Basics of International Business

Basics of
International
Business
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Basics of
International
Business
James P. Neelankavil and Anoop Rai

____________________________
To
Angel, Prince, Erica, and Salve
and
Justin, Sonali, and Pat
with our love
____________________________
First published 2009 by M.E. Sharpe
Published 2015 by Routledge

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Notices
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Practitioners and researchers must always rely on their own experience and
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Library of Congress Cataloging-in-Publication Data
Neelankavil, James P.
Basics of international business / by James P. Neelankavil and Anoop Rai.
p. cm.
Includes bibliographical references and index.
ISBN 978-0-7656-2392-8 (pbk. : alk. paper)
1. International business enterprises. 2. International finance. I. Rai, Anoop, 1955– II. Title.
HD2755.5.N44 2009
658'.049—dc22 2008049003
ISBN 13: 9780765623928 (pbk)

Contents
PREFAcE AND AcKNOWLEDGMENTS ix

1. INTRODUCTiON AND OVERViEW 3
Learning Objectives 3
Reasons for Growth in International Business 7
Types of International Operations 8
International Business Research and the Need for Information 11
Ethical Considerations in International Business 17
Stakeholder Theory and Corporate Social Responsibility 22
Corruption 28
Chapter Summary 35
2. INTERNATiONAL BUSiNESS ENViRONMENT: CULTURE 38
Cultural Environment 39
Framework of Cultural Classification 47
Cultural Generalization 60
Cultural Convergence 61
Culture Shock 61
Cultural Orientation 62
Chapter Summary 63
Application Case: Business Negotiations and Cultural Pitfalls—Mexico 65
3. ECONOMiC AND OTHER RELATED ENViRONMENTAL VARiAbLES 67
The Economy 67
Economic Development and International Business 72
Economic Factors and International Business Strategy 78
Economic Factors and Country Risk Analysis 81
Chapter Summary 90
Application Case: China’s Economy and Foreign Direct Investment Flows 92
4. THE POLiTiCAL AND LEGAL ENViRONMENT 94
The Political Environment 94
v
VI CONTENTS
The Legal Environment 107

Chapter Summary 114
Application Case: Adapting Finance to Islam 115
5. INTERNATiONAL TRADE AND FOREiGN DiRECT INVESTMENTS 117
International Trade 117
Mercantilism 118
Theory of Absolute Advantage 118
Theory of Comparative Advantage 119
Heckscher-Ohlin Factor Proportions Explanation for International Trade 121
The Product Life Cycle Theory 121
Global Patterns of Trade: Statistics 122
World Trade Organization 124
International Trade in the Future 125
Foreign Direct Investment 126
Chapter Summary 142
Application Case: Siemens in Argentina 144
6. ENTRY STRATEGiES 146
Export/Import Strategy 147
Direct Investments 160
Comparison of the Various Modes of Entry Strategies 168
Chapter Summary 169
Application Case: General Electric 170
7. FUNCTiONAL INTEGRATiON 172
Production and Operations Management 174
Finance 176
Marketing 177
Human Resources 180
Accounting 182
Management Information Systems 183
Research and Development 184
Chapter Summary 185
Application Case: BMW in India 187
8. INTERNATiONAL PRODUCTiON & OpERATiONS MANAGEMENT
AND SUppLY-CHAiN MANAGEMENT 189
Operations Management in Manufacturing vs. Services 190
Internationalization of Production & Operations Management 191
Decisions in Production & Operations Management 192
Operations Management Strategies and Supply-Chain Management 215
CONTENTS VII
Chapter Summary 218

Application Case: Toyota and Lean Manufacturing 219
9. GLObAL OUTSOURCiNG OR OffSHORiNG 221
Outsourcing, Offshoring, Inshoring, and Near-Shoring 223
Offshoring of Services: Internet Technology vs. Business
Process Offshoring 225
Future of Offshoring Services 230
Toward a Global Offshoring Strategy 232
Advantages and Disadvantages of Offshoring Services 233
Chapter Summary 241
Application Case: Evalueserve and Knowledge Process Outsourcing 243
10. THE FOREiGN EXCHANGE MARKET 245
Definition of Foreign Exchange 246
Appreciation and Depreciation of Currencies 247
Major Currencies of the World 249
The Euro 249
History of Foreign Exchange 250
Size of the Foreign Exchange Market 255
Determination of Foreign Exchange Rates 256
Participants in the Foreign Exchange Market 258
Exchange Rate Regimes 259
Multinationals and Foreign Exchange 260
Chapter Summary 264
Application Case: Dollarization and the Case of Ecuador and El Salvador 265
11. INTERNATiONAL MARKETiNG 268
Final and Industrial Consumers 269
Goods vs. Services 269
Marketing Activities 270
Basics Steps in International Marketing 273
Developing an International Marketing Strategy 274
Chapter Summary 297
Application Case: Natura—A Brazilian Success Story 299
12. INTERNATiONAL HUMAN RESOURCES MANAGEMENT AND
ORGANiZATiONAL STRUCTURES 301
Managing the Human Resources Function 303
Organizational Structures 314
Chapter Summary 326
Application Case: Chiba International 329
VIII CONTENTS
13. INTERNATiONAL FiNANCiAL MANAGEMENT 331

International Expansion 331
International Banks 334
International Transactions 337
International Shipping 341
International Insurance 343
Stock Exchanges and Markets 344
Regulatory Agencies 347
The Foreign Corrupt Trade Practices Act of 1977 349
The Financial Crisis of 2008 349
Chapter Summary 350
Application Case: Iceland 2008—Concern for Exporters and Importers 352
14. INTERNATiONAL ACCOUNTiNG 354
Basics of International Accounting 355
History of Accounting 359
Toward a Global Accounting System 360
International Accounting and Taxes 367
Chapter Summary 373
Application Case: The Fannie Mae Accounting Scandal 375
Appendix 14.1. Summary of Some Similarities and Differences
between IFRS and U.S. GAAP 377
Appendix 14.2. Global Corporate and Indirect Taxes, 2007 380
AppENDiX 1. REGiONAL ECONOMiC INTEGRATiONS 382
Benefits of Integration 383
Activities and Operations of NAFTA and the European Union 384
AppENDiX 2. WORLDWiDE ORGANiZATiONS AND INTERNATiONAL AGENCiES 402
The International Monetary Fund 402
The Organisation for Economic Co-operation and Development 408
The United Nations 411
The World Bank 422
AppENDiX 3. THE INTERNET iN INTERNATiONAL BUSiNESS 427
The Internet and Business 427
The Internet and International Business 428
Appendix 3 Summary 433
NOTES 435
GLOSSARY 455
NAME INDEX 463
SUBJEcT INDEX 465
ABOUT THE AUTHORS 485
Preface and Acknowledgments
This textbook is aimed at students who wish to learn and work in the field of in-
ternational business. International business consists of the activities of commercial
organizations across borders. Over the past 50 years, international business has
grown rapidly, and it is now fair to say that it makes up a large portion of the busi-
ness activities around the world. Moreover, the globalization of markets—that is, the
trend toward borderless markets—has further enhanced the growth in activities of
international companies.
The field of international business is dynamic, complex, and challenging. Daily
worldwide events such as changes in governments, economic shifts, political tur-
moil, and natural disasters all affect the operations of international companies. To
function under these challenging conditions, international business executives need
to understand the complexities of their external environments; furthermore, they
need to have a sound knowledge of business practices that can help them develop
viable strategies to manage their operations. With this in mind, the objectives of this
introductory textbook are to familiarize students with the external environments that
affect international businesses, to show students how to recognize the processes in
identifying potential foreign markets, and to help students understand the functional
strategies that can be developed to succeed in this highly competitive environment.
Every student of international business should be familiar with this process.
The concepts, theories, and techniques presented here are organized around seven
major topical areas:
1. An introduction and overview of international business

2. Environmental variables and in-depth discussion of the key variables
a. Culture and its effects on businesses and customers

b. Political and legal environment
c. Economic and competitive environment
3. Discussion of entry strategies

4. International trade and foreign direct investments
5. Integration of functional areas
6. Discussion of specific functional areas
ix
X PREFAcE AND AcKNOWLEDGMENTS
a. Production and operations management

b. International marketing
c. Human resources management and organizational structures
d. International financial decisions
e. Managing foreign exchange
f. International accounting
7. Global outsourcing and its role in international operations
In writing this book, we have drawn from our collective experiences in teaching
international business courses. Our philosophy in developing this textbook has been
shaped by many authors, who over the years have influenced our thinking.
Many people assisted us in the preparation of this book by contributing their time
and efforts in suggesting revisions, compiling data, writing programs, and being
cheerleaders. To them we owe a great debt of gratitude. Of the many individuals who
helped in the development of this text, the following went out of their way to see this
work to its completion: our colleagues Mauritz Blonder, Claudia Caffereli, Debra
Comer, Songpol Kulviwat, Keun Sok Lee, Rusty Mae Moore, Shawn Thelen, Rick
Wilson, and Yong Zhang; our graduate assistants Eugene Dotsenko, Daniel Novello,
and Sila Saylak; and Eileen G. Chetti for her editorial work.
ACKNOWLEDGMENTS
We appreciate the helpful suggestions of our peers who took time out from their busy
schedules to read individual chapters and suggest changes that have considerably
improved the material in the text:
Dr. Sandip Dutta, Southern Connecticut University

Dr. Tao Gao, Northeastern University
Dr. Jing Hu, California State Polytechnic University
Dr. M. P. Narayanan, University of Michigan
Dr. Sam Rabino, Northeastern University
Dr. Gladys Torres-Baumgarten, Kean University
Dr. Ashok Vora, Baruch College
Dr. Erik Devos, University of Texas—El Paso
We would like to extend a special thanks to Harry M. Briggs, executive editor of

M.E. Sharpe, for his interest in and wholehearted support of this project. Also, thanks
to all the staff at M.E. Sharpe, especially Stacey Victor, Production Editor, and Eliza-
beth Granda, Associate Editor for their help during the production process.
Finally, we would like to thank our families—Angel, Prince, Erica, and Salve, and
Justin, Sonali, and Pat—for being there for us throughout this process and encouraging
us during times of frustrations and setbacks; to them, we are eternally indebted.
Basics of
International
Business
1 Introduction and Overview
International business involves understanding the external environment,

conducting country risk analysis, deciding on an entry strategy, managing the
strategic functions, understanding the effects of foreign exchange
transactions, and recognizing the value of global outsourcing.
LEARNiNG ObJECTiVES
• To understand the growth and importance of international business
• To understand the scope of international business
• To recognize the differences among various international organizations
• To understand the importance of international business research
• To understand the ethical considerations in international operations
• To understand stakeholder theory and corporate social responsibility in an inter-
national setting
• To understand the causes and effects of corruption
Businesses have engaged in international trade for thousands of years. In fact, in-
ternational business has played a major role in shaping world history, from nations’
attempts to control trading routes to their colonization of countries. International trade
(exports and imports) has grown from US$50 billion just 50 years ago to US$12 tril-
lion in 2006.1 Between 2000 and 2006, international trade grew at an annual rate of
13 percent for a total growth rate of 87 percent over the course of just six years. The
following sections discuss some of the critical activities involved in international com-
panies’ business operations, including (1) the reasons for pursuing overseas markets,
(2) the various forms of entry into foreign markets, (3) the types of organizations that
are involved in international operations, (4) the need for information and functional
strategies among international companies, and (5) the ethical and corporate social
responsibility considerations in international operations.
In the new world order, Chinese, European, Japanese, South Korean, and U.S.
companies will not only be competing with each other; they will also be competing
with highly competitive companies from many parts of the world, including companies
from other Asian countries, Latin American countries, and central European countries.
3
4 CHApTER 1
Because of these changes, the World Economic Forum’s Global Competitiveness Index
(GCI) will reflect the emergence of many countries that were not on the previous lists.
For example, Brazil and Russia have both moved up to the top half of the list. One
surprising element is that the United States—even with its recent economic turmoil
due to the 2008 credit crisis—is still ranked number one on the index.
International business management is a complex, multidimensional field. The
intense competition for world markets, global expansion, and dramatic changes in
technology have made the task of managing an international firm very challenging.
Phenomenal growth in many Asian and Latin American countries is shifting the world
economic order from the West to other parts of the world. Singapore, which a few years
ago was labeled a newly industrialized country (NIC), is now a fully industrialized
country. China has been experiencing double-digit economic growth rates for nearly
a decade and projections point to a sustained growth rate of greater than 8 percent for
the coming decade. India’s real gross domestic product (GDP) grew by 7.5 percent
in 2005, by 8.1 percent in 2006, and by an estimated 8.5 percent in 2007.2 China
and India are expected to be major economic powers of the twenty-first century. On
a macroeconomic level, these countries pursue different strategies: China follows
a state-driven export-oriented economy; India, however, follows a market-oriented
consumption-driven economy. Both countries have been successful in their pursuit
of economic growth.
The emergence of China and India as major forces in international trade is not an
isolated random occurrence. Countries such as Brazil, South Korea, and Taiwan are
leading exporters of high value goods, including automobiles, commercial airplanes,
and computer hardware. South Korea is one of the world’s leading shipbuilders. These
countries present a vast and untapped market for goods and services. Such growth,
coupled with stagnant and saturated markets in most of the industrialized nations, is
forcing many companies to seek their own growth in these emerging markets. For
example, Hewlett-Packard (HP) has weathered the softening of demand for its com-
puters through its expanding international operations. HP generates approximately
65 percent of its revenues from overseas markets.3 Similarly, domestic sales for
Power Curbers, a U.S.-based machinery manufacturer, are expected to decline by 10
percent, but this decline is offset by the firm’s foreign sales, which are growing at
a much higher rate.4 Hence, the foreign expansion of U.S. companies into overseas
markets is driven by both large and small to medium-sized companies, and most U.S.
companies have recognized the immense potential for growth in foreign markets.
According to the Standard & Poor’s 500 stock index (S&P 500), more than half of
these companies’ sales are expected to come from abroad.5
Rising input costs in industrialized countries are another motivation for compa-
nies to expand their operations into overseas markets. An assembly line worker in
the Volkswagen plant in Wolfsburg, Germany, earns $25 an hour and works 33 to
35 hours per week compared to a factory worker in China who earns $2 to $3 a day
and works 45 to 48 hours per week. (Minimum wage standards in China vary from
province to province. For example, in Shenzhen the minimum wage is $101.25 per
month, in Shanghai it is $86.25 per month, and in Fujian it is $53.75 per month.)6 The
availability of low-cost resources such as labor and raw materials in foreign markets
INTRODUcTION AND OVERVIEW 5
Table 1.1
Average Hourly, Weekly, and Monthly Wage Rates in the Manufacturing Sector for
Selected Countries (US$), 2006
# Country Hourly Wage Rate Weekly Wage Rate Monthly Wage Rate
1 Austria 19.38 — —
2 Australia — 870.00 —
3 Canada 17.76 — —
4 Czech Republic — — 884.32
5 China — — 102.00a
6 Ireland 19.04 758.10 —
7 Japan — — 3,569.10
8 Netherlands — 1,082.72 —
9 Philippines 5.32 — —
10 Romania — — 383.83
11 Singapore — — 2,364.70
12 South Korea — — 2,799.35
13 Spain 16.97 — 2,382.50
14 Taiwan — — 1,298.40
15 United Kingdom 19.25b — —
16 United States 16.50–25.00c — —
Source: ILO Statistics and Database, available at http://www.ilo.org/ (accessed June 19, 2007).
Notes: The International Labor Organization (ILO) reports labor rates in hourly, weekly, and monthly
rates depending on how each country reports the data. The ILO reports rates in local currency. Rates have
been translated in U.S. dollars using the average exchange rate for the year.
aAs reported by China Labor Watch, July 2006, pp. 1–4.
bUK Statitistics Authority, “Wage Rates.” Available at http://www.statistics.gov.uk/ (accessed June 19,
2007).
cU.S. Bureau of Labor Statistics, available at http://www.bls.gove/oes (accessed June 19, 2007).
makes global expansion attractive to international firms. For example, Motorola, a

U.S.-based electronics company, has set up two large manufacturing plants in China
to tap into the low-cost but highly trained workforce. Motorola has invested more
than $3 billion in China and is the largest foreign investor in China’s electronics
industry. It employs 9,000 Chinese workers and has committed itself to improving
China’s technological base. Similarly, Intel is building a chip manufacturing facility
at Dalian at a cost of $2.5 billion. Table 1.1 presents hourly, weekly, or monthly labor
costs for 16 selected countries.
As shown in Table 1.1, wage rates range widely from country to country. China’s
monthly wage rate, one of the lowest at $102.00, is one-thirty-fifth of Japan’s monthly
rate of $3,569.10. It is no wonder, then, that international companies seek out countries
where they can benefit from these low wage rates, provided the skill and productivity
levels of the workers from the low-wage-rate countries are comparable to those of
higher-wage-rate countries.
Businesses are adapting to a more global philosophy, as well. Globalization im-
plies that the countries of the world are more interdependent on each other and that
the people in these countries are affected by events and conditions outside their own
country. Take for example the 2008 credit crisis. The mess caused by fast-and-loose
6 CHApTER 1
Table 1.2
The World’s Ten Largest International Corporations Ranked by Revenues, 2007
Revenues Net Earnings Total Assets Employees In # of

Rank Company Country (000,000,000) (000,000,000) (000,000,000) (000) Countries
1 Wal-Mart U.S. 351.1 11.2 151.2 1,900.0 15
2 ExxonMobil U.S. 347.2 39.5 235.3 108.0 130
3 Royal Dutch Shell Netherlands 318.8 25.4 192.8 114.0 145
4 British Petroleum U.K. 274.3 22.0 217.6 96.0 100
5 General Motors U.S. 207.3 (2.0) 284.0 186.2 150
6 Toyota Japan 204.7 4.1 244.6 299.4 170
7 Chevron U.S. 200.6 17.1 125.8 62.5 180
8 DaimlerChrysler Germany 190.2 3.2 201.6 360.4 Over 100
9 ConocoPhillips U.S. 172.5 15.6 164.8 32.7 40
10 Total France 168.4 14.8 126.3 96.4 130
Source: “Global Five Hundred,” Fortune, July 24, 2008, pp. 89–98; Fortune Global 500, July 23, 2008,
pp. 130–139, and company financial reports, December 2007.
mortgage lending in the United States escalated into a perilous global crisis of con-
fidence that revealed both the scale and the limitations of globalization. The credit
crisis worsened and became a global problem because of the interdependence of the
countries of the world. Tied together in an increasingly tattered web of loans, banks
around the world dragged one another down.
Globalization proposes that companies view the world as one single market to as-
semble, produce, and market goods and services. Globalization is defined as sourcing,
manufacturing, and marketing goods and services that consciously address global
customers, markets, and competition in formulating a business strategy. According
to John Zeglis, CEO and president of AT&T, in the future, there will be two kinds of
companies: those companies that go global and those companies that go bankrupt.7
From simple across-the-border transactions a few decades ago, international busi-
ness has grown to encompass a vast network of countries, installations, individuals,
resources, and organizations. Table 1.2 presents the world’s ten largest international
corporations ranked by revenues for the year 2007.
The dynamic changes affecting the economic, political, and social climate in many
countries represent a new challenge to businesses. Western Europe has dismantled
the internal barriers to form a unified region with a single currency and a vast market
made up of 500 million consumers. The former Soviet Union has spawned 18 new
countries. Eastern Europe and Russia have acknowledged the failure of centrally
managed economies and have adapted free market economic structures and privatiza-
tion. Indeed, the world has changed profoundly over the past decade. Some perceive
these dynamic shifts as problem areas, but these changes also provide some rare
opportunities that never existed before. Higher economic growth among emerging
economies, coupled with stagnant economic growth in Europe and Japan in the past
decade, has shifted the balance of and direction in investments. Since the 1950s,
growth in international investments has been substantially larger than the growth
in the U.S. economy. Large multinational companies derive more than half of their
revenues and profits from international operations. Examples of such companies and
their percentage of international earnings include Siemens (77 percent), Philips (73
percent), Sony (71 percent), Coca-Cola (70 percent), Toyota (66 percent), Procter &
Gamble (51 percent), and Unilever (50 percent).
REASONS fOR GROWTH iN INTERNATiONAL BUSiNESS

We have mentioned many reasons for the growth in international business. Some are
related to the internal workings of a company; others are market-related factors; and
still others are related to the external environment. The following list includes some
of the main reasons for international business growth over the last 20 years.
• Saturation of domestic markets. In many of the industrialized countries, market

penetration of most goods and services has reached saturation levels. For ex-
ample, penetration of appliances, telephones, and televisions in Europe, Japan,
and the United States is over 95 percent. Therefore, further growth potential in
these countries is nonexistent.
• Sales and profit opportunities in foreign markets. As the markets in industrialized
countries attain saturation levels, consumers in countries that are just attaining
economic growth are demanding goods and services at unprecedented levels—
levels that most often only international companies can meet. For instance, the
number of cars sold in Asia is growing rapidly, with sales in China alone expected
to reach more than 6 million by the year 2008.8
• Availability of low-cost labor. As show in Table 1.1, labor rates in industri-
alized countries are high, driving production costs higher. To counter this
increased cost, international companies shift production facilities to countries
with lower labor costs. For example, 90 percent of the clothes bought by
Americans come from places like China, Mexico, Bangladesh, Honduras,
Indonesia, and Vietnam.9
• Phenomenal economic growth in many emerging economies. The economic
growth occurring in Brazil, China, the Czech Republic, India, South Korea,
Tunisia, and Taiwan, for example, has created a large middle-class consumer
base that is in a position to acquire high-priced quality goods and services from
global brand-name producers.
• Competitive reasons. Either to stem the increased presence of foreign companies
in their own domestic markets or to counter the expansion of their domestic
competitors into foreign markets, international companies have used overseas
market entry as a countermeasure to increased competition. Both these actions are
defensive measures that prevent domestic and foreign competitors from gaining
undue advantage.
• Pent-up demand for goods and services among the population of the emerging
economies. Consumers in countries that did not have the purchasing power to
acquire high-quality goods and services are now able to buy them due to improved
economic conditions.
8 CHApTER 1
• Diversification attempts by international companies to reduce risk. One benefit

of the international expansion of businesses is that international companies are
able to counter the cyclical patterns of growth observed in different parts of
the world. For example, if Asian countries are undergoing a downturn in their
economies that affects profitability, the robust economies of Latin America will
provide opportunities for substantial profits.
• Progressive reduction of trade barriers among nations through cooperation. This
shift has stimulated cross-border trade between countries and opened markets
that were previously unavailable for international companies due to tariff and
nontariff barriers.
• Cultural convergence in tastes and values. Due to advances in telecommunication
technology, the world is well informed about events, product offerings, and sites
(McDonalds, Starbucks, and MTV) that offer goods and services online. This
has led consumers from all over the world to buy goods and services made in
different countries through Web sites such as Amazon.com, eBay, and the like.
• The spread of economic integration among nations facilitating trade and the
barrier-free flow of resources from country to country (expanded European
Union, NAFTA, and other bilateral arrangements). In addition, the integration of
countries has created vast domestic markets that open up investments in capital-
intensive industries.
• Advances in technology in such areas as computers, telecommunications, and
travel. Technological advances have reduced the costs of transportation and
logistics and have also produced improvements in supply-chain management,
significantly reducing the costs of coordinating production among globally dis-
tributed suppliers.
As international companies venture into foreign markets, these companies will need
managers and other personnel who understand and are exposed to the concepts and
practices that govern international companies. Therefore, the study of international
business may be essential to work in a global environment.
TYpES Of INTERNATiONAL OpERATiONS

Businesses can get involved in international operations in many different ways. The
most common and perhaps the easiest way for companies to venture into international
operations is through exports and/or imports of goods and services. Other types of
international operations include licensing agreements such as franchising; direct in-
vestments; and portfolio investments. Chapter 6 discusses these operations in detail
as part of the entry strategies available for an international company.
EXpORTS/IMpORTS
Trading through exporting and importing is a good way for companies to enter and
establish a presence in foreign markets. It may serve as a stepping stone for greater
commitment in the market at a later date. This is especially true for larger interna-
tional companies. In most countries, smaller firms are in the business of exporting or
importing (or both) goods and services. These operations require minimal capital and
very few staff. Typically, exports are the easiest means of generating foreign-currency
reserves, provided the country imports fewer goods and services than it exports. For
example, China’s trade surplus for 2007 was estimated to be more than US$200 billion.
Chinese and foreign companies operating in China exported US$350 billion worth
of goods, while their imports for the year were valued at US$150 billion. Through
exports, an international company can sell any type of goods from slippers to large
commercial airplanes.
Services too, can be exported. Service exports may be in the form of travel,
tourism, financial services (banking, insurance, investment banking, and the like),
and other services such as accounting, education, engineering, and management
consulting. Many Caribbean countries earn a major share of their foreign-currency
reserves through tourism. As people travel to these islands for vacations, they ex-
change their currencies for local currency, which they then use for food, lodging,
and sightseeing.
LIcENSING AND FRANcHISING AGREEMENTS

Licensing agreements allow a local company to use a copyright, patent, or a trademark
that is owned by a foreign company for a preset fee. Franchising is a specific type
of licensing agreement in which the foreign company (the franchisor) sells to a local
company or independent party (the franchise) the use of a brand name or trademark,
which is considered an important business asset. For example, many McDonald’s
outlets in overseas markets are set up as franchise agreements.
FOREIGN DIREcT INVESTMENTS

A foreign direct investment (FDI) is the acquisition of plant, machinery, and other
assets in foreign countries. These investments may be through joint venture partner-
ships or through a wholly owned subsidiary in a foreign country. Through direct
investments, management has partial or full control of its operations. For example,
when Intel invests US$2 billion in Leixlip Ireland to manufacture chips, it is involved
in FDI operations.10 Intel assumes that its investments will generate sufficient cash
flows to justify this investment. In recent years, China has been the world’s biggest
recipient of FDI: in 2006 alone its FDI inflows were nearly US$70 billion. Table 1.3
presents the FDI flows of ten selected countries for 2006.
PORTFOLIO INVESTMENTS
Portfolio investments are purchases of financial assets with a maturity greater than
one year (as opposed to short-term investments, which mature in less than one
year). As companies go global, so do increasing numbers of investors. Investors
are buying foreign stocks and bonds as part of their financial portfolios. The total
return on an investment is made up of dividend or interest income, capital gains
10 CHApTER 1
Table 1.3
FDI Flows to a Few Selected Countries, 2006
# Country FDI flows (US$ hundred millions)

1 Australia 24.0
2 Brazil 18.2
3 Canada 69.0
4 China 69.5
5 Czech Republic 5.9
6 India 16.9
7 Mexico 19.0
8 New Zealand 8.0
9 Philippines 2.3
10 United States 175.3
Source: United Nations Conference on Trade and Development, World Investment Report, 2007.
and losses, and currency gains and losses. International investing diversifies an
investor’s portfolio, which helps reduce risk and provides greater opportunities
than domestic investing.
ORGANIZATIONAL LABELS FOR INTERNATIONAL COMpANIES

International companies are given different names depending on who labels them, that
is, government agencies, international organizations, the business press, or academi-
cians. Though they have similar meanings, these labels are quite often confusing. The
following is a list of labels that apply to international companies.
• International company—a company of any size that participates in any form of

business operation (export/import, licensing/franchising, strategic alliances, and
FDI) outside its national boundaries (cross-border activity).
• Multinational corporation (MNC)—a large international company that has ex-
tensive involvement in international operations through direct investments and
control of operations.
• Multinational enterprise (MNE)—similar to an MNC; a large, well-organized
international company that operates in overseas locations and has considerable
resources invested abroad.
• Transnational corporation (TNC)—an international company owned and managed
by nationals from different countries. For example, Unilever is a joint holding of
British and Dutch nationals. The term “transnational” is also used by the United
Nations in reference to international companies.
• Global company—an international company with a network of worldwide inte-
grative activities that attempts to standardize its products and service offerings.
A global company might have its manufacturing in one country, technology from
another country, capital from a third country, and distribution covering many
countries. For example, Canon Inc. manufactures its products in China, uses
Japanese technology, gets financing from outside Japan, and sells its finished
goods worldwide.
INTERNATiONAL BUSiNESS RESEARCH AND THE NEED fOR INfORMATiON

As businesses venture outside their own countries, the need to understand the
market conditions in foreign countries becomes more and more critical. Business
research, like all business activity, has become increasingly global. Companies
that have operations in foreign countries must understand the unique features of
these markets and determine whether they need to develop customized strategies
to be successful. For example, to tap into the vast Chinese market, international
companies are dispatching legions of researchers to China in order to get a sense
of consumers’ tastes.11 Before 1990 there was only one professional marketing
research firm in the whole of China; today there are more than 300 professional
firms.12 From the first quarter of 2000 to the second quarter of 2002, requests for
market research proposals in China increased dramatically, from 22 percent to 42
percent.13 Most of the world’s large research suppliers now have offices in China.
It is no longer sufficient to try to determine what Chinese consumers want simply
by accessing lists of how much individuals earn and what they own. Companies
need to understand what motivates Chinese consumers and what products they
want and can use.
Information about environments, customers, market forces, and competition is es-
sential in planning entry into an overseas market. Generally, business executives lack
detailed knowledge of overseas market conditions. Compounding the problem is the
unpredictability of the foreign markets compared to markets in many of the industri-
alized countries, which are more stable and predictable. For instance, the economic
turmoil experienced in countries such as Indonesia, Malaysia, and Thailand in July
1997 came as a surprise to most business leaders and economists, as these countries
had been projected to continue their strong growth into the twenty-first century. The
home market presents a known environment for business executives, whereas a foreign
market appears to be a black hole for many of these same executives. The availability
of accurate information is most often the equalizer in this equation, which is why
large international companies spend millions of dollars on information acquisition.
For example, Hitachi Corporation of Japan spends a major portion of its $4 billion
research and development (R&D) budget on understanding its target customers.14
Information is essential to business decision making. Information gathered through
research is useful in defining problems, resolving critical issues, identifying oppor-
tunities, and fundamentally improving the strategic decision-making process in an
organization. Specifically, in international business, research may be used to identify
countries with the greatest growth potential, to predict changes in the political envi-
ronment of a country, to decide on a location for a manufacturing plant, to identify
sources of capital, or to select a target market. In addition, information may be used
to evaluate the effectiveness of a business plan.
Access to current, high-quality information is essential for businesses, whether
they operate domestically or internationally; for international companies, however,
12 CHApTER 1
the need for useful information is much greater because of the uncertainties of
the international markets. As mentioned earlier, international business operates in
an unknown and more volatile environment than domestic business. Many of the
external variables that have little effect on businesses in domestic markets play a
critical role in international operations. For example, changes in political stabil-
ity, exchange-rate volatility, and sudden surges in inflation do not ordinarily take
place in Japan, the United States, and other industrialized countries. For companies
and their executives operating in these countries, managing such environments is
much easier than, say, running a subsidiary in Bolivia, Ghana, or Indonesia, where
inflation sometimes reaches double and triple digits. In addition, some developing
countries can present serious problems such as the sudden collapse of governments,
the unpredicted devaluation of local currencies, or unexplained changes in business
regulations. Outside of the industrialized group of countries, the business environ-
ment tends to be unpredictable.
Many international business failures result from executives neglecting to rec-
ognize cultural and market-related differences. Consider the following examples,
which show how research would have helped the international company avoid an
embarrassing situation while preventing the loss of market share and/or profits.
When a furniture polish company introduced its aerosol spray polish and advertised
its timesaving attribute in Portugal, the product failed miserably; the housewives in
Portugal were reluctant to buy such a labor-saving device for their maids. A com-
prehensive consumer study might have revealed the cleaning habits of Portuguese
households and helped the company avoid this costly mistake. In a similar case,
when General Mills introduced one of its breakfast cereals in the United Kingdom,
its package showed a grinning freckle-faced redheaded kid with a crew cut saying,
“See, kids, it’s great.” The campaign failed to recognize that in the United King-
dom, the family is not as child oriented as it is in the United States; hence, mothers
seldom turn over the decision of which foods to buy to their kids. Also, depicting a
so-called typical American kid on the package was not very helpful either. Again,
some research on food-buying habits in the United Kingdom could have saved
General Mills some time and money without significantly delaying their cereal
entry into the UK market.15
Most international executives recognize the need for and usefulness of reliable
information, but quite often time and competitive pressures force them to act quickly,
without doing adequate research. A systematic approach to business research is a
critical first step in exploring international markets. Gathering information through
research is not just confined to the marketing function anymore; more and more fi-
nancial institutions, manufacturing firms, and even human resource departments of
international companies are using business research to be more efficient and effective
in their decision making. For example, as the competitive landscape for financial
services became crowded, investment companies and brokerage houses rushed to
grab consumer deposits. This meant that these institutions needed information. Today,
financial service companies in many parts of the world use an array of qualitative and
quantitative research techniques to guide their decisions, both strategic and tactical.16
Similarly, sophisticated new techniques in cognitive mapping are now being used
by the human resources departments of international companies to assess managers’

mental models.17
Conducting international research is challenging, expensive, and time-consuming.
There are many factors that affect international research. Key factors that need to be
addressed include the cost of research, the availability of secondary data, the quality of
data, time pressures, lead time (time that it takes to complete an international research
study), the complexity of the study, whether a multicountry study is necessary, and
how the research is ultimately used.
COSTS
International research is expensive, and the cost of conducting research varies considerably
from country to country. However, information is essential in reducing operational costs
through improved decision making, and research should be viewed as an investment, not
an expense. One of the reasons for the higher costs in international research is the inabil-
ity to find uniformly qualified staff to execute research studies. A lack of well-qualified
research staff implies that the people hired to conduct the research need to be trained,
which adds to the overall cost of the research. In addition, many developing countries
lack a research infrastructure (focus-group facilities, training facilities, computing skills,
and so on). Therefore, international companies have to either not use the local research
setup or develop the necessary infrastructure on their own. Choosing the latter means
these companies have to train staff, establish research facilities, and develop the needed
computing systems. Such efforts add costs far and beyond the normal costs associated with
conducting research. In some industrialized countries, the costs of conducting research
are higher due to higher personnel wages. Even among industrialized countries, however,
costs vary considerably. For example, a focus group study may cost as little as $5,000 in
the United States, and the same focus group might cost about $10,000 in Japan.
AVAILABILITY OF SEcONDARY DATA

Secondary data is the backbone of international research. It is cost efficient and easily
gathered. Secondary data is sometimes the only information available for international
executives facing critical decisions. In many countries, though, secondary data is sparse
or nonexistent. Local governments do not have the resources or personnel to collect
data; therefore, economic, financial, and other relevant information at the macro level
is often outdated or unavailable. Researchers in the United States, Japan, and other
industrialized countries who are accustomed to an abundance of government-provided
secondary data find their forays into other countries shockingly disappointing.
In some instances when secondary data is available, it is often inaccurate or unreli-
able. In Middle Eastern and African countries where there are large nomadic tribes,
the size of the population might vary depending on the season. Similarly, population
figures would be less accurate where estimates are drawn from village elders, who
sometimes exaggerate the number of villagers residing in a village. In countries where
national income statistics are compiled from tax returns, population figures tend to
be notoriously understated.
14 CHApTER 1
QUALITY OF DATA
International research suffers from inconsistency in quality. In some countries, such
as Germany, Japan, the Netherlands, and the United States, the quality and the reli-
ability of the data collected are high. In other countries, however, especially among
less-developed countries, the quality and reliability of data collected may be ques-
tionable. Quality problems apply to both secondary data and primary data. In many
countries of Africa, Asia, and Latin America, commonly used secondary data such as
the population census, industrial output, and national incomes are often two to three
years old, and in some cases are not available at all.
TIME PRESSURES
Quite often the decision to enter an overseas market is made under considerable time
pressure. Decisions have to be made fast in order for a firm to be the first in a new
country and attain certain competitive advantages. In some instances competitors are
already in the market, and there is an urgency to follow. At other times the necessary
negotiations with host-government agencies dictate the need for quick action. These
conditions lead to a very small window of opportunity for an international company,
forcing executives to arrive at a decision under less-than-ideal time constraints and
leading to actions based on very little information.
LEAD TIME
Generally, it takes more time to obtain information from overseas markets than from
domestic ones. Some of the problems associated with data collection abroad have
already been identified. In addition, an international executive’s lack of knowledge
of the overseas markets makes the task of compiling data even harder. Sometimes,
to overcome its lack of knowledge in the target country, an international company
will rely on local research suppliers or local staff to collect and process data. Other
factors that contribute to the need for longer lead time in international research are the
lack of sophistication in data-collection techniques, the unavailability of databases to
gather up-to-date information, and the lack of single-source data (scanners that read
bar codes off packaged items).
COMpLEXITY OF INTERNATIONAL RESEARcH

Conducting a successful research project in one’s own country is challenging in
itself. When the project is international in scope, the dynamics are even more com-
plex. In an international setting, even the basic research steps have their own twists.
Schedules tend to be longer, vendor selection is more difficult, and depth of analysis
can be weak. Even more difficult is controlling the exact design and methodology
for each country in a multicountry study.18 Among the factors that contribute to the
complexity in international research are different levels of market development, the
vast differences in government policies toward foreign firms, unique sets of external
variables present in foreign markets, and the unfamiliarity of international managers

with consumers and markets in foreign countries.
COORDINATING MULTIcOUNTRY RESEARcH

By definition, international research is conducted across many countries. The differ-
ences in languages, cultures, business practices, and customs make the coordination
of research activities across these markets all the more difficult. Difficulties in estab-
lishing the comparability and equivalency in data collection and analysis can make
research across countries difficult and unusable.
International operations encompass a multitude of activities from a simple export
operation to management of a wholly owned subsidiary. The information requirements
for decision makers vary from situation to situation, depending on a firm’s level of
international activity.
By nature, the operations of international companies are far-flung. Diverse activities
located, in some instances, thousands of miles away from the home office complicate
the management of an international company. For instance, it is much easier for a
Japanese multinational to manage one of its subsidiaries in Guangdong province in
China, just three hours away by air, than to manage one of its operations in Munich,
Germany, which is more than 12 hours and several time zones away.
The issues discussed in the previous section reinforce the importance of research
in international business. At the same time, they highlight the difficulties of conduct-
ing international research, especially considering how the extent and the method of
international research vary from situation to situation. In other words, the information
required to develop an export strategy is quite different and less involved than that
needed to set up a wholly owned subsidiary.
An early decision that many international companies have to make is the choice of
a country in which to expand their operations. Companies choose different approaches
in selecting which markets to enter. Larger companies tend to do their own (internal)
country risk analysis. For medium-sized companies, outside research suppliers pro-
vide this type of research. For smaller companies, secondary data through government
publications or through periodic reports published by the business press can be used to
assess country risk. There are a few research studies available for free or at a reasonable
cost for companies that do not have the personnel or capabilities to conduct a country
risk analysis; Euromoney’s Country Risk Analysis is one such study.
USES OF RESEARcH
International companies use research to identify market potential, to make financial
decisions, to select locations for manufacturing plants, and to develop strategies.
Determining Market Potential
As domestic markets become saturated, companies branch out into foreign countries
to seek newer, untapped markets and maintain a steady flow of revenues and profits.
16 CHApTER 1
Market potential, which is defined as the upper limit of market demand, is the basis
for selecting a country for entry. In estimating market potential, companies consider
factors such as total demand, the size of the target market, overall sales potential,
the size of the subsegment, the buying power of the target segment, frequency of
purchase, volume of purchase per shopping trip, and individual competitors’ share of
market. Information on these and other related areas can make the decision simpler
for international executives.
Financial Decisions
Financial decisions in the international field are complex and risky. Exchange-rate
fluctuations, different accounting systems, and government intervention often compli-
cate financial decisions. Timely, high-quality information assists financial planners in
making objective financing and investment choices. As technology and computers play
a key role in financial decisions, the need for a fast information turnaround becomes
a necessity. Thus, to compete in a complex global financial market, international
companies need to invest in information systems. International companies, which
have more options for acquiring funds than domestic companies, can borrow euro-
based currencies, make use of offshore banking facilities, and borrow from financial
institutions in the countries where they have operations. Because of the number of
choices available for acquiring funds, information becomes crucial in selecting the
most cost-efficient funding source.
The many options available to international companies also force them to obtain
the most current information to minimize their cost of capital and remain efficient in
the management of their funds. Some of the factors that affect financial decisions are
unpredictable and may undergo dynamic shifts. A case in point is the recent exchange-
rate volatility observed in Latin America, Russia, and Southeast Asian countries.
Exchange-rate fluctuations, along with a rise in inflation, increase both the cost and
the risk associated with financial decisions.
Manufacturing Plant Location Decisions
Production facilities are located to take advantage of such factors as inexpensive

and technically qualified labor forces, abundant supplies of raw materials, qualified
supplier sources, efficient transportation systems, and proximity to markets. If raw
materials and adequate parts suppliers are available near major markets, then a pro-
duction facility can be located closer to both the source and the market, completing
the value chain. However, for many multinational firms, inputs come from around
the world, and markets may or may not be located near supply sources.
In addition to location of the production facility, international companies must
decide on the size of the plant, or the capacity, for each of its manufacturing facilities.
Some companies adopt a concentrated production approach, that is, a small number
of large plants in a few locations. Other companies have set up a dispersed strategy,
that is, a large number of small plants in many locations. Matsushita of Japan has just
a few manufacturing facilities, most of them concentrated around Asia and servicing
the entire world market. On the other hand, Philips of the Netherlands has hundreds
of plants located in many countries and servicing one or two markets each.
As international companies develop their manufacturing strategies, they need to
be aware of the highly competitive environment in which they operate. Many fac-
tors affect manufacturing strategies. Some, like costs, are relatively easy to control,
while others, such as quality, are affected by a combination of variables and tend to
be difficult to manage. Efficiency, reliability, and flexibility are the other factors that
international firms need to manage well to gain a competitive advantage in global
operations. Competitive reports and information on sources of materials and suppliers
can help companies create an effective manufacturing strategy. As the globalization
process continues, the need for information on business-related areas also grows.
Formalizing Strategies
High-quality information is essential for developing strategies. By understanding

competitors’ strengths and weaknesses and taking that information through a thor-
ough internal analysis, firms are better able to develop both functional and corporate
winning strategies in the marketplace. Functional strategies focus on individual func-
tions such as manufacturing and marketing. Corporate strategies guide the company’s
overall efforts in all its functional areas. For example, Sharp, the large consumer
electronics company based in Japan, was able to use market research information
called “Town Watching” to increase its operating income by 25 percent in fiscal year
1994 alone.19
Most companies realize that going global is more important than ever before and
something they can no longer avoid. In developing a global strategy these companies
must assess global opportunities and establish a tracking system to evaluate their
efforts. International research is the key to the development of a global strategy.20
International business research has definitely increased since the late 1990s. Many
large international companies make use of research to chart their strategies. In cases
where resources are scarce, global companies typically concentrate on the data that
is most important in conducting their overseas operations.21 The size of the non-U.S.
market for research is now larger than it was in the past. Additionally, some small
exporters are using research to explore foreign markets. These exporters do not make
use of traditional research approaches but rely on personal contact with distributors,
agents, customers, and even competitors to gather information concerning the markets
they serve.22
ETHiCAL CONSiDERATiONS iN INTERNATiONAL BUSiNESS

Ethical behavior in general relates to actions that affect people and their well being.
Whereas the need for ethical behavior at the corporate level applies both to domestic
and international firms and their management, our discussion focuses on international
companies and their managers.
In business, the wrongful actions of managers and their companies can have dras-
tic effects on their employees, their customers, their suppliers, the general public,
18 CHApTER 1
and the environment. When companies disregard safety standards, employees risk
injury or death due to dangerous working conditions, customers may be harmed by
unsafe products, the lives of the general public may be endangered due to dumping of
chemicals in residential neighborhoods, and the environment may be harmed due to
the emission of pollutants into air and water. A firm’s disregard of legal and financial
rules—using corrupt bookkeeping practices, for instance—may result in suppliers
incurring losses or, in a worst case scenario, a company going bankrupt.
It is generally accepted that beyond their normal profit maximization goals,
businesses have a responsibility to society at large, referred to as “corporate social
responsibility,” or CSR. CSR involves the ethical consequences of companies’ ac-
tions, policies, and procedures and is defined as “the social responsibility of business,
[which] encompasses the economic, legal, ethical, and discretionary expectations that
society has of organizations at a given point in time.”23 Mark S. Schwartz and Archie
B. Carroll advanced the three-domain model of CSR, stressing that economic, legal,
and ethical responsibilities are equally important and that managers need to find a
balance among the three in developing their strategies.24 The definition implies that
social responsibility requires companies not only to strive for economic gains, but
also to address the moral issues that they face.
Companies seek economic gains to enhance the value of their investors (U.S.
model of business). Accordingly, the primary duty of managers is to maximize share-
holder returns. Some argue, however, that management’s responsibility is to balance
shareholders’ financial interests against the interests of others, including employees,
customers, and the local community, even if it reduces shareholders’ returns. Ad-
vocates of this opinion feel that employees, customers, and the general community
(called the stakeholders) contribute either voluntarily or involuntarily to a company’s
wealth, creating capacity and activity, and are therefore its potential beneficiaries and/
or risk bearers.25 The principle of social responsibility means that companies need
to be concerned as much about the wider group of stakeholders as about the typical
company stockholders. The issue of satisfying the shareholders versus satisfying
the stakeholders is not as simple as it appears. In a competitive global environment,
executives who wish to make their organizations better “corporate citizens” face sig-
nificant obstacles. If they undertake costly initiatives that their rivals do not embrace,
they risk eroding their competitive position.26
Companies are often held responsible for behavior that in some way affects the
society in which they operate; clearly, businesses must consider the welfare of the
people and their environs. International companies have made major shifts in their
CSR policies and actions in recent years. Initiatives such as investing in organic
products, sustainable energy, and environmentally sound practices are becoming
part of international companies’ standard business operations; such practices now
are considered mainstream.27 For example, in its efforts to improve its CSR, Royal
Dutch Shell, the large Anglo-Dutch oil company, has initiated a three-step process
in dealing with stakeholders’ concerns: after soliciting input from stakeholders, the
company develops an organizational language so that CSR is uniformly understood
by every member of the organization, and finally it takes actions that resolve some
of its stakeholders’ concerns.28 Shareholders are increasingly pressuring companies
to ensure that their investments are morally and ethically justified, showing the close
relationship between business ethics and social responsibility. Some of the initiatives
taken by international companies in the area of CSR include donating money for
improving neighborhoods, providing grants to improve agricultural practices, setting
up medical clinics, and sponsoring educational programs.29
For international managers and their companies, these issues are complicated, as
they are foreigners in the countries where they operate. As a result, their behavior is
scrutinized more closely than that of local businesses and their managers. Furthermore,
because of cultural differences and unique business customs, there may be differences
in what is considered harmful. Depending on the country, the extent to which unethical
behavior is tolerated might vary, as well. For example, under the banner of economic
development, logging has reached new heights in countries with vast tracts of forest.
Logging in the Amazon forests of Brazil and the jungles of Borneo has helped efforts
to increase arable land and add to housing stocks. At the same time, indiscriminate
logging has created vast tracts of barren land that have changed the weather pat-
terns, increased soil erosion, decreased the land’s fertility, and created devastating
mudslides. The governments of developing countries such as Bangladesh, Mexico,
and Nigeria may set a premium on employment to the detriment of the environment,
making them unintended supporters of environmental hazards. Hence, international
managers constantly face ethical issue that they may not be equipped to deal with.
In a dynamic global community, potential conflicts in ethical business behavior
become inevitable due to differences in values and business practices across cultures.
Global business ethics is the application of moral values and principles to complex
cross-cultural situations.30 The question is, Which country’s moral values should be
applied? That is, should business executives adopt the moral values of their home
country, called “absolutism,” or the moral values of the host country, called “rela-
tivism”? Absolutism theorists suggest that the home country’s ethical values must
be applied everywhere the multinational corporation operates. In contrast, relativ-
ism theorists follow the adage “when in Rome, do as the Romans do.” In practice,
however, companies do not tend to adopt one of these two extreme positions when
faced with cross-cultural ethical questions, but consider a middle range of ethical
responses that might be less controversial.31 The case of Levi Strauss & Co. illus-
trates this issue very clearly. Levi Strauss & Co.’s contractors in Bangladesh employ
young children, a legal practice in Bangladesh, but one contrary to U.S. laws and the
company’s own policy. The fact that these children were often the sole providers—
or supplied a significant source—of their family’s income did not change the fact
that Levi Strauss was using child labor. The company’s response to the problem was
to send the children to school and at the same time pay the families their children’s
wages as if they were working.
Local cultures and customs also affect business ethics in other ways. Research has
shown that dimensions of national cultures could serve as predictors of the ethical
standards desired in a specific society.32 It has been suggested that in some countries
societal norms and local institutions may unwittingly encourage people to behave
unethically. For example, cultures that value high achievement and are highly indi-
vidualistic societies are likely to pursue achievement at any cost, even if it means
20 CHApTER 1
Table 1.4
International Companies: Areas of Ethical and Social Responsibility Concerns
Affected Stakeholder Ethical/CSR Issues Situations

Customers • Product safety • Should a company delete safety features to make
• Fair price a product more affordable for people in poorer
• Labels countries?
• Should a sole supplier of goods or services take
advantage of its monopoly?
• Should a company assume the cost of translating all
its product information into other languages?
Stockholders • Fair return on invest- • If a product is banned because it is unsafe in one
ment country, should it be sold in other countries where it
• Fair wages is not banned to maintain profit margins?
• Safety and working • What should a company do if it is found that its
conditions executives have been involved in accounting scan-
dals?
• How much should CEOs be paid? Should share-
holders ignore extremely generous severance
packages?
• Should company pay more than market wages
when such wages result in people living in poverty?
• Should a company be responsible for the working
conditions at its own facilities as well as those of its
suppliers?
• Should an international company use transfer
pricing and other internal accounting measures to
reduce its actual tax base in a foreign country?
Employees • Child labor • Should an international company use child labor if it
• Discrimination is legal in the host country?
• Impact on local • Should a company assign a woman to a country
economies where women are expected to remain separate
from men in public?
Host country • Following local laws • Should an international company follow local laws
• Impact on local that violate home-country laws?
social situations • Should an international company require its workers
• Environment to work on local religious holidays?
• Is an international company obligated to control its
hazardous waste to a degree higher than local laws
require?
Society in general • Raw-material deple- • Should an international company deplete natural
tion resources in countries that are willing to let them
do so?
Source: John B. Cullen and K. Praveen Parboteeah, Multinational Management: A Strategic Approach,
4th ed. (Mason, OH: Thomson Publishing), p. 138.
taking unethical actions.33 Therefore, it is more likely that international managers from
the United States—a nation that values high achievement and is an individualistic
society—will engage in unethical behavior than will Japanese managers, who belong
to a collectivistic society in which high achievement is not pursued as vigorously as
it is in the United States. Table 1.4 summarizes the ethical and social responsibility
concerns of international companies.
ETHIcAL THEORIES
From a philosophical point of view, business ethics can be discussed from three dif-
ferent perspectives: the utilitarian (also called teleological), the deontological, and
the moral language philosophies. Utilitarian philosophy suggests that “what is good
and moral comes from acts that produce the greatest good for the greatest number of
people.”34 Many international companies operate under this philosophy, especially
when establishing offices or plants in developing countries. It would be morally justifi-
able, then, to operate plants that fail to comply fully with home-country environmental
laws as long as they meet the host-country standards. Although the plant’s operation
would most probably pollute the environment, it would likely result in higher em-
ployment, as well, thus aiding in the host country’s economic growth and providing
the nation’s people with an opportunity to use modern technology.
Deontological philosophy focuses on actions by themselves, regardless of the
consequences that factor into utilitarian philosophy. Deontology philosophy is also
called the theory of obligation: it postulates that rightness or wrongness resides in
the action itself.35 Therefore, actions themselves are morally good or bad. Hence,
in the previous example, the international company that pollutes the environment is
doing something morally wrong in spite of the positive benefits that are accrued due
to higher employment or improvement in the economy.
The moral language approach builds on the utilitarian and deontological theories
and focuses on international business ethics. First proposed by Thomas Donaldson,
it suggests that the moral code of international corporations can be explained through
the “language of international business ethics.”36 The key questions raised by this
philosophy are: “In what ways do people think about ethical decisions, and how do
they view their choices?” The moral language that is based on rights and duties, avoid-
ance of harm, and social contracts is more appropriate for understanding international
corporate ethics than those based on virtues, self-control, or the maximization of
human happiness. Each one of these variables is entrenched in human behavior and
results in how managers act in international business situations. For example, rights
and duties imply that each individual has certain responsibilities that bestow on the
individual certain rights. Similarly, avoidance of harm focuses on the consequences
of behavior, but unlike the utilitarian principle, it stresses avoiding unpleasant conse-
quences; therefore, actions by managers that do not harm people or the environment
are considered acceptable behavior.
REGULATIONS AND SELF-REGULATIONS TO COMBAT ETHIcAL BEHAVIOR

Today, there are different management standards, codes of conduct, and certification
requirements at the international level. These standards and codes are meant to reduce
or correct unethical corporate behavior and promote adherence to CSR by international
companies. Most international regulations are aimed at transnational corporations,
but business regulations can be created by governments or by nongovernmental or-
ganizations. When the regulations are established by a particular industry—known as
self-regulation—individual industries or firms establish their own rules of behavior
22 CHApTER 1
and codes of conduct.37 Similarly, the European Union has developed policies to
ensure that international companies operating within its boundaries follow certain
accepted behavior in terms of CSR and have become part of the European regula-
tion process.38 In self-regulation, certification is a system by which a firm’s products
and services comply with basic management or output standards agreed upon by the
industry group. For example, the International Advertising Association monitors and
certifies the actions of its members.
To assist their managers in avoiding unethical behavior, international companies
often develop programs that help these managers to behave ethically. Such programs
have a definite country bias. For example, international companies in France rely on
ethical codes; in the United Kingdom and the United States, international managers
depend on a set of written procedures; and in Germany, international companies rely
on training as a means to foster ethical behavior.39
STAKEHOLDER THEORY AND CORpORATE SOCiAL RESpONSibiLiTY

From the earliest of times, safeguarding shareholders’ and/or owners’ interests has
been the paramount goal of corporate executives; taking responsibility for the con-
cerns of and interests of stakeholders, on the other hand, is a relatively new concept,
probably less than a hundred years old. The earliest recorded reference to stakeholders
was made by E. Merrick Dodd, Jr., a Harvard law professor, in the 1930s. Based on
information from General Electric (GE) executives, Dodd referred to shareholders,
employees, customers, and the general public as the stakeholders of a company.40 The
only current major stakeholder missing from Dodd’s original grouping is the suppli-
ers. This implies that GE and probably a few other American companies may have
considered the stakeholder concept even before the 1930s. Since Dodd embraced the
stakeholder concept, about a dozen books and more than a hundred articles focusing
on stakeholder issues have been published.41
The formal introduction of the stakeholders concept into management literature,
though not by that name, is credited to William R. Dill based on a 1958 Scandinavian
field study that referred to many of the present groups considered stakeholders.42
Other equally important figures in the evolution of the stakeholder concept and gen-
eral stakeholder theory are Edward R. Freeman, who traced the term “stakeholder”
to a 1963 CRI internal memo,43 and James D. Thompson,44 who along with Freeman
formalized the stakeholders’ principles and wrote extensively about them.
WHO ARE STAKEHOLDERS?

A stakeholder “is an individual or group, inside or outside the organization that has a
stake in and can influence an organization’s performance.”45 Among the many defini-
tions that are used to describe stakeholders, this one seems to capture the essence of
the group. Using this definition, we can identify a number of stakeholders, including
shareholders/owners, employees, customers, suppliers, the community at large, the
government, banks, other service providers (accounting firms, consultants, and so
on), trade unions, and even competitors. Although the potential list of stakeholders
can number into the double digits, in most research studies related to stakeholders,
the commonly identified groups are the shareholders/owners, employees, customers,
suppliers, and the community.
STAKEHOLDER THEORY
According to the stakeholder theory, every company should identify individuals
or groups whose involvement is critical to a company’s success and make every
attempt to satisfy each one’s needs and interests. Moreover, the company must be
seen through numerous interactions with its stakeholders.46 The theory implies that
as a company strives to create shareholder wealth, it should also meet the expecta-
tions of its employees, customers, suppliers, the community in which it operates,
and any other individual or group that it affects. The theory does not imply that
any one stakeholder is more important than the others; hence, it assumes that a
company and its managers should strive to satisfy the interests and concerns of
all. From a practical standpoint, the level of satisfaction that needs to be delivered
to the stakeholders is not defined, and herein lies the conundrum for executives,
practitioners, academicians, and community representatives. Is it possible to satisfy
the needs and interests of all concerned parties? Some believe it is, but others view
this notion as impractical.
INTERESTS AND CONcERNS OF VARIOUS STAKEHOLDERS

To simplify the discussion of the issues concerning the stakeholders, only the major
stakeholders are addressed here. As noted earlier, researchers have identified the major
stakeholders of a company as the shareholders/owners, the employees, the customers,
the suppliers, and the general community.47,48 Each of these stakeholder groups has
varied concerns and interests, and they may not all fit into one neat package. Some
of the concerns of the community may be part of CSR. Table 1.5 offers a brief listing
of the interests, needs, and concerns of the major stakeholders.
As seen in the table, the interests, needs, and concerns of the major stakeholders
seem diverse and sometimes conflicting. For example, one way to increase profits
and create shareholder wealth, at least in the short run, would be to offer acceptable
quality products at the highest possible prices and pay employees low salaries and
wages. This strategy may help the shareholders achieve their goals, but it goes against
the interests and concerns of employees and customers.
STAKEHOLDERS’ DYADIc VS. SYMBIOTIc RELATIONSHIp WITH THE COMpANY

One of the controversial discussions in regard to the stakeholder theory has been
whether the relationship between a company and its stakeholders is dyadic or symbi-
otic. In the dyadic mode, each company establishes a relationship with and meets the
interests and needs of each stakeholder on a one-to-one basis (see Figure 1.1). This
model is simple and presumably easy to maintain, but it does not take into account
the interrelationships among the stakeholders. For example, employees and customers
24 CHApTER 1
Table 1.5
Interests, Needs, and Concerns of Major Stakeholders
# Stakeholder Interest, Need, and Concerns Major Driving Force in Achieving the Goals
1 Shareholder/owner • Wealth • Costs
• Capital gains • Efficiency
• Dividends • Effective management
• Core competency
• Competitive advantage
2 Employees • Job satisfaction • Recruiting
• Salaries/wages • Competitive salaries and benefits
• Fringe benefits • Training
• Working conditions • Motivation
• Opportunities • Fair evaluations
• Fair treatment
3 Customers • Quality products/services • Reasonable quality
• Satisfaction • Effective communication
• Value • Extensive distribution
• Reasonably priced • Customer relationship
• After-sales service • Dependability
4 Suppliers • Fair prices • Competitive prices
• Good accounts payable policy • Good quality
• Strong commitment • Flexible
• Long-term relationships • Innovative
• Flexible • Financially sound
• Prompt
5 The community • Safe environment • Setting up plants and facilities with fewest
• Employment affects on the environment
• Funds for community • Hiring locally
development • Funding projects for schools, hospitals, the
• Socially responsible arts etc.
not only are in direct contact with the company, but also happen to be members of a
larger community in which the company operates.
Proponents of the symbiotic relationship acknowledge a wider network of rela-
tionships between the stakeholders and the company (see Figure 1.2). According
to this theory, the stakeholders are dependent on one another for their success and
well being; hence, managers must acknowledge interdependence among employees,
customers, suppliers, shareholders, and the community.49 Furthermore, this type of
relationship is not simply a contractual exchange between parties: it involves interac-
tion and network effects, as well.50 It also means that in order to solve core strategic
problems associated with the stakeholders, one must understand the firm’s entire set
of relationships with all entities.
Once the symbiotic relationship is accepted, the task of providing above-minimum
levels of satisfaction to each member of the stakeholder group becomes difficult and
complex. The interconnectivity among the groups assumes that each stakeholder is
in contact with all the others and understands their needs. Therefore, the company’s
employees not only want good wages and benefits, they also want the company to
spend money on improving the community in which they live.
Figure 1.1 Dyadic Relationship between the Company and the Stakeholder
COMPANY Shareholder
Employees
Customer
Supplier
Community
Figure 1.2 The Symbiotic Relationship between the Company and Its Stakeholders
Supplier Shareholder
COMPANY Employees
Customer Community
26 CHApTER 1
COMpLEXITY AND PROBLEMS WITH AcHIEVING SUccESS WITHIN A

SYMBIOTIc MODEL
The symbiotic relationship believes in the importance of the interactions and intercon-
nectivity between the stakeholder groups and the company. Therefore, it suggests that
the company be knowledgeable about each stakeholder’s interests, needs, and concerns
and develop a strategic action plan to deliver the desired results. Based on current
research, some companies have at least partially accomplished this. For example,
Sears has successfully provided a high level of employee satisfaction and customer
satisfaction, and at the same time has delivered very good financial results.51 In a study
of some Australian companies, Jeremy Galbreath found that corporate governance and
employee management are positively associated with corporate performance.52 In a
similar vein, DuPont has decided to widen its sustainable goals for 2015 to include
a commitment to expand its reach by addressing safety, environment, energy, and
climate change, according to its CEO Charles Holliday.53
Though the evidence suggests that companies can meet multiple concerns through
their symbiotic relationships with the stakeholders group, in reality this ideal has
not yet been reached. For starters, not everyone believes that the various primary
stakeholders are equally important for the company. According to this view, the
needs of the most important stakeholders must be met first; only then should the
needs of others be addressed. In the traditional American corporate model, the most
important stakeholders are the shareholders, and satisfying their needs overrides the
interests of all others. This may seem contrary to the proposed direction advocated
by the stakeholder theorists, but a surprising amount of influential individuals are
staunch supporters of the idea that increasing the value of the shareholders is the
most critical goal for corporate executives. People like the late economist Milton
Friedman have always stressed this point; according to Friedman, “Corporations
exist entirely for the benefit of their shareholders.”54 Similarly, Robert Lutz, former
vice chairman of Chrysler Corporation and now a top executive with General Mo-
tors, once stated that “we are here to serve the shareholder and create shareholder
value.”
From a theoretical standpoint, it seems easy to fulfill the needs and concerns of
all stakeholders equally. But, based on current research, it appears that meeting the
expectations of all stakeholders is bound to create some imbalances. Hence, many
suggest a proportionate approach to satisfying the needs of the stakeholders by find-
ing a balance among the diverse and potentially competing interests.
REASONS FOR A BALANcED AppROAcH TO SATISFYING STAKEHOLDERS’ INTERESTS

Stakeholder groups are connected through dynamic relationships. The question is how
to create an acceptable level of satisfaction for each group. Ideally, a company would
like to create a high level of employee satisfaction, which leads to greater employee
effort, which leads to higher-quality products and services, which results in customer
satisfaction, which leads to more repeat business, which generates higher revenues
and profits, which leads to investor satisfaction and more investment in the company,
which then provides additional funds for community development projects, which
leads to a satisfied community and general public.55
It is difficult to present a case for treating all stakeholders equally. Who is more
critical to the company: the investors who supply the funds; the employees who labor
to deliver goods and services; the customers who provide the main source of revenue
for the company; the suppliers who provide the necessary materials for assembling
goods and services; or the community, which to a large extent supports the company,
its employees, and its customers? Strong arguments can be made for considering the
investors most important, and in many quarters they still are. A strong case could also
be made for either the employees or the customers.
It is not easy for corporate executives to devote equal amounts of energy and time
to shareholders’ expectations and community concerns. Moreover, in each company
there may be specialists who are responsible for dealing with different stakeholder
groups. For example, the marketing group may have the primary responsibility for
satisfying customer’s needs and developing programs to maintain a core group of
loyal customers. Similarly, the purchasing group may be responsible for maintaining
supplier relationships. In some companies, there may even be a group responsible for
community activity. But, the question remains, if the shareholders clamor for higher
dividends and at the same time the community wants a school playground, which
group will get the most attention?
Added to the aforementioned concerns are modern global corporations’ problems.
These companies operate in several countries with equally large numbers of stake-
holders whose interests and concerns may not be homogenous. How should these
companies proceed when local laws differ and internal policies may not necessarily
meet the expectations of all the diverse stakeholders?
WHAT IS A BALANcED AppROAcH TO DEALING WITH STAKEHOLDER’S INTERESTS?

