when expressed in a common currency, will tend to equalize across
countries as a result of exchange-rate changes. Put another way, the theory claims a
change in the comparative rates of inflation in two countries necessarily causes a
change in their relative exchange rates in order to keep prices fairly similar. An
interesting illustration of this theory is the “Big Mac Index” (see Table 10.2). While
purchasing-power parity may be a reasonably good long-term indicator of
exchange-rate movements, it is less accurate in the short-run because it is difficult
to determine an appropriate basket of commodities for comparison purposes, profit
margins vary according to the strength of competition, different tax rates will
influence prices differently, and the theory falsely assumes no barriers to trade exist
and transportation costs are zero.
G. Exchange Rates and Interest Rates
Although inflation is the most important long-run influence on exchange rates,
interest rates are also important.
1. The Fisher Effect. While the Fisher Effect theory links inflation and interest
rates, the International Fisher Effect (IFE) theory links interest rates and
exchange rates. The Fisher Effect theory states a country‟s nominal interest rate
r (the actual monetary interest rate earned on an investment) is determined by
 the real interest rate R (the nominal rate less inflation) and the inflation rate i as
follows:

(1 + r) = (1 + R)(1 + i) or r = (1 + R)(1 + i) - 1

Because the real interest rate should be the same in every country, the country
with the higher interest rate should have higher inflation. Thus, when inflation
rates are the same, investors will likely place their money in countries with
higher interest rates in order to get a higher real return.
2. The International Fisher Effect. The International Fisher Effect implies the
currency of the country with the lower interest rate will strengthen in the future,
i.e., the interest-rate differential is an unbiased predictor of future changes in
the spot exchange rate. The country with the higher interest rate (and higher
inflation) should have the weaker currency. In the short-run, however, and
during periods of price instability, a country that raises its interest rate is likely
to attract capital and see its currency rise in value due to increased demand.

V. FORECASTING EXCHANGE-RATE MOVEMENTS

Managers must be able to formulate at least a general idea of the timing, magnitude, and
direction of exchange-rate movements.
A. Fundamental and Technical Forecasting
While fundamental forecasting uses trends regarding fundamental economic
variables to predict future exchange rates, technical forecasting uses past trends in
exchange-rate movements to spot future trends.
1. Dealing with Biases. Smart managers develop their own exchange-rate
forecasts and then use the fundamental and technical forecasts of outside
experts to corroborate their analyses.
2. Timing, Direction, and Magnitude. Forecasting includes predicting the
timing, direction, and magnitude of exchange rate movements. For countries
whose currencies are not freely floating, the timing is often a political decision,
and not so easy to predict. Predicting the direction is easier than predicting the
magnitude. The problem with attempting to predict the value of a freely floating
currency is that you never really know what will happen to its value.
B. Factors to Monitor
When forecasting exchange-rate movements, key variables to monitor include:
• the institutional setting (the extent and nature of government intervention)
• fundamental analysis (PPP rates, balance-of-payments levels, the level of
foreign-exchange reserves, macroeconomic data, fiscal and monetary policies,
etc.)
• confidence factors
• circumstances
• technical analysis (market trends and expectations).

VI. BUSINESS IMPLICATIONS OF EXCHANGE-RATE CHANGES

Exchange-rate fluctuations can affect all areas of a company‟s operations.
A. Marketing Decisions
Exchange-rate changes can affect demand for a firm‟s products, both at home and
abroad. For instance, the strengthening of a country‟s currency could create price
competitiveness problems for exporters; on the other hand, importers would favor
that situation.
B. Production Decisions
Firms may choose to locate production operations in a country whose currency is
weak because initial investment there is relatively inexpensive; it could also be a
good base for exporting the firm‟s output. Exchange-rate differentials contribute to
this situation across industrialized nations, as well from industrialized to developing
nations.
C. Financial Decisions
Exchange-rate fluctuations can affect financial decisions in the areas of sourcing
funds (both debt and equity), the cross-border remittance of funds, and the reporting
of financial results.
 CHAPTER ELEVEN

THE STRATEGY OF INTERNATIONAL BUSINESS

I. INTRODUCTION
This chapter shifts the focus from external factors that exert influence on the
international business to internal decision making that helps determine how
effectively a given firm competes in its industry. The concepts that anchor
managers’ evaluation of strategy, the tools that support their strategic choices, and
the processes that managers use to ultimately convert their analyses into strategies
that create superior value in international markets are all examined.

II. INDUSTRY, STRATEGY, AND FIRM PERFORMANCE

In general, the forces in the MNE’s environment that routinely have the greatest
impact on its strategy are in its immediate industry and competitive environment.
Industry Organization Paradigm Leading Strategy Perspectives
The industry a company operates in can significantly influence its profitability.
As postulated by the industry organization (IO) paradigm, the forces in the
MNE’s environment that routinely have the greatest impact on its strategy are in
its immediate industry and competitive environment. Research indicates that
industry effects explain up to 75 percent of the difference in average returns for
companies. Despite this influence, significant variation does occur within given
industries and companies. Industry structure is not necessarily deterministic of
firm performance—the quality of both management and strategy also has an
impact. The fact that competition is not necessarily perfect creates the potential
for a company to convert an innovative strategy into superior competitiveness.
Managers must understand what strategy is, the tools that they can use to make
it, and the implication of their choices to the performance of their company.

The Idea of Industry Structure: The Five-Forces Model

Industry structure can be understood better by modeling the so-called “five
fundamental forces” of an industry. These forces include (1) rivalry among
competing sellers, (2) the potential for new entrants to enter the industry, (3) the
likelihood that substitute products will be offered by firms in other industries,
(4) the push by input suppliers to charge more for their inputs, and (5) the push
by output buyers to pay less for products. The five-forces model develops a
representation of the structure and competition in an industry that prepares
managers to figure out what forces shape strategic conduct, how strong each
force is, what forces are driving changes in the industry, what strategic moves
rivals are likely to make next, and what the key factors are for future
competitive success. [See Fig 11.3] The financial services industry is a case in
point. Firms in the industry must compete globally, and changing environmental
factors such as the sophistication of buyers makes for a more challenging
competitive environment.
 Industry Change
The structure of industries is dynamic, with new products, new firms, new
markets, and new managers triggering new developments that impact the five
industry forces.

Forces That Can Change Industry Structure. Changes in variables such as the
long-term industry growth rate, new technologies, new consumer buying and
usage patterns, manufacturing innovations, government regulation, the entry and
exit of major firms, and the diffusion of business and technical expertise across
countries can all lead to industry change.

Strategy and Value

Strategy defines the perspectives and tools managers use to appraise the
company’s present situation, identifies the direction the company should go, and
determines how the company will get there. Strategies are ultimately about
creating value. The idea of value can be defined in a variety of ways (i.e.,
economic value, market value, pro forma value, etc.) and can be defined from a
number of perspectives (such as those of customers, employees, stakeholders, or
shareholders).

Creating Value
Companies create value either by making their products for a lower cost than
any other firm in their industry (the strategy of low-cost leadership) or making
those products that consumers are willing to pay a premium price for (the
strategy of differentiation).
1. Low-Cost Leadership. This strategy usually targets a broad market and
pushes a firm to sell its products either at average industry prices to earn a
higher profit than rivals or at lower than average prices in order to increase
market share. This strategy is a key advantage in highly competitive
industries. Cost leaders are well positioned to withstand price wars in the
industry.
2. Differentiation. This strategy requires the development of products that
offer unique attributes that are highly valued by customers and demand a
price premium. The uniqueness that companies generate must be difficult to
copy if the differentiation strategy is to be successful.

III. THE FIRM AS A VALUE CHAIN

Questions central to the task of creating value include how the company will design,
make, move, and sell products; how it will find efficiencies in doing so; and how it
will coordinate the decisions in one part of the business with those made in other
parts.
What Is the Value Chain? Thinking of the firm as a value chain provides a strong
tool to deal with these challenges. The value chain is a representation of the firm as
a series of discrete value creating activities.
Dimensions of the Value Chain. The value chain has four organizing dimensions:
Primary activities—those that are involved in the physical movement of raw
materials and finished products, the production of goods and services, marketing
and subsequent services of the outputs of the business.
Support activities—include procurement, technology and system development,
human resource management, and firm infrastructure.
Profit margin—represents the ultimate purpose of the value chain which is to
result in more revenue generated by sales than the costs of the activities that led
to those sales.
Upstream and downstream—upstream refers to those activities which gather and
process the inputs that the company uses to make a product while downstream
refers to those activities that deal more directly with the end customer.

Using the Value Chain

A company’s competitiveness is determined by how effectively it manages its
value chain. Value chain analysis serves to guide managers’ efforts to build
expertise in those value activities that are critical to reducing costs or improving
differentiation. Configuration of the value chain refers to the process of
dispersing value chain activities to those locations around the globe where
perceived value is maximized or where the costs of value creation are
minimized. Coordination of the value chain describes the process of integrating
dispersed activities into a cohesive, coherent whole.
Configuration. Every MNE looks to establish elements of its value chain in the
best spots in the world.
Location economies arise when MNEs locate activities in the optimal location
for that activity, wherever in the world that may be. Effective configuration is
difficult to achieve, however, due to the complexity and dynamism of the
international business environment. Conditions that shape how managers
configure value chains worldwide include cost factors, business environments,
cluster effects, logistics, degree of digitization, economies of scale, and buyers’
needs.
Cost Factors. Differences in wage rates, worker productivity, inflation rates,
and government regulations create significant variations in production costs
from country to country. In 2003, the average hourly wage (including benefits)
for production workers in China was $.80 versus $25.34 in the United States.
Notably, just two countries—China and India—account for more than 43
percent of the total labor in the world.
Cluster Effects. The cluster effect occurs when a particular industry gradually
clusters more and more related value creation activities in a specific location.
Examples of these clusters are London for global finance, Silicon Valley for
technology, Hollywood for mass media, Baden-Württemberg for cars and
electrical engineering, and Mumbai for business process outsourcing.
Logistics. Logistics refers to how companies obtain, produce, and exchange
material and services in the proper place and in proper quantities for the proper
value activity.
Degree of Digitization. The degree to which an analog product can be
converted into a digitized product influences value chain configurations.
Processes that were once rooted to a place can now be digitized and moved
easily and outsourced or offshored.
Economies of Scale. Economies of scale refer to the decrease in the unit cost
of production associated with the increase in total output. Scale economies
generally occur in industries with high capital costs and high production
volumes, allowing capital costs to be spread over many units of production.
Business Environment. Companies also configure their value chain to take
advantage of favorable business conditions such as lower tax rates, more flexible
operating requirements, and public policies or to avoid riskier environments.
Customer Needs. The physical location of activities is often influenced by a
need to be close to buyers, especially such activities as distribution to dealers,
sales and advertising, and after-sale service. Some companies physically locate
these capabilities in every country in which they operate.

Coordination
Coordination is the way that managers connect the discrete activities of the
value chain. The task of coordinating the different activities that go into making
and moving a product around the world has emerged as the basis of the superior
performance that separates good from great MNEs. As seen in the opening case,
Zara’s strategy of rapid response to ever-changing fashion trends demands lots
of coordination in order to succeed.

Core Competencies. MNEs often try to identify core competencies, unique

skills and/or knowledge that are better than those of its competitors, and link
these through different parts of the value chain. Examples of core competencies
include Procter & Gamble’s marketing and distribution skills or Apple’s ability
to convert innovative ideas into well designed products. A core competency can
emerge from various sources such as:
• Product development
• Employee productivity
• Manufacturing expertise
• Marketing imagination
• Executive leadership
As a company’s value chain becomes more globally dispersed, the challenges of
coordination increase. Coordinated well, MNEs can leverage their core
competencies, using them to boost sales and profits. With poor coordination,
MNEs will not be able to transfer even more mundane capabilities and
resources from country to country. Several factors moderate managers’
analyses of how to coordinate value activities.

Operational Obstacles. Communication challenges resulting from the need to

synchronize languages and electronic interfaces can hinder the efficient flow of
materials and information. Differences in currencies and measurement systems
(i.e., metric vs. decimal) can also lead to breakdowns in coordination.
National Cultures. The performance of even the simplest value chain depends
on each link meeting a specified timetable. Differences in cultural perceptions
of the importance of schedules and deadlines can wreak havoc with tightly
timed supply channels. Other conflicts revolving around disagreements about
how much and what types of information should be shared with other units
within the company and who should take lead responsibility for certain
activities are often culturally based and can result in delays, misunderstandings,
and inefficiencies.

Learning Effects. Learning effects refer to cost savings that come from
learning by doing. Managers learn through experience how to transfer best
practices from one country to another.
The Experience Curve. Companies learn through experience what approaches
work best in different parts of the world. The experience curve is a phenomenon
that occurs as firms gain greater efficiencies as they become more experienced
at producing a product or providing a service. An MNE with a factory in
Mexico, for example, might adopt a traditional labor intensive assembly line
operation there while a similar operation in Japan may use lean production
systems. Differences in capital structures and productivity present challenges of
coordination that can only be overcome through experiential learning.
Coordinating Services. Service industries run into similar challenges in
coordinating the sharing of specialized knowledge across their globally
dispersed value chains.
Subsidiary Networks. The growing connectivity within and between MNEs,
as well as the growth in the number of companies operating internationally, has
resulted in an integrated market ecology where ideas can emerge from and
easily travel to subsidiaries around the world. Skills, ideas, and technologies
can be created anywhere within an MNEs global network of subsidiaries. It is,
therefore, becoming increasingly vital that managers are able to identify new
sources of value creation within the subsidiary network and transfer them
effectively to other parts of the network where they can further enhance value
creation.

Change and the Value Chain

The configuration and coordination of a value chain responds to changes in
customers, competitors, industries, and environments. Because the features and
functions of products that consumers judge most critical change over time, the
basis of value creation in an industry evolves. Such is the case with Samsung,
the South Korean electronics company, which in 1997 began reconfiguring its
value chain and increasing its spending on R&D and capital, resulting in a more
dominate market position.
Caveat: A Limitation of Strategy. No matter how highly tuned the company’s
strategic compass, executive' limitations, along with marketplace uncertainty,
can quickly turn prized core competencies into strategic liabilities.
IV. GLOBAL INTEGRATION VERSUS LOCAL RESPONSIVENESS
Global and local pressures challenge how the firm configures and coordinates its
value chain. On the one hand, firms must often respond to global competitive
pressures demanding efficiency and lower cost achieved through standardization and
scale economies. On the other hand, local competitive pressures place demands on
the firm to customize its products or services to meet distinctive needs country by
country. The strategic alternatives available to MNEs are often influenced by the
relative strength of pressures for global integration and local responsiveness.
Pressures for Global Integration
Global markets produce more than 20% of world output currently, and are projected
to increase to 80% of output by 2025. The trend toward rapid economic integration
appears poised to continue. Although many factors can explain this trend, the two
primary factors behind pressures for global integration are the globalization of
markets and the efficiency gains of standardization.
Globalization of Markets. Global buying patterns and company strategies suggest
that consumers seek and accept standardized global products. Consumers are
searching for products which meet their needs and provide superior value, regardless
of where they originate. As communication and transportation infrastructures have
become more integrated across borders, consumer preferences have begun to
homogenize and companies’ abilities to meet those preferences on a global scale
have increased. The resulting economies of scale translate to even lower prices,
higher quality standardized goods, and yet more homogenization of consumer
demand. More and more goods are being viewed as commodities—traded on the
basis of price, not on differences in quality or features. In global markets, product
differentiation is difficult and competition tends toward price wars.
Efficiency Gains of Standardization. Standardization is the process of increasing
the uniformity of a product or service by decreasing the extent of variation.
Worldwide standardization of an MNE’s products, purchases, methods, and policies
can significantly reduce the costs of its operations. Standardization is also a
powerful means to exploit location economies, since value chain activities can be
placed in optimal locations for global production and distribution. Standardization
pressures have steadily increased as more countries have joined the global economy
in general and the WTO in particular.

Pressures for Local Responsiveness

International companies face several pressures to tailor their operations to local
market conditions. Consumer divergence and host-government policies are two of
the major forces contributing to pressures for local responsiveness.
Consumer Divergence. Contrary to the globalization of markets thesis, some argue
that differences in consumer tastes and preferences across countries emerge and
endure due to cultural predisposition, historical legacy, emergent nationalism,
economic prosperity, and other factors. In some industries, like food production,
products are unsuitable for standardization and local preferences remain strong.
Host-Government Policies. Differences in policies among host-country
governments contribute to great variability in political, legal, and economic
situations in various markets. Policies such as trade protectionism, local content
 rules, and national product standards require some degree of local responsiveness
and counterbalance the policy shifts toward privatization, economic freedom, legal
uniformity, and deregulation that encourage standardization.

Pressures for global integration and local responsiveness interact as expressed in the
integration-responsiveness [IR] grid. This grid expresses how a company’s choice
of strategy is a function of the particular relationship the company sees between its
idea of value creation and the corresponding pressures for global integration or local
responsiveness in its industry.

V. TYPES OF STRATEGY
Generally, MNEs choose from four basic strategies to guide how they will enter and
compete in the international environment. These strategies correspond to the relative
demands for global integration and national responsiveness and include the
international, multidomestic, global, and transnational strategies.

International Strategy. The international strategy emphasizes the transfer of core

competencies from the domestic operation to foreign subsidiaries. It allows for
limited local customization. Examples of companies using this strategy include
McDonald’s, Kellogg, Google, Yahoo!, Haier, Wal-Mart, and Microsoft. Some
subsidiaries may have latitude to adapt products to local conditions, but ultimate
control resides in the home office.

International Strategy and the Value Chain. Many critical activities, such as
research and development or branding, are usually centralized at headquarters. An
international strategy makes sense if a firm has a core competence that local
competitors in other markets lack and if industry conditions do not push the firm to
improve its cost controls or local responsiveness.

Liability of International Strategy. The liability of the international strategy is that

headquarters’ central role hinders identifying and responding to local conditions and
can lead to missed market opportunities.

Multidomestic Strategy. Firms following a multidomestic strategy adjust

products, services, and business practices to meet the needs of individual countries
and regions.
Multidomestic Strategy and the Value Chain. A multidomestic company,
sometimes called a locally responsive company, follows a strategy that allows each
of its foreign-country operations to act fairly independent. Management that chooses
the multidomestic strategy believes in responding to the unique conditions prevailing
in different markets.

Benefits of a Multidomestic Strategy. This strategy makes sense when the

demands for local responsiveness are high and the demands for global integration are
low. Other benefits include minimizing political risk, lower exchange rate risk,
greater prestige, higher potential for innovative products from local R&D, and
higher growth potential.

Limitations of Multidomestic Strategy. The benefits of this strategy do come with

costs. The multidomestic strategy leads to widespread duplication of management,
design, production, and marketing activities since each local subsidiary must
perform each of these activities. Corporate headquarters may have a harder time
controlling more independent subsidiaries.

Global Strategy. A global strategy requires worldwide consistency and

standardization in order to be effective. Firms that choose the global strategy face
strong pressures for cost reductions but weak pressure for local responsiveness.
Operationally, MNEs that adopt a global strategy usually are or aim to become the
low-cost player in their industry. This generally requires global-scale production
facilities in a few low-cost locations.
1. Global Strategy and the Value Chain. The efficiency goals of the global
strategy have plain implications for configuring a value chain. R&D,
production, and marketing activities are concentrated in the most favorable
locations, which may not all be in the same country. Dispersed activities
are coordinated by formal linkages, overseen by executives at the
centralized world headquarters who standardize practices and processes.
Strategic decision making authority resides almost exclusively at
headquarters.
2. Strengths of Global Strategy. Generally, the global strategy is best suited
fro those industries that put strong pressures on efficient operations and
where local responsiveness needs are either nonexistent or can be
neutralized by offering a high-quality product for a lower price than the
local substitute.

Transnational Strategy
Transnational strategy aims to simultaneously exploit location economies,
leverage core competencies, and pay attention to local responsiveness. It is arguably
the most direct response to the growing globalization of business. Capabilities and
contributions are differentiated from country to country, with an emphasis on
learning from various environments and then integrating and diffusing this
knowledge throughout global operations.
Transnational Strategy and “Global Learning.” The transnational strategy
champions the cause of interactive global learning. Rather than a top-down (global
strategy) or bottom-up (multidomestic strategy) flow of ideas, the transnational
strategy champions a flow from the idea generator to idea adopters wherever these
may be.
Transnational Strategy: A Case in Point. In the 1980s, GE faced competitive
threats from emerging low-cost competitors in Asia. This caused GE to look more
seriously at global markets. GE's sense of globalization moved from finding new
markets to finding new worldwide sources that could provide higher quality
resources for lower costs. GE made ideas, constantly renewed, enhanced, and
exchanged within the expanding context of globalization the basis for its value
creation.

Limitations of Transnational Strategy.

While the transnational strategy offers many advantages, it is difficult to build, poses
serious challenges, and is prone to shortfalls.
 CHAPTER TWELVE

COUNTRY EVALUATION AND SELECTION

INTRODUCTION
Because companies lack the resources to take advantage of all international opportunities they identify, they
must determine both the order of country entry as well as the rates of resource allocation across countries. In
choosing geographic sites, a firm must determine both where to sell and where to produce The answer can be
one and the same place if transportation costs are high and/or government regulations make local production a
necessity. In many industries, facilities must be located near foreign customers; in others, market and
production sites are continents away. Developing a site location strategy that helps a firm maximize its
resources and competitive position is very challenging, given that many estimates and assumptions about
factors such as future costs and prices and competitors’ reactions must be made.

HOW DOES SCANNING WORK

A. Scanning is useful insofar as a company might otherwise consider either too few or too many possibilities.
Managers use scanning techniques to compare countries on broad indicators of opportunities and risks.
B. Managing the Alternatives With approximately 200 different countries, managers might overlook good
opportunities while focusing on a limited set of markets.
C. Scanning versus Detailed Analysis Managers may lump certain countries together, such as Latin
American countries, without realizing that there are significant differences among the countries in the
region.
1. Scanning as Step 1. Through the use of scanning, decision makers can perform a detailed analysis of
a manageable number of geographic locations. Managers can usually complete the scanning process
without having to incur the expense of visiting foreign countries. Instead they rely on analyzing
information found on the Internet and other publicly available sources, as well as communicating with
people familiar with the foreign countries they are interested in.
2. Detailed Analysis as Step 2. Once managers narrow their consideration to the most promising
countries, they need to compare the feasibility and desirability of each. The more time and money
companies invest in examining an alternative, the more likely they are to accept it regardless of its
merits—a phenomenon known as escalation of commitment. Companies should be careful about
taking forced actions based on peer and/or media pressure and should instead carefully weigh
important variables when comparing countries of interest.

WHAT INFORMATION IS IMPORTANT IN SCANNING

Managers should consider country conditions that could significantly affect success or failure. These
conditions should reveal both opportunities and risks.
Opportunities
The section on opportunities is divided into two parts—sales expansion and resource acquisition—
although some conditions may affect both, given the relationship between decisions of where to sell and
where to produce.
1. Sales Expansion. Sales expansion is probably the single most important motive for international
business. It is often difficult to estimate sales potential in a new market, and managers may have to
rely on sales of similar or complementary goods, or use economic or demographic data to estimate
market potential.
Examining Economic and Demographic Variables. Some of the main things to consider when
examining economic and demographic variables include:
i. Obsolescence and leapfrogging of products. Consumers in some emerging economies skip
entire generations of technology in favor of more recent technologies, such as Chinese
consumers going from having no telephones to using cellular phones almost exclusively.
 ii. Prices. The relative prices of essential and non-essential goods can have a significant
impact on consumption patterns. Higher prices for necessary goods leave less discretionary
income for non-essentials.
iii. Income elasticity. Market potential can be calculated by dividing the percentage of change
in product demand by the percentage of change in income in a given country. Income
elasticity varies by product and income level, with demand for necessities being less elastic
than demand for luxuries.
iv. Substitution. Depending on local conditions, consumers in some countries may be more
willing to substitute some products or services for others. For example, people in high
population density areas typically substitute mass transit for automobiles.
v. Income inequality. Even in areas where per capita incomes are low, there may be middle-
and upper-income people with substantial income to spend due to income inequality.
vi. Cultural factors and taste. Countries with similar income levels may exhibit different
demand patterns based on differences in cultural values and tastes.
vii. Existence of trading blocs. Countries with small populations and/or low per capita incomes
may have a much larger market due to participation in a regional trading bloc.

Resource Acquisition. Companies undertake international business to secure resources that are either
not sufficiently available or are too expensive in their home country. They may purchase these
resources from another organization or they may establish foreign investments to exploit them.
Cost Considerations. Total cost is made up of numerous sub costs that need to be considered. Many
of these are industry or company specific, which must be examined in the detailed onsite visitations.
Several costs that apply to a large cross section of companies are outlined below.
Labor. Labor compensation remains an important cost for most organizations. In the scanning
process, factors such as labor market size, labor compensation, minimum wages, customary and
required fringe benefits, and unemployment rates can be used for comparison. When companies move
into emerging economies because of labor cost differences alone, their advantages may be short-
lived. Competitors often follow leaders into low-wage areas, there is little first-mover advantage for
low-labor cost production migration, and the costs can rise quickly as a result of pressure on wage or
exchange rates.
Infrastructure. Poor internal infrastructure and social services may easily negate cost differences in
labor rates. In many developing countries, infrastructure is both poor and unreliable, which adds to
companies’ cost of operating.
Ease of Transportation and Communications. There are advantages to companies to locate close to
their customers and suppliers. Other factors to consider are country isolation, trade restrictions, and
transportation and communication options that are available.
Governmental Incentives and Disincentives. Countries often compete to attract investors, offering
incentives such as lower taxes, training of employees, loan guarantees, low interest loans, exemptions
on import duties, and subsidized energy and transportation costs. There may also be disincentives
such as taxes, labor conditions, and environmental compliance. Government corruption may also be
present and represent a disincentive.
Risks
Is it ever rational for a firm to invest in a country with high economic and political risk ratings? Such
questions must be carefully weighed when making international capital-investment decisions.
Factors to Consider in Analyzing Risk. There are a number of factors to consider when analyzing
risk: 1) companies and managers differ on risk perception, tolerance for risk, and the expected returns;
2) one company's risk is another company's opportunity; 3) there are means available for reducing risk
other than avoiding locations; 4) there are trade-offs between risk and return.

Political Risk. Political risk reflects the expectation the political climate in a given country will
change in such a way that a firm’s operating position will deteriorate. It relates to changes in political
leaders’ opinions and policies, civil disorder, and animosity between a home and host country. When
evaluating political risk, decision makers refer to past patterns in a given country, expert opinions,
and country analysts. They also look for economic and social conditions that could lead to political
instability, but there is no consensus as to what constitutes dangerous instability or how it can be
predicted.
Analyzing Past Patterns. Predicting risk based on past patterns can be problematic in that situations
change. Also, the overall situation in a county may mask political risks with the country.
Analyzing Opinions. Managers should study the statements made by political leaders and access
political polls to attempt to determine the likelihood of a candidate gaining political office. Managers
should visit short-listed countries for a cross-section of opinions. Analysts and commercial political
risk assessment services can also be used.
Examining Social and Economic Conditions. Countries' social and economic conditions may
lead to unrest if large sectors of the population have unmet needs. Frustrated groups may disrupt
business and destroy property. Foreign leaders may place blame on foreign companies.

Monetary Risk. Companies may be affected by either changes in exchange rates or ability to move
funds out of a country.
Exchange Rate Changes. Changing exchange rates may be a benefit or a disadvantage, depending
upon the direction of the change and if the firm is seeking to sell or acquire resources. If the U.S.
dollar depreciates, it makes American products abroad, however, it will cost firms more to acquire
foreign resources.
Mobility of Funds. If a firm’s expansion occurs through foreign- direct investment, foreign-
exchange rates and access to investment capital and earnings are key considerations.
Liquidity preference refers to the theory that investors want some of the holdings to be in highly
liquid assets on which they are willing to take a lower return. Firms must carefully evaluate a
country’s present capital controls, recent exchange-rate stability, balance-of-payments account,
inflation rate, and level of government spending.

Competitive Risk. The comparison of likely success among countries is largely contingent on
competitors’ actions. Four competitive factors that should be considered when comparing countries
are discussed below.
Making Operations Compatible. Companies are highly attracted to countries that are located
nearby, share the same language, and have market conditions similar to those in their home countries.
The liability of foreignness refers to the fact that foreign firms have a lower rate of survival than
local firms for the initial years after the start of operations. However, those foreign firms that manage
to overcome their initial problems have long-term survival rates comparable to those of local firms.
Managers should also try to assure those countries’ policies and norms allow them to use their
competitive advantages effectively, and consider local availability of resources in relation to their
needs.
Spreading Risk. By operating in diverse countries, companies may be able to smooth their sales and
profits. Geographical diversification can reduce risk since countries far removed from the home
country may be less correlated economically. Diversification also reduces risk of the loss of key
suppliers or customers, and helps balance risk-return countries.
Following Competitors or Customers. Companies may also reduce risk by avoiding overcrowded
markets, or conversely, they may purposely crowd a market to prevent competitors from gaining
advantages therein that they can use to improve their competitive positions elsewhere, a situation
known as oligopolistic reaction. Firms may also seek “clusters” of competitors (also known as
agglomeration) that attract multiple suppliers, customers and highly trained personnel in order to gain
access to new products, technologies, and markets. One example of this would be the computer firms
clustered in California’s Silicon Valley.
Heading Off Competition. A company may try to reduce competitive risk by either getting a strong
foothold in markets before competitors do or by avoiding strong competitors altogether. A company’s
innovative advantage may be short-lived. When pursuing a strategy known as imitation lag, a firm
moves first to those countries most likely to adapt and catch up to the advantage. In some instances
firms may seek those countries where they are least likely to confront significant competition; in
 others they may gain advantages by moving into countries where competitors are already present. By
being the first major competitor in a market, companies can more easily gain the best partners, best
locations, and best suppliers—a strategy to gain first-mover advantage.

COLLECTING AND ANALYZING DATA

Firms perform research to reduce uncertainties in their decision processes and to assess their operating
performance. The costs of data collection should always be weighed against the probable payoffs in terms of
revenue gains or cost savings.
A. Some Problems with Research Results and Data
Numerous countries have agreed to standards for collecting and publishing various categories of national
data. However, the lack, obsolescence and inaccuracy of data on other countries can make research
difficult and expensive to undertake.
1. Inaccurate Information. For the most part, there are five basic reasons why reported information
may be inaccurate:
a. Limited Resources. Incomplete or inaccurate data result from the
inability of governments to collect the needed information. Both economic and educational
factors will affect the quantity and quality of available data.
b. False or Misleading Data. Of equal concern is the publication of false or purposely misleading
information designed to mislead government superiors, the country's rank and file, or companies
and institutions abroad. Therefore, it is useful for managers to consider carefully the sources of
information.
c. Reliance on Legally Reported Market Activities. National income figures may report only
legal and reported market activity. Further distortions may occur as a result of non-reporting or
under-reporting of information people wish to hide such as illegal income.
d. Poor Research Methodology. Many inaccuracies are due to poor collection and analysis by
researchers. Too often, broad generalizations are drawn from too few observations.
2. Noncomparable Information. Comparability problems result from definitional differences across
countries (e.g., family categories, literacy levels, accounting rules), differences in base years,
distortions in foreign currency conversions, the measurement of investment flows, the presence of
black market activities, etc.

B. External Sources of Information

Both the specificity and cost of information will vary by source.
1. Individualized Reports. Market research and business consulting firms conduct country studies for a
fee. The fact that a firm can specify the information it wants may make the cost worthwhile.
2. Specialized Studies. Certain research organizations generate specific studies about countries,
regions, industries, issues, etc., that they make available for general purchase. The price is much
lower than for an individualized study.
3. Service Companies. Most international service-related firms publish reports that are usually geared
toward either the conduct of business in a given country or region or about some specific subject of
general interest, such as tax or trademark legislation.
4. Government Agencies. Governments and their agencies publish tomes of information designed to
stimulate business activity both at home and abroad.
5. International Organizations and Agencies. The UN, the WTO, the IMF, the OECD, and the EU are
but a few of the multilateral organizations and agencies that collect and disseminate data. Many of the
international development banks even help fund investment feasibility studies.
6. Trade Associations. Many trade associations collect, evaluate, and disseminate a wide variety of
data dealing with competitive and technical factors in their industries. Their reports may or may not
be available to nonmembers.
7. Information Service Companies. Certain companies offer information-retrieval services; they
maintain databases from hundreds of sources from which they will access data for a fee, or sometimes
for free at public libraries.
C. Internal Generation of Data
When firms have to conduct studies in foreign countries, they may find traditional data gathering and
analytical methods do not reveal critical insights. In that case, a researcher must be extremely imaginative
and observant. In some instances, useful information may be found by analyzing indirect or
complementary indicators.

COUNTRY COMPARISON TOOLS

Two common tools for analyzing information collected via scanning are grids and matrices. Also, once a firm
commits to a location, it will need continuous updates regarding external conditions that might affect its
operations there.
A. Grids
A grid can be used to make country comparisons according to a wide variety of relevant factors, such as
ownership rules, potential returns, and perceived risk. Variables can be ranked and weighted according to
specific criteria that reflect a firm’s situation and objectives. Although useful for establishing minimum
scores and for ranking countries, grids often obscure interrelationships among countries.
B. Matrices
One matrix frequently used when doing country comparisons is the opportunity-risk matrix. When using
this matrix, the manager plots a country according to the perceived value of the opportunity the country
offers, on the one hand, and the expected level of risk associated with operating in that country on the
other. Factors that are good indicators of risk and opportunity and the weight assigned to each must be
identified and assigned by the firm. Once scores are determined for each country being considered, they
can be plotted and reviewed from a comparative perspective. A useful application of this technique is to
develop both present and future scores for countries (e.g., five years hence) because a significant shift in a
score in the future could have serious implications with respect to the country selection process.

ALLOCATING AMONG LOCATIONS

The scanning tools just discussed are useful for narrowing alternatives among countries. They are also useful
in allocating operational emphasis among countries, but there are other factors, discussed below, that
companies need to consider.
A. Alternative Gradual Commitments Companies favor operations in countries similar to their home
country. A company does not necessarily move at the same speed along each axis. A slow movement
along one axis may free up resources that allow faster expansion along another.
B. Geographic Diversification versus Concentration
A firm may take different paths en route to gaining a sizable presence in most countries. At one end of the
spectrum is a diversification strategy, whereby a firm moves rapidly into many foreign countries and
then gradually builds its presence in each. At the other end of the spectrum is a concentration strategy,
whereby a firm moves into a limited number of countries and develops a strong competitive position there
before moving into others. When deciding which strategy, or perhaps some hybrid of the two, is desirable,
a firm must consider a number of variables
1. Growth Rate in Each Market. When the growth rate in each market is high, a firm will likely
concentrate on a few markets because of the cost of keeping up with market expansion.
2. Sales Stability in Each Market. The more stable sales and profits are within a single market, the less
advantageous a diversification strategy will be.
3. Competitive Lead Time. Sequential entry into multiple markets is more common than simultaneous
entry. If a firm has a long lead time before competitors can copy or supercede its advantages, then it
may be able to follow a concentration strategy and still beat competitors to other markets.
4. Spillover Effects. Spillover effects represent situations in which a marketing program in one country
results in the awareness of a product in other countries. When a single marketing program can reach
many countries (via cross-country media, for example), a diversification strategy is advantageous.
5. Need for Product, Communication, and Distribution Adaptation. When companies find it
necessary to alter products, promotion and/or distribution strategies in foreign markets, a
concentration strategy will be advantageous because the associated costs cannot be spread over sales
in other countries to capture economies of scale.
 6. Program Control Requirements. The more a company needs control over a foreign operation, the
more appropriate a concentration strategy is because additional resources will be required to maintain
that control.

REINVESTMENT VERSUS HARVESTING

Once a firm makes an initial investment, it will then need to decide whether to continue investing in that
operation or to harvest the earnings (and possibly divest the assets) and use them elsewhere.
1. Reinvestment Decisions. Reinvestment refers to the use of retained earnings to replace depreciated
assets or to add to a firm’s existing stock of capital. Aside from competitive factors, a company may
need several years of almost total reinvestment (and often allocation of additional funds) in order to
realize its objectives at a given location.
2. Harvesting. Harvesting or divesting refers to the reduction in the amount of an investment; a firm
may choose to simply harvest the earnings of an operation or divest the assets there as well. If an
operation no longer fits a company’s overall strategy, or if better opportunities exist elsewhere, it
must determine how to exit that operation. When selling or closing facilities, firms must consider
possible government performance contracts as well as potential adverse publicity, plus the possible
difficulty in re-establishing operations in that country in the future.

NONCOMPARATIVE DECISION MAKING

Companies often examine one opportunity at a time rather than ranking a set of foreign operating proposals
using predetermined criteria. This sequential process leads to go-no-go decisions and is often necessary due to
the speed with which companies need to respond to opportunities as they arise. Decision makers often need to
react quickly for both offensive and defensive motives. Three factors inhibit companies from comparing
investment opportunities: cost, time, and interrelation of operations on global performance.
 CHAPTER THIRTEEN
EXPORT AND IMPORT STRATEGIES

INTRODUCTION
Successful exporting is a challenging process. Once a company has identified the good or service it wants to
sell, it must assess and explore market opportunities among many countries. It must also develop a production
development strategy, a means of transportation, and interact with different cultures, banking systems, and
market forces.

EXPORTING AND IMPORTING

Whereas exporting represents goods and services flowing out of a country, importing represent goods and
services flowing into a country. Exports result in receipts and imports result in payments. Although export and
import activities are a natural extension of distribution strategy, they also include elements of product,
promotion and pricing factors, and decisions. Both exporting and importing entail a lower level of risk than
foreign direct investment, but while exporting offers less control over the marketing function, importing offers
less control over the production function.

EXPORT STRATEGY
A firm’s choice of entry mode depends on various factors, such as the ownership advantages of the firm, the
location advantages of the market and the internalization advantages of specific assets, international
experience and/or the ability to develop differentiated products.

Advantages to Consider Ownership advantages are the firm's specific assets, international experience, and
the ability to develop either low-cost or differentiated products within the context of its value chain.
Internalization advantages are the benefits of retaining a core competency within the company and threading it
through the value chain rather than opting to license, outsource, or sell it. In general, companies that have low
levels of ownership advantages either do not enter foreign markets or, if they do, they enter through low-risk
modes.

Strategic Advantages of Exporting

Companies export in order to increase sales revenues, achieve economies of scale in production, diversify
markets, and minimize risk. All of these objectives are ultimately motivated by the potential for greater
profitability.
Diversification
The Role of Serendipity. While it is convenient to view the export process as a proactive process, research
shows that firms can enter the export market by chance and become successful.
Profit Potential. Companies can often sell their products at a greater profit abroad than at home due to
differences in the competitive environment or differences in stages in the product life cycle in foreign markets.
Government actions at home and abroad in such areas as tax policy can also affect profitability and stimulate
exporting.

Characteristics of Exporters
Research conducted on the characteristics of exporters has resulted in three basic conclusions: (i) the
probability of exporting increases with size of company revenues, (ii) export intensity (the percentage of total
revenues generated by exports) is not positively correlated with company size, and (iii) exporting is engaged in
by both big and small companies.
Size. While the largest companies are routinely the largest exporters from their countries, smaller firms play an
important part in overall export activity. The data show that small businesses make up about 88% of U.S.
exporters and account for a fifth of the total value of U.S. exports.
Perspective on Risk and Other Industry Factors. Factors such as the risk profile of management and the
nature of industry competition are just as important as firm size.
Stages of Export Development Several factors can trigger exporting. As previously mentioned, exports can
occur by serendipity with unplanned sales requests, random contacts, and personal travels abroad. Achieving
strategic advantages in exporting, however, requires a sound export strategy.
Three Phases of Export Development. Firms tend to move through three phases of export development: pre-
engagement, initial exporting, and advanced exporting. As they do so, they tend to (i) export to more countries
and (ii) expect exports to grow as a percentage of total sales. In addition, they also tend to (iii) diversify their
markets to more distant countries and (iv) move into environments that are increasingly different from those of
their home countries.

Pitfalls of Exporting
Dealing with Financial Management. Exchange-rate changes and transactions require more advanced
financial management skills. Foreign customers may also expect help with the financing of the goods they
are importing.
Dealing with Customer Demand. Customers around the world are increasingly demanding a greater range of
services from their vendors. Customers may require the installation and set up of equipment which may
require service engineers in the foreign market.
Dealing with Communications Technology. Before the Internet, exports were customarily arm's-length,
ship-it-and-forget-it transactions. Now the ease of contacting vendors via email or inexpensive voiceover
Internet protocol plans spurs customers to seek greater real-time involvement in transactions.
A Catalog of Additional Stumbling Blocks. The operational mistakes associated with exporting can be very
costly. Most new exporters stumble once or twice before experiencing consistent success. Export specific
problems include:
1. Failure to obtain qualified export counseling in developing a plan to guide export expansion
2. Insufficient commitment by top management to overcome initial and ongoing difficulties
3. Miscalculating the trade-off between a lean export department and the cost in delays or
violations in export compliance
4. Misestimating the complexity and costs of ocean shipping and customs clearance to export
transactions
5. Poor selection of overseas agents or distributors
6. Chasing orders from around the world instead of establishing a base of profitable operations and
manageable growth
7. Neglecting export markets and customers when the domestic market booms
8. Classifying products inaccurately according to the destination country’s tariff schedule, thereby
incurring a higher tax or slowing delivery
9. Failure to treat international distributors on an equal basis with their domestic counterparts
10. Unwillingness to modify products to meet other countries’ regulations or cultural preferences
11. Failure to print service, sales, and warranty messages in locally understood languages
12. Failure to consider use of an export management company or other marketing intermediary when
the company lacks personnel to direct export
13. Failure to prepare for disputes with customers
Designing an Export Strategy
To design an effective export strategy, managers must:
• Assess the company’s export potential by examining its opportunities and resources.
• Obtain expert counseling on exporting. Seek specialized financial assistance. Secure government
payments guarantees (EX-IM Bank). Hire an agent or distributor to oversee the transaction.
• Select a market or markets.
• Formulate and implement an export strategy.

IMPORT STRATEGY
Importing is the process of bringing goods and services into a country and results in the importer paying
money to the exporter in the foreign country.
Types of Importers
The three basic types of importers are those that:
 • look for any product around the world that will generate a positive cash flow
• look to foreign sourcing as a means to minimize product costs
• use foreign sourcing as part of their global supply chain strategy.
1. Why Import? Generally companies import for three reasons:
• They can buy goods or services at lower prices from foreign suppliers.
• The goods or services are of higher quality than similar goods produced locally.
• The goods or services needed in their production processes are unavailable from local
companies.