Assuming a symbiotic relationship among the various stakeholders, a company needs
to develop programs and procedures to meet those stakeholders’ diverse needs. Stake-
holders’ concerns are a part of the business environment, and there is no escaping the
effects of poorly planned strategies to meet their needs. This implies that companies
must to some extent satisfy some or all of the stakeholders’ needs. The results of inef-
fective stakeholder relationships may be a decline in sales, a boycott of the company
and its products by the general public, or even government sanctions. Following are
suggested steps to deal with growing stakeholder concerns.
• The first step in developing a comprehensive stakeholder strategy is to develop a

communication link between the company and its stakeholders. This link should
be used for understanding the concerns of the various stakeholders, determining
priorities, and preempting problems. The keys are, “informing,” “responding,”
and “involving.”56 It is important that managers build legitimacy and a positive
reputation.
• The next step in the process is ranking the effects and consequences of not
meeting the needs of each stakeholder and setting priorities accordingly. For
28 CHApTER 1
example, the shareholders are expecting their stock prices to go up; at the same
time, the employees are seeking substantial pay raises. Which is more critical?
Each company must have a system for addressing these competing demands.
• Reevaluate stakeholder relationships periodically to see whether any of the
dynamics have changed. If they have changed, then the priorities need to be
reconfigured.
• In all dealings with the various stakeholders, it is important to make sure that
the treatment of each is perceived to be fair. For example, a community will not
demand a major water-treatment plant from a company if it is losing money.
ADDITIONAL REcOMMENDATIONS AND CONcLUSIONS

Based on our review of the literature, it is apparent that all the concerns of all stake-
holders cannot be met all the time. As one gets its wishes, others may lose. Hence,
this process may be viewed as a zero-sum game. But is there an approach by which
the losses of one party could be reduced without significantly compromising the
gains of the others?
Corporate executives are often driven to satisfy the interests of the most criti-
cal member(s) of their stakeholder group. This drive is based on their fundamental
business training and their mindset that every action has a cost-benefit trade-off
relationship attached to it. In making decisions, these executives must decide which
of their actions returns the highest reward or has the lowest cost. In such a decision-
making environment, corporate executives aim to meet the minimum expectations
(threshold) of each stakeholder group; at the same time, they try to deliver satisfac-
tion levels above the minimum for different stakeholders. Usually, a company might
aim to satisfy its customers, perform well for its employees, and deliver a threshold
level of satisfaction to the general public. In setting these levels, the executives must
be careful not to violate the various stakeholder groups’ sense of fairness about the
relative treatment they are getting.57
CORRUpTiON
International business corruption affects adversely national economies as well as the
international business environment. Some attempts have been made in the past two
decades to resolve this complex problem. Although some success has been achieved,
the problem is far from being totally eradicated.
Corruption is not a new phenomenon: incidents of bribing and seeking illicit favors
have been recorded for centuries and existed in early Chinese, Egyptian, Greek, and
Indian civilizations. Mankind, with its proclivity for power and wealth, has always
succumbed to corruption in one form or another.
Corruption is found in all walks of life. Naturally, it is endemic to the business
world. Internationally, it is even more pervasive, and it affects many aspects of business
from cost of operations to business relationships and even government-to-government
relationships. Understanding corruption in the international environment is made more
difficult because international business transcends many countries and cultures. How
Table 1.6
Types of Corruption
# Type of Corruption Examples Predominantly found in

1 Business corruption • Bribing officials Most countries
• Accounting irregularities
• Tax evasion
• Insider trading
• Money laundering
• Embezzlement
• Falsifying documents (research data)
2 Political corruption • Voting irregularities Mostly in developing and

• Holding on to power against the will of less developed countries
the people
• Nepotism and cronyism
• Rule of the few
should international companies with one set of rules and codes of conduct in their
home country operate in countries that may have different sets of rules, especially if
the host-country rules are less stringent than the ones in their home country?
TYpES OF CORRUpTION
Corruption involves many types of misdeeds. The extent to which people abuse their
position for personal gain is virtually limitless. At one end of the spectrum we have
a local low-level official taking small sums of money to expedite routine approvals
or transactions, called petty corruption; in the middle we have defense contractors
paying millions of dollars to lawmakers for awarding them major defense or transpor-
tation projects, called grand corruption; at the far end of the spectrum are the huge
campaign contributions by lobbyists to politicians, called influence peddling.58 Cor-
ruption is also classified by sphere—business corruption and political corruption—as
shown in Table 1.6.
DEFINITION OF CORRUpTION
Corruption implies some form of illicit and criminal behavior for personal enrich-
ment. Any definition of corruption starts with the premise of “abuse of power.” In
the international business context, there are three key players who are part of the
corruption problem: the principal or the receiver, the entity that has the authority to
grant and approve projects (for example, a government agency such as the ministry
of industry); the agent or the intermediary who represents the principal and is actu-
ally responsible for granting permission on behalf of the principal (for example, a
civil servant); and the client or the solicitor, a company or an individual who seeks a
favor such as a permit for projects or investments (for example, a business entity).59
See Figure 1.3.
30 CHApTER 1
Figure 1.3 Key Actors in International Business Corruption
Principal
Agent Client
In this model, corruption occurs when the agent betrays the interests of the principal
and accepts gifts or monies from the client to grant a favor to the client; the agent acts
without any thought for the fairness of such an exchange. Corruption could also stem from
the principal going directly to the client. Therefore, in defining corruption all three actors
must be included in this triumvirate. Over the years various agencies have tried to define
corruption. Table 1.7 presents the five most commonly used definitions of corruption.60
CORRUpTION PERcEpTION INDEX

In light of the ongoing problem with international business corruption, Transparency
International (TI) has developed a scale called the corruption perception index (CPI)
to measure the level of corruption among different countries. Each year using various
factors and survey methods, TI classifies countries on a ten-point scale, with 10 = least
corrupt and 0 = the most corrupt. The CPI uses seven different sources to assemble
its ranking, including the World Competitiveness Yearbook, Gallup International,
and DRI/McGraw-Hill Global Risk Service. Table 1.8 presents the ten least corrupt
countries listed by TI among the 179 that it surveyed in 2007.
Countries like Finland and Denmark that rank very high on the CPI list have a
relatively stable political system, very efficient government agencies, and a high level
of trust between politicians and the populace.
The ten most corrupt countries in the world for 2007, according TI’s corruption
perception index, are presented in Table 1.9 (p. 32).
According to TI, Somalia and Myanmar rank as the worst two countries in terms
of corruption. Over the years TI has successfully publicized the problem of inter-
national business corruption. Hence, more and more people are becoming aware of
this issue.
EFFEcTS OF CORRUpTION
Corruption can have adverse economic/monetary, social, and political effects.
• Economic effects. Corrupt systems do not provide open and equal market op-
portunities to all the firms. Payments and/or bribes do not have a market value,
Table 1.7
Definition of Corruption as Defined by a Particular International Organization
International organization
# that defines it Definition of corruption
1 The United Nations (UN) “Commission or Omission of an act in the performance of or in con-
nection with one’s duties, in response to gifts, promises or incentives
demanded or accepted, or the wrongful receipt of these once the act
has been committed or omitted.”
2 Organisation for Economic “The offering, giving, receiving, or soliciting of any thing of value to
Co-operation and Develop- influence the action of a public official in the procurement process or
ment (OECD) in contract execution.”
3 Transparency International “The misuse of entrusted power for private gain.” Transparency
(TI) International further differentiates corruption “according to rule’ or
“against the rule.” In the first instance, the definition covers all the
areas in which the receiver is required by law to receive some form
of compensation (bribe), and in the second instance, the receiver is
prohibited from providing some of these services and therefore is not
entitled to any compensation (bribe).
4 World Bank and Asian De- “Corruption involves behavior on the part of officials in the public
velopment Bank (ADB) and private sectors, in which they improperly and unlawfully enrich
themselves and/or those close to them, or induce others to do so, by
misusing the position in which they are placed.”
Table 1.8
The Ten Least Corrupt Countries of the World, 2007
Rank Country Corruption Perception Index (CPI)*

1 Denmark 9.4
1 Finland 9.4
1 New Zealand 9.4
4 Singapore 9.3
4 Sweden 9.3
6 Iceland 9.2
7 Netherlands 9.0
7 Switzerland 9.0
9 Canada 8.7
9 Norway 8.7
Source: Transparency International, “Corruption Perception Index.” Available at http://www.transpar-
ency.org/ (accessed June 5, 2008).
*CPI Scale: 10 = Clean; 0 = Corrupt.
so they raise the overall cost of operations. Many international companies try to
avoid investing in countries that appear to be corrupt. A lack of foreign direct
investment (FDI) flows to a country increases financing costs for both private
and public projects. The limited capital within the country forces local investors
to pay higher rates for borrowings. For example, a study done by the Milken
32 CHApTER 1
Table 1.9
Ten Most Corrupt Countries of the World, 2007
Rank Country Corruption Perception Index (CPI)*

179 Somalia 1.4
179 Myanmar 1.4
178 Iraq 1.5
177 Haiti 1.6
175 Uzbekistan 1.7
175 Tonga 1.7
172 Sudan 1.8
172 Chad 1.8
168 Laos 1.9
168 Guinea 1.9
Source: Transparency International, “Corruption Perception Index.” Available at http://www.transpar-
ency.org/ (accessed June 5, 2008).
*CPI Scale: 10 = Clean; 0 = Corrupt.
Institute61 found that in comparing sovereign bond issues, countries with a higher
corruption index had to pay much higher premiums than those with a lower cor-
ruption index. In comparing Sweden and Brazil with a similar amount of bond
issuance for 1997 and 1998 ($23 billion versus $22 billion, respectively), Brazil’s
financing costs were about 25 times greater than that of Sweden ($38,157 billion
versus $1,531 billion) because of graft and corruption.
• Social effects. Besides the monetary costs, corruption leads to some social costs
that could be detrimental to a country’s overall economic growth. Some of the
social costs associated with higher corruption levels are seen in the areas of
health, education, and hygiene. Because of corruption, the amount spent on
public services is considerably lower than the spending in other comparable
countries with lower corruption levels.62 Using regression analysis, Paulo
Mauro demonstrated that a country that improves its corruption perception
index (CPI) by 2 points ends up increasing its education budget at least by 1
percent of its GDP.63
• Political effects. Politically, corruption strengthens the power of corrupt, self-
serving leaders. They amass wealth for themselves, allocate very low levels of
funds for projects that could benefit the country, perpetuate the rule of a few, and
suppress the rights and voices of the majority of the population. To continue in
power, these leaders need funds, and most often the monies come from bribes.
PREScRIpTION TO REDUcE INTERNATIONAL BUSINESS CORRUpTION

Efforts to curb corruption in the past three decades have had somewhat less than stellar
results. Some improvements have come with the actions of individual governments
like the United States, international organizations such as the Organisation for Eco-
nomic Co-operation and Development (OECD) and TI, and individual companies.64
Because of globalization, many more companies operate internationally compared
to 20 years ago. All indications are that the number of cases of corruption is on the
rise. In order to reduce worldwide corruption that affects businesses, there has to be
a concerted and well-coordinated effort on the part of all concerned. The parties that
must take an active role in this effort are listed below.
Individual Country Governments
Any attempt to curb corruption has to start at the country level. Governments in the
most corrupt countries must introduce programs to root out the offenders. Since many
highly corrupt countries are economically poor, the incentives for these countries to
get rid of corruption must be economic in nature. Through greater FDI flows, transfer
of technology from industrialized countries, and reduction in unemployment, these
countries can attain an unprecedented level of economic growth. Some specific steps
that countries with high levels of corruption should undertake to curb corruption are
listed below.
1. Enact anticorruption regulations. Most of the countries with high levels of

corruption either do not have anticorruption laws or have them but do not
enforce them.
2. Set up monitoring systems. Laws and regulations will be observed only if
there is a mechanism to monitor and enforce them.
3. Penalties. Anticorruption laws will not be obeyed unless there are severe
penalties meted out to law breakers.
4. Codes of conduct for government employees. It is imperative that codes of
conduct for government employees be developed and then enforced.
5. Incentive systems for government employees. Most social scientists agree that
individuals are more likely to obey rules if compliance is reinforced with a
reward system. Rewarding employees who are honest and obey the codes of
conduct lowers the temptation to take bribes.
6. Better salary structure for government employees. In many developing coun-
tries, taking bribes is almost a necessity for some government employees
because of poor wages.
International Organizations
Because of lack of funds and technical knowledge, attempts by individual countries

to reduce corruption would not work without outside help. To assist the countries in
curbing corruption, some of the international agencies must get involved with neces-
sary financing and training. Corruption is a worldwide problem that funnels produc-
tive funds out of the economic system and into the hands of a few who then use it for
personal gains without contributing to the developments efforts of the country.
Some specific steps that these agencies could undertake include:
1. Providing knowledge and training. Organizations such as the World Bank, the
International Monetary Fund (IMF), TI, and the United Nations could provide
34 CHApTER 1
technical help to those countries suffering from high corruption. Initiatives

might include formulating laws, developing codes of conduct for government
employees, and helping in the development of monitoring systems to track
the violators of these corruption codes.
2. Providing funding. In order to curb corruption in developing countries, fund-
ing is needed to carry out some of the prescriptions/steps outlined earlier. The
countries with highest level of corruption are those that are economically
poor; therefore, it is imperative that some of the international organizations
that have developmental funds at their disposal—for example, the IMF and
the Asian Development Bank—provide some of these funds.
3. Harmonizing the codes. At present countries (especially the industrialized
countries) set their own standards for business behavior. The process of
curbing corruption would go a long way, if anticorruption codes could be
standardized so that there is no confusion, especially when an international
firm operating in two different countries has to follow two different sets
of rule.
International Firms
Among the key participants in the corruption process are the international firms who
try to use influence, gifts, and bribes to get better deals from host nations. It is impor-
tant that international firms collectively follow uniform codes of conduct in dealing
with host countries for the benefit of the consumers, the economic growth of the host
country, and for their own profit objectives. To help in the fight against corruption,
international firms could:
1. Set up internal codes of conduct. Typically, international firms have their

own internal codes of conduct for conducting business with host nations and
vendors. For example, in many companies, the specific amount of gift that
one can accept from vendors is limited to a very small amount. Similarly,
there are written rules banning bribes to host-country officials and also an
explanation of what constitutes a bribe. Firms need to improve the way they
monitor and enforce these rules and policies.
2. Employee training. Employee training programs can help employees under-
stand the rationale for the good behavior rules.
3. Provide funding. For the worldwide anticorruption program to succeed, it needs
developmental funds that could be used at the country level for establishing
various programs. The countries themselves are poor and do not have the funds
to set up anticorruption programs. Some of the international organization may
provide some funding, but it appears that this is not adequate. To augment the
existing budgets, international firms could step in and fill the need. The funds
that are provided by the international firms should not go to individual countries,
but to the international agencies who then can distribute these funds.
Figure 1.4 presents a summary of the key issues of international business corruption.
Figure 1.4 Framework of Corruption: Summary of Causes and Prescriptions
CAUSES PRESCRIPTIONS
1. Environmental 1. Country Level
• Power concentration • Setting up a monitoring
• Lack of rules system
• Economic conditions • Enact regulations
• Poverty • Severe penalties for law
• Cultural traits breakers
• Moral standards • Codes of conduct for
• Lack of Competition government employees
• Incentive systems for
2. Individual government employees who
• Greed follow the rules
• Integrity/honesty • Better salary structure for
• Living wages government employees
• Maintain power • Establish democracy
3. International Firms 2. International Organizations

• Market expansion • Harmonize codes of conduct
• Competitive advantage for business
• Profit motive • Assist country governments in
CORRUPTION TYPES
setting up anticorruption
1. Petty legislation
Misuse of power 2. Grand • Provide funding to fight
3. Influence peddling EFFECTS corruption
• Set up systems to monitor
1. Economic corruption
• Decrease in FDI
• Lack of capital 3. International Firms
• Lower growth • Draw up codes of conduct for
• Unemployment employees
• Provide training to employees
2. Consumers on corruption
• Higher prices for goods • Adhere to rules
• Poor quality goods • Provide funding to
international organizations
3. International Firms
• Higher investments
• Higher operating costs
• Unfair competition
• Loss of projects
• Breaking the law
Source: James P. Neelankavil, “International Business Corruption: A Framework of Causes, Effects, and
Prescriptions,” Conference Presentation, Academy of European International Business, Athens, Greece,
December 8–10, 2002.
CHApTER SUMMARY
International business management is a complex, multidimensional field. The intense
competition for world markets, global expansion, and dramatic changes in technol-
ogy have made the task of managing an international firm challenging. Phenomenal
growth in many Asian and Latin American countries is shifting the world economic
order from the West to other parts of the world.
As a result, businesses are adapting to a more global philosophy. Globalization
proposes that companies view the world as one single market to assemble, produce,
and market goods and services. Globalization is defined as sourcing, manufacturing,
and marketing goods and services that consciously address global customers, markets,
and competition in formulating a business strategy.
The dynamic changes occurring in the economic, political, and social climate
36 CHApTER 1
in many countries represent a new challenge to businesses. Western Europe has

dismantled its internal barriers to form a unified region with a single currency and
a vast market made up of 500 million consumers. The Soviet Union does not exist
anymore, but instead has spawned 18 new countries. Among the many reasons for
the growth in international business are those that are related to the internal workings
of a company, others that are market-related factors, and still others that are related
to the external environment.
Businesses can get involved in international operations in many different ways. The
most common and probably the easiest way companies get involved in international
operations is through exports and/or imports of goods and services. Other types of
international operations include licensing agreements and franchising, direct invest-
ments, and portfolio investments.
As businesses venture outside their own countries, the need to understand that the
market conditions in foreign countries is becoming more and more critical. Business
research, like all business activity, has become increasingly global. Firms that conduct
business in overseas markets must understand the unique features of these markets
and determine whether they need to develop customized strategies to be successful.
Information is essential to business decision making. Information gathered through
research is useful in defining problems, resolving critical issues, identifying oppor-
tunities, and fundamentally improving an organization’s strategic decision-making
processes. Conducting international research is challenging, expensive, and time-
consuming. Many factors affect its outcome, including the cost of conducting the
research, the availability of secondary data, the quality of the data collected, time
pressures, lead time (the time it takes to complete an international research study),
the complexity of the study, and whether a multicountry study is necessary.
Ethical behavior in general relates to actions that affect people and their well-being.
In business, the actions of managers and their companies may have drastic effects on
their employees, customers, suppliers, the general public, and the environment. The
need for ethical behavior among managers and their companies is not restricted to
international companies, but extends to domestic firms as well. In a dynamic global
community, potential conflicts in ethical business behavior due to differences in values
and business practices across cultures are inevitable. Global business ethics is the
application of moral values and principles to complex cross-cultural situations.
It is generally accepted that beyond their normal profit-maximization goals, referred
to as corporate social responsibility (CSR), businesses have a responsibility to society
at large. CSR is generally defined as the ethical consequences of companies’ actions,
policies, and procedures.
Companies seek economic gains chiefly to enhance the value for their investors.
Accordingly, managers have a duty primarily to maximize shareholder returns. Some
argue, though, that a manager’s duty is to balance the financial interests of the share-
holders against the interests of others such as employees, customers, and the local
community, even if it reduces shareholder returns. In their opinion, these individuals,
called the stakeholders, contribute either voluntarily or involuntarily to a company’s
wealth, creating capacity and activity, and are therefore its potential beneficiaries and/
or risk bearers. The principle of social responsibility means that companies need to
be concerned about the wider group of company stakeholders, not just the typical
company stockholders.
A large number of stakeholders exist, including shareholders/owners, employees,
customers, suppliers, the community at large, the government, banks, other service
providers (accounting firms, consultants, and so on), trade unions, and even competi-
tors. Although the potential list of stakeholders can number into the double digits, in
most research studies related to stakeholders, the commonly identified groups are the
shareholders/owners, employees, customers, suppliers, and the community.
International business corruption is a worldwide phenomenon with no end in sight.
Its effects on local economies are very damaging. A few industrialized nations and
international organizations such as the OECD and Transparency International have
introduced new initiatives to curb the problem of corruption. The collective efforts of
these groups have succeeded to some extent in publicizing the problem and forcing
countries to take action.
The three main actors in the corruption equation are: the principal, the agent, and
the client. Any attempt to curb corruption has to bring order into all three parties;
attempting to solve the problem from one entity alone will definitely fail. To truly
reduce corruption, the efforts of the countries involved, the international firms who
participate in corruption, and international watchdog organizations must all work
together. The main focus of their efforts must be in developing codes of conduct,
harmonizing those codes, providing training, establishing monitoring systems, and
setting up a judicial process to hear corruption cases.
KEY CONCEpTS
Globalization
Reasons for International Expansion
International Business Ethics
Corporate Social Responsibility
DiSCUSSiON QUESTiONS
1. Identify and explain the reasons why companies seek foreign markets.
2. Define globalization. What are the implications of globalization for companies?
3. How do companies get involved in international business?
4. Identify and distinguish among the various types of international organizations.
5. Why is international research important?
6. What are some of the complexities and difficulties inherent in conducting
international research?
7. How do international companies use research?
8. What is corporate social responsibility (CSR)?
9. Why is corporate social responsibility important?
10. Enumerate and explain the various ethical theories of international business.
11. How does corruption affect international business?
12. What is the corruption perception index (CPI)?
2 International Business
Environment: Culture
Culture, because it is learned, constitutes the major method that people

use to adapt to a changing environment, whether the changes happen
through traditional means or through technological advances.
LEARNiNG ObJECTiVES
• To understand the importance of the international business environment
• To understand the cultural environment
• To understand cultural components
• To understand the various dimensions of culture
• To understand cross-cultural differences
• To learn about cultural clusters
• To understand the differences between cultural convergence, culture shock, and
cultural orientation
Every business operates in an environment that is outside its control. This envi-
ronment is external to the firm and influences its actions. Therefore, the external
environment in which a business operates is the sum of all forces surrounding
and affecting its operations. Each factor plays a critical role in a firm’s decisions,
whether these decisions include entering a particular market or how to behave once
a firm enters this market.
The external environment in which a firm operates includes:
• The cultural environment

• Economic factors
• The political system
• Technological development
• The banking and financial systems
• Infrastructural capabilities
• The competitive environment
• Regulatory developments
• Social systems
• Supplier networks
38
INTERNATIONAL BUSINESS ENVIRONMENT: CULTURE 39
These external factors confront all companies—both domestic and international—

though dealing with the environmental factors is easier in the domestic market than
in international markets. The external environment of international markets is more
complex and unpredictable, making it difficult to analyze. Take, for example, the is-
sue of foreign exchange. The costs, prices, revenues, and profits for a domestic firm
such as Toshiba, operating in Japan, are expressed in the local currency, the yen,
and so Toshiba’s domestic division is not subject to the exchange-rate risks that its
international division faces. Exchange rates can make costs rise and profits disappear.
Tracking and predicting exchange-rate movements are important for international
companies, but at the same time it is difficult to forecast exact rate changes. In con-
trast, for a purely domestic firm, this is less of a problem (unless that firm imports all
its raw materials and supplies). Similarly, culture plays an important role in business
strategy, but for domestic firms operating under a single cultural environment, this
is not a major issue. On the other hand, international firms often operate in countries
with cultures that are very different from those of their home countries, and in many
instances the firms have little familiarity with these cultural distinctions.
All of the above-mentioned external factors are collectively very important and dictate
how an international firm operates. Depending on the industry and product category,
some factors are more important than others; for example, in the computer and software
industry, technological development may be more important than social systems.
Analysis of the external environment is useful in the selection of foreign countries/
markets, as well as for developing viable strategies once a firm enters a particular
market. Most environmental analysis is done using secondary sources, that is, us-
ing existing information that is available through government sources, journal and
newspaper publications, and databases, and utilizing internal information that was
previously collected for other purposes.
For international companies, the most critical external variables are culture, the
economy, political stability, the banking and financial systems, and the competitive
environment. Culture is important because a majority of international business blun-
ders can be traced to a lack of understanding of the host country’s cultural values
and business customs. Economy is important because economic factors contribute
to the firm’s overall financial viability. Political systems are important because it is
difficult for an international firm to succeed when the host country’s political systems
are unstable. A sound banking and financial system helps international companies
avail themselves of operating capital, manage export transactions through letters of
credit and other instruments, and repatriate profits to the home country. Finally, the
competitive environment is critical because competitive forces dictate strategic ac-
tions and ultimately influence performance in the marketplace.
CULTURAL ENViRONMENT
International companies have to deal with different cultures in different countries.
Companies such as Coca-Cola that operate in many countries (about 197 in Coke’s
case) have to learn, understand, and use these cultural differences in their strategic
action plans. Learning new cultures does not mean just mastering a few of the “hid-
40 CHApTER 2
den languages” of the host country; it also means learning to bridge the differences
between cultures to create successful interactions. Culture operates on the unconscious
level, and its effects are subtle. For example, the French are very proud of their culture
and language and therefore are sensitive to issues that deal with the cultural environ-
ment, especially in business transactions. The Japanese run their meetings not with
a set agenda, but with a flexible one, which sometimes unnerves Western business
executives. And one has to be aware when dealing with German executives that they
are sensitive about titles and are very formal in their business negotiations.1
In fact, as cultures tend to be more societal in nature (each society has its own cul-
ture), international companies sometimes have to deal with more than one culture in
a single country. For instance, culturally, northern Italians are different from southern
Italians in their behavior and tastes. Similarly, the various regions of China are made
up of multiple cultures with contrasting cultural differences. Hence, different layers of
culture exist at the national, regional, societal, gender, social class, and corporate levels.2
At the country level, research has shown that cultural values have significant effects on
a country’s economic development, regulatory policies, and levels of corruption.3 At the
regional level, studies indicate that cultural settings create opportunities and limitations
for people that vary from country to country within the same region.4 Similarly, at the
corporate level, research reveals that culture affects not only the strategic level, but also
the area of management and its market orientation.5 In the discussions on culture that
follow, the terms “country” and “society” are used interchangeably.
Cultural changes take place very slowly, and their influence endures for centuries. Even
with the technological advances in travel and communications, cultural traits within societ-
ies have remained virtually unchanged. The static nature of culture is often a mechanism
whereby a society can preserve its values and guard against outside influences.
The impact of culture on international business is real and far-reaching. The effects
of culture can be seen as a firm selects a country for market entry and determines what
mode of entry it will use. For example, researchers have found that for international
companies the choice between licensing and establishing a wholly owned subsidiary
depended to a large extent on cultural differences between the host and home coun-
tries. Specifically, differences in levels of trust impact perceptions of transaction costs
and thereby influence a firm’s choice of entry mode into a foreign market.6 Culture
also affects international companies’ strategic actions. For example, the relationship
between culture and brand image has been found to be very strong and is often a
key consideration in developing brand image in foreign markets.7 For international
companies, culture might be a key variable to consider in their efforts to standardize
their international strategies or develop global brands. In a study that examined trans-
ferring advertising strategies across countries, researchers found that the consumers
in the host markets did not always understand the focus of the advertising campaign
and therefore did not buy the product.8 Finally, culture also plays a role in how an
international company is organized in foreign markets.9 In many collectivistic societ-
ies, organizational structures need to consider the effect of a particular design on the
group as a whole rather than on the individual.
The student of international business must recognize that culture does not fit into
a neat, compact, and manageable model. Each society and its culture is a unique and
complex system of values, norms, folklore, mores, codes of conduct, standards of

behavior, and relationships. Hence, most definitions of culture tend to be descriptive
ones that identify a culture’s individual elements.
CULTURE DEFINED
A good working definition of culture is the knowledge, beliefs, art, law, morals,
customs, and other capabilities of one group distinguishing it from other groups.
In other words, culture is the way of life of a society. From a practical standpoint,
culture includes behavior, symbols, skills, heroes, knowledge, superstitions, motives,
traditional ideas, artifacts, and achievements that are learned and perpetuated through
a society’s institutions to enhance its chances for survival. Since culture contains so
many elements, it is no wonder that businesses find it very difficult to fully understand
its influence on a society. It also explains international business failures that can be
traced to ignoring and/or not understanding the basic cultural patterns of a country.
Culture is mostly an internalized phenomenon. Cultural behaviors evolve over time;
they are learned and tend to be passed down from generation to generation. Few if
any books are prescribed by a society to understand its own culture. Most individu-
als are hard-pressed to explain these natural values, customs, attitudes, and behavior
patterns, and practice them without a second thought.
CULTURAL PROcESS AND CULTURAL COMpONENTS

As a learned behavior, culture is influenced by and learned through experiences. Some
of the institutions that play a critical role in learning a particular culture include fam-
ily, religious institutions, schools, and social groups such as friends, neighbors, and
the general society. These institutions, through their dominant role in many societies,
shape the value systems of that society.
The key components of culture are:
• Language and communication

• Social structure
• Religion
• Values
• Attitudes
• Customs
• Aesthetics
• Artifacts
These components also form the core of the definition of culture.
Language and Communication
Language is one of the defining expressions of culture. It is used for communicating

ideas, thoughts, emotions, and decisions. Language includes spoken thoughts (vocal),
42 CHApTER 2
signs, gestures, and other nonspoken means that people use to communicate with one
another. It is the means by which a society transfers its value systems to others and
how norms and customs are expressed and communicated. To understand another
culture, one first has to learn the language of that culture.
In the Internet age, English is becoming the lingua franca of the business world.
Though English is the official language of only about 500 million people (less than 8
percent of the world’s total population), it is universally accepted as the language of
business because of its extensive business-related vocabulary.10 In a borderless global
marketplace, the importance of communication is forcing the emergence of one busi-
ness language that can be understood by all. This does not mean that communication
among people and businesses is simple. Even if people use the same language, it does
not necessarily mean that the language is equally understood by people who come
from different backgrounds. Words and expressions in the same language differ from
society to society. English in the United States is not the same as English spoken in
the United Kingdom, especially in the use of slang words. For example, truck in the
United States is lorry in England, and gas is petrol. If the Americans and the British
have problems understanding each other, one can imagine the difficulties that arise
in business negotiations if participants come from different parts of the world, even
if they all speak English.
Nonverbal language, which includes hand gestures and body language, is unique
to each society, as well. In fact, in some cultures the nonverbal language may be
more important than the spoken language. Italians, for example, are known to be
animated in their conversations, with hand gestures that demonstrate the feelings
behind their spoken words. Nonverbal language is also an area that leads many in-
ternational companies to embarrassing blunders. For example, the A-OK sign used
by Americans (closing of the thumb and index figure to form an O) implies zero for
the French, money or change for the Japanese, and an obscene symbol for Brazilians
and Greeks.
For international companies, knowing the nuances of languages, understanding
the differences in dialects, and recognizing the usage of slang is very important. To
succeed in international business, it is important to respect different languages and
gain knowledge of host cultures.11 Language blunders by international companies are
common. Calling one of its automobile models Nova in Puerto Rico, General Mo-
tors virtually killed the car’s launch. Though the literal translation of nova is “star,”
when spoken, it sounds like no va, which in Spanish means “it doesn’t go.” Similarly,
the now-defunct Braniff, an American airline that proudly advertised “rendez-vous
lounges” on its newest jets, may have wished that its advertisements had never reached
Brazil. In Portuguese, rendez-vous means “a room rented out for prostitution.” Braniff
also inadvertently exhorted Mexican airline passengers to “fly naked for major com-
fort,” when they actually meant to promote the comfort of their leather seats. Other
examples of language blunders include Pepsi-Cola’s advertisement “comes alive,”
which translated into Chinese as “brings your ancestors from their burial place,” and
a hair product, Mist Stick, which unintentionally conjured up thoughts of “manure”
in Germany, as “mist” is slang for manure in German.12
As mentioned earlier, in international business, language can be a problem even if
the language in question is the same language spoken in different countries. Use of
words and contexts differ from country to country. For example, the Spanish word for
“wastebasket” in Colombia is caneca; in Puerto Rico it is zafacón; and in Venezuela it
is basurero. In an interesting case, Electrolux, a Swedish appliance maker, introduced
its vacuum cleaners in the United Kingdom with the tagline “nothing sucks like an
Electrolux.” In introducing the vacuum cleaner in the United States, the company
used the same previously successful tagline from the United Kingdom with disas-
trous results. In the United States, “sucks” has an entirely different meaning (in fact
several meanings, none of them very complimentary). This example demonstrates
the complexities of selling products in countries where the same language may be
spoken, but the local slang and use of words may be different.
Social Structure
Social structure is a society’s fundamental organization; it determines the roles of in-

dividuals within different groups. A social group is a collection of two or more people
who identify and interact with one another and have common interests. The different
groups that members of a society belong to include family, households, social class/
caste, and other similar institutions, such as friendship groups and reference groups.
Social structure also determines individuals’ social positions and their relationships
to others within the group.
International companies strive to understand social structures in their management
of foreign operations. In many societies, traditional social structures are strong and
have great impact on how workers relate to one another. It has been observed that a
key distinguishing characteristic of work behavior in societies is the way in which
members relate to one another as a group.13 Companies may use social classes to
segment markets. Social groups are also used in international advertising as a way
to disseminate information.
Family. Family units differ in size and structure from country to country. The basic
family unit is the nuclear family, which is made up of a father, a mother, and their
children. The nuclear family structure is often found in industrialized countries,
including Australia, Canada, most of Europe, and the United States. Even in these
countries, however, the traditional nuclear family structure is changing. With the high
divorce rate in these countries, it is common to find families where only one of the
parents resides with the child (or children).
In many societies, an extended-family structure exists. An extended family is made
up of the basic nuclear family plus grandparents, uncles, aunts, and other relatives.
Countries in Africa, Asia, the Middle East, and Latin America have extended-family
structures. The relationships and influences of family members differ in an extended-
family structure as compared to a nuclear-family structure. In an extended-family
system, grandparents and uncles may have influence over children and their behav-
ior. Therefore, while marketing products to children in these societies, companies
may have to consider the role of other extended-family members in influencing the
purchase decision.
44 CHApTER 2
Household. A household includes single people or unrelated individuals living in a single

dwelling. Mostly found in industrialized countries (the United States, for example),
households are targeted by companies as potential purchasers of goods and services. In
households that have more than one individual, the group dynamics and social relation-
ships can be strong, as in the case of friends or classmates living together; a household
can also be simply an arrangement among people to save on living expenses, in which
case the social structure is loose and does not influence behavior. In either case, the
structure forces consumption of common household items such as appliances and fur-
niture. Each type of household has a distinctive set of buying habits.
Social Class. Social class refers to relatively homogeneous divisions in a society, divi-
sions that are hierarchically ordered and whose members share similar values, interests,
and behaviors. Social classes exist in every society and are quite often determined
by social status, including income level, education, occupation, area of residence,
and other such variables. Typically, people in a particular class have similar buying
habits and seek similar products. In fact, they also exhibit similar brand preferences.
They tend to behave more alike than people from other social classes. Hence, social
classes tend to be used by companies for segmenting markets and determining market
trends. In extreme cases, the social class structure may be very rigid and formalized
into a caste system, as in India. Whereas social mobility is easy under a social class
system, it is virtually impossible to change under the caste system.
Religion
In many industrialized countries, especially in Europe, religion has lost its position
as a cultural institution that influences society’s value systems. Sweden, for example,
is a secular country with no national role for religion, and, to some extent, this is true
in China, too, though for different reasons. In Sweden, religion has lost its impact on
society due to the country’s economic success and the liberal attitudes adopted by its
people; in China, the years of communist rule have made religion less of a factor in
people’s daily lives. But in many countries, religion plays a critical role in people’s
lives. To some extent, religion’s impact touches people’s secular lives, as well. It is
important for international companies to understand and adopt practices that will
satisfy religious decrees or beliefs. The religious taboo on eating meat among the
Hindus in India led to the introduction of veggie burgers by McDonald’s. Similarly,
in Muslim countries where Islamic law prohibits charging interest on loans, banks
have devised other alternatives such as offering shares to depositors and charging a
nominal fee. The success of these alternate means to charge customers has led many
Islamic banks in the Persian Gulf area to enter many of the predominantly Muslim
countries of North Africa.14
The four major religions of the world are:
• Christianity (including Roman Catholic, Protestant, and Orthodox), with more

than 1.7 billion followers
• Islam, with more than 1.2 billion followers
• Hinduism, with more than 750 million followers

• Buddhism, with more than 350 million followers
Christianity and Islam are termed “global religions” because their followers are found
in many countries of the world, whereas religions that are dominant in one culture or
country—Hinduism, for instance—are called cultural religions. Hinduism is found
largely only in India. Islam is the fastest-growing of the world’s religions and its fol-
lowers are passionate about their beliefs. The other important religions of the world
are Sikhism, Judaism, and Shinto. Confucianism holds a similar place in the lives of
its followers, though it is technically a philosophy of life rather than a religion.
Many human values and attitudes are derived from religious tenets. The direct con-
sequences of religion can sometimes be seen and felt in how managers and businesses
behave in international negotiations and competition. For example, the Protestant work
ethic states that there is more economic growth when work is viewed as a means of
salvation and when people prefer to transform productivity gains into additional output
rather than additional leisure. In other words, you need to give glory to God and at the
same time work hard. This has led to the hard-charging work ethic of many Western
societies. Buddhists believe in spiritual life, self-control, and the attainment of nirvana
(salvation) rather than amassing wealth. There is very little conflict and aggression
among the followers of Buddha, resulting in calm interpersonal relationships. Buddhism
and other similar religions are also the roots of the collectivistic societies in Far East
Asia. Similarly, followers of Hinduism tend to view the world and its purpose in terms
of spiritual redemption and, to a lesser degree, accumulation of wealth. Islam asks of
its followers their total dedication to Allah (the prophet); anything and everything they
do, including how businesses are conducted, is viewed through this belief.
Values
Values are the belief systems that underlie a society’s behaviors, the things that people
believe to be important. People are emotionally attached to these belief systems, so to
some extent they influence people’s behavior. The work ethics that are practiced by
different societies are value based. For example, the Japanese believe that work is very
important, and their philosophy is “live to work.” In contrast, the Europeans’ philoso-
phy is “work to live.” Both philosophies are culture based and deeply rooted in their
respective value systems. Therefore, values are important to international companies
because they affect human behavior in organizations. In addition, some universal value
elements are observed among international managers from different countries. In a
study of managers from five different countries, researchers observed that managers
from Australia and the United States were similar in social processes used to devise
strategies for industrial development. The researchers also found similarities between
American managers and Japanese managers in their pursuit of international expansion.15
Despite these similarities, international companies must manage their employees in
a way that recognizes prevailing cultural value systems. Treating all employees the
same, irrespective of their cultural backgrounds, can often lead to disastrous results.
Take, for example, the experience of an American company that introduced the merit
46 CHApTER 2
system to its operations in Japan. To help coordinate the various individual tasks, the
American manager delegated one individual to be the leader of one of the groups. In
no time, the group was functioning poorly, with performance levels lower than those
before the change was made. In investigating the cause of the decline in productivity,
the American manager realized that he had essentially destroyed the harmony of the
workgroup. Japan is a collectivist society, where individuals in a group are all equal;
no single individual is ranked above the rest. By appointing a leader, the manager had
created disharmony in the system. The employee who was appointed leader did not
want to be the leader, and the group did not feel appreciated.
Attitudes
Attitude is a person’s enduring favorable or unfavorable evaluations, emotions, and

tendencies toward some object or idea. Attitudes put people into a frame of mind of
liking or disliking, and in general, attitudes lead people to behave in a fairly consistent
way in similar situations. For example, attitudes toward time vary among cultures.
For Swedes, being on time is very important, and they will adhere to this attitude at
all costs. In Mexico and other South American countries, however, the attitude toward
time is casual; therefore, being prompt may not be given the high priority there that
it receives in other cultures, particularly if a family member or other relationship
simultaneously vied for the individual’s attention. Business executives from Japan,
Sweden, and the United States, where being prompt and on time for meetings is very
important, find it difficult to function in societies where time is viewed casually.
People’s attitudes affect the international companies’ operations in two ways. First,
a manager’s attitude affects how he or she runs a foreign subsidiary; attitudes about
work, time, and age need to be considered in managing employees. People’s attitudes
regarding family-career trade-off, workplace relations, and salary scales differ from
country to country. In Asian countries, women often choose family over career,
whereas in many Western countries, women balance family and career. Important
cultural differences exist in attitude toward age. In Asian and Arab cultures, age is
respected and elders are revered. Important positions in companies are often held by
experienced older people. In the United States, however, age does not matter. Com-
panies often appoint capable young people to very senior positions. In international
operations, this can sometimes lead to problems. Sending a young fast-track executive
to negotiate with senior government officials in Japan is probably unwise.
Second, in selling products and services in a given market, international companies must
consider people’s attitudes toward them. For example, Levi Strauss has sold jeans in the
United States using functional and reliable positioning, whereas in many overseas markets,
it stresses its American/Western toughness as a strong reason to buy its products.
Customs
Customs are ways of behaving under specific circumstances. Like culture, customs
are handed down from generation to generation. Customs dictate how people
react to situations. For example, a custom that varies from country to country
is the role of alcohol in business dealings. In Asian countries, alcoholic drinks

such as beer, liquor, and sake are usually shared at business events and are part
of the business custom, whereas in the United States, alcohol consumption has
no place in business.16
Aesthetics
Aesthetics play an important role in culture. Cultural preferences in color, beauty,

arts, and architecture are unique to each society. International companies need to
recognize these cultural differences in packaging and advertising their products and
services. For example, the use of the color green in any commercial transactions is
unacceptable for Islamic countries (it is the color of their flag), and red in China is a
royal color and therefore not used for commercial purposes. The color of mourning
differs from country to country: in the West it is black, in Japan it is white, and in
many Latin American countries it is purple, and therefore avoided in some product
categories, especially clothing. International companies need be aware of host coun-
tries’ preferences, which may differ from those of the home country, in order to avoid
business blunders.
Artifacts
Artifacts are buildings, monuments, architectural objects, and other works of art built
by people to reflect some of the values and beliefs of their respective societies. These
buildings are designed and built to last for a long time. Some ancient structures such
as the Great Wall of China, the Parthenon in Athens, the pyramids of Egypt, and the
Coliseum in Rome have withstood the passage of time and speak volumes about the
people of that time. Similarly, seventeenth- and eighteenth-century monuments such
as the London Bridge, the Taj Mahal in India, and the Eiffel Tower in Paris also tell
us about the people of that era. More recently, buildings such as the Empire State
Building in New York, the Tokyo Tower, and the Petronas Twin Towers (at present
the tallest building in the world) in Kuala Lumpur, Malaysia, all reflect something of
the people and society in their respective countries.
FRAMEWORK Of CULTURAL CLASSifiCATiON

Cross-cultural management is defined as the study of the behavior of people from dif-
ferent cultures working in organizations. To understand the cultural variations across
countries, researchers have created useful frameworks that make it easier to compare
them. A variety of cultural classification models have been developed to assess cultural
similarities and differences, four of which are presented here. By no means do these
four provide all the answers to cultural issues faced by international managers, but
collectively they present a useful framework for understanding cultural differences.
These models may also assist international companies in managing employees suc-
cessfully across cultures.
The four cultural frameworks discussed here are:
48 CHApTER 2
• Hofstede’s cultural dimensions

• Kluckhohn and Strodtbeck’s value orientation
• Hall’s low-context high-context approach
• Ronen and Shenkar’s cluster approach
HOFSTEDE’S CULTURAL DIMENSIONS

By far the most discussed work on cultural classifications was written by Gert Hofstede,
who as human resources manager at IBM surveyed about 100,000 IBM employees in
many countries in the 1980s.17 Based on his study, Hofstede proposed five dimensions
of culture (he first proposed four; later, in 1989, he added the fifth).
• Individualism-collectivism
• Power distance
• Uncertainty avoidance
• Masculinity-femininity
• Long-term/short-term orientation
A few of these dimensions were originally proposed in 1961 by the anthropologists

Florence Kluckhohn and Fred Strodtbeck, but Hofstede is the one who studied them
extensively in a corporate setting.
Individualism-Collectivism
Individualism-collectivism refers to the degree to which a society accepts individual

actions or the degree to which individuals perceive themselves to be separate from
others. In a collectivist society, group actions are emphasized. In some ways, the
individualism-collectivism dimension is the most observed and practiced of the five
dimensions studied by Hofstede.
In individualistic societies, such as Australia, Canada, the United Kingdom, and
the United States, people exhibit more individualistic behavior, often pursuing their
own goals, and more likely making decisions that affect their own situations. In col-
lectivistic societies, people tend to consider the group’s interest first and put the good
of the group ahead of their own personal welfare. Countries that have been found to
have collectivist societies include China, Colombia, Greece, and Mexico.
For international companies the individualism-collectivism dimension is a very
important consideration in the management of foreign operations. In individualistic
societies, individual performance is rewarded, individual initiatives are encour-
aged, and individual decision making is the norm; the corporate cultures in these
countries tend to be more impersonal. Research has shown that employees from
individualistic countries prefer individual rather than group-based compensation
practices.18 Corporate policies in individualistic-oriented cultures tend to allow
individuals to take initiatives, work on their own, and make individual decisions.
In collectivistic societies, groups make decisions, work is performed in groups, and
compensation packages are based on the groups’ results. In addition, in collectivist
societies, group performance is more important, and the organizational structures

tend to reflect a “family” orientation.19 Corporate policies in collectivistic cultures
are set up to encourage group results, group actions, and harmony within the group’s
structure.
Power Distance
Power distance refers to the degree to which a society accepts hierarchical (power)
differences; societies will accept either equal or unequal distribution of power. In
countries where power is distributed evenly, that is, where power distances are low,
there is greater acceptance of ideas among people. In these societies senior executives
consult with their subordinates in the workplace. This behavior is also exhibited within
families and in other social settings. In countries with low power distance, children
are encouraged to participate in family decisions and students are encouraged to dis-
cuss and present their points of view in the classrooms. Low power distance is also
called “power tolerance.” Low power distance countries include Austria, Denmark,
Norway, and Sweden.
In high power distance countries, the society believes that there should be a
well-defined order in which everyone knows their individual positions. In these
societies children are supposed to respect their parents and obey them, the teacher
is the center of the educational process, and subordinates are told what to do by
their superiors. Higher power distance countries include India, Mexico, and the
Philippines.
For international companies, the implications of power distance dimensions affect
organizational structure, decision making, and overall management of foreign opera-
tions. Studies have shown that power distance and uncertainty avoidance hinder the
acceptance of new products in some countries.20 Generally, in high power distance
countries, international companies need to set up centralized decision making, a
well-defined hierarchy, and close control. The opposite may be adopted in low power
distance countries.
Uncertainty Avoidance
Uncertainty avoidance refers to the degree to which a society is willing to accept

and deal with uncertainty; in other words, it ranks how a society deals with risk. In
countries with high uncertainty avoidance, people seek security and certainty. They
are comfortable knowing the parameters of their lives and are eager to avoid risk.
People in these societies do not want to deal with ambiguous situations. Countries with
high uncertainty avoidance include Japan, France, Greece, and Portugal. In countries
with low uncertainty avoidance (uncertainty acceptance), people like change and
constantly seek new opportunities. In these countries routine activities and certainty
in future actions lead to boredom, and people tend to be less productive. Countries
with low uncertainty avoidance include Denmark, Sweden, the United Kingdom,
and the United States.
In a study that assessed cross-cultural differences in the perception of financial
50 CHApTER 2
risk, researchers found that the risk judgment differed with nationality and culture.
The attitudes toward risk of respondents from Western societies such as the Nether-
lands and the United States differed from those respondents in Eastern societies such
as China.21 This finding was consistent with cross-country variations in uncertainty
avoidance, suggesting that multinationals operating in countries with high uncertainty
avoidance countries have to provide clearly defined work rules and job security (such
as lifetime employment, which until recently was offered by Japanese firms). In
contrast, when operating in countries with low uncertainty avoidance, international
companies should provide opportunities for quick decision making and should also
encourage risk taking.
Masculinity-Femininity
Masculinity-femininity refers to the degree to which traditional male values are ac-
cepted and followed in a society. In a highly masculine society, behaviors such as
aggressiveness and materialism are viewed favorably. Cultures with a strong mascu-
linity dimension have clearly differentiated sex roles, and men in these societies tend
to be dominant. Men in masculine societies are expected to work and provide for the
whole family. Highly masculine countries include Austria, Italy, Japan, and Mexico.
In highly feministic societies both men and women tend to work and provide for the
family. The sexes have less defined roles and share the responsibilities of parenting,
doing chores, and shopping equally. Countries with a stronger femininity dimension
include Denmark, Finland, and Sweden.
The masculinity-femininity dimension impacts the operations of international
companies in several ways. For example, companies that operate in feministic cul-
tures find that it is more important to maintain easy work schedules and offer better
fringe benefits (maternity/paternity leaves), and they find their employees to be less
interested in promotions. In these countries workers also tend to be more concerned
with community and environmental issues. In countries with a greater masculinity
dimension, workers are interested in pay raises and promotions and tend to be much
more goal oriented.
Long-Term/Short-Term Orientation
Long-term/short-term view refers to time orientation and view of life and work in
terms of a time horizon, either long-term or short-term. People living in cultures that
are long-term oriented, such as Brazil, China, India, and South Korea, tend to be
thrifty; they worry about the future, and they are more dedicated to tasks and causes.
Some experts refer to long-term orientation as a Confucian philosophy. Short-term
oriented cultures, such as Canada, New Zealand, the United Kingdom, and the
United States, worry about the present, seek instant gratification, and are less likely
to save. International companies operating in long-term oriented cultures may find it
necessary to treat their workers differently than do those that operate in short-term
oriented cultures.
Researchers have observed the collective effects of Hofstede’s five cultural dimen-
sions in marketing situations. Studies have found that consumers from collectivist, high
power distance, uncertainty-avoidance, and Confucian (long-term oriented) cultures
such as China and Taiwan definitely have different preferences in their consumption
of goods and services when compared with masculine, individualistic cultures such
as the United States.22
Criticism of Hofstede’s Cultural Dimensions
Hofstede’s cultural dimensions are probably the most studied and discussed of all
cultural dimension models. Hofstede’s is also one of the few cultural models to receive
worldwide publicity. Since it is based on a large sample covering many countries, it
is generally viewed as a reliable model. In addition, some of the dimensions identi-
fied by Hofstede have been identified by other anthropologists and social scientists.
In empirical studies by Sondergraad (1994);23 Hoppe (1998);24 and Neelankavil,
Mathur, and Zhang (2000),25 some of Hofstede’s results on a few of the dimensions
have been validated.
The criticisms leveled against Hofstede’s cultural dimensions relate to:
• appropriateness of the sample

• labeling of the terms
• other biases
Appropriateness of the Sample. Hofstede’s survey was conducted at one company,

IBM. Because IBM is a large multinational company with a strong corporate culture,
its employees may not be a representative sample of the general population. Doubts
exist about results based on a sample from a single company; therefore, researchers
are not sure whether Hofstede’s original four dimensions would have been identified
if the study had been done across many companies. Despite Hofstede’s large sample
size, researchers question the validity of the results based on the fact that the responses
may have actually represented the values of just a few.
Labeling of Terms. Hofstede studied business cultures. The information he gathered

and the conclusions he reached may not shed light on the core societal culture and the
values that are prevalent in a given society. Additionally, Hofstede studied manag-
ers’ attitudes, which may not necessarily reflect a society’s behavior patterns. In fact,
a few studies have demonstrated that cultural categorization is based on dominant
cultural value orientations; it does not provide a complete explanation of cultural
similarities and differences among cultures (a general criticism of all cultural dimen-
sion models).26
Other Biases. Hofstede’s survey was based on an instrument (questionnaire) and scales
that were developed for people in Western societies. Therefore, the terms used in the
questionnaire may not be exactly translated across cultures and in some cases may have
entirely different meanings in different cultures. Some research studies have shown
that questionnaires in organizational psychology are skewed by Western assumptions
52 CHApTER 2
Table 2.1
Summary of Hofstede’s Cultural Dimensions
Dimension Definition Characteristics Countries

Individualism- Extent to which the self or Interest of the indi- Individualistic: Australia, Canada,
collectivism the group constitutes the vidual versus United Kingdom, United States
center point the group
Collectivistic: China, Colombia,

Greece, Mexico
Power Extent to which hierarchical Centralization Power respect: Brazil, India, Mexico,
distance differences are accepted, versus decentral- Philippines
ranging from power ization
respectability to power
tolerance Power tolerance: Austria, Denmark,
Norway, Sweden
Uncertainty Extent to which uncertainty Structure versus Structured: Japan, France, Greece,
avoidance or ambiguity is tolerated, less structure Portugal
ranging from uncertainty (more rules or
avoidance to uncertainty fewer rules) Less structured: Denmark, Sweden,
acceptance United Kingdom, United States
Masculinity- Extent to which traditional How sex roles Masculine: Austria, Italy, Japan,
Femininity masculine (aggressiveness are defined and Mexico
and assertiveness) values practiced
are emphasized Feminine: Denmark, Finland, Sweden
Long-term– Extent to which a society Short-term view vs. Long-term view: Brazil, China, India,
Short-term values thrift and respect of long-term view South Korea
social obligations
Short-term view: Canada, New Zea-
land, United Kingdom, United States
and values that might not be appropriate for use in more traditional societies.27 In
fact, Hofstede originally had only four dimensions. The fifth, long-term orientation,
based on Chinese philosophies, was added much later. Other problems associated
with Hofstede’s study include the difficulties of measuring cultural variables that are
highly subject to contextual interpretation and judgment.
Despite these criticisms, Hofstede’s work has been recognized as a centerpiece
of corporate cultural studies and is widely referred to by scholars and practitioners
of international business research. Table 2.1 summarizes Hofstede’s five cultural
dimensions.
KLUcKHOHN AND STRODTBEcK’S VALUE ORIENTATIONS

Anthropologists Florence Kluckhohn and Fred Strodtbeck were the first (1961) to
describe a cultural framework that was based on dimensions or factors.28 They pro-
posed a framework for identifying cultural differences using six dimensions based
on past versus future and beliefs in individual versus group. To arrive at their cultural
dimensions, Kluckhohn and Strodtbeck looked at the following set of relationships

in a society:
• Are people viewed as good, bad, or a combination?

• Do people live in harmony with or subjugate (conquer) nature?
• Should people in a society act in an individual manner, or should they consider
the group?
• Should people accept and enjoy the current situation or change and make it better?
• What is the concept of space in a society; that is, do people think that most things
are private or public?
• What is the temporal orientation of a society—past, present, or future?
Based on their research, Kluckhohn and Strodtbeck concluded that most societ-
ies have a dominant cultural orientation that could be explained through six cultural
dimensions:
• Human nature
• Relationship to nature
• Human relationship
• Activity orientation
• Concept of space
• Time orientation
Human Nature
Human nature refers to society’s belief in people. Some societies, such as the Japanese,
believe that people are essentially good. In these societies, people trust one another
and are more likely to rely on verbal agreements. There are also societies in which
people are viewed as essentially evil; hence, these societies enact codes and set up rules
of behavior. The result of the mistrust in such societies is that they draw up detailed
contracts in business dealings and specify up front the penalty for not fulfilling the
contract. Contracts with penalty clauses are common in many European countries. A
third type of society views people as both good and evil. In these societies, of which
the United States is an example, people are viewed as changeable, and the members
of these societies try to develop systems to modify behavior.
The human-nature dimension may provide international companies with the clues
that dictate how they run their operations. Therefore, international companies may
have a very participative form of management, with unwritten rules and verbal agree-
ments, in a country where people are viewed as essentially good. In countries where
people are viewed as evil, a more directive form of management should be adopted,
with written rules and formal contracts. For the third group of countries, where people
are viewed as both good and evil, employees may be rewarded for good behavior and
punished for bad (evil) behavior. In a study conducted in China, researchers found
that trust played a significant role in resolving conflicts between expatriate managers
and their Chinese workers.29
54 CHApTER 2
Relationship to Nature
The relationship to nature refers to a society’s relationship between people and

nature—in other words, whether people live in harmony with or subjugate nature.
Societies that believe in living in harmony with nature, such as people in Middle
Eastern countries, tend to alter their behavior to accommodate nature. Countries
where the people view themselves as able to master nature, such as Australia, tend
to harness the forces of nature.
International companies can make use of the relationship-with-nature dimension
by encouraging innovation, changing existing beliefs, and implementing planning
in those countries where people believe that they can conquer (master) nature.
In societies where people tend to view nature as part of their lives, international
companies should be more environmentally conscious, for example, by using
biodegradable packing and by selling goods and services that foster ecological
concerns.
Human Relationship
The human relationship (the same as Hofstede’s individualism-collectivism dimen-

sion) refers to a society’s understanding of relationships among people. In some
societies, people focus on themselves in their actions, decisions, and interactions.
These societies are said to be individualistic; and examples include Denmark, Sweden,
and the United States. The opposite of individualism is groupism, or collectivism.
In collectivist societies people tend to place the interests and welfare of the group
ahead of themselves. In these societies group accomplishments, group decisions, and
group interactions are encouraged. Groupism is practiced in countries such as China,
Japan, and South Korea.
For international companies operating in collectivistic countries, group deci-
sions must be emphasized and individual recognitions and rewards should be
avoided.
Activity Orientation
Activity orientation refers to the primary mode of activity in a given society, that is,
whether people in the society accept or attempt to change their current situations.
Societies that accept the status quo, such as Brazil, Italy, and Mexico, go along with
the flow of events and tend to enjoy the current situation. In those societies where
change is desired, people seek ways to improve the current situation by setting spe-
cific goals, planning for the future, and working toward results. People in Finland,
Sweden, and Switzerland normally tend to be change oriented.
International companies can use the activity dimension in decision making and
the development of long-term plans. If they are operating in a society that looks for
change, employees should be encouraged to innovate and suggest ideas for improve-
ments, and they should be rewarded for successful innovations.
Concept of Space
The concept of space describes the extent to which a society views meetings be-
tween people as private or public. In countries that view space as private, such as the
United Kingdom, people do not get too close to one another. Open discussions are
not common, and ideas are restricted to just a few at one time. The opposite is true for
those countries in which space is considered public, such as Italy. In these countries,
participation is encouraged, decision making is more democratic, and feelings are
expressed publicly.
International companies must consider the space concept in running their for-
eign operations. In a very private society, for example, management-employee
meetings and discussions must be managed differently than those that take place
in a public society.
Time Orientation
The time orientation (somewhat similar to Hofstede’s long-term/short-term view) is

the extent to which people view their value systems based on time frames. Are their
value systems governed by the past, present, or future? In some societies, the past is
very important. People in these societies use historical experiences and traditions to
guide them in their day-to-day activities. These societies also make use of the past in
their business dealings. For example, the Chinese are traditionalists and use the past
as their reference point in conducting business.
In some societies the past is not that important; the present and the immediate are
what counts. Instant gratification is the norm among people that value the present.
Businesses in these societies tend to develop short-term plans. Companies publish
quarterly financial reports and managers are rewarded on short-term goals. The United
States is often cited as a society focused on the present.
Societies that are future oriented are interested in long-term results. Japan is an
example of a society that is long-term oriented. The Japanese people have one of
the highest savings rates in the world, and they value lifetime employment. Japanese
companies emphasize long-term planning; for example, Matsushita Company (now
Panasonic) set up a 100-year business plan, but more commonly Japanese companies
have 25-year plans.
The time orientation has significance for international companies not only
in terms of corporate planning, but also in terms of how their employees view
their day-to-day activities. In past-oriented societies, traditional practices never
go away; hence, management has to be careful when introducing new systems.
International companies that operate in future-oriented societies have difficulty
operating in a present-oriented society. Japanese companies operating in the
United States encounter difficulties in instituting long-term business plans for
American managers. Table 2.2 summarizes the six Kluckhohn-Strodtbeck cultural
dimensions.
56 CHApTER 2
Table 2.2
Summary of Kluckhohn-Strodtbeck Cultural Dimensions
Dimension Definition Characteristics Countries

Human Extent to which people Focus on good, evil, or a Focus on good: Asian
nature view one as good or evil combination countries (Japan)
Focus on evil: European

countries
Focus on good and evil:

United States
Relationship Extent to which people live Belief in accepting, altering, Accepting: Middle Eastern
with nature in harmony or try to subju- or managing their destinies countries
gate (harness) nature
Harnessing: Australia,
United Kingdom, United
States
Human rela- Extent to which people Individualistic versus group Individualistic: Denmark,
tionship believe in independence or oriented United Kingdom, United
dependence States
Group oriented: China,

Japan, South Korea
Activity orien- Extent to which people ac- Expression of feelings vs. Accept: Brazil, Italy, Mexico
tation cept the current situation seeking change Change: Finland, Sweden,
Switzerland
Concept of Extent to which a society In private society people are Private: United Kingdom
space views meetings as private distant; in public society peo- Public: Italy
or public ple encourage participation
Time Extent to which people Past provides the solutions; Past: China
orientation view the past, present, or effects of present are impor- Present: United States
future as important tant; effects in the long run Future: Japan
HALL’S LOW-CONTEXT–HIGH-CONTEXT FRAMEWORK

In explaining the use of language and how information is obtained, Edward T. Hall
characterized the differences in cultures as low-context and high-context cultures.30
In low-context cultures, the words used by the speaker convey precisely what the
speaker has in mind. Hence, in obtaining information in a low-context culture, only
firsthand information is considered relevant. Communication in low-context societies
is direct and people avoid small talk. Many European countries and the United States
are considered low-context cultures.
In high-context cultures, it is not the words alone that convey the message, but
also the context. Cultural clues are important in understanding what is being com-
municated, making the context as important as the spoken words. When interpreting
information in these cultures, one has to be sensitive to the peripheral information.

In countries with high-context cultures, the person’s status and the importance of the
situation are just as important as the communication itself. High-context cultures are
found in Asia, Latin America, and the Middle East.
From a practical standpoint, the context dimension of culture affects commu-
nication, information gathering, and decision making. For managers from low-
context cultures supervising subordinates from high-context cultures, information
provided by subordinates may sound as if it is an excuse as they explain the current
status of the task in a roundabout way. The opposite may happen if managers are
from high-context cultures are supervising subordinates from low-context cul-
tures. Managers from high-context cultures may feel that their subordinates are
too aggressive and do not like to follow orders. The low-context–high-context
dimension is equally problematic in business negotiations, as either side may feel
offended due to differences in approaches. Many negotiations between Japanese
executives and Western European executives have been strained due to commu-
nication problems.
It is important for business executives from low-context cultures to under-
stand that in high-context cultures, building a good relationship is the first order
of business and must occur before actual long-term arrangements are made.
The initial meetings between the parties are simply to earn one another’s trust.
Therefore, bringing lawyers to early meetings sends the wrong signal (implies a
lack of trust). In this environment, negotiations and agreements take a long time;
managers from low-context cultures must be prepared for delays in completing
business arrangements.
The low-context–high-context cultural dimension also affects international compa-
nies’ advertising strategies. In Austria, Germany, and the United Kingdom, advertising
is fact based and contains few words. Therefore, companies from high-context cultures
need to adapt to the direct approach used by low-context cultures in presenting their
messages. For example, Japanese automakers’ ads in Europe are very direct and to
the point in comparison to the lengthy ads used in Japan. In high-context cultures,
advertisements take on emotional overtones and the ad copy is long. International
companies from low-context cultures need to adjust their ad copy to fit into the cultural
context in which they are operating. For example, in high-context countries Procter
& Gamble’s ads for its Joy brand of dishwashing soap are especially descriptive and
explain in detail the merits of the soap.
RONEN AND SHENKAR’S CLUSTER AppROAcH

By grouping countries that share cultural dimensions such as language, Simcha Ronen
and Oded Shenkar were able to classify countries into nine clusters:31
• Anglo
• Arab
• Far Eastern
• Germanic
58 CHApTER 2
Table 2.3
Ronen and Shenkar Culture Clustering
# Culture cluster Characteristics

1 Anglo (7 countries): Australia, Canada, Ireland, Common language, British influence in busi-
New Zealand, South Africa, United Kingdom, ness and law
United States
2 Arab (6 countries): Abu Dhabi, Bahrain, Kuwait, Common language, common religion, common
Oman, Saudi Arabia, United Arab Emirates customs and practices, proximity to one another
3 Far Eastern (8 countries): Hong Kong (not a Common Asian traditions and customs
country anymore), Indonesia, Malaysia, Philip-
pines, Singapore, Taiwan, Thailand, Vietnam
4 Germanic (3 counties): Austria, Germany, Common language, historic links, and proximity
Switzerland to one another
5 Independent (4 countries): Brazil, India, Israel, No common characteristics

Japan
6 Latin American (6 countries): Argentina, Chile, Common language, former colonies of Spain,
Colombia, Mexico, Peru, Venezuela proximity to one another
7 Latin European (5 countries): Belgium, France, Some common cultural values and proximity to
Italy, Portugal, Spain one another
8 Near Eastern (3 countries): Greece, Iran, Historic links and proximity to one another
Turkey
9 Nordic (4 countries): Denmark, Finland, Many common cultural dimensions, historic

Norway, and Sweden links, proximity to one another
Source: Simcha Ronen and Oded Shenkar, “Clustering Countries on Attitudinal Dimensions: A Review
and Synthesis,” Academy of Management Review, 10, no. 3 (1985): 435–454.
• Independent—nothing in common
• Latin American
• Latin European
• Near Eastern
• Nordic
The basic premise of Ronen and Shenkar’s cultural clustering is that similarities
among cultures do exist. It follows, then, that it is possible for international com-
panies to implement standardized strategies across countries. In addition, Ronen
and Shenkar’s culture clustering can be used to select countries for market entry.
By using a similar analysis for countries in the same clusters, international compa-
nies can more quickly evaluate potential locations. If there are cultural differences
between the home country and the host country, an international firm may want to
avoid the uncertainty these countries present. Cultural differences may foreshadow
difficulties in adapting to local conditions. For example, recognizing the similarities
in cultures, many U.S. companies often choose Canada and the United Kingdom
as their first overseas markets. Similarly, China is the first entry point for some
Taiwanese companies.
International companies have also used cultural clustering to design organiza-
tional structures that take into consideration the similarities and differences among
cultures. In designing organizational structures, international firms try to create
balance between international/global integration (coordination of activities) and
local responsiveness (response to specific needs by the subsidiary). This balanc-
ing act is often dependent on how culturally similar or dissimilar the home and
host cultures are. For example, Unilever’s organizational setups in Germany and
Switzerland are similar, whereas the organizational structure in India is totally
different from that found in Europe. Table 2.3 presents the Ronen and Shenkar
culture clustering.
OTHER CULTURAL CLASSIFIcATIONS

Besides the four frameworks of cultural dimensions that have already been examined,
there are two other cultural classification models that are often discussed in the inter-
national business context. The first is the cultural classification by S.H. Schwartz and
the second is the Charles Hampden-Turner and Fons Trompenaars cultural model.
Schwartz’s classification focuses on the social relationships and social environ-
ment in which people interact. Schwartz’s model identifies three key dimensions: (1)
embeddedness versus autonomy; (2) hierarchy versus egalitarianism; and (3) mastery
versus harmony.32 The first dimension, embeddedness versus autonomy, explains
people’s cultural orientation toward social relationships. In some societies, people
are very independent and express their feelings with no regard for others (autonomy).
Countries in which individuals seek autonomy include Denmark, France, and Ger-
many. In contrast, societies that exhibit embeddedness (also called conservatism) are
more traditionalists. Countries in which embeddedness is observed include Singapore,
Taiwan, and Turkey.
The hierarchy versus egalitarianism dimension deals with the roles of people in
social situations—those who seek important roles versus those who are more con-
cerned with their relationships with others. Countries such as China and Thailand
are very hierarchical; countries such as Estonia and Mexico are more egalitarian.
Schwartz’s third dimension deals with mastery of nature versus harmony. In some
societies, people value success, and in others they pursue harmony with nature and
tend be less ambitious. People in Brazil and Spain are found to be driven by ambi-
tion, whereas people from Italy and Finland are more concerned with the broader
social system.
Hampden-Turner and Trompenaars developed a classification that is based on
the premise that foreign cultures are basically not very different, but rather mirror
images of one another. According to their theory, a society’s values and rewards are
based on order and sequence of looking and learning. In a very basic sense, we need
to understand why in some societies people write their given name first and family
name last, as in many Western cultures, whereas in many Asian cultures the family
name comes first. At the same time, most Western societies are individualistic and
60 CHApTER 2
Asian societies are collectivist (community oriented). Is there a link between these
two patterns? Is the reason that members of Western society write their given name
first because they are very individualistic in their behavior, and vice versa? Similarly,
in some societies people write left to right and in others they write right to left (Arabic
language). How much of this is value driven? Based on their research, Hampden-
Turner and Trompenaars developed three value dimensions: (1) universalism (applies
to many) versus particularism (emphasizes exceptions); (2) individualism versus com-
munitarianism (collectivism); and (3) specificity (precision or getting to the point)
versus diffuseness (larger context).33 There are similarities between Hampden-Turner
and Trompenaars’s classifications and other cultural classifications, most obviously
Hofstede’s individualism-collectivism and Hampden-Turner and Trompenaars’s
individualism/communitarianism.
Some overlap exists among all the cultural dimension models. For example, the
individualism-versus-collectivism dimension is mentioned in three of the models.
Similarly, Hofstede’s power distance dimension is the same as the hierarchy dimen-
sion in Schwartz’s framework.
Clearly, culture can have a powerful effect on international business operations.
Because people belong to different societies that have their own cultural norms,
beliefs, and values, their behavior and expectations at the workplace are affected. If
international companies make a concerted effort to understand foreign cultures, some
of the problems associated with differences in culture may be reduced.
One suggestion for global managers to be successful in overseas markets is to
develop five cultural competencies; cultural self-awareness, cultural consciousness,
ability to lead cultural teams, ability to negotiate across cultures, and a global mind-
set.34 Though these skills are extremely useful, in practice they are hard to teach. In
understanding different cultures, it becomes apparent that it is quite difficult to master
and be proficient in all their variations.
All the cultural models that are presented here have some common themes, but
they do not address each and every unique aspect of the hundreds of cultures that
exist around the world.
CULTURAL GENERALiZATiON
The cultural models presented here, along with others, may give the impression that
one can easily capture, compartmentalize, and learn about other cultures. The truth
of the matter is, cultures cannot be classified, it is not easy to understand them, and
learning individual cultures is a long and tedious process. Some cultural differences
are easy to observe and learn, such as a society’s acceptable attire or how to greet
people. However, it is difficult to learn the culturally ingrained responses to situations
that are second nature to the locals but completely unfamiliar to foreign executives.
The best way to learn a culture fully is to immerse oneself in that culture, that is, to
live and practice the culture for a long period of time and learn the language. Time,
however, is one item that international businesses and their executives do not have.
Therefore, many international managers end up receiving only a macro treatment of
culture and never become well-versed in the deep-rooted cultural values, norms, and
customs of their host nations. It is no wonder that many international blunders can
be traced to cultural misunderstandings.
Cultural generalizations based on different models, though useful, are often
the problem in learning about foreign cultures. Armed with a few cultural dimen-
sions, executives feel confident that they are ready to conduct business in foreign
countries. But these dimensions may not provide the complete picture. Some of
the information gathered about foreign cultures may be stereotypes that can pose
even more problems. A few examples of stereotypical generalizations include:
“Americans are brash and make quick decisions,” “Japanese are slow to come
to an agreement,” and “Italians love to talk.” There are so many cultural varia-
tions and nuances that it is not possible to understand or memorize all of them
for every country.
CULTURAL CONVERGENCE
Advances in technology that have enabled people to travel and communicate in
ways that were difficult if not impossible just a decade ago have made the world
smaller and brought people closer. This phenomenon has led to a better understand-
ing of foreign cultures and an acceptance of values and norms that until recently
had been foreign to many. In addition, some uniform consumption patterns have
emerged that seem to transcend cultures. In a study conducted among Web us-
ers, it was found that the satisfaction levels across cultures provided equivalent
measurement.35 Take, for example, the success of Starbucks coffee in China, a
tea-drinking society; the proliferation of American-style fast food in Japan, India,
and Latin American countries; the widespread wearing of denim jeans among
young people in many parts of the world; and the success of Japanese cuisine in
America (especially raw fish, which differs from the traditional preferences.) Add
to this the spread of globalization; it is not surprising to see more similarities in
cultural practices.
CULTURE SHOCK
Even after managers complete their cross-cultural training in preparation for an
international assignment, many are likely to feel disoriented upon arrival at the
new location. For instance, someone accustomed to calling colleagues by their first
names must adjust to the widespread use of titles and last names in the workplace.
In some countries, the degree of respect given to people and use of proper names in
addressing people is very important.36 How does one adjust to people coming late
for meetings? How does a manager from a cold weather country adjust to hot and
humid climates? This disorientation faced by foreign workers is generally referred
to as “culture shock.”
Culture shock is defined as “a generalized distress one experiences in a new and
different culture because of a lack of understanding of the local culture.” If often
occurs because the foreign worker is facing an unfamiliar set of behavioral cues that
are different from the ones he or she is used to or knows about.
62 CHApTER 2
Most experts agree that culture shock is accentuated by the difficulty in interacting
in the local environment, leading to a focus on the negative aspects of the local cul-
ture and its people. The more successful foreign workers are those who are willing to
learn the culture, accept the differences in cultures, and adapt to the new environment.
There are no shortcuts in preparing international managers to be ready for cultural
shock, but training, role-playing, and exposure to people from different cultures and
environments can often make the transition a little easier.
CULTURAL ORiENTATiON
Understanding foreign national cultures and adapting to these cultures in the business
world depend on two factors: (1) the cultural similarities found between the home
country’s culture and the host country’s culture, and (2) the managers’ attitudes toward
other cultures. The attitudes of managers and their companies toward outside cultures
can be classified as ethnocentric, polycentric, or geocentric.
ETHNOcENTRISM
Ethnocentrism—the belief that one’s own culture is better than or superior to other
cultures—is one of the most common attitudes found among international managers.
Managers with an ethnocentric attitude often ignore important host-country cultural
values. For example, a study of Chinese workers employed by multinational companies
found that the expatriate managers were persistent in maintaining their own cultural
values in relationship building.37 Of course, this resulted in poor working relation-
ships between the locals and the expatriates. It was also noticed that the expatriate
managers tried to change the cultural orientation of the host-country personnel, which
did not help the situation. International companies that tend to have an ethnocentric
attitude more often use a centralized organizational structure. These companies often
dictate policies and procedures from headquarters, with very little input from sub-
sidiary personnel. Interestingly, the managers themselves may not be aware of their
ethnocentric attitudes, and herein lies the challenge for international firms in handling
their executives’ ethnocentric behavior. Ethnocentrism has been identified as a major
cause of many international business difficulties.
POLYcENTRISM
Polycentrism is the recognition that it is important to understand the differences in
cultures and act accordingly in interacting with people from other cultures. Interna-
tional companies and their polycentric managers try to accommodate cultural dif-
ferences, and to facilitate its local responsiveness, the company is often organized
in a decentralized structure. Some experts feel that while polycentric firms adapt
readily to various countries, this adaptation can lead to serious inefficiencies for the
firm (as it is often unable to capitalize on economies of scale). This situation may
ultimately have a negative impact on the firm’s competitiveness. Trade-offs between
local adaptation and cost efficiency usually depend on the nature of the product or
service being marketed. For example, consumer packaged-goods companies may

need to be more sensitive to national differences than, say, firms selling industrial
goods. International companies that have a polycentric attitude may also be reluctant
to adopt certain practices and procedures simply because they were successful in the
home country or other host countries; in this way, polycentric companies are being
sensitive to a given host-country personnel’s attitudes and behaviors.
GEOcENTRISM
Geocentrism is the belief that in certain cultures change can be made and in oth-
ers one has to adapt to the host culture. In these cases, international companies and
their managers base their decisions and manage their operations after thoroughly
understanding the host culture and its unique features. The geocentric attitude avoids
the main problems associated with ethnocentric and polycentric attitudes, and the
international company is able to introduce proven systems and be innovative at the
same time.
CHApTER SUMMARY
Culture is a critical environmental variable that international companies need to con-
sider in entering and managing their foreign operations. Mistakes rooted in cultural
misunderstandings are some of the most common blunders committed by international
executives. Hence, there have been many attempts made to identify similarities and
differences between cultures through cultural dimensions.
A good working definition of culture is the knowledge, beliefs, art, law, morals,
customs, and other capabilities of one group distinguishing it from other groups.
Culture is a learned behavior that is passed down from generation to generation and
evolves over a long period of time. The key institutions that instill culture are family,
schools, and religion.
Language, religion, and social structures are important correlates of culture that
influence international business operations. Researchers have attempted to study and
understand the reasons for cultural similarities and differences. Based on these studies,
researchers have developed various classifications of country cultures. The most cited
and discussed cultural classification is the one proposed by Gert Hofstede. Hofstede
identified five cultural dimensions that may be used to find similarities between cul-
tures. The other classifications of culture include those of Kluckhohn and Strodtbeck;
Hall; and Ronen and Shenkar. Though each of these systems explains some of the
similarities between cultures, they do not provide all the answers to cultural behavior
and the differences found between cultures.
International companies need to recognize the importance of culture and use it to
avoid major mistakes. The influence of culture should be considered in developing
entry strategies, designing organizational structures, managing subsidiary operations,
and developing marketing strategies.
In understanding cultural influences, international businesses have to recognize
concepts such as cultural generalization, cultural convergence, cultural shock, and
64 CHApTER 2
various types of management orientation such as ethnocentrism, polycentrism, and

geocentrism.
KEY CONCEpTS
Cultural Components
Cultural Dimensions
Culture Shock
Cultural Convergence
Cultural Orientation
1. What is culture?
2. Identify the key elements of culture.
3. How is culture learned?
4. What are the key institutions that influence cultural behavior?
5. How do societies communicate, and what role does language play in inter-
national operations?
6. Explain the role of religion in culture and how it affects international business
operations.
7. What are social structures? How do international companies use social struc-
tures in designing their organizational structures?
8. What are cultural dimensions?
9. Identify and discuss some of the important cultural dimensions.
10. What is cultural convergence?
11. What is culture shock?
12. Explain and discuss ethnocentrism, polycentrism, and geocentrism.
ADDiTiONAL READiNGS
Ajiferuke, Musbau, and Jean J. Boddewyn. “Culture, and Other Exploratory Variables in Comparative
Management Studies.” Academy of Management Journal (June 1970): 153–63.
Ashkansay, Neal M., and Celeste P.M. Wilderom. Handbook of Organizational Culture and Climate.
Beverly Hills, CA: Sage Publications, 2000.
Dunlop, J.T., F.H. Harbison, C. Kerr, and C.A. Myers. Industrialism and Industrial Man Reconsidered.
Princeton, NJ: Princeton University Press, 1990.
Gannon, Martin J., and Associates. Understanding Global Cultures: Metaphorical Journeys through
17 Countries. Beverly Hills, CA: Sage Publications, 1994.
Griffin, Ricky W., and Michael W. Pustay. International Business. 4th ed. Upper Saddle River, NJ:
Pearson-Prentice Hall Publishers, 2005, chap. 4.
Krech, David, Richard S. Crutchfield, and Egerton L. Ballachey. Individual in Society. New York:
McGraw-Hill, 1962.
Punnet, Betty Jane, and David A. Ricks. International Business. Boston, MA: PWS-Kent, 1992, chap. 6.
Shenkar, Oded, and Yadong Luo. International Business. Hoboken, NJ: John Wiley & Sons, 2004,
chap. 6.
AppLiCATiON CASE: BUSiNESS NEGOTiATiONS AND CULTURAL