Strategic Advantages of Imports

There are two basic types of imports: industrial and consumer goods to independent individuals and companies
and intermediate goods and services that are part of the firm’s global supply chain.
1. Specialization of Labor. Specialization of labor makes export to and imports from countries more
efficient.
2. Global Rivalry. Global rivalry pushes the procurement of lower priced import components.
3. Local Unavailability. Not all goods are available in the domestic market.
4. Diversification of Operating Risks. Developing alternative suppliers usually makes a company less
vulnerable.

THE IMPORT PROCESS

The import process mirrors the export process, involving both strategic and procedural issues. An import broker,
also known as a custom broker, is an intermediary who helps an importer best navigate custom regulations. A
customs broker can help an importer minimize duties by (i) valuing products in such a way that they qualify
for more favorable treatment, (ii) qualifying for duty refunds through drawback provisions, (iii) deferring
duties by using bonded warehouses and foreign trade zones and (iv) limiting liability by properly marking an
import’s country of origin.
Customs Agencies
Customs reflect a country’s import and export procedures and restrictions. The primary duties of a customs
agency are the assessment and collection of all duties, taxes and fees on imported products, the enforcement of
customs and related laws and the administration of certain navigation laws and treaties. National customs
agencies are increasingly involved in dealing with smuggling operations and preventing foreign terrorist
attacks.
Procedural Assistance. An importer needs to know how to clear goods, what duties to pay, and what special
laws exist regarding the importation of products.
Efficiency Improvement. Increased efficiency of customs agents concerning import and export are being
achieved through things like uniform customs forms and electronic filing.
Import Documentation
The import documentation process can be both complicated and cumbersome. Without proper documentation,
customs agencies will not release shipments. Documents are of two types: (i) those that determine whether
customs will release the shipment and (ii) those that contain the information necessary for duty assessment and
data gathering purposes. At a minimum, the required documents would include an entry manifest, a
commercial invoice, and a packing list.
Bureaucratic Impediments. Import documentation in the form of delays, documents, and administrative fees
still remain a challenge for companies. These hindrances aren't likely to disappear anytime soon given the
heightened importance of national economic agendas.

THE EXPORT PROCESS

Direct exports represent products sold to an independent party outside of the exporter’s home country; indirect
exports are first sold to an intermediary in the domestic market, who then sells the products in the export
market. While services are more likely to be exported on a direct basis, goods are exported via both avenues.
A. Indirect Selling
 Indirect selling, i.e., selling products to or through an independent domestic intermediary, is carried out
via a variety of export intermediaries—independent (unrelated) firms that facilitate international trade
transactions by assisting both importers and exporters.
1. Export Intermediaries. Exporters and importers use a variety of third-party intermediaries to
facilitate the trade of goods. Export intermediaries may perform any or all of the following functions:
• Stimulate sales, obtain orders, and do market research.
• Make credit investigations and perform payment-collection activities.
• Handle foreign traffic and shipping.
• Support the company’s overall sales, distribution, and advertising.
a. EMCs and ETCs. The major types of indirect intermediaries are the export management
company (EMC), the export trading company (ETC), and export agents, merchants, or
remarketers.
• Export Management Companies. An export management company (EMC) is a firm that
either acts as a manufacturer’s agent or buys merchandise from manufacturers for
international distribution. EMCs generally operate on a contractual basis, provide exclusive
representation in a well-defined foreign territory and act as the export arm of a manufacturer.
Often, export management companies are small and specialize according to product,
function and/or market area.
• Export Trading Companies. An export trading company
(ETC) is somewhat like an export management company, but its primary purpose in
becoming involved in international trade as an independent broker is to match domestic
exporters to foreign customers. Export trading companies that are based in the United States
may be exempt from antitrust provisions in order to allow them to penetrate foreign markets
by collaborating with other U.S. firms. The primary difference between ETCs and EMCs is
that ETCs tend to operate on the basis of demand rather than supply.
• Foreign Trading Companies. While the original functions of a
trading company were to handle the paperwork, financing, transportation and storage
services related to import and export transactions, many have expanded the scope of their
operations to include production and processing facilities and operations, as well as fully
integrated marketing systems. In 1995, three large Japanese trading companies (Mitsubishi,
Mitsui, and Itochu) were the top three companies on Fortune’s Global 500 list. Due to the
implementation of new accounting rules that significantly lowered trading companies’
revenues, by 2004 none of these companies remained anywhere near the top of Fortune’s
list.
B. Direct Selling
Competitive pressures to leverage core competencies and improve the performance of value chains push
exporters to consider one of two things. The first option is to build a network of sales representatives
stationed in key markets around the world.
1. Direct Selling through Distributors. Direct selling, i.e., exporting through sales representatives to
distributors, foreign retailers, or final end users, gives exporters greater control over the marketing
function and offers the potential to earn higher profits as well. Whereas a sales representative usually
operates on a commission basis, a distributor is a merchant who purchases goods from a
manufacturer and resells them at a profit.
a. Evaluating Distributors. Companies evaluating potential foreign
sales representatives or distributors usually examine:
• The size and capabilities of its sales force
• Its sales record
• An analysis of its territory
• Its current product mix
• Its facilities and equipment
• Its marketing policies
• Its customer profile
• Its promotional strategies
 2. Direct Selling to Foreign Retailers and End Users. The growth of
global retail chains such as Wal-Mart facilitates the export of an increasing range of products directly
to storefronts around the world. Exporters can also sell directly to end users through catalogs and
trade shows.
3. Direct Selling over the Internet. E-commerce is easy to engage, provides faster and cheaper
delivery of information, generates quick feedback on new products, improves customer service,
accesses a global audience, levels the field of competition, and supports electronic data interchange
(EDI) with both suppliers and customers.

C. Export Documentation
Direct selling requires the exporter to complete many documents that regulate international trade. Duties,
customs clearance, and entry processes for each country differ and each country has the sovereign right to
determine which goods pass through its borders.
1. Key Documents. Depending on the situation, important documents for
exporters may include:
• A pro forma invoice—an invoice from the exporter to the importer that outlines the selling
terms, price, and delivery if the goods are actually shipped.
• A commercial invoice—a bill for the goods from the buyer to the seller.
• A bill of lading—a receipt for goods delivered to the common carrier for transportation, a
contract for the services rendered by the carrier, and a document of title.
• A consular invoice—sometimes required by countries as a means of monitoring imports.
• A certificate of origin—indicates where the products originate and usually is validated by an
external source.
• A shipper’s export declaration—used by the exporter’s government to monitor exports and to
compile trade statistics.
• An export packing list—itemizes the material in each individual package, indicates the type of
package, and is attached to the outside of the package.
D. Sources of Regulatory Assistance
Government agencies such as the Department of Commerce in the United States are particularly useful
resources for export assistance. In Japan, offices such as the Small and Medium Enterprise Agency,
Agency of Industrial Science and Technology, and the Ministry of International Trade and Industry
(MITI) all are available to assist exporters. Agencies in the United States such as the Ex-Im Bank and
Small Business Administration can help international traders obtain financing for their activities. Most
states and several cities fund and operate export financing programs as well.
E. Foreign Freight Forwarders
A forward freight forwarder is a foreign trade specialist who deals in the movement of goods from
producer to customer, and is the largest export intermediary in terms of value and weight of products
managed. Even export management companies may use the specialized services of foreign freight
forwarders.
a. Forwarder Functions. The typical freight forwarder is the largest export intermediary in terms of the
weight and value of cargo handled. Some may specialize in the type of mode used, others in the
geographical area served.
b. Transportation Options. The movement of goods across a variety of modes from origin to
destination is known as intermodal transportation. Forwarders help manufacturers get the best
contract and help prepare the products for shipping. Despite the cost advantage of
containerization, airfreight continues to thrive because of the need for light-weight, higher-value
shipments
c. Forwarder Fees. Freight forwarder fees are usually charged as a percent of the shipment value,
plus a minimum charge depending on the number of services provided.
COUNTERTRADE
Countertrade involves a reciprocal flow of goods and services. It provides a means to complete a transaction
when a firm (or government) does not have sufficient convertible currency to pay for imports, or it simply
does not have sufficient funds. Countertrade transactions can be divided into two basic types: (i) barter (based
on clearing arrangements used to avoid money-based exchange) and (ii) buybacks, offsets and
counterpurchase (all of which are used to impose reciprocal commitments).
1. Inefficiencies. Countertrade is inefficient. Buyers and sellers must enter into a complex and time-
consuming negotiation to reach a fair value on the exchange.
2. Benefits. The benefits of countertrade come mainly from teh fact that many emerging markets lack the
cash to pay for goods or services and it is necessary to make the deal. The use of countertrade also shows
a manager's good faith in dealing with emerging countries.
 CHAPTER FOURTEEN

DIRECT INVESTMENT AND COLLABORATIVE STRATEGIES

I. INTRODUCTION
Companies must choose an international operating mode to fulfill their objectives
and carry out their strategies. When forming objectives and implementing strategies
in a variety of country environments, firms must either handle international business
operations on their own or collaborate with other companies. Although exporting is
usually the preferred alternative since it allows firms to produce in their home
countries, participating in some markets may require using a variety of other equity
and nonequity arrangements. These can range from wholly owned operations to
partially owned subsidiaries, joint ventures, equity alliances, licensing, franchising,
management contracts, and turnkey operations.

II. WHY EXPORTING MAY NOT BE FEASIBLE

Companies may find more advantages by producing in foreign countries rather than
by exporting to them due to a variety of reasons.
A. When It’s Cheaper to Produce Abroad
Competition requires companies to control their costs and to choose production
locations with costs in mind.
B. When Transportation Costs Too Much
Some products and services become impractical to export after the cost of
transportation is added to production costs. In general, the farther the target
market is from the home country, the higher the transportation costs. Also, the
higher transportation costs are relative to production costs, the more difficult it
is to be competitive through exporting. Some services are impossible to export
and require establishing operations in the target country.
C. When Domestic Capacity Isn’t Enough
As long as a company has excess capacity, it can service foreign markets and
price on the basis of variable rather than full costs. When demand exceeds
capacity, however, new facilities are needed and are often located nearer to the
end consumers in other countries.
D. When Products and Services Need Altering
Special requirements for products in some markets may require additional
investments that are often better made in the country the company intends to sell
to. The more that products must be altered for foreign markets, the more likely
production will shift to those foreign markets.
E. When Trade Restrictions Hinder Imports
Although import barriers have been on the decline, some significant tariffs
continue to exist. In these situations, avoiding barriers through production in the
target country must be weighed against other considerations such as the market
size of the country and the scale of technology used in production. When
barriers fall within a group of countries, companies may be attracted to make
 direct investments to serve the entire region since the expanded market may
justify scale economies.
F. When Country of Origin Becomes an Issue
Consumers may prefer goods produced in their own country over imports
because of nationalistic feelings. For some products, consumers may prefer
imported goods from specific countries due to a perception that those products
are superior. Other considerations like the availability of service and
replacement parts for imported products, or adoption of just-in-time
manufacturing systems may influence production locations.

III. NONCOLLABORATIVE FOREIGN EQUITY ARRANGEMENTS

Two forms of foreign direct investment (FDI) that do not involve collaboration are
wholly owned operations and partially owned operations with the remainder widely
held.
A. Taking Control: Foreign Direct Investment
To qualify as a foreign direct investment, the investor must have control. This
can be established with a small percentage of the holdings if ownership is
widely dispersed. The more ownership a company has, the greater its control
over the management decisions of the operation. There are three primary
reasons for companies to want a controlling interest—internalization theory,
appropriability theory, and freedom to pursue global objectives.
1. Internalization. Control through self-handling of operations is known as
internalization. Transactions cost theory holds that companies should
organize operations internally when the costs of doing so are lower than
contracting with another party to handle it for them. Internalization may
result in lower costs because:
• Different operating units with the same company likely share a
common culture which expedites communications
• The company can use its own managers, who understand and are
committed to carrying out its objectives
• The company can avoid protracted negotiations with another company
on such matters as how each will be compensated for contributions
• The company can avoid possible problems with enforcing an agreement
2. Appropriability. Appropriability theory is the idea that companies want
to deny rivals and potential rivals’ access to resources such as capital,
patents, trademarks, and management know-how that might be captured
through collaborative agreements.
3. Freedom to Pursue a Global Strategy. When a company has a wholly
owned foreign operation, it may more easily have that operation participate
in a global strategy. Furthermore, the fact that most countries have laws to
protect minority shareholders’ interest means that sharing of ownership may
restrict a company from implementing a global strategy.
B. How to Make FDI
FDI usually involves international capital movement, but could also involve the
transfer of other assets, such as managers or cost control systems. Companies
 can either acquire an interest in an existing company or construct new facilities,
known as a greenfield investment.
1. Buying. Companies may acquire existing operations in order to avoid
adding further capacity to the market, to avoid start-up problems, obtain
easier financing, and get an immediate cash flow rather than tying up funds
during construction. A company may also save time, reduce costs, and
reduce risks by buying an existing company.
2. Making Greenfield Investments. Companies may choose to build if no
suitable company is available for acquisition, if the acquisition is likely to
lead to carry-over problems, and if the acquisition is harder to finance. In
addition, local governments may prevent acquisitions because they want
more competitors in the market and fear foreign domination.

IV. WHY COMPANIES COLLABORATIVE

Each participant in a collaborative arrangement has its own basic objectives for
operating internationally as well as its own motives for collaborating with a partner.
A. Alliance Types Scale alliances aim at providing efficiency through the pooling
of similar assets so that partners can carry out business activities in which they
already have experience. Link alliances use complementary resources to expand
into new business areas.
B. General Motives for Collaborative Arrangements
Companies collaborate with other firms in either their domestic or foreign
operations in order to spread and reduce costs, to specialize in particular
competencies, to avoid or counter competition, to secure vertical and/or
horizontal linkages and to learn from other companies.
1. To Spread and Reduce Costs. When the volume of business is small, or
one partner has excess capacity, it may be less expensive to collaborate with
another firm. Companies should periodically reappraise the question of
internal versus external handling of their operations.
2. To Specialize in Competencies. The resource-based view of the firm
holds that each firm has a unique combination of competencies. Thus, a
firm can maximize its performance by concentrating on those activities that
best fit its competencies and relying on partners to supply other products,
services, or support activities.
3. To Avoid or Counter Competition. When markets are not large enough
for numerous competitors, or when firms need to confront a market leader,
they may band together in ways to avoid competing with one another or
combine resources to increase their market presence.
4. To Secure Vertical and Horizontal Links. If a firm lacks the competence
and/or resources to own and manage all of the activities of the value-added
chain, a collaborative arrangement may yield greater vertical access and
control. At the horizontal level, economies of scope in distribution, a better
smoothing of sales and earnings through diversification and an ability to
pursue projects too large for any single firm can all be realized through
collaboration.
 5.To Gain Knowledge. Many firms pursue collaborative arrangements in
order to learn about their partners’ technology, operating methods, or home
markets and thus broaden their own competencies and competitiveness over
time.
C. International Motives for Collaborative Arrangements
Companies collaborate with other firms in their foreign operations in order to
gain location-specific assets, overcome legal constraints, diversify
geographically, and minimize their exposure in high-risk environments.
1. To Gain Location-Specific Assets. Cultural, political, competitive, and
economic differences among countries create challenges for companies that
operate abroad. To overcome such barriers and gain access to location-
specific assets (e.g., distribution access or a competent workforce), firms
may pursue collaborative arrangements with local companies.
2. To Overcome Governmental Constraints. Countries may prohibit or limit
the participation of foreign firms in certain industries, or discriminate
against foreign firms via tax rates and profit repatriation. Firms may be able
to overcome such barriers via collaboration with a local partner. It is also
helpful to have a collaborative relationship with a local firm to protect
assets. Some countries provide protection only if intellectual property is
exploited locally within a specified time period. Local partners can monitor
the illegal usage of the firm's intellectual property.
3. To Diversify Geographically. By operating in a variety of countries, a firm
can smooth its sales and earnings; collaborative arrangements may also
offer a faster initial means of entering multiple markets or establishing
multiple sources of supply.
4. To Minimize Exposure in Risky Environments. The higher the risk
managers perceive with respect to a foreign operation, the greater their
desire to form a collaborative arrangement.

V. TYPES OF COLLABORATIVE ARRANGEMENTS

While collaborative arrangements allow for a greater spreading of assets across
countries, the various types of arrangements necessitate trade-offs among objectives.
Finding a desirable partner can be problematic. A firm has a wider choice of
operating forms and partners when there is less likelihood of competition and when it
has a desired, unique, difficult-to-duplicate resource.
A. Some Considerations in Collaborative Arrangements
Two critical variables that influence the choice of collaborative arrangement are
a firm’s desire for control over its foreign operations and its prior expansion into
foreign ventures.
1. Control. The loss of control over flexibility, revenues and competition is a
critical variable in the selection of forms of foreign operation. The more a
firm depends on collaborative arrangements, the more likely its control will
be lessened over decisions regarding quality, new product directions and
production expansion.
 2. Prior Expansion of the Company. If a firm already owns and controls
operations in a foreign country, the advantages of collaboration may not be
as attractive as otherwise.

B. Licensing
Under a licensing agreement, a firm (the licensor) grants rights to intangible
property to another company (the licensee) to use in a specified geographic area
for a specified period of time; in exchange, the licensee ordinarily pays a royalty
to the licensor. Such rights may be exclusive or nonexclusive. Usually the
licensor is obliged to furnish technical information and assistance, while the
licensee is obliged to exploit the rights effectively and pay compensation to the
licensor. Intangible property may be classified as:
• patents, inventions, formulas, processes, designs, patterns
• copyrights for literary, musical, or artistic compositions
• trademarks, trade names, brand names
• franchises, licenses, contracts
• methods, programs, procedures, systems
1. Major Motives for Licensing. Licensing often has an economic motive,
such as the desire for faster start-up, lower costs, or access to additional
resources (e.g., technology). For the licensor, the risks and costs of a given
venture are lessened; for the licensee, costs are less than if it had to develop
a product or process on its own. Cross-licensing represents the situation in
which companies in various countries exchange technology rather than
compete with each other with every product in every market.
2. Payment Considerations. The amount and type of payment for licensing
arrangements may vary. Each contract tends to be negotiated on its own
merits; the bargaining range is based on dual expectations. Both agreement-
specific and environment-specific factors may affect the value of a license.
Companies commonly negotiate a "front-end" payment to cover transfer
costs when technology is involved. In addition, they usually charge fees
based on actual usage. Licensors of technology do this because it usually
takes more than simply transferring explicit knowledge, such as through
reports. The move requires the transfer of tacit knowledge as well, such as
engineering.
3. Selling to Controlled Entities. Many licenses are given to firms owned in
part or in whole by the licensor. From a legal standpoint, subsidiaries are
separate companies; thus, a license may be required in order to transfer
intangible property.
C. Franchising
Franchising represents a specialized form of licensing in which the franchisor
not only sells an independent franchisee the use of the intangible property
essential to the franchisee’s business, but also operationally assists the business
on a continuing basis. In a sense, the two partners act like a vertically integrated
firm because they are interdependent and each produces a part of the product
that ultimately reaches the customer.
 1. Franchise Organization. A franchisor may penetrate a foreign country by
dealing directly with its foreign franchisees, or by setting up a master
franchise and giving that organization the right to open outlets on its own or
to develop sub franchises in the country or region.
2. Operational Modifications. Franchise success is derived from three
factors: product standardization, effective cost control, and high
identification through promotion. Nonetheless, franchisors face a classic
dilemma: the more they standardize on a global basis, the lower the
potential for product acceptance in a given country; the more they permit
adaptation to local conditions, the less the franchisor can offer the
franchisee, the higher the costs and the less the control by the franchisor.
D. Management Contracts
A management contract represents an arrangement in which one firm provides
management personnel to perform general or specialized functions to another
firm for a fee. A firm usually pursues such contracts when it believes a partner
can manage certain operations more efficiently and effectively than it can itself.

E. Turnkey Operations
Turnkey operations represent a type of collaborative arrangement in which one
firm contracts with another to build complete, ready-to-operate facilities.
Usually, suppliers of turnkey facilities are industrial-equipment and construction
companies; projects may cost billions of dollars; customers most often are
government agencies or large MNEs.
1. Contracting to Scale. One characteristic that sets the turnkey business apart
from most other international business operations is size of the contract.
2. Making Contacts. The nature of the business requires executives with top-
level contacts abroad.
3. Marshaling Resources. Many turnkey operations are in remote areas and
necessitate massive housing construction and the importation of personnel.
4. Arranging Payment. Payment for a turnkey project usually occurs in
stages, with 10-25% paid upfront, 50-65% paid as the contract progresses,
and the remainder paid at the completion of the contract.
F. Joint Ventures
A joint venture represents a direct investment in which more than one
organization shares ownership. Although companies usually form a joint venture
to achieve particular objectives, it may continue to operate indefinitely as the
objective is redefined. A consortium represents the joining together of several
entities (e.g., companies and governments) to combine resources and/or to
strengthen the possibility of pursuing a major undertaking.
1. Possible Combinations. Other forms of joint ventures include:
• Two companies from the same country joining together in a foreign
market, such as NEC and Mitsubishi (Japan) in the United Kingdom
• A foreign company joining with a local company, such as Great Lakes
Chemical (U.S.) and A. H. Al Zamil in Saudi Arabia
• Companies from two or more countries establishing a joint venture in a
 third country, such as that of Tata Motors (India) and Fiat (Italy) in
Argentina
• A private company and a local government forming a joint venture
(sometimes called a mixed venture), such as that of Petrobras (Brazil)
with the Venezuela government-owned PDVSA
• A private company joining a government-owned company in a third
country, such as BP Amoco (private British-U.S.) and Eni
(government-owned Italian) in Egypt
G. Equity Alliances
An equity alliance represents a collaborative arrangement in which at least one
of the collaborating firms takes an ownership position (usually a minority) in the
other(s). The purpose of an equity alliance is to solidify a collaborating contract,
thus making it more difficult to break.