PiTfALLS—MEXiCO
Two companies had been shortlisted for a major infrastructural contract in Mexico:
one was an American and the other Swedish. Both companies were invited to Mexico
to present their proposals to the relevant ministry and to start negotiating the terms
of the deal.
The Americans put a lot of effort into producing a high-tech, hard-hitting presen-
tation. Their message was clear: “We can give you the most technically advanced
equipment and quality of service at a price our competitors can’t match.” The team,
which consisted of senior technical experts, lawyers, and interpreters, flew down
from the company’s New York head office to Mexico City, where they had reserved
rooms in one of the top hotels for a week.
In order to put on the best possible performance for the minister and his officials,
the Americans arranged to give the presentation in a conference room at the hotel.
They brought all the necessary equipment with them from the United States. All the
arrangements had been written down in great detail and sent to the Mexican officials
two weeks earlier.
At the agreed-upon time, the American team was ready to present, but they had
no one to present to. The people from the ministry arrived at various times over
the next hour. The ministry staff did not apologize for being late, but just began to
chat amicably with the Americans about a wide range of nonbusiness matters. The
leader of the American team kept glancing anxiously at his watch. Finally, he sug-
gested that the presentation should start. Though the Mexicans seemed surprised,
they politely agreed and took their seats. Twenty minutes later, the minister, ac-
companied by some senior officials, walked in. He looked extremely angry and
asked the Americans to start the presentation again from the beginning. Ten minutes
later, the minister started talking to an aide who had just arrived with a message
for him. When the American presenter stopped talking, the minister signaled that
he should continue. By this time, most of the Mexican representatives were talk-
ing amongst themselves. When invited to ask questions at the end, the only thing
the minister wanted to know was why the Americans had told them so little about
their company’s history.
Later, during lunch, the Americans were very surprised to be asked questions about
their individual backgrounds and qualifications, rather than technical details about
their products. The minister had a brief word with the American team leader and left
without eating or drinking anything.
Over the next few days, the American team contacted their Mexican counterparts
several times in an attempt to fix a meeting time and start the negotiations again. The
Americans reminded the Mexican team that they had to fly back to the United States
at the end of the week. But the Mexican response was always the same: “We need
time to examine your proposal amongst ourselves first.” At the end of the week, the
Americans left Mexico angry and frustrated.
66 CHAPTER 2
QUESTIONS
1. Who do you think received the contract?
2. Explain in specific detail the American team’s steps (right or wrong) that
produced this outcome.
ADDITIONAL READINGS
Shirley Taylor, “Communicating across Cultures,” British Journal of Administrative Management
(June-July 2006): 12–21.
SOURcE
Chris Fox, “Cross-Border Negotiation,” British Journal of Administrative Management (June-July
2006): 20–23.
3 Economic and Other Related
Environmental Variables
Economic variables such as the gross domestic product, balance of payments, inflation,
and other such factors have a great impact on the operations of a global company.
LEARNiNG ObJECTiVES
• To understand the environmental variables that affect international business
• To understand the influence of macroeconomic factors on international opera-
tions
• To understand the variables used to measure the strengths and weaknesses of
individual economies
• To understand the differences among industrialized, emerging, and developing
economies
• To understand the differences among market-based, centrally planned, and mixed
economies
• To learn about the underground, or parallel, economies and their effects on in-
ternational companies
• To understand techniques to conduct country risk analysis
• To understand the importance of competitive analysis in international business
operations
Aside from the cultural factor, discussed in Chapter 2, the environmental factors
that affect an international business include a country’s economy, competition,
infrastructure, technology, political stability, and government regulations. In this
chapter, the effects of economy, competition, infrastructure, and technological fac-
tors are discussed.
THE ECONOMY
The last 20 years have brought the world more trade, more globalization, and more
economic growth than in any such period in history.1 The economy of a country af-
fects businesses in many ways. Economic downturns might result in a reduction in
consumer expenditures, affecting sales revenues. A drop in a country’s gross domestic
67
68 CHApTER 3
product (GDP; the total value of all goods and services produced in a country in a
given period of time) or gross national income (GNI; includes the total value of goods
and services produced within the country together with external net income received
in the form interests and dividends; the World Bank uses the GNI measures to report
on a country’s economic activity) may imply a contraction in a country’s total output.
A decline in a country’s currency value may suggest an underlining weakness in the
economic structure of country and, hence, may mean difficulties for businesses.
Recognizing the possible impact of this key external variable, international manag-
ers continuously monitor economic factors to be prepared for the dynamic shifts that
occur in each country’s economic activities. The unexpected Asian crisis in July 1997
sent shockwaves throughout the region. As a result, many investors were unwilling to
provide loans and subsidies to developing countries. The ensuing credit crunch led to
an economic slowdown in many developing countries, which resulted in a decrease
in demand for foreign goods, affecting many international companies. Similarly, the
continuing decline in the value of the U.S. dollar against the European euro and the
British pound is affecting businesses on both continents.
More recently, the credit crisis of 2008 that started in the United States has had
global financial repercussions; the crisis is engulfing developing countries from Latin
America to Central Europe, raising the specter of market panic and even social un-
rest. The list of countries under threat is growing by the day and now includes such
emerging market stalwarts as Brazil, South Africa, and Turkey. The fast-growing
economies of the world depend on money from Western banks to build factories, buy
machinery, and export goods to the United States and Europe. When those banks stop
lending and the money dries up, as it did in 2008, investor confidence vanishes and
the countries suddenly find themselves in crisis.
International managers consider the changes in the economic environment when
selecting countries for market entry, and when developing specific market-related
strategies. Among the various external factors, the economic environment is more
consistently structured and the information on economic activities for most countries
is readily available; hence, this external factor can be accessed easily.
In international markets, the level of a country’s economic activity as measured by
its GDP, GNI, inflation rate, and/or exchange rates is critical to a company’s opera-
tions. These economic variables attempt to describe a set of conditions that influence
the company’s strategic operations. A growing and robust economy implies higher
consumption expenditures by consumers and better revenues for companies. A higher
inflation rate creates economic instability and leads to increases in commodities prices,
and a depreciating local currency makes imports cheaper and domestic exports more
expensive, resulting in trade deficits.
Evaluating countries for market entry or for developing operational strategies
depends to a large extent on the soundness of the selected country’s macroeconomic
conditions. Economic strength is dependent on the structural foundation of the econ-
omy for sustained economic growth and economic stability. Specific components of a
country’s economic strengths include investments, both internal and foreign, domestic
consumption, the population’s real income levels, performance of the individual sec-
tors within the economy, and infrastructure development.
EcONOMIc AND OTHER RELATED ENVIRONMENTAL VARIABLES 69
Local and foreign investments add to the factors of production, including the cre-
ation of jobs. They also stimulate the economy through the introduction of advanced
technologies, higher productivity levels, and overall improvements in key sectors
of the economy. A case in point is the phenomenal economic growth in the United
States during the 1990s that was brought on by investments in technologies during
the previous decade. Equally important are changes in the consumption expenditures,
specifically per capita consumption. Increases in consumption expenditures imply
that the people have steady jobs, their real incomes (income minus rate of inflation)
are rising, and many of them are very confident about the robustness of the economy.
When consumption expenditures in a country decline, its economy suffers. A case in
point is the situation that the Japanese economy experienced in the late 1990s. Due
to general weaknesses in the economy and a lack of confidence in the government
leaders to pull the economy out of its downturn, many consumers in Japan reduced
their consumption expenditures, which further destabilized the economy.
Economic strength and stability are also affected by the performance of a coun-
try’s economic sectors—agriculture, manufacturing, and service. Quality of output,
efficiencies in each sector, use of technology in each sector, and overall productivity
levels greatly influence the economy. A strong and stable economy normally relies
on the development of its economic sectors. Countries with a strong manufacturing
base, such as China, or those that rely heavily on the service sector, as the United
States does, normally have strong economies. Countries that rely heavily on the
agricultural sector and have relatively fewer workforces in the manufacturing and
service sectors typically have underdeveloped economies. Countries in Africa, parts
of Asia, and Latin America are good examples of countries that are underdeveloped.
These countries are not competitive and receive very little foreign investment, which
further hinders their economic development.
As mentioned earlier, an economy’s strength is normally deduced through key
economic variables such as GDP/GNI growth rates, per capita GDP/GNI, inflation,
current account balance (part of the balance of payments), and external debt.2
GROSS DOMESTIc PRODUcT AND GROSS NATIONAL INcOME

Gross domestic product (GDP) can be calculated by totaling up the amount of a country
spent on final goods and services; this is called the expenditure method. It can also be
calculated by totaling up all the wages, rents, interest incomes, and profits earned by
all factors in producing the final goods and services; this is called the income method,
or gross national income (GNI). The GDP/GNI is used as a measure of a nation’s
total output. The GDP/GNI growth rate measures the annual increase in a nation’s
total output from the previous year to the next. For example, the German economy
grew by 2.7 percent in 2006, a moderate increase; in contrast, the Chinese economy
grew by 9 percent during the same year, a substantial growth rate. The growth rate
is a good indicator of a nation’s economic vitality. The stronger the growth rate, the
more robust the economy. For international companies, countries with a strong growth
rate are attractive locations for investment.
Per capita GDP/GNI is a nation’s total GDP/GNI divided by its population. The
70 CHApTER 3
Table 3.1
Inflation Rates for Few Select Countries, 2007
Country Inflation Rate (%)

1 Zimbabwe 1,035.5
2 Iraq 53.2
3 Guinea 30.0
4 Sao Tome and Principe 23.1
5 Yemen 20.8
6 Myanmar 20.0
7 Uzbekistan 19.8
8 Congo 18.2
9 Afghanistan 16.3
10 Serbia 15.5
Source: “World Statistics,” http://www.infoplease.com/January 2008.
GDP/GNI per capita is a better reflection than overall GDP/GNI of the well being
of the country’s people. Based on GNI per capita figures for 2006, the people of
Switzerland at $58,050 seem to be leading a very good life. On the other hand, with
a GNI per capita for 2006 of only $230, the people of Malawi seem to have a dif-
ficult life.3 For international companies, the higher the GNI per capita, the better the
market potential, as the people in the country with higher GNI per capita can afford
to spend more on a vast variety of goods and services.
INFLATION
Inflation is another factor that international companies use to measure a country’s
economic strength. Inflation is defined as an increase in the overall price level of
goods and services in a country. The rate of inflation is calculated by averaging the
percentage growth rate of the prices of a selected sample of commodities. Inflation
affects many aspects of an economy, including prices of goods and services and prices
of raw materials and components used by companies in the manufacture of goods.
The inflation rate also determines the real cost of borrowing and affects a country’s
exchange rate. Real interest rates are calculated by subtracting inflation from the
nominal interest rate. Most countries control inflation through monetary and fiscal
policies. Japan and the United States, for example, have a good record in keeping
inflation under control through monetary and fiscal policies.
Inflation rates vary from country to country. Most industrialized countries try to
maintain low inflation—in the single digits. For example, for the year 2007 the infla-
tion in Japan was 0.8 percent; during the same time period Serbia registered a 15.5
percent rate of inflation. Developing economies have difficulty maintaining single-
digit inflation, however. For example, Zimbabwe experienced an inflation rate of
1,035.5 percent for 2007, and Iraq’s inflation rate for 2007 was 53.2 percent. Table
3.1 presents the inflation rates for selected countries for the year 2007.
Due to fundamental structural problems, it is difficult for developing countries to
keep inflation under control. For most developing countries, an unending cycle of
high unemployment and low incomes combined with scarcity of goods and services
leads to a general rise in price levels. Long-term inflation is caused by excessive
demand, called demand-pull inflation, or a rise in costs, called cost-push inflation or
supply-side inflation. Demand-pull inflation occurs when there are general increases
in the aggregate demand and the supply of goods and services lags behind—that is,
consumers are purchasing too many goods, and the producers are not able to meet
the needs, resulting in higher prices. In cost-push inflation, input costs keep rising;
the producers pass this increase on to the consumers.
Setting prices is never an easy task for international companies. Prices are affected
by many factors, including competition, price elasticity of demand, government
regulations, and other internal factors. However, when a firm must set a price within
a high-inflation market, these factors become compounded.4
BALANcE OF PAYMENTS
Balance of payments refers to all of a nation’s transactions in goods, services, assets,
and donations with all of its trading partners. It is a double-entry bookkeeping system
that is balanced at the end of a specific time frame, usually a year. Balance of payments
consists of two separate accounts: (1) the current account, which is made up of all
of a country’s exports and imports, any income earned or remitted because of assets,
and employee compensation received or paid, and (2) the capital account, a financial
transaction between countries in which assets are purchased or sold. The current ac-
count is the one most watched by policy makers and international companies.
The difference between a country’s exports and its imports in goods and services
is referred to as its balance of trade. A trade surplus is said to occur when a country’s
exports are greater than its imports; a trade deficit occurs when a country’s imports
are greater than its exports. Countries such as Japan and China have huge trade
surpluses each year. China had a trade surplus of $262.2 billion for the year 2007,
a nearly 50 percent increase from the previous year.5 In contrast, the United States
runs deficits every year. The U.S. trade deficit for just one month (March 2008) was
close to $60 billion.
EXTERNAL DEBT
A country’s external debt is its total borrowing through foreign government sources
or private banks. Many developing countries borrow from foreign sources to finance
their developmental programs, as they themselves lack the required capital. In many
instances, the poorer countries are not able to pay back the amount outstanding, and
banks have to reschedule their debts. An agreement is reached whereby the debtors
are given extensions on their payment schedules, and in some cases a portion of the
debt may be written off. During the 1970s and 1980s some American banks, primar-
ily Citigroup and JPMorgan Chase, lent considerable funds (close to $700 billion)
to foreign countries, including Brazil, Mexico, and Venezuela. Table 3.2 presents
the current external debt of selected countries. Countries with large external debts
72 CHApTER 3
Table 3.2
External Debt for Selected Countries, 2007 (estimate)
# Country External Debt (in $ billions) External Debt as a % of GDP

1 Brazil 557.1 43.9
2 China 614.1 18.9
3 Mexico 204.8 23.1
4 Russia 90.0 7.0
Source: Central Intelligence Agency, “Country Statistics,” The World Factbook. Available at https://www.
cia.gov/library/publications/the-world-factbook/ (accessed June 10, 2008).
have fundamental problems in their economies. Any economic downturn among the
industrialized countries hurts poorer countries’ exports, reducing their capacity to
pay back the loans. The profits and other remittances of international companies that
plan to operate in these countries may be compromised.
ECONOMiC DEVELOpMENT AND INTERNATiONAL BUSiNESS

Traditionally, international companies have sought countries that have substantial market
potential—specifically, the industrialized countries of the world, such as Japan, most
of the Western European countries, and the United States. These countries provide
economic stability but also a larger than average consumer base that can buy goods and
services beyond basic necessities. For example, the European Union had an estimated
population in 2006 of 457 million. Of this population, nearly 70 percent or 320 million
were in the middle-income category, providing a substantial consumer base to which
foreign companies could sell their goods and services. Because of the economic stability
and high purchasing power of the fully developed countries’ population, international
companies find the business environment in these countries safer. For example, com-
panies such as Boeing and Coca-Cola in the United States, Switzerland’s Nestlé, and
Unilever of the Netherlands derive a substantial portion of their revenues from a select
few countries. Coca-Cola obtains about 15 percent of its revenues from Japan alone,
and Nestle receives about 20 percent of its revenues from the United States, the world’s
two largest economies. Hence, a country’s economic development has considerable
influence on whether an international company will invest in it.
Less industrialized countries offer smaller markets for international companies and
also have marginal growth rates. The total market potential of all the less developed
countries put together is relatively small. Hence, the business environment in these
countries is riskier for international companies. But some radical changes are taking
place in the flow of globally based companies’ investments and operations. In recent
years, because of the saturation of industrialized countries’ domestic markets and the
dynamic changes that have occurred in some of the developing economies, interna-
tional companies are investing in these economies to tap into the newfound opportu-
nities. For example, countries such as Brazil, China, the Czech Republic, Hungary,
Malaysia, Peru, and Thailand are attracting attention in the corporate sphere. In fact,
China has become the world’s “manufacturing base,” with many foreign companies
investing heavily there. Currently China is the world’s single largest cellular phone
user, with more than 432 million subscribers. By the year 2020, China will be the
second-largest market for automobiles, with expected sales of 9 million cars per year.
It is no wonder that the world’s major automobile manufacturers, including Mercedes-
Benz of Germany, are setting up manufacturing operations in China.
A country’s economic development is measured by the following variables: per
capita GDP/GNI, wealth distribution, quality of life, literacy rates, and life expec-
tancy. Using a country’s level of economic activity, various international agencies
such as the United Nations (UN), the World Bank, and the International Monetary
Fund (IMF) have grouped countries of the world into different classes. The tradi-
tional (and old) economic development classifications included industrialized/fully
developed countries; newly industrialized countries; less developed countries; and
underdeveloped, or third world, countries. These classifications are often based on
a multitude of factors including the level of industrialization, the country’s wealth,
availability of capital for investments, and the general well-being of the country’s
citizens. Under this system, Canada, France, Germany, Japan, Singapore, Sweden,
the United Kingdom, and the United States would be classified as “industrialized,”
or “fully developed,” nations. “Newly industrialized” countries include Brazil, South
Korea, and Taiwan. Examples of countries that are considered “less developed” or
“developing” are Chile, India, Malaysia, Mexico, Peru, and Thailand. And Angola,
Burundi, and Myanmar are countries that could be classified as “underdeveloped.”
The current classification of a country’s stage of economic development no longer
contains categories such “third world” or “underdeveloped,” but rather more accept-
able terms such as “developing” or “less developed.” Each international agency uses
not only different terminology to classify countries but also different variables to group
them. For example, the IMF uses terms such as “advanced economies” that include
both “developed countries” and “newly industrialized economies.” Similarly, the
United Nations generally uses just two categories to classify countries—”developed”
and “developing” economies.
Perhaps the simplest and most useful classification of countries based on their
stage of economic development was developed by the World Bank, which uses GNI
as the sole variable to classify countries. A country’s gross national income is defined
as “income generated by a country’s residents from domestic and international ac-
tivity.” Using GNI per capita, the World Bank classifies countries as “high income”
(54 countries), “upper-middle income” (37 countries), “lower-middle income” (56
countries), and “lower income” (61 countries). The exact statistics used by the World
Bank to group the countries are as follows:
High income $10,726 or more

Upper-middle income $9,075–2,936
Lower-middle income $2,935–736
Low income $735 or less
Table 3.3 presents selected countries classified according to GNI.
74 CHApTER 3
Table 3.3
Selected Countries as Classified by the World Bank, 2006
GNI per Capita

# Country (Current US$)
High-Income Countries
1 Australia 33,940
2 Canada 36,280
3 Denmark 36,190
4 Germany 32,680
5 Italy 28,970
6 Japan 32,840
7 Netherlands 37,940
8 Singapore 43,300
9 United Kingdom 33,650
10 United States 44,070
Upper-Middle Income Countries
1 Argentina 11,670
2 Chile 11,300
3 Gabon 11,180
4 Hungary 16,970
5 Malaysia 12,160
6 Mexico 11,990
7 Slovak Republic 17,060
8 South Africa 8,900
9 Uruguay 9,940
10 Venezuela 10,970
Lower-Middle Income Countries
1 Albania 6,000
2 Belarus 9,700
3 Brazil 8,700
4 Ecuador 6,810
5 Egypt 4,940
6 Honduras 3,420
7 Jordan 4,820
8 Morocco 3,860
9 Philippines 3,430
10 Thailand 7,440
Low-Income Countries
1 Bangladesh 1,230
2 Chad 1,170
3 Eritrea 680
4 Haiti 1,070
5 Kenya 1,470
6 Liberia 260
7 Nigeria 1,410
8 Senegal 1,560
9 Tajikistan 1,560
10 Vietnam 2,310
Source: The World Bank, “World Development Data.” Available at http://devdata.worldbank.org/data-
query (accessed June 10, 2008).
A problem faced in GNI and other economic statistics is the question of comparability
between various data. Is 100 euros in Berlin equivalent to 600 Chinese yuan at an ex-
change rate of !1.00 = 6.00 yuan? The answer is no. With !100, a German family would
probably be able to buy one week’s worth of food and beverages. In contrast, a Chinese
family might need only 100 yuan to buy food for a week. Since 1 yuan is not equal to
!1, the Chinese person is spending only !16.60 (100/6.00) per week, compared to the
German’s !100. Therefore, a simple conversion of a country’s GNI per capita or GDP
per capita into another currency in which country statistics are maintained (U.S. dollars
or euros) might not be an accurate measurement of that country’s economic state.
To overcome the conversion problem, international organizations such as the United
Nations have developed a technique to compare economic statistics across countries.
The technique, known as “purchasing power parity” (PPP), is defined as the number of
units of a currency required to buy the same amount of goods and services in the domes-
tic market that could be bought with the U.S. dollar in the United States. For example,
suppose a basket of essential goods (food, rent, clothing, and the like) for a family in the
United States costs $1,000.00. That same basket of goods costs a family in the Philippines
P1,000. When the cost of goods is converted from pesos into U.S. dollars, a family in the
Philippines spends only $200, at an exchange rate of US$1 = P50. Therefore, it appears
that a Filipino family needs only a fifth (200/1000) of the expenditure of an American
family to buy the same quantity of essential goods. Hence, according to purchasing power
parity, if the GDP per capita of the Philippines was $1,000, using the PPP method it will
be recorded as US$5,000 (multiplied by a factor of 1,000/200 = 5).
The World Bank does not use straightforward official exchange rates or the purchas-
ing power parity approach to a country’s economic data; instead, it uses the “Atlas”
methodology. Conversions using the Atlas method are normally more stable and take
into account historic exchange rates by utilizing three factors: (1) the average of the
current exchange rate, (2) the exchange rates for the two previous years, and (3) the
ratio of domestic inflation to the combined inflation rates of the European Union,
Japan, the United Kingdom, and the United States. In calculating the conversion of
economic data using the Atlas approach, the World Bank adjusts the two-year historic
domestic exchange rate by the ratio of domestic inflation to the combined inflation
of the four aforementioned groups/countries. Table 3.4 presents GNI per capita for
selected countries using the Atlas method and the PPP method.
Because of the lower cost of living in countries such as Argentina, Bangladesh,
and Colombia, the GNI per capita using the PPP method is higher than the GNI per
capita using the Atlas method for these countries. In contrast, for Norway, the GNI
per capita using the PPP method is much lower than the Atlas method.
In addition to the GNI classification of countries, the World Bank uses a measure of
indebtedness to group countries when compiling global economic data. Using indebted-
ness as an economic factor, countries are classified into four groups: “severely indebted”
(53 countries, including Argentina, Indonesia, and Turkey); “moderately indebted” (39
countries, including Bolivia, Malaysia, and Slovak Republic); “less indebted” (44 coun-
tries, including Algeria, Guatemala, and Thailand); and “not classified” (77 countries,
including the wealthiest in the world such as the Nordic countries).
The GNI classification of economic development is useful for a broad-based macroanal-
76 CHApTER 3
Table 3.4
GNI per Capita for Selected Countries Using the Atlas and PPP Methods, 2006
GNI per Capita GNI per Capita

Country (Atlas Method) (PPP Method)
Argentina 5,150 11,670
Australia 35,860 33,940
Bangladesh 450 1,230
Canada 36,650 36,280
Colombia 3,120 6,130
Germany 36,810 32,680
Ireland 49,960 33,740
Malaysia 5,620 12,160
Norway 68,440 50,070
Philippines 1,390 3,430
Sweden 43,530 34,310
United States 44,710 44,070
Source: The World Bank, http://devdata.worldbank.org/data-query (accessed June 10, 2008).
ysis of countries. However, in evaluating countries or formulating operational strategies,

international managers make use of the more traditional economic indicators such as GDP
growth rate, GDP per capita, rate of inflation, current account balance, and so on. These
statistics have more direct influences on the consumption patterns of a population.
Countries can also be classified by their overall economic systems. An economic sys-
tem explains how a country allocates its resources. A country’s resources may be owned
by private citizens, by private companies, collectively by the country’s people, or by the
government. When private citizens and private companies own and control resources,
the economy is referred to as a “market-based system.” When the government owns
and controls resources, the system is referred to as a “centrally planned economy” or a
“command economy.” Ownership of resources translates into control of the resources
and the right to allocate them, as in the case of the Netherlands and the United States. In a
market economy, most of the resources are owned and controlled by the private sector. In
a centrally planned economy, such as those found in Cuba or North Korea, the resources
are owned and controlled by the public sector. There are some economies where the re-
sources are owned and controlled by the private sector and the public sector, as seen in
France and India. Table 3.5 presents countries organized by their economic systems.
MARKET-BASED EcONOMY
If given a choice, international managers prefer to operate in a market-based economy
because, by definition, it is consumer driven; that is, consumers have unlimited choices,
and their decisions are not controlled by outside forces. The freedom the consum-
ers enjoy also extends to firms operating within the country. In a pure market-based
system, companies decide what to produce, what to sell, at what prices to sell their
goods and services, and how to market them. Supply and demand dictates prices; they
are not preset by any entity—government or private. That is, when the demand for
Table 3.5
Types of Economic Systems in the World
Type of economy Selected countries No. of countries

Market-based Hong Kong, Singapore, United States 10
Mixed Brazil, Canada, India, Japan, Mexico 125
Centrally planned Cuba, North Korea 27
a particular product increases, companies may raise prices to take advantage of this
opportunity, and when demand falls, they may lower price to stimulate demand.
For international companies, operating in a market-based economy implies that the
country’s economic framework is open to accepting foreign companies and foreign
investments. In an open economy, the country’s economic structure is invariably
sound, and private companies can thrive under these conditions. A company’s suc-
cess or failure is totally dependent on its own strategic actions and the actions of its
competitors. This is similar to the environment that most international companies
are used to in their home countries, and therefore the level of uncertainty for these
companies is minimized.
CENTRALLY PLANNED EcONOMY

In a centrally planned economy, the consumers have no freedom of choice regarding
what they can buy, and most of the country’s goods and services are produced by
government enterprises. Consumers buy what is available, and within a product cat-
egory only one brand is available. If a family wishes to buy sneakers, the only brand
that is available is the one made by the government factory producing them, unlike in
market-based economies such as the United States, where there are plenty of choices.
In a centrally planned economy, resources are allocated to various production facilities
based on the plans of the country’s government, which considers itself a much better
judge than the private sector of what is good for its people. It can divert resources to
various segments of the economy as it sees fit. Economic principles of demand and
supply do not function in a centrally planned economy. Hence, the quality, prices, and
marketing of goods and services are determined by the government. One advantage
for the people in a centrally planned economy is that the prices of commodities remain
the same during high demand as well as low demand. The downside of the system is
that when supply of a product runs out, no efforts are made to add to the supply, no
matter what price a consumer is willing to pay.
The general principle behind centrally planned economies is that everyone in a
society should be able to buy and consume goods and services equally. The concept
of rich versus poor does not exist in these economies. Since the breakup of the Soviet
Union, few countries follow a centrally planned system. In fact, China, which used
to have a centrally based economy, is slowly shifting toward a mixed economy.
Operating in centrally planned economies is often a struggle for international com-
panies. Their success is dependent on factors that are outside their control. Interna-
78 CHApTER 3
tional companies have to fit their plans into an overall country-based economic plan
developed by the country’s government. Depending on the industry, this quite often
puts an international company at odds with local governments. For example, if the
Cuban government in its current five-year (2005–2010) economic plan has identified
food production, health services, and infrastructure as the key sectors toward which
to direct its efforts, and if Unilever plans to enter the Cuban market by introducing
a brand of detergent, the Cuban government may not necessarily deny Unilever’s
request to invest in Cuba, as it seeks foreign investments; at the same time it may not
be too helpful to the company, either.
MIXED EcONOMY
In a mixed economy, the resources are owned and controlled not by individuals or
the government alone, but by both groups. In fact, there are more mixed economies
in the world than there are either market-based or centrally planned economies. The
principle behind mixed economies is that there are some segments of production that
for various reasons should be controlled by the government and some that should
be left to the private sector. Transportation, energy production, telecommunications,
and distribution of food are segments typically controlled by the government. The
reasoning is that these are the lifelines to the existence of a society, and leaving their
control to the private sector may threaten the supply of these essential goods and
services, especially during a national crisis. Mixed economies range widely regarding
how much of the private sector controls the resources versus how much the public
sector controls the resources. France, India, and the Scandinavian countries are good
examples of mixed economies.
In mixed economies, the opportunities in some sectors of the economy are very
attractive for international companies, as they may not have to compete with public-
sector companies. The market environment for nonpublic-sector undertakings in
many of these mixed economies is similar to that of market-based economies. They
are driven by market forces, although at times the government may decide to take
over a particular sector if it determines that this action will serve the public’s best
interest. For example, the French government has slowly reestablished its presence
in the energy industry, especially in the production of electric power, to safeguard
against foreign control of this sector.
ECONOMiC FACTORS AND INTERNATiONAL BUSiNESS STRATEGY

Analysis of the economic and other environmental factors that affect foreign countries
and their markets can help international managers understand the behavior of these
markets and assist them in developing effective strategies. By predicting market
trends and analyzing the size, potential, and characteristics of countries’ markets,
international managers can develop unique strategies to tap into the potential of these
countries. However, the many differences among countries make this process diffi-
cult. Countries vary in size, economic development, economic policies, and view of
investments from abroad. Countries from the former Soviet Union bloc, for example,
do not necessarily look favorably on foreign companies. The governments of these

countries make it difficult for foreign companies to invest in them, even if it would
mean improvements in their economic conditions. Sometimes these countries fear a
change in their political systems due to the influence of international companies. It
is difficult for governments that have been immersed in socialistic ideals to suddenly
forgo these ideals and embrace democratic rules and privatization.
Frequently, international companies find foreign countries’ economic systems
totally alien in comparison to their own domestic economic environment. The learn-
ing process for these companies can be time-consuming and difficult. For example,
the Japanese economy was a puzzle to many American and European companies:
the close relationship between Japanese companies and the various Japanese govern-
ment agencies, whose role was to help private companies and act on their behalf in
negotiations, was new to the American and European managers. Since many inter-
national companies operate in multiple countries, they are required to learn different
economic systems. For example, Siemens of Germany operates in 137 countries, and
the economic patterns that they encounter in Europe are vastly different from those
they find in the Latin American region. The economic compositions of countries vary
widely; no two systems are exactly alike. What is learned in one system may not be
transferable to another. A company that operates in Brazil may find the economic
system in Argentina quite different, even though both countries are situated in the
same region. Therefore, international managers have to learn a new system every
time they enter a new country.
Economic systems in some countries are very volatile. Without warning, the local
economy may enter into a downward spiral; overnight the rate of inflation may hit
double digits; and the local currency may be devalued by 20 to 40 percent in no time,
as happened in Argentina in the fall of 2004. Each of these events places great stress
on the operations of international companies. International managers must always be
prepared to deal with such sudden changes.
As economic conditions shift, international companies have to adjust their cor-
porate strategies. Compared to domestic economic forces, international economic
factors are quite dynamic and difficult to predict. Unfamiliarity with local economic
conditions also makes it difficult for international managers to plan for sudden swings
in a country’s economy. For example, a rise in inflation might affect the costs of
inputs such as labor and material. A sudden appreciation in the local currency might
make exports of goods and services more expensive and cause a country to lose its
competitive advantage. An increase in the local country’s external debt may affect
government expenditures and soften consumption expenditures. In fact, changes in
economic variables affect the overall business environment. These changes mean
that international companies that operate in many countries must react to shifts in
economic conditions in a timely, effective, and well-programmed manner.
To address the difficulties of planning in an uncertain world economy, international
managers follow a systematic strategy-formulation process. The individual steps in the
process are: scenario analysis, business analysis, strategic action plans, execution, and
monitoring/control. Most of these steps are standard management prescriptions used in
developing strategies. Due to uncertainties in the international context, however, these
80 CHApTER 3
tasks become increasingly important. (Some steps are presented in later chapters in the
discussion of functional strategies.) Because of its impact on the overall business envi-
ronment, scenario analysis is the first step undertaken by most international companies.
It helps international managers to develop alternative business strategies.
Scenario analysis is built on the assumption that the future of an economy or event
can be realistically and systematically predicted and that it is possible to identify
the chain of events that might take place in certain situations. Scenario analysis is
defined as quantitative and qualitative descriptions of the possible future state of
an organization developed within the framework of relevant interdependent factors
or events in the external environment. That is, scenario analysis (1) focuses on the
external environment, (2) considers the future of this environment, (3) identifies
the interdependence of the various factors that affect this environment, and (4) uses
research to predict future events.
Scenario analysis is an exercise in identifying the events in the environment that
are most likely to affect a company’s performance. These future events are developed
under logical assumptions about what might impact the market and include existing
uncertainties. International managers developing scenario analyses may use them to
forecast possible actions that would minimize or overcome existing uncertainties,
asking themselves what the best possible course of action would be in a given sce-
nario. To be useful, the scenario analysis should focus on the one or two most likely
possibilities and use indicators that confirm or refute the laid-out scenario.6 A good
example of the application of scenario analysis comes from Southwest Airlines. It was
one of the few American companies that entered into a futures contract to buy oil at
$34 per barrel during the gradual price increases of crude oil in the summer of 2005.
When the price reached $77 in the summer of 2006, Southwest was competitively
well placed in controlling its costs, as it was paying only half the amount for oil that
other U.S. domestic airlines were paying. Similarly, Deutsch Bahn (DB), the Ger-
man railway system, wanted to predict the ridership under different scenarios for its
express trains, which take people to different parts of the country and connect them
to the other rail systems in Europe. DB considered the effects of gasoline prices on
automobile and air travel, and it also considered weather patterns that may influence
people’s travel plans when calculating the number of trains that it should put into
service each year. This action resulted in substantial cost savings for the railways.
As we have said, the economic scenario is made difficult due to its unpredictabil-
ity. Despite their sophistication, the existing econometric models that use complex
simultaneous regression equations are unreliable. Two years ago, no one could have
predicted that a barrel of crude oil would hit $135; nor could anyone have predicted
that the downturn in the Japanese economy would last for more than 10 years. Reces-
sion, the spiraling cost of energy, interest rate hikes, and trade deficits are all variables
that do not behave logically.
In developing a scenario analysis, the following steps may be helpful.7
• Enumerate the strategic intent of the analysis—the analysis may help international
companies to forecast the environment in preparation for subsequent decisions
or for evaluating strategies against chosen scenarios.
• Conduct a trend-impact analysis—using information, media scanning, forecasts,

judgments, and past experiences to identify possible trends.
• Create scenarios—predict which events will occur, at what time, and in what
order.
• Outline actions—for each possible scenario, develop an action plan to take (what
should be done).
ECONOMiC FACTORS AND COUNTRY RiSK ANALYSiS

In selecting a country for entry, international companies conduct a risk analysis to
consider those factors that expose them to various types of risks. Aside from finan-
cial losses, international companies face (1) loss of intellectual property rights (for
example, many pharmaceutical companies have lost their patent rights in India; local
Indian companies have produced generic drugs that are sold at reduced prices, out-
selling international companies); (2) loss of brand image; (3) liability lawsuits (for
example, in 1999 Coca-Cola products were banned in six European countries after
children in school cafeterias became ill after drinking Coke; this was a public rela-
tions nightmare for Coca-Cola, and the company lost close to $300 million in sales
after the recall of its products); and (4) human loss (in some Latin American countries
expatriate executives have been kidnapped, and a few have lost their lives). Factors
used in country risk analyses include political stability, economic conditions, banking
and finance risk systems, laws and regulations, and cultural dynamics. In addition to
these factors, international companies may analyze the quality of infrastructure, level
of technology, quality of life, and a country’s external debt.
Depending on the industry, some factors may be more important than others. For
example, for a fast food company, the cultural and infrastructure variables might be
more critical than the technology factor. For a telecommunications company, however,
the technology factor will most likely be more critical than many others. In most in-
stances, however, researchers believe that the economic and political factors are most
important in an assessment of a country’s risk. In analyzing countries, researchers
assign weights to each factor and then rank the risk element for each country. For
example, in its semiannual country risk rankings, Euromoney, a U.K. publication,
assigns a weight of 25 percent each to the economic and political factors.
Euromoney uses a multiple approach in arriving at its rankings, taking into account
both qualitative information and quantitative data in assessing a country’s risks. To
obtain some of the qualitative data, Euromoney polls economists, political analysts,
and insurance brokers. The quantitative data is collected from the World Bank, the
International Monetary Fund, and credit agencies such as Moody’s and Standard &
Poor’s to arrive at a score for each country. Table 3.6 lists the nine variables consid-
ered by Euromoney in its ranking of countries and the respective weights assigned
to each variable.
Using these variables, Euromoney ranks 185 countries of the world every six
months. Table 3.7 lists the 10 least risky countries to invest in based on Euromoney’s
March 2008 rankings. Table 3.8 lists the 10 most risky countries to invest in based
on Euromoney’s March 2008 rankings.
82 CHApTER 3
Table 3.6
Variables Used in Euromoney’s Country Rankings
Variable Weight %
1 Political risk 25
2 Economic performance 25
3 Debt indicators 10
4 Debt in default 10
5 Credit ratings 10
6 Access to bank financing 5
7 Access to short-term finance 5
8 Access to capital markets 5
9 Forfaiting (discount rate on letter of credit) 5
Table 3.7
The Ten Least Risky Countries of the World, March 2008 Euromoney Rankings
Variables
Country V1 V2 V3 V4 V5 V6 V7 V8 V9 Totals
1 Luxembourg 25.00 25.00 10.00 10.00 10.00 5.00 5.00 5.00 4.88 99.88
2 Norway 24.67 22.93 10.00 10.00 10.00 5.00 5.00 5.00 4.65 97.47
3 Switzerland 24.71 21.63 10.00 10.00 10.00 5.00 5.00 5.00 4.88 96.21
4 Denmark 24.54 19.58 10.00 10.00 10.00 5.00 5.00 5.00 4.27 93.39
5 Sweden 24.68 18.40 10.00 10.00 10.00 5.00 5.00 5.00 4.88 92.96
6 Ireland 24.39 18.09 10.00 10.00 10.00 5.00 5.00 5.00 4.88 92.36
7 Austria 24.36 18.01 10.00 10.00 10.00 5.00 5.00 5.00 4.88 92.25
8 Finland 24.76 17.32 10.00 10.00 10.00 5.00 5.00 5.00 4.88 91.95
9 Netherlands 24.50 17.58 10.00 10.00 10.00 5.00 5.00 5.00 4.88 91.95
10 Austria 23.74 17.53 10.00 10.00 10.00 5.00 5.00 5.00 5.00 91.27
Source: Euromoney magazine, “Country Risk Analysis,” March 2008. Available at http://www.euromoney.com/
Article/1886310/country-risk-March-2008-overall-results.html.
Some large international companies do not rely on rankings published by the busi-
ness press, but conduct their own country risk analyses. Most of the factors considered
by these companies are similar to the ones published by the business journals. For
example, the U.S.-based American Can Company assigns the most weight to economic
and political risk factors in developing its own country risk ranking lists. Table 3.9
lists a few of the key factors used by American Can in its country risk analysis and
the respective weights assigned to each factor.
The World Economic Forum (WEF) conducts a global competitiveness ranking
of countries using both publicly available data and an executive opinion survey.
For the 2007–2008 report, WEF polled more than 11,000 business leaders. Table
3.10 lists the top 10 competitive countries among the 131 WEF polled. United
States was ranked as the top country by WEF, followed by Switzerland and three
other Nordic countries—Denmark, Sweden, and Norway—ranking third, fourth,
and sixth. Similarly, in the “Doing Business” report released by the World Bank,
Table 3.8
The Ten Most Risky Countries of the World, March 2008 Euromoney Rankings
Variables
Country V1 V2 V3 V4 V5 V6 V7 V8 V9 Total
176 Micronesia 13.84 3.98 0.00 0.00 0.00 0.00 0.77 0.44 0.00 19.03
177 Zimbabwe 0.56 0.07 6.97 10.00 0.00 0.00 0.19 1.13 0.00 18.92
178 Zaire 4.48 2.98 0.00 10.00 0.00 0.00 0.58 0.86 0.00 18.89
179 Liberia 4.58 1.78 0.00 10.00 0.00 0.00 0.19 0.38 0.00 16.93
180 Cuba 3.85 5.75 0.00 0.00 3.44 0.00 0.58 0.60 0.61 14.82
181 Marshall Islands 9.83 3.41 0.00 0.00 0.00 0.00 0.00 0.38 0.00 13.61
182 Somalia 0.00 2.37 0.00 10.00 0.00 0.00 0.58 0.38 0.00 13.32
183 Iraq 1.74 3.22 0.00 0.00 0.00 0.00 0.19 0.95 0.00 6.11
184 North Korea 0.29 4.50 0.00 0.00 0.00 0.00 0.58 0.64 0.00 6.01
185 Afghanistan 1.71 3.46 0.00 0.00 0.00 0.00 0.19 0.08 0.00 5.45
Source: Euromoney magazine, “Country Risk Analysis,” March 2008. Available at http://www.euromoney.com/
Article/1886310/country-risk-March-2008-overall-results.html.
Table 3.9
Relative Factor Weights Used by American Can for Analyzing Country Risk
Factor Weight (%)

Political stability 26.0
Political freedom 7.0
Quality of infrastructure 6.7
Inflation 3.6
Currency stability 3.3
Balance of payments 3.3
Table 3.10
The Global Competitiveness Rankings, 2007–2008
Rank Country Score (out of 7)

1 United States 5.67
2 Switzerland 5.65
3 Denmark 5.55
4 Sweden 5.54
5 Germany 5.51
6 Finland 5.49
7 Singapore 5.45
8 Japan 5.43
9 United Kingdom 5.41
10 Netherlands 5.40
Source: The World Economic Forum, “World Competitive Ranking.” Available at http://www.weforum.
org/en/initative/gcp/Global%/20competitivness/20report/index.htm.
84 CHApTER 3
Denmark, Finland, Norway, and Sweden were ranked near the top as well. The
United States was ranked second.
These rankings by the various agencies show that there is some uniformity in all
rankings, and their lists are quite reliable.8
UNDERGROUND EcONOMY
Most of the economic data compiled by individual national governments and various
international organizations is the result of reported economic activity by corporations,
small businesses, and individuals. The official economic statistics, called the “ob-
served economy,” are measured by totaling all expenditures for newly produced goods
and services that are not resold in any form. These expenditures include consumer
spending, investment by businesses, government expenditures, and net exports. It is
believed that in many countries reported economic activity is understated, as some
corporations, small businesses, and private citizens do not fully disclose their financial
records. There may be many reasons for underreporting income and related financials,
including internal tax codes and other government regulations. It is generally alleged
that the higher the income tax rate and the more bureaucratic the process of reporting
financial statements and filing taxes, the greater the nondisclosure of incomes.9
The economic activities that go unreported are commonly referred to as “underground
economic activities.” The underground economies are sometimes called “parallel
economies,” “shadow economies,” or “submerged economies.” Underground economies
were originally thought to be a problem of developing economies or centrally planned
economies (economic systems found in predominantly socialist countries including
China and the bloc of countries that made up the former Soviet Union). Recent statis-
tics compiled by business journals such as the Economist paint a different picture. In
fact, many of the culprit nations of huge underground economies are some of the most
developed countries of Western Europe, particularly Italy and Spain. In addition, three
Scandinavian countries with some of the highest tax rates due to their social welfare
systems are among the top six countries in terms of highest underground economies.
The size of the underground economies among developing countries remains high due
to structural deficiencies and corruption. Some estimates place the figure between 35
and 44 percent. Table 3.11 presents countries with the highest percentage of underground
economies among the industrialized countries in relation to their total GDP.10
For international companies, operating in an economy that is to a large extent based
on the parallel economy poses problems. As foreign companies, they need to adhere
to the country’s laws, and their actions are scrutinized much more carefully than are
those of domestic companies. At the same time, local competitors have an advantage,
as they are used to these conditions and can operate under the radar.
In addition to economic factors, the other four environmental factors that need to be
discussed are competitive environment, infrastructure, technology, and quality of life.
COMpETITIVE ENVIRONMENT
Competitive environment can be divided into two parts: macro and micro. In the
macro competitive environment, the country’s competitive advantage or disadvan-
Table 3.11
Estimate of Underground Economy as Percentage of Total GDP, 2006
Total GDPa Current % of Underground

Country ($ hundred million) Economy of GDPb Corporate tax (%)c
1 Australia 768.20 13.00 30.00
2 Belgium 392.00 21.00 33.99
3 Canada 1,251.50 16.00 36.60
4 Denmark 275.20 19.00 24.00
5 France 2,230.70 16.00 34.33
6 Germany 2,906.70 16.00 25.00
7 Ireland 222.60 10.00 20.00–42.00
8 Italy 1,844.70 26.00 33.00
9 Japan 4,340.10 9.00 30.00
10 Netherlands 657.60 14.00 29.00–34.50
12 Norway 311.00 20.00 28–51.3
13 Spain 1,224.00 24.00 15.00–45.00
14 United Kingdom 2,345.00 12.00 30.00
15 United States 13,201.80 9.00 35.00
Sources:
a The World Bank, http://www.worldbank.org/data/countryclass/countryclass.html (accessed October
15, 2007).
b “Black Hole,” The Economist, August 28, 1999, p. 59.
c Worldwide-Tax.com, available at http://www.worldwide-tax.com (accessed January 2007).
tage as a whole is considered. In the microenvironment, the competitive advantage

or disadvantage at the firm level is evaluated. The macro competitive environment
deals with attractiveness of countries to investors. As Michael Porter put it, “Why
do some nations become the home base for successful international competitors in
an industry?”11 A few countries are more attractive than others for some specific
industries. For example, Switzerland is home to many of the leading pharmaceuti-
cal companies; similarly, China is home to many of the garment manufacturers of
the world, and India has many of the leading software development companies of
the world. Countries attain competitive advantage through various means, including
factor-input costs (India and China), economic stability and regulatory environment
(Switzerland), size of domestic market (Europe and the United States), and techno-
logical developments (Germany and Japan). None of these reasons by themselves
may provide the competitive advantage a country seeks, but a combination of these
factors may explain some of it.
At the micro level, international companies face an array of competitors with var-
ied and unique advantages. Some of the competition comes from local companies,
which are already entrenched in the host country—local competitors. Others are
international firms operating in the global marketplace—global competitors. A third
category of competitors are companies from the same country as the international
firm—home competitors. For example, for General Motors operating in Germany,
BMW, Mercedes-Benz, and Volkswagen are local competitors; Fiat, Renault, Saab,
and Toyota are global competitors; and Ford Motors is the home competitor. By
86 CHApTER 3
understanding the competitive and strategic advantages of each of these groups, an

international company might be able develop its own unique strategies.
International companies conduct competitive analyses to identify current and poten-
tial competitors, to predict the possible strategic actions of these competitors, and to
account for unforeseen events that may give competitors an advantage. In identifying
current competitors, companies consider the following key variables:
• How similar are the company’s product or service offerings to those of other
firms in the same country? For example, Coca-Cola and Pepsi-Cola both offer
cola products that could easily be substituted for each other. Therefore, these
two companies are competing directly with each other for the same target
customers. In contrast, Coca-Cola and Cadbury Schweppes offer carbonated
beverages, but their products are not similar; Cadbury Schweppes offers more
noncola products.
• How similar are the benefits that customers derive from the company’s products
to those they derive from the products or services that the other firms offer?
Once again, the more similar the benefits derived from the products or services,
the higher the substitutability. Weight Watchers and Jenny Craig, two American
companies, offer diet programs, but their methods of losing weight are different,
even though customers signing up for the two programs seek the same benefit.
• Lastly, a company should consider how other firms define the scope of their mar-
ket. Again, the more similar the companies’ definitions of the target customers
or markets, the more likely the companies will view each other as competitors.
For example, BMW, Lexus, and Mercedes-Benz focus on the high end of the
automobile market, where as Hyundai focuses on the low end of the market.
Therefore, BMW, Lexus, and Mercedes-Benz compete with one another, but
they are not in direct competition with Hyundai.
International companies have learned to deal with many of the competitive chal-
lenges that they face on a daily basis. Some successful companies use systematic
approaches to survive the intense competitive pressure they face. One such approach
is to compare competing firms on key variables that may provide a competitive edge.
For example, in the automobile industry critical competitive factors may include fuel
efficiency, level of safety, engine performance, roominess, and acceleration. Some of
these factors are easily measurable: fuel efficiency (EPA ratings), safety (crash tests),
acceleration (industry standards), and roominess (cubic feet of space or distance
between the front seats and the backseats). Using these factors, a company could do
a brand-by-brand comparison across competitors. Table 3.12 presents competitive
analysis for competing brands of cars.
By reviewing the matrix shown in Table 3.12, Ford, for example, could evaluate
its competitive position vis-à-vis of other brands. It is clear that if these factor rank-
ings hold true, in order to be competitive and attract more buyers, Ford will have to
improve its offerings in many areas. The systematic approach to competitive analysis
helps international companies weigh their positions in each country and develop
strategic steps to be successful.
Table 3.12
Systematic Competitive Analysis—Automobiles (Sedans)
Safety (good, Engine Perfor-

MPG acceptable, mance (high, Acceleration (0 to
Brand (city/highway) marginal, poor) medium, low) Roominess 60 in seconds)
Accord 24/33 Good High Moderate 8.6
Century 19/30 Good Medium Moderate 8.5
Camry 23/32 Acceptable High Moderate 8.6
Maxima 20/28 Good Medium Moderate 8.2
Taurus 19/28 Good Medium Moderate 9.0
Source: National Automobile Dealers Association, McLean, Virginia, and Insurance Institute for Highway
Safety, http://www.iihs.org/vehicle_ratings/ratings.html (accessed January 2008).
INFRASTRUcTURE
Infrastructure is the collection of systems, activities, and structures that facilitate lo-
gistics and communications. The efficiency of an infrastructure affects production and
business operations. These systems and structures are able to move the raw materials
and finished goods of a country from suppliers to the marketplace, that is, facilitate both
upstream and downstream distribution. For international companies, the networks of
roads, railroads, communication systems, and warehouse facilities are critical variables
in their choice of target countries. Infrastructure undertakings require substantial gov-
ernment investment, and countries that are in the developmental stages find it harder to
allocate funds for this area than established economies do. At the same time, to attract
foreign investors, developing countries need to provide the basic means of transporting
supplies to manufacturing plants and finished goods to markets.
Industrialized countries continuously improve their infrastructure facilities to lower
costs and improve delivery time. New airports are built to accommodate travel and
shipment of goods. Take, for example, Hong Kong International Airport (HKIA), built
at a cost of $300 billion, which can be used for passenger travel, cargo, shipping, and
air delivery. As a gateway to China and other Asian countries, HKIA has become one
of the most important hubs for international passenger and cargo flow. This facility
has attracted many foreign businesses, which find it cheaper and faster to redistribute
goods through Hong Kong. Similarly, Japan has built the longest combined rail and
road bridge in the world, at a cost of $7.6 billion; it connects the island of Shikoku
with Honshu, the main industrial and commercial center of Japan. The route hops from
island to island and is made up of six separate bridges. Seto Ohashi bridge reduces
travel time between these two islands from two hours to ten minutes, facilitating the
transportation of goods and improving the economy of Shikoku.12
TEcHNOLOGY
Technology has become a key driving force in the development of industrialized coun-
tries. It enables these countries to increase productivity, lower costs, and improve the
88 CHApTER 3
general welfare of their citizens. Use of technology in the agricultural sector has helped
the United States to attain a level output with only 3 percent of its labor force devoted
to farming. Use of computers and software such as CAD (computer-aided design) has
helped automobile manufacturers to design and introduce new models of automobiles
in less than three years (compared to the seven or eight years that it took previously).
Use of broadband communication technology helps companies to transmit data and
information in an instant to any part of the world. Technology allows international
companies to gain competitive advantages through the introduction of innovative and
better-quality products, to lower costs, and to achieve internal efficiencies.
Technology is broadly defined as the science of systematic knowledge used by
industries to help in the production and marketing of goods and services. Technol-
ogy in business has three components—technology of production, technology of
processes, and technology of management.13 Technology used in the development
and manufacturing of goods is called “product technology.” This type of technology
is responsible for the invention of new ideas and the innovation of products. Toyota
is known for its production and product technology. Technology used to organize and
coordinate activities of operations is called “process technology.” Procter & Gamble
has been very successful through its emphasis on process technology. This technology
helps companies to take the innovations to the marketplace more efficiently. Technol-
ogy that enables management to improve efficiencies, manage its people better, and
improve communication and decision making is called “management technology.”
This technology helps companies apply their new knowledge across all parts of their
organizations. GE is a good example of a company that has attained significant com-
petitive advantage through its management technology.
For companies in high-technology industries such as aircraft manufacturing, chemicals,
computers, pharmaceuticals, and telecommunications, the level of technology available
in a country quite often dictates whether the firm will invest in that country. Therefore,
in assessing countries for entry, technology—along with the economy, political stability,
and business regulations—becomes a critical environmental factor that these companies
consider. In some instances, international companies may consider transfer of technology
into some of the less sophisticated countries if the long-term market potential is attrac-
tive. Transfer of technology implies that international firms are willing to disseminate
their scientific knowledge where it is not currently available. By doing so, they are able
to achieve a competitive advantage in these countries, at the same time helping the local
country attain a level of technological advancement that it had not yet achieved on its own.
In fact, many governments of developing countries may insist on transfer of technology
as a requirement before permitting foreign firms to enter their countries. A major concern
for international companies in transferring technology into other countries is the protection
of their technology against pirating and misuse. Consequently, international companies
seek intellectual property rights protection when transferring technology.
QUALITY OF LIFE
Quality of life issues deal with people’s comfort and fulfillment in all aspects of life
in a particular town, city, or locality. Factors that contribute to quality of life include
Table 3.13
World’s Top Ten Cities in Terms of Quality of Life, 2006
Rank City Country Index

1 Zurich Switzerland 108.1
2 Geneva Switzerland 108.0
3 Vancouver Canada 107.7
4 Vienna Austria 107.7
5 Auckland New Zealand 107.3
6 Dusseldorf Germany 107.3
7 Frankfurt Germany 107.1
8 Munich Germany 106.9
9 Bern Switzerland 106.5
9 Sydney Australia 106.5
Source: City Mayors, “Quality of Life Rankings.” Available at http://www.citymayors.com/features/
quality_survey.html (accessed March 7, 2009).
standard of living; quality of education; availability of public transportation; health

services, including life expectancy and availability and quality of hospitals and medical
facilities; crime rate; availability of cultural attractions; freedoms of speech, religion,
and politics; job opportunities; and weather conditions.
Various research groups rank cities by their quality of life. Two such groups are
Mercer Consulting and the Economist Intelligence Unit. The Mercer Consulting annual
Worldwide Quality of Living Survey covers 350 cities and is based on 39 different
criteria, including political, social, economic, environmental, personal safety, health,
education, and transport factors, as well as the availability of other public services.
Cities are ranked against New York as the base city, which has an index score of 100.
The Economist Intelligence Unit, a global business intelligence research firm, uses
nine factors in its quality of life index, including such items as material well-being,
health, and family life. Table 3.13 presents the world’s top 10 cities in quality of life
based on the Mercer Consulting survey.
Based on the survey, Zurich and Geneva, Switzerland, are the top two cities in
terms of quality of life. Both Switzerland and Germany have three cities each among
the top 10 in the Mercer Consulting survey, as reported by city mayors. Honolulu
(ranked twenty-seventh) and San Francisco (ranked twenty-eighth) are the only two
U.S. cities that are ranked among the top thirty.
Besides quality of life, an equally useful ranking for international companies in
selecting locations for setting up operations is a list of the most expensive cities of
the world. A survey for the City Mayors group conducted by UBS, the Swiss financial
company, ranks the most expensive cities based on living costs in 71 metropolises. The
City Mayors is an international network of professionals working to promote strong
cities. The cost of living is based on a shopping basket containing 122 goods and
services geared toward Western European consumers. Cities are ranked against New
York as the base city, which has an index score of 100. Moscow is the most expensive
city in the world. Three of the other 10 most expensive cities are in Asia: Tokyo, Seoul,
and Hong Kong. Table 3.14 lists the 10 most expensive cities to live in.
90 CHApTER 3
Table 3.14
The Ten Most Expensive Cities in the World, 2008
Rank City Country Index

1 Moscow Russia 105.5
2 Tokyo Japan 100.0
3 London UK 94.6
4 Oslo Norway 93.4
5 Seoul South Korea 87.3
6 Hong Kong China 86.3
7 Copenhagen Denmark 85.8
8 Geneva Switzerland 84.3
9 Zurich Switzerland 82.2
10 Milan Italy 80.6
Source: City Mayors, “Most Expensive Cities.” Available at http://www.citymayors.com/economics/
expensive_cities2.html (accessed January 14, 2007).
International executives use the quality of life and cost of living index in assessing
countries for entry. Both indexes are critical in attracting qualified employees from
within the country and from overseas. In addition, since international companies pay
for the cost of living of its overseas staff, a more expensive city may drive up the
cost of operations.
CHApTER SUMMARY
The economy of a country is an important variable that international companies con-
sider in selecting countries for entry as well as for developing strategies. A country’s
economic strength is measured through its gross domestic product, rate of inflation,
balance of payments, and external debt.
A country’s economic development is classified by a variety of factors, including
GDP per capita and income levels. Different international organizations, such as
the International Monetary Fund, the United Nations, and the World Bank, classify
countries using different variables. The World Bank classifies countries using the
gross national income (GNI) factor, with the categories high income, upper-middle
income, lower-middle income, and lower income. High income countries have a GNI
per capita of more than $10,726; upper-middle income countries have a GNI per capita
between $3,466 and $10,725; lower-middle income countries have a GNI per capita
between $876 and $3,465; and lower income countries have a GNI of $875 or less.
When countries are compared across economic data, due to variations in purchasing
power, income levels across countries may not be comparable. To rectify this problem,
most international organizations use a factoring approach called “purchasing power
parity” (PPP). Purchasing power parity is defined as the number of units of a currency
required to buy the same amount of goods and services in the domestic market that
the American dollar would buy in the U.S. market.
Countries are also classified by the economic systems that they follow or use to
allocate their resources. The three basic economic systems are market based, cen-
trally planned, and mixed. In a market-based economy, the allocation of resources

is driven by demand and supply; in a centrally planned economy, the government
decides on the allocation of resources based on its developmental plans; and in a
mixed economy, some resources are allocated by the government and some are al-
located by the private sector.
Many international companies use scenario analyses to plan their activities in
foreign countries. A scenario analysis helps international managers to operate under
uncertainties and in volatile conditions by asking “what if” questions. Knowing the
answers to these questions, companies can develop alternate strategies.
Strategically, international companies analyze economic factors to decide on a
country for entry and also to develop strategies. In choosing a country for entry,
international companies conduct a country risk analysis, which evaluates the
critical economic variables that may impact the companies’ entry. Factors such
as GDP per capita, prevailing inflation rate, interest rate, and balance of pay-
ments are some of the economic factors that international companies consider.
Larger global companies conduct their own country risk analyses, but smaller
companies rely on freely available analyses that are conducted by governments
or a business press. One such country risk analysis is published every six months
by Euromoney.
A major concern for international companies in entering a country is the level
of economic activity that goes unreported. Called the “underground,” or “parallel”
economy, these individual and corporate activities are not part of the country’s eco-
nomic data. International companies have to be careful in their activities in a foreign
country; the underground economy may sometimes pose problems, especially if an
international company directly competes with smaller companies that are part of the
underground economic system. These local companies may have cost advantages that
are not feasible for international companies.
Competitive environment is also a critical factor in the operations of international
companies. Local competitors have unique advantages because of their knowledge of
the local conditions, relationships with local distributors, and influence with the local
government. In conducting a competitive analysis, companies should consider how
similar their products are to the products and services offered by their competitors,
how similar the target customers are, and how similar the benefits derived from the
products or services are.
Infrastructure is another external variable that international companies consider in
their decision-making framework. Infrastructures are systems that facilitate logistics
and distribution. It is essential that countries selected for entry by international com-
panies have some sort of infrastructure in place. These systems facilitate the supply
of goods from the raw-material stage to the production centers, and then on to the
markets where they are sold.
Technology is another environmental variable that has been the driving force behind
the growth of many economies. Use of technology helps international companies
improve productivity, reduce cost, and remain competitive. For those firms that are
in a high-tech industry, the level of a country’s technological capability may be a
critical factor in considering that country for market entry.
92 CHApTER 3
International companies use quality of life and cost of living indexes in selecting
countries for entry. Cities with higher quality of life and lower cost of living are at-
tractive, as they may be used to induce qualified personnel to relocate.
KEY CONCEpTS
Economic Factors
Types of Economies
Economic Stages
Country Risk Analysis
Underground Economy
Competitive Environment
1. Why is the economy of a country a critical environmental variable?
2. How is the level of economic activity in a country measured?
3. What is current account balance?
4. How are the countries of the world classified in terms of their economic de-
velopment?
5. What is purchasing power parity?
6. What are the three types of economic systems?
7. Differentiate between market economies and centrally planned economies.
8. What is scenario analysis? How do international companies make use of
scenario analysis?
9. What is country risk analysis and how is it conducted?
10. Identify the critical variables considered by Euromoney in its country rankings.
11. What is an underground economy?
12. How important is the competitive environment?
13. How do international companies conduct competitive analysis?
14. Why is the infrastructure of a country important for international companies?
15. Why is the level of technology in a country important for international
companies?
16. What are some of the factors used in ranking quality of life indexes?
AppLiCATiON CASE: CHiNA’S ECONOMY AND FOREiGN DiRECT

INVESTMENT FLOWS
The People’s Republic of China (China) is one of the fastest-growing economies in
the world. Since the late 1990s it has consistently attained double-digit economic
growth rates. Between 1997 and 2007, China’s average economic growth was more
than 10 percent. For the period 1980 to 2006, China’s GDP per capita rose from $300
to $2,000. This economic growth is fueled by considerable inflows of foreign direct
investments (FDI flows), which have poured millions of dollars into the manufactur-
ing sector, making China the manufacturing center of the world.
Over a five-year period, net FDI flows into China doubled from $38.4 billion in
2000 to $79.1 billion in 2005. In just the past 10 years, China has been the benefi-
ciary of FDI flows of more than $200 billion. Inward FDI flows account for nearly
10 percent of the gross fixed capital formation of China compared to 4 percent for
the United States. China receives FDI flows from many countries, including Hong
Kong, Japan, South Korea, and the United States.
In addition to the FDI flows, China has also benefited from an increase in its ex-
ports, which has resulted in a current account balance of nearly $180 billion. These
surpluses have helped China accumulate foreign reserves in excess of $1.2 trillion.
China is the second-largest holder of U.S. long-term debt securities, at $677 billion,
surpassed only by Japan, which holds about $827 billion. China, with a GDP of more
than $10 trillion (PPP), ranks second only to the United States in terms of size of the
economy. The two key economic policies that have stimulated the Chinese economy
are trade liberalization and the opening of the country for foreign trade and invest-
ments. China’s trade policy changed from import-substitution and self-reliance before
economic reforms to export promotion and openness.
China has become an attractive market for international and global companies, first
as a low-cost manufacturing center, and second as a vast consumer market. With a
population of more than 1.3 billion, China alone can be a major market for foreign
companies. Currently there are more than 14 million U.S. businesses operating in
China; among them Boeing, Ford, GE, GM, Motorola, and TRW have large opera-
tions in China.
China is expected to become one of the largest markets for many products, in-
cluding automobiles, commercial aircraft, and computers. By late 2009 the Chinese
automobile market is expected to reach 7 million cars per year, the second-largest
market after the United States. Similarly, China will have the second-largest airline
industry in the world and will need about 1,790 commercial aircraft, worth more than
$83 billion over the next 10 years. Moreover, China will be the second-largest market
for personal computers after the United States, and it already has the largest mobile
network in the world, with over 432 million cellular phone users.
QUESTIONS
1. What has led to China’s phenomenal economic growth?
2. How do you think China’s expected economic dominance will affect the Asian
region?
4 The Political and Legal
Environment
International business decisions are affected by developments in the political and legal
environment. Political instability that results in sudden changes in the government and its
policies are risks that international businesses face on a regular basis.
LEARNiNG ObJECTiVES
• To identify and understand different political systems
• To understand the working relationships between governments and international
companies
• To understand political risks
• To understand the factors affecting a host government’s political system
• To learn how to analyze political risks
• To understand the world’s major legal systems
• To understand the various aspects of business affected by the legal system
THE POLiTiCAL ENViRONMENT

A country’s political and legal environments are interrelated. The political system
integrates society into a viable, functioning unit, and the legal environment helps the
society maintain its peace and order. Governments that are designed to rule a country
are set up through a political system. Governments create laws and regulations that
affect every aspect of life in a country, including how businesses are operated. Stable
political systems generally have stable governments that enact laws to benefit the
population and at the same time encourage a receptive environment for businesses.
For many years, the political landscape of Africa has been strewn with governments
that have been dictatorial and have ruled with an iron hand. As these rulers sup-
pressed democratic movements, their relationships with the rest of the world seemed
to have been frayed. Recent studies conducted on African nations seem to indicate
that the Northern African groups of countries that have followed more open political
systems have fared better in their relationships with Europe and North America than
the rest of Africa.1 International businesses face increased political risk when there
is uncertainty about the stability of the host country’s political system. For example,
94
THE POLITIcAL AND LEGAL ENVIRONMENT 95
if President Hugo Chávez of Venezuela goes ahead with his threat to nationalize the
country’s telecommunication and electric utilities, Verizon Communications of the
United States could lose up to several hundred million dollars.2 Political risk is not a
new threat facing international companies; it has existed for centuries—for as long
as there has been business activity across national borders. Due to advanced telecom-
munication technologies, many of the decisions and actions by various governments
in many parts of the world are instantly flashed by the media for everyone to know. In
a knowledge-based environment, information seems to help improve the democratic
control of policy makers.3
Political risk has taken on a new meaning and significance because of the prolifera-
tion of international business activities over past 30 years and also due to the changes
in governments of many countries of the world. Since 1950 many countries in Africa,
Asia, Eastern Europe, and Latin America have gained independence from their former
colonizers and taken steps to rule themselves. In the process many of these countries
have had unsettled governments that were either autocratic or weak, resulting in un-
predictable shifts in laws and business regulations. Many multinational companies
anticipate changes in government and make their decision to invest accordingly. That
is, if an international company expects a left-wing government to take over in a country,
then they will decide against investing in that country, but if they expect a right-wing
government to be elected then they will definitely decide to invest in that country.4 In
the past, political risk analysis was more of an art than a science and was designated to
staff analysts with very little input from upper management. In an environment such as
this, political risk assessment was hit or miss, resulting in some costly investments. For
example, during the Vietnam War, a U.S. oil company that in 1968 was contemplating
an aggressive program of oil exploration in South Vietnamese waters based its rosy
forecasts on the expectations of a win by the South Vietnamese government with the
help of U.S.-led forces. The international managers were expecting to reap great re-
wards from these exploration efforts. But the company’s analysts working in the United
States predicted a downfall of the South Vietnamese government within a few years and
recommended abandoning the project. In spite of these warnings, senior management
went ahead with the project based on the line manager’s recommendations. Needless to
say, the oil company had to abandon the project in the early 1970s, costing the company
millions of dollars.5 Without a focused environmental scanning, many international
companies have been caught off guard by large-scale environmental shifts.6 For the
oil company, not having a systematic political risk analysis with considerable support
from top management was the reason that it failed in recognizing the seriousness of the
political situation in South Vietnam.
Most senior executives of international companies recognize the importance of
conducting political risk analyses. They also understand that it is easy to distinguish
between very stable political countries and very unstable political countries. The
difficulty is in recognizing the gray area between the two extremes. Therefore, con-
ducting an integrated and scientific political risk analysis is critical to the success
of international companies. Effective strategic planning requires that international
companies conduct a thorough environmental assessment, especially a political risk
assessment, or PRA.7,8
96 CHApTER 4
POLITIcAL SYSTEMS
Political systems are institutions that set standards, rules, and policies to govern a
society. These institutions include political parties, political organizations, inter-
est groups, and members of the leading industry groups. There are many types of
political systems, including autocracy, democracy, monarchy, one-party states,
plutocracy, socialism, and theocracy. The three basic and most common political
systems are:
• Democracy
• One-party states
• Theocracy
Democracy
Democracy is a political system in which elections by a country’s citizens form

the basis for the formation of a government. A truly democratic system must
have free and fair elections. Over the years, multiparty democracies have proved
to be the most stable, and the experiences of international companies in such a
system have been risk free. When elections are not controlled or manipulated by
any single party or entity (notably the existing government) and are free of out-
side influences, the result is a free and fair election. In some countries of Africa,
Asia, and Latin America, the ruling party controls the election process, leading
to fraudulent results.
There are two types of democracies—direct and republic. In direct democracy,
the government is formed by elected officials voted on by the citizens, and most
laws are directly enacted by the citizens. The earliest form of direct democracy
was practiced by the Greeks in Athens in the fifth century B.C.E. In modern times,
direct democracy exists to some extent in Switzerland, where citizens vote on
issues that affect their communities and districts. In a republic form of govern-
ment, citizens elect representatives, who, in turn, vote on laws. The leader of the
government most responsible for running the republic is called president (as in
the Philippines and the United States), prime minister (as in India and the United
Kingdom), or chancellor (as in Germany). The Roman Empire was the earliest
known republic.
One-Party States
In the one-party system, only one political party is allowed to form the government.
Countries such as Cuba, China, and North Korea that have communist rules are
prime examples of countries with one-party states. Communism implies a classless
society and a means of equalizing living conditions for all. Therefore, in communist
countries, wealth is distributed equally and no single individual owns any property.
In these societies, collectivism is practiced. There are no elected officials in one-party
systems; rather, a group of party leaders rule the country. Under such a system, the
will and preferences of the population are secondary to the overall well being of the
country, as determined by the leaders of the party in power.
Theocracy
Theocracy is a form of government in which a particular religion plays a critical

role in the formation of the government and influences the enactment of laws and
regulations. In some instances, religious leaders may hold key government posts. The
government in Iran is an example of a theocratic system. Once again, in this system,
the will of the people may not be the basis for the laws of the country; instead, laws
are based on religious edicts. For example, in Iran, serving alcohol in restaurants is
not permitted, as it is against the country’s religious codes.
For an international company to succeed in a foreign country, its management must
first determine if its corporate philosophy and practices fit with the host country’s po-
litical and legal environments. The political process faced by international companies,
though not unique compared to that faced by domestic firms, is more complex and
problematic.9 The political process in a domestic market is at least a known entity,
and companies have experience with the political system. Furthermore, they might
even have some influence in the home country’s political process. In addition, they
can anticipate changes and plan accordingly. In the international arena, the political
process is an unknown quantity for international companies, and they have very little
influence in the host country’s political process. Internationally, political problems
range from catastrophic events such as revolution to a broad range of destabilizing
issues, including endemic corruption, labor unrest, crooked elections, religious vio-
lence, and incompetent economic management.10
MODELS TO ANALYZE INTERNATIONAL COMpANIES’ RELATIONSHIpS WITH