VI. PROBLEMS WITH COLLABORATIVE ARRANGEMENTS

Dissatisfaction with the results of collaboration can cause an arrangement to break
down. Problems arise for a number of reasons. The major strains on collaborative
arrangements are due to five factors:
• Relative importance to partners
• Divergent objectives
• Control problems
• Comparative contributions and appropriations
• Differences in culture
A. Relative Importance
One partner may give more attention to the collaboration than the other—often
because of a difference in size. An active partner will blame the less active
partner for its lack of attention, while the less active partner will blame the other
for poor decisions.
B. Divergent Objectives
Although firms may enter into collaborative arrangements with complementary
capabilities and objectives, their views regarding such things as reinvestment vs.
profit repatriation and desirable performance standards may evolve quite
differently over time.
C. Questions of Control
When no single party has control of a collaborative arrangement, the venture
may lack direction; if one party dominates, it must still consider the interests of
the other. By sharing assets with another firm, a company may lose some control
over the extent and/or quality of the assets’ use. Further, even when control is
ceded to one of the partners, both may be held responsible for problems.
D. Comparative Contributions and Appropriations
One partner’s ability to contribute technology, capital and other assets may
diminish (at least on a relative basis) over time. Further, in almost all
collaborations the danger exists that one partner will use the others’ contributed
assets, or take more than its fair share from the operation, thus enabling it to
become a direct competitor. Such weaknesses may cause a drag on a venture and
even lead to the dissolution of the agreement.
 E. Differences in Culture
Differences in both national and corporate cultures may cause problems with
collaborative arrangements, especially joint ventures.
1. Differences in Country Cultures. Firms differ by nationality in terms of
how they evaluate the success of an operation (e.g., profitability, strategic
market position and/or social objectives). Nonetheless, joint ventures from
culturally distant countries tend to survive at least as well as those between
partners from similar cultures.
2. Differences in Corporate Cultures. In addition to national culture,
differences in corporate culture may create problems for joint ventures. For
example, some firms may have an entrepreneurial culture and others are risk
adverse. Compatibility of corporate cultures is important to the success of
joint venture projects.

VII. MANAGING FOREIGN ARRANGEMENTS

As a collaborative arrangement evolves, partners need to reassess certain decisions in
light of their resource bases and external environmental changes.
A. Dynamics of Collaborative Arrangements
The evolutionary costs of a firm’s foreign operations may be very high as it
switches from one operational mode to another, especially if it must pay
termination fees.
1. Country Attractiveness and Operational Options. A firm must develop
the means to evaluate performance by separating the controllable and
uncontrollable factors at its various profit centers. Based on the variables of
country attractiveness and competitive strength, firms develop different
operating modes such as wholly owned, joint ventures, or nonequity
arrangements.
2. Changing Conditions. Tensions may develop as a company's international
operations change and grow. Some individuals may gain or lose
responsibility as control location change.
B. Finding Compatible Partners
A firm may actively seek a partner for its foreign operations, or it can react to a
proposal from another company to collaborate with it. Potential partners should
be evaluated both for the resources they can offer and their willingness to work
together. The proven ability to handle similar types of collaboration is a key
professional qualification.
C. Negotiating the Arrangement
Certain technology transfer considerations are unique to collaborative
arrangements; often preagreements are set up to protect concerned parties. The
secrecy of financial terms, especially when government authorities consult their
counterparts in other countries, is an especially sensitive area. Market conditions
may dictate the need for different terms in different countries.
D. Drawing Up the Contract
By transferring assets to a joint venture or intangible property rights to another
company in a licensing agreement, a company undoubtedly loses some control
 over the asset of intangible property. A host of potential problems attend this
lack of control and should be settled in the original agreement.
1. A Few Specific Issues. To minimize potential points of disagreement,
contract provisions should address the following factors:
• Terminating the agreement if the parties do not adhere to the directives
• Methods of testing for quality
• Geographical limitations on the asset’s use
• Which company will manage which parts of the operation outlined in
the agreement
• What each company’s future commitments will be
• How each company will buy from, sell to, or use intangible assets that
come from the collaborative arrangement
E. Assessing Performance
All parties should establish mutual goals so all involved understand what is
expected, and a contract should spell out expectations. When collaborating with
another company, managers must continue to monitor performance and assess
whether to take over operations. In addition to the continuing assessment of the
venture’s performance, a firm should also periodically assess the possible need
for a change in the type of collaboration.
 CHAPTER FIFTEEN

THE ORGANIZATION OF INTERNATIONAL BUSINESS

INTRODUCTION
Organizational challenges abound in this era of globally dispersed resources and operations. International
managers must create structures, systems, and a culture that will effectively implement their company’s
strategies around the world. Formulating the appropriate strategy is merely the first step of a long process that
includes crafting an organization that will work to implement that strategy.
Strategy as a Process. Formulating the appropriate strategy for international business is just the first step in a
long process. Throughout this process managers articulate what must be done to sustain the company's
competitive advantage. They focus on how employees individually and collectively can contribute to
achieving the goals of the organization. Building an organization to implement the chosen strategy presents
managers with the job of integrating the efforts of many different people and groups of people.

ORGANIZATION STRUCTURE
Organization structure is the formal arrangement of roles, responsibilities, and relationships within an
organization and is a powerful tool with which to implement strategy. A company’s choice of structure
depends on many factors, including the configuration of a company’s value chain in terms of the location and
type of foreign facilities, as well as the impact of international operations on total corporate performance. Two
central issues in organization structure are vertical and horizontal differentiation.
A. Vertical Differentiation: Centralization versus Decentralization
Vertical differentiation refers to the issue of determining where in the company hierarchy the authority
to make decisions stands. This issue becomes a decision between centralization versus decentralization of
decision making authority.
Centralization versus Decentralization in Organizational Design. Centralization is the degree to
which high-level managers, usually above the country level, make important decisions and pass them
down to lower levels for implementation. Decentralization is the degree to which lower level managers,
usually at or below the country level, make and implement important decisions. Centralized decision
making is usually associated with an international or global strategy, decentralized decision making is
usually associated with a multidomestic strategy, and a transnational strategy usually relies on a
combination of both.
B. Horizontal Differentiation: The Design of the Formal Structure
Horizontal differentiation describes how the company designs its formal structure in order to (i) specify
the total set of organizational tasks, (ii) divide those tasks into jobs, departments, subsidiaries, and
divisions, and (iii) assign authority and reporting relationships.
1. Functional Structure. A functional structure groups personnel according to business function. It is
ideal when products and production methods are undifferentiated across countries and where market
change is more measured than erratic. However, as new and different products are added, the structure
becomes cumbersome.
2. Divisional Structure. Divisional structures specify roles and relationships within the company in
terms of outputs. Each division is assigned responsibility for a different set of products or markets.
a. International Division Structure. An international division groups all international activities
into a single division within a firm. While this structure creates a critical mass of international
expertise, the relationship between the international and domestic divisions is often complicated.
b. Product Division Structure. Product divisions are very popular among international companies
today because most companies’ businesses involve a variety of diverse products. This structure is
well suited for a global strategy and enhances a company’s ability to sell or spin off certain product
lines. There will, however, likely be some duplication of activities among product divisions and
knowledge transfer between divisions is minimal.
c. Geographic (Area) Division Structure. A geographic division groups activities on a regional
basis and is used when a firm has extensive foreign operations that are not dominated by a single
 country or area. The structure is useful when maximum economies of scale and scope can be captured
on a regional rather than a global basis. A drawback of this structure is the potential for duplication of
work among areas as the company locates similar value activities in several places rather than
consolidating them in the most efficient place.
3. Matrix Structure. A matrix structure is a structure designed to give functional, product and/or
geographic groups a common focus. It is based on the theory that the groups will become
interdependent and thus will more readily exchange information and resources with each other.
However, the dual reporting/oversight responsibilities can also create conflicts across groups with
differing objectives.
Advantages and Disadvantages. Product groups, functional groups, and geographic groups must
all compete among themselves to obtain the resources others hold in the matrix. Consequently, the
matrix structure is a useful compromise when managers face great difficulty integrating or separating
foreign operations. The matrix structure also has drawbacks. It requires that groups compete for scare
resources and it is likely that disputes among lower-level managers will develop, requiring higher-
level management intervention.
4. Mixed Structure. Firms seldom if ever get all of their activities to neatly correspond to a single
organizational structure. A mixed structure combines various functional, area, and product
dimensions, particularly with respect to foreign operations, due to legacies, executive preferences,
and other circumstances.
C. Contemporary Structures
Many companies are moving away from traditional structures as the demands and opportunities of the
international environment change.
1. Case: IBM in Europe. Like many MNEs operating in Europe, IBM had pursued a multidomestic
strategy supported by a geographical area structure that provided for a subsidiary for each country. IBM
relied on a regional office in Paris to oversee these operations. Economic integration within Europe in the
1990s pushed IBM to move more decision making from local subsidiaries to the regional office in an
effort to develop a pan-European strategy. Technological, regulatory, and competitive pressures pushed
IBM to dismantle the national and regional fiefdoms it had established in each country in Europe.
2. Removing Structural Boundaries. Some examples of contemporary structures include those
described as learning organizations, virtual organizations, or modular structures. This entire share the
same premise: A structure should not be defined by, or limited to, the horizontal, vertical, or external
boundaries that block the development of knowledge-generating and decision-making relationships in the
company. Contemporary structures aim to have few to no boundaries between different vertical ranks
and functions, different units in different geographical locations, and between the firm and its suppliers,
distributors, joint venture partners, strategic allies, and customers. Other examples of contemporary
structures include the network and the virtual organization.
3. Network Structure. A network structure is a small core organization that outsources value
activities to key partners. The Japanese Keiretsu. Many Japanese firms are linked through keiretsus, i.e.,
networks in which each firm owns a small percentage of the others in the network. Keiretsus may be
either vertical or horizontal in nature.
4. Virtual Organization. A virtual organization is a temporary arrangement among partners that can
be easily reassembled to adapt to market change.
COORDINATION AND CONTROL SYSTEMS
Systems are the framework of processes and procedures used to ensure that an organization can fulfill all tasks
required to achieve its objectives. MNEs use several coordination and control tools to manage the strategic
performance of their value chains.
A. Coordination Systems
Coordination systems link the various activities of a company to counteract the tendency of different
groups of managers and employees to develop different concerns and orientations based on their location
and immediate responsibilities. 1. Approaches to Coordination. Managers tap several approaches to
coordinate the operations of interdependent units and individuals including coordination by
standardization, by plans, and by mutual adjustment.
 a. Coordination by Standardization. Companies with widely dispersed operations often
standardize the ways that employees do their jobs and deal with customers. Standardization sets
universal rules and procedures that apply worldwide and enforces consistency in performance of
activities in geographically dispersed units. Rules and regulations about how employees interact, also
called formalization, aims to reduce workplace uncertainty and simplify the exchange of ideas and
resources. Standardization is undermined when frequent exceptions to rules are made, and is best
suited for strategies that champion constancy and predictability in stable industries. Companies with
an international or geocentric strategy are inclined to emphasize standardization.
b. Coordination by Plan. This type of coordination requires interdependent units to meet common
deadlines and objectives. MNEs following a multidomestic strategy may opt to establish objectives
and schedules that give interdependent units greater discretion in developing coordination systems.
This process is often complicated by the difficulties imposed by distance and cultural differences.
Greater expense, time, and possibility of error are inherent in planning across national boundaries.
c. Coordination by Mutual Adjustment. Coordination by mutual adjustment requires managers
to interact with counterparts to enable flexible coordination mechanisms, largely informally. MNEs
that opt to encourage mutual adjustment also adopt a formal structure and install standardization and
planning systems, but they see great value in engaging an adaptable approach to coordination that
involves creating more opportunity and incentive for parties to work with one another. Mutual
adjustment can be a very effective coordination tool when an MNE faces new problems that cannot
be defined with customary rules or procedures. The frequent discussion and feedback needed to
make mutual adjustment work, however, can be costly in terms of both time and money.
B. Control Systems
Every MNE must regulate what its employees can and cannot do in order to avoid spinning out of control.
Control systems must ensure that people are doing what they are supposed to do and not doing what they
are not supposed to do.
1. Control Methods. There are three prevalent methods of control:
 Market control, which uses external market mechanisms to establish objective standards.
 Bureaucratic control, which emphasizes organizational authority and relies on rules and
regulations.
 Clan control that uses shared values and ideals to moderate employee behavior.
2. Control Mechanisms. MNEs use a range of control mechanisms to direct the activities of
individuals toward the achievement of organizational goals.
a. Reports. Decisions on how to allocate capital, personnel, and technology continue without
interruption, so reports must be timely, accurate and informative. Written reports are crucial for
international operations because subsidiary managers so often lack substantive personal contact with
corporate staff. To permit comparisons across operations, most MNEs use reports for foreign
subsidiaries that resemble those they use domestically. The primary emphasis of an operations report
is to evaluate a subsidiary’s performance.
b. Visits to Subsidiaries. Within many MNEs certain members of the corporate staff spend
considerable time visiting foreign subsidiaries in order to collect information and offer advice and
directives.
c. Management Performance Evaluations. MNEs should evaluate a subsidiary manager
separately from the subsidiary’s performance so as not to penalize or reward managers for conditions
beyond their control. That said, precisely what is within their control is frequently a matter for
disagreement.
d. Cost and Accounting Comparisons. Headquarters needs to use considerable discretion in
interpreting the data it uses to evaluate and change subsidiary performance, especially if it is
comparing a subsidiary’s performance with competitors from other countries whose currencies and
accounting methods are different from its own.
e. Evaluative Measurements. A system that relies on a combination of measurements is more
reliable than one that does not. The most important criteria tend to be budget-compared-with-profit
and budget-compared-with-sales-value. Other non-financial criteria such as market share, quality
control, and host government relations are also important.
 f. Information Systems. With ever-expanding computer and global telecommunications links,
managers can share information more quickly and easily than ever before. In fact, information
technology can facilitate both the centralization and the decentralization of operations. The primary
problems associated with information systems concern the cost of information relative to its value, its
redundancy, and its irrelevance.
ORGANIZATION CULTURE
Organization culture is a system of shared values about what is important and beliefs about how the
world works.
A. The Importance of Culture
There is a significant link between organization culture and the financial performance of a firm, and
organization culture can be the most critical component of a company’s transition from “good” to “great”
status.
1. Culture and Values. Key features of organizational culture include values and principles of
management, work climate and atmosphere, patterns of “how we do things around here”, traditions,
and ethical standards. The shared values that make up organization culture influence what employees
perceive, how they interpret, and what they do to respond to their world. When confronted with
opportunities or threats, organizational culture acts as a primary influence on how employees act and
react.
2. Culture and the Value Chain. Organization culture often shapes the strategic moves a company will
consider and reject and can dramatically influence the success of corporate initiatives. Culture is
increasingly important as team-based approaches to management and reliance on individual-level
behaviors such as learning and collaboration become more commonplace.
B. Challenges and Pitfalls
Companies increasingly develop and manage their cultures, rather than allowing them to emerge
naturally. This becomes increasingly difficult in an international context, where managers from different
countries often have different values than those endorsed by the company. Convergent values ease the
exchange of ideas between people from different countries, while different values tend to create
boundaries and barriers. To overcome these challenges, many MNEs promote closer contact among
managers from different countries by rotating mangers among operations in different countries.
C. Organization Culture and Strategy
The type of strategy a company is pursuing both influences and is limited by the principles and practices
of its organization culture .Companies pursuing a global strategy often aim to develop a forceful culture
that reinforces standardized goals, priorities, and practices. Multidomestic strategies require sensitivity to
local outlooks and norms and do not lend themselves well to a strong company-wide culture. Despite
specific differences, organization culture shares similar attributes across the different types of strategies.
Employees typically perceive culture on the basis of what they see, hear, or experience within the
company. Even though individuals have different backgrounds, work at different levels, etc., they tend to
describe company culture in similar terms.
 CHAPTER SIXTEEN: MARKETING GLOBALLY

INTRODUCTION
Although basic marketing principles may be the same in both domestic and foreign markets, environmental
differences often require those principles be applied in different ways.

MARKETING STRATEGIES
Overall international marketing strategies should depend on the company’s marketing orientation and target
market.
Marketing Orientations
The international applications of five common product policies are highlighted below.
Production Orientation: A production orientation indicates a firm is more concerned about production variables
such as efficiency, quality and/or capacity than it is about marketing. Firms assume customers want lower prices
and/or higher quality. Such an approach is still used internationally for selling commodities, for passive exports and
for serving foreign-market segments that resemble domestic markets.
Sales Orientation: A sales orientation indicates a firm assumes global customers are reasonably similar and it can
therefore sell abroad the same product it sells at home. A firm will be aided in this approach when there is also a
spillover of product information from one country to another.
Customer Orientation: A customer orientation indicates a firm is sensitive to customer needs, i.e., it thinks in
terms of identifying and serving the needs of the customer. Given a particular country market, what products are
needed?
Strategic Marketing Orientation: A strategic marketing orientation indicates a firm is committed to continuously
serving foreign target markets and to making incremental product adaptations to satisfy local customers. It draws
upon elements of the production, sales and customer orientations, as appropriate.
Societal Marketing Orientation: The societal marketing orientation indicates a firm recognizes it must conduct its
activities in a way that preserves or enhances the well-being of all its stakeholders, i.e., as it serves the needs of its
customers it must also address the environmental, health, social, and work-related problems that may arise when
producing or marketing its products abroad.

SEGMENTING AND TARGETING MARKETS

Market size is not only a function of population in a given country, but is more specifically related to how many
people are likely to consume a particular product. The most common way of identifying market segments
within a country is through demographic factors such as income, age, gender, ethnicity, and religion.
Three Approaches to Segmentation. When targeting and segmenting markets, companies have three basic
alternatives including segmenting by country, by global segment, or by multiple criteria.
By Country. A company may choose to segment its market by selecting a single country to enter. There is little
opportunity of gaining economies through standardization with this approach.
By Global Segment. A company may identify some segments globally, such as segments based primarily on
income. Thus each country may have some people within the same segment.
By Multiple Criteria. A company can combine these approaches by looking first at countries as segments, second
by identifying segments within each country, and third by comparing these within-country segments with those of
other countries.
Mass Markets versus Niche Markets. Companies must decide when introducing their products abroad to enter in
with a mass market or niche market strategy because the percentage of people that fall into any segment may vary
substantially among countries, a niche market in one country may be a mass market in another.

PRODUCT POLICIES
Although adopting marketing orientations that involve product adaptations for foreign markets is often costly, many
companies continue to make product alterations for foreign markets for a variety of compelling reasons.
Why Firms Alter Products
The primary reasons behind the tendency of firms to alter their products to meet local conditions are legal,
cultural, and/or economic in nature.
Legal Considerations. Explicit product-related legal requirements vary widely by country but are usually meant to
protect customers, the environment, or both.
Packaging Requirements. One of the more cumbersome product alterations for companies is adjusting to different
laws on packaging and warning labels.
Environmental-Protection Regulations. Some countries prohibit certain types of containers, others restrict the
volume of packaging materials, and there are sometimes mandates on container reusability.
Issues of Standardization. A recurring issue is the need to arrive at international product standards and eliminate
some of the wasteful product requirements for alterations among countries.
Indirect Legal Considerations. Marketing managers must also watch for indirect legal requirements such as higher
taxes on heavy automobiles that may shift demand to lighter ones.
Cultural Considerations. Cultural factors affecting product demand may or may not be easily discerned. While
religious beliefs may offer clear guidelines regarding product acceptability, other factors such as color, design,
and artistic preferences may be much more subtle.
Economic Considerations. Levels of income, differences in income distribution, and the extent and condition of
available infrastructure can all affect demand for a particular product. Often, price-reducing alterations are required
if a firm wishes to participate in a particular country market.
Alteration Costs
Usually firms will choose to standardize basic components while altering critical end-use characteristics. Certain
alterations (such as packaging and color options) may be inexpensive to make, yet they can have an important effect
on demand.
The Product Line: Extent and Mix
Although most companies produce multiple products, it is doubtful that all of these products could generate
sufficient sales in a given foreign market to justify the cost of penetrating that market.
Sales and Cost Considerations. When making product line decisions, managers must consider the cost and effect
on sales of offering just one or a few products internationally as opposed to an entire family of products. Whereas
narrowing a product line allows for the concentration of effort and resources, the broadening of a product line may
lead to distribution economies.
Product Life Cycle Considerations. Differences will likely exist across countries in both the shape and the length
of a product’s life cycle. A product facing declining sales in one country may have growing or sustained sales in
another. Such country differences can lead to an extended life for a given product.

PRICING STRATEGIES
Price represents the value asked for a product. In the long run, price must be low enough to generate sufficient
demand but high enough to yield a profit to the firm.
Potential Obstacles in International Pricing
The complexities of pricing are exacerbated in the international arena.
Government Intervention. Every country has laws that either directly or indirectly affect prices at the consumer
level. Price controls may set either maximum or minimum prices for designated products. The WTO permits a
government to establish restrictions against any imports that enter the country at a price below the price charged to
customers in the exporting country (dumping). However, a firm may charge different prices in different countries
because of competitive and demand factors (e.g., a firm may choose to exclude fixed costs in the price calculation of
products exported to developing countries in order to be price competitive in those markets.)
Market Diversity. Country variations lead to many ways of segmenting the market for a particular product.
Consumers in some countries simply like certain products more and are willing to pay more for them.
Pricing Tactics. Depending upon market conditions, a firm may adopt any of the following pricing strategies. A
skimming strategy sets a high price for a new product, which is aimed at market innovators. Over time, the price
will be progressively lowered in response to demand and supply conditions, i.e., the presence of additional
competitors. A penetration strategy sets an aggressively low price to attract a maximum number of customers
(some of whom may switch from other brands) and to discourage competition. A simple cost-plus strategy sets the
price at a desired margin over cost. Cash versus credit buying also affects demand.
Export Price Escalation. If standard markups occur within distribution channels, either lengthening the channels or
adding other expenses somewhere within the network will further increase the delivered price of the product.
Common reasons for price escalation in export sales are tariffs and the often greater distance to the market. To
compete in export markets, a firm may have to sell its products to intermediaries at a reduced price in order to lessen
the amount of price escalation
Fluctuations in Currency Value. Pricing in the case of highly volatile currencies can be extremely difficult,
especially under conditions of high inflation. Pricing decisions must assure the company of sufficient funds to
replenish inventory. This may result in the need for frequent price adjustments. Further, currency fluctuations also
affect pricing decisions for any product that faces foreign competition; when a currency is strong, producers may
have to accept a lower profit margin if they wish to be price competitive.
The Gray Market. The longer-term viability of a distribution system can be undermined in some cases by activities
in the gray market, the selling and handling of goods through unofficial distributors.
Fixed versus Variable Pricing. MNEs often negotiate export prices, while small companies frequently give price
concessions too quickly. This limits small companies’ ability to negotiate on a range of marketing factors that affect
their costs such as: Discounts for quantity or repeat orders, Deadlines that increase production or, transportation
costs, Credit and payment terms, Service, Supply of promotional materials, Training of sales personnel or customers
The extent to which manufacturers can or must set prices at the retail level varies substantially by country. There is
also substantial variation in whether, where, and for what products customers prefer or expect to negotiate an
agreed-upon price. Local laws and customs may limit firms’ abilities to set prices as they choose. In many cultures,
prices are simply the starting point in the bargaining process.
Supplier Relations. Dominant retailers with substantial clout may get suppliers to offer them lower prices, which in
turn will enable them to compete as the lowest-cost retailer. However, such clout may not exist in new foreign
markets. In addition, many industrial buyers are claiming large price reductions through Internet purchases.

PROMOTION STRATEGIES
Promotion consists of the messages intended to help sell a product or service. The types and direction of messages
and the method of presentation may be extremely diverse, depending on the company, product, and country of
operation.
The Push-Pull Mix: Promotion strategies may be categorized as push (which uses direct selling techniques) or
pull (which relies on mass media). Most firms use a combination of both.
Factors in Push-Pull Decisions. Factors that will determine the mix of push and pull strategies include the type
of distribution system, the cost and availability of media, customer attitudes toward sources of information, and
the relative price of the product as compared to disposable income. Push is more likely when self service is not
predominant, advertising is restricted, and product price is a high portion of income.
Some Problems in International Promotion
Because of diverse national environments, promotional problems are varied. In many countries regulations pose an
even greater barrier. In emerging economies, MNEs usually have to use more push strategies for mass consumer
products.
Standardization: Pro and Con. Advertising represents any paid form of media (nonpersonal) presentation.
Although savings from the standardization of advertising are not as great as those from product standardization, they
can nonetheless be substantial. However, in addition to reducing costs, standardized advertising may also improve
the quality of advertising at the local level, prevent the confusion associated with different national messages and
images and speed the entry of products into new country markets. Standardization usually implies using the same
agency globally. However, it is difficult to completely standardize an advertising campaign for a number of reasons.
A Few Related Issues. The issue of standardization in advertising raises problems in a few other areas—namely,
translation, legality, and message needs. Translation: When a media transmission spans multiple countries, there is
no opportunity to translate a message into other local languages. When messages are translated, numerous
difficulties can be encountered with both language (content and meaning) and images. Legality: What is deemed to
be legal advertising in one country may in fact be illegal elsewhere. Differences result mainly from varying national
views on consumer protection, competitive protection, standards of morality, and nationalism. Message Needs: An
advertising theme may not be appropriate everywhere because of national differences in how well consumers know a
product, how they perceive it, who makes the purchasing decision, and what features are most important.

BRANDING STRATEGIES
A brand is a name, term, sign, symbol and/or design that is intended to identify a product or product line and
differentiate it in the marketplace. A trademark is a brand, or a part of a brand, that is granted legal protection
because it is capable of exclusive appropriation. It protects the seller’s exclusive rights to use the brand name
and/or brand mark.
Worldwide Brand versus Local Brands
In addition to the same branding decisions that every producer has to make, international marketers must make a
decision about whether to adopt a worldwide brand or to brand products for a variety of local markets.
Some Problems with Uniform Brands. A number of problems are inherent in trying to use uniform brands
internationally.
Language. Both the translation and pronunciation of brand names pose potential problems in many markets. Often
the problems are obvious, but other times they are quite subtle, yet critical. In addition, brand symbols (shapes and
colors) are culturally sensitive in many societies.
Brand Acquisition. When an MNE acquires a (foreign) firm, it automatically acquires its brands. In some instances
those brands will be maintained; in others they will be folded into a larger brand in order to capture economies of
scale and to promote regional/global brand recognition.
Country-of-Origin Image. Firms must determine whether to promote a local or foreign image for their products.
The products of some countries may be perceived as being particularly desirable and of higher quality than products
from other countries. A firm may be able to enhance its competitive advantage by effectively exploiting this
perception.
Generic and Near-Generic Names. While firms want their brand names to become household words, they do not
want those names to become so common they are considered to be generic (e.g., Kleenex and Xerox). Generic
names may either stimulate or frustrate the sales of the firm from whom the name was expropriated.

DISTRIBUTION STRATEGIES
Distribution refers to the physical and legal path that products follow from the point of production to the point of
consumption. In many instances, geographic barriers and poor transportation infrastructure and facilities will divide
a country into very distinct viable and non-viable markets.
Deciding Whether to Standardize
Distribution is often the marketing mix variable that firms find the most difficult to standardize. This is because each
country has its own national distribution system that is historically intertwined with its cultural, economic, and legal
environments. Other factors that influence the ways in which consumer products are distributed within a given
country include people’s attitudes toward entrepreneurship, the ability to pay retail workers, restrictions on the size
of stores and their hours of operation, the financial ability to carry large inventories, the efficacy of the national
postal system.
Choosing Distributors and Channels
Just as in the case of production, a firm may choose to handle the distribution function internally or outsource it to a
specialized provider.
Is Internal Handling Feasible? When sales volume is low, it is usually more cost effective for a firm to contract
with an external distributor. On the other hand, distribution may be handled internally when sales volume is high,
when the firm has sufficient human, capital and financial resources, when after-sales service is extensive and
complex, when customers are global and when a firm can otherwise enhance its competitive advantage.
Which Distributors Are Qualified? Common criteria for evaluating and selecting distributors include financial
strength, good relationships with their customers, the extent of their other business commitments regarding both
complementary and competitive products, the state of a distributor’s equipment, facilities and personnel,
trustworthiness, and compatibility with product image. A final consideration is how quickly start-up can occur.
How Reliable Is After-Sales Service? The more complex and expensive a product, the more important that
after-sales service will be. When after-sales service is critical, firms may need to invest in service centers, which
can in turn become important sources of revenues and profits.

The Challenge of Getting Distribution

Distributors choose the products and firms they wish to represent and emphasize. A new entrant must therefore
convince a desired distributor of the viability of both its products and the company itself. To do so it may need
to provide extra incentives or be willing to enter into exclusive arrangements provided a competitor does not
already occupy that position.
Hidden Costs in Distribution
Because of the differences in national distribution systems, the cost of getting products to customers varies widely
from one country to another. Five factors that often contribute to cost differences in distribution are infrastructure
conditions, the number of levels in the distribution system, retail inefficiencies, size and operating-hour restrictions,
and inventory stock-outs. In many countries, ports, roads, and warehouse facilities are so poor that getting goods to
customers in a timely fashion and at a reasonable cost, with minimal damage or loss en route, is truly difficult.
Many countries have multi-tiered, wholesale systems through which a product must move before reaching the retail
level. Because each intermediary adds a markup, final delivered prices increase. In some countries, low labor costs
and a basic distrust by owners of all but family members combine to result in retail practices that raise consumer
prices, especially when there is an insistence upon counter (as opposed to self) service. Many countries have laws
that protect small retailers, which in turn effectively limit the number of large retail firms and the efficiencies they
bring to their operations. Many countries also limit operating hours. When retailers have little space for storing
inventory, distributors must incur the cost of making more frequent but smaller deliveries to prevent retail-level
stock-outs.
E-Commerce and the Internet
As electronic commerce increases, customers worldwide can quickly compare prices from different distributors, thus
intensifying price competition.
Opportunities. Electronic commerce offers companies an opportunity to promote their products globally, however,
it does not relieve them of the need to develop marketing tools. Companies may need to adapt to country
differences, such as providing access through different languages.
Problems. Global Internet sales are not without problems. Many households, especially in developing countries,
lack access to Internet connections. A firm cannot easily differentiate its marketing program because the same Web
advertisements and prices reach customers everywhere. At the same time, however, a firm’s Internet ads and prices
must comply with the laws of each country where it markets its product.

MANAGING THE MARKETING MIX

Although every element in the marketing mix is important, the relative importance of one versus another may
vary from place to place and over time. Thus management must monitor and adjust its marketing programs
accordingly.
Gap Analysis
Once a company is operating in a country and estimates that country’s market potential, it must calculate how well it
is doing there. One tool that can be used to accomplish this is gap analysis—a method for estimating potential sales
by identifying market segments a company is not serving adequately
Three Types of Gaps.
Usage Gaps. Gaps may exist in a country's usage of the product. Marketing campaigns may be developed to attempt
to persuade consumers in those countries to use more of the product.
Product Line and Distribution Gaps. Gaps that develop due to the lack of a wide line of products sold by the
company.
Competitive Gaps. Gaps in sales due to the actions of competitors such as lower prices and/or higher quality.
 CHAPTER SEVENTEEN
GLOBAL MANUFACTURING AND SUPPLY CHAIN MANAGEMENT

INTRODUCTION
Global manufacturing and supply chain management are important in companies' international business
strategies.

WHAT IS SUPPLY CHAIN MANAGEMENT?

The supply chain function encompasses the sourcing and coordination of materials, information and funds
from the initial raw material supplier to the final customer. It concerns the management of the value-added
process from the supplier’s supplier to the customer’s customer. Suppliers can be part of the manufacturer’s
organizational structure, as in the case of a vertically integrated organization, or they can be independent
organizations. An important part of the supply chain function is logistics (aka materials management), which
encompasses the planning, implementation and control of the efficient and effective flow and storage of
products and information from the point of origin to the final customer. Because the supply chain is quite broad,
the coordination of the network actually occurs through interactions within the network. The greater the
geographic spread of the firm, the more difficult it becomes to manage the supply chain effectively.

GLOBAL MANUFACTURING STRATEGIES

Four Key Factors in Manufacturing Strategy
The success of a global manufacturing strategy depends on four key factors: (i) compatibility, (ii) configuration,
(iii) coordination, and (iv) control.
Compatibility: Compatibility refers to the degree of consistency between a firm’s foreign direct investment
decisions and its competitive strategy.
Efficiency/Cost Strategies. Reduction in the costs of manufacturing, Offshore Manufacturing, Total Cost
Analysis.
Dependability Strategies. The degree of trust in a company's products, its delivery, and price promises.
Innovation and Quality Strategies. The ability of the production process to make different kinds of products
and to adjust the volume of output.
Flexibility Strategies. The ability of the production process to make different kinds of products and to adjust
the volume of output.
Changes in Strategy. As a company's competitive strategies change, so too do its manufacturing strategies. In
addition, MNEs may adopt different strategies for different product lines, depending on the competitive
priorities of those products.
Manufacturing Configuration. MNEs consider three basic configurations en route to developing their global
manufacturing strategies. They are:
Centralized Manufacturing Strategy. Centralized manufacturing in a single country (basically a manufacture
and export strategy).)
Regional Manufacturing Strategy. Regionalized manufacturing in the specific regions served (a regionalized
marketing and manufacturing approach)
Multidomestic Manufacturing Strategy. Local manufacturing in each country market served (multidomestic
marketing and manufacturing approach) using country-specific manufacturing facilities to meet local demand..
Coordination and Control. Coordination represents the linking or integrating of participants all along the
global supply chain into a unified system. Control embraces systems, such as organizational structure and
performance measurement, which are designed to help ensure strategies are implemented, monitored, and
revised, when appropriate.

INFORMATION TECHNOLOGY AND GLOBAL SUPPLY CHAIN MANAGEMENT

Global supply chain management concerns the sourcing and coordination of materials, information and funds
from the initial raw material supplier to the final customer. A comprehensive supply chain strategy should
include the following 10 elements: customer-service requirements, plant and distribution-center network design,
inventory management, outsourcing and third-party logistics relationships, key customer and supplier
relationships, business processes, information systems, organizational design and training requirements,
performance metrics, performance goals, The key to making a global information system work effectively is a
good information system.
Information Technology
With competitive demands to produce high-quality products quickly and efficiently, manage inventory levels
proficiently, communicate effectively with suppliers, and meet customer demand adequately, companies are
coming to rely more and more on information technology (IT) to manage their needs.
Electronic Data Interchange (EDI). Electronic data interchange: (EDI) refers to the electronic movement of
money and information via computers and telecommunications equipment in a way that effectively links
suppliers, customers and third-party intermediaries, and ultimately enhances customer value.
Enterprise Resource Planning/Materials Resource Planning. Enterprise resource planning (ERP) refers to
the use of software to link information flows from different parts of a business and from different parts of the
world. An extension of ERP is material requirements planning (MRP), a computerized information system that
addresses complex inventory situations and calculates the demand for parts from the production schedules of
the companies that use the parts.
Radio Frequency ID (RFID). Radio frequency ID (RFID) is a system that labels products with an electronic
tag that stores and transmits information regarding the product’s origin, destination, and quantity.
E-Commerce. E-commerce refers to the use of the Internet to link suppliers with firms and firms with
customers.
Extranets and Intranets. An intranet can be used to help automate and speed up internal processes in a
company. The term extranet refers to using the Internet to link a company with external constituencies. Private
Technology Exchange (PTX) refers to an online collaboration model that brings manufacturers, distributors,
resellers and customers together to execute trade transactions and to share information regarding demand,
production, availability, etc.
“The Digital Divide.” While many networks can in fact be managed via the Internet, others (especially those in
developing countries) cannot because of the lack of available, leading-edge technology.

QUALITY
Quality refers to meeting or exceeding the expectations of the customer. More specifically, it incorporates
conformance to specifications, value enhancement, fitness for use, after-sales support, and psychological
impressions (image).
For Eg: Car Quality. Quality can have a big impact on the success of a company in this industry. American
companies have traditionally lagged the Japanese in quality rankings; however, recent rankings show
improvements for American and European companies.
Zero Defects versus Acceptable Quality Level
Acceptable quality level (AQL) is a premise that allows for a tolerable (negotiable) level of defects that can be
corrected through repair and service warranties. Zero defects describe the refusal to tolerate defects of any
kind.
The Deming Approach to Total Quality Management
W. Edwards Deming, a key individual in the Japanese approach to quality stressed his 14 points, espousing the
idea that responsibility for quality resides within the polices and practices of managers.
Deming’s 14 Points. To emphasize the point that quality responsibility resides within the policies and practices
of managers, Deming created his "14 Points."
Total Quality Management (TQM): Total quality management (TQM) stresses three principles: (i)
customer satisfaction, (ii) employee involvement and (iii) continuous improvements at every level of the
organization. The goal of TQM is to eliminate all defects. It focuses on benchmarking world-class standards,
product and service design, process design and purchasing practices. Kaizen represents the Japanese process of
continuous improvement, which requires identifying problems and enlisting employees at all levels of the
organization to help eliminate the problems.
Six Sigma: Six Sigma is a highly focused quality-control system designed to scrutinize a firm’s entire
production system and eliminate defects, slash product cycle time, and cut costs across the board.
Quality Standards: The three different levels (types) of quality standards are: (i) a general level, (ii) an
industry specific level and (iii) a company level.
General-Level Standards. The International Organization for Standardization (ISO) was created to
facilitate the international coordination and unification of industrial standards. It partners with the IEC
(International Electrotechnical Commission), the International Telecommunications Union, and the World
Trade Organization, and represents a network of standard setters in 158 countries around the world.
ISO 9000 and ISO 14000. ISO 9000:2000 is a set of universal standards initially designed to harmonize
technical standards within the EU that is now accepted worldwide; it is applied uniformly to companies in any
industry and of any size in order to promote quality at every level of an organization. Rather than judging the
quality of a product, ISO 9000:2000 evaluates the management of the manufacturing process according to
standards in 20 domains, from purchasing to design to training. ISO 14000 is concerned with environmental
management and what the company does to improve its environmental performance.
Industry-Specific Standards. Industry-specific standards represent the quality-related requirements expected
of suppliers.
Company-Specific Standards. Individual companies also set their own standards for suppliers to meet if they
are going to continue to supply them.

SUPPLIER NETWORKS
Sourcing is the path a firm pursues in obtaining materials, components and final products either from within or
outside of the organization and from both domestic and foreign locations. Global sourcing represents the first
step in the process of global materials management (logistics)
Global Sourcing.
Sourcing in the home country avoids numerous problems such as lengthy supply chains and foreign currency
risk, however, for many companies, domestic sources may be unavailable or too expensive.
Why Global Sourcing? Firms pursue global sourcing strategies in order to reduce costs, improve quality,
increase their exposure to worldwide technology, improve the delivery-of-supplies process, strengthen the
reliability of supply, gain access to strategic materials, establish a presence in a foreign market, satisfy offset
requirements and/or react to competitors’ offshore sourcing practices.
Concerns That Come with Global Sourcing. Quality , safety, and other concerns come with global sourcing.
The countries that churn out the cheapest products often lack adequate regulations, enforcement, and logistical
infrastructure, leaving it up to the purchasing companies to ensure quality and safety
Major Sourcing Configurations
Vertical Integration. The company owns the entire supplier network, or at least a significant part of it.
Industrial Clusters. Buyers and suppliers locate in close proximity to facilitate doing business.
Japanese Keiretsus. Groups of independent companies that work together to manage the flow of goods and
services along the entire value chain.
The Make or Buy Decision: In determining whether to make or buy, MNEs should focus on making those
parts and performing those processes critical to a product and in which they have a distinctive advantage. Other
things can potentially be outsourced.
Supplier Relations: When an MNE decides to outsource rather than integrate vertically, it must determine the
nature and extent of its involvement with suppliers.
The Purchasing Function: Global progression in the purchasing function includes four phases: 1. Domestic
purchasing only, 2. Foreign buying based on need, 3. Foreign buying as a part of procurement strategy and 4.
Integration of global procurement strategy. The last phase is reached when a firm realizes the benefits from the
integration and coordination of purchasing on a global basis. At this point, the MNE may once again be faced
with the centralization vs. decentralization dilemma.
Major Sourcing Strategies. Global sourcing options include: assigning domestic buyers for international
purchasing, using foreign subsidiaries or business agents, establishing international purchasing offices,
assigning the responsibility for global sourcing to a specific business unit or units, integrating and coordinating
worldwide sourcing.