HOST GOVERNMENTS
Three models have been suggested to analyze the relationship between international
companies and the host country’s government.11 All three models make the assump-
tion that the relationship and interactions between the international company and
the host government are conflictual-adversarial, especially in the case of developing
countries. This assumption may not always be true. When an adversarial relationship
exists, the models suggest that the relationship could be labeled as:
• Sovereignty at bay. Most countries consider themselves to be sovereign states

that are free from external control. The host country views the international
company as a threat. First proposed by Jack Behrman,12 the sovereignty at bay
model posits that the multinationals enterprise (MNE) is in a more powerful
position than the national government in their relationship to each other. This
leads to conflicts, as the host country views the MNE as a threat. When the host
country is less developed, the MNE, with its financial strength, seems to have
control over most negotiations, especially if the MNE’s operations are in a vital
industry such as mining, transportation, food, or the like.
98 CHApTER 4
• Neomercantilism. The host country sees benefits in its relationship with the
international company. Therefore, the relations between the MNE and the host
government are more cordial. This leads to favorable treatment of the foreign
company and both parties benefit from such a relationship.
• Dependency. In the dependency relationship, there is more cooperation between
the international company and its host government. The extent of the relation-
ship may vary depending on the economic level of development of the host
country. If the host country is a fully industrialized country, the relationship
between the country and the MNE might be that of two equals. However, if
the host country is a developing or less developed country, the government in
this case might be more dependent on the MNE, and the balance of power may
shift in favor of the MNE.
Though all the three models have some merit, international companies must use their
judgment in assessing the kind of relationship they can develop with the host country’s
government and not be constrained by theories or labels.
FAcTORS IN POLITIcAL ENVIRONMENTS

Political risks faced by international companies are due to sudden changes in the
existing political conditions that affect government policies and rules toward for-
eign and domestic companies. International business executives agree that a stable
government that is hospitable to foreign companies attracts foreign direct investment
(FDI) and encourages international businesses to establish operations in that coun-
try. FDI is the acquisition abroad of physical assets, such as plant and equipment,
with operating control residing with the parent company. Research has shown that a
country’s political system influences an international company’s decision to invest
in a foreign country. Studies have identified that a democratic form of government is
important for FDI flows in the service sector.13 While FDI is beneficial to the invest-
ing company, it also provides valuable foreign currency reserves to the host country.
These investments, therefore, help the host country to improve its own economic
conditions. More on FDI and its workings is discussed in the international finance
chapter of this text (Chapter 5).
The purpose of a sound political system is to integrate various parts of a soci-
ety into a single functioning unit.14 A country’s political policies are established
through a continuous interaction of people, philosophies, and institutions. The
aggregated viewpoints of politicians, businesspeople, interest groups, and the gen-
eral masses form the core principles of a country’s political system.15 The needs
and proposals of this wide group of interested parties are then considered by
the government and proposed as policy alternatives. Policy initiatives may be
further influenced by lobbying groups, who have their own vested interests. In
many countries the U.S. Chamber of Commerce acts on the behalf of American
international companies on policy initiatives that may be detrimental to them.
These policy initiatives then become a country’s laws, which are implemented
by the government’s bureaucrats.
Many factors influence a country’s political environment, including ideology,

nationalism, unstable governments, traditional hostilities, public-sector enterprises
(the proportion of businesses that are government owned), terrorism, corruption, and
international companies.
Political Ideology
Political ideology is a set of ideas, theories, and goals that constitute a sociopolitical
program. Ideology is the thought process that guides individuals in the formation of
institutions or social movements. Since no single ideology is acceptable to all the people
in a given country, diverse political views coexist side-by-side, forming a pluralistic
society. In India, for example, more than 36 ideological views coexist, forming the great-
est number of political parties in a democratic country. The major ideological systems
that form governments to manage a country’s economic policies include:
• Capitalism
• Socialism
• Conservativism and liberalism
• Communism
• Authoritarianism
Capitalism is an economic system in which the means of production and distribution

of goods and services are for the most part privately owned; the businesses in a capi-
talistic system operate for profit, and market forces determine demand and supply. In
capitalism, or the free-enterprise system, the government’s role is limited. Capitalism
is practiced in most Western European countries, Japan, and the United States.
Capitalism goes hand in hand with democratic forms of government. Democracy
implies rule of the people, by the people, for the people. In a democratic system,
people make the decisions. Democracy affords its people unique rights that are the
envy of people living under other forms of government. Democracy guarantees people
the following basic rights:
• Freedom—freedom of expression, freedom of opinion, freedom of association,

freedom of the press, and freedom to organize. These freedoms allow the citizens to
participate in the government and express their views without the fear of repercus-
sions. Freedom of the press ensures the dissemination of views, opinions, and other
relevant information whether it is favorable to or critical of the ruling party.
• Elections—democratic governments are elected by the people. Elections are
held periodically to ensure representation by the people’s choices and a smooth
transition of the government.
• Limits on terms—a major benefit of democracies, the term limit placed on elected
officials guarantees that they do not become complacent and that they continue to
work for the people. For example, the president of the United States is allowed
to serve only two four-year terms.
• Independent judiciary—The independence of the judicial systems guarantees the
100 CHApTER 4
people a place for bringing up disputes, an assurance of fair trials, and protection
of individual rights.
Socialism is the opposite of capitalism. Under this system, the government owns
or controls the production and distribution of goods and services. The goal of the
state-run enterprises in a socialist system is not profits but rather the availability of
basic commodities for all of its citizens at reasonable prices.
Conservativism and liberalism are not political systems; they represent people’s
views of the role of the government. Conservatives feel that the government’s role
should be minimal and encourage private ownership. Liberals feel that there is a role
for the government in the free-enterprise system that includes social spending by the
government to benefit its people.
Communism proposes a classless society. In communist countries, the government
owns and controls production and distribution of all goods and services. Communism
promotes the seizure of power by suppression of internal opposition. It is a single-
party rule, with communists being in power. Examples of countries with communism
as the core political ideology are China, Cuba, and Russia.
Authoritarianism describes a government in which authority is centered in one
person within a small group, and that person is not accountable to the nation’s people.
In most instances of authoritarianism, a single person rules the country, as in the case
of dictatorships, and tries to control the people through intimidation. Zaire under the
rule of President Mobutu Sese Seko is a good example of an authoritarian regime.
During his rule as president for life, Mobutu controlled all aspects of civilian life
and plundered the nation of all its resources. In some instances, a junta made up of
three or four military leaders may rule the country and try to control the people, as
in the case of Myanmar.
Nationalism
Nationalism is the attachment and dedication of people to their own country. Some
experts suggest that in earlier times, when people of a country shared the same race,
language, and religion, it made sense to be nationalistic. In the twenty-first century,
however, many countries are based on borders that were politically drawn, and the
homogeneity that was there before does not exist anymore; hence, the true spirit of
nationalism no longer exists. For example, immigration has made the United States
into a country of diverse nationalities, languages, and religions.
Unstable Governments
A government is considered stable if it is able to maintain power and sustain uniform

rules and regulations; that is, its political, fiscal, and monetary policies are predictable.
In an unstable government, political, fiscal, and monetary policies change suddenly
and drastically. As mentioned earlier, a stable government encourages foreign direct
investments.
Control of power by the government does not imply that it holds on to the power
by force, but by democratic means. In fact, when a group of people maintain power
by force, that government is not very attractive for foreign investors.
Traditional Hostilities
Traditional hostilities are those that constitute a deeply rooted hatred between people
of the warring countries, and the conflict is long-standing. Affinity or animosity
between nations reflects how closely aligned or estranged they are based on histori-
cal, religious, cultural, and political realities.16 These affinities or animosities affect
international companies. Businesses from friendlier countries are welcomed by the
host countries, and those viewed as unfriendly are not so welcome. For example, most
French international firms are welcome in many of the western African countries, as
these countries were former colonies of France, and they therefore have a friendly
relationship with each other. Conflicts in central Europe and the Middle East are
historic in nature—they are deeply rooted and will not end soon—and the resulting
instability has discouraged foreign investments. The lack of FDI flows might have
deprived these countries of potential economic growth.
Public Sector Enterprises
When a government gets involved in the business sector, its objective is to provide
goods and services at a reasonable price to its citizens. In most instances, though,
the entry of governments into the business sector results in poor-quality products,
fewer choices, and inefficient utilization of resources. International companies find
it difficult to operate in countries where the large businesses are in the hands of the
government. Government-owned companies have distinct competitive advantages
over foreign-based companies: they are not driven by profits and consequently can
control prices to the detriment of international companies. Moreover, the governments
that already own businesses may be tempted to expropriate foreign-owned companies
if they view them as threats.
Terrorism
Part of the problem of unstable political environments is terrorism. Terrorism con-

sists of unlawful acts of violence committed by individuals or groups against people
and their institutions. Terrorism violates the basic principles of human rights, and
unfortunately it has become a worldwide phenomenon. To spread their cause, ter-
rorists groups have kidnapped people for ransom, murdered kidnapped individuals,
hijacked planes, and bombed buildings. In the past 30 years, 80 percent of terrorist
attacks against the United States have been aimed at American businesses.17 Therefore,
American international companies are very sensitive to the issue of terrorism and
spend considerable sums of money to protect their operations from terrorist attacks.
Terrorism creates political instability, and international companies are reluctant to
invest in countries and regions that are hotbeds of terrorism, such as Latin America
and the Middle East.
102 CHApTER 4
Corruption
Corruption is defined by the United Nations as the commission or omission of an act

in the performance of or in connection with one’s duties, in response to gifts, promises
or incentives demanded or accepted, or the wrongful receipt of these once the act has
been committed or omitted. In simple terms, corruption implies some form of illicit
and criminal behavior for personal enrichment.
Corruption is part of the political process, as it is tied to the lack of political will
to root it out. Corruption is a means for shady politicians to enrich themselves and
perpetuate their rule. For international companies, corruption increases the cost of
operations and creates an uneven playing field—that is, those companies that bribe
officials are granted favors, while those that follow the rules are at a competitive
disadvantage. Chapter 1 contains a more detailed discussion on corruption.
International Companies
International companies also play a role in influencing political systems with their
financial strength (some companies such as ExxonMobil and Wal-Mart have rev-
enues greater than the GNP of many of the countries in which they operate). Inter-
national companies are sometimes drawn into local politics because of the friendly
or adversarial relationship that may exist between the company’s home country and
the host country in which they operate. For example, the Cold War defined much
of what U.S. international companies could do in some overseas markets. The U.S.
government basically influenced the actions of U.S. corporations, including which
countries they could invest in and which goods and services they could sell abroad.
If the U.S. government’s policy changed toward a traditionally hostile nation, then
that country became an immediate opportunity for American companies, as in the
case of China.18 On the other hand, the United States views Cuba as an unfriendly
country, so American companies are prohibited from operating there. At other times,
international companies may be drawn into host countries’ politics through pres-
sures from the international community at large. For example, some multinational
companies left South Africa and its apartheid policies in the 1970s as a result of the
diplomatic stance taken by European countries. U.S. international companies are
not always passive victims of political forces; at times they are the force.19 Through
their links to the U.S. government and strong financial and economic might, some
U.S. firms become indirect yet active participants in local politics and influence the
actions of the local governments.
COUNTRY RISK ASSESSMENT

One of the critical decisions that an international company has to make is the choice
of which country to enter. As discussed in Chapter 3, in selecting a country for entry,
international companies assess the country’s risk by analyzing various factors, includ-
ing political dynamics. Political risk is one of the major factors that most companies
consider in evaluating country risk.20 Political risk is defined as the fear of losses
incurred by international companies through sudden and unexpected changes in the

host country’s political environment. These losses can vary in nature from financial
to human to corporate image to intellectual property rights to expropriation. Because
of the vulnerability to political risks, many international companies have started
conducting nonmarket-related scientific research, including studies that shed light
on political risks and issues.21
In most country risk analyses, the factors that carry the most weight are economic
and political variables. Political risk is one of the key factors that all international
companies consider in assessing countries.22 Political instability is caused by the
sudden changes that occur in a given environment. These changes might be in the
form of revolutions, social unrest, labor strikes, wars, or terrorism. Such conditions
pose problems for international companies. Political unrest often results in economic
upheaval and may pose a risk to humans, especially expatriates. Some international
companies conduct their own political risk analysis by actually visiting the country
they are interested in and exploring its political environment firsthand. A few oth-
ers rely on the opinions of trusted and knowledgeable people, including academic
scholars, consultants, journalists, and diplomats. These approaches generally take
time; consequently, many international companies use their own internally devel-
oped models to assess political risk or employ outside research suppliers to conduct
these assessments. For example, Embraer of Brazil was able to set up a joint venture
partnership with a Chinese aerospace company after conducting a thorough political
and business analysis, even though the Chinese authorities wanted to build their own
aerospace industry.23
Many research studies have reviewed the practices of international companies in
assessing political risk as they conduct country risk analysis. It is generally agreed
that the political environment has become more complex in recent years. The unifica-
tion of Europe, the breakup of the Soviet Union, the emergence of China as a super-
power, the continuing conflicts in the Middle East, and the collapse of governments
in Africa have changed the economic landscape and heightened the political risk for
international companies.24 In a study of American-based international companies,
researchers observed that these companies conduct mostly an organizational-based
analysis of political risk.
Many of the political risk analyses conducted by external agencies use a combina-
tion of factors in assessing a country’s political risk. The PRS Group, an East Syra-
cuse, New York-based research company, ranks countries on political risk using two
methodologies: Political Risk Services and International Country Risk Guide (ICRG).
ICRG uses 12 factors, including government stability, socioeconomic conditions,
internal conflicts, external conflicts, and corruption (see Table 4.1 for all 12 factors
used by ICRG and the corresponding weights for each factor). The scores are based
on a rating scale that uses various internal and external sources to assess the risk for
each factor. The list of factors used by ICRG provides a glimpse into the underlying
causes that may lead to a destabilized political environment. The PRS Group also
publishes the Political Risk Yearbook, which is available online and contains detailed
information on the political, economic, and general business environment in most
countries of the world.
104 CHApTER 4
Table 4.1
ICRG Factors and Corresponding Weights
Factor Explanation of Factors Weight (%)

1 Government stability Consistency of policy and continuity 12
2 Socioeconomic conditions Unemployment, consumer confidence, poverty 12
3 Investment profile Profit repatriation, payment delays, expropriation 12
4 Internal conflict Civil war, terrorism, coup threats 12
5 External conflict Cross-border conflicts, wars, foreign pressures 12
6 Corruption Bribery, fairness in awarding contracts 6
7 Military politics Military’s influence in politics and the government 6
8 Religious tensions Single dominant religion that exerts influence in framing 6
government policies
9 Law and order Crime rate, independence of the judicial system 6
10 Ethnic tensions Periodic ethnic conflicts, acts of genocide 6
11 Government accountability Responsiveness of government to people’s concerns 6
12 Bureaucracy Qualifications and abilities of government officials 4
Total 100
Source: Political Risk Services, International Country Risk Guide. Available at http://www.prsgroup.
com/ (accessed June 2008). International Country Risk Guide, http://www.countryrisk.com/reviews/ar-
chives/000029.html, June 2008.
The scores obtained for each country provide the level of political risk associated
with that country. The higher the score, the less risky that country’s political environ-
ment. The ICRG scores are grouped into five categories, as follows:
Score Risk
00.00–49.90 Very high risk
50.00–59.90 High risk
60.00–69.90 Moderate risk
70.00–79.90 Low risk
80.00–100.0 Very low risk
Using these ratings, ICRG lists the level of political risk faced by international
companies in many parts of the world. Table 4.2 lists the 10 least politically risky
countries of the world.
STRATEGIc AcTIONS
International companies must develop specific strategic action plans to overcome
political instability before they enter a foreign country. These plans can help the
companies to be better prepared for anticipated or unanticipated political shifts. To
protect themselves from adverse political events by reducing some of the risk factors,
international companies rely on forecasting models to predict the risk-reward matri-
ces. In addition, many companies operating in overseas markets might also insure
themselves as a protection against political upheavals in the country in which they are
Table 4.2
Ten Least Politically Risky Countries
Factor Factor Factor Factor Factor Factor Factor Factor Factor Factor Factor Factor
Country 1 2 3 4 5 6 7 8 9 10 11 12 Total
Luxembourg 11.0 11.0 12.0 12.0 11.5 5.0 6.0 6.0 6.0 5.0 5.0 4.0 94.5
Finland 9.5 9.5 12.0 11.0 11.5 6.0 6.0 6.0 6.0 6.0 6.0 4.0 93.5
Ireland 10.5 11.0 12.0 11.5 11.0 3.5 6.0 5.0 6.0 5.5 6.0 4.0 92.0
Sweden 8.5 10.0 12.0 11.0 11.5 5.5 5.5 6.0 6.0 5.0 6.0 4.0 91.0
Netherlands 8.5 10.5 12.0 11.0 12.0 5.0 6.0 5.0 6.0 4.5 6.0 4.0 90.5
New Zealand 9.0 10.0 11.5 11.5 <11.0 5.5 6.0 6.0 6.0 4.0 6.0 4.0 90.5
Austria 9.0 10.0 12.0 11.5 11.5 5.0 6.0 6.0 6.0 4.0 5.0 4.0 90.0
Canada 9.5 8.5 12.0 12.0 11.0 5.0 6.0 6.0 6.0 3.5 6.0 4.0 89.5
Norway 7.5 10.0 11.5 11.5 11.5 5.0 6.0 5.0 6.0 4.5 6.0 4.0 88.5
Switzerland <8.5 10.5 11.5 12.0 11.5 4.5 6.0 5.0 <5.0 4.0 6.0 4.0 88.5
Source: Political Risk Services, International Country Risk Guide. Available at http://www.prsgroup.com/ (accessed June 2008). International Country
Risk Guide, http://www.countryrisk.com/reviews/archives/000029.html, June 2008.
105
106 CHApTER 4
operating. For example, global financial companies that face political risks such as
nationalization of the banking industry have developed sophisticated computer models
that test insurance policies against worst-case political scenarios.25 Similarly, a few
international companies have developed models that assesses the effects of political
risk on direct investment projects by considering all the elements that generate losses
and relating them to the risk’s evolution process.26 As more and more international
companies enter the transitional economies of Central and Eastern Europe—economies
that can experience significant political turbulence—they have adopted some unique
strategies to overcome the uncertainties. A few of these international companies have
developed a diverse network that includes the host government, local businesses, and
public partners to help them navigate through the political minefield.27 Of course, this
opportunity for networking might not always be available, which means international
companies must devise other approaches to combat political uncertainties. Before
the advent of computer-generated models, many international companies dealt with
political risk by investing in a wide group of countries, thereby spreading out the risk
that they would encounter through political instability; this strategy is known as the
portfolio approach28 and to some extent is still very useful.
Generally, international companies are well prepared to deal with most political
uncertainties, and if the risks are very high, they pass up the opportunity to invest in
such countries. The key concern for international business executives is the loss of
their assets. Research has shown that after the initial difficulties and insecurity, inter-
national businesses find that political risk might actually decrease once they are able
to understand the intricacies of the system.29 One of the reasons for such a shift might
be the familiarity of the situation and the subsequent confidence international business
managers develop in dealing with the existing uncertainty. The keys to developing politi-
cal strategies are understanding how political decisions are made, how the government
operates, what some key current political agendas of the ruling government are, and the
general political climate. If the governments are democratically elected, it is much easier
to formulate strategies for avoiding political risks because drastic shifts in the political
environment can be predicted. In contrast, the more authoritarian the government, the
more difficult it is to predict the political shifts. One approach to deal with political risk
is to understand the key issues and follow the steps outlined below.30
• Identify the specific political actions facing the company.

• Analyze the issues upon which these political actions are based.
• Determine which interest groups are behind the political actions.
• Identify the parties affected by the political actions (other international companies).
• Identify the key players that may have a role in the political actions (legislators,
government agencies, and so on).
• Formulate strategies based on company goals, resources, core competencies, and
management know-how.
• Identify the potential outcome of implementing the outlined strategies in the host
country and home country (determine, for example, whether the strategies or its
effect are unpopular).
• Select the most suitable strategy from a list of options.
Although the aforementioned steps seem simple, in practice they can be challenging.
Often it can be difficult to identify the key players and interest groups in the system,
specific political actions might not be clear, the effects of some political actions are
not apparent, and the possible strategic options might be limited.
THE LEGAL ENViRONMENT
The following quotes from Newton Minow, the former chairman of the U.S. Federal
Communications Commission, seem appropriate in understanding the international
legal landscape.31
“In Germany, under the law, everything is prohibited, except that which is permitted.”
“In France, under the law, everything is permitted, except that which is prohibited.”
“In the Soviet Union, under the law, everything is prohibited, including that which is
permitted.”
“In Italy, under the law, everything is permitted, especially that which is prohibited.”
Like other environmental variables, legal systems vary from country to country. The
two key differences observed in the legal systems around the world are the nature of
the system and the degree of independence of the judiciary. Most of the world’s legal
systems are derived from three major legal structures. These are
• Civil law. Legal codes are the basis of civil law. Rules are developed for every
aspect of life, including how to conduct business. Most countries of the world,
including Germany and Japan, follow the civil law system.
• Common law. The common law system is based on traditions, precedent, cus-
toms, usage, and interpretation. Common law is practiced in about 30 countries
of the world, especially former British colonies. The United States follows the
common law system.
• Theocratic law. Theocratic law is based on religious doctrines and teachings.
Most Islamic countries follow the theocratic legal system.
The key differences in the three legal systems center on how the legal system is
developed and how the courts decide on issues. Civil law is based on how the law
is applied to the given facts and on the application of preset codes. Common law is
based on the courts’ interpretation of events; and theocratic law is based on what is
acceptable within the religious precepts.
Besides these three legal systems, many other tribal legal systems are practiced
in Africa, some parts of Asia, and Latin America. Such systems are based on tradi-
tions and cultural influences. Until recently, these legal systems were not studied
and analyzed because very few international companies ever ventured into the
more remote parts of the world where they prevail. An increase in exploration and
108 CHApTER 4
heightened interest in the search for natural ingredients and minerals has forced
some international companies to deal with tribal legal systems that have no writ-
ten records.
For international companies that operate in more than one foreign country, varia-
tions in laws from country to country pose problems. Additionally, there is no single
body of codes or laws that applies across country borders. Hence, disputes between
international companies and host governments are harder to resolve than domestic
disputes. To facilitate resolution of disputes between international companies and
host governments, a few international agreements have been reached, resulting in the
establishment of institutions that can be used for mediation. These institutions include
the World Trade Organization (WTO), the International Court of Justice (ICJ), and
the International Labor Organization (ILO).
The WTO was set up to negotiate trading agreements and resolve trade disputes
between countries. The ICJ, also called the World Court, renders legal decisions in-
volving disputes between countries and helps resolve broader issues that may affect
international companies. The ILO is a multilateral organization that promotes the
adoption of humane labor conditions.
At the macro level, a country’s legal system affects international companies in
many different ways, including how they conduct business in the host country, how
they deal with cross-border legal issues, and how they deal with international trea-
ties (tax treaties between countries, trade agreements, intellectual property rights
agreements, and the like). At the micro level, a country’s legal system affects many
aspects of business, including
• Ownership
• Mode of entry
• Taxation
• Labor laws
• Currency controls
• Expatriates issues
• Price controls
• Antitrust laws
• Product liability
• Repatriation of profits
• Tariffs and other nontariff barriers
Every country has its own set of laws governing the aforementioned aspects
of business. International companies must review these laws carefully to ensure
compliance.
OWNERSHIp
Ownership laws are those that govern the extent to which foreigners can own busi-
nesses and the types of businesses that they can own. These laws are meant to ensure
that sensitive industries—industries that may have national security implications,
such as media, food distribution, and defense—are not owned by foreigners, as they
could become a national safety issue.
Individual countries’ ownership laws are intended to help the growth of domestic
businesses, increase competitiveness, and encourage transfer of technology and man-
agement skills. Typically, international companies have superior products, efficient
production technology, and sound management and marketing skills that often over-
power those of domestic companies. The protection afforded by their governments
through ownership rules provides the local companies with some relief and gives
them an opportunity to compete.
In many industrialized countries, foreign companies are allowed to have 100
percent ownership (these are referred to as wholly owned or fully owned subsid-
iaries). In most cases, international companies prefer 100 percent ownership of
their subsidiaries, as it gives them complete control of their operations. It also
allows them to apply their own management and marketing skills, and protect
their technology and intellectual property rights (IPR) without interference. But in
many countries of the world, foreign ownership is restricted to joint ventures only.
Even in joint ventures, foreign companies are restricted to minority ownership.
For example, in China, joint ventures are restricted and in some cases entirely
prohibited in such industries as banking, insurance, and distribution. Similarly,
in India, foreign ownership in the telecommunications industry is limited to 49
percent, and in Brazil, foreign ownership is limited to 20 percent in aviation and
mass media.
MODE OF ENTRY
Laws governing mode of entry deal with how foreign-owned companies can enter
a given country. These laws specify whether a foreign company can enter through
exports, licensing agreements, franchise operations, strategic alliances, joint ven-
tures, or Greenfield investments. For example, in China, the government permits
foreign-owned service companies to enter Chinese markets only through joint
ventures (Chapter 6 discusses the various entry modes and the advantages and
disadvantages of each).
TAXATION
Most countries levy some form of tax on their citizens as well as businesses in the
form of personal tax, business tax, value-added tax, or some other tax. Through taxa-
tion, governments collect revenues from their people and businesses. Revenues are
used for providing services that benefit its citizens, such as police protection, social
programs, national defense, and infrastructure. In addition, tax revenues are used by
governments to redistribute income, discourage consumption of some products (such
as alcohol and tobacco), and encourage consumption of domestic products (through
tariffs). Tax laws vary from country to country and govern various issues including
tax levels, tax type, tax treaties, and tax incentives.
Tax levels determine the amount owed by individuals (as income tax) and busi-
110 CHApTER 4
Table 4.3
Tax Rates for Select Countries
Income tax rate Corporate tax rate Tax treaty with

Country (%) (%) other countries
Belgium 25–50 33.99 Yes
Brazil 15–27.5 34 Yes
Canada 15–29 36.1 Yes
China 5–45 33 Yes
Egypt 20–40 40 Yes
France 48.09 34.33 Yes
Germany 15–42 25 Yes
India 10–30 30–40 Yes
Italy 23–43 33 Yes
Japan 10–37 30 Yes
Mexico 3–29 29 Yes
Netherlands 0–52 29.6 Yes
Spain 15–45 35 Yes
Taiwan 6–40 25 Yes
United Kingdom 0–40 30 Yes
United States 0–35 35 Yes
Source: Worldwide-tax.com, The Complete Worldwide Tax & Finance Site, www.worldwide-tax.com,
January 2007.
nesses (as corporate profit taxes) to the government. These levels can range from
zero tax policy to 70 percent tax policies. Table 4.3 presents tax rates for a selected
group of countries.
Tax types are the various categories of taxes a government levies against its citizens
and businesses. The most common types of taxes are the following:
• Personal income tax—levied on the income of individuals

• Corporate income tax—levied on corporations on incomes earned
• Capital gains tax—levied on sales of assets when the asset is sold for an amount
greater than its cost
• Value-added tax—levied at each step of the production-to-distribution process.
Tax treaties are arrangements between governments that agree (1) to share infor-
mation about taxpayers, (2) to cooperate in tax law enforcement, and (3) to avoid
double taxation (that is, an individual from one country working in another is not
subject to income taxes in both countries). Tax treaties define and explain “tax terms”
and “taxable activities.” Some of the tax terms defined includes income, source of
income, and residency.
Tax incentives are exemptions and allowances offered by governments to encourage
foreign direct investment and other forms of participation by international companies.
These incentives may include reduced corporate tax rates for a period of time, ad-
ditional depreciation allowance, and foreign tax credit (credits offered to individuals
or companies for taxes paid in another country).
LABOR LAWS
Labor laws are enacted to protect workers’ rights. Most countries have laws that
deal with working conditions, workplace safety, minimum wages, hiring practices,
termination guidelines, health benefits, working hours, sick leaves, vacation leaves,
and general working conditions. Most of these laws apply to international companies,
too.
The governments of some countries have passed laws mandating minimum wage
rates for workers. This ensures that workers are compensated sufficiently to earn a
decent living. For example, in the Philippines, by law, the minimum wage rate has
been set at 250 pesos per day (equivalent to $5.00 a day or 63 cents an hour) and in
the United States as of 2008, minimum wage was $7.50 an hour (in some states such
as Washington, the rates are higher, at $8.75 per hour).
CURRENcY CONTROLS
Most developing countries have currency exchange controls that deal with the pur-
chase and sale of foreign currencies. These countries tend to have weak economies,
and they impose regulations on foreign exchange transactions to stem the outflow of
foreign currencies and help shore up their own currencies. Some of the currencies
held as reserves by many of the world’s countries are the euro, Japanese yen, Swiss
franc, and the U.S. dollar. Developing countries hold foreign currencies as reserves
to undertake economic development projects such as infrastructure improvements,
including investing in electricity generation and water works. In order to make these
advances, foreign governments have to buy industrial goods such as farm equipment
(tractors), road-building equipment (earth movers), construction equipment (bull-
dozers), and transportation equipment (railroads, ships, airplanes). If controls were
not imposed on foreign exchange transactions, individuals and companies in these
developing countries could easily use up their limited amount of foreign reserves and
cause economic disaster.
In countries that impose exchange controls, the government allocates and controls
the trading of foreign currencies. Individuals entering and leaving these countries
must declare the value of funds that they have in foreign currencies. Anyone wish-
ing to buy foreign currency must have a permit to do so, and, normally, the amounts
are limited.
EXpATRIATE ISSUES
Expatriates are foreign workers brought into a country by international companies.
These workers include technical staff, specialists, and executives. International com-
panies bring in expatriates for a variety of reasons, including (1) to ensure control
over their operations, (2) to establish policies and procedures that are in line with
those of the parent company, and (3) to provide training to executives that might be
tapped for future senior assignments. For host countries, the presence of expatriates
results in lower opportunities for local personnel. In addition, expatriates also inhibit
112 CHApTER 4
the development of local managers. In some countries, the government restricts the
number of expatriates an international company can bring in.
In addition to restrictions on the number of expatriates that can be brought into a
country, host governments in some cases might restrict expatriates born in certain
countries. For example, European and American international companies are not
permitted to bring Israeli expatriates into some Middle Eastern countries.
PRIcE CONTROLS
Some countries have laws that govern commodities prices. These countries prohibit
upward price spirals, especially on food items. The intent of these laws is to protect
the citizens from sudden changes in commodities prices that cause unnecessary strain
on the poor. In addition, these laws are intended to control inflation.
ANTITRUST LAWS
Antitrust or restrictive trade practices laws are intended to free up competition and en-
able the free market system to operate efficiently. Antitrust laws are generally directed
at price fixing, the sharing of competitive information, and the formation of monopolies.
Most of the industrialized countries of the world have some form of antitrust laws on
their books. The recently formed European Union monitors business operations within
its member countries, including operations of international companies. The European
Union’s antitrust laws govern issues such as cartels and price fixing (Article 81 EC)
and price discrimination and exclusive dealings (Article 82 EC). In 2002, the European
Union’s Competition Commission played a critical role in blocking the proposed merger
of General Electric and Honeywell, both U.S. firms. The rationale for the commission’s
action was that the merger would create a virtual monopoly that might hinder overall
competition in the field of electricity generation in Europe.
In the United States, the major antirust laws are the Sherman Act, the Clayton
Act, and the Robinson-Patman Act. The Sherman Act, passed in 1890, was the first
of many U.S. government actions addressing such competitive issues as cartels and
antitrust activities. The U.S. government did not actively enforce the Sherman Act,
and its effectiveness was questioned by many. The Clayton Act was passed in 1914
to address some of the weaknesses of the Sherman Act. Specifically, the Clayton Act
addressed price discrimination and business merger issues. The Robinson-Patman
Act, passed in 1936, was a further refinement of the earlier acts; it governed such
issues as price discrimination and exclusivity that reduces competition. Under the
act, the same goods could not be sold to different purchasers at different prices if the
effect of such sales reduced competition or made it difficult for small, independent
retail firms to stay in business.
PRODUcT LIABILITY
Product liability laws are intended to hold manufacturers, their executives, and their outside
directors responsible for causing injury, harm, death, or any other damage to consumers.
The challenge for international companies is how to deal with the different legal systems
that provide various consumer safeguards. In some countries, the scarcity of lawyers and
the long delays in the legal process discourage consumers from seeking legal help to col-
lect compensatory or punitive damages from companies whose products may have failed
or caused them harm. A good example of a country that has few cases of product liability
is Japan: lawyers in Japan are scarce, the Japanese Bar Association sets all legal fees, and
foreign lawyers are not allowed to file cases against companies. In contrast, in the United
States, consumers use the court systems to extract damages for various reasons, including
for injuries and deaths caused by using a particular product. In fact, one U.S. automobile
company was hit with 250 product liability suits in just one year.32
REpATRIATION OF PROFITS
International companies operate in foreign countries to earn profits. Once they earn these
profits, foreign-owned companies normally repatriate their profits to the parent office.
The profits generated from various operations are then pooled as a source of funds for
investments. In many countries, international companies have the freedom to transfer
funds and profits as they wish; in others, however, the host government restricts these
outflows through local laws. These laws basically ensure the channeling of profits by
the international companies to local investments, as well as the protection of the foreign
currency reserves held by the country. International companies’ continuous outflow of
profits may weaken the local currency and raise concerns of inflation.
TARIFFS AND OTHER NONTARIFF BARRIERS

Tariffs are taxes on imported goods that raise the prices of imported goods and services,
thereby discouraging their local consumption. The purpose of tariffs is to restrict the flow
of imports that may jeopardize the host country’s industries and put pressure on foreign
currency reserves. Through the passage of various laws, these countries are able to con-
trol the flow of imports. Tariffs aid and protect local producers and reduce competition.
Though the intent of the tariff is to develop local industries, in most cases it fails to attain
the stated objective. Because local businesses lack some of the basic ingredients for ef-
ficient use of resources, they are not able to compete with the larger and more efficient
foreign firms. The price and quality of locally produced goods and services never attain
international standards, and local consumers suffer. For example, after gaining indepen-
dence from the British, the Indian government levied high duties on imported cars (as
much as 150 percent) and also restricted foreign investments in the automobile sector.
The intent was to develop its own automobile industry. But the automobile industry was
not able to produce efficient cars at reasonable enough prices for the industry to prosper.
Car models that were introduced in the 1950s continued to be manufactured and marketed
year after year without change or improvement. Once the government opened the industry
to foreign manufacturers, the competitive dynamics were altered. Foreign manufacturers
introduced more fuel-efficient and better-performing cars at much lower prices, resulting
in a considerable drop in the local producer’s market share, from more than 85 percent of
the market in the 1950s to only 7 percent of the market in 2000.
114 CHApTER 4
CHApTER SUMMARY
Political and legal environments play a critical role in international business. Some
political and legal factors create problems for international companies in managing
their operations in the host country.
The purpose of a sound political system is to integrate various parts of a society into
a single functioning unit. The aggregated viewpoints of politicians, businesspeople,
interest groups, and the general masses form the core principles of a country’s political
system. Political systems are influenced by ideology, nationalism, unstable govern-
ments, traditional hostilities, proportion of government ownership of businesses,
terrorism, corruption, and the activities of international companies.
There are five basic ideological systems that form governments to manage a coun-
try’s economic policies: (1) capitalism, (2) socialism, (3) conservative versus liberal
views, (4) communism, and (5) authoritarianism. Democratic forms of government
and capitalism go hand in hand.
International companies conduct political risk analyses before entering foreign
markets. Political strategic actions assist international companies in better managing
their operations.
Like the political environment, a country’s legal system plays a critical role in a
company’s operations. Legal systems vary from country to country, but differences
can be categorized as differences in the nature of the legal system and the degree
of judicial independence. The three major judicial systems are civil law, based on
legal codes and rules; common law, based on precedents; and theocratic law, based
on religious precepts.
At the macro level, a country’s legal system affects how international businesses
operate in the host country, how the system affects cross-border issues, and how
laws affect international treaties. At the micro level, the legal system affects specific
aspects of business operations, including ownership, taxation, antitrust issues, and
trade regulations. The best laid plans by an international company may be sabotaged
by political upheaval or legal obstacles, the apparent signs of which the company
may have totally missed or misunderstood.
KEY CONCEpTS
Political Systems
Political Ideology
Political Risk Assessment
Legal Systems
1. What is the purpose of a political system?
2. Define a political system.
3. What are the components of a political environment?
4. What are the key influencers of a country’s political environment?
5. What is a political ideology?

6. How many different political ideologies exist?
7. What are the basic differences between capitalism and socialism?
8. What specific strategies does an international company develop to handle
diverse political systems?
9. What are the two key differences in legal systems among countries?
10. Identify and explain the three major judicial systems.
11. Enumerate the various business activities that come under the legal system.
12. How can international companies prepare to deal with the legal environment
when entering a new market?
AppLiCATiON CASE: ADApTiNG FiNANCE TO ISLAM

Deutsche Bank entered the Malaysian market in 1967 with one branch. Focusing
mainly on affiliates of foreign companies, the bank did well, but it was not a force
in the retail business of banking. Competitors such as HSBC (Hong Kong Shanghai
Bank Corporation), which had a presence in Malaysia since 1884, and Citigroup were
much bigger and had multiple branches. To further extend their reach in the banking
sector, HSBC bought out the Mercantile Bank of Malaysia and became one of the
largest foreign banks in the country. Meanwhile, by 2006, Deutsche Bank had two
offices in Malaysia and employed 130 professionals.
A major problem for most overseas banks, including Deutsche Bank, was under-
standing banking rules in a predominantly Muslim country that must adhere to the
laws of the Koran. Islamic laws prohibit charging interest on loans; for bankers,
this means sharing borrowers’ risks. Therefore, Islamic banking rules resulted in
financial institutions treating their customers as shareholders, sharing a portion of
the profits. Hence, when a bank wants to lend funds to one of its customers to buy
a house or other property, it enters into a partnership by forming a joint venture
to raise the capital to acquire the property. The customer and the bank become the
joint owners of the property, and each has its respective shares based on a ratio
equivalent to the capital raised. The bank then leases its share to the customer. The
customer makes monthly payments over an agreed-upon period of time. Over time,
the bank’s share diminishes and the customer becomes the 100 percent owner of
the property.
Similarly, to avoid the problems created by interest earned on deposits by custom-
ers, local banks in Muslim countries enter into an agreement with their customers
through which the bank is allowed to invest a customer’s deposits for profits. The
ensuing profits are then shared between the customer and the bank according to a
predetermined profit-sharing ratio. The local Islamic banking institutions, which
were controlled by nationals, thrived under this law, but foreign banks had difficulty
understanding the law’s nuances and adapting to them. However, HSBC—through
its merger with Mercantile Bank of Malaysia—and Citigroup—by hiring locals as
senior executives—were able to succeed under the Islamic banking laws. Deutsche
Bank, with its entrenched European-style banking, had problems adjusting to the
local religious laws.
116 CHApTER 4
QUESTIONS
1. As Malaysia’s country manager for Deutsche Bank, would you train your for-
eign staff to adapt to the Islamic laws, hire a few Malaysians as senior execu-
tives, or remain as an institutional banker? Give reasons for your choice.
SOURcE
This case was developed from information gathered from the Deutsche Bank, Citigroup, and HSBC
Web sites, and also from an article on Islamic banking in Malaysia by Arnold Wayne titled “Adapting
Finance to Islam,” New York Times, November 22, 2007, pp. C1, C4.
5 International Trade and Foreign
Direct Investments
Since NAFTA went into effect, U.S. trade with NAFTA partners has more than
doubled. Today, nearly half of total U.S. exports to the world go to Canada and
Mexico. The only “giant sucking sound” we have heard over the last 10 years is the
sound of U.S. goods and services headed to Mexico and Canada.1
LEARNiNG ObJECTiVES
• To understand the economic reasons for international trade
• To recognize the impact of international trade on domestic welfare
• To appreciate the role of the World Trade Organization (WTO) in regulating trade
• To understand the economic reasons for foreign direct investment
• To learn the impact of foreign direct investment on domestic welfare
• To offer insights into the future of global trade and investments in the twenty-first
century
INTERNATiONAL TRADE
International trade refers to the exchange of goods and services between countries. In pre-
historic times, when there were no formal countries or boundaries, international trade was
simply a barter of goods between two individuals or groups separated by a “long” distance,
which over time spanned continents. Evidence exists of trading routes connecting Egypt,
Mesopotamia (the area around modern-day Iraq), and the Indus Valley civilizations (near
modern-day Pakistan and western India) as early as 3000 B.C.2 Trade did not take place
only via land routes, however. The Phoenicians (modern-day Lebanese) were sea traders
who established trading posts throughout the Mediterranean coasts in 1000 B.C.E.
International trade continued to flourish right through the periods of the Greek
and Roman empires, increasing in volume as technological advances progressed in
shipbuilding and navigation. Famous personalities in the history of international trade
include Venetian Marco Polo, who traveled to China in the thirteenth century, and
Vasco de Gama, from modern Portugal, who opened the spice trade when he sailed
around Africa to India in 1498. In the 1600s, Holland became a center of trade in
several commodities, including financial futures contracts. In 1688 Edward Lloyd
117
118 CHApTER 5
opened a coffee house in London where marine insurance was openly traded. Today
Lloyd’s continues to be a leading market for insurance in the world.
The term “international trade,” as understood today, is more applicable to the
practice that took place after the formation of nation-states in the eighteenth century,
when feudal states coalesced and formed specific boundaries and a formal currency
was created to establish clear legal and political boundaries. However, boundaries
continued to change as a result of wars or popular uprisings, making it difficult to
measure the exact volume of trade between nation-states prior to the twentieth cen-
tury. Recent examples include Italy, whose boundaries were only defined in 1870, and
Ireland, which separated from the United Kingdom in 1922 and became a separate
country formally after World War II.
Irrespective of boundaries, when does trade benefit a nation-state or country? From
an economic perspective, it is clear that individual traders engage in the export and
import of goods and services to enjoy monetary benefits. However, it is not clear
whether international trade benefits a country as a whole. Initial works on the topic,
written as early as the 1500s, all considered international trade as beneficial only if
a country managed to export, rather than import, in exchange for gold or silver. This
doctrine, termed mercantilism, was widely popular until the nineteenth century.
MERCANTiLiSM
The theory of mercantilism evolved gradually as trade increased in importance after
the fifteenth century. Exporting allowed a country to obtain gold and silver, the two
most widely accepted forms of payment prior to the introduction of paper money. Gold
enabled a country to become rich and powerful and increased its ability to finance
wars. However, excess gold without a corresponding increase in output can lead to
inflation in the economy. If inflation continues, it is difficult for a country to maintain
its exports, as prices become less favorable. Under the price-specie flow mechanism
proposed by the British economist David Hume in the middle of the eighteenth cen-
tury, such increases in prices ultimately reduce exports, and the balance of trade is
restored back to equilibrium. (Specie refers to gold and silver.)
Unfortunately, mercantilism continued to be popular and accepted by rulers and
thinkers alike until the 1800s. Monarchs and feudal lords encouraged the expansion
of exports, mostly to finance wars. It was easy to justify and enact laws—and to
intervene militarily—to protect local industry and employment. It was not until the
dissemination of works by Adam Smith (1732–1790) and later economists, which
showed how countries could be better off when engaged in mutually beneficial two-
way trade, that mercantilism philosophy fell from favor. Two-way trade required
countries to specialize in products where they possessed distinct advantages in pro-
ductive efficiency, as explained in the next section.
THEORY Of AbSOLUTE ADVANTAGE

With his book The Wealth of Nations, Smith became the first economist to openly
oppose the doctrine of mercantilism. He was a proponent of laissez-faire economics
INTERNATIONAL TRADE AND FOREIGN DIREcT INVESTMENTS 119
and is considered the first free market economist. Instead of focusing only on exports,
Smith argued that it was beneficial for countries to specialize in the production of goods
in which they enjoyed productive efficiency. Goods can be exported in exchange for
other goods produced more efficiently elsewhere. The net result is an overall increase
in output for all countries, as shown in the following example.
Assume that Country A and Country B, for a given amount of capital and labor,
can produce 100 bushels and 50 bushels of wheat and 200 yards and 300 yards of
textiles, respectively.
Wheat Textiles If Resources Are Divided Equally

Country A 100 bushels 200 yards 50 bushels of wheat and 100 yards of textiles
Country B 50 bushels 300 yards 25 bushels of wheat and 150 yards of textiles
If the resources in each country are divided equally between farming and textiles,
the combined output is 75 bushels of wheat and 250 yards of textiles.
Adam Smith’s theory of absolute advantage requires each country to specialize
in goods in which it enjoys a production advantage. In the above example, Country
A has an absolute advantage in producing wheat, while Country B has an absolute
advantage in producing textiles. If Country A specializes in and devotes all its re-
sources to wheat, the total output is 100 bushels. Similarly, if Country B devotes all
its resources to textiles, its output will be 300 yards. Through specialization, total
output increases by 25 bushels of wheat and 50 yards of textiles.
This additional output can be shared by both countries through trade. For example,
Country A could export 40 bushels of wheat to Country B in exchange for 125 yards
of textiles. This leaves Country A with 10 more bushels of wheat and 25 more yards
of textiles than it would have if it had produced both the wheat and the textiles on
its own. Country B will end up with 15 more bushels of wheat and 25 more yards of
textiles than it would have if it had produced both products on its own. This simple
example highlights the benefits of specialization under Adam Smith’s theory of ab-
solute advantage. The actual gains to each country will depend on the exchange rates
and the countries’ bargaining power.
THEORY Of COMpARATiVE ADVANTAGE

The theory of absolute advantage requires each country to have an absolute advan-
tage in the production of at least one good. For some countries, the advantages come
about because of weather or geography. For example, coconuts and pineapples can
grow only in temperate climates, while production of oil and gas requires the natural
elements to be located physically in the country. For other countries, the advantages
may be realized through efficient production processes, superior managerial skills,
or technological superiority.
What happens when one country does not have the capacity to produce goods more
efficiently than another? Smith’s model will not work, because without specialization
and increased output, trade may not take place to benefit both countries. However,
David Ricardo (1772–1823) showed that it was still possible for countries to engage
120 CHApTER 5
in trade, even without possessing an absolute advantage. According to Ricardo, as

long as a country possessed a comparative advantage in producing one of the goods
to be traded, mutually beneficial trade could still take place. The following example
demonstrates how this is achieved.
Assume for given amounts of land, labor, and capital, Country A and Country B
can produce the following:
Wheat Textiles If Resources Are Divided Equally

Country A 100 bushels 200 yards 50 bushels of wheat and 100 yards of textiles
Country B 50 bushels 150 yards 25 bushels of wheat and 75 yards of textiles
In the above example, Country B does not have an absolute advantage in producing
either wheat or textiles. However, Country B has a relative advantage in producing
textiles over wheat. To understand this, recognize that Country A has to give up 2
yards of textiles for every 1 bushel of wheat produced (2 : 1 ratio). Country B has to
give up 3 yards of textiles for every 1 bushel of wheat (3 : 1 ratio). This difference in
ratios means that Country B has a relative advantage in producing textiles over wheat
compared to Country A. Ricardo showed that trade can still take place if Country B
specializes in producing textiles.
How much should Country A and Country B produce in order to maximize total output?
There are several possibilities, but one scenario is for Country A to specialize and produce
80 bushels of wheat. This would use up 80 percent of its resources, and the remaining
20 percent could be used to produce 40 yards of textiles. Country A can keep 50 bushels
of wheat for itself and export the remaining 30 bushels to Country B. Country B could
specialize in producing 150 yards of textiles and export 75 yards of textiles to Country A.
Country A will now have a total of 115 yards of textiles, 15 yards more than if it were to
spread its resources equally, without trade. Country B will have a total of 30 bushels of
wheat, 5 bushels more than if it were to equally split its resources, without trade.
Ricardo’s theory of comparative advantage was instrumental in showing countries
that international trade benefits all participants through specialization. It provided a
new paradigm to international trade theory by rejecting the principles of mercantilism
and offering a new approach that relied on specialization, two-way trade, and mutual
benefits. Unfortunately, it required cooperation and coordination between countries
that was often difficult to achieve, especially when domestic politics conflicted with
the consequences of free trade, specialization, and reliance on other countries for
imports of necessities or sensitive goods.
Indeed, it took a long time for specialization and free trade to be associated with
increased output and mutual benefits. The mercantilist philosophy continued to shape
public policy right up to World War II. Countries were often in dire need of gold
and money to finance their wars, and exports provided the quickest means to earn
bullion. Nationalist and labor groups often managed to blame free trade for loss of
industries and increased unemployment. Industrial and agricultural groups lobbied
governments to impose tariffs and laws that discouraged imports of goods, especially
those that threatened domestic production. It was not until the end of World War II
that the principles of free trade were formally incorporated into global treaties under
the auspices of the General Agreement on Trade and Tariffs (GATT; now the World
Trade Organization [WTO]).
The free trade theories of Adam Smith and David Ricardo continue to be relevant
today. One area of trade they do not delve into is why some countries produce goods
more efficiently than others. It is assumed that natural resources and technology play a
role in the way countries are able to gain relative advantage in production. Two theories
that purport to explain the patterns of trade are discussed in the next section.
HECKSCHER-OHLiN FACTOR PROpORTiONS EXpLANATiON fOR

INTERNATiONAL TRADE
Eli Heckscher (1879–1952) and Bertil Ohlin (1899–1979), two Swedish economists, were
among the first to offer explanations for the differences in trade specializations. They
proposed that the abundance of productive resources determines the ability of a country
to produce goods efficiently. If a country has an abundant source of labor, it should be
effective in producing labor-intensive goods. In contrast, if a country has an abundance
of capital, it should specialize in producing capital-intensive goods. Although capital in
economics usually refers to the nonlabor equipment and machinery required to produce
goods, it also can include money for investments in the purchase of capital goods.
The Heckscher-Ohlin (H-O) model is intuitively very consistent and appealing,
but it was not able to predict actual behavior in international trade. In 1954, Wassily
Leontief (1906–1999), found that that the Heckscher-Ohlin proposition did not hold
up empirically for U.S. trade patterns. His analysis showed that the United States
continued to export labor-intensive goods and import capital-intensive goods in spite
of having significant advantages in producing capital goods. The abundance of endow-
ments themselves appears not to be sufficient to guarantee the production of goods
efficiently. The use of technology and the effective management of the production
process also play a role in exploiting factors of production to increase output.
China and India are other examples that violate the H-O theory. Both countries
continue to lag in the production of agricultural output compared to countries with
lesser amounts of labor resources. For example, Europe and the United States have
continued to maintain their superiority in the production of agricultural commodities.
The explanation lies in their efficient implementation of farming methods, which
includes the use of harvesters, fertilizers, and pesticides, better drainage systems,
crop rotation, and cross-fertilization of seeds. Farms in the midwestern United States
continue to yield higher quantities of wheat and corn per acre than anywhere else in
the world. Thus, an abundance of natural resources alone does not appear to be able
to predict trade patterns. The efficient use of technology and capital also factor into
a country’s ability to specialize in production.
THE PRODUCT LifE CYCLE THEORY

The product life cycle (PLC) theory provides another explanation for patterns in inter-
national trade.3 Under this hypothesis, the flow of trade depends on the stage in the life
cycle of a product. It does not discount the comparative theories or the H-O hypothesis.
122 CHApTER 5
Rather, it complements them by adding another dimension to the explanation, the nature
of the product itself. Trade depends on the demand for a product by overseas customers.
As demand increases, not only is the product exported, but it eventually gets produced
overseas, a phenomenon unheard of in the times of Smith and Ricardo.
The PLC hypothesis begins with the premise that new products are usually devel-
oped in countries where purchasing power is high—in other words, rich countries.
This period is defined as the introductory stage. The product is manufactured locally
using available capital and labor. Demand for the product that spurred its innovation
is less sensitive to the price or cost of the product. This is followed by the second
stage, the growth stage, in which the product gets accepted more widely and usage
increases. Prices fall as market share increases and additional features are added to
the product to satisfy the demands of a larger clientele. During this period, the prod-
uct may change from being a luxury or exclusive item to being one of necessity. An
example is a copier machine or an automobile. Initially the product is considered an
item of luxury to a consumer, but over time it becomes a necessity.
During the latter part of the introductory stage and the beginning of the growth stage,
the product is likely to be exported to other countries as foreign consumers become
aware of its availability. Demand is most likely to come from other rich countries that
can afford the initial high prices. During the growth stage, some production may take
place overseas, as the higher demand for the product cannot be satisfied by domestic
production alone. Although patent protection may prevent duplication of the product,
near substitutes are likely to enter the market.
The next stage, defined as the mature stage, sees a flattening of the demand curve
as the product gets well established both locally and overseas. Production takes place
around the globe. Trade continues to increase as products are shipped from overseas
facilities to new markets. Products may even be imported back to the country that first
manufactured them as a result of cheaper manufacturing costs overseas. Innovations
and new features are likely to be standardized across competitor products, and prices
are likely to stabilize into a long-run equilibrium.
The final stage of the life cycle process is the declining period, when the product is
replaced by new innovations. During this declining phase, production is likely to take
place in countries that are able to produce the product at the lowest cost. Industrialized
and rich countries are likely to be the largest importers of these products.
To a large extent, the PLC theory provides a coherent explanation for the patterns of
trade of popular consumer durables. It can also predict the trade flows of raw materials
that are used in the production process and the sale of after-market supplies. Unfortu-
nately, the theory is better at explaining ex post trade patterns rather than providing a
formal framework for future trade flows. This is because at the product level, it is dif-
ficult to predict the demand, cost of production, exchange rates, innovations, and other
factors affecting supply and demand for the product during the life cycle.
GLObAL PATTERNS Of TRADE: STATiSTiCS

As international trade increases, the standard of living increases for all countries
involved, as more output is available to their citizens. Although international trade
Table 5.1
Merchandise Exports by Region
Region 1948 1963 1983 2003 2005

World1 $58 $157 $1,838 $7,369 $10,159
United States2 21.7% 14.9% 11.2% 9.8% 8.9%
Canada2 5.5% 4.3% 4.2% 3.7% 3.5%
Mexico2 0.9% 0.6% 1.4% 2.2% 2.1%
European Union2 n.a 27.5% 30.4% 42.4% 39.4%
Africa2 7.3% 5.7% 4.5% 2.4% 2.9%
Middle East2 2.0% 3.2% 6.8% 4.1% 5.3%
Asia2 14.0% 12.4% 19.15% 26.1% 27.4%
Japan2 0.4% 3.5% 8.0% 6.4% 5.9%
China2 0.9% 1.3% 1.2% 5.9% 7.5%
India2 2.2% 1.0% 0.5% 0.8% 0.9%
Source: World Trade Organization, World Merchandise Exports by Region and Selected Economy, Table
II–2. Available at http://www.wto.org/english/res_e/statis_e/its2006_e/its06_overview_e.pdf (accessed
August 27, 2008).
1In billions of U.S. dollars.
2In percentages (of world total).
has been increasing since the 1500s, its dramatic growth during the second half of the
twentieth century provides clear evidence that cooperative efforts benefit all countries.
During the interwar period between 1918 and 1939, countries around the world, in-
cluding the United States, were still engaging in antitrade policies. After World War
II, a concerted effort was made to increase international trade. As a result, it grew
at an unprecedented pace, not only among rich countries, but also between rich and
poor countries. Table 5.1 illustrates the increase in trade in the last six decades. Trade
increased from $58 billion in 1948 to more than $10 trillion in 2005, for an annualized
growth rate of more than 10 percent. The largest increases took place between 1963
and 1983, when trade increased at an average rate of 13.1 percent annually. Between
1983 and 2003, it increased by 7.2 percent annually.
Table 5.1 also shows some variations in trade patterns by region. The proportion of
international trade as a percentage of total trade in the United States dropped gradually
from a high of 27.1 percent in 1948 to 8.9 percent in 2005. Within North America,
Canada’s share of world trade also declined to 3.5 percent from a high of 5.5 percent
in 1948, while Mexico’s gradually increased to a high of 2.1 percent in 2005.
The increase in trade in the European Union (EU) is difficult to measure because
countries are continuously being added to the bloc. Table 5.2 shows the members
that have been gradually admitted to the union. The European Union, with 27 mem-
ber countries as of January 1, 2007, had a combined share of 39.4 percent of world
trade in 2005, with Germany and France registering the highest share at 9.5 percent
and 4.5 percent, respectively. The proportion of trade in Asia has also been showing
a steady growth since 1963, registering 27.4 percent in 2005. As expected, China
experienced rapid growth, reaching 7 percent in 2005, while Japan’s share declined
to 5.9 percent in 2005 from a high of 9.9 percent in 1993. India’s share has been
124 CHApTER 5
Table 5.2
European Union Members
Year Countries Total Comments

January 1, 1958 Belgium 6 Establishment of the European Economic Commu-
France nity (EEC)
Germany
Italy
Luxembourg
Netherlands
January 1, 1973 Denmark 9 No referendum keeps Norway out
Ireland
United Kingdom
January 1, 1981 Greece 10
January 1, 1986 Spain 12 Euro becomes official currency in 2002 except in
Portugal the UK
January 1, 1995 Austria 15 Euro is the currency of Austria since 2002
Finland
Sweden
May 1, 2004 Cyprus 25
Czech Republic
Estonia
Hungary
Latvia
Lithuania
Malta
Poland
Slovakia
Slovenia
January 1, 2007 Bulgaria 27 Slovenia adopts the Euro
Romania
January 1, 2008 Malta and Cyprus adopt the Euro
Source: Adapted from European Union, “Key dates in the history of European integration.” Available at
http://europa.eu/abc/12lessons/key_dates/index_en.htm (accessed July 7, 2008).
showing a gradual increase, reaching approximately 0.9 percent in 2005. In contrast,

the proportion of trade in Africa has decreased from a high of 7.3 percent in 1948 to
2.4 percent in 2003.
WORLD TRADE ORGANiZATiON

The World Trade Organization (WTO) is the successor to the General Agreement on
Tariffs and Trade (GATT). GATT was created as part of the Bretton Woods agreement
at the end of World War II.
The economic events that occurred between World War I and World War II convinced
several economists that the best approach to achieving postwar recovery was for all
countries to grow together toward full employment and output. GATT’s mission was to
ensure that the trading rules were fair to all countries, and a coordinated approach was
required to encourage countries to produce goods efficiently and export freely.
The initial work of GATT was to reduce the tariffs imposed by countries on im-
ports of commodities. Tariff reductions were later extended to other consumer and
capital goods. Between 1986 and 1994, under the aegis of the Uruguay Round of
conferences, countries began to work on reducing barriers to the free flow of services,
agriculture, capital, and intellectual property. The WTO is the result of this round of
negotiations. It should be noted that GATT, although much maligned and criticized
by various groups at times, deserves much of the credit for the successful growth in
trade in the postwar period.
The main objectives of the WTO, which was formally created in 1995, are to for-
mulate and implement trade rules through multilateral trading agreements rather than
bilateral agreements. The WTO’s members come from 150 countries, with another
30 countries in various stages of negotiations to join the organization. An important
task of the WTO is to handle disputes between countries in areas of trade violations,
including allegations of dumping, hidden taxation, and subsidies. The WTO, like its
predecessor, prefers to reach agreement by consensus, but unlike GATT, majority
voting is allowed in cases when a consensus is not achieved. A majority-approved
law is applicable only to those countries that accept the vote.
INTERNATiONAL TRADE iN THE FUTURE

International trade will continue to increase in the near future as more countries im-
prove their production capabilities and innovations continue to spur new products.
Earlier models that helped explain the growth and pattern of international trade are
less applicable today because of changes in the production environment. The major
change in international trade—one that began as early as the middle of the nineteenth
century—has been the movement of labor and capital across national boundaries. A
phenomenon such as this affects the dynamics of trade because goods can now be
produced using labor and capital imported from overseas. The United States, where
waves of immigrants contributed to a rapid increase in the speed of industrialization,
is the best example of this dramatic change in the international trade environment.
The United States also imported capital goods and machinery from Europe, which,
combined with new labor, made the country into a major manufacturer and consumer.
As its production processes became more efficient, it became a major exporter of
capital and consumer goods. Similarly, Japan, in spite of being an island with scarce
arable land and natural resources, became an industrial power by importing oil, steel,
and other natural resources to skillfully produce consumer durables for export around
the world. The old theories of comparative advantage would never have predicted
that Japan, with few natural resources, would become a leading exporter of industrial
goods in the second half of the twentieth century.
The second major change in the international trade environment was the formation
of multinational corporations in the twentieth century. Multinationals changed the
dynamics of international trade because their wealth and power allow them to estab-
lish production centers around the globe. Today they have the flexibility to relocate
globally, enabling them to maximize output at the lowest cost. Multinationals have the
ability to transform a country with few resources into a fledgling modern industrial-
ized state. Hypothetically, even in a country with few natural resources, unfavorable
126 CHApTER 5
climate, and a lack of skilled workers, multinationals can set up factories to produce
a range of goods from basic agricultural produce to advanced microchips. In such
cases, multinationals must construct the required infrastructure, including roads and
electricity, import the necessary raw materials, and recruit skilled labor to produce
and export the output. It should be noted that such an investment does not guarantee
a country will prosper, since development can be impaired by a corrupt government
or exploitation by multinationals themselves. Singapore and Taiwan are examples
that are close to such a model where multinationals were major contributors to their
development.
Multinationals foster the movement of labor and capital through foreign direct
investment. Foreign direct investment in recent years has been a major factor to
increase in global trade, accounting for nearly one-third of international trade flows.
Hence, international trade today cannot be studied in isolation. This new paradigm
recognizes that international trade and foreign direct investment go hand in hand,
unlike in the past. This topic is explored in the next section.
FOREiGN DiRECT INVESTMENT

Foreign direct investment (FDI) represents capital investments made by firms in
another country. When IBM invests in the construction of a plant in Belgium to
manufacture semiconductors, it represents U.S. FDI in Belgium. The United States is
considered the sending country and Belgium the receiving country of FDI. Similarly,
when Lenovo acquired IBM’s personal computing division in 2004, it represented
FDI by a Chinese company in the United States. The United States is the receiving
country of the FDI. The companies that engage in FDI are usually multinational
corporations (MNCs) or transnational companies (TNCs).
It is not necessary for a multinational to own 100 percent of an overseas firm for
its investment to be classified as FDI. An investment is considered FDI as long as the
multinational has a controlling interest in the overseas firm. The amount of shares a
multinational must own to possess a controlling interest can vary and in some cases
can be as low as 10 percent.
It should be noted that there is a difference between foreign direct investment and
overseas portfolio investment. The latter refers to the purchase of stocks in an over-
seas company for passive investment. A mutual fund, for example, may purchase up
to 10 percent of an overseas company’s shares and seek no controlling interest. The
fund is interested only in receiving dividends with the prospect of selling the shares
in the future at a higher price. It is difficult to separate overseas portfolio investment
and foreign direct investment, as there are no clear guidelines or accepted practice
for distinguishing them.
The U.S. State Department considers 15 percent ownership in a company sufficient
for classification as FDI. The European Union classifies FDI as follows: “Foreign
direct investment (FDI) is the category of international investment made by an entity
resident in one economy (direct investor) to acquire a lasting interest in an enterprise
operating in another economy (direct investment enterprise). The lasting interest is
deemed to exist if the direct investor acquires at least 10 percent of the equity capital
of the direct investment enterprise.”4 This is consistent with the definition used by the
Organisation for Economic Co-operation and Development (OECD), an influential
group of 30 countries that generates research for policy making.
For measurement purposes, countries prefer to categorize FDI by outward (OFDI)
or inward investment (IFDI). OFDI refers to outward foreign direct investment made
by residents of one country to another country. It represents an outflow of money and
investment from domestic investors to foreign countries. OFDI is usually perceived
negatively by domestic residents because it reduces investment and employment in the
domestic market. The positive aspect of OFDI is that at some future date earnings from
the overseas operations will be repatriated back to the originating country in the form of
dividends and interest, bringing income and foreign currency to the domestic country.
IFDI refers to foreign direct investment by foreign residents in the domestic economy.
Although it represents investment and employment in the domestic market, it is also
sometimes viewed negatively by domestic residents. The reasons are usually nationalis-
tic, as ownership of assets by foreigners rouses jingoistic sentiments among certain seg-
ments of the population. A recent example in the United States includes that of Japanese
investments during the 1980s. Japanese firms, flush with dollar reserves after a period
of rapid growth of exports, found investments attractive in the United States because of
the weakened dollar compared to the yen. It also represented a strategic move because
the weak dollar made it difficult for Japanese firms to maintain their exports from Japan
to the United States. As a result, several car companies, such as Honda, Nissan, and
Toyota, and other manufacturers decided to build plants in the United States.
Politicians and nationalists initially portrayed the investments as an economic
invasion, and the press often hyped the so-called Japanese domination of corporate
America. Over the years, this antagonism has disappeared, and time has shown that
the owners’ origin is irrelevant. What matters most is whether the capital is being
invested wisely to employ workers and produce goods competitively.
FORMS OF FOREIGN DIREcT INVESTMENT

There are three ways for companies to engage in foreign direct investment: construct
new plants or facilities (greenfield investments), acquire existing plants or facilities
(brownfield investments), or establish licensing arrangements.
Greenfield investments refer to the establishment of new plants and offices over-
seas by multinational corporations as a means of FDI. The process usually involves
setting up a separate corporation in the host country, either as a 100 percent–owned
subsidiary or as a joint venture with a local partner. The capital for the investment is
usually sent by the parent company in the form of equity or a combination of equity
and debt. The parent company maintains full control over the operations of the plant,
including control of the board of directors and the senior management.
Brownfield investments refer to the acquisition of existing firms or plants as a
means of FDI. Such investments save a multinational from building new plants and
incurring the associated costs of obtaining regulatory approvals, zoning, and dealing
with local contractors. Recent data suggest that 70–80 percent of new FDI takes place
in the form of mergers and acquisitions. Another benefit of brownfield investments
128 CHApTER 5
is the savings in time and money because a multinational does not have to recruit
new staff or establish vendor, supplier, and bank relationships. A disadvantage of
acquiring a firm or existing business is that it may be difficult to introduce change,
especially in countries with pro-labor laws and weak corporate governance. If a
multinational acquires a foreign firm with the intent to restructure the business and
change the existing work flow process, it may find it difficult to reassign workers or
close down divisions. Such institutional rigidities may turn out to be costly in terms
of both capital and employee morale.
Licensing agreements refer to contractual agreements between a parent company
(the multinational) and a local company, allowing the local company, with or with-
out partnership, to produce goods or services in exchange for fees and royalties.
This arrangement eliminates the risks associated with operating in an unfamiliar
local environment. Instead, the responsibility for the production and marketing of
goods is fully passed on to the local investor. A disadvantage of this approach is
that the local vendor is provided access to private business information, including
technology that may be misused in the future, resulting in new competition to the
parent company.
TYpES OF FOREIGN DIREcT INVESTMENT

FDI can also be classified by the types of investments a company makes, based on
whether they are horizontal or vertical to the existing line of business.
Horizontal FDI
Horizontal FDI refers to overseas investment in plants and services in the investing
company’s existing line of business. This is the most popular form of FDI. For ex-
ample, in June 2007, Hilton announced plans to build more than 55 hotels in Russia,
Britain, and Central America, to be completed in 2012, with total construction costs
exceeding $1.7 billion. In May 2007 Dell announced that it would open a second
plant in Hortolandia, close to São Paulo, Brazil, where 70 percent of Dell’s Brazilian
customer base is located. The new plant manufactures Dell’s traditional line of note-
books and desktops. Both these initiatives are classified as horizontal FDIs because
both companies are expanding their original line of business overseas.
Vertical FDI
Vertical FDI refers to overseas investments in plants or services that contribute either to
the upstream or downstream segment of a business. For example, in 1998, Total SA of
France announced plans to acquire Petrofina SA of Belgium. Total SA was primarily in
the business of oil exploration and extraction. Petrofina, in contrast, specialized in the
post-production marketing and refining of oil, considered downstream operations. Hence,
Total was acquiring a line of business downstream. Other examples include automotive
companies purchasing steel manufacturers, or McDonald’s purchasing farms to raise chick-
ens and grow potatoes so they can supply their franchisees with consistent ingredients.
MOTIVES FOR FOREIGN DIREcT INVESTMENT

In a perfectly competitive market, there is no reason for FDI because a company should
be able to distribute its products to all markets at some equilibrium price. A company
that produces a good in New York should be able to sell it throughout the United States
at one equilibrium price, plus transportation costs. Similarly, if the world market is per-
fectly competitive, the company should sell its output globally at one equilibrum price
and geographic boundaries should be of no consequence. The only reason for FDI to take
place is the existence of market imperfections. A majority of studies have focused on the
macroeconomic imperfections in the marketplace to explain the motivations for FDI. An-
other branch of study has looked at FDI from a microeconomic perspective; the skills and
know-how of a firm require that it be located overseas to exploit its full productivity.
Among the various theories offered in the literature, John Dunning’s eclectic
OLI paradigm provides an overview of both the imperfections in the market and the
uniqueness of the firm to explain FDI.5 The O stands for ownership, L for location,
and I for internalization.
• Ownership advantages refer to the special know-how belonging to a firm. It can

be in the form of a patent, technological skill, managerial skill, or process skill
that gives the firm an advantage in the production of a good or service.
• Location advantage refers to the exploitation of local resources that would oth-
erwise be unavailable to provide added value to the product. An example would
be the extractive industry, where the special know-how to dig very deeply for
ores still requires the company to be located near the mines.
• Internalization refers to the process by which it is more efficient for the multi-
national to execute the project through intracompany transfer than to transfer its
know-how to a third party. There can be many reasons for this scenario, including
special expertise as well as the potential loss of the know-how.
Dunning’s OLI paradigm is able to integrate the multiple motivations for FDI into
three broad and simple categories. It recognizes the impact of both macro and micro
factors involved in the decision to go overseas and substitute FDI for trade.
Other authors have classified the motives strictly from the perspective of the
multinational as it operates in a global environment without national boundaries.
Multinationals engage in FDI to seek resources and markets and to achieve global
efficiency and strategic fit. Strategic fit may encompass several different criteria such
as securing markets, cutting costs, and accommodating other factors, including import
barriers, shortage of foreign exchange, and uniqueness of product.
Resource-Seeking Motives
Multinationals are very adept at seeking locations globally to produce output at the
lowest cost. The lower costs may be the results of cheaper labor, lower transportation
costs, and lower costs of raw materials. Overseas expansion can also be viewed within
the context of the product life cycle (PLC) theory. As discussed earlier, during the
130 CHApTER 5
second stage of the PLC, when demand rises overseas, a firm may be better served
by plants established near customers. Overseas expansion also allows companies to
devote more attention to the tastes and needs of their overseas customers and build
separate R&D facilities for the overseas markets. Competition or the threat of com-
petition can also force companies to seek cheaper resources. If a competitor sets up
plants overseas to produce goods more cheaply than it can at home, it becomes dif-
ficult for a domestic company to maintain its competitive edge.
Market-Seeking Motives
Another reason for multinationals to engage in FDI is to create or increase new mar-
ket share, usually near their existing markets. The production of cars in the United
States by foreign automobile manufacturers is one example of market-seeking FDI.
Volkswagen was the first foreign car company to open a plant in the United States, in
Westmoreland, Pennsylvania, in 1978. Within a few years, many foreign car compa-
nies entered the market, beginning with Honda in Marysville, Ohio, in 1982. Similar
competitive positioning behavior is now being practiced by U.S. car manufacturers
overseas. In anticipation of a booming market, GM started to assemble Buick cars in
China in 1999. GM has now been joined by other U.S. car companies. Ford opened
its first factory in China in February 2003 and has already announced plans to build
a few additional plants. Such expansion also provides diversification benefits. For
example, while GM has announced plans in late 2008 to close plants in North America
as a result of an impending economic recession, it continued to open plants in China
where demand for cars is expected to grow for the foreseeable future.
In vertical FDI, the strategic motive focuses on gaining a competitive advantage
on a company’s upstream or downstream operations. Mergers and acquisitions that
seek to control upstream and downstream operations are subject to antitrust laws in
order to prevent the likelihood of a monopoly. In 2008, ALCOA, the world’s largest
producer of aluminum, announced a joint venture with Vietnam’s premier minerals
development company, Vietnam National Coal-Mineral Industries Group (Vinacomin),
to develop its aluminum industry. This will enable ALCOA to consolidate its upstream
operations by having access to Vietnam’s high quality bauxite reserves.6
Import Barriers
Another strategic reason for a company to use FDI to enter new markets or expand its
operations in existing markets is to overcome trade barriers, usually import restrictions.
Countries often discourage imports by imposing high import duties, labeling require-
ments, health certifications, and quality tests. Some countries may have legitimate
reasons for imposing restrictions on imports, most often as a result of scarce foreign
exchange. A developing country with limited foreign reserves may want to discourage
the import of luxury items such as perfumes, jewelry, and expensive cars and instead
encourage the import of capital equipment into vital or fledgling industries. A country
may also attempt to encourage selected industries to develop without fear of foreign
competition. The effectiveness of these measures depends on their implementation;
they can have negative consequences if they are exploited by domestic companies
for their own benefit.
For example, India banned the imports on luxury cars and charged very high du-
ties on other cars in the 1950s to promote its domestic car production. This led to the
development of three local car manufacturers who dominated the domestic market for
many years. Unfortunately, the lack of competition provided no incentive for these
companies to improve the quality of their cars, and over time they began to lag behind
cars produced overseas. When import restrictions were removed in the 1990s and for-
eign cars began to penetrate the Indian market, domestic manufacturers were forced to
focus on quality and service. By 2006, fierce competition among several car companies
led not only to increased quality but also to reduction in the prices of all cars. In 2007,
Tata Motors (an Indian car manufacturer) and Nissan-Renault announced plans to start
manufacturing cars that would cost less than $3,000, a clear signal that competition,
and not import barriers, helps local manufacturers in the long run.
Trade barriers have been coming down in recent years as a result of the work of
GATT and the WTO. Several studies have confirmed the impact of trade barriers on
FDI, including research by Theo Eicher and Jong Woo Kang (2004), who demonstrate
empirically that when trade barriers are low, overseas companies prefer to export but
will opt for FDI when trade barriers are high.7
Shortage of Foreign Exchange
As mentioned earlier, developing countries often face a shortage of foreign exchange

earnings, forcing governments to restrict their use for the import of essential items
such as capital goods, oil, and food. Luxury items such as cars get a lower priority.
Strategically, it makes sense for a foreign car manufacturer to produce locally rather
than exporting to a country that lacks foreign exchange. If the initial investment can
be obtained locally, the company needs only to secure foreign exchange sufficient to
remit profits as dividends back to the parent country, a much smaller amount than if
they imported the cars to the country.
Nature of Product
In some cases, the nature of the product or service requires that the company invest
locally in a plant or an office (Dunning’s location-specific advantage). Two prominent
examples are power plants and extractive industries. These industries require huge capital
investments in the local area and a long-term commitment. Such projects are also very
risky and require contractual agreements with the local government that will guarantee
the safety of their investments for many years. In some cases, it is possible for firms to
license their technology and collect only royalties and special fees for its use.
Other examples of foreign direct investment that require local presence include
several service industries such as the legal, financial, banking, and food services. In
the food industry, for instance, it is common for firms to franchise their services with
a local owner. The franchisee pays the parent company a percentage of the revenue in
exchange for use of the brand name and the process for food preparation and compli-
132 CHApTER 5
ance with the franchisor’s standards. The franchisee is also expected or required to
import the ingredients from the franchisor for preparation of their food products.
NEW TRENDS IN FOREIGN DIREcT INVESTMENT

As the WTO continues to reduce tariffs across the globe, firms are finding it strate-
gically necessary to reduce their costs of production at all stages of the product life
cycle. The trend is no longer to move overseas in the third stage of the product life
cycle; rather, the process may begin as early as the first stage. An entrepreneur or
company today has the luxury of patenting a product first before deciding on the loca-
tion to manufacture the output. With information from the Internet, and assisted by
the various branch offices of the U.S. Chamber of Commerce, companies can obtain
quotations and proposals worldwide to develop prototypes of their products.
Technological advances have also made it possible for a firm to develop a product
initially in electronic format, using advanced 3-D modeling and manufacturing software.
The software enables the computer to test the product for durability, strength, wear and
tear, and safety. Additional software also enables the prototype to be generated with dif-
ferent types of materials unique to each country. Based on the results, a firm can decide
to produce products in multiple locations using different materials and processes.
COSTS AND BENEFITS OF FOREIGN DIREcT INVESTMENT

The impact of FDI on both the sending and receiving countries depends on a number
of factors. There is a general consensus that FDI provides significant benefits to the
receiving or host countries in terms of employment, income, trade, investments in
human capital, infrastructure development, and technology transfers. Noneconomic
benefits include better corporate governance, awareness of the environment, social
equality, and political freedom. There are also costs associated with FDI, particularly
if host countries’ economic policies are not geared to spread the benefits of FDI
in a positive manner. Inappropriate policies can lead to income inequality, social
unrest, pollution, degradation of the environment, depletion of resources, and po-
litical instability. We first examine the impact on employment and income to both
the sending and receiving country, followed by the impact on trade, investment,
and technology transfer.
The impact of FDI on employment and income to the sending country is still open to
debate. When U.S. companies open subsidiaries overseas to take advantage of cheaper
labor costs, the initial impact on employment and income is usually negative. Labor
unions and economists complain that sending jobs overseas also generates negative
externalities to the domestic economy. When a company closes a plant down, it also
affects ancillary industries and local businesses. The net effect on society may be
larger than the savings generated for the company shareholders. Others have argued
that it is not labor costs that drive firms overseas but rather the tax breaks and other
financial incentives host countries provide to multinational corporations. However,
many economists cite the low unemployment rate in the United States over the last
two decades prior to 2008 as an indicator that FDI does not lead to lower employment
and income. Rather, the income from export services has been growing steadily over
the years, indicating that overseas investments are beginning to pay off.
From the perspective of the receiving country, the influx of FDI often means more
jobs and income and a boost to the economy. Unfortunately, there can also be nega-
tive externalities. Labor exploitation is among the most common criticisms leveled
against multinationals, especially when they operate in developing countries. They are
often accused of using child labor, compromising on worker safety measures, paying
substandard wages, and contributing to environmental degradation. It is difficult to
take sides on this issue as it can be viewed from several standpoints.
For example, on the issue of substandard wages, one needs to use the proper
benchmark to evaluate the wage level. The most appropriate index to use is the
median wage within the country or industry sector. By and large, most multina-
tionals pay higher than the local wages, but without proper controls, it is still
easy for labor to be exploited, most notably by firms that use contracted labor. In
August 2007, China Labor Watch, a watchdog group in New York, reported that
it investigated eight factories supplying toys to well-known companies in the
United States such as Disney, Hasbro, and Sega and found widespread violations,
including mandatory overtime, verbal and sexual abuse by managers, and hiring
of underage workers.8
Another consideration is the impact on employment and income when FDI is
achieved through mergers and acquisitions (M&A). In the case of FDI through M&A,
employment may either drop or not increase in the initial phase. This can happen if
the multinational introduces new technology or work flow processes that improve
efficiency in the firm. However, if the firm succeeds in its reorganization, employment
should increase in the long run.
TRADE, INVESTMENTS, AND TEcHNOLOGY TRANSFERS

One of the benefits of FDI for a receiving country is increased investments that may
not otherwise be available. When FDI flows into a country, the immediate benefits
that result from the influx of investment are increased employment and income to
local industries. The sending country generates a positive payoff only after a period
of time when it is able to repatriate profits and dividends. FDI can also lead to tech-
nology transfers and eventually help a receiving country upgrade its human capital
and productive capacity. This transfer may hurt the sending country in the long run
if the technology is duplicated or it results in an erosion of its technological lead. If
FDI leads to increased exports to a country, then it offers additional benefits in that
the country also earns foreign exchange through trade.
FDI’s impact on trade, investments, and technology transfers is considered next
for three industries: manufacturing, services, and extractive.
Manufacturing Industry
FDI for manufacturing is undertaken by companies that plan to produce goods for local
consumption or for export to other countries, including their home countries. Such
134 CHApTER 5
investments require machinery and other equipment to be imported from overseas for
installation in the receiving country. Examples include IBM building a semiconductor
plant in France or Siemens building a power plant in India.
Trade. Whether FDI increases or decreases a receiving country’s exports depends

on the reasons for the establishment of the plant. If the multinational opens the plant
because it is unable to meet local demand through exports, it is very likely that all the
output will be sold in the local market. If the plant was constructed for cost-savings
reasons, then the output is likely to be exported back to the sending country and ex-
ports will increase for the receiving country.
Investments. Plant production, especially new investments (greenfield investments),

usually require substantial investment in building infrastructure, equipment, and
manpower. Plant construction also leads to investment in ancillary industries that are
in close proximity to the new plant.
Technology Transfer. There is some transfer of technology whenever plants are

constructed overseas. The extent of the transfer depends to the kind of technology
chosen and the ease of adoption. If the technology is simple and requires low levels
of investment, it will be easier for local countries to imitate it or create near imita-
tions. If the technology is sophisticated or requires a large investment, it is unlikely
for technology to be transferred for many years.
Services Industry
FDI for establishing services overseas is made in the hotel and food businesses, theme
parks, retail chains, and transaction services including banking. Examples include
Hilton opening a chain of hotels in Mexico, American Express opening offices in
Colombia, and Disney opening a theme park in France. The core business model
remains the same globally, although local culture and tastes may require adaptations
and changes to the mix of services and delivery.
Trade. Most service industries usually cater to domestic consumption. However,

some services such as those in the leisure business may cater to foreign tour-
ists that can help earn foreign exchange indirectly for the country (export of
services). Examples include tourist resorts run by global brands such as Hilton,
Starwood Group, and Novotel, which are usually frequented by tourists and
foreign businesspeople.
Investments. The investments required to establish services overseas are usually

lower than those for plant construction. In the service industry, the main invest-
ments are in buildings and manpower. The returns on service investments are typi-
cally high, especially for brand-name companies. Examples include Citibank and
HSBC for banking services and McDonald’s and Burger King for food services.
However, service industries face higher risk than others, for they are subject to
expropriation or excessive regulation and are also often easy targets for nation-
alistic politicians.
Technology Transfer. Technology transfer is limited to the training of individuals and

the delivery of services. Such expertise may in the long run be transferable to local
companies. It is not yet clear whether technology transfers by service industries hurt
overseas companies. Well-known brand-name companies are difficult to replace, and
any negative effects may only be marginal.
Extractive Industry
FDI for the mining and excavation of minerals and fossil fuels requires large in-
vestments, usually in the form of capital goods and equipment. Extractive FDI has
received much criticism in the recent past because of the environmental degradation
associated with this industry.
Trade. The output of extractive industries is usually exported and can earn large
amounts of foreign exchange for the receiving country. However, the earnings can be
very volatile because demand for commodities is influenced by the global economy and
sometimes by the economies of a few countries. If these select countries experience
a recession, then the exports of the receiving country are also affected. The impact of
a recession is felt more strongly in countries that have only one or two commodities
as their main foreign exchange earners. A decline in export earnings has significant
effects on a country’s overall economy. According to a 2004 report by the Food and
Agriculture Organization of the United Nations (UN), approximately 43 developing
countries relied on a single commodity to generate 20 percent of their export earn-
ings. Most of them were in sub-Saharan Africa, Latin America, or the Caribbean and
exported products such as sugar, coffee, cotton, and bananas.9
Investments. Investments in the extractive industries are usually large and tend to
continue for many years. In 2007, the UN Conference on Trade and Development
(UNCTAD), a body of the UN that monitors global foreign direct investment, re-
ported that Africa remains the largest recipient of mining FDI where total inflows
reached $56 billion.10 In oil extractions, as well as in the mining of bauxite (used to
make aluminum) and gold, investments can run into billions of dollars. The offshore
drilling, open-pit quarrying, and dredging industries are now coming under scrutiny,
especially in relation to labor exploitation and environmental concerns. Consequently,
further investments have been demanded by UNCTAD for improvements in mining
technology during and after the projects are completed.
Technology Transfer. Although the capital investments for extractive industries are
high, the technology can range from simple, as in open-pit quarrying, to highly
complex, as in offshore drilling. Multinationals possess significant advantages in
high technology extraction. As in the case of manufacturing, it takes many years for
complex technology to be transferred to the receiving countries.
136 CHApTER 5
Table 5.3
Global Foreign Direct Investment (FDI) Inflows and Outflows (in billions of U.S. dollars)
1994–1999
Region Annual Average 2003 2005
FDI Inflows
Europe 220.4 274.1 433.6
Japan 3.4 6.3 2.8
USA 124.9 53.1 99.4
Africa 8.4 18.5 30.7
Asia 92.4 110.1 199.6
World 548.1 557.9 916.3
FDI Outflows
Europe 326.5 317 618.8
Japan 22.8 28.8 45.8
USA 114.3 129.4 –12.7
Africa 2.5 1.2 1.1
Asia 43.5 19 836
World 553.1 561.1 778.7
Source: Adapted from United Nations, “World Investment Report 2006: FDI from Developing and Transi-
tion Economies: Implications for Development,” Table 1, p. 2. Available at http://www.unctad.org.
FDI STATISTIcS
In a 2006 survey by UNCTAD, total global FDI outflows were estimated at $778.8
billion while inflows totaled $916.3 billion, as shown in Table 5.3. This represents
nearly 10 percent of global trade flows. FDI and trade go hand in hand, with FDI
serving as a major catalyst for trade. For example, a majority of U.S. and European
firms that have invested in China send the output back to the home countries—another
way of contributing to international trade.
Table 5.3, which is based on information from the UN’s “World Investment Report
2006,” also shows that the bulk of FDI inflows and outflows are concentrated in Europe.
The inflows and outflows do not equal each other because of reconciliation errors. In Japan,
FDI outflows ($45.8 billion) are much higher than inflows ($2.8 billion). In contrast, the
United States has continued to be a magnet for FDI, with $99.4 billion in inflows. The
outflows show a negative $12.7 billion. Developed countries are also a target for invest-
ment, accounting for 36.5 percent of total inflows and just 15.1 percent of total outflows.
Africa has received an increasing share of FDI as well, from $8.4 billion in the late 1990s
to $30.7 billion in 2005, with South Africa receiving 21 percent of the total inflows.
A new pattern in international trade is for developing countries to invest more in
developed countries. This phenomenon reflects a maturity of industries in the devel-
oping countries and a readiness to compete with the rest of the world. In December
2007, Tata Motors from India successfully bid $2 billion for the Rover and Jaguar
divisions of Ford, which represents the first major acquisition of a car company in a
developed country.
Table 5.4
Role of Foreign Affiliates in Global Foreign Direct Investment (in billions of dollars and
percent)
Value at current prices Annual growth rate

Variable 1982 2005 1996–2000
Sales of Foreign Affiliates 2,620 22,171 10.1
Total Assets of foreign Affiliates 2,108 45,564 21.0
Export of Foreign Affiliates 647 4,214 4.8
Employment of Foreign Affiliates 19,537 62,095 11.0
Royalties and License Fees Receipts 2,247 12,641 3.6
Table 5.5
The World’s Top 10 Multinational Corporations, Ranked by Foreign Assets, 2004

(in billions of dollars and percentage)
Foreign Percentage of Foreign Percentage of

Corporation Country Assets Foreign Asset Sales Foreign Sales
General Electric USA 44,890 59.8 5,689 37.2
Vodaphone Group UK 24,875 95.8 5,330 8.5
Ford Motor USA 17,985 58.9 7,144 4.2
General Motors USA 17,369 36.2 5,913 3.1
British Petroleum UK 15,451 80.0 23,238 8.2
ExxonMobil USA 13,492 69.1 20,287 7.0
Royal Dutch/Shell UK/NL 12,993 67.4 17,028 6.4
Toyota Motor Japan 12,296 52.6 10,299 6.0
Total France 9,871 86.1 12,326 8.1
France Telekom France 8,566 65.3 2,425 4.1
Table 5.4 shows the growth in assets of foreign affiliates, representing nearly $46
trillion in 2005. In addition, cross-border mergers and acquisitions totaled $716 bil-
lion. Finally, the exports of affiliates accounted for $4,214 trillion, providing evidence
of the importance of FDI in increasing trade globally.
Table 5.5 shows the top 10 multinationals, or transnational corporations, in
the world. In 2005, there were 77,000 parent companies with 770,000 foreign af-
filiates (not reported). They generated employment and produced $45 trillion in
output. Japan, Europe, and the United States continue to dominate the list of the
top companies in the world. France, Germany, the United Kingdom, Japan, and the
United States account for 73 of the top 100 companies in the world. This is slowly
changing, however, as more firms from developing countries, especially India and
China, enter the market.
138 CHApTER 5
Figure 5.1 The Extractive Industry Transparency Initiative
The Extractive Industry Transparency Initiative (EITI) was formed under the auspices of UNCTAD
in 2002 to improve the governance in resource-rich countries. The goal of the initiative is to ensure
that the wealth generated from the earnings is distributed properly for economic growth and pov-
erty reduction. The EITI has members throughout the globe, including twenty African countries. The
basic principle of EITI is that there should be sufficient transparency in the business of extraction
that governments are forced to spend the earnings carefully and for the benefit of the citizenry as a
whole. Open information on the amount of extraction, payments, and costs ensure that the people
of the country have a voice in the distribution of the wealth.
Source: David Mayer-Foulkes and Peter Nunnenkamp, “Do Multinational Enterprises Contribute to
Convergence or Divergence? A Disaggregated Analysis of US FDI,” Working Paper 1242, University of
Kiel, Germany, May 2005. Available at www.ssrn.com (accessed July 11, 2008).
FOREIGN DIREcT INVESTMENT AND POLITIcS

The amount of foreign direct investment that flows from one country to another is
affected by the government policies in both the sending and receiving countries. A
country can use tax incentives and disincentives or impose burdensome rules and
regulations to influence FDI outflow or inflow. Which approach is used depends on
the political system in each country and their philosophy toward FDI. At one extreme
is the negative view, based on the early Marxist interpretation, that multinationals
seek access to foreign markets to only exploit the local resources. At the other ex-
treme is the positive or free market view that claims FDI is always beneficial for the
recipient country. In reality, whether or not FDI is beneficial depends on a range of
factors, including policies set by the local government, goals of multinationals, and
the skills of local labor.
Negative View
Taken primarily from Marxist literature, the negative view of FDI tends to consider
all FDI as exploitative; multinationals are seen as being interested only in taking
advantage of cheap labor. This may true in some cases, especially in the extractive
industries, and it usually happens when the local government is corrupt and exploits
the benefits from the FDI to enrich a few. The situation is made worse if the land
and environment are left in a polluted condition after the ores have been extracted
completely. David Mayer-Foulkes and Peter Nunnenkamp found that U.S. FDI in
developed countries tends to increase the benefits for the recipient country, but its
effect has been the opposite for developing or poorer countries. See Figure 5.1 on
the Extractive Industry Transparency Initiative (EITI).
Positive View
Proponents of free markets and free trade usually point to the positive aspects of FDI.
The negative impact is less severe in nonextractive industries, where the production
of output or services requires the use of the local land, capital, and labor. This is es-
pecially true if FDI is managed carefully by the host countries through multilateral
agreements that ensure a level playing field for both domestic and foreign investors.
The benefits come not just from employment, taxes, and net income, but also from
the positive externalities. Employment through FDI leads to the development of
improved employee skills and higher income, which eventually lead to additional
development of local industry. Technology transfers, direct and indirect, ultimately
benefit the local residents of the receiving country.
FDI has always been a sensitive issue because, unlike international trade, the invest-
ment includes ownership of assets and repatriation of profits. When Japan exported
cars in the 1970s to the United States, there was not as much ill will as when the
Japanese began to make investments in the United States. For example, the purchase
of Rockefeller Center by Mitsubishi in 1989 raised a chorus of criticism by politi-
cians and industry leaders. Some authors suggested that it amounted to discrimination
because Britain and the Netherlands were also very large investors during this period,
yet their investment in the United States never became a hot issue.11 Similarly, during
the 1960s and 1970s, nationalistic politicians in Europe and Asia found it easy to as-
sociate FDI by U.S. companies with exploitation of the country’s economic wealth.
FOREIGN DIREcT INVESTMENT AND GOVERNMENT POLIcIES

Many countries use tax policy as a means to lure or repel foreign direct investment.
Tax breaks are a common means to attract FDI into a country. They can come in the
form of zero taxes on the parent company for the first five years, followed by gradual
increases over the remaining years. Withholding taxes, in addition to normal corporate
taxes, are used to discourage FDI. Withholding taxes are levied on companies when they
have to repatriate their profits or dividends back to the parent company. By increasing
withholding taxes, countries can make the cost of FDI higher to potential investors.
Example of Withholding Taxes
Assume that a U.S. multinational in Singapore generates revenues of S$10 million

and incurs costs of S$6 million in variable and fixed costs. If the tax rate is 40 percent,
then its after-tax earnings available to shareholders are as follows:
Revenues S$10,000,000
Costs S$6,000,000
Gross profit S$4,000,000
Taxes (40 percent) S$1,600,000
Net income S$2,400,000
This amount can be sent back to the parent company in the form of dividends. How-
ever, most governments will impose a withholding tax. Assuming that this tax is 15
percent, this means the multinational is allowed to send only S$2,400,000–S$360,000
= S$2,040,000 back to the parent company. Withholding taxes provide incentives to
companies to reinvest their money back in the foreign country.
140 CHApTER 5
Subsidized Loans
Another way for countries to attract FDI is to provide subsidized loans to foreign
companies and lower their cost of investments. Although it imposes a cost on the local
country or city to attract the industries, the subsidized loan is justified if its costs can
be recouped. Typically, the higher employment and income generated by the invest-
ments will result in greater tax revenues to the lending country or city.
Regulation
Many companies use outright regulation to prevent or encourage FDI. To prevent

FDI, countries can usually invoke reasons such as national security or protection of
specific industries. For example, the United States has stringent rules on trading with
countries designated as those that promote terrorism. Such rules make it difficult for
U.S. firms to engage in any kind of investment in those countries. In August 2007,
Iran, North Korea, Syria, Cuba, and Sudan were on the list.
In 2006, Dubai Ports World acquired the British P&O shipping company to be-
come the world’s third-largest shipping operator. P&O also had contracts to operate
port facilities in six cities in the United States, including Philadelphia and Miami.
The issue became political when Miami-based Continental Stevedoring & Termi-
nals, a rival port operator, went to court to block the acquisition on national security
grounds. Although it was approved by the Committee of Foreign Investment of the
U.S. Treasury, politicians found it easy to exploit the issue based on the backlash of
the September 11 hijackings. The result was that Dubai Ports decided to sell those
contracts as part of the agreement to acquire P&O.
Ownership Restrictions
Restricting the percentage of foreign ownership in a company is an effective way for

countries to regulate the flow of inward FDI. Nearly all countries have some laws
restricting foreign ownership. A popular restriction in many countries is to limit the
percentage of foreign ownership to 49 percent, allowing domestic shareholders to have
a majority control. The reasons usually cited for ownership restrictions are the protec-
tion of strategic industries and providing breathing room for infant industries.
Strategic Industries. Countries like to ensure that firms in sectors deemed to be of

strategic importance are owned by domestic investors. The sectors usually include
telecommunications, utilities, airlines, financial services, and media. In the United
States, for example, when the semiconductor industry was threatened with closure
due to cheap imports from Japan and Asia, there were calls to protect this industry
by providing subsidies. It was deemed a critical sector because shortages of chips
could affect a majority of industries. Indeed, in 1985, a glut of chips forced many
U.S. companies to abandon production. Japanese companies continued to produce
them at a loss estimated at US$4 billion; however, Japan’s investment paid off as
demand soared back and increased sixfold by 1990.12 Companies in the United States
were forced to buy chips at highly inflated prices until production was ramped up
by domestic companies.
Similarly, shortages in critical components such as oil and steel can lead to severe
repercussions in the domestic market if supply is restricted. Governments have to de-
cide which industries are strategically critical and pass appropriate laws to encourage
those companies to stay at home. Unfortunately, categorization of strategic industries
can be tainted by domestic politics and corporate lobbying, which can instead lead
to unnecessary protectionism.
Infant Industries. Many countries provide protection to domestic infant industries
in order to give them time to develop and to protect them from foreign competition.
Examples include India, which for many years protected its car industry, and Brazil,
for its aerospace industry. However, protection can be misused and companies may
stagnate rather than innovate and achieve higher standards. The result is a likely
deterioration in the quality of the output, and protection may have to be continued to
maintain employment and output locally.
FOREIGN DIREcT INVESTMENT IN THE TWENTY-FIRST CENTURY: THE ROLE OF
PRIVATE EqUITY
The growth of free market policies around the globe in the last quarter of the twentieth
century has resulted in dramatic changes in the flow of foreign direct investment. A
new element has been injected into the dynamics—the role of private equity. Private
equity firms purchase companies and manage them with the intent of either listing
them in the public markets at some future date or selling them to other private in-
vestors. In 2007, private equity firms engaged in a record $700 billion in takeovers
and also raised more than $500 billion in 2006 as new capital. The power of private
equity is beginning to be recognized by governments and the financial markets. This
is because acquisitions by private equity can impact domestic companies based on
the portfolio of firms in the current inventory.
Example
Assume that two private equity firms raise $100 million each to engage in purchases
of companies. Assume that the existing inventory of the firms is as follows:
Private Equity A Private Equity B

Auto parts firm in Belgium $25 million Software firm in Thailand $50 million
Electrical retail firm in Poland $50 million Bicycle company in India $25 million
Yet to be invested $25 million Yet to be invested $25 million
Assume that both firms plan to bid for an engineering firm in the United States.
In order to optimize their global efficiency, the firms may develop different business
plans after the acquisition. Private Equity A may choose to reduce the engineering
staff in Belgium and Poland and consolidate all the operations in the United States.
142 CHApTER 5
Employment in the U.S. engineering firm will increase at the expense of the Belgian
and Polish firms. Private Equity B may choose to reduce the engineering staff in the
United States and funnel more of the work through its engineering base in Thailand
and India.
Depending on which firms succeed, the impact of private equity can affect employ-
ment and flow of capital in several countries because the firms operate on a global
portfolio basis. As private equity becomes a dominant factor in FDI, the flow of capital
will be influenced by its growth.
FOREIGN DIREcT INVESTMENT AND TRADE

The flow of international trade is affected significantly by the flow of foreign direct
investment. FDI can either complement trade or act as a substitute for trade. Earlier
studies had pointed to a negative correlation between FDI and trade, especially bi-
lateral trade. Recent studies overwhelmingly show a positive relationship between
FDI and trade.13
This interaction requires new policies and coordination by and between countries. If
FDI results in increased trade for both countries, it makes sense to lower trade barriers
to the fullest extent possible. However, the benefits of trade through FDI may not be
immediate, and the short-term effects of FDI can be destabilizing for a country. The
World Trade Organization has to balance the social and economic consequences of
FDI and trade to achieve the right balance of free trade policies.
CHApTER SUMMARY
The beginnings of international trade can be traced back to 3000 B.C.E. with the dis-
covery of several trading routes in Asia Minor. In the sixteenth century, the economic
policies of mercantilism, which emphasized the dominance of exports over imports,
prevailed in Europe. By the nineteenth century, Adam Smith and David Ricardo
showed the flaws in the philosophy of mercantilism and replaced it with the benefits
of specialization and mutual trade. Trade has been increasing ever since, achieving
very high rates after World War II. Global trade policies, encouraged by the World
Trade Organization, are lowering trade barriers for all forms of business activity.
Foreign direct investment, or FDI, is another phenomenon that grew significantly
in the second half of the twentieth century. FDI represents capital investment—such
as building a factory or purchasing a company—in another country. When foreign
capital is invested in the domestic market, it is labeled as inward FDI. When domestic
residents invest capital abroad, it is defined as outward FDI. The motivations for FDI
include (1) seeking new markets and cheaper resources, (2) avoiding trade barriers,
and (3) strategically increasing efficiency of a firm’s foreign operations.
When a company establishes a plant overseas, it usually imports capital goods
to the foreign country. It may or may not export goods out of the country. FDI also
contributes to the transfer of technology, which can benefit both countries. From a
political perspective, FDI can be a sensitive issue. Foreign investment in domestic
markets may be viewed negatively—as loss of ownership—to domestic outsiders.
Similarly, when domestic companies go overseas, critics will point to the loss in
employment and income as negatives for the home country.
FDI and international trade will grow as long as trade barriers continue to fall under
the stewardship of the World Trade Organization. Although there are occasional calls
for protectionism, the growth of FDI and international trade continues unabated as
we head toward a truly global market.
KEY CONCEpTS
International Trade Theory
Global Trade Patterns
Trade and the Economy
Foreign Direct Investment (FDI)
Global FDI Pattern
FDI and Trade
1. Why is it difficult to measure international trade prior to the eighteenth century?
2. What is mercantilism and why is it not possible to maintain a mercantilist
policy for long?
3. Assume that Country A can produce 100 units of wheat and 400 units of steel
for a given amount of land, labor, and capital. Country B can produce 200
units of wheat and 350 units of steel with the same volume of land, labor,
and capital. Show how specialization can increase total output. How much
additional wheat and steel would each country get if they were to share the
gains equally?
4. What is the difference between absolute advantage and comparative advantage
in international trade?
5. Assume that Country A can produce 100 units of wheat and 200 units of
steel for a given amount of land, labor, and capital. Country B can produce
50 units of wheat and 150 units of steel with the same volume of land, labor,
and capital. Show how specialization can increase total output.
6. What is the basic premise of the Heckscher-Ohlin theory on international
trade? Has empirical evidence supported this theory? Explain.
7. Explain how the product life cycle (PLC) theory can provide an explanation
for trade flows between countries.
8. What is the WTO, and what role does it play in international trade?
9. Distinguish between foreign direct investment and foreign portfolio investment.
10. What are the forms and types of FDI? Explain the differences.
11. What are the major motivations for FDI? Explain them within the context of
Dunning’s OLI paradigm.
12. How can governments affect the flow of FDI into or out of a country? Explain
how withholding taxes can affect the flow of FDI.
13. Discuss the relationship between FDI and international trade.
144 CHApTER 5
AppLiCATiON CASE: SiEMENS iN ARGENTiNA

In recent years, as foreign direct investments have increased globally, the number
of disputes over cross-border agreements has also increased. In 2008, an estimated
200 cases were pending with several tribunals.14 The absence of a true global mul-
tilateral set of standards and rules to govern global investments has led companies
and countries to use a variety of international tribunals to settle their cases. This, in
turn, has led to a patchwork of rulings that are inconsistent and often contradictory
across cases. One popular tribunal chosen by investors is the International Center for
the Settlement of Investment Disputes (ICSID), an autonomous institution set up in
1995 under the auspices of the World Bank with 155 signatory countries. The ICSID
finds itself struggling to adopt uniform rulings as the cases between sovereign nations
and private companies are often complex and by no means clear-cut. One recent case
involved Siemens AG in Argentina.
In 1998, Siemens IT Services of Argentina, a subsidiary of Siemens AG of Germany,
was awarded a $1.26 billion contract by the government of Argentina to develop a
national identification and immigration control system. The government was then
headed by President Carlos Menem of the Justicialist Party. In 1999, Fernando de la
Rúa of the Radical Civic Union Party became president of the country and annulled
the agreement, citing irregularities in the procurement process. In 2001, Siemens
took the case to international arbitration on the grounds that its contract was unjustly
terminated. Six years later, after extensive hearings, the ICSID ruled in favor of Sie-
mens and ordered the government of Argentina to pay $217 million in restitution and
release $20 million posted by the company as performance bond.
In a separate incident in 2003, the auditors of a bank in Liechtenstein discovered
a number of suspicious transactions originating from a company named Martha
Overseas in Greece. The country of Liechtenstein had recently agreed to make its
banking services more transparent in order to combat money laundering. Upon further
investigation, the bank discovered that the disputed account belonged to an execu-
tive of a subsidiary of Siemens AG in Greece. The investigators gradually realized
that they were uncovering one of the largest bribery scandals in corporate history.
Siemens executives routinely used slush funds in overseas accounts to bribe officials
in various countries throughout the world. A slush fund is not set aside for a specific
purpose; slush fund money is sometimes used for questionable, or illegal, expenses.
The scandal became public only when German authorities raided the offices of Sie-
mens in November 2006. Nearly a decade earlier, Siemens was fined 200 million
euros for its alleged role in bribing officials in several countries. As the investigation
continued, U.S. and Swiss investigators found additional evidence of slush finds
exceeding over $2 billion.
On August 15, 2008, Argentinean officials raided the offices of Siemens in Buenos
Aires, the capital of Argentina. The new raids were prompted by evidence supplied
by the German authorities indicating that Siemens may have continued to pay bribes
to Argentinean politicians and government officers until 2004, even while the ICSID
was holding hearings to determine the contract termination case. Argentina thereafter
officially asked the ICSID to reconsider its earlier findings and rescind the $217 mil-
lion in fines imposed in 2007. The request was based on the following grounds—if a
company engages in bribery to obtain contracts, investment disputes do not fall within
the purview of bilateral treaties, and that includes the current treaty between Argentina
and Germany. It is very likely that ICSID may be forced to rescind its earlier decision
and step out of the case altogether as evidence of the illegal payments are verified.
Siemens, a 160-year-old company, is bracing for further losses as a result of in-
vestigations worldwide. The company employs over 400,000 people in 160 countries
and has a reputation for engineering excellence. This episode makes it clear that it
is difficult for international arbitration panels to settle disputes when companies are
confronted with local political environments that demand bribery in order to win con-
tracts. In the United States, the Foreign Corrupt Trade Practices Act of 1977 strictly
prohibits the bribing of foreign government officials to win contracts. In Europe,
similar provisions were enacted on November 21, 1997, when the 30 OECD member
countries and five nonmember countries—Argentina, Brazil, Bulgaria, Chile, and the
Slovak Republic—adopted a Convention on Combating Bribery of Foreign Public
Officials in International Business Transactions. After a period of lax intervention,
European authorities are finally beginning to crack down on such behavior. In Au-
gust 2008, German authorities initiated multimillion euro lawsuits against several of
Siemens’s previous executives for having knowledge of such clandestine activities
and not taking actions to stop them.
QUESTIONS
1. Do you agree with the Argentinean authorities’ decision to request the ICSID
to rescind its earlier ruling and fine of $217 million? Why or why not?
2. Do you think laws preventing bribery will create a level playing field for
business worldwide? Why or why not?
6 Entry Strategies
Companies can enter foreign markets using a variety of methods and various strategies.
Each entry strategy provides unique benefits, but international companies also face many
difficulties. Therefore, companies planning international expansion need to consider
various factors in selecting an appropriate entry strategy.
LEARNiNG ObJECTiVES
• To learn about the various international market entry methods
• To understand the decision-making process in selecting a particular entry strategy
• To understand the export/import process
• To understand elements of export/import strategy
• To understand the differences between direct and indirect selling
• To understand the differences between licensing and franchising arrangements
• To understand the various strategic alliances that international companies
undertake
• To understand the use and importance of joint ventures
• To understand why companies enter into joint venture agreements
• To understand why companies invest in a wholly owned subsidiary
• To understand the benefits and major issues faced by companies that invest in a
wholly owned subsidiary
In deciding to go international, a company must choose an entry strategy to achieve

its international expansion goals. Entry strategies set the stage for an international
company’s success in its expansion into overseas markets. Choosing the right entry
strategy saves money and time, provides strategic advantages, and lessens the risks
associated with international operations. The choice of a particular entry strategy is
most often a result of a thorough analysis of the company’s strengths and weaknesses
and a comprehensive external environment analysis that includes the market potential.
Some key internal factors that are considered include a company’s core competencies
and its risk threshold, or how much financial risk the company is willing to take. In
entering a foreign market, a company can choose from a minimal investment option
to one that requires a large investment. International companies can choose from four
146
ENTRY STRATEGIES 147
distinct entry strategies: exporting/importing, licensing/franchising, joint ventures,

and wholly/fully owned subsidiaries. Licensing/franchising, joint ventures, and
wholly owned subsidiaries require direct investments in the foreign country. Each
strategy is designed for gaining entry into foreign markets under varying conditions.
These entries are not necessarily unique to large international companies; small and
medium-sized companies also use them.
As mentioned earlier, the selection of an entry strategy is often dictated by both
internal and external factors the company faces. The firm’s size, the number of prod-
ucts/services it offers, its financial position, its marketing expertise, and the number
of countries the company operates in are some of the internal factors that may dictate
its entry strategy. In the external environment, factors such as market size, potential
growth of the market, regulatory environment, intensity of competition, knowledge
of the market, and the host country’s economic and political conditions might all play
a role in the choice of entry strategy.
It is also possible that once a company selects a particular entry option, it might
decide to shift into another mode based on internal and external changes. For example,
a company that started out as an exporter might sometime in the future decide to enter
into a joint venture agreement or even invest in a wholly owned subsidiary. Toyota
Motors entered the U.S. market with exports of its vehicles from Japan; eventually
it built manufacturing plants in the United States to serve the growing market it had
captured. International companies have sometimes taken the reverse approach; that
is, after starting out as a wholly owned subsidiary, a few have downsized their opera-
tions and used exports to cater to the needs of the market. For instance, after many
years of operations in India, IBM left the country and returned as an exporter of its
hardware and software.
A brief description of each entry strategy follows.
EXpORT/IMpORT STRATEGY
Exports are goods and services produced by a company in one country that are sold
to customers in a different country. Importing is the purchase of goods and services
by a company in one country from sellers located in another country. Importing is
the reverse of exporting. Since importing is not necessarily a market expansion, but a
means to efficiently distribute goods and services that reach a country, the discussion
that follows will center on exporting.
Exporting is an easy entry strategy that is used by small, medium-sized, and large
companies. Large global companies such as Boeing, Embraer (Empresa Brasileira
Aeronáutica S.A.), GE, Panasonic, Philips, Siemens, and Toyota export their prod-
ucts all over the world. Similarly, large service companies such as AIG, Deutsche
Bank, Goldman Sachs, and SAP export their services to many parts of the world. At
the same time, these large companies also have wholly owned subsidiaries in many
countries. Large global companies, therefore, may have export entry strategies and
wholly owned subsidiaries to exploit the opportunities offered by larger markets in
different ways.
Exporting is also used by smaller companies that do not have the resources or
148 CHApTER 6
management expertise for engaging in a wholly owned subsidiary, but see the po-
tential to sell in a given market through exports. In fact, there are more exporting
companies in each country than those that have full-fledged invested operations. For
every Boeing, there are literally thousands of small companies that are involved in
exporting. For large and small companies, exports provide an opportunity to sell goods
and services in other countries, increase their revenues, gain additional profits, test
the market for further expansion, gain experience, and achieve economies of scale
in their domestic operations. Exports are also known to improve productivity levels
within companies and raise national productivity levels. In a study of 500 export
managers in the United Kingdom, researchers found that exporting firms experienced
faster productivity growth than nonexporting firms and, therefore, contributed more
to national productivity growth.1
For some companies, an export strategy might be part of a well-laid international
plan that evaluates markets, identifies potential, assesses competition, develops a
marketing program, and identifies potential distributors. However, involvement in
export might occur by chance; that is, a foreign distributor may request that a com-
pany’s goods and services be sold in the distributor’s country. The Internet and other
worldwide media have exposed consumers to goods and services more rapidly than
ever before. This has led to an increased demand for goods and services from many
corners of the world. Through Web marketing, consumers in many countries are able
to purchase goods and services that they find unique, that serve a particular need, and
that are priced reasonably. Therefore, it is not uncommon for customers surfing the
Web or reading a catalog in China to order cosmetics, computers, clothing, and other
goods from a company based in another part of the world.
Small, independent entrepreneurs in particular find exporting attractive, as it re-
quires no additional investment, very little additional personnel, minimal marketing
effort, and an opportunity to increase revenues and profits at reasonably low risk.
Exporting allows both small and large companies to tap into a new market without
investing much time and effort and at the same time provides valuable lessons in
entering foreign markets. Research has shown that the current performance of a com-
pany involved in exporting is influenced by the firm’s past experiences.2 Research
has also shown that small and medium-sized companies can improve their export
performance by better understanding the export process and also by increasing the
level of commitment to exporting.3 Exporting is also a good way to diversify risks;
that is, economic downturn and loss of revenues in the domestic market could be
compensated by the additional revenues and profits from exports. Exporting has proved
useful in smoothing seasonal fluctuations in sales providing tax advantages; many
governments, including that of the United States, encourage exports by offering tax
incentives to international companies.
The disadvantages of exporting include higher transportation costs, which in some
instances price a firm out of a market. Exporters also face trade barriers in the form
of tariffs and nontariff barriers such as additional documentation, tedious inspections
of goods, additional certification, and port-of-entry restrictions. In addition, many
exporters face problems with inefficient and ineffective local agents. Finally, exports
result in relatively lower rates of return compared to other modes of entry. Exporting
Figure 6.1 The Export Process
Performing country risk analysis and country selection
Determining market potential
Selecting product/service
Analyzing and understanding regulations

that govern exports for the selected country
Making necessary changes to product/service and packaging, including labels
Deciding on type of exporting
Understanding document requirements
Selecting importer
Drawing up agreements
Deciding on terms of sale and payment arrangements
allows companies to have control of the operations side of the business, but they must
forfeit strategic marketing controls: most of the marketing functions are undertaken
by the importer and the local distributors.
THE EXpORT PROcESS

The decision to export begins with the expectation that a company is committed to
expanding its operations into overseas markets. Once it is established that a company
wants to grow through international expansion, some critical steps must be taken
in order for the firm to succeed in the foreign market. Although export strategy is
relatively less complex than other entry modes, it does require careful planning and
execution. The specific steps in the process are presented in Figure 6.1
Some of these steps are uniform to all the four modes of entry. For example,
150 CHApTER 6
performing country risk analysis and determining market potential must be com-
pleted for exporting, licensing/franchising, joint venture, and wholly/fully owned
subsidiaries. However, deciding on a type of exporting and selecting an importer are
tasks performed only in exporting. Each of these steps must be carefully executed,
especially by first-time exporters. After a firm has exported to a few countries, the
lessons learned could make this process a little more easier.
PERFORMING COUNTRY RISK ANALYSIS AND COUNTRY SELEcTION

The country risk analysis conducted for exporting is similar to the one conducted
for most international expansion strategies. As outlined in Chapter 3, a country risk
analysis evaluates a country’s various external variables that might cause a company
to lose assets, its intellectual property rights (IPR), its image, its competitiveness, or
human life.
Country selection is often based on two key factors: market potential and
country risk assessment. Country risk is evaluated by understanding the factors
or variables that have an effect on the product (or industry) that is considered for
export. The many variables that determine a country’s risks include its economy,
politics, culture, regulatory environment, social factors, technology, infrastruc-
ture, sophistication of the banking and financial systems, and geography. All of
these variables are not necessarily critical for all types of goods and services. For
example, in exporting chemicals to industrial users, factors such as the economy,
political stability, and level of technology might be more critical than, say, cultural
and social factors. Once identified, the critical factors may hold varying degrees
of importance on the export plan, with some having a greater effect than others.
Consider the case of the chemical exporter: the importing country’s economy (be-
cause chemicals are an industrial product) and level of technology will probably
have a greater impact on that company than the level of banking and the finan-
cial system. However, for an investment bank exporting its services to a foreign
country, the level of the banking system would typically be of greater importance
than technology.
Country risk assessment is undertaken by identifying the critical factors that affect a
company’s international operations, measuring each variable, and assigning weights to
these factors to reflect the importance of each identified variable. In some of the large
multinational companies, country risk assessment is conducted by internal staff who
are specialized in this area, as these companies constantly need to identify potential
countries (i.e., these companies expand their markets on a regular basis). Medium-
sized international companies that do not have internal staff can hire professionals to
conduct risk assessment studies. Some of the leading consulting service companies
that provide risk assessment services include Control Risks Information Services,
the Economist Intelligence Unit, and Standard and Poor’s Rating Group. For smaller
companies that do not have the internal staff or the funds to hire consultants, there
are a few publicly available sources that are useful in assessing country risks. These
include Euromoney, Japan External Trade Organization (JETRO), the Financial Times,
and the U.S. Department of Commerce.
DETERMINING MARKET POTENTIAL

Market potential is the maximum available sales for a specific product/service
in a given country for all companies operating in that industry. The potential is
the upper limit of the size of the market. In most instances, this potential is never
achieved because of less-than-optimal marketing efforts, environmental factors,
consumer uncertainties, and substitutes that are close enough to the one marketed
by the companies. For example, India’s full market potential for automobiles is
more than 3 million cars per year. At the present time, only 2.2 million cars are
sold in India because of factors such as the high cost of the automobile, the poor
road conditions, the cost of gasoline, and the high tariffs levied on imported au-
tomobiles. For these reasons, the Indian automobile market has never reached its
full potential.
International companies are reluctant to enter foreign markets (even through ex-
porting) unless the market potential is sufficiently large. Considering the cost of entry
and the risks associated with international operations, companies avoid countries that
offer a small potential with very few growth possibilities. Total market potential and
demand for a company’s goods and services are not one and the same. As explained,
market potential is the upper limit in a given market, whereas a demand for a com-
pany’s particular product is the estimated share of the total potential for that product
that a company can achieve under ideal conditions. Most exporting companies try
to establish a “sales forecast,” which is the realistic goal within an expected demand
under the total market potential.
SELEcTING PRODUcT/SERVIcE
Companies sell many products and services. In fact, larger companies may have
hundreds of different products. For example, Unilever markets more than 660 differ-
ent products in various countries of the world. Similarly, Citigroup offers nearly 100
different services to its retail and corporate clients. For the purposes of exporting,
companies with multiple products/services must decide on one or a few on which
to concentrate. When a company first begins exporting to a particular country, there
might not be a demand for all the company’s products/services. For example, when
Deutsche Bank entered Malaysia for the first time, it offered only transactional ser-
vices to its corporate clients and did not enter the retail banking sector until nearly a
decade later. Similarly, when Natura Cosmetics of Brazil entered the Mexican market,
it exported only skin care products for women, not its whole range of beauty care
products. The limited offerings of smaller companies with a single product or service
make the choice of the product/service to export easier.
In selecting the product or service to export, it is important to conduct market
research in the chosen country to identify opportunities as well as constraints. Specifi-
cally, market research helps companies (1) to ascertain the demand for the product
and the specific needs of the market, (2) to identify a target market, (3) to understand
the unique characteristics of the market, and (4) to identify regulations that affect
imports to the country. Selection of the product or service is sometimes made easier
152 CHApTER 6
if a company receives unsolicited orders from abroad. In such instances, there is no

need to conduct market research.
ANALYZING AND UNDERSTANDING REGULATIONS

Companies that export goods and services need to understand the specific regulations
that apply to exporting to a particular country. These regulations include types of
products that can be exported, regulations that cover the size or volume of the product,
packaging and labeling restrictions, restrictions on the choice of distributors, rules
regarding transfer of funds, and tariffs and quotas.
Foreign countries restrict the flow of goods and services to their countries for many
reasons, among them
• To protect domestic industries; if a local industry is in its infancy, imported goods

and services might affect its growth
• To force importers to comply with environmental controls; for example, many
of the Nordic countries restrict importing goods that are packaged in nonbiode-
gradable material
• To protect the health of the people; for instance, the United States restricts toys
containing lead-based paints (the 2007 recall of toys made in China is a good
example of this)
• To comply with the local standards; requiring the metric versus English system
of measurement is an example
• To prohibit goods and services that influence culture, especially clothing, movies,
videos, and music
• To restrict goods and services from countries that are considered unfriendly, as
in the case of many Middle Eastern countries restricting importation of goods
and services from Israel
• To generate revenues; in other words, tariffs and other import duties not only
help countries restrict flow of goods and services, they also generate revenues
MAKING NEcESSARY CHANGES TO PRODUcT/SERVIcE AND PAcKAGING,

INcLUDING LABELS
Companies that export goods and services quite often have to make adjustments to items
that they sell to comply with local laws, cultural taboos, buyer preferences, local standards
of living, local market conditions, and geographic and climatic conditions. For example,
in introducing its retail banking services in Malaysia, Deutsche Bank had to revise how
it calculated interest owed by clients in order to comply with the edicts of the Koran,
which prohibits charging interest. Similarly, a German floor-tile manufacturer had to
apply stronger glue to all the tiles exported to many Asian countries to address the hot
and humid conditions there (if it had not done so, many of the tiles would have buckled
and separated from the floors). Likewise, Unilever modified its shampoo packaging to
introduce single-use sizes in many developing countries to reflect the standards of living
(the price of full-size shampoos was prohibitive for local consumers).
Product and service changes to suit local conditions may take the form of minor
modifications or major alterations. Simply changing the language on a package’s
label or changing the size of the package might be considered a minor modification.
However, shifting the steering wheel from the left to the right in automobiles sold in
Japan or making changes to appliances to fit the size constraints of small apartment
units in some foreign countries are considered major modifications.
Finally, exporting companies have to consider the issue of warranties and after-
sales service. Most products come with a warranty, especially high-priced items
such as computers, appliances, automobiles, and telecommunications equipment.
The question arises of who will perform the after-sales service, and how. On the one
hand, the exporter’s reputation is at stake; on the other, it might not be practical to
provide overseas service from the exporting country. Normally, if the country is well
developed, the warranty service can be provided locally. Exporters have also used
local distributors to provide after-sales service by training the distributors and giving
them incentives. If a country does not have the technology or skills to provide service
locally, exporters have asked their customers to ship the products back for servic-
ing or in some cases provided after-sales service at a third location. For example,
Singapore and Australia are often used as warranty fulfillment centers by American
and European exporters.
UNDERSTANDING THE DOcUMENT REqUIREMENTS

Exporting requires extensive documentation that describes the product, its origin,
package size, value, and so on, and contains all pertinent information from both the
exporter’s and importer’s point of view. Fortunately, beginning and even experienced
exporters can make use of freight forwarders, specialists who act as travel agents for
shipping cargo instead of people. These agents specialize in maritime as well as air
freight. The various services provided by freight forwarders include quoting freight
rates for all modes of transportation, preparing the necessary documents, making ar-
rangements for the transportation and shipment of the product, and clearing customs
and other regulatory requirements.
Some of the required export documents include the following:
• The commercial invoice is similar to invoices that are found in most domestic
sales. The commercial invoice contains: the exporter’s address; the importer’s ad-
dress; the invoice date; the number of units being shipped; the terms of sale, that
is, whether it will be free on board (FOB) or cost insurance and freight (CIF); and
the country of origin. A sample commercial invoice is presented as Figure 6.2.
• The packing slip contains the same information as the invoice except that it does
not contain the price.
• The bill of lading is a receipt given by a carrier of goods, which could be a
trucking company, a shipping company, or an air carrier, that agrees to carry the
shipment to its final destination. The bill of lading is made to the order of the
buyer and is a document of title. It can be used by the holder of the bill of lading
as collateral for a loan.
154 CHApTER 6
Figure 6.2 Sample Commercial Invoice
COMMERCIAL PRO FORMA INVOICE
Date: __________ __________ Reference Number: __________ __________
Shipper: Consignee/Importer:
VIA AIRFREIGHT
Country of Origin: Country of (Temporary) Destination:
MARKS & NO. OF DESCRIPTION OF WGT QTY UNIT TOTAL

NUMBERS PKGS GOODS YDS VALUE*
*Value for Custom Purposes only.
Source: U.S. Department of Commerce, Economics and Statistics Administration, and U.S. Census Bu-
reau, Bureau of Export Administration, Form 7525-V, “Shipper’s Export Declaration.” Available at http://
www.census.gov/foreign-trade/regulations/forms/new-7525v.pdf.
• The shipper’s export declaration contains information found in the commercial

invoice and lists the relationship between the exporter and the importer (for
example, if the importer is a subsidiary or under the control of the exporter), the
names of the ultimate and intermediate consignee, transportation details (type
of carrier, port of embarkation, port of disembarkation), and other pertinent
information. Figure 6.3 is a sample shipper’s export declaration.
• Certificate of origin is similar to a bill of lading and is requested by an importer
to ensure that the origin of the goods is as stated in the commercial invoice and
the bill of lading. Figure 6.4 is a sample certificate of origin.
• Legalization and consularization is required by some countries; a few of the docu-
ments must be approved by their consulate offices before shipping the items.
• An insurance policy is necessary in most cases of exports to cover any damages
and losses that might occur in the shipment of goods.
DEcIDING ON THE TYpE OF EXpORTING

Exporting channels can be direct or indirect. In direct exporting, an exporter deals
directly with an overseas buyer, is actively involved with the operations, has control
of the many aspects of the export process, and takes some risks. Because of the sig-
nificance of the various activities associated with direct exporting, management has
to commit substantial time and attention to achieve success. The direct exporter must
be involved in the selection of the markets and distributors, must make most of the
payment arrangements, and must do the follow-up work with the distributors. Direct
exports have the potential to reap optimal results.
In indirect exporting, an intermediary is used to locate buyers, ship the goods,
and collect payments. Several kinds of intermediaries are available, including
export trading companies and export management companies. These are special-
ized agents who have knowledge of the various markets, well-established contacts
with distributors in each country, and a wealth of experience. These intermediaries
can be located through foreign government consulate offices or, in the case of
many industrialized countries, through their own government agencies. For U.S.
exporters, the Department of Commerce is a useful agency to identify intermedi-
aries. The principal advantage of indirect exporting, especially for inexperienced
small companies, is that it provides an easy means to penetrate foreign markets.
Indirect exporting is easier to implement, requires fewer resources, and demands
far less management time and commitment. Typically, indirect exporting results
in less-than-optimal profits and market expansion. In service industries such
as banking and insurance, direct selling is used with a branch or sales office to
service the local customers. Figure 6.5 presents various export channels in direct
versus indirect exporting.
The decision to use direct or indirect exporting depends on many factors, includ-
ing the company’s human resources capabilities, its financial resources, its size,
the type of goods and services being exported, its prior knowledge of the import-
ing country, prior exporting experience, and the country’s general economic and
business conditions.
156 CHApTER 6
Figure 6.3 Sample Shipper’s Export Declaration
SHIPPER’S EXPORT DECLARATION

1a. U.S. PRINCIPAL PARTY IN INTEREST (USPPI) (Complete name and addr ess)
ZIP CODE 2. DATE OF EXPORTATION 3. TRANSPORTATION REFERENCE NO.
b. USPPI’S EIN (IRS) OR ID NO. c. PARTIES TO TRAN SACTION

Related Non-related
4a. U LTIMATE CONSIGN EE (Compl ete nam e and address)
b. INTERMEDIATE CONSIGN EE (Compl ete nam e and address)
5a. FORWARDING AGENT (Complete name and addr ess)
5b. FORWARDING AGENT’S EIN (IRS) NO. 6. POINT (STAT E) OF ORIGIN OR FTZ NO. 7. COUNTRY OF ULTIMATE D ESTINATION
8. LOADING PIER (Vess el only) 9. METHOD OF TRANSPORTATION 14. CARRIER IDENTIFICATION CODE 15. SHIPMENT REFERENCE NO.
(Specify)
10. EXPORTING C ARRIER 11. PORT OF EXPORT 16. ENTRY NUMBER 17. HAZ ARDOUS MATERIALS
Yes No
12. PORT OF UNLOADING (Vess el and air 13. CONTAIN ERIZED (Vess el only) 18. IN BOND CODE 19. ROUTED EXPORT TRANSACTION
only) Yes No Yes No
20. SCHEDULE B DESCRIPTION OF COMMODITIES (Use c olumns 22–24) VALUE (U.S. dollars,
omit cents)
D/F QUANTITY – SHIPPING WEIGHT VIN/PRODUCT NUMBER/ (Selling price or c ost if not
or M SCHEDULE B NUMBER SCHEDULE B UNIT(S) (Kilograms) VEHICLE TIT LE NUMBER sold)
(21) (22) (23) (24) (25) (26)
27. LICENSE NO./LICENSE EXCEPTION SYMBOL/AUTHORIZATION 28. ECCN (When required)
29. D uly authorized offic er or empl oyee The USPPI authorizes the forwar der named abov e to
act as forwardi ng agent for export control and customs
purposes.
30. I certify that all statements made and all information contai ned herein are tr ue and correct and that I hav e read
and understand the i nstructi ons for prepar ation of this doc ument, set forth in the "Correct Way to Fill Out the
Shipper’s Export Declaration." I understand that civil and criminal penalti es, incl udi ng forfeiture and sal e, may
be imposed for maki ng false or fraudulent statements herei n, failing to provide the requested i nformati on or for
violation of U.S. l aws on ex portation (13 U.S.C. Sec. 305; 22 U.S.C. Sec. 401; 18 U.S.C. Sec. 1001; 50 U.S.C.
App. 2410).
Confident ial – Shipper’s Ex
Export
port Declarations (or any success or document)
Signature wherev er located, shall be exemp t from pub lic disclosure unless the Secretary
determines that such ex emption would be contrary to the nationa l in terest (T itle 13,
Chapter 9, Section 301 (g)).
Title Export shipments are subject to inspection by U.S. Customs

Service and/or Office of Export Enforcement.
Date 31. AUTHENTICATION (When r equired)
Telephone N o. (Incl ude Area Code) E-mail addr ess
This form may be printed by private parties provided it c onforms to the official form. For s ale by the Superintendent of Doc uments, Government
Printing Office, Washington, DC 20402, and loc al Customs District Directors. The "Correct Way to Fill Out the Shipp er’s Export
Declaration" is av ailabl e from the U.S. Census Bureau, Washi ngton, DC 20233.
Figure 6.4 Sample Certificate of Origin
CERTIFICATE OF ORIGIN
The undersigned _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
(Owner or Agent, or Co.)
for _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
(Name and address of shipper)
that the following mentioned goods shipped on S/S _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

(Name of ship)
on the date of _ _ _ _ _ _ _ _ _ _ _ _ _ _ consigned to _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ are the product of the United States of America.

NO. OF PKGS.,
MARKS AND NUMBERS BOXES, OR WEIGHT IN KILOS DESCRIPTION
CASES GROSS NET
Sworn to before me
Dated at _ _ _ _ _ _ _ _ _ on the _ _ _ _ _ day of _ _ _ _ _ 19 _ _ _ _
this _ _ _ _ _ day of _ _ _ _ _ 19 _ _ _ _
_____________________ ________________________
(Signature of Owner or Agent)
The _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ , a recognized Chamber of Commerce under the laws of the State of
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ , has examined the manufacturer’s invoice or shipper’s affidavit concerning the

origin of the merchandise and, according to the best of its knowledge and belief, finds that the products named originated
in the United States of North America.
Secretary _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
Source: UNZ & CO., Form No. 10-906. Copyright © 1990 UNZ & CO. Available at http://www.haasin-
dustries.com/files/certificateOfOrigin.pdf.
158 CHApTER 6
Figure 6.5 Export Channels
Domestic Producer
Direct Exports Indirect Exports
Domestic Sales Office Int’l Sales Office Trading Company Manufacturer’s Agent Importing Distributor
Wholesaler
Retailer Retailer
User User User
SELEcTING AN IMpORTER
For companies that use indirect exports, the selection of the right importer is critical.
Since the key marketing functions in the selected country are handled by the importer,
an importer that has experience, knows the market, and can handle the local problems
could be the difference between success and failure.
Importers can be small or large. The smaller companies, whose only business is to
import, deal with fewer product categories and handle imports to just one country. At
the same time, there are large multinationals involved in imports (besides conducting
other businesses) that are active in many countries, handle a variety of products, and
have a large number employees who specialize in certain functions such as dealing
with the documentation, making payments, and arranging logistics.
One of the key factors to consider in selecting a qualified importer includes
the firm’s financial strength. Through research, credit checks, and other available
secondary information, an exporter must determine whether the importer has the
capital resources to make payments for the goods imported. Financial capability
is a precondition to selecting a viable importer. The next factor to consider is the
importer’s experience. Exporters do not want an importer to learn the business
with their products, as this will make it difficult to penetrate the market, and the
importer’s learning curve will make it hard to generate profits. The third factor to be
considered is the importer’s local market knowledge: it should be extensive, since

the importer handles local marketing efforts, and the importer should demonstrate
knowledge of the distribution system, the targeted customer, and the competition.
It is also useful to determine the number of employees working with the importer,
the size of its facilities, and its location.
DRAWING Up AGREEMENTS
International transactions require carefully drawn contracts and agreements. These
are meant to protect both the exporter and the importer. The terms of the contract
should include length of the specified arrangement, payment options, payment de-
faults, antipiracy clauses, geographical limitations, liability and safety issues with
the exported product, who will fulfill warranty and guarantee services and how they
will be fulfilled, and termination clauses. The contracts and agreements are drawn
by legal specialists, and many are similar in content.
DEcIDING ON TERMS OF SALE AND PAYMENT ARRANGEMENTS

The final steps in the exporting process (in some cases these may be agreed upon
very early in the process) are the terms of sale and payment arrangements. Many
conditions need to be agreed upon regarding terms of sale, but the critical ones are
accounts payable and payment arrangements. Normally, exporters will not ship goods
unless they have been guaranteed payment for the goods by a third party, usually a
bank. The guarantee of payment is normally handled through a letter of credit (LC).
An LC is a document with which the importer’s bank extends credit to the importer
and the bank agrees to pay the due amount to the exporter. In some cases, especially
if the exporter has had a long-standing business arrangement with the importer, the
exporter may extend terms that allow payment to be due after the goods have landed
in the entry port. These terms may be for 30 to 60 days after the goods have arrived to
help the importer manage its cash flow. Even in extending the credit terms, an exporter
will still insist on drawing up a letter of credit to assure timely payments.
In some instances, an exporter might settle for a barter arrangement instead of a letter
of credit for two reasons: (1) to gain entry into a market where economic conditions
prevent the importer or the importing country from paying in foreign currencies, or
(2) if some of the local commodities can easily be traded in the world market and, in
some cases, the barter commodity is a raw material for the exporter. For example, in
the 1980s Pepsi exported its products to the Soviet Union, which paid the company
in either sugar or vodka. Sugar was a raw material in many of Pepsi’s soft drinks, and
vodka was easily traded for cash. Barter is also used in trade between countries. In
an agreement between Indonesia and Thailand, Indonesia agreed to supply Thailand
with small aircraft, train carriages, and fertilizer in exchange for rice from Thailand.
The critical issue in barter is establishing equivalency between the bartered goods. Is
one ton of Thai rice equal to one aircraft? In practice, the value is determined by the
market value of the goods exchanged. In case of barter, it is necessary to negotiate
the value of each barter for each transaction.
160 CHApTER 6
DiRECT INVESTMENTS
Entry strategies such as licensing/franchising, joint ventures, and wholly owned
subsidiaries involve direct investments. Licensing/franchising and joint ventures
are also referred to as “collaborative arrangements”—formal, long-term contractual
agreement between companies.
Investments in foreign countries involve capital movement as well as noncapital
movement. Most FDI flows does involve some capital movement, but licensing/
franchising involve other types of assets, including management expertise, technical
systems, and so on. International companies may undertake investments in foreign
countries for specific benefits, as detailed below.
RATIONALES FOR FOREIGN DIREcT INVESTMENT

Benefits
Spread the Investments and Reduce Risk. By operating in many countries, interna-
tional companies can spread their overall risk, especially in managing operations in
politically unstable countries. For example, British Petroleum (BP) has drilling and
refining operations in the United States, the Middle East, Latin America, and Africa.
It considers its operations in the United States and most of Middle East to be in po-
litically safe regions, but its operations in Africa are vulnerable to political unrest.
Because of its safer operations in other parts of the world, BP can limit its losses
while operating in riskier regions such as Africa.
Avoid Local Competition. International companies enter into collaborative arrange-

ments to improve their competitive position. By joining with local companies, a
foreign company might gain a stronger position in the market than if it had acted
alone. For example, in the early 1990s, Pepsi-Cola Corporation entered into a joint
venture agreement with Punjab Agro Industrial Corporation, a state-owned entity in
India, and Voltas Ltd. to distribute agricultural-based products as well as market its
soft drink brands. The move helped Pepsi gain a stronger competitive position vis-à-
vis its U.S. rival Coca-Cola, as well as in relation to its competitors.
Gain Market Knowledge. For most international companies entering foreign markets,
the most vexing problem is a lack of knowledge of the local market. Collaborative
strategies help these companies gain instant knowledge of the local market conditions
through their partners.
Benefit from Specialization. By operating in countries that have distinct competencies

that differ from the strengths of the collaborating firm, the collaboration will be mutu-
ally beneficial.4 For example, Coca-Cola is strong in the bottling and distribution of
soft drinks but lacks expertise in manufacturing the promotional items they sell such as
clothing, caps and so on. To tap into the expertise that Coca-Cola lacks, it might enter
into a collaborative arrangement with a foreign promotional items manufacturer.
Benefit from Geographic Diversification. By operating in multiple countries, inter-

national companies can smooth out revenues and earnings by generating income
in countries whose economies are doing well even while underperforming in those
that face an economic downturn. For example, Coca-Cola’s operations in Asia had
double-digit growth in 2006, a stark contrast to its flat revenues and earnings in the
United States that same year.
Gain from Country of Origin Effects. Many consumers associate quality of goods and
services on the basis of where they are made. For example, Switzerland is well known
for its outstanding watches, France and Italy are known for their designs, Japan is known
for producing quality automobiles, and the United States is recognized for its investment
banking capabilities. Therefore, companies set up operations in foreign countries to gain
from the country-of-origin effects. For example, GM’s Opel automobiles, manufactured
in Germany, are more highly regarded than its comparable U.S.-made vehicles.
Reasons
Avoid Legal Constraints. Many countries impose restrictions on imports and wholly
owned subsidiaries to encourage local businesses to undertake operations that other-
wise would be controlled or owned by foreigners. For example, China restricts full
ownership of companies in many industries. One way for international companies to
avoid these restrictions is to form partnerships with local businesses.
Reduce Costs. Many of the developing countries of Asia and Latin America have
much lower labor costs, which attract foreign investors. The lower labor costs and
reduction in other operational costs such as transportation and some utilities help
companies to price their goods and services lower than in their home markets. The
lower price tag in turn attracts segments of the local market that now can afford
these products. For example, Whirlpool entered into a joint venture agreement with
an Indian company to produce washing machines. Washing machine usage in India
until then was very low due to the high cost of the machines and the fact that many
Indian households had servants who did the wash. Once Whirlpool machines were
available in the Indian market, sales of washing machines skyrocketed, as consum-
ers were attracted by the lower prices as well as the status symbol associated with
owning a washing machine.
Reduce Transportation Costs. A major problem with exporting is the added cost of trans-
portation that is incurred by the buyer, especially for those products that have to travel
long distances. For example, the distance between the United States and Japan is nearly
10,000 miles. For some products, such as clothing and toys shipped from China to the
United States, the transportation cost is double the actual cost of the product itself.
Avoid Duties and Tariffs That Some Countries Impose on Imports. Even with growth in
the number of countries joining the WTO, trade barriers in some form still exist. The
most common trade barriers are in the form of tariffs that increase the landed price of a
162 CHApTER 6
given product. For example, India levies tariffs of more than 100 percent on imported
automobiles. Because of the high tariffs, many foreign manufacturers, such as Ford,
GM, Hyundai, and Volkswagen, have set up joint venture operations in India.
Gain Control of Operations. Direct investments allow international companies to

have a measure of control over their operations that would not exist in an exporting
venture. One of the problems in exporting is a company’s lack of control over its own
marketing and related activities. Without this control, a company may fail to reach
its full sales potential, may experience poor customer relations, and may encounter
weak after-sales service. Through direct investments, an international company has
much more control over its operations in a foreign country.
LIcENSING AND FRANcHISING