INVENTORY MANAGEMENT
Whether a firm decides to source from inside or outside the company or from domestic or foreign suppliers, it
needs to manage the flow and storage of inventory. However, the distance, time, and uncertainty associated with
foreign environments will surely complicate the inventory management process.
Lean Manufacturing and Just-in-Time Systems
Lean manufacturing is a productive system that focuses on optimizing processes and reducing waste. One
method of reducing costs in lowering inventory levels. A just-in-time (JIT) manufacturing system reduces
inventory costs by having raw materials and components delivered just as they are needed in the production
process. JIT typically implies sole sourcing for specific parts in order to get the supplier to commit to the
stringent delivery and quality requirements inherent in the system. A company’s inventory management strategy
determines the desired frequency and size of shipments and whether JIT will be used.
Risks in Foreign Sourcing. Foreign sourcing can create big risks for companies that use lean manufacturing
and JIT because interruptions in the supply chain can cause major production problems. Because of distances
alone, the supply chain is open to more problems.
The Kanban System. The word "kanban" in Japanese means card or visible record. It is used in Toyota's
production system to control the flow of production through the factory.
Foreign Trade Zones: Foreign trade zones (FTZs) are government-designated areas in which goods can be
stored, inspected and/or manufactured without being subject to formal customs procedures until they actually
leave the zones. FTZs often serve as a site to store inputs until they are needed at a particular production site.
General-Purpose Zones and Subzones. A general-purpose zone is usually established near a port of entry,
such as a seaport, an airport, or a border crossing. A subzone is under the same administrative domain but is
usually physically separate from a general-purpose zone. Exports for which FTZs are used fall into one of the
following categories: Foreign goods transshipped through U.S. zones to third countries, Foreign goods
processed in U.S. zones and then transshipped abroad, Foreign goods processed or assembled in U.S. zones
with some domestic materials and parts, then re-exported, Goods produced wholly of foreign content in U.S.
zones and then exported, Domestic goods moved into a U.S. zone to achieve export status prior to their actual
exportation
Transportation Networks
The international transportation of goods is extremely complicated with respect to documentation, choice of
carrier (air, land, ocean) and the decision to outsource the function to a third-party intermediary or to establish
internal transportation capabilities. The key is to link manufacturers and suppliers on one end and manufacturers
and final customers on the other.
 CHAPTER EIGHTEEN
INTERNATIONAL ACCOUNTING ISSUES

I. INTRODUCTION
International business managers cannot make informed decisions without relevant
and reliable accounting and taxation information. While the financial manager of any
firm is responsible for procuring and managing the company’s financial resources,
today’s corporate controller (accountant) is responsible for providing information to
the firm’s financial decision makers, and to a wide variety of other stakeholders as
well.
A. The Crossroads of Accounting and Finance
The accounting and finance functions are closely related. The MNE must learn
to cope with differing inflation rates, exchange-rate changes and controls,
expropriation risks, different tax systems, and other complications of doing
businesses in multiple jurisdictions.
1. What Does the Controller Control? Accounting is defined as a
service activity whose function is to provide quantitative information,
primarily financial in nature, which will be useful in making strategic
decisions and reasoned choices among alternative courses of action. A
company's controller collects and analyzes data for internal and external
users. The role of the controller has expanded beyond the traditional roles of
management accounting and now involves strategic issues.

II. ACCOUNTING FOR INTERNATIONAL DIFFERENCES

Accounting origins and traditions are as individual as the languages of the nations
that produce them. As a result, financial statements in different countries appear
different from each other both in form (format) and in content (substance). For
example, the balance sheet for U.S. companies is in the format of Assets = Liabilities
+ Shareholder's Equity. This format is known as the balance format. The balance
sheet for many European companies are prepared in a different format known as the
analytical format which is Fixed Assets + Current Assets - Current liabilities -
Noncurrent Liabilities = Capital and reserves. While some people argue differences
in format are a minor problem, the fact that companies can value assets and
determine income differently in different countries is not. Countries doing business
in multiple countries must often produce financial statement using the standards of
the countries in which they operate.
A. Accounting Objectives
It is crucial that the accounting process identify, record, and interpret economic
events. The private sector body that establishes financial accounting standards in
the United States is the Financial Accounting Standards Board (FASB). The
FASB states that the external reporting of accounting information should help
investors (i) make investment and credit decisions, (ii) assess cash flow
prospects and (iii) evaluate enterprise resources, claims to these resources, and
changes in them.
 1. Who Uses Accounting Information? The international private-sector
organization that sets financial accounting standards for worldwide use is
the International Accounting Standards Board (IASB). The IASB and its
predecessor, the International Accounting Standards Committee
(IASC), identified the following key users of accounting information:
investors, employees, lenders, suppliers and other trade creditors,
customers, governments and their agencies, and the public.
B. Factors in International Accounting Practices
While equity markets are an important influence on accounting standards in the
United States and the United Kingdom, banks are influential in Switzerland and
Germany, and taxation is a major influence in France and Japan. The
international public accounting firms are also important sources of influence
because they transfer high levels of auditing practices worldwide.
1. The Emergence of Convergence. Differences in accounting practices
around the world have resulted in a move toward convergence—the
process of bringing different nationally generally accepted accounting
principles into line with IFRS issued by the IASB.
C. Cultural Differences in Accounting
Culture influences both measurement practices (how firms value assets) and
disclosure practices (how and what information firms provide and discuss).
1. The Secrecy-Transparency/Optimism-Conservatism Matrix. From
an accounting standpoint, secrecy and transparency refer to the degree to
which corporations disclose information to the public. Optimism and
conservatism refer to the degree of caution that companies exhibit in
valuing assets and recognizing income. Anglo-Saxon countries such as the
United Kingdom and the United States have accounting systems that tend to
be transparent and optimistic, while countries such as Germany,
Switzerland, and Japan, among others, tend to be secretive and
conservative.
a. Generally Accepted Accounting Principles. Foreign companies
operating in the United States usually issue financial statements
according to U.S. generally accepted accounting principles (GAAP).
Increasingly firms operating in the EU are adopting International
Financial Reporting Standards issued by the IASB. Optimism and
conservation are two variable that cause differences in accounting
principles globally.
D. Classifying Accounting Systems
Although accounting standards and practices vary worldwide, systems can
nonetheless be classified according to common characteristics.
1. From Macro-Uniform to Micro-Based Systems. While macro-
uniform accounting systems are shaped more by government influences
(strong, codified, tax-based legal systems), micro-based accounting systems
rely on pragmatic business practices.
2. Strong versus Weak Equity Markets. Countries can be distinguished
between those with strong and weak equity markets and shareholder
orientations.
 3. Differences in Financial Statements. Because MNEs must adjust to
different accounting systems on a worldwide basis, the international
accounting function becomes increasingly complex and costly. Financial
statements differ from one country to another in four major ways: (i)
language, (ii) currency, (iii) the type of statement (including format and
extent of footnote disclosure), and (iv) the underlying GAAPs on which
financial statements are based.
a. Differences in Language. English tends to be the first choice of
companies choosing to raise capital abroad. many companies provide
their financial statements in different languages.
b. Differences in Currency. Companies around the world prepare their
financial statements in different currencies.
c. Differences in Types of Statements. Financial statement format can
be confusing for a reader when accustomed to a different format. The use
of accounting footnotes also differs greatly globally.
d. Differences in GAAP Usage. A major hurdle in raising capital in
different countries is dealing with widely varying accounting and
disclosure requirements.
• The Principle of Mutual Recognition. Major approaches to
dealing with accounting and reporting differences include mutual
recognition (a foreign registrant need only provide information
prepared according to the GAAPs of the home country),
reconciliation to the local GAAPs (a foreign registrant reconciles
its home-country financial statement with the local GAAPs), and
recasting financial statements in terms of local GAAPs. A Form
20-F is the document used to recast financial statements in the
United States.
E. International Standards and Global Convergence
Forces encouraging the harmonization of national accounting standards include:
investor orientation, the global integration of capital markets, the need for
MNEs to raise foreign capital, regional political and economic harmonization,
MNEs’ desire to reduce their accounting and reporting costs, and convergence
efforts of standard-setting bodies.

1. The New IASC. The International Accounting Standards Committee

(IASC) has worked toward harmonizing accounting standards by issuing a
set of International Accounting Standards (IAS). The key turning point in
the significance of the IAS standards came in 1995 when the International
Organization of Securities Commissions (IOSCO) announced it would
endorse IASC core standards if a set were developed that both organizations
could agree upon. Another major factor affecting the harmonization of
accounting standards worldwide was the reorganization of the IASC in
2000. Trustees for the IASC foundation searched for and appointed
members of the IASB, representing all areas of the world, in 2001. Trustees
for the IASC foundation search for and appoint members of the IASB. The
trustees come from countries all over the world.
 a. International Financial Reporting Standards (IFRS). When the
IASB was organized, all of the old International Accounting Standards
were adopted, and the board began to issue new standards called
International Financial Reporting Standards (IFRS).
• The EU and the IASC. The IASB has expanded its influence
and effectiveness due to the decision of the EU, Australia, and
New Zealand to require all of their publicly listed companies to
adopt IFRS
• The Quest for Convergent Standards. The FASB and IASB also
decided to adopt a process of convergence of accounting standards.
• The European Response to Convergence. The convergence
process has been very unsettling for some Europeans. Differences
in opinions exist on how IFRS should be applied and how the rules
should be enforced.
• Convergence and Mutual Recognition. The SEC may soon
allow U.S. - listed firms to report financial results using IFRS.

III. TRANSACTIONS IN FOREIGN CURRENCIES

In addition to minimizing or eliminating foreign-exchange risk, firms must concern
themselves with the proper recording and subsequent accounting of transactions
resulting from the purchase or sale of products and the borrowing or lending of
foreign currency.
A. Recording Transactions
When accounting for assets, liabilities, revenues and expenses, foreign-currency
receivables and payables result in gains and losses whenever the relevant
exchange rate changes. Such transaction gains and losses must be included on
the income statement in the accounting period in which they arise.
B. Correct Procedures for U.S. Companies
The Financial Accounting Standards Board Statement (FASB) No. 52 requires
U.S. firms to report foreign-currency transactions at the original spot exchange
rate in effect on the initial transaction date and to report receivables and
payables at the subsequent balance sheet date at the spot exchange rate on those
dates. Any foreign-exchange gains and losses associated with carrying
receivables or payables are taken directly to the income statement. This is
basically the same procedure required by the IASB as well as IAS 21.

IV. TRANSLATING FOREIGN-CURRENCY FINANCIAL STATEMENTS

An MNE must eventually develop one set of financial statements in its home-country
currency. Translation involves the process of restating foreign-currency financial
statements, and consolidation is the process of combining the translated financial
statements of a parent and its subsidiaries into a single set. In the United States,
translation is a two-step process: first, statements are recast according to U.S.
GAAPs; then all foreign currency amounts are translated into U.S. dollars.
A. Translation Methods
FASB No. 52 and IAS 21 are alike in that they require MNEs to translate their
foreign-currency financial statements into the currency of the parent’s country.
 The two standards yield the same result.
1. Two Methods: Current-Rate and Temporal. The method the firm
chooses depends on the functional currency of the foreign operation,
which is the currency of the primary economic environment in which the
entity operates. If the functional currency is that of the local operating
environment, the firm must use the current-rate method, which provides
that all assets and liabilities be translated at the current exchange rate (the
spot exchange rate on the balance sheet date). All income statement items
are translated at the average exchange rate, and owner’s equity is translated
at the rates in effect when the firm issued capital stock and accumulated
retained earnings. If the functional currency is the parent’s currency, then
the firm must use the temporal method, which provides that only monetary
assets such as cash, marketable securities and receivables and liabilities be
translated at the current exchange rate. Inventory and property, plant and
equipment are all translated at the historical exchange rates in effect when
the assets were acquired. In general, income statement accounts are
translated at the average exchange rate, but cost of goods sold and
depreciation expenses are reported at the appropriate historical exchange
rates (not an average for the period).
a. Disclosing Foreign-Exchange Gains and Losses. Under the
current-rate method of translating foreign-currency financial
statements, the gain or loss is called an accumulated translation
adjustment and is recognized in owners’ equity. Under the temporal
method, the gain or loss is taken directly to the income statement, thus
affecting earnings per share.

V. MANAGEMENT ACCOUNTING ISSUES

Up to this point the chapter has focused on preparing financial statements for
external users. Now we turn to important accounting issues that MNEs face
including performance evaluation and control, transfer pricing, and the use of a
balanced scorecard for broadly evaluating performance.
A. Performance Evaluation and Control
Different measures are used to evaluate performance of foreign operations,
including ROI, sales, cost reduction, quality targets, market share, profitability,
and budget to actual. Although most MNEs use a variety of measures, U.S.-
based MNEs are more likely to use ROI as the most important measure of
performance. In a study of British MNEs, companies tended to use budget
versus actual comparisons, followed by some type of ROI. In a study of
Japanese MNEs, it was found that sales were the most important criterion for
performance evaluation.
1. Performance Evaluation in the Budgeting Process. A complicating factor
for MNEs is setting targets or budgets in different currencies. Budgets are
usually either set in the headquarters country’s currency and translated into
local currency, or set in local currency and translated to headquarters’
currency. Since currency values will likely change during the budgeting
period, companies need to consider the actual exchange rate at time of
 budget, the projected rate at the time the budget was established in the local
currency, and the actual exchange rate at the end of the budget period.
a. Forecast Rates. the most widely used approach for taking into
consideration foreign exchange when comparing budgets for British
MNEs is the use of a forecast rate.
b. Hedging Strategies. Companies may also use a hedging strategy
instead of a forecast rate when setting budgets.
B. Transfer Pricing and Performance Evaluation
Transfer pricing refers to prices of goods and services that are bought and sold
(transferred) between members of a corporate family. Transfer prices may be set
with little consideration for market prices or production costs due to tax policies,
competitive purposes, to avoid dumping regulations, to lessen the impact of
national controls, to lower the apparent profitability of a subsidiary, and a host
of other reasons.
C. The Balanced Scorecard
The balanced scorecard (BSC) is an approach to performance measurement
that closely links the strategic and financial perspectives of a business. It
provides a framework to look at the strategies giving rise to value creation from
the following perspectives: (i) financial, (ii) customer, (iii) internal business
processes, and (iv) learning and growth.

VI. CORPORATE GOVERNANCE

Corporate governance refers to the combination of external and internal mechanisms
implemented to safeguard the assets of a company and protect the rights of
stockholders.
A. External Control Mechanisms: The Legal System
An important external mechanism in corporate governance is the legal system of
a country. Countries with strong legal systems generally have laws to protect
shareholders, where in underdeveloped countries, few such laws exist.
1. The Sarbanes-Oxley Act in the United States. In the U.S., the
Sarbanes-Oxley Act of 2002 (SOX) was passed placing stricter reporting
requirements on U.S. firms and firms listed in the United States. SOX also
required stronger internal controls and tougher oversight on the part of
external auditors.
B. Internal Control Mechanisms
Internal mechanisms refer to management and ownership structures of the firm,
and the role of the Board of Directors in overseeing the operations of the firm.
 CHAPTER NINETEEN
THE MULTINATIONAL FINANCE FUNCTION

I. INTRODUCTION
MNEs access both local and global capital markets in order to finance their
operational and expansion activities. This chapter examines external sources of debt
and equity capital available to companies operating abroad as well as internal
sources of funds that arise from intercompany links. Additional topics explored
include international dimensions of the capital investment decision, global cash
management, foreign exchange risk-management strategies, and international tax
issues.

II. THE FINANCE FUNCTION

The finance function in the firm focuses on cash flows, both short term and long
term. Cash flow management is divided into four major areas: (i) capital structure,
(ii) capital budgeting, (iii) long-term financing and (iv) working capital management.
A. The Role of the CFO
It is the responsibility of an organization’s chief financial officer (CFO) to
acquire (generate) and allocate (invest) financial resources among activities and
projects.
1. The CFO’s Global Perspective. The CFO’s job becomes increasingly
complex in the global environment because of factors such as foreign-
exchange risk, currency flows and restrictions, political risk, differing tax
rates and laws and regulations regarding access to capital.

III. CAPITAL STRUCTURE

Capital structure is the mix between long-term debt and equity.
A. Leveraging Debt Financing
The degree to which a firm funds the growth of business by debt is known as
leverage. The amount of leverage used varies from country to country, and
country-specific factors are a more important determinant of a company’s
capital structure than any other factor because companies tend to follow the
financing trends in their own country and their particular industry within their
country. Leveraging is often perceived as the most cost-effective route to
capitalization.
1. When Is Leveraging Not the Best Option? Leveraging may not be the
best approach in all countries for two reasons. First, excessive reliance on long-
term debt increases financial risks and thus requires a higher rate of return
for investors. Second, foreign subsidiaries of a MNE may have limited
access to local capital markets.
B. Factors Affecting the Choice of Capital Structure
A company’s choice of capital structure depends on tax rates, degree of
development of local equity markets, and creditor rights within its country and
in other countries.
 1. Debt and the Asian Financial Crisis of 1997. A major cause of the
Asian financial crisis of 1997 was excessive dollar bank debt. Some of the
Asian companies that borrowed dollars directly from foreign banks couldn't
generate enough local currency to pay off the debt.
C. Debt Markets as Means of Expansion
Companies can raise funds in both local and international debt and equity
markets (such as the Eurodollar, Eurobond, and Euroequity markets) as well as
raise internal funds from the corporate family.

IV. GLOBAL CAPITAL MARKETS

A. Eurocurrencies and the Eurocurrency Market
A Eurocurrency is any currency banked outside its country of origin.
1. Major Sources of Eurocurrencies. There are four major sources of
Eurocurrencies: foreign governments or individuals who want to hold
dollars outside the U.S., MNEs that have excessive cash, European banks
with excessive currency, and countries with large balance-of-trade
surpluses.
2. Characteristics of the Eurocurrency Market. The market is a
wholesale market, with very large transactions, typically consisting of short
to medium term loans.
3. Interest Rates in the Eurocurrency Market. A major attraction of the
Eurocurrency market is the difference in interest rates compared with those
in the domestic market. Eurocurrency deposits tend to yield more than
domestic deposits, and loans are cheaper.
a. London Inter-Bank Offered Rate. The deposit rate that applies to
interbank loan within London.
• Subprime Loans. Loans made to borrowers who are below
prime quality. These loans are made and then, at times, sold as
securities by lenders to investors.
B. International Bonds
Many companies have active bond markets available to domestic and foreign
investors.
1. Types of International Bonds.
a. Foreign Bonds. A bond sold outside the country of the borrower, but
denominated in the currency of the country of issue.
b. Eurobonds. A bond issue sold in a currency other than that of the
country of origin.
c. Global Bonds. Bonds introduced by the World Bank that are a
combination of domestic bonds and Eurobonds, in that they must be
registered in each national market according to that market's
registration requirements.
2. What’s So Attractive about the International Bond Market?
Attractions of the international bond market include diversification and
lower costs.

C. Equity Securities and the Euro equity Market.

 Whereby an investor takes an ownership position in return for shares of stock
and possible capital appreciation and/or dividends.
1. Access to Equity Capital. One way a company can easily and
inexpensively get access to capital is through private placement. In addition,
the company can issue stock on one or more foreign exchanges.
D. The Size of Global Stock Markets.
1. Emerging Stock Markets. Emerging markets have been growing rapidly
for many years.
2. The Rise of the Euro equity Market. Prior to 1980, few companies
thought about issuing stock outside their national boundaries. This market,
selling securities outside of one's home country rose significantly since
1980.
a. The Trend toward Delisting. The trend of multiple exchange
listings is beginning to reverse. Increased costs and increased
regulations have caused this trend of delisting.
• American Depositary Receipt. Most foreign companies that
list on U.S. stock exchanges do so through an ADR, which is a
financial document that represents a share or part of a share of
stock in a foreign company.

V. OFFSHORE FINANCING AND OFFSHORE FINANCIAL CENTERS

Companies can raise debt or equity funds in their domestic market or offshore.
Offshore financing is the provision of financial services by banks and other agents
to nonresidents of a country.
A. What’s an OFC?
Offshore financial centers (OFC) are cities or countries that provide large
amounts of funds in currencies other than their own and are used as locations in
which to raise and accumulate cash; they represent major centers for the
Eurocurrency market. OFCs are (i) jurisdictions that have relatively large
numbers of financial institutions engaged primarily in business with
nonresidents, (ii) financial systems with external assets and liabilities out of
proportion with domestic needs, (iii) are a tax haven country (a country with
low or no taxation), have moderate to light financial regulation, and offer
banking secrecy and anonymity.
1. Characteristics of OFCs. Generally, OFCs provide a more flexible and
less expensive source of funding for MNEs and exhibit one or more of the
following characteristics:
• a large foreign-currency (Eurocurrency) market for deposits and loans
• a large net supplier of funds to the world financial markets
• an intermediary or pass-through for international loan funds
• economic and political stability
• an efficient and experienced financial community
• good communications and supportive services
• an official regulatory climate that is favorable to the financial industry.
2. Operational versus Booking Centers. Centers are either operational
centers, with extensive banking activities involving short-term financial
 transactions (e.g., London), or booking centers, in which little actual
banking activities takes place but in which transactions are recorded to take
advantage of secrecy laws and/or low or no tax rates (e.g., the Cayman
Islands).
3. OFCs as “Tax Havens”. The Organization for Economic Cooperation and
Development (OECD) has been working closely with the major OFCs to
ensure that they are engaged in legal activity and to eliminate harmful tax
practices such as having low or no taxes on relevant income, separating
non-resident financial activities from those of residents, lacking
transparency and regulatory supervision, and lacking the effective exchange
of information with other countries.