Under a licensing arrangement, a firm grants “rights” to some process or other
intangible property—such as patents, formulas, designs and the like—to another
company for a specified period of time in exchange for a fee. For example, many
clothing brands such as Vanderbilt jeans and Ralph Lauren Polo shirts license their
designs for manufacture by companies in countries where they do not have distribu-
tion arrangements. The company providing the license is called the “licensor,” and
the recipient is called the “licensee.”
Franchising is a specialized form of licensing in which the original company not
only sells the use of a trademark—an essential asset for conducting business—but
also assists the recipient on a long-term basis in the actual operations of the busi-
ness. Some companies set up multiple franchise operations through a single business
partner, who then might decide to open others in the country (subfranchisees). This
helps the franchisor establish many outlets in one country without having to deal with
a large number of individual operators. For example, Holiday Inn has many franchise
hotels all over the world that are owned and managed by local entrepreneurs, but
Holiday Inn provides assistance in terms of personnel, marketing, accounting, and
food and beverage operations. A good number of franchise operations are from the
United States. Most of these operations are in the service sector, especially hotels and
fast foods. The franchise-granting company is called “franchisor,” and the company
receiving the franchise is called the “franchisee.” Licensing and franchising are entry
modes that have low developmental costs and relatively low risks. Countries that
have been the beneficiaries of franchising arrangements seem to have high income
levels, a well-educated population, and entrepreneurs willing to take risks.5 In the
United States, the franchising industry employs 11 million people, generating about
4.4 percent of the U.S. economic output.6 For the remainder of this chapter, licensing
and franchising will be discussed as if they are one and the same.
Advantages of Licensing/Franchising
Licensing/franchising offers a faster way than other modes of entry into foreign
markets. Because the investment needs are small and the local operations are
handled by the licensee/franchisee, the licensor is required to do very little analysis

of the market. Licensing and franchising help companies extend their markets very
quickly, and some of the risks of the expansion are borne by the licensee/franchi-
see. In some instances, licensing agreements also provide valuable technological
benefits for the licensor. For example, Merck & Co. of the United States was able
to obtain valuable ultraviolet-absorbing technology used in skin care products
from Sol-Gel Technologies, its Israeli licensee.7 Although licensing and franchis-
ing arrangements are easy to establish, it is important that the licensee/franchisee
be carefully selected.
Selection of Licensing/Franchising Partners
The three principal considerations in most collaborative arrangements are deci-

sions about operational factors, the importance of negotiations, and payment
arrangements.
Factors that come to play in setting up licensing/franchising arrangements in-
clude the partners’ financial capabilities, business knowledge, understanding of
the local markets, experience, and enthusiasm for the business, all of which must
be carefully evaluated. For example, Outback Steakhouse was very successful
in South Korea when the local franchisee was given the freedom to use its local
market knowledge and cultural patterns in developing local marketing strategies.8
Similarly, in a study of franchising operations in Ireland, researchers found that
franchises succeeded when the local company approached the agreement with
higher commitment and used its knowledge of the local market in developing
strategies.9
A second consideration in all collaborative entry strategies is the importance of
negotiations between the two parties. This is a critical consideration in joint ventures,
where the involvement is much more than an arrangement between partners involving
investments, operational factors, and sharing of profits. Unless the partners in col-
laborative strategies feel that each party is being treated fairly, the collaboration will
fail. Internationally, the process of negotiations is complex and takes considerable
time, especially in the case of joint ventures.
A third factor in licensing/franchising agreement that requires special attention
is the payment arrangements. In licensing/franchising, unlike in joint ventures, the
parties in the agreement must reach an understanding on the terms of the fees and
royalties to be paid to the licensor/franchisor. For the foreign company, this represents
payments for its brand name and other intellectual property rights. There are no set
standards for these payments, and, hence, the parties have to negotiate to arrive at
fair fees or royalties. Some of the factors that play a role in the final settlement of the
payments include volume of sales, future potential for growth, the life (perishability)
of the technology, the extent of the contract, the relationship between the parties,
and the licensor/franchisor’s level of experience. The payment negotiations should
also include how often (quarterly, semiannually, or annually) and in what currency
payments will be made.
164 CHApTER 6
Disadvantages of Licensing/Franchising
Licensing/franchising is not without its share of problems. One of the disadvantages

of licensing/franchising is the foreign company’s lack of control over technology
and intellectual property rights, especially in cases of high-tech companies operating
in countries that lack piracy laws. A few companies, including Vanderbilt (jeans)
and Apple (iPods), have seen their products copied and sold back into the market
at a much cheaper price. In licensing/franchising, since the local entrepreneur is
the one who handles the marketing of goods and services, the franchisor/licen-
sor does not get a chance to learn about the local market. This also removes the
learning curve experience for the foreign company’s future international market
expansions. Another disadvantage in licensing/franchising arrangements is that the
foreign company does not fully benefit from market growth. For example, when
Disney decided to enter Japan with its theme park in 1981, it was not sure how the
Japanese would react to Disney characters such as Mickey Mouse, Pluto, and the
like and decided to license the local partner instead of investing in a joint venture
operation. Against all odds, Disney Tokyo became a huge success and the only rev-
enues Disney gained from the success were the fees, not the profits, which would
have been 10 to 20 times greater.
JOINT VENTURES
Joint ventures are direct investments in which two or more companies share owner-
ship. Joint venture agreements can be established between companies and, in some
cases, between a foreign company and the host government, with the foreign com-
pany’s ownership at anywhere from 1 percent to 99 percent. The company that holds
a majority in a partnership arrangement has controlling interest in the joint venture.
Most joint venture agreements are long-term arrangements. Many developing coun-
tries encourage and provide incentives to foreign companies setting up joint venture
operations. For these countries, joint ventures provide the maximum benefit.
Joint ventures allow developing countries to receive badly needed capital, valu-
able technology, and aid in the development of local entrepreneurial skills. Such
business ventures also provide employment, help build local managerial talent, and
make quality goods and services available to the people. Among the entry strategies,
joint venture partnerships are probably the most popular and the most preferred by
developing countries. Entering into a joint venture with a local partner provides the
foreign company with an opportunity to learn about the partner’s technology and
operating methods, which might result in enhancing the competencies of the foreign
company.10 Joint ventures definitely have many advantages; but research has shown
that nearly half of them dissolve after a few years.
Critical Factors in Forming Joint Venture
The critical factors in forming a joint venture are finding the right partner, developing
mutual trust, sharing common business goals, resolving control issues, establishing
an active partnership, and viewing shared benefits as greater than if each partner
went on its own.
The Right Partner. As it is true in most collaborative strategies, one of the most im-
portant steps in joint ventures is finding the right partner. Joint venture partnerships
are established when a foreign company actively seeks local partners in foreign
countries or responds to proposals it receives from host-country businesses to form
joint ventures. Before making a final decision, international companies seeking joint
venture partners typically do exhaustive research on their most viable options, includ-
ing contacting their embassies, reviewing business newspapers for leads, or hiring
international research companies to select a joint venture partner. Failures in joint
venture arrangements have been traced to problems between partners.11 The selection
of a suitable partner or partners is based on the value that the local partner brings to
the table. Usually, the foreign firm is able to bring financial capital, technology, ma-
chinery, and personnel. The local partner’s share might include capital, raw material
and parts, knowledge of the market, government contact, and a supplier network. In
selecting a partner, a foreign company is interested in whether the partners’ assets and
skills complement their own, and whether the foundations for a successful working
relationship exist.
Mutual Trust. Joint venture partnerships are built on trust. One partner should not
take advantage of another, and both should strive to make the joint venture a success.
Some companies have successfully built trust through their actions as partners, that
is, by investing time and effort in the joint venture to make its operations a success.12
The day-to-day operations of a joint venture involve individuals working together,
and, human behavior being what it is, problems can arise that undermine the joint
venture. Since international joint venture arrangements are between companies from
different countries, cultural and language differences can cause misunderstandings
that lead to mistrust. Therefore, it is imperative that the managers involved in the
joint venture maintain their focus on the goals of the partnership, openly discus is-
sues before they become too complex to manage, and seek common ground when
problems occur.
Common Business Goals. Right from the start, joint venture partners should establish
mutually beneficial goals. These goals must be easily measurable, must be beneficial
to all the partners, and must be equitable and fair. Most problems in joint venture
arrangement arise from the sense that one of the partners is benefiting more from
the venture than another. It is also critical that achievable goals be negotiated early
in the relationship.
Control Issues. In a joint venture arrangement, because of the differences in ownership

percentages, one partner (the majority owner) might have more control over the joint
venture’s operations. This may lead to differences in goals and strategies that could be
viewed by one partner as not in its best interests. It is difficult for the minority partner
to impose its ideas even if they are better for the joint venture operation.
166 CHApTER 6
Active Partnership. To be successful, joint venture partners must be active in the

venture’s operations. If one partner gives more management attention to the joint
venture and the results are less than optimal, the other partner might blame the more
active partner for the losses. There should not be a silent partner in a joint venture,
as it creates mistrust and friction between the partners.
Shared Benefits. Finally, each partner should be convinced that it would not be able to
achieve more if it had conducted the business on its own. That is, each partner should be-
lieve that the partnership results in much greater rewards than a lone venture would.
Advantages of Joint Ventures
A discussion of the many advantages of joint ventures follows.
Lower Investments. Because more than one partner is involved in a joint venture,
the investment required of each partner is much lower than if a business began the
venture on its own.
Shared Risks. As in the case of investments, risks are also shared, and each partner’s
exposure to those risks is lowered.
Taking Full Advantage of Market Potential. Since the foreign company is involved
in some aspects of the operations and marketing, it has the opportunity to explore
the local market fully.
Taking Advantage of Local Regulations. Many developing countries restrict entry of

foreign companies but are willing to allow them to form joint venture partnerships.
In some instances, to attract foreign companies to form joint ventures, countries may
offer incentives in the form of tax breaks, discounts on utilities, and easier terms for
repatriation of profits.
Partners’ Complementary Skills and Resources. Quite often, the joint venture partners
have complementary skills that give them a strong competitive position. For example,
Motorola of the United States formed a joint venture with WiPro Technologies of
India. Together, they deliver managed services and computing mobility that taps
into the cellular phone technology of Motorola with the software expertise of WiPro
Technologies.13
Making Full Use of the Profit Potential. As in the case of making full use of sales
potential through joint venture partnerships, these arrangements also result in fully
utilizing the profit potential of the market.
Gaining Relationships with Government, Suppliers, and Customers. Host countries’

governments view joint ventures as the preferred mode of entry, so the foreign investor
who forms joint ventures is perceived more favorably and gains politically. Besides,
the local partners in joint ventures are usually business owners who have long-standing
relationships with government agencies, suppliers, and customers, which then become
part of the joint venture network. This relationship helps the foreign company succeed
where going on its own would have posed problems, as it would have to establish its
own network and build relationships from the bottom up.
Acquiring Knowledge of the Market. One of the reasons foreign owned companies
fail in overseas markets has been attributed to their lack of knowledge of local mar-
ket conditions and difficulties posed by the cultural differences. By taking on a lo-
cal partner, the foreign company is able to instantly acquire knowledge of the local
market and existing cultural nuances, and it becomes easier for the foreign company
to develop strategies that succeed.
Gaining Experience. International companies that look for growth in foreign countries
learn from each experience they have with a new market. By joining a local joint
venture partner, the international company gains experience with minimal risk as its
local partner can help it to navigate through difficult situations. Each joint venture
experience makes the next one that much easier. For example, GE was always reluctant
to undertake joint venture agreements; it was driven by having control of its opera-
tions, and in joint ventures companies need to cede at least some of the control. But
once GE entered into a joint venture arrangement with a French company, it found it
to be a very easy form of entry, and since then it has entered into many joint venture
partnerships.
Disadvantages of Joint Ventures
One of the disadvantages of joint ventures is the lack of control over the overall busi-
ness operation. For successful international companies, this is a major issue: at times
they cannot implement their proven and successful strategies because of interference
by the local partner. Equally troublesome for international companies is the loss of
control over their technology. There have been incidents in which local partners have
pirated foreign technology and then competed against their previous joint venture
partners not only in local markets but also in other overseas markets. Even with a local
partner, joint ventures are high-cost, high-risk investments, because the expectations
of the foreign company are very high and the results of the joint venture might not
meet those expectations. Joint ventures are not easy to manage due to differences in
philosophies, cultures, business practices, and prevailing goals.
WHOLLY OWNED SUBSIDIARIES

The most complex and high-risk form of direct investment occurs when a foreign
company owns a local subsidiary outright. It can accomplish this by acquiring a lo-
cal company, or it can build from the bottom up by buying or leasing land, building
a plant, and embarking on business operations in the host country; this is referred
to as a “greenfield investment.” There are definite advantages to acquiring a local
168 CHApTER 6
company, including the shorter time required to set up such an operation compared
to starting from scratch. Additionally, there are difficulties in transferring resources
to a foreign operation, especially when the local conditions are drastically different
from those in the home country.14
Wholly owned subsidiaries assume that the international company is ready to fully
explore the foreign market and reach the full potential the market offers. Through
wholly owned subsidiaries, an international company takes full control of all its
operations, including marketing. Control is very important for some companies,
particularly those that have managerial or technical expertise. Sharing this expertise—
as a firm would in a joint venture, for instance—might lead to piracy and reverse
competition. Having a wholly owned subsidiary is a high-investment venture, but if
successful it can be an added benefit in a global expansion strategy. When companies
invest in a wholly owned subsidiary, they also lessen the probability of developing
local competitors. In essence, this approach, which is referred to as appropriability
theory, denies competitors access to resources.15 Wholly owned subsidiaries are not
the normal mode of expansion for small companies, since the investments and risks
are so high. Besides tapping into the full potential of the new market, wholly owned
subsidiaries offer larger companies the protection of their technologies, an important
factor for high-tech companies specializing in electronics, chemicals, pharmaceuticals,
and telecommunications.16
Wholly owned subsidiaries are a gamble because of the high investments in-
volved and the risk of entering into an unknown market. Lack of knowledge about
local conditions, difficulties in building supplier networks, cultural differences, and
host-country regulations that mostly favor local companies make full ownership of a
foreign subsidiary challenging. The type of subsidiary ownership a foreign company
chooses is also to some extent the outcome of the host-country market and regulatory
environment. For example, most foreign companies that invest in the United States
do so in the form of greenfield investments. Hence, companies such as Canon, Nestlé,
Olympus, Siemens, Toyota, and Unilever operate as wholly owned subsidiaries of
their parent companies. However, investments in developing countries and some of the
emerging markets take the form of joint ventures or other type of ownership, including
licensing/franchising and exporting. As mentioned earlier, developing countries prefer
joint ventures because they assist local companies in gaining managerial expertise and
technical knowledge while providing employment. For example, most foreign opera-
tions in China are in the form of joint ventures. Wholly owned subsidiaries also take
time to implement, whereas a joint venture can be up and running fairly quickly.
COMpARiSON Of THE VARiOUS MODES Of ENTRY STRATEGiES

When ranking various entry strategies by ease or difficulty, it appears that an export
entry is the easiest to implement, but the exporter does not have control of the opera-
tions and is not able to develop the full potential of the local market offers. On the
other hand, a wholly owned subsidiary offers full control and the foreign company is
able to exploit the market’s full potential, but this mode of entry is risky and takes time
to implement. The other two modes of entry, joint ventures and licensing/franchising,
Table 6.1
Comparison of Various Entry Strategies
Licensing/ Joint Wholly Owned

Factors Exporting Franchising Ventures Subsidiaries
1 Ease of entry High Medium Medium/high High
2 Speed to market High Medium Medium/high Low
3 Regulatory constraints Medium Low Medium High
4 Market penetration Low Medium Medium/high High
5 Access to customer feedback Low Low Medium High
6 Control of operations Low Low Medium High
7 Management commitment Low Low Medium High
8 Cost, tariffs, fees Med. Medium Low Low
9 Capital needs Low None Medium High
10 Profit potential Medium Low Medium High
11 Financial risks Low Low Medium High
12 Technology risks Medium High Medium Low
13 Economies of scale High Low Medium Medium
14 Nationalization risk Low Low Medium High
do not offer control of the operations but are easy to implement. Table 6.1 presents a
comparison of the ease and difficulties involved in the various entry strategies.
CHApTER SUMMARY
In entering foreign markets, international companies have four distinct entry modes
available: exporting, licensing/franchising, joint ventures, and wholly owned sub-
sidiaries. Of the four modes of entry, exporting is the easiest to implement. It also
has the advantage of low investment and allows international companies to gain
knowledge and experience in international markets. However, exporting does not
allow the company to exploit the full potential of the market, and the loss of control
of operations and marketing could pose problems in the future.
Licensing/franchising is another low-investment entry mode that some companies
pursue. Like other foreign market strategies, licensing/franchising has its share of
problems, including the fact that it does not allow the international company to ex-
ploit the full potential of the market, and it can result in loss of control—especially
in the area of intellectual property rights, which might lead to piracy and related
problems.
The joint venture is the entry mode most commonly used by international compa-
nies, as it provides sufficient control and allows the international company to fully
exploit the market. It is also the entry mode preferred by developing countries. In
addition, the local partner complements the expertise of the foreign company with
its superior knowledge of local market conditions and also can help the joint venture
partnership through its relationship with the local supplier network.
Wholly owned subsidiaries provide the maximum control of foreign operations
with the potential to fully exploit the local market. At the same time, this entry mode
requires the highest investment and carries with it high risks.
170 CHApTER 6
KEY CONCEpTS
Export Process
Export Strategy
Licensing/Franchising
Joint Ventures
Wholly Owned Subsidiary
1. Identify the four entry modes used by international companies in entering
new markets.
2. When and why would you use export as an entry mode?
3. What are some of the disadvantages of exporting?
4. Identify the various collaborative strategies used by international companies
in entering foreign markets.
5. Discuss the advantages and disadvantages of licensing/franchising agree-
ments.
6. Why and when do international companies use joint ventures?
7. What is the biggest advantage of using greenfield investments in international
business?
8. Compare the four entry modes. Does any single one appear to have an ad-
vantage over the others?
AppLiCATiON CASE: GENERAL ELECTRiC

General Electric (GE) is a diversified global company with its headquarters in Fairfield,
Connecticut. In 2006, GE’s worldwide net earnings were $21 billion on revenues of
$163 billion. GE has been at the forefront of both industrial and consumer goods and
services. Under its legendary CEO Jack Welch, the company was known for its com-
mitment to excellence and its market dominance in all the various business areas in
which it was involved. With Welch at the helm, GE would withdraw from a market
if it did not hold either the number one or number two position in terms of market
share. Yet another of GE’s strict philosophies was: “If you don’t have full control,
don’t do the deal.” This meant that GE’s mode of entry into a new country was either
as an exporter or as full owner of a subsidiary.
For years, GE would enter a new market by buying up a small company and tak-
ing it to the top through its proven strategic initiatives and management approach.
Internally, the process of taking small operations into market leaders was referred
to as “GE-izing.” Lately, GE’s approach to entering foreign markets has become
difficult because of shifting market conditions, including the growth of large local
competitors. During the 1980s and 1990s, GE would enter a new country with a bag
full of money and buy up whatever it wanted. But these days, if there are opportuni-
ties to gobble up small companies, it is being done by private equity funds with even
greater money power. According to GE’s current CEO, Jeffrey Immelt, the days
when it could buy whatever it wanted are pretty much over. It seems that it is better
for GE to partner with a number three company that wants to be number one. In the
past, GE had a few joint ventures—for example, its 50/50 partnership with Snecma,
the French manufacturer of aircraft engines—but these ventures came about after
GE had explored other ways to gain access to a particular market technology. In the
case of the Snecma joint venture, GE could not have bid for Airbus engine contracts
without the help of the French government.
In a shifting marketplace and with globalization forcing companies to be nimble
and have shorter reaction time, GE is slowly rethinking its philosophy of “control”
over its operations. For GE, the global market is an increasingly important factor
in driving its growth strategy. Much of its growth in the past few years has come
from its overseas operations. More important, the growth markets are the emerging
countries of Asia, including China. GE has very little market presence in China or
in other Asian countries. In many of these countries, the legal and cultural landscape
is a difficult to understand, making it better for an international company to have a
local partner who is familiar with the local market conditions. Therefore, when an
opportunity arose for GE to set up a retail lending arm in South Korea with Hyundai
Capital, it explored the feasibility of being a minority joint venture partner, with a
43 percent stake in the new venture. Hyundai Capital offers credit cards, auto loans,
and mortgages. Each of these services requires a thorough understanding of local
consumer behavior, cultural nuances of lending, and the financial legal systems. GE
could not have embarked into this environment alone and been successful.
QUESTIONS
1. Analyze GE’s entry strategy philosophies of the 1980s and 1990s in compari-
son with their philosophies of today.
SOURcE
This case was developed from articles in International Herald Tribune and Wall Street Journal.
7 Functional Integration
Businesses are organized around functions, but their activities need to be coordinated in
order to efficiently employ the resources of an international company.
LEARNiNG ObJECTiVES
• To understand the importance of functional integration
• To identify the critical factors in the integration of the various functions of an
international company
• To understand the procedures used in integrating functional areas
• To understand the complexities of integrating functions in an international
organization
Businesses are organized around functions as a way to benefit from specialization of

activities. Most medium-sized and large international companies are organized into
eight functional areas: accounting, administration and legal, finance, human resources
management (HRM), management information systems/information technology
(MIS/IT), marketing, production and operations management (POM), and research
and development (R&D). The strategic decisions a company develops center on these
functions. Hence, we have human resources strategy, marketing strategy, and so on.
The critical question for managers is, how will an international company manage
these diverse functions in developing the most effective strategies and maximizing
the available resources? International companies view development of their strategies
as a collective effort, even though the company develops strategies specific to each
function. In other words, strategies for a function such as marketing are developed in
conjunction with and through the coordination of activities in the areas of production,
finance, R&D, and so on. Coordination is the critical process in linking and integrat-
ing an international company’s various functions and activities. Figure 7.1 presents
how the functions are linked to one another.
Due to the growing emphasis on customer satisfaction and customer relations, com-
panies have been forced to rethink their organizational emphasis away from individual
functions and toward more interdependent customer groupings. Research has shown
that interdisciplinary thinking and a cross-functional approach to streamline process and
delivery strategies improve overall coordination of functions.1 Some researchers suggest
that companies need to organize to make full use of the synergies between individual
172
FUNcTIONAL INTEGRATION 173
Figure 7.1 Functional Linkages
Production
R&D and Accounting
Operations
International
Marketing Corporate Finance
Strategy
Administration Human
MIS
and Legal Resources
functions to provide the necessary focus on customers.2 For example, Intel Corp., under
CEO Paul Otellini since 2005, reorganized to bring together its engineering, software-
writing, and marketing functions to offer a much more coordinated group that can service
its customers more effectively.3 The interdependent and well-coordinated functional
linkages that many companies are introducing are turning out to be an effective way to
gain an advantage in a highly competitive global environment by creating capabilities
that are strengthened through synergies.4 It seems synergy through integration is the
catchphrase for attaining organizational effectiveness.5
In fact, academic research has shown that there are some functions that are natu-
rally linked to one another. Functions such as R&D, manufacturing, and marketing
seem to flow logically from one to the other. Studies have shown that superior busi-
ness performance can be achieved through integrative approaches.6 That is, the in-
novations created by R&D are implemented in the manufacturing process and in the
development of new products, and these are then sold by the marketing department
to potential customers. Hence, the integration of these functions is necessary for the
production and successful marketing of goods and services.7 Similarly, marketing
and information systems go hand in hand, and their activities should be integrated.
Marketing strategies across countries and functions can be made more effective by
sharing these strategies through information systems and avoiding duplication.8
174 CHApTER 7
Global integration of functions within an organization is essential in managing the

multifaceted activities of international companies that are spread over many regions.
Through coordination and control of business operations, international companies can
integrate corporate functions more smoothly.9 International functional coordination
results in linkages among geographically dispersed units and their varied functions.
Because international business is an interdisciplinary area, a thorough understanding
of the independence of each function is required, along with the ability to recognize
the interdependence of the various functions; that is, each function is only effective
when combined with other functions. For example, international operations deal
with the generation of goods and services for consumption by users. But to produce
goods and services, the operations side of the business has to have the right personnel
(HRM), and depends on the finance group for the necessary funds, the accounting
department for control of the operations, the R&D department for technologically
superior materials and innovative products, and the marketing department to use its
resources for selling the goods and services.
Individually, each function undertakes specific and unique activities that benefit
from specialization. For example, assembly workers in a manufacturing plant that
produces automobiles are more efficient in that function than at evaluating an invest-
ment opportunity. Evaluating investment opportunities is best left to the people in the
finance department. Specialization results in more efficient use of resources within
a functional jurisdiction. In-depth knowledge of a function and repeated use of the
knowledge allows personnel within a function to be more productive; this is known
as the learning-curve effect.
Following is a summary of activities that fall under each of the eight functions.
(A detailed treatment of six of the critical functions is presented in Chapters 8
through 13).
PRODUCTiON AND OpERATiONS MANAGEMENT

The following activities are associated with production and operations management.
(See Chapter 8 for a more complete discussion of this topic.)
SOURcING
Sourcing is part of supply-chain management. International and domestic companies
search globally for sources of raw materials and components to take advantage of lower
prices and better designs: in some instances, a few countries serve as the exclusive
sources for some raw materials. For example, Brazil is the largest producer of coffee
beans and South Africa is the largest producer of diamonds. Hence, these countries
offer the best opportunities to obtain coffee beans and diamonds, respectively.
SETTING Up MANUFAcTURING FAcILITIES

International companies set up manufacturing facilities in many parts of the world to
be closer to their markets. For example, Siemens of Germany has many manufacturing
facilities in Europe (Denmark, Germany, and the Netherlands), Asia (Singapore), and
the Americas (the United States). These different facilities produce different products,
depending on the particular demand for a product, the available level of technology,
the labor force’s skills, and investment requirements. Therefore, an international
company operating in multiple countries might have a highly sophisticated and tech-
nologically advanced manufacturing plant in one country and a labor-intensive and
low-technology manufacturing facility in another country. Michelin, the French tire
maker, has quite a few manufacturing plants in Europe, including those in France,
Germany, and Italy, that are fully automated and employ very few assembly work-
ers, but its plants in Asia, including one in India, are labor intensive and tend to have
low-technology assembly lines.
LAYOUT
Modern manufacturing facilities and service centers to handle customer transactions are
built around efficiency and maximization of available space. This involves bringing people,
machines, and space together. The layout helps companies manage the flow of material,
people, and machines in the most efficient way in producing goods and services.
DESIGN AND TEcHNOLOGY ISSUES

Design of goods to some extent influences the amount and types of materials and
other inputs that are required to produce a product. For example, in the 1980s many
automobile manufacturers began using plastic components instead of metal in the
assembly of cars to reduce the weight of the car and achieve higher gas mileage.
This shift from metal to plastics was made possible through design changes and the
development of stronger plastics and epoxies for attaching the plastics. Also, when
international companies implement standardization strategies across countries, they
rely on universally accepted designs to accomplish this cost-saving strategy. In de-
signing the overhead luggage bins in its latest versions of planes, for instance, Boe-
ing placed the door openings at the bottoms of the luggage bins instead of the top to
accommodate height differences between passengers from different countries (many
of the European passengers being taller than some of their Asian counterparts).
QUALITY CONTROL
Good quality is essential for the success of a company’s products and services. Qual-
ity control is the management of the quality of finished goods and services. Quality
is relative, though, and standards vary from country to country. In an industrialized
country, where multiple brands of goods and services are available and where the
competition is intense, companies might have to offer very high-quality products.
In countries with limited offerings, where consumers do not have many choices, the
quality of the products offered might not meet the standards of industrialized coun-
tries. For example, the cars in Germany are of much higher quality than the ones
available in Bolivia.
176 CHApTER 7
INVENTORY MANAGEMENT
Inventory management encompasses the activities involved in developing and manag-
ing the inventory levels of all materials, components, and finished goods to maintain
an adequate supply of these items to ensure availability. With an efficiently designed
inventory control system, international companies can save on costs and ensure timely
supply of materials and finished goods in the marketplace.
FiNANCE
The following activities are associated with the finance function. (See Chapter 13 for
a more complete discussion of this topic.)
FINANcING
Financing is the acquisition or sourcing of funds for use by an international company for
operations and investment. Most international companies have a variety of sources for
raising capital, both internal (within the company) and external (from outside sources).
Internally, companies raise funds from retained earnings and through dividend policy,
intracompany borrowings (especially from subsidiaries), and the management of accounts
receivables and payables (lead/lag effect). External sources consist of equity, loans, bonds
(including Eurobonds), and government grants, including incentives and subsidies.
INVESTMENTS
Investments are decisions a company makes on how its available funds should be al-
located. Investment decisions are influenced by many factors, including the company’s
investment policies, the types of projects selected for investment (for example, should
the company invest in a manufacturing plant in China or a joint venture arrangement
in Vietnam?), and the returns on each investment. Investment decisions are governed
by the fact that each company has limited resources and, hence, needs to utilize the
funds judiciously. Most investment decisions are made by evaluating the projects
using one of the more accepted assessment techniques, such as net present value
(NPV), internal rate of return (IRR), or adjusted present value.
WORKING CApITAL MANAGEMENT

Working capital management is the selection of the best possible mix of cash, mar-
ketable securities, accounts receivables, and inventory (current assets) that can be
used to maximize the value of the firm. For international companies, there are the
additional considerations of exchange controls, currency fluctuations, and countries’
differential tax rates. The objectives in working capital management are to manage
the company’s cash resources efficiently and to achieve maximum conservation and
utilization of the available funds.
DESIRED CApITAL STRUcTURE

A company’s desired capital structure is important in deciding how the firm’s total
sources of funds should be divided between equity and debt. Furthermore, for loans,
management must determine how much of the debt should be divided between long-
term and short-term financing. A company’s responses to these issues determine the
amount of financial leverage the company is employing. The capital structure of firms
varies from industry to industry and from firm to firm.
MANAGING FOREIGN EXcHANGE RISKS

By definition, international companies operate in more than one country. Hence,
they transact business in multiple currencies and are frequently exposed to the risks
associated with fluctuations in currency exchange rates, that is, the amount of gains
or losses attributed to currency fluctuations. International companies are exposed
to a variety of risks, including transaction risk (the effect of exchange rate change
on foreign-currency-denominated transactions) and translation exposure (change
in the value of a firm’s foreign-currency-denominated accounts due to changes in
exchange rates).
DEBT POLIcIES
Each international company has its own set of guidelines on how much debt it is will-
ing to service during the life of a project. Some are willing to finance their operations
from debt, and others consider this too risky. Some companies’ tolerance for debt
capacity, that is, the amount of debt-type securities a firm can service, is relatively
higher than that of other companies.
MARKETiNG
The following activities are associated with the marketing function. (See Chapter 11
for a more complete discussion of this topic.)
SELEcTING TARGET MARKETS

A target market consists of potential buyers of a company’s goods and services.
In selecting a target market, international companies distinguish the market by
important consumer variables such as demographics, buyer behavior, and the like,
and then decide to sell to one or more of these groups, called the target markets.
In marketing a particular product, an international company may target the same
group (also called segment) in every country in which it operates, or it may target
a different market from country to country. For example, in selling its shampoo
products, Unilever may target a segment made up of middle-class consumers in
Europe and the United States, but may target just the upper-middle-class group
in Indonesia.
178 CHApTER 7
UNDERSTANDING CONSUMERS’ NEEDS

People need basic items such as food, clothing, and shelter to survive. In addition,
people need products and services to look good, to be entertained, to participate in
leisure activities, and so on. Different groups of consumers satisfy these needs through
different products. For example, to satisfy hunger, some consumers may go to a grocery
store and buy ingredients to cook a meal at home, some may buy a pizza from a pizza
parlor, and still others may eat at a fancy restaurant and spend a considerable amount
of money to satisfy their basic need. Each of these situations provides opportunities
for marketers to sell goods and services to various target markets by country.
INTERNATIONAL MARKET RESEARcH

International market research is a systematic technique to collect and analyze infor-
mation from different countries. This information is used by international marketing
managers to make strategic decisions. The necessary information may be gathered
from internal sources or external sources, or it may be obtained through research
vendors who provide specific information on particular problems or issues a com-
pany faces.
DEVELOpING PRODUcTS AND SERVIcES

After selecting the target market and identifying the needs of its customer base, inter-
national companies have to place their products and services in the chosen market. For
global companies, it is often a question of determining which of their product items
are best suited for the various international markets. If possible, companies would like
to sell the same product or service that is sold in their domestic market without any
modifications (otherwise known as standardization). For example, Gillette’s Mach 3
Turbo shaver has the same features and packaging in United Kingdom that it has in
the United States. In some instances, due to differences in taste, purchasing power, or
regulations, international companies are forced to modify their products when they
enter new markets. McDonald’s sells veggie burgers in India instead of beef burgers,
as eating beef is taboo according to Hindu religion.
SETTING PRIcES
Setting prices is a critical activity for international marketers. On the one hand, price
produces revenue for the company, and as such, it puts pressure on the marketers
to produce as much revenue as possible. On the other hand, for customers, cost is a
major factor in the decision to purchase goods—they like to pay as little as possible
for a given product. Marketers have to find a fine balance between these two aspects
of pricing. Most companies set their prices based on cost, demand for the product,
and the unique competitive advantage that a particular brand might have in the mar-
ketplace. Price is a flexible marketing element that can be changed very quickly, is
often copied equally quickly, and is used for comparison purposes by customers.
SELEcTING CHANNELS OF DISTRIBUTION

Marketers use channels, or marketing intermediaries, to get their products from the
manufacturing facilities to the customers. This is the downstream part of the sup-
ply chain. Even though some international companies such as Dell Computers and
Avon Cosmetics use direct channels rather than intermediaries, most companies do
not sell directly to the consumer. Channels allow marketers to focus their attention
on their core competencies and not be diverted into activities that may be handled
more efficiently by another source. The main purpose of channels is to facilitate the
movement of goods and services from their source to the place where there are cus-
tomers who want them. Channel membership (the number of intermediaries) varies
from country to country, and international marketers select channels that best suit
their requirements
PLANNING COMMUNIcATION STRATEGIES

To succeed, marketers must not only produce quality products but also must let the
target customers know about them. Passing on the necessary information to custom-
ers to generate sales is achieved through a comprehensive communication program.
In communicating with their customers, international companies need to decide on
a specific target group, have a clear message, and make sure that the target group
understands that message. International companies make use of different media to
reach their customers, including television, print media, the Internet, and so on. One
of the most important issues for international marketers to consider is the cultural and
legal barriers that restrict their message content or selection of a medium.
REcOGNIZING THE IMpORTANcE OF CUSTOMER RELATIONS

Most companies realize that acquisition of new customers is a costly activity, so
companies make every attempt to retain as many of their existing customers as pos-
sible. Customer relations management (CRM) attempts to streamline the process
of customer acquisition and retention through a systematic approach. The focus of
CRM is to manage the relationship between a company and its customers through
proactive initiatives such as understanding individual customer needs, understanding
customers’ likes and dislikes, gathering as much information on each customer as
possible, responding to customers’ concerns in a timely manner, and generally being
a concerned partner rather than viewing customers as adversaries. The emergence
of computerized databases and sophisticated communication systems has helped
international companies manage this activity much more easily.
EVALUATING MARKETS AND OBTAINING FEEDBAcK

Customer feedback enables companies to identify weaknesses in their marketing
strategies and provides the necessary information to modify these strategies. Cus-
tomer feedback should be continuously collected to improve the product/service and
180 CHApTER 7
a company’s marketing program. Through scanner data, information from syndicated

service companies such as Nielsen, and customer surveys, international companies
are able to obtain extremely valuable feedback.
HUMAN RESOURCES
The following activities are associated with the human resources function. (See
Chapter 12 for a more complete discussion of this topic.)
REcOGNIZING THAT HUMAN RESOURcE MANAGEMENT IS PEOpLE DRIVEN

Human resources management (HRM) recognizes people as an organization’s key
resources.10 Managers, staff, and technicians run the operations of a company. Hence,
utilizing this resource efficiently is critical to an international company’s success.
Japanese companies, with their people-driven philosophy and lifelong employment
policy, have achieved phenomenal success in international markets. For many Ameri-
can companies, the ethnocentric and parochial human resource systems and policies
that they inherited, which focused on the parent company and were projected onto the
rest of the world, are found to be a barrier to the implementation of effective global
organizational processes.11
KNOWING THE EXISTING SKILLS AND TRAINING OF COMpANY PERSONNEL

To develop an effective human resources management program, a company has to
identify the existing skills, qualifications, experience, and potential of its employees
by conducting a sort of audit or inventory. This is especially true for international
companies because of their widespread operations and the cultural diversity of their
employees. By recognizing its internal capabilities, a company can develop a more
realistic HRM plan for its operations.
HUMAN RESOURcES PLANNING

Human resource planning is a systematic way to project the HRM needs of an inter-
national company throughout its operations. It outlines the specific jobs to be filled by
location; the necessary qualifications and experience of each employee; where various
employees should come from (that is, the home country, the host country, or a third
country); and the optimal mix of these employees. By planning ahead, international
companies are able to fill present vacancies and hire for future needs.
REcRUITING AND SELEcTION

Recruiting and selection encompass the process of finding the most suitable person for
a specific job. Companies have to identify, screen, and select candidates from a pool
of possible recruits. For international companies, sources of recruits include internal
candidates, candidates from competitors in the home country, internal candidates from
the company’s regional or subsidiary offices, candidates from host-country competi-

tors, and other host-country nationals. Through various screening devices, interviews,
and tests, companies try to select the best possible candidate for each job opening.
COMpENSATION
Compensation packages are set to attract the most qualified personnel. Most interna-
tional companies compensate their employees based on the prevailing compensation
packages in their industries. International companies operating in developing countries
tend to pay higher salaries and benefits than most local companies do. For international
companies, this premium package leads to hiring the most qualified individuals in a
given country. Furthermore, most locals prefer to work for international companies
rather than local companies due to the higher compensation package and the prestige
associated with working for an international company.
TRAINING AND DEVELOpMENT

International companies provide their employees with training in an effort to help
the employees complete their assigned tasks effectively. These programs may be di-
rected at enhancing specific job-related skills, such as training in a particular software
package, or may be more general in nature, such as providing cultural orientation
to an employee assigned to a foreign country. The purpose of all training programs
is twofold: (1) to improve the productivity of an employee, and (2) to prepare an
employee for new assignments.
PERFORMANcE REVIEW
Performance reviews are meant to provide feedback to employees about how they are
performing their assigned tasks. These performance reviews can be used for award-
ing bonuses, identifying employees who may be ready for greater responsibilities, or
identifying areas where an employee needs additional training. Performance reviews
need to be objective and fair. Many sophisticated instruments have been developed
to conduct performance reviews.
EXpATRIATE ISSUES
A unique HRM issue faced by international businesses is the hiring of personnel who
are not citizens of the host country. These staff could be from the home country or
from a country other than the host country (a third country). Personnel who are not
citizens of the host country are referred to as expatriates (“expats,” for short). Expa-
triates normally hold senior-level positions or are part of the technical staff. Though
expensive to maintain, expatriates offer some distinctive benefits to the international
company: they provide a link to the home office, they serve as managers who may be
considered for future promotions, and they may act as a protection against pirating
of intellectual property rights.
182 CHApTER 7
LABOR RELATIONS
Labor relations are the various activities that encompass labor-management in-
teractions. Labor relations are governed by laws, economic conditions, the level
of unionization in the country, accepted business practices, cultural values, and
societal norms. For international companies, maintaining normal working rela-
tions with the labor force is critical. Compared to local companies, international
companies are more vulnerable to poor labor relations and may become the target
of negative publicity. Unionization of labor varies from country to country. In
some countries such as the United States, only a small portion of the workforce
is unionized, whereas in other countries such as Germany, most factory work-
ers are unionized. International companies must learn to operate under different
unionization systems.
ACCOUNTiNG
The following activities are associated with the accounting function. (See Chapter
14 for a more complete discussion of this topic.)
AcTING AS A STRATEGIc CONTROL MEcHANISM

Accounting systems are used to identify a company’s economic status and to pro-
vide reasonable judgments of a company’s financial health to investors, government
agencies, and the public. Through its role as an internal watchdog, the accounting
department provides the necessary checks and balances to company executives as
they develop strategic initiatives. Through accounting reports, managers are con-
stantly reminded of the available funds, cost overruns, and inefficiencies in project
management.
DEVELOpING REpORTS
One of the more visible tasks of accounting is generating reports, such as the balance
sheet, income statements, budgets, cash-flow statements, and so on to assist interna-
tional managers in managing their day-today operations. These reports also provide
information to the public on the performance and health of the company.
TAX MANAGEMENT
Taxes affect a company’s cash flow and profitability. Each country’s tax laws and
corporate tax rates are different. It is critical that the international tax specialist in an
international company understands the home country’s tax policy on foreign opera-
tions as well as the tax policies of all the countries in which the company is operating.
Tax management impacts an international company’s decisions on where to invest,
as well as the mode of entry it should employ (exports, licensing/franchising, joint
ventures, or a wholly owned subsidiary).
AccOUNTING FOR TRANSAcTIONS THAT ARE DENOMINATED IN FOREIGN

CURRENcIES
Financial reports such as income statements and balance sheets for international
companies are consolidated reports that combine all the activities of the company
across all countries. As a result, one of the tasks of the accounting department in an
international company is to translate financial reports from foreign currency to home-
country currency. Depending on the home country, international companies have to
follow the rules of their home countries while consolidating all the reports into one
currency. For example, for U.S-based international companies, Financial Accounting
Standards Board (FASB) statement 52 describes how international companies must
translate their foreign-currency financial statements into U.S. dollars.
ASSIMILATING AND WORKING THROUGH DIFFERENT AccOUNTING STANDARDS AND

GOVERNING BODIES FOUND IN VARIOUS PARTS OF THE WORLD
Accounting standards differ from country to country, and so do the governing bod-
ies that maintain these standards. For example, in the United States, the standards
are influenced by business practices and the monitoring agencies are industry based.
In contrast, in France, Germany, and Japan, the standards are based on laws and the
governing agencies tend to be government sponsored.
MANAGEMENT INfORMATiON SYSTEMS

Management information systems (MIS) are a critical component in coordinating the
activities of the various functions in an international company. In a knowledge-based,
information-driven global economy, it is vital that international companies develop
a comprehensive system to manage the flow of information that is continuously be-
ing assembled. A well-organized information system is an assembly of components
that is designed to collect, retrieve, process, store, and disseminate information to
the various functional departments of an organization. Such an organized system
provides the necessary information to decision makers and also assists the interna-
tional company in coordinating its various activities. Recognizing the importance of
information flows to the modern global economies, many international companies
are utilizing the advances in information technology to create more interdependent
functional organizations.12 The various components of an MIS include computers
that are able to process/analyze and disseminate information; telecommunications
systems that are used for collecting, distributing, and retrieving information; statisti-
cal packages that are used to analyze data; databases that are used to store the vast
information that is generated by these systems; and software packages that are used
for processing information and connecting the system to the various functional areas
of an international company.
Because the operations of an international company are spread out in different
countries and through different time zones, MIS acts as the linchpin through direct
communication links with the various subsidiaries and their operations on a 24/7
184 CHApTER 7
basis. These links often provide real-time information and are usually interactive so
that everyone can respond easily to the dynamic changes in the environment and di-
rectives from upper management. The various activities of an MIS department focus
on information, processing, and dissemination/distribution.
INFORMATION
The starting point of MIS is information. Various data and information that are gener-
ated during a company’s normal business activities need to be collected, organized,
and stored for future use. These data or information may include cost data, sales data,
employee salaries, the various transactions a company might engage in, and so on. In
addition, an international company might gather external information from its suppliers,
information about its competitors, and information about the external environment.
PROcESSING
The raw data or information that is collected in the previous step needs to be con-
verted into useful information. MIS achieves this by sorting the data/information into
categories, subjecting it to statistical or other forms of analysis, reconfiguring the
data/information, and then storing it in subsystems that can be retrieved for decision
making or other useful purposes. For example, the raw cost data that is collected by
the accounting department may be sorted into subcategories that can then be analyzed
to form a line item in the income statement, such as cost of goods sold or marketing
expenditures.
DISSEMINATION/DISTRIBUTION
Once the information has been collected, analyzed, and processed, it must be dis-
tributed to persons and or departments that can use the reconfigured data for some
action. Through computer technology and modern telecommunications systems, MIS
is able to provide managers with interactive access to real-time information. This is a
tremendous help in a fast-paced, dynamic global environment. For example, companies
have found that they are able to satisfy their customers’ needs and achieve a higher
rate of customer retention through the development of customer-centric information
systems.13 Similarly, manufacturing companies have found that they can reduce their
costs and improve quality through greater application of information technology in
their outsourcing strategy.14
RESEARCH AND DEVELOpMENT (R&D)

For many international companies, the road to success is through innovation. Whether
this innovation is in product development, process engineering, or operational innova-
tion, they all tend to provide companies with significant competitive advantages. Most
innovations are a result of R&D efforts by individual companies or the collective efforts
of government, industry, and academia. Understanding the importance of R&D for the
economic development of a country and its resulting effects on worker productivity, many
governments initiate and also encourage R&D efforts by industries. By far, the United
States allocates the largest amount of funds for R&D. For the year 2007, U.S. spending
(both public and private sector spending) on R&D reached $350 billion, and it is projected
to rise to $365 billion.15 Historically, Japan was the second leading country in terms of
overall R&D spending, but in recent years, China has overtaken Japan in R&D spend-
ing, reflecting its resurgent dominance in the global economy. For the year 2007, China’s
spending on R&D was in the range of $217 billion, while Japan spent $151 billion.
Based on industry statistics, it appears that U.S. pharmaceutical industries spend
about 15 percent of their revenues on R&D, followed by technology industries
(computers, telecommunications, and the like), which spend about 7 percent of their
revenues on R&D, and industrial companies (appliances, automobiles, and so on),
which spend about 3.5 percent of their revenues on R&D.16 In the United States,
the semiconductor industry alone spent more than $30 billion on R&D for the year
2005.17
Among the global companies, GE and Toyota are recognized as leaders in innova-
tion, especially in the areas of product and process innovation. The GE global research
division has been the cornerstone of GE technology for more than 100 years. With
more than 2,500 of the world’s brightest researchers spread out in multidisciplinary
facilities around the world, GE has maintained its competitive edge in aircraft engine
technology, turbine technology, and medical devices. Similarly, Toyota has outpaced
most of its competitors through its focus on manufacturing engineering and new
product development. Through its R&D efforts, Toyota has achieved significant ef-
ficiencies in manufacturing and quality control.18 In 2005, Toyota’s R&D spending
was in excess of $7 billion, or 4 percent of its total revenues. Corolla and Camry are
the best-selling automobiles in their class, and by the end of 2008 Toyota is slated
to be the number one automobile manufacturer in the world in terms of total vehicle
production.
The research and development efforts of a country are to some extent influenced
by the types of industries that are dominant in the country, the size of the domestic
market, the government’s philosophy on R&D, and a country’s tax policies. Those
countries that have industries concentrated in chemicals, computers, high-technology
firms, and pharmaceuticals have a distinct advantage in overall R&D spending com-
pared to countries that are agricultural and have only light-manufacturing industries.
Therefore, China, Japan, the United States, and countries in Europe that have more
of the technology-driven industries and also have a large domestic market to sustain
R&D expenditures tend to lead the way in R&D spending. The governments of these
countries spend on R&D to stimulate the economy and improve labor productivity.
They also stimulate R&D expenditures within the private sector through their liberal
tax policies on R&D spending.
CHApTER SUMMARY
As explained in this chapter, an international company is comprised of many func-
tional areas. Each division is a standalone unit but it cannot be effective unless it is
186 CHApTER 7
paired with other functional areas to produce and sell goods and services. In order
for an international company to be efficient and successful, all the various functions
and their activities need to be organized, coordinated, and integrated.
International companies must ask the question, What is the critical factor of each
function that makes that function efficient? For example, it could be shown that for
R&D to be effective, the two most critical factors are people and information. Like-
wise, manufacturing is dependent on people and information. Therefore, companies
can benefit from the integration of manufacturing and R&D. By integrating the
modes of each function, management can achieve the synergistic effects of functional
integration.19
Functional integration is not necessarily implemented in all areas of a business
at the same time. In some cases, it may be necessary to integrate just a few of the
functions to achieve efficiency. For example, research has shown that functional in-
tegration has been very useful in logistics management. By integrating the activities
of logistics with supply-chain management, it is possible to improve efficiency and
reduce long-term distribution costs.20 In the financial services area, the challenge
is to find the optimal balance that will maximize cost reductions, boost sales, and
increase customer retention. Therefore, in financial services firms, it is essential that
the operations and marketing departments integrate their strategies to reduce costs
and retain loyal customers.
As more and more international companies try to improve functional integration to
cut costs, improve strategic effectiveness, and ensure success, they are reevaluating
their existing organizational structures with an eye toward smoothing coordination
among the functional areas of their organization. Some major international companies
such as IBM and Fidelity Investments have dismantled their product/service-driven
organizations to create customer-centered organizations in an attempt to be more re-
sponsive to customer needs; all of their functions are linked to this single goal. These
companies have achieved functional integration by making a key account manager
responsible for all the functional activities that lead to the development, sales, and
after-sales activities within the organization.21
Research has shown that international companies can achieve their corporate goals
by integrating administrative mechanisms within many of the company’s functional
divisions.22
KEY CONCEpTS
Functional Linkages
Functional Integration
Strategic Decisions
1. Why are international companies organized into functions?
2. List the key functions in an international company.
3. How are the various functions linked?
4. Why is functional integration and coordination important for companies to

be successful?
5. Which of the eight functions would be most essential for a small exporting
company?
AppLiCATiON CASE: BMW iN INDiA

BMW is one of the leading luxury automobile manufacturers in the world. Head-
quartered in Munich, Germany, the company was established in 1916. Its brands of
automobiles are recognized for their high quality and high performance. BMW’s
models include the MINI Cooper and the Rolls-Royce. Classified as luxury auto-
mobiles, they have extremely high brand recognition, and the firm as a whole has a
loyal customer base.
BMW automobiles are exported to many parts of the world. Starting in the 1970s,
the company embarked on a major expansion program in an effort to increase its in-
ternational market share of luxury automobiles by setting up manufacturing facilities
in selected countries. Its first plant outside of Germany opened in 1972 at Rosslyn
(near Pretoria), South Africa. Since then, BMW has set up 17 manufacturing plants
in six countries, including Austria, the United Kingdom, and the United States. The
U.S. manufacturing facility was established in 1994 and is located in Spartanburg,
South Carolina. In addition, as China’s economy grew and the Chinese government
encouraged foreign investment, BMW saw an untapped potential market there for
luxury cars. In 2003, BMW established a manufacturing plant in Shenyang, China,
to cater to the growing Chinese market.
The success of BMW in China led the company to explore other opportunities in
Asia, and India was selected as a new market. Like China, India was considered a
less-developed country for years, having never attained a large measure of economic
success. In 1991, however, the country reversed its previous policies of restrictive
foreign investment rules and opened up to foreign investors. Since then, India has
achieved high economic growth rates, averaging over 8 percent for the five-year
period from 2002 to 2006. The automobile market in India is growing at an annual
rate of 16 percent.
Typically, BMW conducts extensive research before it chooses a country for
investment. The selection is based on country risk factors, market potential, and a
feasibility study that projects costs, revenues, and potential profits. In proposing a
new operation in a foreign country, BMW involves most of its functional divisions
in coordinating the various activities so that it has a reasonable chance to succeed.
It is critical for BMW that the functional entities communicate with one another in
developing an overall strategy. After conducting a thorough analysis of the data,
BMW decided to set up an assembly plant in India to target the affluent group of
consumers who could afford a high-end luxury car. By 2004, India had 20 automobile
manufacturers, primarily foreign manufacturers with Indian joint venture partners.
Although some luxury automobiles were imported into India, Mercedes-Benz was
the only luxury manufacturer in India at that time. Mercedes sold approximately
2,000 cars annually.
188 CHApTER 7
Based on the feasibility study, BMW decided to construct an assembly plant in

Chennai, South India, with an initial capacity of 1,700 cars on a single shift (BMW’s
target was to sell 2,000 cars by 2008). With an initial investment of €20 million that
included the factory, machinery, and a subsidiary office in Delhi, BMW was ready
to sell luxury cars in India. In selecting Chennai, BMW considered the availability
of a skilled labor pool, the cost of operations, and the availability of suppliers. All
components to assemble the cars—except for seats and door panels—would be
imported from Germany. In 2007 in the Indian subsidiary, BMW sold 743 of the 3
Series models, 320 of the 5 Series models, and 251 of the 7 Series models, for a total
of 1,387 cars, far exceeding its first-year target of 1,000. Reflecting the demand for
its cars, BMW plans to streamline its production facilities at an additional cost of
500,000 euros and increase annual production in India to 3,000 cars.
QUESTIONS
1. Is BMW’s time-consuming integrative approach justified under the current global
competitive environment? Explain.
SOURcE
Most of the information for this case was obtained from press releases in newspapers, including the
Economic Times, the Telegraph, and the BMW Web site (http://www.BMW.com, accessed January
14, 2007).
International Production &
8 Operations Management and
Supply-Chain Management
One of the most critical business functions in organization is operations

management. It is responsible for transforming inputs into finished goods and
services. Supply-chain management is the coordinating of materials,
funds, and information to facilitate the transfer of materials and components from their
source to the marketplace in the form of finished goods and services.
LEARNiNG ObJECTiVES
• To understand the scope and strategic importance of international production
and operations management
• To understand the application of production and operations management to busi-
ness operations
• To understand the various decisions and their importance to the process of inter-
national production and operations management
• To recognize the significance of quality management and understand the tech-
niques used to manage quality
• To understand the importance of inventory control in the production and opera-
tions process
• To understand the role and importance of supply-chain management
Businesses produce goods and services that are marketed to potential consumers.
All other functions of an organization, such as marketing, finance, human resources,
accounting, research and development, and information technology, interface with
operations management to produce goods and services. With the availability of fast-
paced computers and advanced models of enterprise resource planning, international
companies can achieve high-level efficiencies in their production and operations
management (POM) systems.1 Operations management is not restricted to the manu-
facture of goods but also deals with the production of services. POM concepts are
equally applicable in the service sector and in manufacturing. Service industries such
as banking, insurance, health care, retail sales, and not-for-profit organizations also
make use of POM techniques. Take for example, a large hospital. In order to operate
efficiently, the hospital has to coordinate all the activities that need to be completed
189
190 CHApTER 8
to provide the best possible patient care. Most of the activities performed by the
medical director, doctors, nurses, hospital administrators, technicians, and other staff
fall within the field of operations management. These activities include scheduling
surgeries, assigning doctors and nurses, preparing the surgical wards, buying medi-
cine, equipment, and other supplies, managing the food service, supervising the staff,
taking care of the repairs and maintenance, and keeping the hospital clean. In order
for the hospital to run efficiently, its functions have to be coordinated and managed
as if they were an assembly line operation. Whether the hospital is in New York or
Lagos, Nigeria, similar operational systems must be applied.
Operations management helps with the creation of goods and services. That is, it
transforms inputs into finished goods or services through tooling, assembly, coordina-
tion, transportation, and storage. The transformation in the case of a desktop computer
may be in assembling circuit boards, memory chips, and other components to produce
a finished product. Similarly, a bank also has to assemble various services in order
to provide a bank loan or other banking products. In the manufacture of computers,
it is easy to see the transformation from parts into finished goods. On the other hand,
the transformation of a bank product such as a mortgage loan is not so obvious. It is
easier to understand the transformation of goods and services from the input stage to
the finished stage through the concept of value added. Value added is the difference
between the input costs and the price of outputs. Hence, in the case of a PC, one
could easily discern the difference between the input and the output. A customer is
willing to pay $600 for a personal computer (PC), knowing that the console by itself
may be worth only $50. In the case of the banking service, the difference between the
input and the output cost is not as clear, but value is added through a service such as
a home loan that the bank packages for a borrower. If the borrower feels that the fee
charged (price of the service) by the bank is more than is warranted, he or she may
go to another bank or may decide against taking the loan. Production and operations
management provides significant strategic advantages to international companies. Of
all the factors that contribute to strategic/competitive advantages, it is believed that
more than 25 percent is derived from operations management.2
OpERATiONS MANAGEMENT iN MANUfACTURiNG VS. SERViCES

The applications of operations management in the manufacturing and service sec-
tors are identical, but these sectors differ in many other ways. As mentioned earlier,
manufacturing involves transformation of material and components into tangible
output. For example, steel, rubber, plastic, and machine parts are assembled to obtain
a finished automobile—a tangible good. In contrast, service involves transformation
without a tangible output. Take the case of educational services: the output cannot
be seen or touched, but transformation of knowledge occurs in the form of an intan-
gible output. Manufacturing and services are similar in what is done, and, therefore,
the major difference between them is in how it is done. The similarities between the
two are easy to understand. Both require inputs (for an automobile it may be steel
and other necessary materials, and for education it is the students, instructors, and
instructional materials). Both are based on design and managerial decisions such as
INT’L PRODUcTION & OpERATIONS MGMT AND SUppLY-CHAIN MGMT 191
how much to invest, whom to hire, and where to locate. But services have four major
characteristics that make them different from goods/products and that greatly affect
their design, processing, and marketing. These are:
• Intangibility. Services are intangible because they cannot be seen, felt, tasted,
smelled, or heard before they are bought. Because a service is intangible, its
quality is not known by the buyers before they purchase it. Buyers will draw
inferences about quality and results of the use of a service from other evidence,
including references from people who have used a particular service. Therefore,
service providers must be able to manage the available evidence from the intan-
gibles to their advantage.3
• Inseparability. Services are produced and consumed simultaneously. The buyer
and the provider of a service are both integral parts of that service. Since the
customer is present as the service is produced, provider-client interaction is a
unique feature of services.
• Variability. Service quality and the extent of the service received can vary from
transaction to transaction. Service outcomes are dependent on who provides them
and when and where they are provided. Hence, the service quality provided by
one bank teller may not be the same as the next.
• Perishability. Services cannot be stored as physical goods. Physical goods can
be manufactured, placed in inventory, distributed through multiple channels, and
consumed later, whereas services, because of their inseparability, are consumed
as they are being provided. Storing services for future demand is not possible.
In addition, a product can be mass-produced, and through automation almost all

units can be uniform. In service, each transaction can be different from the previous
experience, as it is provided by humans and not machines.
INTERNATiONALiZATiON Of PRODUCTiON & OpERATiONS MANAGEMENT

The globalization process, with its borderless network of operations, has created a
complex system of manufacturing and operations management that is indifferent to
where goods are manufactured, where services are offered, and where these goods
and services are distributed. The dynamic shift in the world over the last decade
has resulted in China becoming the manufacturing center of the world and India
becoming the information-technology hub of the world. As international companies
seek cost advantages to compete successfully in the international marketplace, they
constantly look for countries that have lower input costs. In addition, the techno-
logical advances achieved during the late twentieth century have helped companies
adopt more advanced manufacturing systems, including lean manufacturing. Lean
manufacturing improves productivity through cost and time management. 4 The
growth in globalization has opened opportunities for small entrepreneurs in many
countries. Many of these small entrepreneurs use modern management and opera-
tions concepts and extended value chain management practices to be competitive.5
As businesses from industrialized countries scan the globe for lower input costs, they
192 CHApTER 8
modify their strategies to take advantage of opportunities available in developing

countries that may offer a reasonably skilled labor force at a fraction of the cost in
their own countries. Many companies seek competitive advantages through produc-
tion and operations management.6
DECiSiONS iN PRODUCTiON & OpERATiONS MANAGEMENT

An international firm setting up a POM system has to make some strategic decisions.
These decisions assist companies in utilizing their resources in the most effective
and efficient way in transforming inputs into outputs. The nine most critical strategic
POM decisions are:
1. Location—where to set up operations

2. Product—which product design to adopt and which products to introduce in
which market
3. Process—how to utilize people, material, machines, and technology to produce
high-quality products at the lowest possible cost
4. Quality—how to meet and exceed customers’ quality expectations
5. Layout—how to set up machines and manage the interaction among people,
materials, and machines
6. Scheduling—setting up time, date, and volume of output
7. Purchasing—cost, quality, and delivery are critical decisions in purchasing
8. Inventory—managing the inventory levels to meet unexpected demand at the
lowest possible costs
9. Human resources—assigning tasks based on skills and requirements of the
operation
Each of the above strategic decisions has to be made individually to result in syn-
ergy and cost effectiveness.
LOcATION DEcISIONS
Strategy
One of the critical long-term strategic decisions companies make is where to locate
their operations. As discussed in Chapters 2 and 3, companies carry out detailed as-
sessments of risks in selecting countries. After selecting the country in which to set
up operations, international companies have to decide where to locate their manufac-
turing plants or service centers based on many factors, including the upstream and
downstream efficiencies in the supply-chain process. Upstream distribution deals
with the supply of materials and other components used by manufacturing plants
and service centers. Downstream distribution handles the supply of finished goods
and services to the marketplace. In the era of globalization, locational decisions are
not necessarily confined to where the market for the finished good or service is, but
may depend on other factors, including input costs. Therefore, international compa-
nies may sometimes locate their plants and service centers far away from the actual
marketplace to take advantage of labor costs and/or the availability of a skilled work-
force. For example, Canon Inc. and Olympus Optical Co. Ltd. of Japan have major
manufacturing operations in China, but the markets for these companies’ products
are elsewhere. Similarly, Siemens of Germany has a major research facility in India,
but most of the work assigned at this center targets Siemens’s markets in Europe and
North America. American companies, too, have established manufacturing facilities
outside the United States. For example, Motorola and General Motors have major
operations in China. In 1992, Motorola announced plans for a $120 million plant in
China, which has since been completed. It has also set up a software-engineering
laboratory in India. In addition, Motorola has 18 R&D laboratories in Europe with
14 manufacturing plants, accounting for about 23 percent of the company’s total
revenues. Clearly, location decisions transcend national boundaries.
In selecting a location, international companies consider some key variables that
influence their decisions, including the items below.
1. Availability of skilled workers, staff, and technical people. It is important that
the company selects a location where it has easy access to qualified employees. For
example, many garment manufacturers have moved their production facilities to China
to tap into the skilled and inexpensive labor force available there. In fact, in China
there are cities that produce just one type of clothing, and all key manufacturers have
plants in these cities. Some of the factory towns have even been renamed for the gar-
ments that they produce—for example, “Socks City,” “Underwear City,” and so on.
2. Wages and salaries that affect input costs. The cost of goods sold is affected by
wages and salaries. For example, as the hourly rates of factory workers in Germany
and other European countries rise, companies such as Volkswagen are relocating
their manufacturing operations to lower-wage locations such as Poland and the
Czech Republic.
3. Worker productivity rates. Hourly rates alone should not be the criteria for select-
ing a location; productivity should also be part of the equation. Productivity is the rate
of output per unit of input. If hourly rates are high but the productivity is high, too,
it may be worth remaining in the present location, as there may be no significant dif-
ference in the input costs in a different location. For example, if the hourly wage rate
in the United States is $20 and a worker in the United States can produce 10 units of
output per hour, the cost per unit is $2. In contrast, if the hourly wage rate for similar
work is $5 in Mexico and the Mexican worker is able produce two units of output
per hour, the cost per unit is $2.50. In this instance, there is no significant benefit for
an American company to relocate its operations to Mexico. In studies done across
manufacturing plants in various countries, researchers have found that productivity
levels are influenced by management competency and workers’ skill levels.7
4. Local tax rate. Depending on the corporate tax rate, international companies
may select those countries that have lower rates to increase the profitability of their
operations. For instance, the corporate tax rate in Egypt is roughly 40 percent,
whereas in Brazil it is 33 percent. If all other factors of production are the same, an
international company would set up its operations in Brazil to take advantage of the
favorable tax rates.
194 CHApTER 8
5. Distance to suppliers (upstream). The cost of transporting required raw materi-

als and other supplies affects the cost of goods sold. Hence, international companies
may select locations that are close to suppliers to reduce the upstream supply cost.
This is especially true for the mining and oil exploration industries, as transportation
costs for these industries are very high. Therefore, oil refineries are usually located
near where the oil wells are drilled.
6. Distance to markets (downstream). Companies locate their operations close to
markets to reduce distribution costs. In industries where the consumer purchase rate
is high (consumers go to stores often to buy such goods), it is critical that companies
locate their operations close to markets. Soft drink companies such as Coca-Cola and
Pepsi-Cola have many independent bottlers in a given country to make sure that the
supply of their beverages reaches the markets quickly.
7. Logistics. Logistics helps with the movement of goods and services from one
point to another. It involves transportation, loading and unloading, communication,
storage, tracking, and rerouting if necessary. One aspect of logistics issues concerns
the downstream and upstream distribution of materials and finished goods. In the
modern era, with the new technologies available, logistics has become a key activity
for businesses to improve efficiency and reduce costs.
8. Availability of utilities. The supply of utilities such as water, electricity, and gas
is essential for operations, especially in the manufacturing sector. In selecting loca-
tions, international companies that require these utilities may try to select countries
that have a reasonable supply of water, electricity, and gas. For example, automobile
and appliance manufacturers who operate heavy machinery in their production pro-
cesses require a continuous supply of electricity and would be constrained if it were
not available. In many developing countries, power supplies are not reliable, and in
some instances there are frequent power outages. Companies that operate in these
countries most often invest in their own power generation to augment the local sup-
ply. This additional investment adds to the cost of operations.
9. Local government regulations. Regulations are often enacted to assist the
overall well being of a country’s people. Some of these regulations may also be
unfavorable for foreign investors. Regulations that are meant to protect local indus-
tries from competition can be an impediment to foreign companies. For example,
ownership regulations that require foreign companies to own only a minority position
in a company are intended to help local entrepreneurs. Similarly, regulations that
levy higher duties on imported goods are intended to help local companies compete
against foreign goods that may be more attractive to local customers because of
their superior quality.
10. Local government incentives. In some instances, countries encourage the flow
of foreign investments to improve their economic condition. In order to attract foreign
investors, some countries offer incentives including tax relief, lower utility rates, or
low-cost land. In a highly competitive environment, countries offer substantial incen-
tives to attract foreign investors. Even within individual countries, states/provinces
may offer incentives to attract foreign investors. For example, the state of Alabama in
the United States offered Mercedes-Benz of Germany various incentives that totaled
$253 million, including tax breaks. In addition, the state government promised to buy
25,000 new Mercedes-Benzes. The reward: an investment estimated to be worth $300

million, 1,500 high-paying jobs, and the satisfaction of outbidding 30 other states.8
11. Quality of life considerations. Quality of life issues help companies attract
skilled workers to the location and are used as incentives to attract qualified expatri-
ates to manage overseas operations. Quality of life issues include environmental fac-
tors, cost of living, educational facilities, transportation, personal safety and health,
cultural facilities, and other public services. For example, in the annual rankings by
the mayors of major cities of the world for 2007, the best cities for relocation were
Zurich, Switzerland, with a score of 108.1 points, followed closely by Vienna, Austria,
and Geneva, Switzerland, tied at 108.0 points (where New York is the base city, with
a score of 100 points). These cities were followed by Vancouver, British Columbia
(107.6), Auckland, New Zealand (107.3), and Düsseldorf, Germany (107.3).9 The
mayors also ranked Moscow, Russia, as the most expensive city to live in, followed
by Tokyo, Japan; London, England; and Oslo, Norway for 2008.
12. Economic factors. (Already considered in the selection of the country.) Companies
may weigh each of these variables differently depending on the industry they are in,
their market position, and their competitors’ actions. For example, when General Elec-
tric decided to set up its research center in Bangalore, India, it chose a location where
other high-tech firms were located—Bangalore is referred to as the Silicon Valley of
India—and that had a large pool of skilled workers, with an excellent quality of life that
was attractive for relocation. Similarly, when BankBoston was planning its expansion
strategy into Latin America, where it generates about 20 percent of its profits, it chose
São Paulo, Brazil, as the gateway to service the region. BankBoston made the decision
on the basis of the size of the country (Brazil is the largest country in Latin America),
proximity to other countries such as Argentina, Chile, and Peru, and the importance of
São Paulo as a banking center, where offices of many foreign banks are located.10
Locational Decision Analysis
In selecting locations, international companies conduct elaborate feasibility studies to

make sure that their choice is in the best long-term interest of the firm. Studies have
shown that international companies decide on facility locations based on economic,
infrastructural, and legal factors.11 If a wrong location is selected, the firm faces in-
surmountable difficulties, including loss of competitive advantage (a competitor may
have already selected a better location), financial loss (forgone profits, costs of selling
off assets, and uprooting cost), and loss of market position. International companies
do not follow a single approach to decide on a location. Many of them use different
models that are found to be beneficial in certain environments and under certain situa-
tions. But market size appears to be a key variable that many international companies
consider seriously. Studies of American, European, and Japanese companies have
shown that market size as defined by the number of manufacturing establishments in
a country is strongly associated with foreign manufacturers’ locational decisions.12
Probably the fact that there are so many manufacturers at one site implies that the
market is large, a supplier network is in place, and the collective wisdom of so many
manufacturers could not be wrong. To evaluate locations, some companies use analyti-
196 CHAPTER 8
Table 8.1
Break-Even Analysis to Select Locations (€)
Item Hanover Rotterdam

Overhead 80,000 100,000
Total variable 200,000 150,000
Total cost for producing 100,000 units 280,000 250,000
Cost per unit 28.00 25.00
cal techniques to make the selection as objective as possible. Two such approaches
are locational break-even analysis and the factor rating method.13
In the break-even analysis approach, both fixed costs and variable costs are esti-
mated by location, and the selection is made on the basis of the lowest unit cost. For
example, an international firm has to choose between two locations, say, Hanover,
Germany, and Rotterdam, the Netherlands. The cost associated with manufacturing
100,000 units of its product is shown in Table 8.1. If all the factors remain the same,
the company should select Rotterdam on the basis of lower unit cost.
In the factor rating method, an international company first identifies the critical
factors in its operations, then assigns weights based on the importance of each of the
critical factors, and finally arrives at a score that reflects the importance of each factor.
For example, a company might identify hourly wage rate, worker productivity, taxes,
and quality of life as the most important factors in selecting a location. The company
has two choices, Manila, Philippines, or Saigon, Vietnam. Based on past experience, it
assigns the following weights to each of the four selected factors: wages = 30 percent;
productivity = 30 percent; taxes = 25 percent; and quality of life = 15 percent.
Using available information from government and other sources, it rates (on a
10-point scale, where 10 is best) each city on the four factors, as shown below.
Factor Manila Saigon

Wages 7.0 8.0
Productivity 6.0 5.0
Taxes 7.0 5.0
Quality of life 5.0 4.0
Using the factor weights and factor ratings, the international company can select between
Manila and Saigon on the basis of the factor weights, as shown in Table 8.2. If all other fac-
tors remain the same, the company should select Manila as its location for operations.
PRODUcT DEcISIONS
Most international companies produce and sell hundreds of different goods and ser-
vices. For example, Unilever, the British- and Dutch-owned conglomerate, offers more
than 660 different items, from food products to detergents, in many of its markets.
After selecting a new location, Unilever has to make a choice of which product(s)
Table 8.2
Factor Weights to Select Locations
Ratings Weighted scores

Weight Manila Saigon Manila Saigon
Factor (%) (/10) (/10) (col. 2 × col. 3) (col. 2 × col. 3)
Wages 30 7.0 8.0 21.0 24.0
Productivity 30 6.0 5.0 18.0 15.0
Taxes 25 7.0 5.0 17.5 11.5
Quality of life 15 5.0 4.0 7.5 6.0
Total 64.0 56.5
to sell there. Usually, international companies do not introduce all their products to
the market when they start out in a new country. They normally try to introduce the
most marketable product and slowly build up the line. This approach reduces the
risk of failure and allows management to be focused and to direct all its attention to
that single product. In some instances, an international company introduces two or
three products if they are viewed as linked and if they complete a single package. For
example, when Citicorp, the large global full-service bank, enters a country for the
first time, it may initially introduce checking and savings accounts and, after some
time, introduce other services such as credit cards, car loans, and so on.
Cost is the compelling reason why international companies in a new country prefer
to introduce an existing product that has been successful in other countries. The ex-
perience gained in marketing one product in other markets is a valuable competitive
advantage. In some instances, due to market forces, an international company may
introduce a totally new product in the new country. Take, for example, the experience
of McDonald’s Corporation. When the company was planning to enter the Indian
market, it realized that it would not be successful in India with its standard beef
hamburgers, as many Indians do not eat meat, especially beef, for religious reasons.
Hence, the company experimented with a vegetable burger, called a “veggie burger,”
which was successfully introduced into the Indian market.
PROcESS DEcISIONS
The manufacturing and operations process transfers inputs into finished goods and
services. Process function brings together people, material, machines, and technology
in the transformation of products and services for use by customers. Hence, process
management is equally applicable to all organizations—goods and services, for profit
and not-for-profit. It addresses such issues as:
• Which aspects of the process should be done in-house, and which should be
outsourced? In the internal business context, this is becoming a critical issue
as companies seek lower wage areas to manufacture and process services using
modern technology. For example, many of the world’s computer companies are
198 CHApTER 8
using China and Taiwan as their manufacturing bases to make use of the rela-
tively inexpensive, yet technically skilled, labor force. Similarly, many financial
institutions are outsourcing their customer service departments to call centers in
India and the Philippines. Chapter 9 discusses the outsourcing area in detail.
• What is the best proportion of human skills to the level of technology (labor-
intensive processing versus technology-driven processing)? For international
companies that have manufacturing plants in nonindustrialized countries,
the choice of how much technology should be applied in manufacturing is a
complex issue. On the one hand, technology-driven manufacturing is cost ef-
ficient and can produce high-quality finished goods; for example, most of the
automobile manufacturing in Europe is totally automated. On the other hand,
the workers in many nonindustrialized countries lack the skills to operate
highly sophisticated machinery; these countries have an abundant labor force
and high unemployment, both of which favor low-technology processing. The
automobile-manufacturing process in China, India, and Mexico has higher
labor content. In addition, the higher the technology, the more capital intensive
the operation, which raises the financial risk. Even in commercial banking,
the question is: How much of the automated banking system that is the norm
in the United States and many other industrialized countries is feasible or
practical in countries with low literacy rates?
• How can the selected process help the company attain quality, reduce cost, and
increase flexibility? As discussed earlier, with higher technology components
in the manufacturing process, the human element is reduced, which in turn cuts
down on the number of errors, resulting in better quality. A robot that welds
parts on an assembly line can produce welds of the same strength 24 hours a
day, with consistency, and with little waste. In contrast, if this task is given to a
human, fatigue, boredom, and other factors would produce inconsistent results
and a greater amount of waste. Flexibility in process management is equally
important. Firms improve their ability to compete by examining each step of
their processes and responding quicker than their competitors to market and
consumer changes.14
• How can process management be improved? Competitive pressures and shifts in
the environment dictate that companies constantly seek improvements in their
manufacturing processes.15 For example, Toyota’s move to lean manufacturing
has enabled the company to cut production costs by 10 percent or more. This
has led other automobile manufacturers to play catch-up.
Process management is important to many aspects of a business organization, from

accounting to manufacturing. From an accounting point of view, process manage-
ment seeks better ways to perform accounting functions such as cost analysis. In
manufacturing, process management helps determine product designs that maximize
customer value.
The two major process decisions that companies have to make involve (1) the
type of process to be used, and (2) the extent to which the company wants to achieve
integration.
Type of Process to Be Used
Companies have a choice in organizing their operations around the products that they
plan to sell or around the process that they plan to use in producing a particular prod-
uct. Depending on the choice, the company’s resources—especially an international
company’s resources—have to be organized for optimal operations. For international
companies, the choice of a process may vary from country to country, depending on
factors such as capital investment, labor costs, level of labor skills, local regulations,
size of the market (volume), and whether the process is for the short term or the long
term (life of the existing technology).
The five types of processes most often used by companies are: project based (single
item), job based (consulting assignments), batch (garment manufacturing), line process
(assembly line operations), and continuous process. When an international company
such as Bechtel is involved in a major construction project, the process selection is
project based and highly customized. No two bridges or buildings are alike; hence,
each project needs to be customized to suit the needs of the customer. In contrast, the
processing of many consumer goods is volume driven, and the same process is applied
continuously, as in ExxonMobil’s oil-refining process or Pinnacle Foods Group, Inc.’s
Duncan Hines cake mix production process. The different types of processes are in-
fluenced by level of customization, volume of output, and variations within a product
category. In many developing countries, the number of variations in a given product
is limited compared to that in industrialized countries. For example, the number of
models of automobiles available in Argentina, Bangladesh, Egypt, and Vietnam is
far fewer than the number available in many European countries. Similarly, in pack-
aged goods such as soap and shampoo, the varieties available in Bolivia, China, and
Thailand are fewer compared to the choices that American consumers might have.
Integration
Most companies purchase some materials or parts from outside vendors. For example,
automobile manufacturers such as GM, Toyota, and others buy sheet metal, plastic,
batteries, and tires from suppliers that specialize in these items. Similarly, Coca-Cola
buys sugar and packaging materials from outside companies. The extent to which a
company processes all its required materials, parts, and components is referred to as
integration. Integrating activities that precede or follow the manufacture or assembly
of goods and services is called vertical integration. Vertical integration flows in two
directions: backward and forward.16 For example, when a jeans manufacturer also
manufactures cloth, thread, and buttons that it uses to make the garment, the process
is called backward vertical integration. Now, if the same garment manufacturer also
retailed the jeans that it manufactured, this would be referred to as forward vertical
integration (see Figure 8.1).
The more processes in the supply chain that an organization performs itself, the more
vertically integrated it is. For example, Purdue grows its own chickens, manufacturers its
own feed for the chickens, and does its own packaging. On the other side of the spectrum,
Dell Computers outsources most of its parts, components, and technical services.
200 CHApTER 8
Figure 8.1 Vertical Integration
Button Cloth Thread
BACKWARD
Jeans
FORWARD
Retail
The decision by a company to integrate fully is referred to as a make decision.

In contrast, when a company outsources many of the required items/functions for
its product, it is referred to as a buy decision. The advantages of integration, or the
make decisions, are (1) total control over the process, including product quality, (2)
economies of scale, (3) timely deliveries, (4) protection of intellectual property, and
(5) cost efficiencies through centralization of product design and R&D. For example,
Mercedes-Benz designs all its cars and has a vast R&D facility in Germany to direct its
state-of-the-art developments in automobile engineering. The advantages of outsourc-
ing, or the buy decisions, are (1) the organization can focus on its core competencies,
(2) management can concentrate on key strategies that affect its products/services
rather than get involved with noncore businesses, (3) the company can obtain parts
and components from suppliers who have specialized expertise in single items (Intel
is much better suited to developing chips than HP or Dell), (4) the costs are lowered
by buying from suppliers who have economies of scale, and (5) because of global-
ization, more supplier options are available. Modern technology allows companies
to coordinate the activities of these suppliers, who are located in different countries.
For example, many financial institutions and large hospitals have technicians, such
as radiologists, in India who read X-rays, CAT scans, and MRIs and have the reports
ready for next day by taking advantage of the time differences between the United
States and India. In a global economy that transcends distances and time with op-
portunities for cost savings, very few companies are fully integrated.
QUALITY DEcISIONS
Quality is one of the most critical factors in the success of a product or service. Qual-
ity is the ability of the product or service to satisfy customers’ expectations. Quality
translates into value for the customer: it does not imply that a customer is getting
the very best product or service, but within a given price range, it implies that it is
the best available product. A customer looking for an automobile that runs well, is
fuel efficient, is the safest in the market, has a lot of room, is equipped with the best
sound system, has a quiet ride, and will not break down might have to pay more than
$50,000. There are automobiles under $15,000 that are reasonably good, and there
are automobiles that are priced at $50,000 that are excellent in comparison. For a
customer who can only afford an automobile in the $15,000 range, the higher qual-
ity found in the automobile that costs $50,000 is meaningless; that customer is not
going to be able to buy such an automobile. Hence, quality is a range of satisfaction
for different segments of consumers at different price levels. However, quality does
imply that the product or service has some minimum standards of performance and
that those consumers who buy the product benefit from it.
From a firm’s point of view, quality is a strategic tool it can use to attract custom-
ers, create brand loyalty, and gain a competitive advantage. Many Dell customers
believe the company makes excellent computers and place special value on the abil-
ity to customize their purchases. Buyers of Dell computers have implicit faith in the
quality of the company’s products. Similarly, business travelers select a particular
hotel chain such as the Marriott or the Hyatt Regency expecting a certain quality of
service and presumably willing to pay the price for it. Quality cannot be measured
in a single dimension; therefore, comparisons across products or services are not
possible. Quality can mean different things for different people. For some, it may be
the performance, or the main characteristics of the product or service. For example,
in a five-star restaurant, it may be the status of the chef and the impeccable service
of the waitstaff that make the difference for the customer. For some, quality implies
reliability, or consistency of performance. A photocopier purchased for home use, for
instance, should not break down during the first six months of use. For some, quality
may simply mean reputation of a given brand. For example, owners of BMW auto-
mobiles buy them because the brand is well known and has an excellent reputation.
Although quality has many dimensions, the fact is that if consumers perceive a
product/brand to be of poor quality, they will not buy that brand. Therefore, for com-
panies, quality has implications that may determine their financial success. Whereas
high quality results in customer loyalty, repeat purchase, brand recognition, and in-
creased profits, poor quality results in loss of customers, higher costs, and, in some
cases, liability (court settlements due to injuries).
In manufacturing high-quality products, firms try to control certain aspects of their op-
erations. The first and the most critical aspect of the quality process is controlling product
failures that result from defective parts or workmanship. This is an internal failure, and
202 CHApTER 8
most quality-control procedures are developed to minimize internal failures. Businesses’

quality-control systems have evolved over the years from very simple approaches to the
more sophisticated methods that are employed by many international companies.
In the early part of the twentieth century, most companies checked product quality
after production runs. However, this approach to quality control posed problems for
companies that produced thousands of units in a single run. It was not possible to
check all the units produced, so companies designed quality-control checks called
statistical quality control (SQC) to monitor the final quality of a particular product.
This procedure was widely used by many of the international companies of that era.
SQC is based on statistical techniques of sampling. That is, by using small samples,
companies determined the quality level (defective rates) of the whole production run.
In SQC, a random sample of finished products is measured against predetermined
standards. Hence, the defective rate of a production run of 100,000 units might be
decided by testing a sample of a few hundred units. In SQC, the margin of error in
testing the sample can be established at the 90, 95, or 99 percent level. Therefore,
based on the results of the sample, a technician testing a batch would conclude that
the defective rate was not too high and that it fell within the boundary of tolerance at
the 95 percent significance level (or other pre-established level). Based on the sample
test, the quality-control technician would either accept the whole batch or reject it.
If the technician were to reject the sample, a check of the whole production batch
would have to be done to remove the defective units from the batch.
As the international environment became more competitive and the importance of
product quality became an issue for consumers, the SQC process seemed to lack the
precision that was required in this evolving environment. Companies started relying
on process quality control, also called statistical process control (SPC), to improve
quality. Unlike SQC, which checks batches of output, SPC checks quality at every
step of the production process, including the supplier level. Though this was an im-
provement over the SQC methodology, it did not fully solve quality-control problems.
Companies realized that SQC and SPC were focused on the production part of the
process without taking into account the design stage of the product. They soon real-
ized that in the quality game it was critical to prevent mistakes rather than finding
mistakes and correcting them. Therefore, companies such as Toyota Motors of Japan
started focusing on the design stage of their products. For Toyota, the design stage
not only included designing a better product but also designing better machinery and
better processes to reduce mistakes at the source. To implement this new emphasis
on design at all levels of production, Toyota works very closely with all its suppliers
to assure a continuous supply of high-quality parts and components.
The next phase in the evolution of quality control was the introduction of quality
theories and philosophies that addressed management issues. These theories were
pioneered by individuals who viewed the quality problem in a holistic way and pos-
tulated that most product defects are preventable. Some of the prominent theorists
who introduced these philosophies were W. Edwards Deming, Joseph M. Juran,
Philip B. Crosby, and Kaoru Ishikawa. The major contributions of these four quality
philosophers are summarized in Table 8.3.
The next phase in the quality-control evolution was the introduction of the total
Table 8.3
Quality Philosophers and Their Philosophies
Name Philosophy
W. Edwards Deming Cause of poor quality is the system
14-point prescription to achieve quality (consistency, constancy, finding prob-
lems, etc.)
Joseph M. Juran 80 percent of defects are controllable

“Fitness-for-use”–quality planning, quality control, and quality improvement
Philip B. Crosby Concept of zero defect

Management commitment, persistence, articulation, and doing right
Kaoru Ishikawa Cause-and-effect diagrams for improving quality

Use of quality circles to involve workers in quality improvement
Sources: W. Edwards Deming, Quality, Productivity, and Competitive Position (Cambridge, MA: MIT
Center for Advanced Engineering Study, 1982); Joseph M. Juran, “The Quality Trilogy,” Quality Progress
19, no. 8 (1986): 19–24; Philip B. Crosby, Quality without Tears: The Art of Hassle-Free Management (New
York: McGraw-Hill, 1984); and William J. Stevenson, Production/Operations Management, 5th ed. (Chicago:
Irwin Publishers, 1996), p. 101.
quality management (TQM) concept, a comprehensive strategy that combines the

process element with human resources involvement in controlling defects and reducing
costs. Introduced first in Japan, it has its roots in the quality-control principles that
were proposed earlier by Deming, Juran, and Ishikawa. In general terms, TQM can
be defined as an organization-wide approach to continuously improving the quality
of an organization’s product and processes that are important to the customers.17
Total quality management focuses on three primary areas:
1. Its goal is total satisfaction of both the internal and external customers.
2. It is management driven.
3. It seeks continuous improvement of all systems and processes.
This approach was a drastic shift from the previous quality-control systems. First, there
was recognition that product and service quality was important for customer satisfaction.
Second, top management involvement was necessary to achieve quality. Third, quality
is not a onetime effort, but implies continuous improvement. Finally, quality has to be
applied to all systems. The critical elements of the TQM approach are:
• It is customer driven. The final arbiter of all goods and services is the customer.
If the customer does not perceive value in a product, no amount of promotional
campaigns will translate into sales.
• It is championed by a firm’s leadership. Quality should be understood as an
important component within an organization, and this needs to be embraced by
all, including senior management.
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• It is employee driven. For quality programs to be successful, they should be

adhered to by everyone in the organization. The easiest way to achieve this goal
is to make every individual employee responsible for quality.
• It focuses on continuous improvements. Quality is not static. It is a dynamic
process and should be reviewed and improved upon on a regular basis.
• It uses benchmarks to recognize deficiencies. As goods and services compete in
the marketplace, comparisons of brands are inevitable. The TQM procedures
recommend that firms evaluate performance on the basis of external standards,
especially among key competitors. The goal is to find the best possible practice
of quality management and to introduce the technique into the organization.
• It emphasizes design quality. Producing superior-quality products depends on both
the actual transformation of inputs into outputs and also on design of the product.
TQM techniques have been successfully utilized by many companies worldwide,

including Toyota and Sony of Japan, Philips Electronics and Siemens of Europe, and
General Electric and Ford Motor Company of the United States. In the United States,
14.1 percent of manufacturing firms use TQM.18
The next phase in the evolution of the quality-control process was the development
of Six Sigma principles. Six Sigma is a disciplined methodology that uses data and
statistical analysis to measure and improve a company’s operational performance
by identifying and eliminating defects. Sigma is the standard deviation of a normal
distribution. In Six Sigma, the parameter values fall under 99.99966 percent of the
normal curve. Adopted in 1987 by Motorola, an American cellular and other advanced
technology manufacturer, Six Sigma attempts to reduce defects to a maximum of 3.4
items per one million. Compared to the traditional SQC systems that operated at two
sigma (43,600 defects per million) or at three sigma levels (2,600 defects per million),
the Six Sigma approach virtually eliminates all defects. In the United States, companies
that use two sigma quality standards end up redoing close to 33 percent of their work,
adding to overall cost. Based on the success of Motorola’s Six Sigma approach, GE
quickly adopted the technique to improve its own quality-control program.
The Six Sigma technique has resulted in higher quality output at Motorola and GE,
improving customer satisfaction and reducing costs for both companies. At Motorola,
the reported cost savings over the years is estimated to be nearly $16 billion.19 General
Electric saved close to $750 million through its Six Sigma program in 2003 and $1.5
billion in 2004.20 About 4.9 percent of American manufacturers use Six Sigma to
improve quality.21 International companies using Six Sigma initiatives transcend both
manufacturing and service companies, and the technique is used in many parts of the
world. Table 8.4 presents a partial list of the international companies that make use of
Six Sigma quality procedures. Implementing Six Sigma quality-control procedures
involves setting up and monitoring procedures. Table 8.5 presents the key steps in
Six Sigma and its differentiating features.
Manufacturing companies have used Six Sigma to improve quality and precision
of process outputs. Six Sigma has been found to be equally beneficial to service com-
panies, which use it to design, measure, analyze process losses, and guide process
improvements.22 For example, because of Six Sigma, Bank of America was able to
Table 8.4
Partial List of International Companies Using Six Sigma
Company Country Company Country

Amazon.com United States Johnson & Johnson United States
American Express United States Mayo Clinic United States
Bank of America United States Motorola United States
Bharat Heavy Electrical India Nokia Finland
Boeing Corp. United States Samsung Corp. South Korea
Daimler-Chrysler Corp. Germany Singapore Technologies Singapore
Dell Computer Corp. United States Sony Corp. Japan
Deloitte & Touche Ltd. United States Sumitomo Chemicals Japan
DuPont Corp. United States Tata Group of Companies India
Eastman-Kodak United States Toshiba Corp. Japan
Ford Motor Company United States 3M United States
Glaxo-Smith Kline United Kingdom Toyota Motors Japan
Hondo Motors United States Volvo Sweden
IBM United States Xerox United States
JPMorgan Chase United States
Source: 209 Six Sigma & Quality Article Archive. Available at http://www.isixsigma.com/library (ac-
cessed June 2008).
Table 8.5
Steps in Six Sigma and Its Differentiating Features
Steps in Six Sigma Differences from other techniques

1 Identify the product/service Six Sigma is more of a business strategy
2 Identify the customer It is a disciplined statistical problem-solving
technique
3 Identify what specific benefits customers seek Resources are dedicated to continuous
performance improvement
4 Determine attributes that should be offered to Six Sigma is customer driven
satisfy the customers’ needs
5 Define the work process Emphasis is on training
6 Modify the process to eliminate waste Results are measured by quantifiable costs/
revenues
7 Ensure continuous improvement through measure- Six Sigma uses a fact-based approach; there
ment, analysis, control, and refinement is no room for guesstimates
reduce payment errors by 22 percent and deposit errors by 83 percent in 2007.23 Also,
Bank of America completed thousands of Six Sigma projects in 2003 alone, improving
its profits and gaining considerable competitive advantage in the process.24 From an
organizational standpoint, Six Sigma is implemented by trained personnel who have
achieved a degree of competence in its technique. Individuals trained in Six Sigma
can attain different levels of expertise, which are identified by different colors of
belts, similar to the martial arts belt. (At the first level is the Green Belt, followed by
the Black Belt, and finally the Master Black Belt.)
In a competitive global environment, international companies have to deliver
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goods and services to meet customer needs. However, it is not possible to introduce
a uniform quality-control technique in every country. Due to cost considerations
and difficulties in adopting some of the more sophisticated techniques, international
companies may use two or three different techniques across different countries. In
any event, it is critical that international companies produce goods and services that
meet the expectations of their customers, wherever they are.
LAYOUT DEcISIONS
Layouts are arrangements of machines and work centers and the flow of materials de-
signed to transform inputs into finished goods/services most efficiently. Well-designed
layouts increase productivity and reduce costs. Consider a manufacturing plant that
assembles automobiles. The number of parts that go into assembling an automobile
run into the thousands. Therefore, if the plant floor is laid out poorly, parts may not
arrive in time at the point of assembly, or workers may have to travel unnecessarily
long distances to obtain the necessary tools to complete the assembly process. Even
in service industries, the layout is important. Take for example, the branch office of a
bank. The flow of people that are being serviced by the tellers, customers waiting to
see the bank officers, customers waiting for the safety deposit area, and the customers
waiting for an ATM machine all have to be taken care of without confusion or delay.
Consequently, a bank branch should be organized to help the flow of customers and
provide quick and efficient service. Traditional straight-line assembly lines are now
being modified to take advantage of robotics, computer networks, and just-in-time
inventory systems. One such innovation is the U-shaped assembly line, which reduces
the worker and machine downtime by organizing the parts and equipment around
the workers. A few studies have shown that the U-shaped layouts used by companies
that have adopted lean manufacturing are very effective in optimizing assembly line
operations.25 Also, companies that use U-shaped assembly lines claim improvements
in their worker productivity.26
There are different types of layouts—product based, process based, and fixed
position. Product-based layouts are used to process a large volume of products or
customers. The process is standardized and repetitive. For example, serving a large
number of customers in an office cafeteria is a good example of product-based lay-
out. In the case of a cafeteria, the focus is on serving the food. Product-based layouts
may be arranged in a straight line or may be U-shaped. U-shaped layouts are more
compact, and distances between workstations are reduced. When the processing
is not standardized and instead presents a variety of requirements, product-based
layouts are inefficient. In these situations, it is best to use a process-based layout,
which divides processes into groups that complete similar tasks. In a tire plant, for
instance, the rubber-mixing section of the plant is a separate department from the
tire-curing department; once the process in one department is completed, a batch of
semifinished products is taken into the next department to be processed. In a fixed-
position layout, workers, materials, and equipment are brought to the workstation
for completion of the process. For example, in the construction of an electric power
generator, a fixed-position layout might be used. The generator position is fixed, but
technicians, various materials, and equipment are brought to the site to complete the
generator. Fixed-position layouts are most often used with construction projects where
the project is bulky and cannot be moved around for processing. Besides the three
layouts mentioned here, others have been developed due to improvements in technol-
ogy. One such layout is called the cellular layout, in which machines are grouped to
perform similar tasks. As cellular layouts require a continuous flow of information,
they are used in countries where communication technology is well advanced and
computer networks are easily available.
International companies adopt different types of layouts in different countries to
adapt to local conditions. In countries where the use of technology is low, companies
may adopt more labor-intensive techniques, which may require different layouts than
the ones used in more advanced countries. Consider Michelin Tires of France: it has
a completely automated system of tire assembly that requires very few workers, with
the plant layout geared for fewer worker movements to complete the assembly because
it is completely dependent on computers and neural networks. In contrast, Michelin’s
factory in Thailand has more workers, and the layout is designed to facilitate the
movement of people and materials.
ScHEDULING
Organizing the timing and flow of materials to complete the production process while
meeting market demands is the function of scheduling. The demands on people and
the specific tasks each worker needs to complete must be planned ahead of time to
provide a smooth sequence of task completions. Scheduling therefore involves as-
signing due dates to specific jobs to utilize all available resources efficiently. In some
industries, products have to arrive at specific time periods. For example, 60 percent of
all retail sales in the United States take place in a five-week window between the last
weekend in November and the twenty-fourth of December. In industries where the
market due dates are known beforehand, companies do a backward scheduling; that
is, they schedule the final step first, and other steps in the process are then scheduled
in reverse order. In industries where the product is mass-produced and consumers
purchase the product frequently, it is critical that the product be available at all times.
Household products such as food, soap, and cosmetics are produced continuously to
keep stock levels steady; in such instances, companies follow a forward-scheduling
method, beginning with the purchase of raw material, the delivery of components,
and so on. Forward scheduling is also used in industries where the products are made
to order and companies plan the schedule after receiving orders. In the construction
industry, scheduling is done once the construction project is commissioned.
The basic objectives of scheduling, whether for a domestic company or an inter-
national company, are to ensure that the production process is completed in a timely
and efficient manner. There are some key differences between scheduling for goods
(manufacturing) and scheduling for services. In the manufacturing operations, the
emphasis is on material delivery, assembly, and delivery of finished goods, whereas
in services the most critical resources are the people, and maximizing their efficiency
is an overriding scheduling concern. Keep in mind that services cannot be stored, so
208 CHApTER 8
scheduling plays an even bigger role in the service industry. In other words, manu-
facturing scheduling can rely on inventory to smooth out the scheduling process;
this opportunity is not available in the service industry. In industrialized countries,
order quantities are large and scheduling is critical to the delivery of goods to the
marketplace. In developing markets with smaller sales volumes, scheduling is simpler.
Scheduling to a great extent depends on the following factors:
• Market size. The larger the market, the greater the volume of materials that need
to be ordered, and scheduling such a vast quantity of inputs complicates the
scheduling process.
• Product type. Products that are complex (assembling a robot is more difficult than
assembling a ballpoint pen), bulky (assembly of an automobile versus assembly of
a plastic toy), have high input costs (assembly of a Rolex watch versus assembly
of rubber slippers), or are purchased infrequently (a personal computer that is
purchased once in three years versus a bar of soap that may be purchased once
a month) tend to require careful planning. A misstep in the scheduling process
could tie up resources and cost the company its market position.
• Resource utilization. In the final analysis, the goal of organizations is to utilize
scarce resources efficiently and to make goods and services that satisfy their
customers. Poor scheduling may hold up the production process and reduce the
efficient utilization of people and machines.
• Inventory cost. Inventory helps companies to manage the uneven demand for
goods in the marketplace. If the cost of inventory is low, companies can take
chances with the accuracy of their scheduling, as inventory provides the needed
buffer and satisfies the customer demand in the marketplace.
• Willingness of customers to wait for the product. Customers are willing to wait for
unique products and products for which there are no substitutes. A patient may wait
for the highest quality reading glasses but may not wait for a particular brand of
ballpoint pen. Similarly, a customer may wait three months for a luxury automobile
but may not wait more than a week for an automobile that has mass appeal.
PURcHASING
Most international companies have to purchase many items from outside suppliers
to complete the production process. For example, Toyota Motors buys tires for its
automobiles from Bridgestone, Deutsche Bank buys software programs for its finan-
cial analysis from SAP of Germany, and Coca-Cola buys aluminum cans from Alcoa
Corporation. The main reason why international companies purchase materials and
other components from outside suppliers is to be able to focus on their core com-
petencies. Toyota is much better at assembling cars than producing tires; Deutsche
Bank is knowledgeable in banking and finance, but not necessarily in developing
sophisticated software; and Coca-Cola is a master formulating popular soft drinks
but has little expertise in making aluminum cans. Therefore, most companies end up
purchasing materials rather than making them internally. The decision to make or
buy is one that companies have grappled with for ages.
Table 8.6
Pros and Cons of Make-or-Buy Decisions
Pros of Make Decision Pros of Buy Decision

1 Lower production cost Lower acquisition cost
2 Ensure adequate supply Preserve supplier commitment
3 Avoid unreliable suppliers Obtain superior capabilities
4 Utilize surplus resources Avoid investment in additional capacity
5 Obtain desired quality Reduce inventory costs
6 Avoid supplier collusion Ensure constant supply of items
7 Make unique items that may be difficult to buy Limited internal resources
8 Avoid layoffs Reciprocity
9 Protection of intellectual property Items that are protected by patents
10 Increase the size of the company Focus on core competency
Source: Jay Heizer and Barry Render, Production and Operations Management: Strategic and Tactical
Decisions (Upper Saddle River, NJ: Prentice Hall, 1995), p. 531.
The make-or-buy decision has its pros and cons. Companies weigh these advantages and
disadvantages in making their final decision as to make items internally or buy them from
an outside supplier. Table 8.6 presents the advantages of make-versus-buy decisions.
The advantages of the “make” decision are the disadvantages of the “buy” deci-
sions, and vice versa. In the twenty-first century, it is difficult to find a company that
produces all its input factors internally. Some companies make less and buy more from
outside suppliers. The use of outside suppliers is called outsourcing. For example,
Toyota Motors of Japan makes only 28 percent of its car materials and components
internally; the rest it buys from outside sources. International companies take ad-
vantage of their global reach by purchasing components from suppliers located all
over the world. Using efficient suppliers, international companies can drive down
the cost of goods sold. In a study of 50 U.S. firms that used outsourcing, a majority
(69 percent) mentioned cost savings as the overriding reason for buying parts and
components from outside suppliers.27 Boeing, an American aircraft manufacturer,
buys about 20 percent of the parts for its Boeing 777 airplane from Japan. Besides
the cost benefits, outsourcing helps companies sell their products and services to
customers in the countries that provide the materials and components they buy, as
the local buyers take pride in their own country’s involvement in the processing of a
particular product or service.
In some industries, however, it is customary to make most of the parts and com-
ponents internally. For example, companies that are in the extraction industry, such
as mining and oil drilling, make their core products internally. ExxonMobil Corpora-
tion of the United States drills for crude oil, refines the crude to make petroleum and
petroleum-based products, and distributes them through their outlets. Recall from
earlier in this chapter that when a company has control over the different stages of
the production process from raw materials to distribution, the process is referred to
as vertical integration. International companies may be vertically integrated in their
home countries or in countries where they have a sizable market, but rarely do they
have integrated operations in smaller markets.
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NEWER DEVELOpMENTS IN MANUFAcTURING PROcESSES

Competitive pressures and recent developments in communication technologies and
network computing have enabled international companies to develop advanced manu-
facturing strategies.28 Two such developments are lean manufacturing and flexible manu-
facturing. Lean manufacturing was first introduced in Japan and is now utilized by many
companies in Europe and the United States. In lean manufacturing, the resources needed
to complete a process are reduced considerably; that is, the objective of lean manufac-
turing is to use fewer workers, less inventory, and as little space as possible. To achieve
lean manufacturing, companies have to hire more skilled workers to perform specific
tasks, use flexible equipment, produce items in smaller lot sizes (batches), use inventory
efficiently, and set up machines to optimize space. Skilled workers not only learn tasks
quicker but also are able to solve problems when they occur. Flexible equipment helps
companies to organize multitask functions and save valuable production time. By using
smaller lot sizes, companies make it less likely that a large number of defective items
will be made before they are discovered. Lower levels of inventory are achieved through
better scheduling and just-in-time (JIT) systems, which reduce waste and inventory costs.
Finally, in lean manufacturing systems, the setup of various assembly line machines and
conveyor belts that bring parts and components is organized to be closer to workstations
and occupy the least amount of space. Lean manufacturing operations stress the impor-
tance of eliminating waste at all levels, especially at the process stage.29
Research has shown that for lean manufacturing to work, companies need to build
the necessary social systems as well. Simply copying techniques from successful
Japanese companies without integrating social systems capable of supporting the
new technical changes will not work. Social systems include the interactions of the
people working on the process, the organizational structure in which they operate, and
the existing corporate culture. Therefore, for American companies to implement lean
manufacturing, they first have to transform their companies from autonomous and
individualized structures to a teamwork-oriented and collaborative problem-solving
culture.30 Companies that have implemented lean manufacturing systems have vastly
improved the efficiency of their operations. In the United States, approximately 35.7
percent of manufacturing firms make use of lean manufacturing systems.31
Flexible manufacturing is a system that allows production facilities to respond
more quickly to varying demand patterns. This system integrates the core competen-
cies of supply-chain members to respond to market shifts and helps the introduction
of customization at a mass level (Dell Computer Corp. is an example of a firm that
employs this system successfully). Mass customization uses a flexible manufacturing
process to produce and deliver customized products and services for individual cus-
tomers around the world through computer-aided manufacturing systems. Developed
by Toyota to customize production, flexible manufacturing attempts to save unneces-
sary downtime and improve efficiency in the assembly line. The core principle of the
flexible manufacturing system is its ability to switch from making one product type
or model to making another that is in greater demand at a faster rate using the same
assembly platform. This system can reduce months of the factory downtime formerly
necessary to switch the assembly line to accommodate building a different model. The
key to flexible manufacturing is standardized equipment for every step in the process.
For example, Ford Motor Company uses flexible manufacturing at its new factories
in Norfolk, Virginia, and Kansas City, Missouri. Ford estimates that the new factories
could save $2 billion over six years. In addition, Ford is able to switch assembly lines
in as little as 15 percent of the time it used to take, and the cost of building these new
plants is 22 percent lower than the cost of building the old ones.32
INVENTORY
Maintaining inventory helps companies to meet the fluctuating and unexpected de-
mand patterns observed in the marketplace. Specifically, inventory helps international
companies to accomplish the following:
• Meet the normal (forecasted) demand and the unexpected demand for goods.
• Uncouple the production process from distribution; that is, inventory can be used
to balance the production process, so that, regardless of the demand (seasonal,
cyclical), the production run can be maintained at the same level throughout the
year, reducing costs through underutilized resources during slow seasons.
• Hedge against inflation. In international operations, firms are often confronted
with double-digit inflations in developing countries, which increase the costs
of manufactured goods. By maintaining inventory, these companies can reduce
costs during high inflationary periods.
• Take advantage of quantity discounts.
• Protect against stock outs. Stock-out problems occur both at the upstream and
downstream distribution ends of a supply chain. When there are stock outs at the
upstream end, companies may not have materials and parts to maintain production
runs. In contrast, when there are stock outs at the downstream point, the company
not only loses potential sale but also may have dissatisfied customers.
Inventories can be maintained at different levels of the production stage. Hence,

companies may have raw-material inventory, work-in-progress inventory, and fin-
ished-goods inventory. For example, automobile companies may stock up on steel
(materials), inventories of partially assembled cars (work-in-progress), and fully as-
sembled cars (finished goods). Finished-goods inventory may be held at any point in
the distribution process—at the factory warehouse, at the transportation company’s
facilities, and at the distributor warehouses. For international companies that operate
far from their home bases, maintaining inventory is a critical strategic activity. For
companies that export, transportation of goods may take weeks and in some cases
months to reach their destinations. In such instances, having a reliable stock of goods
for sale is crucial to their operations. For companies that have to import raw materials
and other parts for assembly, holding these items as inventory ensures continuous
and trouble-free production runs.
Holding material and goods in the inventory system can be expensive and, if not
managed properly, can increase the cost of operations and reduce profits. There are
many costs associated with managing inventories, including:
212 CHApTER 8
• Holding costs (also called carrying costs). These are the costs of keeping items
in a storage facility. They include costs such as rent for the facility, security, and
staffing (staff used in maintaining records of the incoming and outgoing materials
and goods).
• Ordering costs. Any costs associated with placing an order are part of the order-
ing costs. These costs include salaries, order processing, and supplies.
• Setup costs. Setup costs are costs incurred in starting an inventory system. These
costs include purchase of machinery (forklifts, computers, etc.), conveyor sys-
tems, and investment in materials handling.
• Transportation costs. Transportation costs are the costs incurred in shipping
inventory items to the storage facility.
• Opportunity costs. Opportunity costs are defined as the required return that is
forgone by choosing one investment over an alternative investment of similar
risk. By investing capital in the inventory of materials and goods, a firm may
be losing an opportunity to obtain greater returns by investing that capital in an
alternate investment opportunity.
• Spoilage/breakage/obsolescence costs. By placing a large quantity of materials
and goods in storage, a firm may face changes in style or upgrades in technol-
ogy that render the items in the inventory obsolete (use of a newer generation of
chips in computers makes the older models less desirable), or items may spoil
over time (products that have a limited shelf life, such as food items and some
pharmaceutical products).
• Insurance costs. To lower the risk of spoilage/breakage/obsolescence, companies
may buy insurance to protect the value of their items in inventory.
• Stock-out costs. Stock-out costs are costs associated with the loss of sales due to
lack of inventory. Stock-out costs have a short-term effect and a long-term effect.
In the short term, a firm may lose a sale because the item/brand is not available,
but the consumer may return to buy the brand during the next purchasing cycle.
However, if the stock out of the brand occurs frequently, consumers may abandon
the brand and buy a competing brand.
To control inventory costs, international companies develop models that help them
rein in some of the costs associated with inventory management. This is especially true
in those countries where transportation and storage systems are inadequate, making
inventory costs much higher than in those countries that have excellent infrastructures.
In managing inventory, companies try to minimize the costs incurred in ordering,
transporting, and placing items in storage. However, inventory costs are not linear.
While some of the costs associated with holding inventory are directly proportional
to the quantity held, other costs are inversely proportional to the quantity held. Hold-
ing costs, for example, are directly proportional to the quantity held. Therefore, as
the quantity of items held increases, the holding costs rise. In contrast, setup costs
decrease with larger quantities. The same amount of start-up costs may be required
to hold 100 units or 10,000 units. Similarly, ordering costs normally decrease with
larger orders. Due to the conflicting nature of costs, attaining cost effectiveness implies
finding a balance between rising costs and decreasing costs. Holding costs, opportu-
Figure 8.2 Total Inventory Costs and Economic Order Quantity
40
35
30
25
Cost
20
15
10
0
5 10 15 20 25 30 35 40 45
Quantity
nity costs, and other such costs will increase if larger inventories are maintained, but
annual setup costs, ordering costs, and other such costs decrease with larger orders.
If the objective of inventory control is to minimize total cost, an order quantity has
to minimize both types of cost. This concept is illustrated in Figure 8.2.
The three cost lines shown on the figure are: total cost, costs that are inversely
proportional to quantity, and costs that are directly proportional to quantity. The total
inventory cost is lowest at the point of intersection of the two types of cost. The size
of order that minimizes the total cost of maintaining inventory is called economic
order quantity, or EOQ. Economic order quantity depends on many factors, includ-
ing volume of annual sales, cost of the item, holding cost, ordering cost, and so on.
Therefore, if the unit cost of an item to be held in inventory is very high, only a small
amount of the item should be placed in inventory; otherwise, the opportunity cost with
the tied-up capital may be very high. On the other hand, if the demand for an item is
very high, it is important for it to be easily available; therefore, a company may stock
up on this item. There are many models available that assist managers to determine
the EOQ. A simple model to compute EOQ is presented below (the derivation of the
EOQ formula is not presented here).
'2
EOQ =
8+
214 CHApTER 8
where D = annual demand in units, O = ordering and setup costs, U = unit cost, and
H = holding cost/year.
Example:
ABC, a German manufacturer of high-end toys, purchases console boxes from

South Korea. These console boxes are used in game boards sold by the company.
The company sells about 1,000,000 game boards per year. The holding cost per unit
for one year is €4.00, the unit cost is €10.00, and the ordering/setup cost per order is
€16.00. Calculate the optimal order quantity that ABC should place with its South
Korean vendor.
For this problem, D = 1,000,000, O = €16.00, U = €10.00 and H = €4.00.

Therefore, EOQ = =

= = 894.427
Maintaining inventory is expensive and can increase the cost of goods sold. Rec-
ognizing this problem, some Japanese manufacturers, especially Toyota Motors in the
1950s, experimented with a novel idea in which production runs would be maintained
not by securing large inventories of required parts, but by asking suppliers to deliver
the parts on demand. Called the just-in-time (JIT) system, it was a phenomenal suc-
cess, and most Japanese companies and some European and American companies
adopted the JIT system. By eliminating inventory, Japanese companies were able to
reduce their inventory cost by 40 percent.33 The just-in-time system is a balanced
system in which no inventory is maintained but materials and parts are brought in as
required. In the JIT system, the exact numbers of required parts/components arrives
at the factory as they are needed.
The just-in-time system has been extremely successful in Japan and is part of
the lean production manufacturing and TQM processes adopted by many Japanese
companies. The focus in lean manufacturing and JIT is on avoiding waste and re-
ducing unnecessary downtime. In the United States and parts of Europe, JIT is not
yet universally accepted. It appears that there are some fundamental differences in
how businesses are organized in Japan and in the West. Japanese firms have very
close relationships with their suppliers, and they have an ownership stake in many of
them. The term keiretsu is used to describe a group of companies with interlocking
businesses and shareholdings. Japanese companies also rely on a single supplier for
a specific part. Furthermore, most of the suppliers that deliver parts and components
are located close to the manufacturing plants. In this type of arrangement, it is easier
to practice JIT than when multiple suppliers are used and they are located far from
each other. JIT systems rely on transportation to serve as their temporary warehouse.
In the United States, most suppliers are geographically far away from their customers;
U.S. companies spread their orders across many suppliers, reducing their control over
the suppliers (ownership or otherwise). In addition, for many U.S. manufacturers,
strained global supply lines have further complicated their use of the JIT system. If
conditions fit, however, JIT is an excellent form of inventory control.
To make JIT work, there has to be a philosophical shift in the thinking about the
manufacturing process. “Just in time” implies more than timely deliveries. It assumes
that the design is optimal, the machines are in good condition, the workers are well
trained, scheduling is based on excellent forecasts, and there are no delays along the
entire production line. The goals of JIT are very simple: avoid all disruptions along
the production process, design the process to be flexible so it can accommodate quick
changeovers, reduce setup times, minimize inventory, and eliminate waste.
HUMAN RESOURcES
Human resources are the key to the success of any production and operation system.
A well-trained workforce that understands the entire operations system can be highly
productive, improve quality, reduce downtime, and reduce waste. All functions in an
organization are either handled or managed by people. Therefore, the various tasks in
the operations management area—the decision about where to locate, the processing
of materials, maintaining quality, scheduling the flow of materials, designing layouts,
and managing inventory—are all completed by people.
Human resources planning for POM is similar to planning for human resources
in other functional areas. This area is examined in greater detail in the international
human resources chapter (Chapter 12). That is, in managing human resources, firms
have to draw detailed job specifications, recruit the right people, provide continuous
training, motivate the workforce to optimize their capabilities, empower workers,
provide incentives, evaluate their performance, set up an appropriate salary structure,
and provide a work environment that is interesting and challenging.
OpERATiONS MANAGEMENT STRATEGiES AND SUppLY-CHAiN

MANAGEMENT
For operations management to function efficiently, it needs to be supported by an
equally efficient supply chain. A supply chain is defined as the activities that facilitate
the movement of materials, parts, and other needed supplies for the processing of goods
and services for delivery to the final customer. Supply-chain management improves
the efficiency and effectiveness of a firm’s total operations. Efficient supply-chain
management requires the coordination of all resources that are applied to the supply-
chain activities. As material and transportation costs rise, international companies seek
efficient supply-chain systems to control these costs, which are estimated to be nearly
80 percent of revenues.34 As more and more companies make use of worldwide sup-
pliers, supply-chain bottlenecks can increase operating costs and eat into a company’s
profits.35 In the international context, the supply-chain system assists managers in
acquiring materials and parts from low-cost suppliers that may be located thousands
of miles and several time zones away. For example, Dell Computer Corporation buys
216 CHApTER 8
its supplies from more than 200 suppliers, over half of which are located outside the
United States. More than 50 percent of its major suppliers are in countries in Asia,
12 hours ahead of Eastern Standard Time (EST) in the United States.36
Source management, or sourcing, is the selection and retention of reliable suppliers.
Companies seek suppliers that can offer them the highest quality materials and parts at
the lowest possible cost. For example, since the late 1990s, China has become a major
auto parts manufacturer, supplying auto parts to many major automobile manufacturers.
East China’s Zhejiang province exported $192 million worth of auto parts during the first
four months of 2004.37 Once a good supplier is located, it is important that a company
build a close relationship with the supplier and make it part of its extended team.
For international companies that operate across countries, sourcing strategies
vary from country to country. European companies that supply manufactured parts
to American companies quite often try to locate their facilities closer to the users of
their products. In contrast, Japanese companies prefer to export parts and compo-
nents made outside the United States.38 Sourcing strategies are constantly evolving
due to technological changes, spread of globalization, and open market conditions.
International companies have many more options when it comes to selecting suppli-
ers, and companies try to take advantage of the abundant supplier sources that are
currently available, especially for commonly used materials, parts, and other supplies.
Outsourcing—that is, buying goods and services from outside suppliers, is also a
major part of the supply-chain management system.
Supply-chain management can be divided into sourcing, logistics, management
of suppliers, customer relations management, and continuous improvement of the
system.
SOURcING
Sourcing relates to finding outside suppliers to obtain materials, parts, and supplies
that a firm needs to process its goods and services. It is not economical and in some
instances it is impossible for a firm to make all the materials, parts, supplies, and
services that it needs. For example, it is typically more cost effective and cost efficient
to have the offices cleaned by outside janitorial service companies than to hire work-
ers and manage them internally. Firms focus on their core competencies in managing
organizations, and for IBM, managing a janitorial service to clean its offices does not
fall under its expertise in developing software and computer systems. In sourcing
decisions, international companies focus on cost effectiveness and, at the same time,
maintaining high quality standards. In a global environment, outsourcing has been
extended to include any suppliers in any part of the world that can supply materials,
parts, or services that are either not available locally or can be obtained at lower prices
(a detailed discussion on outsourcing is included in Chapter 9.)
LOGISTIcS
Logistics refer to activities that facilitate the movement of materials, parts, and sup-
plies to processing facilities, as well as activities that deliver the finished goods to
the marketplace. This includes the shipping of materials, parts, supplies, and finished
goods from various locations to storage facilities, processing centers, and end markets.
Logistics also include coordinating the various activities, tracking shipments, and
ensuring safe deliveries of shipments to all the points in the chain. In the international
context, logistics can be troublesome. Materials, parts, and supplies have to travel
greater distances, a single tracking system may not be sufficient, and government
bureaucracy may further complicate the logistical process.
MANAGEMENT OF SUppLIERS
Suppliers are crucial to the success of a supply-management system. The more involved
the suppliers are, the more likely the supply-chain system will function smoothly. Sup-
pliers can be of great help in designing parts and materials, adjusting production to fit
into the processing system, improving the quality of finished items, reducing costs, and
improving reliability. Suppliers should be considered partners and companies should
develop long-term relationships with them. For international companies, managing their
suppliers is challenging, as they may not have the same level of relationships with the
suppliers as the local companies do. In addition, international companies’ supply-chain
systems are more geographically widespread, thereby adding to the difficulties.
CUSTOMER RELATIONS MANAGEMENT

Customer relations management (CRM) is made up of systems developed to learn and
understand consumers by integrating all information about each individual customer
into a database. CRM systems are able to add value to customer transactions by cus-
tomizing some of the activities. Development of CRM systems offers companies fast
access to records of actual customer buying behaviors. The supply-chain management
system through CRM is able to link the manufacturing process to the customer transac-
tion system. Supply-chain management systems can be improved to serve customers
better through CRM systems. Studies have shown that a good CRM system can assist
companies in acquiring and retaining customers. Companies such as IBM, Procter &
Gamble, and Unilever have successfully adopted CRM systems that have provided them
with valuable information about the characteristics and behavior of their customers.
With the help of CRM, the supply-chain management system is able to coordinate a
company’s internal resources and capabilities for more effective and efficient utilization
of its resources.39 For international companies that operate in large markets and where
the local communications and transportation systems are fully developed, use of CRM
has become necessary in a highly competitive environment. In developing countries
with smaller markets and a smaller customer base, international companies do not make
full use of supply-chain management systems, and hence the use of CRM is rare.
CONTINUOUS IMpROVEMENT SYSTEMS

As supply-chain management coordinates the activities of various internal functional
units and external suppliers, it provides opportunities for improving every aspect of the
218 CHApTER 8
system from source to delivery of goods to the marketplace. By analyzing individual

components of the system, managers can focus on those activities that reduce costs and
improve efficiencies. For example, suppose through its tracking system that a company
finds it has a bottleneck at a distribution center. It can immediately study the problem
and try to rectify it instead of waiting for complaints from distributors. Continuous
improvement implies preempting problem situations. International companies do not
apply continuous improvement systems across all countries due to cost considerations
or the marginal benefits derived from such systems in smaller markets. The investments
are not worth the benefits in countries where the markets are not fully developed.
CHApTER SUMMARY
The production and operations management (POM) function transforms inputs into
finished goods and services. Production and operations management concepts and
principles are equally applicable in the service sector and in manufacturing. Because of
the inherent differences between manufacturing and service, some POM applications
may vary in practice. The key difference between the manufacturing sector and the
service sector is in the tangibility of goods in manufacturing versus the intangibility
of the service sector. Therefore, POM concepts are applied differently in manufactur-
ing and services.
The nine key decisions in POM are: location, product offering, process, quality,
layout, scheduling, purchasing, inventory, and staffing. Each element of the decision
process has to be carefully evaluated in setting up the POM operations.
Location decisions are affected by many factors, including labor costs, productivity,
taxes, and quality of life. International companies typically weigh the most critical
factors that affect their firms and/or their industries in arriving at a location decision.
Many international companies use quantitative techniques to arrive at a location
decision that avoids subjective and otherwise biased choices. Similarly, the quality
issue is influenced by many factors, including customer expectations, competitive
environment, and costs. Recently, international companies have adopted more well-
known quality-control techniques, such as total quality management (TQM) and Six
Sigma. These techniques provide management with tools that improve the overall
quality of their goods/services offerings. Many of these techniques assign much of
the responsibility for quality at the lowest level of the assembly by empowering as-
sembly line workers to take the initiative in producing quality products and services.
Quality is achieved by monitoring and evaluating a product or service through each
and every step of the assembly line process.
Every decision in the POM process is important. Therefore, international manag-
ers have to direct each of the steps in POM to offer quality goods and services to
customers.
KEY CONCEpTS
Operations Management in Manufacturing and Service Industry
POM Decisions
Location Decision
Quality Control
Inventory Management
Supply-Chain Management
1. Identify the key differences between the manufacturing sector and the service
sector.
2. Why is manufacturing of goods and services shifting to less industrialized
countries?
3. Identify the nine major decisions to be made in POM.
4. What are the critical factors used by international companies in deciding on
a location?
5. What is upstream distribution?
6. What is downstream distribution?
7. How is the break-even analysis approach used for location decisions?
8. Discuss the factor weights method of selecting locations for setting up foreign
operations.
9. What is process management?
10. Discuss vertical integration.
11. What is TQM, and how is it applied?
12. Why is the Six Sigma approach to quality useful to companies?
13. How do layout choices affect operations management?
14. Discuss make-or-buy decisions.
15. What are some of the newer developments in manufacturing processes?
16. How and why do companies use inventory?
17. Explain the just-in-time (JIT) system of inventory management.
18. What is supply-chain management?
ADDiTiONAL READiNGS
Chase, Richard B., F. Robert Jacobs, and Nicholas J. Aquilano. Operations Management for Competi-
tive Advantage. New York: McGraw-Hill/Irwin, 2004.
Fagan, Mark L. “A Guide to Global Sourcing.” Journal of Business Strategy (March–April 1991):
21–25.
Heizer, Jay, and Barry Render. Production and Operations Management. Upper Saddle River, NJ:
Prentice Hall, 1996.
Krajewski, Lee J., and Larry P. Ritzman. Operations Management: Strategy and Analysis. Upper Saddle
River, NJ: Prentice Hall, 2006.
Stevenson, William J. Production/Operations Management. Chicago: Irwin, 1996.
AppLiCATiON CASE: TOYOTA AND LEAN MANUfACTURiNG

Lean manufacturing helps companies achieve efficiencies far beyond the normal rates
by combining techniques and philosophies in optimizing operations. Lean manufac-
220 CHApTER 8
turing was introduced by Toyota as the Toyota Production System (TPS) to better
compete with its more entrenched and larger competitors from the United States and
Europe. Toyota’s TPS and lean manufacturing systems borrowed heavily from Henry
Ford’s principles of the 1930s.
In the last 10 years, Toyota has been the most successful automobile manufacturer
in the world. In 2007, it surpassed General Motors as the world’s leader in automobile
sales. Toyota’s automobiles are known for their quality, design superiority, and high
profit margins. Because of the efficiency obtained through lean manufacturing, the
company has one of the lowest costs per automobile in the industry—an advantage
that translates into high profit margins. For Toyota, lean manufacturing has meant
lower operating and overhead costs, higher revenues per employee, lead time cut by
over 50 percent, and higher employee satisfaction.
By designing vehicles on common platforms, Toyota is able to change production
runs to suit market and customer needs, as well as to adjust to the supplier logjams
that delay production runs. In its various assembly plants spread throughout the world,
the lean manufacturing systems are practiced without fail.
The principles of lean manufacturing focus on:
• Understanding customers’ needs

• Adhering to continuous improvements in manufacturing and process engineering
• Recognizing and eliminating waste by cutting down on overproduction, reduc-
ing inventory through just-in-time delivery systems, achieving zero defects, and
reducing unnecessary processes
• Motivating the workforce
Lean manufacturing is achieved by:
• Analyzing customers and markets

• Assessing current process and improving on it
• Training the workforce
• Integrating lean manufacturing into every function, including engineering, design,
marketing, R&D, and supply-chain management
• Educating suppliers
• Accepting lean manufacturing as a corporate culture that is driven down from
the top management to the lowest paid employee
SOURcE
Adapted from Process Quality Associates Inc., “Lean Manufacturing.” Available at http://www.pqa.
net/ProdServices/leanmfg/lean.html (accessed March 2008).
9 Global Outsourcing or Offshoring
Europe has only lost eight percent of its jobs due to outsourcing and that’s also a very
important message because the problem is not all about outsourcing. . . .
Europe’s share of global exports has gone up in the last five years and
I think that is a very important message as well.
—Mark Spelman, Chairman, American Chamber of Commerce, Belgium, 20081
LEARNiNG ObJECTiVES
• To introduce the phenomenon of overseas outsourcing as a global trading activity
• To distinguish between offshoring, inshoring and near-shoring
• To examine the growth of the new phenomenon of offshoring services
• To distinguish between Internet technology (IT) and business process offshor-
ing (BPO)
• To understand the advantages and disadvantages of offshoring
• To assess the factors for an effective global offshore strategy
As explained earlier in Chapter 5 on international trade and investments, global trade

has been increasing at an unprecedented pace since the 1950s. More countries than
ever before are engaged today in exports and imports leading to increased income and
consumption globally. The creation of the General Agreement on Tariffs and Trade
(GATT) in 1945, and its successor, the World Trade Organization (WTO), helped spur
the growth by successfully lowering trade barriers among countries. Foreign direct
investment (FDI), the process by which companies set up plants and factories in other
countries, also increased in volume. In the early years after World War II, FDI flowed
from the United States to Europe. As European countries recovered from the war and
demand for both capital and consumer products increased, U.S. firms found it more
convenient to serve the markets by establishing plants overseas rather than exporting
products from the United States. Not only was it economical, but products could be
tailored to local markets and distributed through local channels.
In the 1970s, U.S. multinationals continued to increase their FDI, but this time
to take advantage of the lower cost of production available in developing countries.
The preferred countries were the then newly industrialized countries (NICs) of Hong
Kong, South Korea, Taiwan, and Singapore. The combination of cheap labor and
favorable business climate allowed multinationals to expand production and ship the
221
222 CHApTER 9
output back to the United States. Over time this led to the closure of many plants and
factories in the United States.
When companies opt to locate plants overseas to save costs, it can have a major
impact on the domestic economy. The direct effect is a loss of jobs, especially
if a factory is closed or downsized. A secondary effect is the loss of ancillary
industries that support the main plant or factory, impacting a wider swath of the
local economy.
The loss of manufacturing jobs in the United States accelerated in the 1980s,
when China opened its borders to FDI. U.S. and European companies flocked to
China not only because of the cheap labor but also because of the availability of
natural resources and a strong infrastructure, built by the Chinese government
to attract as much foreign investment as possible. In the United States, the loss
of manufacturing jobs became a politically sensitive issue. Although Congress
made several attempts to dissuade U.S. companies to move overseas, they were
not successful.
In the 1990s, another form of job outsourcing to companies overseas began in the
United States. Service-related, or “white-collar,” jobs began to migrate to develop-
ing countries. The first wave began in the early 1980s, when data-entry jobs were
exported to the Caribbean countries. Airline companies such as American Airlines and
Delta and telephone companies such as AT&T found it cost-effective to ship paper
copies of data to offshore companies located in the Caribbean for input into large
IBM machines. When Internet technology boomed in the 1990s, low-level computer
programming jobs began to be outsourced to such countries as Poland, Romania, In-
dia, and China. In due course, U.S. companies found that they could transfer clerical,
back-office, and call-center work to these countries and take advantage of the lower
wages. With a huge pool of English-speaking engineers, India managed to establish
a lead among all the countries by providing a variety of Internet-technology-related
services to companies globally.
The outsourcing of service jobs to companies overseas has created controversy
again in the United States and Europe. Politicians and labor organizations continue
to condemn multinationals for putting profits first, before labor and local develop-
ment. Research on the effects of overseas outsourcing on the domestic economy is
still in its infancy. Most economists would agree that free trade and open FDI lead
to long-term benefits to all countries, including increased employment and income.
This has proved to be true for the United States, where in spite of the outsourcing of
both manufacturing and service jobs beginning in the late 1970s, the overall rate of
unemployment in the United States has remained low. The highest unemployment
peaked in November 1982 at 10.8 percent and thereafter registered a steady decline,
averaging 5 percent through the 1990s and until 2007. In 2008, unemployment in-
creased dramatically as a result of a financial crisis caused by the collapse of the
housing bubble in the United States. How this crisis, that has spread to countries
globally, affects traditional relationships between FDI, international trade, and out-
sourcing remains to be seen.2
Some economists contend that the loss of manufacturing jobs from developed
to developing countries is inevitable as technical know-how is passed on to these
GLOBAL OUTSOURcING OR OFFSHORING 223
countries and their labor force improves its skills. The low unemployment rate up to
2007 reflected significant flexibility on the part of U.S. labor, which is essential for
adaptation in today’s global market. When manufacturing jobs were lost, U.S. labor
moved to the service sector to compensate for the losses. In contrast, European un-
employment rates have remained high, between 9 and 11 percent, with the exception
of the Netherlands and Ireland. The reasons for the high rates have been attributed to
the labor forces’ lack of flexibility and innovation.3
Before we discuss different aspects of the new form of outsourcing, we define
new terms that have crept into the English lexicon over the past few decades:
offshoring, inshoring, and near-shoring. We begin with the generic term out-
sourcing.
OUTSOURCiNG, OffSHORiNG, INSHORiNG, AND NEAR-SHORiNG

OUTSOURcING
The term “outsourcing” denotes the contracting by a company of selected work, pre-
viously performed in-house, to a third-party vendor. The location of the third-party
vendor is immaterial; it may be domestic or overseas. The work may be relatively
minor and peripheral to the company’s main activity, for example, janitorial services,
facility maintenance, landscaping, or worker training. Alternatively, it can involve
work that is more integral to the core business of the company, such as manufactur-
ing, accounting, payroll, or marketing.
A company may choose to manufacture and assemble all the components of its
product in-house, or it may choose to manufacture only selected components that
are considered noncore elements. Another option, or business model, for a company
is to outsource the manufacturing of all the components and perform only the as-
sembly work in-house. A third possible model is to outsource the design, marketing,
and accounts receivables (collection of payments) services while performing the
manufacturing and operations in-house. Outsourcing can include a combination of
core and noncore activities, and the actual model chosen will depend on the strategic
mission of the company and potential cost savings.
Thus, outsourcing has the following characteristics:
1. The work may be peripheral or integral to the business of the company.

2. The third-party vendor may be located in a domestic or a foreign country.
3. The work may or may not be defined by a long-term contract.
4. The outsourced work may be performed in-house or at the location of the
third-party vendor.
As a result of negative publicity surrounding the practice, the term “outsourcing”

has taken on a narrower definition, referring only to jobs sent overseas. In the business
and academic world, however, to clearly distinguish between kinds of outsourcing
activities and locations, three new words have supplemented the term “outsourcing”:
“offshoring,” “inshoring,” and “near-shoring.”
224 CHApTER 9
OFFSHORING
Since outsourcing can be domestic or foreign, a more appropriate and common term
used today for jobs that are sent overseas is “offshoring.” Offshoring has the follow-
ing characteristics:
1. It includes both manufacturing and service jobs outsourced overseas, although

the term is more commonly used for service jobs.
2. It includes transfer of jobs by companies to their own overseas affiliates man-
aged by their own staff. Such offshore affiliates are called captive firms.
3. It includes offshore work offered to joint ventures, where the company owns
an affiliate in partnership with a local vendor.
INSHORING
“Inshoring,” the opposite of offshoring, is a practice in which companies bring the
job back to the country of domicile. This can happen when companies terminate their
offshoring contracts or close down their captive affiliates.
It also includes jobs sent by overseas vendors back to the United States, the coun-
try that originally provided the outsourcing orders. For example, many large Indian
service vendors that were the beneficiaries of offshoring from U.S. firms have now
opened offices in the United States and employ U.S. workers. There are three reasons
for the growth of inshoring:
1. As overseas vendors perform more complex jobs, they require skilled labor
that is available only in the United States.
2. As overseas wages increase, the cost differential between U.S. and overseas
workers narrows and the offshoring is reversed.
3. Some business models require managers to be posted at client sites in order
to ensure effective communication between the company and the overseas
vendor.
Inshoring is relatively a new term. The volume of inshoring is expected to increase

as the dollar continues to depreciate and the wage differentials between the United
States and offshoring countries narrow over time.
NEAR-SHORING
“Near-shoring” is a practice in which companies send work offshore to countries
that are geographically close. This practice has come about because companies
in the United States are finding that the logistics of managing projects in faraway
countries such as China, India, and the Philippines can be problematic. This is of
particular concern to U.S. manufacturing firms that have sent work offshore to
countries in Asia.
The reasons cited for the preference of near-shoring are as follows:
1. Logistics Costs: Companies that send work offshore to Asia have to pay extra
for transportation costs. The fourfold increase in oil prices in 2008 makes
transportation costs a significant factor, especially for the delivery of heavy
items such as cars, cranes, and the like.
2. Inventory Costs: The amount of inventory a company maintains when work-
ing with an overseas production facility is usually higher the farther away the
location of the vendor. In addition, companies with a single offshore transit
point are vulnerable to disruptions and must also carry more inventory. A
strike by the International Longshore and Warehouse Union on April 7, 2003,
to protest the Iraq war led to delayed shipments that hurt many companies in
the United States practicing lean inventory management.
3. Time Zone: Near-shore countries usually have the same time zone as the
contracting company, which allows for easier management of the offshore
unit. The disadvantage of using a firm in the same time zone is the inability
to get jobs done during off-hours for delivery the subsequent morning.
4. Free-Trade Zone: The signing of the Dominican Republic–Central America–
United States Free Trade Agreement (CAFTA-DR) in 2005 has made it
financially more attractive for U.S. companies to set up offshoring centers in
the near-shore countries of the Dominican Republic, El Salvador, Guatemala,
Nicaragua, Honduras, and Costa Rica.
5. Exchange Rates: As the dollar continues to depreciate, the cost of offshoring
increases, thereby reducing the benefits of sending work overseas. In contrast,
the currencies of nearby countries tend to move together.
The advantages of near-shoring, based on the aforementioned factors, are especially

relevant for the manufacturing industry. The major beneficiaries of near-shoring by
U.S. companies are those countries located in Latin America and South America.
There is talk that Latin America and South America could improve their infrastruc-
tures and labor skills to become the new India and also excel in offering services,
aided in part by their geographical proximity to the United States.4 Similarly, the
beneficiaries of near-shoring by European companies are countries in North Africa
and Eastern Europe.
OffSHORiNG Of SERViCES: INTERNET TECHNOLOGY VS. BUSiNESS

PROCESS OffSHORiNG
Offshoring of services has become an important element of global trading activity.
As a new phenomenon, it is not clear whether the impact of offshoring service jobs
has the same impact as that of manufacturing jobs.
One difference between manufacturing and services offshoring is that the latter has
been spurred by rapid advances in Internet technology. Internet technology makes it
possible to send a wide variety of service jobs overseas, some of which were once
thought immovable and believed to require physical presence at the performance site.
For example, surgeons can now perform delicate operations on patients in another
country using robotics and Internet technology, termed “telesurgery.” A new paradigm
226 CHApTER 9
for global trade and economics may have to be defined as Internet technology changes
the work process to accommodate labor that can be sourced globally.
The new technology offers much more flexibility when a company is developing
a global business model. Companies can now outsource or send offshore any or all
components of the business process. In addition, a company can plan such that a lack
of inventory caused by a disruption in production or service in one country can be
compensated for immediately by a contracted company in another country. Manag-
ing an offshoring project requires a completely new business approach, as it involves
incorporating additional variables such as culture, attitude, work ethic, and leadership
style. Before we discuss the offshoring of services in detail, we define the two most
popular forms of jobs that are offshored: IT and business process.
“Internet technology offshoring,” or “IT offshoring,” is the term used for offshoring
all services related to a company’s use of computers and Internet technology. Most
of these projects involve the development of programs and software for companies,
including customized and automated processes, business applications, web portals,
and scientific equipment. In addition, IT managers of offshore companies work on
in-house program development and maintenance. IT offshoring may be outsourced
to third-party vendors or to a captive subsidiary of the company itself.
IT offshoring services mushroomed in the 1990s as Internet technology became
established in the commercial sector. Shortages of trained programmers in the United
States forced companies to search the overseas market, and India became a popular
destination. Not only was there a large labor pool specialized in engineering, but the
language of instruction in most colleges was English.
In the late 1990s, there was worldwide concern about what was termed as the year
2000 crisis, commonly referred to as the Y2K crisis. The problem stemmed from the
two-digit programming code used in a majority of software for the “year” variable.
For example, the year 1990 was written as “90” and 1980 as “80.” As the year 2000
approached, it was not clear how the programs would interpret the “00”—as “1900”
or as “2000.” This potential problem would affect not only software applications
but many of the algorithms embedded in microchips. Unless the year was specified
clearly, there was a danger that applications would fail to operate on January 1, 2000,
shutting down systems around the globe. Doomsday scenarios were predicted by the
popular press, including the possibility of airplanes failing in mid-flight and nuclear
power plants shutting down.
Private companies and government organizations undertook a major effort to
rewrite critical programs. This rework required a massive amount of labor skilled in
programming, and India was the only country that could supply it at short notice. The
year 2000 proceeded without any major disaster, and it is still unclear whether it was
a real problem and whether the reprogramming averted potential disasters.
An interesting offshoot of this programming effort was that India was ready with a
large pool of skilled labor to provide IT services. Coincidentally, companies throughout
the world had just begun to incorporate IT programs at a rapid pace into their workflow
processes. India benefited the most from this upsurge, as companies began to send their
IT services offshore. In 2007, six major companies in India—Satyam, Wipro, Infosys,
TCS, Cognizant, and HCL (known as SWITCH)—accounted for 2.4 percent of the global
IT services and 3.6 percent of IT services in the United States. They also accounted for
1.9 percent of European IT services, an increase from 1.5 percent in 2006.5
“Business process offshoring,” or BPO, is the term used to denote a variety of work
processes that are outsourced to foreign countries. They include a whole spectrum of
company work ranging from data entry, payroll, human resources, and budgeting
to pension fund management. Broadly speaking, any work process apart from IT
services that can be outsourced to a third-party vendor can be defined as a BPO. BPO
services can be sent offshore to captive companies or to third-party vendors.
BPOs are subdivided into back-office or front-office services.
BAcK-OFFIcE SERVIcES
Back-office activities relate to the business functions of a company that are processed
at the back of the office and usually do not require interaction with customers. The
following are some examples of back-office services that are sent offshore, listed by
type of institution.
Financial Institutions
Commercial banks, investment banks, credit card companies, and other financial
companies perform a range of back-office work at the end of the day. This labor-
intensive work includes recording, verifying, and settling all trades and transactions
incurred during the day. For investment banks, the work involves documenting the
day’s trades made by hundreds of brokers engaged in buying and selling commodities,
foreign currencies, and securities. The back office of American Express, for example,
processes all credit card purchases recorded during the day and updates the statements
of clients worldwide. With Internet technology, these updates now take place in China
and India during the middle of the night in the United States.
Insurance Companies
Every day, insurance companies process thousands of claims by customers, requiring

continuous updates of client records, verification of claims, and payments. In the case
of medical insurance, claims processing requires checking and recording all patient
bills, Medicare payments, and the posting of balances and notices.
Hospitals
Doctors usually use a handheld voice recorder to document the diagnoses of their
patients; these recordings are later transcribed into an electronic or paper format. This
labor-intensive process is now outsourced offshore by a majority of U.S. hospitals
to third-party vendors in countries such as India and the Philippines. Medical tran-
scription, as it is termed, involves a pool of typists located overseas who transcribe
the recordings into electronic documents that are then sent back the United States by
the following business day.
228 CHApTER 9
Other forms of back-office processes include payroll services, human resource

services, legal services, and bookkeeping services.
FRONT-OFFIcE SERVIcES
The front office usually handles sales-related jobs, including marketing, advertising,
account maintenance, and customer support. The majority of front-office BPO services
are performed through call centers that provide support services such as technical
support, customer service, and telemarketing. Call centers require the establishment
of a full infrastructure of trained personnel who are able to make and receive overseas
telephone calls. Computer companies were among the first group of companies to
outsource these services offshore.
Support centers for software- and hardware-related products require a highly
skilled labor force that understands the products thoroughly and are able to answer
all customer queries. The most frequently chosen offshoring destinations are Ireland,
Canada, India, Mexico, Jamaica, and the Philippines. Not only do companies need to
invest heavily in setting up the offices and training the local workers, they also have to
monitor the offshore employees’ progress continuously. An advantage of call centers
located offshore is that they are able to offer customer support services around the
clock. The most popular support services are discussed next.
Customer Service Support Center
Many companies provide customer support services through offshore affiliates or

vendors that are able to respond to basic service requests and answer low-level que-
ries. If a customer’s request requires personal attention or the query is complex, the
call is transferred back to a U.S. call center. The types of companies that have set up
offshore customer support service centers include telephone, insurance, mortgage,
and software companies.
Help Desk
Companies have also established help desks at their offshore locations to provide a
variety of troubleshooting services and assist companies in effectively selling their
products. The initial help desks were set up for computer- and software-related com-
panies. Today, offshore help desks are being created for both consumer and indus-
trial companies. For example, Siemens, a large German multinational, outsourced
their help desk services offshore to Ireland to take advantage of that country’s lower
wages. All queries on a range of consumer products are routed to the company’s Irish
offshore center.
Many companies separate their technical and customer service centers, providing
one resource for corporate accounts and another for individual and home accounts.
Since corporate accounts usually provide larger profit margins, companies may choose
to route business service calls to local centers while serving individual or home ac-
counts with offshore services.
Telemarketing and Sales Calls
Another front-office activity being sent overseas is telemarketing services. Teams of

salespersons in various call centers around the globe call customers in the United States
to sell a company’s services or products. Cost savings has been the primary reason cited
for offshoring telemarketing services. The most frequently chosen destinations for tele-
marketing call centers are India, the Philippines, Mexico, Jamaica, and Canada.
Several types of telemarketing services can be provided by offshoring companies.
The most popular services include:
1. Sales: Call centers are given a list of targeted people to call, and the company’s
product or service is sold directly to the customer. Insurance and mortgage
products, long-distance telephone services, and banking services are often sold
through call centers. Bonuses are typically provided for successful sales.
2. Appointment Setting: Call centers are given lists of targeted people to set up
appointments for the marketing team. This is usually done for products or
services that cannot be sold directly to customers but require negotiations,
pilot projects, or detailed discussions.
3. Lead Generation: Lead generation is perhaps the most difficult of all services
since target customers are not clearly identified and therefore may not expect
the call. Call centers are provided with a general list of companies or phone
numbers, and telemarketers are tasked with generating sales, mostly through
a hit-or-miss approach.
4. Market Research: Call centers perform a variety of analyses required for
market studies. Data is collected through direct phone calls, e-mails, surveys,
or other research. Market research services conducted in this manner include
market profiling, customer satisfaction surveys, competitor evaluations, and
analysis of lost sales and customer retention.
5. Database Update: Companies’ databases, including client lists, office loca-
tions, new employees, or other information pertinent to a business, must be
kept up-to-date. Call centers contact companies, persons, or other entities to
perform the updates to the databases.
The performance of offshore call centers has recently come under criticism due
to an increase in complaints about the quality of service, including callers’ difficul-
ties in understanding foreign operators’ accents. This has led many companies to
reevaluate the benefits and effectiveness of offshoring front-office services. A well-
publicized case is that of the computer company Dell Inc., whose technical support
services came under intense criticism for providing a mediocre level of service. Dell
was forced to reroute most of its corporate client services back to the United States.
Similarly, Conseco, an insurance and financial services firm based in Carmel, Indiana,
purchased an offshoring firm in 2002 with plans to move 14 percent of its workforce
to India. At the end of the first year, it decided to sell the company, citing difficulties
in managing the offshore location.6
However, these failures were short-lived. In due course, both companies reopened
230 CHApTER 9
or expanded their offshoring activities. On April 8, 2008, Conseco awarded a five-year

outsourcing contract to one of India’s largest offshoring companies. In July 2007,
Dell opened a manufacturing plant in Chennai, India, to meet the growing demand
for computers in India. This will be their third plant in the Asia-Pacific region (plants
have already been established in Penang, Malaysia, and Xiamen, China).7
The return can be explained partly by the higher learning curve and migration
pains required when services are outsourced to foreign vendors. With improvements
in the quality of foreign labor, extensive training, and improved delivery by call
centers, both companies have recognized that offshoring in the end pays off with
proper project management. Another reason cited for their return to India has been
the growth in the internal market of India for a range of consumer products and
services as a result of its growing middle class. Companies planning to tap into
this market will have an advantage if they already have established a subsidiary
or office there.
The offshoring of services is expected to grow for the foreseeable future. As discussed
earlier, there is a learning curve when companies send services offshore to countries with
different cultures. Companies have to be patient and should plan on spending sufficient
time to fine-tune the offshoring process if it is to be implemented successfully.
FUTURE Of OffSHORiNG SERViCES

A study by McKinsey and NASSCOM (a trade group representing Indian offshoring
services) concluded in 2005 that India accounted for 46 percent of global BPO services
and 65 percent of IT offshoring services. The total value of these services was expected
to reach $60 billion by 2010. The biggest impediment to the increase in offshoring
was the lack of resources in India to keep up with the expected demand. The study
projected an increase in demand of more than 25 percent per year for the foreseeable
future.8 In the meantime, other countries have recognized the benefits of accepting
offshoring service jobs and are investing heavily in the appropriate infrastructure to
attract them. A 2008 survey by Gartner reported a list of 30 countries that were ac-
ceptable to U.S. companies for offshoring services, listed in Table 9.1. Among the 10
criteria used were language proficiency and availability, including written proficiency
and competency; government support; and potential labor pool.9
The last few years have also seen an increase in companies from Europe, Japan,
Australia, and New Zealand offshoring service jobs. As offshoring becomes an integral
component of multinational planning by non-U.S. firms, the choice of countries will
depend on the language skills (other than English) that can be offered. The follow-
ing is a list of locations with advantages in offering offshoring services in languages
other than English.
1. Northern Ireland: Northern Ireland’s labor force is able to deliver services

in 18 languages throughout Europe and South America. The country’s long
civil war pushed its younger population to study overseas, and over the years
these individuals have returned to their home country equipped with various
IT and BPO skills for offshoring services.
Table 9.1
Thirty Acceptable Countries for U.S. Offshoring Services
Americas Asia-Pacific Europe, Middle East, and Africa

Argentina Australia Czech Republic
Brazil China Hungary
Canada India Ireland
Chile Malaysia Israel
Costa Rica New Zealand Northern Ireland
Mexico Pakistan Poland
Uruguay Philippines Romania
Singapore Russia
Sri Lanka Slovakia
Vietnam South Africa
Spain
Turkey
Ukraine
Source: Denise Dubie, “Gartner: Top 30 Offshore Locations for 2008,” Network World, May 20,
2008. Available at http://www.networkworld.com/news/2008/052008-gartner-top-offshore-locations.
html?page=1.
2. South Africa: South Africa’s long history with the Netherlands allows the
country to provide services in Dutch.
3. Brazil: Brazil has the largest Japanese population outside of Japan and has
been effective in servicing Japanese projects.
4. Dalian, China: Dalian, a city in northeast China, has a large Japanese-speaking
population; Japan occupied it in 1895 and later leased it from China until
1945.
5. Guatemala: Guatemala has a bilingual population that can provide services
in both Spanish and English.
6. Algeria, Tunisia, and Morocco: Their long history with France has provided
all three countries with a large educated population that is capable of provid-
ing a variety of services in French.
China is touted as the next country to dominate the offshoring market for services
as it possesses the requisite infrastructure and labor. Although offshoring of manu-
facturing services to China is expected to continue and grow in the near future, it is
facing strong competition from other countries. Wage inflation and strains on China’s
infrastructure are also expected to exert a downward pressure on its growth. A recent
scandal involving lead found in children toys and the discovery of diethylene glycol
in toothpastes from China created a massive recall by many toy makers and dental
product manufacturers. The Chinese government has acted swiftly to curb the abuses,
but they have exposed the vulnerability of the country’s dependence on the manufac-
turing sector. The Ethical Corporation reported that FDI to China from the European
Union fell 29.4 percent in 2007; from the United States during the same period it fell
12.8 percent.10 As a result, China is focusing on efforts to increase its capabilities in
232 CHApTER 9
offering offshoring services. A recent report in McKinsey Quarterly predicted that if

China pursues an aggressive strategy, the value of the offshore services sector could
reach $56 billion by 2015.11
TOWARD A GLObAL OffSHORiNG STRATEGY

Although U.S. companies have been outsourcing work offshore for more than three
decades, with Europe and Japan following shortly thereafter, offshoring is still a new
phenomenon for a majority of companies. This is because the process of offshoring
is more complicated than that of domestic outsourcing. First, the company has to
ensure that the offshoring is consistent with its strategic objectives. Second, it has
to ensure that the organizational structure is in place to handle the flow of commu-
nication between the United States and overseas offices. Third, the company has to
ensure that the workflow from offshore units is fully integrated into the domestic
business units.
Once the decision has been made to send work offshore, the following steps must
be followed to ensure successful implementation.
1. Determine those sectors that should be outsourced domestically and those that
should be sent offshore. The following factors have to be considered for the offshor-
ing of any manufacturing or services jobs:
• Critical Functions: Identify noncore and core services. Core services are those
that can cripple a company if the offshoring fails or if there is an interruption
in delivery; for example, the failure to deliver components can halt work in an
assembly line.
• Domain Expertise: Estimate the level of difficulty for the foreign vendor to ac-
quire the company’s domain expertise. If it can be copied and duplicated easily,
it may be too risky to offshore.
• Scalability: Identify offshored services that can be scaled up in the event they
are successfully implemented. A what-if scenario analysis can help determine
the best time to expand or opt out of offshoring.
2. Perform a cost-benefit analysis for offshoring the services. This can be a tricky
task, as a complete and thorough analysis requires reliable and detailed information
on offshoring costs. A number of factors have to be taken into account when under-
taking the analysis:
• Single or Multiple Vendors: A company must choose between employing single

or multiple vendors. The advantages of using a single vendor are lower costs
as a result of economies of scale and easier communications management. A
disadvantage is the potential bottleneck that may occur if there is a failure in the
delivery of services by the single vendor.
• Captive or Third-Party Vendor: Costs will be affected by whether the company
sets up its own office or plant (captive unit) or outsources the work offshore to
a third-party vendor. In general, it is more expensive to set up a captive center,

but a captive center provides more control over the management and execution
of projects.
• Large or Small Vendor: It is important to evaluate potential vendors thoroughly.
Large vendors usually have the expertise to provide the required services and
additional skills that can benefit a company. However, they are typically more
expensive and may be bureaucratic. Not only may small vendors be cheaper, but
they usually provide more attention to a company’s requirements. In all cases, it is
essential that the vendors have the capacity to perform the requested services.
3. Implement the process slowly and ramp it up in tandem with the success of each leg of
the project. The following issues need to be considered for successful implementation.
• Establish a set of criteria to measure the progress or success of each leg of project.
This will include a timetable for completion of projects with a reasonable time
allotted for the learning curve.
• Create and assign the appropriate personnel responsible for managing each of the
projects outsourced or sent offshore. For large and multiple projects, the person
in charge should be the chief technology officer (CTO) or the chief information
officer (CIO).
• Perform periodic evaluations based on the established criteria to recommend
continuation or abandonment of the projects.
ADVANTAGES AND DiSADVANTAGES Of OffSHORiNG SERViCES

It is difficult to measure the gains or losses from offshoring services to both the sending
and receiving countries. Research has only recently begun on the impact of offshoring
of services, and the issue continues to be influenced by the politically sensitive nature
of the topic. Labor groups and politicians of sending countries see offshoring as a net
loss to society; critics find it easy to bolster their case by highlighting the losses to
the local economy without looking at the overall picture. Similarly, most economists
and business professionals see offshoring in a positive light but tend to underestimate
the impact of job relocations, labor anxiety, and lack of worker commitment that can
negatively impact the economy in the long term. The following points highlight some
of the observable gains and losses to both the receiving and sending countries.
Receiving Country
At first glance, it would seem evident that the country receiving the offshoring services
is always a net beneficiary. While this may not always be true, some of the possible
positive impacts are:
1. Offshoring increases employment and generates income to the economy.