VI. CAPITAL BUDGETING IN A GLOBAL CONTEXT

Capital budgeting is the process whereby MNEs determine which projects and
countries will receive capital investment funds. Several approaches to capital
budgeting are possible.
A. Methods of Capital Budgeting
1. Payback Period. One method uses a payback period—the number of
years required to recover the initial investment made.
2. Net Present Value. Another method is to determine the net present
value (NPV) of a project, which is a function of the annual free cash flow in
a period, the required rate of return or cost of capital, the initial outlay of
cash, and the project’s expected life.
3. Internal Rate of Return. A third approach is to compute the internal rate
of return—the rate that equates the present value of future cash flows with
the present value of the initial investment.
B. Complications in Capital Budgeting
Several aspects of capital budgeting are unique to foreign project assessment:
• Parent cash flows must be distinguished from project cash flows
• Remittance of funds to the parent (such as dividends, interest on loans,
payment of intra company receivables and payables) is affected by differing
tax systems, legal and political constraints on the movement of funds, local
business norms, and differences in how financial markets and institutions
function
• Differing rates of inflation
• Unanticipated exchange-rate changes
• Political risk in the target market
• The terminal value of the project is difficult to estimate because potential
purchasers from host, home, or third countries may have widely divergent
views on the project’s value
Because of these complications, it is very difficult to estimate future cash flows.
There are two ways to deal with these variations: 1) determine several different
cash flow scenarios and 2) adjust the minimum required rate of return that the
project must achieve.
VII. INTERNAL SOURCES OF FUNDS
Funds refer to working capital, i.e., the difference between current assets and current
liabilities. Internal sources of funds include loans, investment through equity capital,
interfirm receivables and payables and dividends.
A. Cash Flows and the MNE.
Inter firm financial links become extremely important as MNEs grow in size
and complexity. Funds can flow from parent to subsidiary, subsidiary to
parent and/or subsidiary to subsidiary. Goods, services and funds all can
move within an MNE, thus creating receivables and payables. Entities may
choose to pay quickly (a leading strategy) or to defer payment (a lagging
strategy). Transfer pricing can be used to adjust the size of a payment. In
addition, firms can generate cash from normal operations. Whatever the
means, international cash management is complicated by differing inflation
rates, fluctuating exchange rates and distinct national and regional bloc
policies regarding the flow of funds.
B. Global Cash Management
Global cash management strategy focuses on the flow of money to serve specific
operating objectives. Effective cash management hinges on the following
questions:
• What are the local and corporate system needs for cash?
• How can the cash be withdrawn from subsidiaries and centralized?
• Once the cash has been centralized, what should be done with it?
Cash budgets and forecasts are essential in assessing a firm’s cash needs. Cash
may be transferred within a firm via dividends, royalties, management fees, and
the repayment of principal and interest on loans.
1. Multilateral Netting. Multilateral netting is the process of coordinating
cash inflows and outflows among subsidiaries so that only net cash is
transferred, reducing transaction costs. Multilateral netting allows
subsidiaries to transfer net intercompany flows to a clearing account, which
disburses cash to net receivers. Netting requires sophisticated software and
good banking relationships in different countries.

VIII. FOREIGN-EXCHANGE RISK MANAGEMENT

As illustrated earlier, global cash-management strategy focuses on the flow of money
for specific operating objectives. Another important objective of an MNE’s financial
strategy is to protect against the foreign-exchange risks of investing abroad.
Strategies to protect against such risks may include the internal movement of funds,
as well as the use of foreign-exchange instruments such as options and forward
contracts.
A. Types of Exposure
The three types of foreign-exchange exposure include translation exposure,
transaction exposure and economic exposure.
1. Translation Exposure. Translation exposure reflects the foreign-
exchange risk that occurs because a parent company must translate foreign-
currency financial statements into the reporting currency of the parent, i.e.,
the value of the exposed asset or liability changes as the exchange rate
 changes.
2. Transaction Exposure. Transaction exposure reflects the foreign-
exchange risk that arises because a firm has outstanding accounts receivable
or payable that are denominated in a foreign currency, i.e., the receivable or
payable changes in value as the relevant exchange rate changes.
3. Economic (or Operating) Exposure. Economic or operational
exposure arises from effects of exchange-rate changes on future cash flows,
the sourcing of parts and components, the location of investments, and the
competitive position of the company in different markets.

B. Exposure-Management Strategy
Management must do a number of things if it wishes to protect assets from
exchange-rate risk.
1. Defining and Measuring Exposure. An MNE must forecast the degree of
exposure in each major currency in which it operates and adopt appropriate
hedging strategies for each. A key aspect of measuring exposure is
forecasting exchange rates, where the major concerns are the direction,
magnitude, and timing of exchange-rate fluctuations.
2. Creating a Reporting System. A firm must devise a uniform reporting
system for all its entities that identifies the exposed accounts it wants to
monitor, the amount of the exposure by currency of each account and the
different periods under consideration. The system should combine central
control with input from foreign operations. Exposure should be separated
into translation, transaction and economic components, with the transaction
exposure identified by cash inflows and outflows over time. Specific
hedging strategies can be taken at any level, but each level of management
must be aware of the size of the exposure and its potential impact on the
firm.
3. Formulating Hedging Strategies. A firm can hedge its position by
adopting operational and/or financial strategies, each with cost/benefit and
operational implications.
a. Operational Hedging Strategies. Firms may choose to balance
local assets with local debt by borrowing funds locally, because that
helps avoid the foreign-exchange risk associated with borrowing in a
foreign currency. They may also choose to take advantage of leads and
lags for interfirm payments.
• Leads and Lags. A lead strategy means collecting foreign-
currency receivables before they are due when the currency is
expected to weaken, or paying foreign-currency payables before
they are due when a currency is expected to strengthen. A lag
strategy means delaying collection of foreign-currency receivables
if the currency is expected to strengthen, or delaying payment of
foreign-currency payables when the currency is expected to
weaken. However, such strategies may not be useful for the
movement of large blocks of funds, and they may also be subject
to government restrictions.
 b. Using Derivatives to Hedge Foreign-Exchange Risk. A firm
can also hedge exposure through forward contracts and options, which
establish fixed exchange rates for future transactions and currency
options, i.e., derivatives, which assure access to a foreign currency at a
fixed exchange rate for a specific period of time. A foreign-currency
option is more flexible than a forward contract because it gives the
purchaser the right, but does not impose the obligation, to buy or sell a
certain amount of foreign currency at a set exchange rate within a
specified amount of time.

IX. TAXATION OF FOREIGN-SOURCE INCOME

Taxes can profoundly affect profitability and cash flow, especially in international
business. Taxation has a strong impact on several choices including:
• Location of operations
• Choice of operating form (export/import, licensing, overseas investment)
• Legal form of the enterprise (branch or subsidiary)
• Use of facilities in tax haven countries to raise capital and manage cash
• Method of financing (internal or external sourcing, debt or equity)
• Capital budgeting decisions
• Method of setting transfer prices
A. International Tax Practices
1. Differences in Tax Practices. Countries differ in terms of the types of
taxes they have, the tax rates applied to income, the determination of
taxable income, and the treatment of foreign income.
a. Differences in Types of Taxes. Two major types of taxes are income
taxes and excise taxes.
b. Differences in GAAP. Variations among countries in GAAP can lead
to differences in the determination of taxable income.
c. Differences in Tax Rates. Corporate tax rates differ from country to
country
2. Two Approaches to Corporate Taxation.
a. Separate Entity Approach. Each separate entity, company or
individual, is taxed when it receives income.
b. Integrated System Approach. Avoids double taxation. When
shareholders report the dividends in their taxable income, they also get
a credit for taxes paid on that income by the company that issued the
dividend.
B. Taxing Branches and Subsidiaries
To illustrate the complexities of taxing foreign-source income, it is useful to
examine how U.S.-based companies tax earnings from a foreign branch and a
foreign subsidiary.
1. The Foreign Branch. Since a foreign branch is an extension of the parent
company, any foreign branch income (or loss) is directly included in the
parent’s taxable income.
2. The Foreign Subsidiary. A foreign corporation is an independent legal
entity set up in a country according to the laws of incorporation of that
 country. When an MNE purchases or establishes such an entity, it is called
a subsidiary. Subsidiary income is either taxable to the parent or tax
deferred (not taxed until it is submitted as a dividend to the parent). The tax
status of a subsidiary depends on whether the subsidiary is a controlled
foreign corporation (CFC) and whether the income is active or passive.
3. The Controlled Foreign Corporation. In a CFC, U.S. shareholders hold
more than 50% of the voting stock. A U.S. shareholder is any U.S. person or
company that holds 10 percent or more of the CFC's voting stock. Any
foreign subsidiary is consider a CFC for tax purposes. A joint venture
company abroad may not be considered a CFC if the U.S. MNE does not
own more than 50% of the stock in the joint venture.
a. Active versus Passive Income. Active income is derived
from the direct conduct of a trade or business. Passive, or subpart
F income, comes from sources other than those connected with the
direct conduct of a trade or business (generally in tax haven
countries). Subpart F income includes holding company income,
sales income, and service income.

C. Transfer Prices
Transfer pricing applies to transactions between related entities and is not
usually an arm’s length price (price between two unrelated entities). The
assumption is that an arm’s-length price is more likely than a transfer price to
reflect the market accurately.
1. Transfer Prices and Taxation. Companies establish arbitrary transfer
prices primarily because of differences in taxation between countries. The
OECD, however, is very concerned about the way companies manipulate
transfer prices in order to minimize tax liability and has set transfer pricing
guidelines to eliminate this manipulation.
D. Double Taxation and Tax Credit
In the United States, the IRS allows a tax credit for corporate income tax for tax
that U.S. companies pay to another country in order to avoid double taxation. A
tax credit is a dollar-for-dollar reduction of tax liability and must coincide with
the recognition of income.
Tax Treaties: Eliminating Double Taxation. The purpose of tax treaties is to
prevent double taxation or to provide remedies when it occurs. When agreeing
to a treaty, countries generally grant reciprocal reduction on dividend
withholding and exempt royalties, and sometimes interest payments, from any
withholding tax.
 CHAPTER TWENTY
HUMAN RESOURCE MANAGEMENT

I. INTRODUCTION
This chapter looks at the role of the individual in international business and discusses
facets of human resource management as they apply to managers in the company with
international operations.
A. What is HRM? Human resource management refers to the activities that a
company, whether solely domestic or thoroughly global, takes to staff its organization.
Managing a company's human resources is a function of implementing its strategies.
1. HRM and the Global Company. Factors that cause international human
resource management to be more complex than the domestic function
include environmental differences and organizational challenges.
a. Global HRM as Competitive Advantage. Insightfully dealing with
these challenges creates a competitive advantage for the firm. The
HRM mandate is to build, develop, and retain the cadre of managers
that will lead an international organization to greater performance.

II. THE STRATEGIC FUNCTION OF INTERNATIONAL HRM

Anecdotes suggest and research confirms a powerful relationship between HRM
processes, management productivity, and strategic performance.
1. When HRM Is Strong. International HRM can be a source of creating
superior value and competitive advantages. Superior human resources can
sustain high productivity, competitive advantage, and value creation for the
international company.
2. When HRM Is Weak. Despite the importance of international HRM,
many multinationals report that effectively developing and managing human
resources is one of their weakest capabilities. Research reports and executives
acknowledge that the effectiveness of human resources practices materially
affects firm performance, but many fail to achieve their HRM goals.
A. Strategizing HRM
a. Case: Transnational Strategy at GE. Beginning in the 1980s, GE
focused on globalizing its markets and materials sourcing. At each step
along the way to its current transnational strategy, GE rethought its
HRM philosophy to make sure it had the human capital to achieve its
strategy.
1. Taking the Expatriate Perspective. An expatriate is a person who is sent
temporarily to work in a country other than his or her legal residence.
Expatriates can be home-country nationals or third-country nationals.
Home- country nationals are citizens of the country in which the company is
headquartered, whereas third-country nationals are citizens of neither the local
assignment country nor the company headquartered country.
a. Trends in Expatriate Assignment. Expat staffing has been
 changing in recent years to shorter assignments, more junior level
employee assignments, and employees from emerging markets being sent
to developed countries.
B. Developing Staffing Policies
Staffing policy is the process by which the company assigns the most appropriate
candidate to a particular job. For most of these companies, staffing policy revolves
around the decision of whether to run international operations with local workers in
the host nation, expatriates sent from the home country, or third-country nationals.
1. Ethnocentric Approach. An ethnocentric staffing approach fills all key
management positions with home-country nationals.
a. Advantages of the Ethnocentric Approach.
• Transferring Core Competencies. People transferred from
headquarters are more likely to have a thorough understanding of the
company’s core competencies and values. The leading reasons to
staff foreign operations with expatriates include maintaining
command and control consistent with headquarters’ policy, filling
local talent gaps, using international assignments as a mechanism for
social integration, safeguarding intellectual property in joint ventures,
transferring best practices from other locations, counteracting high
turnover among local employees, and as a management development
tool to help managers develop a global outlook
• Countering Cognitive Dissonance. Companies often use an
ethnocentric staffing approach to reduce the degree of cognitive
dissonance, or the incompatibility between home-country and host-
country attitudes. Relying on people familiar with proven workplace
methods and labor procedures helps companies cope with the stress
of foreign situations.
b. Drawbacks of the Ethnocentric Approach. This approach can,
however, lead the company to adopt a narrow perspective in foreign
markets and blinds the company to the benefit of exposure to different,
and possibly better, ways of doing things. Ethnocentric staffing policies
can leave local managers and workers unmotivated and demoralized.
Local employees will likely resent someone coming from a foreign
country who they see as no more qualified than they are.
2. Polycentric Approach. A polycentric staffing policy uses host-country
nationals to manage local subsidiaries and helps local motivation and morale.
a. Advantages of the Polycentric Approach. A polycentric approach is
used to control costs, to cater to host-country nationalism, to develop local
management talent, to boost employee morale, to counteract high
expatriate failure rates, and to maximize local adaptations for particular
products
• Political Considerations. Hiring local managers may be an
astute political choice in that they may be seen as "better citizens,"
improve employee morale, and be the preferred choice of
employees of the local company.
• Economic Considerations. The high cost of sending someone
to work overseas makes the choice of a local manager in many
cases a better economic decision.
• Considerations of Efficiency and Effectiveness. Local
managers should be able to perform better, sooner, given their
understanding of local customers, markets, and institutions.
b. Drawbacks to the Polycentric Approach. This approach can,
however, result in problems of accountability and allegiance if a gap
develops between headquarters and local operations. Compounding the
situation is the subtle drawback of a polycentric staffing problem is the
potential disengagement of local staff from the parent company.
3. Geocentric Approach. A geocentric staffing policy seeks the best people for
key jobs throughout the organization, regardless of their nationality. a.
Advantages: Geocentric Staffing and Core Competencies.
This policy is instrumental to companies pursuing a global and, especially,
a transnational strategy. Both types of strategies rely on learning
opportunities around the world to generate ideas that enhance their core
competencies.
b. Drawbacks to the Geocentric Approach. This approach is hard to
develop, costly to maintain, and can be complicated by economic factors,
decision making routines, and legal contingencies. In some cases, such an
approach may be practically impossible due to immigration laws and/or
workplace regulations that push MNEs toward local staffing.
4. Determining an Approach: Pros and Cons. Each of the three staffing
approaches has its merits and drawbacks. Broadly speaking, an ethnocentric
approach is congruent with an international strategy, a polycentric approach is
congruent with a multidomestic strategy, and a geocentric approach is
congruent with global and transnational strategies. Although companies may
use elements of each staffing policy, they tend to champion the policy that is
most congruent with their current standard of value creation.
III. MANAGING EXPATRIATES
Screening executives to find those with the greatest inclination and highest potential for
a foreign assignment is the process of expatriate selection. Few MNEs have a large
cadre of mobile and experienced expatriates to call on as needed.
A. Selecting Expatriates There is no specific set of technical indicators that
consistently distinguishes a good from a bad expatriate. It is a persistent challengeto
judge a potential expatriate's adaptability to foreign places, people, and processes.
1. Technical Competence. Technical competence (usually indicated by
past performance) is a significant determinant of success in foreign
assignments. The foreign subsidiary manager must understand both the
technical necessities of a position and also how to adapt to foreign conditions,
such as scaled-down plant and equipment, varying productivity standards and
less efficient national infrastructure.
2. Adaptiveness. Three types of adaptive characteristics influence an
expatriate’s success when entering a new culture.
a. Self-Maintenance. Qualities such as personal resourcefulness are useful
precisely because things do not always go as planned in a foreign
environment.
b. Satisfactory Relationships with Host Nationals. Whether called
cultural empathy, others-orientation, or simply leadership, this orientation
enhances an expatriate's ability to interact with new people.
c. Sensitivity to Host Environments. Better interpreting how colleagues,
customers, and competitors in the local market see events goes far to working
well in a different country.
3. Leadership Ability. Leadership ability is increasingly seen as a key to an
expatriate’s success since expatriates often assume a greater breadth and depth
of leadership responsibility on a foreign assignment than they likely would in
the home country. Communication skills, motivation, self-reliance, courage,
risk-taking, and diplomacy become essential qualities for success. Skills and
attitudes such as optimism, drive, adaptability, foresight, experience, resilience,
sensitivity, and organization are necessary for expatriates to be successful.
4. Causes and Consequences of Expatriate Failure. Expatriate failure is
when a manager returns home from a foreign assignment prematurely due to
poor job performance and is very expensive for the MNE. In the 1980s,
research reported that between 16–40% of Americans sent abroad to developed
countries returned early, while nearly 70% sent to less developed countries
returned home early. Expatriate failure reflects a failure of the MNE’s
selection policies to find the right individual for the job.
a. The Costs of Failure. The average cost of an expatriate failure can
be as high as three times the annual domestic salary plus the cost of
relocation. in addition, there are additional personal, family, and career
costs to expatriate failure.
b. Preventing Failure. MNEs may try to reduce failure rates through
improved training and better selection procedures. Assessment of
expatriate abilities has focused on technical abilities, the ability to
 cope with the increased responsibilities, the ability of the spouse to
adapt, and personal and emotional problems.
• Dealing with Adjustment and Stress. The leading cause of
expatriate failure is the inability of a spouse to adapt to the host
nation. Foreign assignments are usually more stressful for the
expatriate’s family than for the expatriate.
B. Training Expatriates
Companies recognize the need to prepare expatriates for their overseas assignment;
however, many companies struggle with these issues. While most companies profile
employees’ technical capabilities and accomplishments, few focus on adaptive
capabilities, willingness to accept foreign assignments, geographic preferences, or
foreign-language qualifications.
1. Focusing on Adaptiveness and Related Characteristics. The MNEs
historic concern with technical competence has neglected the need for expats to be
adaptive and culturally sensitive.
a. General Country Understanding. The most common predeparture
training is an informative briefing about the way things work in the host
country. Topics generally include things like politics, economics, features
of the workplace, and lifestyle.
b. Cultural Sensitivity. Cultural training tries to preempt the effects of
culture shock by helping employees to take an open mind to the different
ideas, attitudes, and beliefs they are likely to encounter in the host culture.

c. Practical Skills. This type of training attempts to familiarize the

expatriate and his or her family with the routines of life in the host
country. Issues such as schooling, socializing, and shopping are
addressed.
d. Trends in Training Gaps. Many managers don’t receive adequate
training prior to an overseas assignment, despite the proven effectiveness
of training programs. Companies usually blame too much urgency as the
reason for not investing in more training for individual employees.
• Two Approaches: Specialized Knowledge versus
Cultural Sensitivity. Sometimes companies struggle because of
uncertainty as to whether they should emphasize country specific
knowledge or general cultural sensitivity in their training programs.
Research has shown there is no significant difference in the relative
effectiveness of the two approaches.
• Broader, More Sophisticated Programs. The increased need for
employees to understand worldwide business operations and
opportunities has expanded training once reserved for expatriates to a
broader set of MNE employees.
C. Compensating Expatriates
The amount and type of compensation needed to entice an individual to accept a
foreign assignment may vary widely by person and locale. Company practices also
vary in terms of compensation for differences.
1. The Pay-Performance Link. Compensation can determine the
likelihood and success of expatriate assignments. While the pay-
performance link is weak, it is necessary to design a compensation package
that encourages people to go abroad, maintain their standard of living, and
reflects their responsibilities in the foreign assignment.
2. Types of Compensation Plans. The most common approach to expatriate pay
is the balance sheet compensation plan, which aims to develop a salary
structure that equalizes purchasing power across countries so expatriates have
the same standard of living in their foreign assignment as they had at home.
There are three common methods of implementing the balance sheet
compensation plan.
• Home-Based Method. The home-based method sets compensation based
on the salary of a comparable job in the expatriate’s home city.
• Headquarters-Based Method. The headquarters-based method sets
salary in terms of the salary of a comparable job in the city where the
MNE has its headquarters.
• Host-Based Method. The host-based method bases compensation on the
prevailing pay scales in the locale of the foreign assignment, plus foreign-
service premiums, extra allowances, home-country benefits, and taxation
compensation. This method is also sometimes referred to as destination
pricing and localization.
3. Key Aspects of Expatriate Compensation.
a. Base Salary. Usually falls in the same range as the base salary for
the comparable job in the home country and is paid in either home-country
currency or local currency.
b. Foreign Service Premium. This is extra pay given to the expatriate for
working outside the home country which rewards expatriates for living far
from family and friends, dealing with a new culture, language, and
workplace.
c. Allowances. Companies adjust the total compensation package with a
variety of allowances that help reduce the difficulties the executive and his
family face.
• Cost-of-Living Allowances. Companies usually pay for differences
in cost-of-living for more expensive locations so that expatriates can
enjoy the same living standards abroad as they would at home.
• Housing Allowances. Housing allowances ensure that expatriates
will duplicate their customary quality of housing. Housing costs vary
significantly globally.
• Spouse Allowances. A spouse allowance compensates for a spouse to
find work and offsets the loss in income due to a spouse forsaking his
or her job.
 • Hardship Allowances. A hardship allowance is paid to expatriates
assigned to dangerous or especially difficult locations. Companies
may also need to purchase ransom insurance, provide safety training,
pay for home alarm systems and security guards, and assess their
legal liability regarding employee safety for employees working in
remote or dangerous areas. Hardship allowances may also include
travel allowances pay for visits back to the home country, and
education allowances pay for the cost of children’s schooling.
• Trends in Allowances. Overall, companies are now offering fewer
allowances due to the desirability of an international assignment, the
high costs associated with foreign placement, and the fact that some
locations are less difficult than they once were due to economic
development.
d. Fringe Benefits. Firms typically provide the same level of medical and
retirement benefits abroad as they would at home, and may expand
benefits to deal with local contingencies such as transferring ill employees
or family members to out-of-country medical facilities.
e. Tax Differentials. Companies may adjust compensation even higher in
high tax rate countries in order to make sure that expatriates have an
equivalent after tax income in the new location. In cases of double
taxation, the MNE generally pays the expatriate’s tax bill in the host
country.
4. Complications Posed by Nationality Differences. As firms employ
expatriates from home and third countries, compensation issues grow more
complicated. Salaries for similar jobs vary substantially across countries, as do
the relationships of salaries within the corporate hierarchy. There is no general
consensus as to how to deal with such issues.

D. Repatriating Expatriates
Repatriation is the process of returning the expatriate to his or her home country
working environment, and is a process fraught with difficulties. Repatriation
problems arise in three general areas.
a. Changes in Personal Finances. Most expatriates enjoy a rich
lifestyle and returning home will fewer benefits and perks may be
difficult.
b. Readjustment to Home-Country Corporate Structure.
Returning home can be difficult in a work sense in that others may have
been promoted, the manager is long longer a "big fish in a little pond,"
and a job may not be ready for their return.
c. Readjustment to Life at Home. Expatriates may experience
reverse culture shock when returning home. They may find that they
have to relearn things they took for granted.
1. Managing Repatriation. Effective human resource practices for soothing re-
entry includes placement in jobs that build on foreign experiences, a
reorientation program and a corporate mentor who looks after expatriates’
 interests while they’re abroad. The principal cause of repatriation frustrations
is finding the right job for someone to return to.

IV. INTERNATIONAL LABOR RELATIONS In each country in which the MNE

operates, managers have to deal with different labor relations issues. These differences
reflect the local sociopolitical environment. The environment affects whether they join a
union, how they bargain collectively, and what they want from companies. Little
mobility among classes may present the labor issue as a class struggle in some countries.
A. How Labor Looks at the MNE
Some labor groups argue that MNEs systematically weaken the rights and roles of
labor due to the power of their globally dispersed value chains and abilities to
manipulate markets and governments. Labor argues it is disadvantaged because it
is hard to get full data on MNEs’ global operations, MNEs can manipulate
investment incentives, MNEs can easily move value activities to other countries,
and ultimate decision making can be in another country.
1. The MNE’s Advantages. MNEs have a number of advantages such as
the ability to hold out longer during a strike, to move goods and activities
among different countries, and the inability of labor unions to contest the
information provided by the MNE.
a. Product and Resource Flows. If labor strikes, MNEs can divert output
from the striking facilities to other facilities in other locations. This is
only possible, however, if the MNE has excess capacity in other areas and
manufactures the same product elsewhere.
b. Value Activity Switching. MNEs often threaten to switch activities to
other countries in order to extract wage reductions or other concessions
from workers. This trend has gained greater visibility in the context of the
offshoring of jobs.
c. Operational Scale and Complexity. Labor often has trouble identifying
where decisions at the MNE are being made and also may have difficulty
interpreting financial data for the typical MNE. Because of these
ambiguities, labor can be at the mercy of activities, decision makers, and
resources far from the country in which labor is employed.
B. How Labor Responds to the MNE
Labor can strengthen its position toward MNEs by organizing in unions that
cooperate internationally.
1. Labor’s Options. Unions engage in several tactics to counter MNE’s
bargaining power.
a. Exchanging Information. International confederations and other
labor groups can exchange information that may be helpful to particular
unions in dealing with MNEs.
b. Coordinating Activities. Labor groups in one country may support
their counterparts in another country in the form of refusing to work,
sending financial aid, and disrupting work.
c. Calling Upon Transnational Institutions. Labor can also appeal to
transnational institutions such as the International Labor Organization
 (ILO) for help across countries. In addition, the enhancement of global
communication can publicize the different labor conditions among
countries.
C. The Labor Struggle: Barriers to International Unanimity
Although there is sometimes cooperation among unions across countries, it is
difficult due to the ongoing competition among unions in different countries for
jobs and resources.
1. Different Country-Specific Goals. Canada and the United states have long
shared a common union membership. Still there are ongoing moves among
Canadian workers to form unions independent of the United States. Even when
labor in one country helps labor in another, it likely aims to achieve its own
specific goals.
2. Different Structures and Ideals. Further impeding international unanimity
among unions is the fact that unions largely evolved independently in each
country.
3. Different Collective Bargaining Methods. Unions in different countries
prefer different methods of collective bargaining.
4. Different Approaches to Reconciling Labor Tension. Approaches to
reconcile labor tensions differ from country to country.
5. Regulatory Difficulties. In some countries, particularly in northern Europe,
labor is given the legal right to participate in the management of companies.
a. Codetermination. A concept known as codetermination emphasizes the
cooperative decision making within firms that benefits both the workers
and the company. Despite some voluntary moves toward codetermination,
most examples have been mandated by the government.

D. Trends in MNE–Labor Relations

Union membership as a percentage of the total workforce has been declining in
most countries because (i) there has been an increase in white-collar workers as a
percentage of total workers and white-collar workers are less likely to organize, (ii)
there has been an increase in service employment relative to manufacturing
employment with more variation in service activities making organization more
difficult, (iii) the participation of women in the workforce is rising and women are
traditionally less apt to join unions, (iv) there has been a rise in the percentage of
part-time and temporary workers who are more difficult to organize, (v) there is a
trend toward smaller plant size that leads to more aligned interests between
management and labor at the plant level, and (vi) there has been a decline in the
belief in collectivism among younger workers. MNEs have also become more
adept at managing international labor relations and effectively use threats of
production switching or resource redirection to further strengthen their positions.
 Multiple Choice Questions

1. ___________is defined as ‘the worldwide trend of businesses expanding beyond their domestic
boundaries’.
a. International Business
b. Globalization
c. Foreign Direct Investment
d. Licensing

2. ______________remains the most common means of entry into international markets.

a. Export Strategy
b. Licensing
c. Franchising
d. Foreign Direct Investment

3. By ________________, the domestic company need not bear any costs and risks of entering
foreign markets on its own, yet it is able to generate income from royalties.
a. Export Strategy
b. Licensing
c. Franchising
d. Foreign Direct Investment

4. _______________is a better option for international expansion efforts of service or retailing companies.
a. Export Strategy
b. Licensing
c. Franchising
d. Foreign Direct Investment

5. FDI is the investment made by a company in a foreign country to start its operations. Various
options available for an FDI are
a. Wholly owned subsidiary
b. Joint Venture
c. Mergers and Acquisition
d. All of the above

6. Any firm can purchase a stake in a foreign company, whereby they are entitled to a share in the profits,
if any. The shareholding can be a minority stake and may be without voting rights. Generally, the
investing company does not participate in the management of the target company. The underlying
concept describes about
a. Wholly owned subsidiary
b. Joint Venture
c. Mergers and Acquisition
d. Strategic Investment

7. is not an advantage of international business.

a. Low Cost of Production
b. Market Forces
c. Large Customer base
d. Diversified Risk
8. The process by which a company buys most, if not all, of the target company's controlling shareholding
in order to assume control of the target firm is called_____________
a. Wholly owned subsidiary
b. Joint Venture
c. Acquisition
d. Strategic Investment

9. What can be defined as any business that crosses the national borders of the country of its establishment?
a. International Business
b. Globalization
c. Foreign Direct Investment
d. Licensing

10. Bretton Woods conference led to the formation of___________

a. WTO
b. IMF
c. UNO
d. GAAT

11. Companies, which invest in other countries for business and also operate from other countries, are
considered as_____________
a. Global Companies
b. Domestic Companies
c. Multinational Enterprises
d. None of the above

12. The nations are involved in international trade because of

a. Price Differentials
b. Supply Differentials
c. Difference in tastes
d. All of the above reasons

13. Which theory is based on the principle assertion that government control of foreign trade is of
paramount importance for ensuring the prosperity and military security of the state.
a. Mercantilism
b. Absolute Advantage Theory
c. Comparative Advantage Theory
d. Heckscher-Ohlin Trade Theory

14. The main tenet of ______________ was that gold and silver were the mainstays of national wealth and
government should endeavour to increase the inflow of gold and silver. This is to be achieved by
exporting more and importing less, thus having a surplus balance of trade.
a. Mercantilism
b. Absolute Advantage Theory
c. Comparative Advantage Theory
d. Heckscher-Ohlin Trade Theory
15. Between mid-16th century and 18th century, governments’ world over that had consistent belief in
__________, advocated and executed policy interventions to achieve a surplus in the balance of trade.
a. Mercantilism
b. Absolute Advantage Theory
c. Comparative Advantage Theory
d. Heckscher-Ohlin Trade Theory

16. In one of the most notable book ’Wealth of Nations‘ in 1776, ______attacked the mercantilism and
argued that countries differ in their ability to produce goods and services efficiently due to variety of
reasons.
a. Adam Smith
b. David Ricardo
c. Heckscher-Ohlin
d. Raymond Vernon

17. Who argued that countries should specialise in production and manufacturing of goods and services in
which they have an absolute advantage. Such cost effective and efficient products can be traded with
goods from other countries in which that country has an absolute advantage.
a. Adam Smith
b. David Ricardo
c. Heckscher-Ohlin
d. Raymond Vernon

18. The crux of _____________ is that a country should not produce goods at home in which it does not
have cost advantage; instead it should import from other countries.
a. Mercantilism
b. Absolute Advantage Theory
c. Comparative Advantage Theory
d. Heckscher-Ohlin Trade Theory

19. Absolute advantage theory was based on ‘positive sum game’ where countries benefit from trade unlike
mercantilism theory which was based on ‘zero game’.
a. Mercantilism
b. Absolute Advantage Theory
c. Comparative Advantage Theory
d. Heckscher-Ohlin Trade Theory

20. __________, in his notable book ‘Principles of Political Economy’ published in 1817 came up with an
improvement on Adam Smith’s ‘absolute advantage theory’.
a. Adam Smith
b. David Ricardo
c. Heckscher-Ohlin
d. Raymond Vernon

21. Which theory stated that a country should specialise in the production of those goods that it can
produce most efficiently and import the goods which it produces less efficiently even if it has absolute
cost advantage in the production of those goods?
 a. Mercantilism
b. Absolute Advantage Theory
c. Comparative Advantage Theory
d. Heckscher-Ohlin Trade Theory

22. Who argued what might happen if one country has an absolute advantage in the production of all goods
and also stated that Adam Smith’s theory suggests that such a country might not have benefitted from
international trade as trade is positive sum game and countries prosper only if they exchange the goods
in which they have absolute advantage?
a. Adam Smith
b. David Ricardo
c. Heckscher-Ohlin
d. Raymond Vernon

23. Which theory explains that a country will specialise in the production of goods and services that it is
particularly endowed with and are suited for production in that country.
a. Mercantilism
b. Absolute Advantage Theory
c. Comparative Advantage Theory
d. Heckscher-Ohlin Trade Theory

24. US is a capital rich country hence its exports basket will be dominated by capital intensive products like,
aeroplanes, submarines, tanks, space system, nuclear plants, super computer, high-end servers etc. This
was advocated in which theory?
a. Mercantilism
b. Absolute Advantage Theory
c. Comparative Advantage Theory
d. Heckscher-Ohlin Trade Theory

25. Who stated that India has labour abundance, so its export basket is dominated by product with labour
contents like gems and jewellery, textiles, handicrafts, sports toys, handlooms, apparel, electronics and
information technology services.
a. Adam Smith
b. David Ricardo
c. Heckscher-Ohlin
d. Raymond Vernon

26. Which one is not the assumption of Heckscher –Ohlin Theory of International trade?
a. Production of goods either requires relatively more capital or land or labour.
b. Factors of production do not move between two countries.
c. Theory has assumption that there is no transport cost for trade between two countries.
d. The consumers and users in two trading countries may have the different needs.

27. Which theory of international trade was proposed by Raymond Vernon in mid 1960’s?
a. Product Lifecycle Theory
b. Absolute Advantage Theory
c. Comparative Advantage Theory
d. Heckscher-Ohlin Trade Theory
28. Who argued that the wealth and size of the market gave American firms a strong incentive to develop
new consumer products and in addition, the high cost of labour was an incentive to develop cost-saving
innovations?
a. Adam Smith
b. David Ricardo
c. Heckscher-Ohlin
d. Raymond Vernon

29. In which stage of the product life cycle theory, the product becomes a commodity, the price
becomes optimised and the makers look for countries where it can be made with the least production
costs.
a. New Product Stage
b. Maturing Product Stage
c. Standardised Product Stage
d. All of the Above

30. The need for a new product in the domestic market is identified and it is developed, manufactured and
marketed in limited numbers. It is not exported in sizeable quantities, since it is primarily for the
national market. This is revealed in__________.
a. New Product Stage
b. Maturing Product Stage
c. Standardised Product Stage
d. None of the Above

31. ___________ outlined four broad attributes that shape the environment in which local firms
compete and these attributes promote the creation of competitive advantage.
a. Product Lifecycle Theory
b. Michael Porter Diamond Model
c. Comparative Advantage Theory
d. Heckscher-Ohlin Trade Theory

32. As a part of National Economic Policy, All governments aspire to achieve

a. Full employment
b. High economic growth rate
c. Low rate of inflation
d. All of the above

33. The _____________is a good overall indicator of a country’s economic health; the likelihood of the
country’s government imposing forex controls, import restrictions and policies such as tax increments
and interest rate hikes.
a. Balance of Payment
b. Balance of Trade
c. Gross Domestic Product
d. National Income

34. Current Account deficit records

a. residents’ pensions,
b. interest and royalties from abroad,
 c. domestic firm’s fees for the movement of goods in other countries
d. All of the above.

35. ___________ refers to the absolute power of the state to coerce and control its citizens.
a. Sovereignty
b. National Interest
c. Political Stability
d. Political Risk

36. __________applies throughout the English-speaking world including most countries of the
Commonwealth. These systems rely on precedent, judgements in specific cases and on ad hoc
legislation to create and interpret statutes
a. Common Law
b. Code Law
c. Islamic Law
d. None of the above

37. ____________refers to the conditions under which a business operates and takes into account all factors
that have affected it.
a. Economic Environment
b. Political Environment
c. Demographic Environment
d. Legal Environment

38. Economic infrastructure is the sum of all the external facilities and services that support the work of
firms including communication, transportation, electricity supply, banking and financial services.
a. Economic Environment
b. Political Environment
c. Economic Infrastructure
d. Demographic Environment

39. ______________ is defined as art and other signs or demonstrations of human customs, civilization and
the way of life of the specific society or group.
a. Culture
b. Religion
c. Language
d. Conflicting Attitudes

40. According to____________, ‘Culture is more often a source of conflict than of synergy.
Cultural differences are a trouble and always a disaster.
a. Dr. Geert Hofstede
b. Michael Porter
c. David Ricardo
d. Adam Smith

41. Coded speech and verbosity is considered a waste of time and in time pressured corporate__________,
it is a crime.
a. Brazil
b. China
 c. USA
d. France

42. In international management, where people are from different cultures, you have to develop and
apply your knowledge about cultures and not use a standard process for everyone. This is called
.
a. Cross Cultural Management
b. Handling Cross Cultural Diversity
c. Factors controlling group creativity
d. Ignoring diversity

43. Which of the following dimensions is not used to differentiate culture?

a. Power Distance Index
b. Individualism
c. Uncertainty Avoidance Index
d. Short Term Orientation

44. Which of the following is not a result of foreign investment?

a. Improvement in human development skills
b. Increased competition improved productivity
c. Grants/ donation to Indian companies
d. Easier Integration into global economy

45. An investment by foreign investor in a sick industrial unit in India needing complete
restructuring for revival is called___________
a. Merger
b. Green Field Investment
c. Brown Field Investment
d. Acquisition

46. A business agreement in which two or more than parties agree to establish and develop a new
entity for a finite time with the objective of making profits; increased sales; and expansions of
firm’s long term goal is called
a. Joint Venture
b. Acquisition
c. Strategic Investment
d. Merger

47. A stock that trades in the United States but represents a specified number of shares in a foreign
corporation is called___________
a. American Depository Receipt
b. Global Depository Receipt
c. Foreign Currency Convertible Bond
d. Foreign Portfolio Investment

48. A bank certificate that is issued in more than one country for shares in a foreign company. The
shares are held by a foreign branch of an international bank. The shares trade as domestic shares,
 but are offered for sale globally through the various bank branches. It is known as
_____________
a. American Depository Receipt
b. Global Depository Receipt
c. Foreign Currency Convertible Bond
d. Foreign Portfolio Investment

49. _________________, on the other hand, is an investment by the foreign investor in the
country’s or region’s financial instrument, such as investment in bond market or stock investing.
a. American Depository Receipt
b. Global Depository Receipt
c. Foreign Currency Convertible Bond
d. Foreign Portfolio Investment

50. Which is not a motive of making foreign investment?

a. Political Motives
b.Economic Motives
c. Demographic Motives
d.Competitive Motives

51. _______________can be defined as the unification of countries into a larger whole. It also reflects a
country’s willingness to share or unify into a larger whole.
a. Regional Integration
b. Globalization
c. International Business
d. Trading Bloc

52. Identify the correct answer. Regional integration should not:

a. Build environmental programs at regional level
b. Strengthen trade integration in the region
c. Contribute to the peace and security of the region
d. Break ties with other countries

53. ________________is an agreement between countries to reduce tariffs and other trade barriers.
a. Regional Integration
b. Globalization
c. International Business
d. Trade Bloc

54. ________________is a free trade area and goods passing through a transit zone are normally not
subject to any customs formalities, duties, or import restrictions of the host country.
a. Custom Union
b. Transit Zone
c. Preferential Trade Agreement
d. Free Trade Agreement

55. The different types of Regional Integration include

a. Free trade area
b. Custom unions
 c. Preferential trade agreement
d. All of the above

56. Which one is not a Regional Integration Agreement?

a. NAFTA
b. OPEC
c. MERCOSUR
d. APEC

57. The countries that are part of an ______________ have common policies on the freedom of
movement of four factors of production, common product regulations and a common external
trade policy.
a. Economic union
b. Custom union
c. Political Union
d. All of the above

58. The main objective of UNCTAD is to formulate policies regarding trade, finance and technology.
a. IMF
b. WTO
c. UNCTAD
d. NAFTA

59. The major support systems for international business are

a. WTO (World Trade Organisation),
b. World Bank,
c. International Monetary Fund (IMF).
d. All of the above

60. _______was established on 1st January 1995. In April 1994, the Final Act was signed at a
meeting in Marrakesh, Morocco.
a. WTO
b. IMF
c. ILO
d. NAFTA

61. The major agreements of World Trade Organization are____________

a. GATS
b. TRIPS
c. GATT
d. ALL OF THE ABOVE

62. ______________is a specialised agency of the United Nations which deals with labour issues. It also
manages work through three main bodies, namely International Labour Conference, Governing Body
and International Labour Office.
a. WTO
b. IMF
c. ILO
 d. NAFTA

63. The components of International Financial Management are

a. Foreign exchange markets only
b. Foreign exchange markets and foreign currency derivatives
c. Foreign exchange market, foreign currency derivatives, and international monetary
system
d. Foreign exchange market, foreign currency derivatives, international monetary
system and international financial markets

64. The scope of International Financial Management includes

a. Working Capital
b. Financing Decisions
c. Taxation
d. All of the Above

65. The bases of international tax system includes

a. Tax neutrality
b. Tax equity
c. Avoidance of double taxation
d. All of the above

66. The principle of ________________states that all equally positioned tax payers should
contribute in the cost of operating the government according to the equal rules.
a. Tax neutrality
b. Tax equity
c. Avoidance of double taxation
d. Tax Planning

67. The____________ provides links among the capital markets of individual countries.
a. Foreign currency markets
b. International security markets
c. International capital markets
d. International money markets

68. _____________are the type of compulsory and regulatory mechanisms for training on financial
reports and conducting successful audit for the same. It is used in almost all countries.
a. Accounting Standards
b. Domestic Accounting Standards
c. International Accounting Standards
d. International Financial Reporting Standards

69. ______________ are principle-based values; interpretations and the arrangement followed by
the International Accounting Standards Board (IASB).
a. Accounting Standards
b. Domestic Accounting Standards
c. International Accounting Standards
d. International Financial Reporting Standards(IFRS)
70. Which practice of a foreign seller representing complementary, non-competing lines is using
another exporter as an intermediary?
a. Direct Exporting
b. Indirect Exporting
c. Piggyback Exporting
d. None of the above

71. ______________is the process of dividing the market into clusters and then positioning the
product with respect to the segment and target audience.
a. Segmentation
b. Branding
c. Positioning
d. Competing

72. The levels of brand value are

a. Core Functionality
b. Emotional Values
c. Added Value Services
d. All of the above

73. _________________is characterised by the intangible aspects of a brand that fits the
psychological profile of the target customer.
a. Core Functionality
b. Emotional Values
c. Added Value Services
d. None of the above

74. Arm’s Length pricing rule is used for determining

a. International pricing
b. Transfer pricing
c. Domestic pricing
d. All of the above

75. Name the pricing strategy where price of the goods are set high initially to skim the revenue
from the market layer by layer?
a. Market Penetration
b. Market Skimming
c. Market Holding
d. Market Positioning