2. Offshoring leads to the development of ancillary industries, contributing
further to the growth and income of the economy.
234 CHApTER 9
3. Over time, the skills and talents acquired while providing the offshoring ser-
vices are turned inward to serve the growing internal market and help propel
the country to the next level.
Negative impacts include the following points:
1. Offshoring may increase the wage rates in the economy, usually as a result
of a shortage of skilled labor to meet the growing demands of the offshoring
market. Both China and India are examples of countries that are experiencing
double-digit wage increases as a result of the growth in offshoring activities.
As companies compete to attract a limited number of skilled workers, upward
pressure on wages can affect other sectors of the economy.
2. Offshoring may lead to increases in inflation rates as a result of the growth
in purchasing power of a growing middle class. The increased offshoring to
India and China has resulted in the development of sizable middle classes in
those countries. India experienced 8 percent inflation in 2007, while China ex-
perienced 4.8 percent inflation in 2007, well above the targeted 3 percent.
3. Offshoring can lead to a growing disparity in income and living standards
between the urban and rural sectors of the country. Both China and India are
witnessing this phenomenon, which has resulted in an accelerated migration
of people from rural to urban areas. If the income inequality is not contained,
it could lead to social unrest.
4. The high wages and inflation rates eventually force companies to search for
other countries to meet their needs for offshoring services.
In sum, receiving countries have to be careful to manage the growth of their

economies, as offshoring generates income and employment. Policies have to be put
in place to prevent high wages, price inflation, uneven development, and currency
appreciation. This requires that resources be allocated in a well-balanced manner.
The government has to balance its infrastructure spending between supporting the
offshoring industry and supporting other population groups in the country.
SENDING COUNTRY
A report in 2005 by the General Accountability Office (GAO), an independent U.S.
government agency that provides objective research and information for Congress,
reported the following benefits and costs to the United States as a result of the send-
ing services offshore in recent years.12 Costs include:
1. Offshoring leads to downward pressure on wages and reduces the standard

of living in the sending country.
2. Offshoring leads to job losses and increases the unemployment rate in the
sending country.
3. As wages decline and profits increase for shareholders, offshoring may widen
income inequality in the sending country. Shareholders stand to benefit the
most when jobs are sent offshore. The flexibility provided to companies with
offshoring opportunities can only result in continual downward pressure on
local wages.
4. Offshoring may impact national security, as transfer of technology enables
other countries to specialize in products that are important for a country to
maintain its lead in critical sectors. An often-used example is the loss of the
semiconductor industry to foreign companies in 1985, when there was over-
production around the world. A sudden shortage of processor chips can have
a devastating effect on a range of industries.
Offshoring may lead to loss of privacy as personal data is passed on to vendors

in countries that have lower standards of corporate governance. This is of particular
importance because of the increase in the offshoring of financial institutions’ back-
office functions from the United States to foreign countries. The Gramm-Leach-Bliley
Act of 1999 mandated that banks take adequate precautions to maintain the privacy
of their clients’ personal data. The Federal Banking Agencies (FBA), consisting of
the Office of the Comptroller of the Currency, the Board of Governors of the Federal
Reserve System, the Federal Deposit Insurance Corporation, the National Credit
Union Administration, and the Office of Thrift Supervision, recently issued tougher
guidelines to cover the work performed by service providers located offshore.
However, offshoring has its benefits, as well:
1. Offshoring increases productivity and, in the long run, increases real wages. If
companies increase productivity by offshoring, the benefits should also accrue to the
company’s remaining workforce.
The GAO report states that total labor compensation as a percentage of net income
in the United States declined from 66 percent in 2001 to 64 percent in 2004. In addi-
tion, wages and salaries declined from 55 percent of net income in 2001 to 52 percent
in 2004. It is not yet possible to conclude whether offshoring depresses wages in the
receiving country. More data is required to infer the impact of offshoring on wages
and salaries.
2. Offshoring does not reduce employment; rather, it increases it in the long run.
Long-term unemployment has remained steady in the United States despite the mi-
gration of manufacturing jobs to foreign countries. The U.S. unemployment rate has
fallen from 5.8 percent in 2002 to 4.6 percent in 2007. Critics have argued, however,
that the unemployment rate by itself may not be a good indicator, as the standard of
living may be lower due to lower real wages and purchasing power.
3. Offshoring leads to lower prices and inflation, enabling U.S. consumers to have
more opportunities to increase consumption.
Most economists would agree that offshoring reduces prices and benefits consum-
ers in the long run. Wal-Mart is a classic example of how imports from China have
managed to keep inflation rates in the United States low for decades. It is estimated
that Wal-Mart is China’s eighth-largest customer, ahead of Russia and Germany.13 It
is somewhat of a paradox that Wal-Mart is the favorite shopping center for a majority
of America’s middle- and low-income population while being equally responsible for
the loss of millions of jobs in the United States.
236 CHApTER 9
Table 9.2
U.S. Inflation Rate, 2000–2007
Year Inflation Rate Year Inflation Rate

2000 3.38% 2004 2.68%
2001 2.83% 2005 3.39%
2002 1.59% 2006 3.24%
2003 2.27% 2007 2.85%
Source: U.S. Bureau of Labor.
Inflation rates, according to the U.S. Bureau of Labor Statistics, for the years 2000
to 2007 are listed in Table 9.2. Although inflation rates increased in 2008, this increase
cannot be blamed on offshoring; rather, steep increases in energy prices and global
food shortages are mostly responsible for the upward trend.
There is sufficient evidence to indicate that offshoring leads to higher wages, lower
prices, and higher productivity for the sending country in the long run. As in the case
of the receiving country, it is necessary for policies to be put in place to ensure that
the short-term effects of offshoring on income and employment are not disruptive.
Appropriate policies have to be established to ensure that the country remains com-
petitive in the long run.
ORGANIZATIONAL STRUcTURE IN OFFSHORING

There are several ways for companies to structure their offshoring projects when they
go overseas. They can set up captive units or joint ventures, or contract out to direct
or indirect third-party vendors.
Captive Units
A firm may decide to pursue offshoring services on its own and set up a captive unit;
in other words, the firm will own and manage the overseas company. Companies can
start from scratch or purchase a local company to form the captive unit. Setting up
a captive unit is the equivalent of FDI. Just as IBM may choose to open a factory in
Belgium, a bank may choose to set up a unit or purchase a vendor in another country
to perform its business processes. The unit will hire local labor to perform the services,
while senior management may be sent to the site from the parent company.
Joint Ventures
In a joint venture, a firm teams up with a local company to form an offshore af-
filiate and provide offshoring services. The agreement may restrict the type of
offshoring activities that can be performed by the joint venture; for example, it
may not be permitted to offer services similar to those performed by the firm’s
competitors. Control is usually shared equally. Over time, if the joint venture is
successful, the firm may acquire the remaining ownership of the local company.
The model, termed “BOT” (build, operate, and transfer), has been used success-
fully by many companies.
For example, in May 2008, Barclays Bank decided to set up a 5,000-seat captive
unit in India to perform BPO services. Barclays had originally invested 50 percent in
a local company called Intelenet Global Services. It had asked the company to build
a 1,000-seat unit and operate it on Barclays’ behalf until it purchased the unit. How-
ever, in this particular case, Barclays decided not to take the transfer (purchase the
company) but instead decided to build its own.14 One reason cited was data security,
and this concern has led many other banks—including Citibank, American Express,
Standard Chartered, Deutsche Bank, and HSBC—to set up their own captive units
in India.
Direct Third-Party Vendors
The other approach for offshoring is to contract the jobs to third-party vendors. There
are many benefits to using third-party vendors.
1. It requires no investment in infrastructure.

2. With lower overhead, the risk is lowered. If the offshoring is a failure, the
investment losses will be borne by the vendor.
3. It allows a company to choose among the best vendors.
4. If the vendors implement the projects successfully, they can be acquired later
and integrated into a captive unit.
The disadvantages are the following:
1. The company must transfer technology and other know-how to a third-party

vendor, who may use it for their other clients.
2. Costs may be higher when compared to a company setting up its own captive
unit.
3. Without complete control of management of the offshoring unit, the company
faces the risk of delays and nonimplementation.
4. Personal data and privacy may be compromised.
In the initial years of offshoring, most companies preferred setting up captive units
in India. However, as wages and attrition rates increased in response to the fierce
competition for talented workers, the average cost has continued to rise. In May
2007, a study by Forrester Research showed that even though 300 firms had opened
captive firms in the previous two years in India, 60 percent of them were struggling
with managing them.15 It predicted that by 2010, 40 to 60 percent of them would
select one of four possible exit strategies:
1. Exit from the offshoring business completely. The prediction is that 10 percent
of the exiting firms will choose this option.
238 CHApTER 9
2. Engage in a hybrid strategy where firms outsource some of the work and
reduce the overhead of the captive unit. About 25 percent of the exiting firms
are expected to choose this option.
3. Adopt a termite approach, where captives partner with vendors and hollow out
the center, leaving only project management functions for the parent company.
About 40 to 50 percent of exiting firms are expected to choose this approach.
4. Outsource all the jobs to offshore units and close the captive unit. About 10
percent of the exiting firms are expected to follow this approach.
In a subsequent study by Everest Research Group in September 2007, a poll of 102

executives from 56 firms yielded different results. Although some major firms are
expected to exit the Indian market, most plan to stay and expand their captive offices.
In 2002, among the Forbes 200 companies, 44 firms had established captive centers
in India; that number increased to 71 in 2003 and to 110 in 2006.16
Indirect Third-Party Vendors
Some companies outsource jobs to domestic companies that, in turn, have offshoring
offices. Indirect third-party vendors provide advantages and disadvantages similar to
those provided by direct offshoring, with the exception that the job is made easier be-
cause the contracting company has to communicate only with the domestic outsourcer.
Care has to be taken to ensure that the relationship between the domestic outsourcer
and its affiliate overseas is sound, reliable, and effective. It may be risky if the domestic
outsourcer is using multiple vendors overseas instead of owning its own affiliate.
WHIcH COMpANIES DO THE MAJORITY OF OFFSHORING?

Although a large number of firms have begun to send service-related jobs offshore to
India, China, the Philippines, and Mexico, the number of firms sending work offshore
is still a very small percentage of the total. A survey by Robert Half in January 2008
of 1,400 chief information officers shows that only 5 percent of them have sent tech-
nology jobs offshore. Companies with more than 500 employees were more likely
to send work offshore, accounting for 11 percent of this group. About 43 percent of
the companies that are presently outsourcing plan to increase their offshoring, while
13 percent plan to decrease it.17
The National Academy of Public Administration published a report in 2006, commis-
sioned by U.S. Congress and the Bureau of Labor Statistics of the Department of Commerce,
on the activity of offshoring services between 1998 and 2004. The panel concluded that:
1. The outsourcing of services to domestic companies between 1998 and 2004

far outstripped the offshoring of services to overseas companies.
2. Offshoring levels in all industry groups were very small during this period.
3. No consistent pattern of growth of offshoring services could be found among
the industries. In fact, there was substantial variation among industries and
across time.18
One therefore has to keep the total picture in perspective when evaluating the offshor-
ing phenomenon. Even though offshoring is increasing in volume, it still is and probably
will remain a small component of total service activity in the United States.
Europe is expected to catch up with the United States in terms of offshoring services.
Strong unions and a business culture that focuses on maximizing stakeholder rather
than shareholder wealth had European companies less enthusiastic about offshoring
jobs. However, with the enlargement of the European Union to 27 countries and the
growth of European markets in developing countries, companies are now beginning
to send services offshore. A 2007 Gartner study predicted that offshoring from Eu-
rope will increase by 60 percent in 2008, with the preferred destinations being India,
China, Russia, and Brazil.19
In the United States, government agencies have also been offshoring some of their IT
services in spite of complaints from several protectionist lawmakers. This issue became
a politically sensitive topic during the presidential election year of 2004. Two states,
New Jersey and Arizona, prohibited the offshoring of government-related work. It is not
clear whether laws banning offshoring are in the best interest of the states’ citizens.
To highlight the issue, assume that a state awards a two-year contract worth $3.75 million
to an offshore company for processing work. Assume the lowest domestic bid is $5 million,
meaning the offshore company saves the state 25 percent. The $1.25 million saved allows
the state to hire or retain approximately 25 individuals for a year at $50,000 per year. Thus,
the decision not to offshore should be based on real long-term costs and benefits.
A 2006 report by the GAO stated that 43 of the 50 states and the District of Colum-
bia sent some work offshore. The types of work sent to offshore locations included
software development and assistance in managing the food stamps program, unem-
ployment insurance, and other temporary assistance programs.20
REASONS TO GO OFFSHORE
There are several reasons for a company to go offshore, with cost being the dominant
factor. Other factors include access to talent, flexibility, and market penetration.
Lower Costs
Lower costs are the primary reason for offshoring projects. However, cost alone is
not sufficient to justify offshoring, as other factors have to be considered, including
an ability to maintain the business model for an extended period of time. This is es-
pecially true for projects that require multiyear implementation and maintenance.
Access to Talent
Many companies are finding a large pool of well-trained engineers and technicians in
offshoring countries that are otherwise unavailable in the home country. The new term
for this kind of offshoring is “BKO,” or business knowledge offshoring. Those firms that
have made offshoring a success with noncore activities are most likely to move to the
next step of knowledge offshoring, which includes R&D and product design work.
240 CHApTER 9
Flexibility
An outsourcing or offshoring model provides flexibility to companies because it

requires lower investments and overhead. It allows companies to ride through peak
and trough cycles with fewer disruptions. It also allows firms to ramp down during
changes in market conditions without incurring much severance pay. Finally, it enables
companies to spread their risks and focus on their core missions.
Market Penetration
A number of firms are now strategically looking to integrate their offshoring activi-
ties with long-range marketing plans to penetrate developing countries. As China and
India become major consumers, companies are finding it strategically important to
set up subsidiaries and offices in these countries in order to establish their presence.
The process is similar to the FDI strategies adopted by the United States in Europe
and by the Japanese in the United States. These investments eventually led to large
markets for the firms as consumer spending increased in their favor.
A 2007 study by PricewaterhouseCoopers of 226 senior executives of private com-
panies and service providers revealed seven reasons to outsource and send some of
their services offshore. About 51 percent of the companies had revenues in excess of
$1 billion. The service providers were located in China, India, the United States, and
the United Kingdom.
Reasons to Offshore
Lower costs (important or very important) 76 percent
Gain access to talent 70 percent
Farm out activities that others can do better 63 percent
Increase business-model flexibility 56 percent
Improve customer relationships 42 percent
Develop new products or markets 37 percent each
Geographic expansion 33 percent
The executives also highlighted the obstacles to outsourcing and offshoring.21
Reasons Not to Offshore

Proving cost benefit 48 percent
Lack of experience 48 percent
Company values favor using in-house employees 45 percent
Lack of skills in managing outsourcing 37 percent
Need to clean up operations before outsourcing 37 percent
Ethics of moving jobs offshore 22 percent
Concerns about public reaction 21 percent
In sum, larger companies are the major users of offshoring of both manufactur-
ing and services to overseas countries. Cost is the major factor in this decision, but
other factors such as access to talent, expertise, and increased business flexibility are
a close second.
CHApTER SUMMARY
The growth of offshoring manufacturing to developing countries began with the open-
ing of plants and factories in Europe by U.S. multinationals. Later, U.S. companies
moved to developing countries to take advantage of cheap labor and a favorable
business climate. Offshoring of manufacturing increased in pace when China opened
its borders to FDI in the late 1970s. In the 1980s, a new form of offshoring began to
take place—that of service, or white-collar, jobs. This service offshoring was made
possible by the rapid advances in Internet technology.
The two major types of offshoring services are IT offshoring and business process
offshoring. The offshoring of IT services began in the aftermath of the Y2K problem,
as U.S. companies found a ready pool of programmers overseas, primarily in India.
In due course, companies started sending offshore services related to the various
workflow processes; this practice was termed business process outsourcing, or BPO.
BPO services were classified into back-office and front-office services, both of which
are popular today. Among front-office services, call centers that make and receive
calls are the most popular and continue to flourish in spite of some negative publicity
generated through to customer complaints.
The decision to use offshoring must be planned carefully by the company. A number of
issues must be considered prior to beginning any offshore project. They include identify-
ing which jobs should be outsourced, evaluating the likelihood that the company’s domain
expertise may not be duplicated, choosing to go with a single or multiple vendors, and
estimating the costs and benefits of each leg of the offshoring process. The company also
has to ensure that the organization is staffed appropriately to handle the communication
and flow of work between the parent and offshore affiliates. Finally, a set of criteria has
to be established to monitor the progress and success of the offshore projects.
There are several advantages and disadvantages in offshoring services to overseas
affiliates or vendors. For the receiving country, the benefits are increased employment
and income to the economy. The negative impacts include high wages and inflation.
For the sending country, the negative impacts include the short-run loss of jobs and
downward pressure on wages. The long-run benefits, however, may be higher income
and employment. For both countries, it is necessary that government policies not
oppose offshoring, but it is important that the governments manage the offshoring
process intelligently, and avoid disruption of their respective domestic economies.
There are four major ways to structure offshoring projects: through captive units,
joint ventures, direct third-party vendors, and indirect third-party vendors. Each struc-
ture offers different costs and benefits, with captive units providing the most control
and the use of indirect third-party vendors providing the least. The most expensive
choice is for a company to set up its own captive unit, while the most cost-effective
choice is to go directly to third-party vendors.
242 CHApTER 9
The reason to go offshore is usually motivated by cost reductions. However, other

factors include access to talent, flexibility to manage the business, and integration
with the company’s long-range strategic market penetration.
In sum, the global outsourcing or offshoring of both manufacturing and services
will continue to increase in the near future. This phenomenon can be compared to the
growth of FDI after 1945, when U.S. companies set up plants and factories overseas
initially to serve local markets and later to take advantage of lower costs. In the 1990s,
the next wave of offshoring service, or white-collar jobs, began to grow in volume
and breadth. As Internet technology continues to innovate, the kinds and forms of
offshoring services will continue to grow and evolve to incorporate all forms of busi-
ness activity. In spite of this growth, offshoring of services will remain only a small
part of a country’s total service activity.
KEY CONCEpTS
Global Offshoring
Business Process Offshoring
Internet Technology Offshoring
Global Offshore Strategy
1. What factors led to growth in the outsourcing of manufacturing from the
United States to developing countries? What is the difference between FDI
made by the United States to Europe and that made to developing coun-
tries?
2. Distinguish between manufacturing and service offshoring. Provide some
examples.
3. Why did India become a favorite destination for U.S. companies to outsource
IT services offshore?
4. Distinguish between the offshoring of IT services and business processing
offshoring (BPO).
5. What is the impact of services offshoring to the domestic economy?
6. Compare offshoring, inshoring, and near-shoring. What are some of the
characteristics of offshoring and inshoring?
7. What reasons are offered for the growth in near-shoring?
8. What was the Y2K problem and how did it spur the offshoring of IT services
overseas?
9. Define business process outsourcing, or BPO. Provide some examples of
back-office services that are sent offshore by U.S. companies.
10. Explain the front-office services provided by BPO firms. How are they dif-
ferent from back-office services? Have the front-office BPO services to India
been successful?
11. What factors need to be considered in deciding whether to send any business
processes offshore to an overseas affiliate or vendor?
12. What changes need to be made to the internal organizational structure if a

firm decides to send work offshore?
13. What are the different structures that can be set up for offshoring projects
overseas? What are the pros and cons for each method?
14. What are some of the reasons for companies to send services offshore? What
are some of the reasons for not offshoring services?
AppLiCATiON CASE: EVALUESERVE AND KNOWLEDGE

PROCESS OUTSOURCiNG
The outsourcing of services to India and other developing countries began with
Internet technology (IT)–related projects in the 1980s. Most of the jobs focused on
providing direct and indirect support to the IT departments of large companies in the
United States and Europe. The work entailed writing software programs to run hard-
ware effectively, creating and maintaining Internet sites, and developing application
software. Business process outsourcing (BPO) evolved as the next growth industry
as companies outsourced the development of complex systems to streamline, auto-
mate, and standardize their workflow processes. Beginning in 2000, BPO services
gave way to knowledge process outsourcing services (KPO), defined as the delivery
of customized and complex processes requiring advanced analytical and specialized
knowledge unique to each project.
The number of companies that outsource KPO services to India come from a
variety of industries. In the pharmaceutical industry, specialized services outsourced
by U.S. and European companies include clinical trials, research and development,
genetic engineering, treatment of new diseases, and biotechnology design. In the
financial services industry, outsourced projects include market research, stock
analyses, risk management and economic analysis. In the area of legal services,
outsourced work to India includes reviewing litigation reports, performing due
diligence on a variety of contracts, researching past cases, and drafting preliminary
analyses and contracts. A common denominator for the success of KPO projects is
the recruitment of skilled personnel holding advanced degrees in science, medicine,
the humanities, and management. India possesses a natural advantage by having
large pool of English-speaking people with a variety of advanced degrees from
hundreds of universities.
One leading KPO firm is Evalueserve, founded in 2000 by Alok Aggarwal and
Marc Vollenweider. Aggarwal earned his Ph.D. in computer science from Johns
Hopkins University and joined IBM in 1984. He went to New Delhi, India, in 1998
to head the IBM India Research Laboratory, which he started while working in the
United States. Vollenweider received his M.B.A. from INSEAD (a graduate business
school in France) and joined the management consulting firm McKinsey & Company
in Switzerland, where he became a partner in 1998. The next year he moved to India
to become the head of the McKinsey Knowledge Centre in Delhi.
Vollenweider was recruiting a number of experts for McKinsey to perform market
analytics and business research to service their clients around the world. His depart-
ment grew from 12 to 125 MBAs in the span of a year. Aggarwal was recruiting
244 CHApTER 9
students with doctorates and master’s degrees to perform a variety of tasks for IBM.
His department grew from nothing to 70 employees in a similar period. Both recog-
nized that the demand for individuals with advanced degrees from India would grow
substantially to satisfy the growing need for advanced analytical work for industries
in the West. A chance meeting in early 2000 resulted in both quitting their jobs in
November 2000 to start Evalueserve with the mission of serving clients worldwide
on specialized and complex projects. After a few difficult years, the company grew
to over 2,500 professionals in 2008.
The KPO sector in India is currently worth about $4 billion but is expected to
reach $10 billion by 2012.22 The industry currently employs 40,000 individuals, but
demand is expected to grow to 100,000 by the year 2012. However, there are several
problems facing KPO industries in India, including Evalueserve.
One such problem is a shortage of talent. As the number of KPO firms has increased,
the available pool of professionals in India has not been able to keep up with demand. The
country is also facing stiff competition from Russia, the Philippines, Pakistan, Malaysia,
Egypt, and Indonesia—nations that are also producing advanced graduates in record
numbers. Evalueserve has opened offices in Russia, Romania, and Chile to diversify
their talent base as one strategy to ensure a steady supply of qualified employees.
Another problem in India is the high attrition rate that has become endemic in
this industry. As companies compete for the limited amount of talent, labor costs
have increased exponentially, making it difficult for companies like Evalueserve to
maintain their cost advantage. In a recent interview, Aggarwal cited “job hopping”
as a serious concern for Evalueserve as employees continue to jump jobs, sometimes
four to five times in a few years.23
Data security and the release of proprietary information is another problem. KPO
services usually require clients to divulge confidential information on their core ac-
tivities and their domain expertise. This is different than outsourcing BPO services,
where the outsourced work is usually peripheral to the company’s core activities. A
leakage of KPO information to a client’s competitors can be potentially damaging—
if not catastrophic—requiring firms like Evalueserve to design and implement the
highest level of security and risk management practices.
The 2008 economic slowdown in the United States and Europe provides some in-
teresting challenges to the KPO industry in India. If the slowdown reduces demand for
their services, Evalueserve may use this opportunity to consolidate its operations and
focus on strategies to combat labor shortage and improve security systems. On the other
hand, it is possible that the slowdown may increase business as Western companies seek
to further reduce their costs. Evalueserve may have to scale up their operations more
than anticipated while simultaneously solving the aforementioned problems.
QUESTIONS
1. How is knowledge process outsourcing (KPO) different from the other forms of
services provided by outsourcings firms in India and other emerging countries.
2. What suggestions can you provide to Evalueserve to resolve their labor short-
age and security concerns?
10 The Foreign Exchange Market
The currency depreciation that we have experienced of late should

eventually help to contain our current account deficit as foreign producers
export less to the United States. On the other side of the ledger, the current account
should improve as U.S. firms find the export market more receptive.
—Alan Greenspan1
LEARNiNG ObJECTiVES
• To understand the role of foreign currencies in international trade
• To comprehend the historical use of money and foreign exchange as a medium
of exchange
• To appreciate the growth of the foreign exchange market into the largest financial
market in the world
• To examine the factors that affect foreign exchange rates
• To understand the importance of foreign exchange markets to multinational
corporations
If goods are purchased by a citizen of one country, with one currency, from a citi-
zen of another country, with a different currency, the buyer in most cases prefers to
make the payment in his or her own currency. This requires an exchange of currencies
from that of the buyer to that of the seller. The purchase or sale of any goods from a
citizen of one country to a citizen of another will always result in two simultaneous
transactions:
1. Physical exchange of the commodity

2. Purchase or sale of a foreign currency
The purchase or sale of the foreign currency affects only one of the parties in the
exchange. If an American importer purchases US$100,000 worth of goods from a
Japanese manufacturer and the invoice is billed in Japanese yen, the burden falls on
245
246 CHApTER 10
the American importer to purchase Japanese yen to complete the transaction. If the
contract is invoiced in U.S. dollars, the Japanese seller is responsible for converting
the American dollars that were received into Japanese yen to complete the transac-
tion. The party that has to convert the currency takes the risk that the exchange rate
on that date of conversion is favorable to that party.
The venue for the purchase and sale of foreign currency is the foreign exchange
market. The dynamics of international business cannot be appreciated without a
thorough knowledge of the structure and workings of the foreign exchange market.
This is all the more important today, as foreign currencies can be delivered in multiple
formats: wire transfer, credit card, letters of credit, and other special instruments.
Corporate managers engaged in exports and imports must be aware of all the avail-
able alternatives and evaluate their costs and benefits if they are to select the most
appropriate methods of payment.
DEfiNiTiON Of FOREiGN EXCHANGE

A foreign exchange rate refers to the price an individual pays in one currency to pur-
chase another currency. A currency is similar to any other commodity, such as gold
or food; its price is determined by the demand and supply for the commodity. Just
as a fisherman quotes US$2 for a pound of fish, a foreign exchange dealer quotes a
price for the purchase or sale of another currency. If a dealer quotes US$1.25 / €, he
or she is quoting US$1.25 for the purchase or sale of €1.
The foreign exchange can also be quoted with the dollar as the unit of commod-
ity; in other words, instead of dollars per euro, the cost can be quoted in euros per
dollar. The rate per dollar is the inverse of the rate per euro, in our example, €0.80
per US$1.
1 / 1.25 = €0.80 / US$1
This is similar to changing the fisherman’s quote from $2 per pound of fish to half
a pound of fish per dollar, that is, from US$2 / pound to ½ pound / US$1.
In the foreign exchange markets, the two forms of quotes are defined as direct or
indirect:
Direct quote = HC / FC
Indirect quote = FC / HC
where HC = home country and FC = foreign currency.

For example—If the direct quote for an American investor is US$2.00 / €1, then
the direct quote for a German investor is €0.50 / US$1.
If the indirect quote for an American investor is €0.50 / US$1, then the indirect
quote for a German investor is US$2 / €1.
Note that a direct quote for an American investor is an indirect quote for a Ger-
man investor.
THE FOREIGN EXCHANGE MARKEt 247
Question: What is the direct quote for a Japanese investor who wishes to pur-
chase the euro if the indirect quote is €0.006 / ¥1?
Answer: The direct quote for a Japanese investor is ¥ / € or 1/0.006 =
¥166.67 / €1.
Hints: To type the symbol € using your keyboard in Windows OS, with the
number lock on, press ALT and 0128.
To type the symbol ¥ using your keyboard in Windows OS, with the
number lock on, press ALT and 0165.
Exchange rates are available for either immediate delivery or for future delivery.
A spot rate is the price of a foreign currency for immediate delivery. Until recently,
immediate delivery in the United States meant two days for most currencies and one
day for Canadian dollars. Assume you purchased €100,000 in exchange for dollars at
a spot rate of US$1.21 for a total of US$121,000. The actual deposit of the $121,000
and €100,000 into the respective bank accounts takes two days because of the time
required for confirmation and initiating the transfer, a process defined as clearing
and settlement.
Advances in online technology have now made it possible for a spot transaction to
be settled on the same day it is made. The CLS Group (Continuously Linked Settle-
ment; www.cls-group.com) is a consortium of the world’s largest banks that is able
to settle all spot transactions on the same day for more than 50 currencies. The goal
of the group is to offer same-day settlement and clearing services for all currencies
in the world.
A forward rate is the rate for the purchase or sale of a foreign currency for delivery
at a future date. For example, a trader agrees to purchase €100,000 from another dealer
for a price agreed upon today, for delivery to take place in three months. No money
is exchanged today. At the end of three months, both traders are obligated to deliver
as promised. In every other feature, the forward rate is similar to the spot rate. The
most common periods for forward currencies are 30-, 60-, and 90-day deliveries.
APPRECIaTION aND DEPRECIaTION OF CURRENCIES

In all competitive markets, prices play an important role in equating supply and demand
for any product. If prices increase, demand for the commodity declines and supply of
the commodity increases, resulting in a new equilibrium price. In the short run, price
changes can cause disruptions in the production of output and services, while in the
long run, demand and production will adjust to the new price levels.
To understand the effects of price increases and price decreases of foreign curren-
cies, it is first necessary to formally define currency appreciation and depreciation.
If the price of the euro increases, that is, moves from US$1.20 / € to US$1.25 / € to
US$1.30 / €, the dollar is said to be depreciating, or, conversely, the euro is said to
be appreciating. If the price of the euro decreases, that is, moves from US$1.20 / €
248 CHApTER 10
to US$1.15 / € to US$1.10 / €, the dollar is said to be appreciating, or, conversely,

the euro is said to be depreciating. One way to remember the difference is based on
whether the buyer has to pay more or less for a currency. Paying more implies hardship
and therefore can be associated with a depreciation of the currency. If an American
pays less for a foreign currency, one can consider that as good news and recognize
that the dollar has appreciated.
A depreciating dollar is a boon to an American exporter, because it reduces the
effective price to the foreign buyer of American commodities. To illustrate:
Assume the current or spot price of the euro is US$1.20 / €.

Assume the price of a candy bar in the United States is US$1.20.
Assume the price of a candy bar in Germany is €1.
Assume now the dollar depreciates drastically (for illustration purposes) to US$2.40 / €.
A German can now purchase two candy bars from the United States for €1.
Thus, whenever the dollar depreciates, U.S. goods become cheaper for German
importers and exports will increase from the United States.
The opposite is true for an American importer; that is, a depreciating dollar will
have a negative impact. Using the same numbers as above, assume the importer has
been purchasing candy bars from Germany at a price of €1.00, or US$1.20, each. If
the dollar depreciates to US$2.40 / €, then the U.S. importer has to pay two times
more to purchase the euro in order to import one candy bar from Germany.
As shown above, changes in the price of currency have opposite effects on
exporters and importers. When the dollar depreciates against the euro, it has a
positive effect on U.S. exports but a negative effect on German exports. A depre-
ciating dollar is equivalent to an appreciating euro to a German exporter. When
the price of the euro goes from US$1.20 / € to US$2.40 / €, it becomes twice as
expensive for an American importer to purchase commodities from Germany.
Hence, German exports will fall. However, the depreciating dollar will be a boon
to a German importer because he or she can purchase twice the amount from the
United States per dollar.
Question: Assume the exchange rate between the Norwegian krone (KR)
and the Brazilian real is NK2.5/real. Assume the export price of
a particular brand of Adidas shoes from Norway is NK700. If the
exchange rate changes to NK3.5/real, has the Norwegian krone
depreciated or appreciated? Will the exports of shoes from Norway
increase or decrease?
Answer: Since more Norwegians krones are required to purchase one Brazilian
real, the Norwegian krone has depreciated (and the Brazilian real has ap-
preciated). This will make Norwegian shoes cheaper for Brazilians, and
exports of shoes from Norway should increase. A pair of these Adidas
shoes will now cost the Brazilian buyers 200 reals instead of 280.
THE FOREIGN EXcHANGE MARKET 249
Table 10.1
Partial List of Major Currencies and Rate against the U.S. Dollar
Rate on
Country Currency Alphabetic Code Numeric Code March 21, 2008
Afghanistan Afghani AFN 971 48.599/$
Australia Australian dollar AUD 036 1.1150/$
Austria Euro EUR 978 0.6371/$
China Yuan renminbi CNY 156 7.0525/$
France Euro EUR 978 0.6371/$
Kuwait Dinar KWD 414 0.4190/$
India Indian rupee INR 356 38.96/$
Norway Norwegian krone NOK 578 5.2614/$
Russian Federation Russian ruble RUB 643
Source: Exchange rates from XE—The World’s Favorite Currency and Foreign Exchange Site, available
at http://www.xe.com. (accessed March 21, 2008). The alphabetic and numeric codes shown in Table 10.1
have been compiled by the International Standards Organization (ISO, www.iso.org). The ISO is comprised
of the national standards institutes of 157 countries, and its mission is to develop a set of standards for various
business activities, to make it easier for firms to operate in a global environment. Based in Geneva, Switzer-
land, it is a nongovernmental body that began by establishing standards for the electrical and engineering
fields and later expanded to include all kinds of industrial services.
Note: The exchange rates shown are direct rates for each country
MAJOR CURRENCiES Of THE WORLD

Most countries issue their own currencies, which come in all sorts of shapes and
colors. A partial list of the major currencies and their rates against the dollar is shown
in Table 10.1.
Most of the currency names originated with the “weights” used to measure silver or
gold. For example, the dollar came from the word thaler, from the city of Joachimsthal
in modern-day Bohemia, where the coins, minted by the Count of Schlick, were trusted
by traders for their consistency and uniformity. As a result, the “thaler” circulated
extensively in Europe. The pound is another unit of weight, as are the lira (from the
Latin libra, a unit of weight) and peso (from Latin pensum, meaning weight). The
Indian rupee came from the Sanskrit word rup, meaning silver, and the Israeli shekel
referred to the weight for a given quantity of silver.
THE EURO
The euro is an exception in that it was created recently by design and with the consent
of participating countries in the European Union (EU). For the first time in history,
countries volunteered to give up an existing currency to create a common currency.
The euro began in 1999 as the currency of 11 EU countries (Belgium, Germany, Spain,
France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal, and Finland),
and was joined by Greece in 2001.
The history of the euro dates back to 1957, when the Treaty of Rome established
plans for the creation of the European Economic Community. Further integration
250 CHApTER 10
continued in small steps until the Maastricht Treaty agreement in 1992 paved the way
for the creation of a common currency. A set of criteria was agreed upon for member
countries to fulfill prior to adopting the euro, including having stable inflation and
interest rates, deficit spending of less than 3 percent, and total public debt at below
60 percent of GDP. By 1999, with the exception of Greece, all countries managed
to stay within the prescribed targets. On January 1, 1999, the exchange rates of 11
countries were locked in at the predetermined rates. Greece managed to fulfill the
minimum criteria to join the group in 2001. On January 1, 2002, the currency of all
12 countries was officially changed with the issuance and distribution of the new cur-
rency. In January 2007, Slovenia adopted the euro, followed by Malta and Cyprus in
January 2008. On January 1, 2009, Slovakia adopted the Euro and became the 16th
country to join the Euro club.
Most economists agree that the euro has been a great success, which bodes well
for the ultimate creation of a single global currency.
HiSTORY Of FOREiGN EXCHANGE

Prior to 800 B.C.E., bartering was the principal means of exchange of goods, with
cattle and grain serving as the mediums of exchange between neighboring com-
munities. The rate of exchange depended on the demand and supply of the goods at
the time of the transaction. If harvest in a given year was weak, less grain could be
exchanged for cattle or any other product. If fishing in a given season resulted in a
large harvest, more fish would be exchanged for other goods, especially since fish is
a perishable product.
Bartering has the disadvantage that the goods have to be physically transported for
the exchange to take place. As trade within and between city-states increased and the
distances between them widened, it was a natural evolution for traders to settle on a
common currency to serve as a medium of exchange. Precious metal was an obvious
choice since it was available universally and was transportable.
The first coins were minted in electrum (a combination of silver and gold) in Asia
Minor around 650 B.C.E. Later Greece and other city-states began minting their own
coins as well, and the process of exchange within a city-state was consequently made
simpler.2 However, a problem with the use of metal coins was the difficulty in verify-
ing the purity of the coins, usually gold or silver. Coins coming from kingdoms that
minted them in pure gold or silver were sought after, such as those made by Croesus
of Lydia in 550 B.C.E. Unfortunately, this was not the norm for most periods. City-
states could mint pure coins only if they had sufficient gold or silver to produce the
needed amount of coins. When a city-state did not have sufficient pure metals, often
in times of wars, the coins were debased, as in the regimes of Nero in C.E. 60 and
Henry VIII in the mid-1500s.
Debasement has two effects:
1. It leads to the hoarding of pure coins, which leaves only debased coins in
circulation. Such a phenomenon, termed Gresham’s law, essentially states
that bad money drives out good money.
2. It leads to inflation because more coins are printed relative to the amount of
reserves.
In a monetary system where coins of precious metal are used as a currency of ex-
change, foreign exchange rates are influenced more by debasement than by the real
demand and supply for the coins. If pure gold or silver coins are used as a medium of
transaction, the coins’ country of origin does not matter; they can always be melted
down and sold again. The value of the exchange depends on the amount of expected
debasement, determined at the venue of exchange.
The two commodities that ultimately became the common denomination of ex-
change were gold and silver, for several reasons:
1. Scarcity: unavailable in abundance, requiring huge investments to extract

2. Divisibility: can easily be melted and shaped to any required quantity
3. Homogeneity: homogeneous and malleable
4. Durability: does not lose luster over time
5. Transportability: easily transported
6. Consistency: no variation in composition
The scarcity of gold eventually led to it being preferred over silver as a reserve
currency.
PApER MONEY
The determination of foreign exchange became more complicated with the advent of
paper money, introduced first in China as early as C.E. 800. Marco Polo brought the
concept to the West in the late 1200s, but its use as a currency did not become popular
until the 1600s. The acceptance of paper money requires a much stronger trust in the
issuer, since paper money could become worthless overnight.
In a world of paper money, the exchange of foreign currency requires two
things:
1. Confidence that the paper currency can be exchanged for something valuable,
such as gold or silver, on demand
2. Confidence by both the buyer and seller that the paper currency will maintain
its value over time without a loss in purchasing power
The risk of paper currency becoming worthless overnight was a major reason why
its acceptance was often limited to the local geographic area in which it was issued.
Rarely was paper money accepted outside a country. In the United States, this concern
continued right up to the twentieth century because the issuers of notes were usually
private banks, which could fail and close down overnight. An additional problem was
the counterfeiting of money, which was rampant at times in many countries.
As an example, the Massachusetts Bay Colony, one of the 13 original colonies, is-
sued the first paper money in the New World in 1690 to finance military expeditions.
252 CHApTER 10
When the colonies were banned from printing currencies by the British government
in 1764, the Continental Congress reissued new currency in 1775 to finance the
Revolutionary War. It lost value soon after, however, because of counterfeiting and
the lack of assurance that it would be repaid in gold or silver.
Congress tried twice to set up central banks, once in 1791 and again in 1816, but
both ventures were short-lived. In 1861, when the government ordered the U.S. Trea-
sury to issue noninterest-bearing demand notes, termed “greenbacks,” the currency
finally stabilized. To this day, all notes issued after 1861 can be redeemed at full face
value. In 1913, the Federal Reserve Act created the Federal Reserve Board (the Fed)
to oversee the U.S. monetary system and authorized it to issue all notes. Once cred-
ibility was established, the exchange rate for the dollar depended less on speculation
and became a function of demand and supply.
The history of the central bank in Britain is somewhat different. The Bank of
England was established in 1694 as a private bank to manage the accounts of the
monarchy. It also did commercial business by accepting deposits and issuing its own
handwritten notes. As a result of its close relationship with the monarchy, the Bank of
England was regarded by many as an (un)official central bank. Indeed, during major
crises, it served as the banker of last resort and issued credit by handwritten paper
that was redeemable with gold or coinage. The bank was nationalized in 1946.3
GOLD STANDARD
One way for a government to instill confidence in its currency is to state its value in
terms of gold or silver. The gold standard, sometimes supplemented by silver, has
been the mainstay for foreign exchange pricing for more than 200 years. The gold
standard was adopted informally as early as 1717, when Sir Isaac Newton was the
master of the mint in England. But the gold standard in conjunction with bank notes
became popular only in the early 1800s, with England formally adopting it in 1821,
followed by Germany in 1875, France in 1878, the United States in 1879, and Russia
and Japan in 1897.
Here is a simple way to understand how the foreign exchange rate is determined
under the gold standard:
• Assume the U.S. government announces that it will always be prepared to ex-
change one ounce of gold for $35.
• Assume the UK government announces that it will always be prepared to exchange
one ounce of gold for £17.50.
• If traders trusted both governments to stick to their pledges, the exchange rate
would be set at:
£1.00 = US$2.00 (US$35 / £17.50)
Trust is a key ingredient in the effective working of a gold standard system. To achieve
this trust, it is necessary for governments to print only as much currency as can be
supported by the gold it holds in reserve.
THE FOREIGN EXCHANGE MARKET 253
What happens when traders lose faith in a government to back its currency with
gold? For example, assume the UK government is unable to stick to its pledge of
converting its pounds to gold on demand. Investors holding pounds will start selling
their notes in exchange for gold. As investors rush to the Bank of England to demand
gold, the country will be left with fewer gold reserves, which will force it to print less
money. Investors will also be unwilling to trade at the old price of US$2.00 / £1, and
the value of the dollar will increase in relative terms. In other words, the exchange
rate will move from US$2.00 / £1 → US$1.90 / £1 → US$1.80 / £1 as traders are
willing to accept fewer dollars to get rid of their pounds.
When will the dollar stop appreciating or, equivalently, when will the pound stop
depreciating? According to the classical theory of the price-specie-flow mechanism, the
flow of gold determines the final equilibrium price. As gold flows from one country to
another, the receiving country will be able to print more banknotes, which in turn will
lead to high inflation. Over time, the receiving country will see an increase in imports
and a decrease in exports, allowing gold to flow back to the original country.
If equilibrium is not restored automatically, the country could officially change
the price of gold. In the earlier example, England could increase the price of gold to
£20 per ounce. This action effectively devalues the pound, and the new exchange rate
will be US$35 / £20 = US$1.75 / £. However, until the beginning of the twentieth
century, most countries were reluctant to use this method as a means to devalue their
currency, mainly for reasons of national pride and a belief that a strong currency is
a sign of national strength.
The gold standard served as the basic framework for foreign exchange transac-
tions throughout the 1800s. When gold and silver were convertible to currency, it
was termed the bimetallic standard. By 1870, nearly all countries in the West had
converted to the gold standard, and it flourished well until 1914. The advent of World
War I forced all countries to abandon their pledge to convert gold to currency. After
the war, many countries returned to the gold standard, but the turmoil and chaos that
followed this period resulted in many countries abandoning it soon after.
THE BRETTON WOODS SYSTEM (MODIFIED GOLD STANDARD)

During the interwar period leading up to World War II, there were major breakdowns
in exchange rate management. Several countries, hoping to stimulate exports and im-
prove their balance-of-trade, devalued their currencies, with the result that exchange
rates fluctuated abruptly, trade further slowed, confidence in all currencies declined,
and global depression deepened and spread.
As World War II was drawing to an end, economists were concerned that the mistakes
made during the interwar period should not be repeated. Under the new system agreed
upon in Bretton Woods, New Hampshire, the United States proposed to guarantee the
convertibility of the U.S. dollar at $35 per ounce of gold (at the end of the war, the United
States held approximately 60 percent of the world’s gold). Other countries were to peg
the price of their currency to gold, although they were not required to offer convertibility.
No country could devalue its currency without the collective permission of all countries.
The International Monetary Fund and the World Bank (officially the International
254 CHApTER 10
Figure 10.1 Foreign Exchange Rates: United States vs. Foreign Countries
4.0
3.5
3.0
Exchange rate
2.5
2.0
1.5
1.0
0.5
0.0
80
82
84
86
88
90
92
94
96
98
00
02
04
06
19
19
19
19
19
19
19
19
19
19
20
20
20
20
Brazil Canada Japan Singapore Australia Euro
Source: Author complied data from the Federal Reserve Board of St. Louis Foreign Exchange database,
available at http://research.stlouisfed.org/fred2/ (accessed October 22, 2008).
Bank for Reconstruction and Development, or IBRD) would provide short- and
long-term financing to ensure that countries were able to maintain currency stability
while promoting growth.
The modified gold standard system of Bretton Woods worked very well in the
aftermath of the war. European countries were able to restore faith in their currencies
and allow convertibility in 1959. Unfortunately, the system was ultimately abandoned
because of a lack of trust in the United States to guarantee full convertibility. Contin-
ued deficits and the inability to control spending in the 1960s meant that not enough
gold was available to the U.S. government to support the dollars circulating outside
of the United States. On August 15, 1971, President Richard M. Nixon closed the
so-called gold window.
FREE-FLOATING EXcHANGE RATE SYSTEMS

The breakdown of the modified gold standard was in some ways a boon to the develop-
ment of the modern international financial system. The aftermath led many countries
to float their currencies, that is, to allow their value to be determined by supply and
demand. Unfortunately, this meant that exchange rates were more volatile than when
the rates were fixed. The increased volatility can be troublesome to businesses whose
sales or purchases are denominated in other currencies, especially if the movements
are temporary.
The United States was one of the few countries that strictly adhered to the doctrine
of free float and rarely intervened to stabilize the exchange rates. As a result, U.S.
exchange rates have been extremely volatile since the 1980s, as shown in Figure 10.1.
In contrast, the European countries continued on a path of managed floating, which
meant that although the currencies were allowed to float, the governments ensured
that they stayed within a fixed band of 2.5 percent against the dollar. If they fell
outside this band, the government would intervene to bring the exchange rate back
to within the specified band. This has led to a more stable environment for European
companies operating in international markets.
SiZE Of THE FOREiGN EXCHANGE MARKET

The foreign exchange market is one of the largest markets in the world, with approxi-
mately $3 trillion traded every day. The Bank for International Settlements (BIS),
based in Basel, Switzerland, and considered the central bank of central banks, tracks
the daily trades of the exchange market among the global banks. A country’s central
bank is usually the monetary authority that implements the country’s monetary policy,
including printing and issuing money. Table 10.2 summarizes the total volume of
foreign exchange transactions traded in U.S. dollars in 1995, 2001, and 2007.
The average daily turnover in 2007 was approximately $3.2 trillion per day, nearly
68 percent more than the 2001 volume of $1.90 trillion. The most common form of
transaction was the foreign exchange swap, where the spot is sold against the forward,
assuring the dealer a fixed spread. The most common forward rates are 30-, 60- and
90-day contracts. The next most common currency transaction was the spot transac-
tion. In the recent past, spot transactions took two days for final settlement, except for
those in Canada, which took one day. However, with the advent of electronic trading
and competition, most spot currencies are now delivered on the same day.
The dramatic increase in trading per day makes the foreign exchange market one
of the largest in the world. It reflects the growing importance of overseas trading for
all countries and the interdependency of the world community. Such high volumes of
transactions require an efficient mechanism and institutional structure to be in place
globally if the markets are to function smoothly. The foreign exchange infrastructure
today is extremely well developed, making it one of the most efficient markets in
the world.
The major players in the foreign exchange market are the large international
banks. There is no centralized location for trading. Instead, banks throughout the
world purchase and sell foreign exchange via telephone, fax, and the Internet. The
purchase or sale of foreign exchange can be classified into two categories: wholesale
and retail. A majority of the trading is in the wholesale market, where banks purchase
or sell deposits in minimum amounts of $5 million. The rest of the trades are made
by corporations and individuals.
Table 10.3 shows the daily foreign exchange turnover by country. The largest
market by volume is London, followed by New York and Tokyo. Other cities where
active foreign exchange activity takes place include Sydney, Hong Kong, Singapore,
Paris, and Frankfurt.
256 CHApTER 10
Table 10.2
Global Foreign Exchange Market Turnover
Amounts are daily averages in April, in billions of U.S. dollars.
1995 2001 2007

Spot Transactions 494 387 1,005
Outright Forwards 97 131 362
Foreign Exchange Swaps 546 656 1,714
Total 1,190 1,900 3,210
Source: Bank for International Settlements; Triennial Central Bank Survey, “Foreign exchange and deriva-
tives market activity in 2007,” December 2007, p. 4. Available at www.bis.org (accessed June 16, 2008).
Table 10.3
Foreign Exchange Market Turnover by Country
Amounts are daily averages in April, in billions of U.S. dollars.
2001 2007
Amount Percent of total Amount Percent of total
United Kingdom 504 31.2 1,359 34.1
United States 254 15.7 664 16.6
Japan 147 9.1 238 6.0
Source: Bank for International Settlements; Triennial Central Bank Survey, “Foreign exchange and deriva-
tives market activity in 2007,” December 2007, p. 6. Available at www.bis.org (accessed June 16, 2008).
Commercial Banks account for a major portion of the foreign exchange activity. In
2007, 12 banks in the United Kingdom and 10 banks in the United States accounted
for over 75 percent of the total turnover in the country. These ratios have declined in
recent years due to consolidations in the banking industry. In 1998, the numbers were 24
percent and 20 percent, respectively.4 However, with Internet technology, more alterna-
tive platforms of trading are emerging, and the dominance of banks may be reduced, as
smaller, more focused, and specialized companies encroach on their markets.
DETERMiNATiON Of FOREiGN EXCHANGE RATES

This section examines the factors that affect the prices of foreign currencies. The
primary reasons for prices of foreign currencies to increase and decrease are similar
to those of every other product—changes in demand and supply. Some variables that
affect demand and supply are common to most currencies, while others are unique
to the country of origin.
In a perfectly competitive market, prices move in anticipation of changes in demand
or supply. As a result, information plays a major role in the pricing of currencies,
in both content and timing. A small country that does not trade much may have few
traders specializing in that currency. With fewer traders, price changes may be slow
and infrequent. In contrast, if hundreds of traders participate actively in the market,

the price of a currency can move up and down in near unison as no single trader
wants to be left behind. The most liquid currencies in the world are the U.S. dollar
and the euro.
For a truly free floating exchange rate regime, where prices are determined solely
by demand and supply, it is necessary for foreign exchange markets to operate without
government intervention or institutional restrictions. Such markets do not exist today,
because most countries impose some form of restriction on the transfer of foreign
currencies. In the United States, it is not possible for individuals to open foreign cur-
rency accounts overseas or write checks in foreign currencies.
Countries that earn a limited amount of foreign currency through exports are usu-
ally the ones that impose the most restrictions. This allows them to allocate the scarce
foreign exchange to industries of economic importance. For example, a small country
earning scarce foreign exchange through the sale of one commodity may allow the
imports of capital goods but ban the imports of luxury goods.
Such barriers to the free movement of foreign currencies distort currencies’ true mar-
ket prices. As a result, forecasting exchange rates is complicated and requires a broad
understanding of the market environment in which foreign exchange is traded.
The following factors play a major role in the determination of foreign exchange
rates for all countries.
INFLATION RATES
The difference in inflation rates between two countries affects the foreign exchange
rates between two countries. The country with the higher inflation rate will experi-
ence a depreciation of its currency relative to the other country, a phenomenon termed
“purchasing power parity.”
INTEREST RATES
Since interest rates and inflation rates go hand in hand, the relationship is similar to
that of inflation rates. Ceteris paribus, the country with the higher interest rate should
see its currency depreciate relative to the other country.
EXpORTS AND IMpORTS
If a country is successful at exporting, it has the ability to earn more foreign ex-
change. If all other things remain unaltered, higher exports increase the demand for
that country’s currency, causing it to appreciate against the dollar. Assume China’s
exports to the United States continue to increase. The increased demand for Chinese
yuan (renminbi) to pay for Chinese goods will lead to an appreciation in the Chinese
currency unless the government intervenes to prevent it.
Conversely, when a country imports more goods than it exports, its demand for
foreign currencies will increase and its currency will depreciate relative to those of
other countries. Take the example of Brazil and Mexico. Mexico is a major exporter
258 CHApTER 10
of oil, while Brazil is a major importer of oil. Oil is priced in dollars. When oil prices
increase, Brazil has to purchase more dollars to pay for the oil. Mexico will receive
dollars for its sale of oil. As a result, ceteris paribus, the Brazilian real will depreciate
against the dollar when oil prices increase, while the Mexican peso will appreciate.
PARTiCipANTS iN THE FOREiGN EXCHANGE MARKET

The major participants in any trading market are the actual users and suppliers of
the commodity. Also included are middlemen, or traders, who link the suppliers
to the users. Together, these participants determine the demand and supply of the
commodity.
Take, for example, a fish market. The suppliers of fish range from individual fisher-
men to companies with vessels that catch large quantities of fish. The buyers of fish
range from restaurants and supermarket chains to large food companies. The major
transactions take place at wholesale markets, and the large number of buyers and
sellers ensures liquidity and depth in the market. In addition, there are speculators
who purchase and sell fish for the purpose of making quick profits. The presence of
speculators also adds depth to the market in that trading activity increases, with trad-
ers able to request prices from more sources. When trading is active, the likelihood
of price distortion is minimized.
The foreign exchange market is very similar to the commodities markets. The only
difference is that foreign exchange is not directly consumable but rather allows for the
purchase of a consumable product or service. As discussed earlier, all transactions are
conducted via phone, faxes, or the Internet. Once a deal is agreed upon, the exchange
actually takes place by way of a transfer from one bank account to another.
The major participants in the foreign exchange markets are commercial and
noncommercial banks, nonbank brokers, central banks, and corporations and
individuals.
COMMERcIAL AND NONcOMMERcIAL BANKS

Commercial and noncommercial banks are some of the largest players in the foreign
currency markets. Commercial banks are depository institutions that accept deposits
from individuals and corporations and convert them to loans. Well-known commercial
banks include JPMorgan Chase, Bank of America, ABN AMRO, and Barclays. Non-
commercial banks are investment banks that underwrite securities, trade shares, and
provide corporate advisory services, as well as insurance companies that have large
foreign exchange desks. Examples include Oppenheimer Holdings, Lazard Capital
Markets, and Brown Brothers Harriman.
These institutions usually have large trading floors where they buy and sell foreign
exchange both for their clients as well as for their proprietary trading. Most of the larger
banks in major cities are market makers for different currencies, while smaller banks
serve as brokers between their clients and the larger banks. The difference between
market makers and brokers (for any commodity) is described below.
Market makers are always willing to buy or sell a currency. For example, if a bank
is a market maker for the Japanese yen, it must be prepared to buy and sell yen at all
times. Market makers do not charge commission; rather, they make their profits on
the spread between the buy and sell (ask) prices. They are expected to quote irrespec-
tive of market conditions. As a result, they are expected to hold some inventory of
the currency.
Brokers are intermediaries that connect buyers and sellers. They earn their income
purely through commissions and, as a result, are not required to hold inventory.
NONBANK BROKERS
Several large specialized brokers in the foreign exchange markets play an important
role in the smooth trading of currencies. Some of the better known brokers include
HIFX Plc, Tokyo Forex & Ueda Harlow Ltd, and Tullet Prebon. The advantage of
using a broker in selling or purchasing foreign currency is that brokers are able to
provide a range of quotes from different market makers. This also enables companies
to keep their trades anonymous, which can be useful especially when large trades are
to be executed. Usually, when the market realizes that a party is selling a large block
of a currency, the price tends to get depressed.
CENTRAL BANKS
Central banks of all countries are also major players in the foreign exchange markets.
Central banks have an obligation to keep their currencies stable, especially from
speculators who may inject wide swings to currencies prices—a phenomenon known
as volatility. To avoid excessive volatility, central banks may intervene by buying or
selling foreign currencies. For example, if the Federal Reserve Board decides that the
current price of dollar against the euro, say US$1.35 / €1, is weak, it can offset this
imbalance by purchasing dollars from the market. If a significant amount of dollars is
removed from the market, the scarce dollar will induce traders to offer fewer dollars
per euro. This should result in a dollar appreciation, for example, from US$1.35 / €1
to US$1.25 / €1 to US$1.20 / €1, and so on.
CORpORATIONS AND INDIVIDUALS
Another group of purchasers and sellers of foreign exchange are individuals and cor-
porations. Corporations that export and import are active participants in the foreign
exchange market. Individuals, on the other hand, are usually small-time purchasers,
most often for their travels overseas as tourists.
EXCHANGE RATE REGiMES

As described earlier, the breakdown of the Bretton Woods system induced several
countries to adopt a freely floating exchange rate regime. The European countries
formed an alliance and adopted the European exchange rate mechanism, which
required countries to manage exchange rates to reduce volatility. The world today
260 CHApTER 10
is divided into countries that have either fixed exchange rate or floating exchange
systems. Most central banks continue to monitor their exchange rates, even if they
prefer that rates be determined by market forces.
FIXED-RATE REGIMES
In today’s fixed-rate regimes, countries do not peg their rates to a commodity such as
gold or silver; rather, they peg them to another more stable and stronger currency. A
majority of countries, including many of the Arab states, have pegged their rates to
the dollar, while others have pegged to the euro or yen, or to a basket of currencies.
China, which has pegged its currency to the U.S. dollar for a long time, has recently
committed to freeing its exchange rates, albeit slowly. There are pros and cons to
pegging the exchange rates to one currency.
Assume a country such as Kuwait fixes the rate at 3 dinars to a dollar (KD3 / US$1).
In a fixed-rate system, it is the responsibility of the government to ensure that the rate
does not deviate from KD3 / US$1 plus or minus a few basis points. Assume that the
country increases its imports, thereby increasing the demand for dollars against the
dinar. Ceteris paribus, that would mean the dinar will have pressure to depreciate,
that is, to KD3.10 / US$1 to KD3.20 / US$1 to KD3.30 / US$1. The Central Bank
of Kuwait will have to sell dollars from its reserves if it chooses to stop this decline
and return the price to KD3 / US$1. If the bank runs out of dollars to continue this
intervention, it will be forced to devalue its currency to a higher rate, perhaps KD3.30
/ US$1. In a fixed exchange rate regime, the responsibility to maintain the exchange
rate at a predetermined level can impose a burden on the country.
FLOATING-RATE REGIMES
In a fully floating and free regime, exchange rates are determined purely by supply
and demand for the currency. Few countries allow absolute freely floating rates. The
United States, considered one of the few countries to rarely interfere in the exchange
rate, has intervened occasionally to stabilize exchange rates. The intervention is un-
dertaken by the Federal Open Market Committee of the Reserve Bank of New York
and the Department of the Treasury. They do not attempt to affect the price of the
currency but to avoid excess volatility in the markets. This is different from interven-
ing to maintain the currency within a stated rate.
Many countries, including those of the European Union, prefer to float their foreign
exchange rates but intervene to keep the rates within desired ranges so as not to cause
major volatility. This system is referred to as a “managed float.”
MULTiNATiONALS AND FOREiGN EXCHANGE

Understanding the foreign exchange market is extremely important for all firms that
engage in international trade, whether they are large multinationals or small firms.
Exposure to foreign currency risks can significantly affect a company’s cash flows.
Foreign exchange also affects a company’s pricing decisions, which in turn can affect
the demand for the company’s products. A financial manager has to monitor the market
continuously and forecast the direction of the exchange rates. However, forecasting of
exchange rates is both a science and an art that requires a much broader understanding
of the forces affecting exchange rates in a dynamic global environment.
The following is a list of areas where foreign exchange plays a role in affecting
business decisions.
PRIcING OF PRODUcTS
When a company plans to sell or purchase goods from another country, it is very
important to predict the expected foreign currency prices several years ahead. A
wrong prediction can lead a company to price its product low and sell at a loss. For
example, assume a company sells a product for US$100 in the United States and
plans to export the goods to the United Kingdom. If the exchange rate is currently
US$2 / £1, it may seem appropriate to export the product at a price of £50. However,
if the dollar appreciates in the future and the exchange rate changes from US$2 / £1
to US$1.75 / £1 to US$1.50 / £1, then the amount received by the company for the
products sold in the United Kingdom will be lower: £50 × US$1.50 = US$75, which
will result in a loss for the company.
Managers have to make assumptions on expected future exchange rates and price
their products accordingly. One way for managers to obtain expected spot rates is
from forward rates. If traders in the market expect rates to be US$1.50 / £1 one year
from today, the one-year forward rate is likely to be in the vicinity of US$1.50 / £1.
Several studies have looked at whether forward rates are unbiased predictors of the
expected spot rates in the future. The results have been mixed. Nearly all studies
have found forward rates to be unreliable predictors in the short run, but some studies
have found them to be reliable in the long run. Several reasons have been offered to
explain this anomaly. In the short run, new information can change the spot prices
from the expected prices. In the long run, the models should include a risk premium
that is demanded when investing over a longer time horizon.
PRIcING OF RAW MATERIAL

The purchase or import of raw materials or other inputs from overseas presents ex-
change rate risks similar to those posed by the export of products overseas. In this
case of imports, a depreciation of the dollar will increase the cost of purchased goods.
For example, assume a U.S. company imports raw materials from Malaysia at a rate
of US$0.25 per ringgit (RM). If the dollar depreciates to US$0.30 / RM1, and then
to US$0.35 / RM1, the cost of the imports will increase, and the company may be
better off seeking alternative sources.
In today’s global markets, even a company that does not import or export is vul-
nerable to exchange rate fluctuations, because its competitors may be engaged in
imports and exports. If a competitor is able to obtain products cheaper as a result of
favorable exchange rates, this may affect the domestic company’s ability to compete
effectively. Exchange rate fluctuations also provide opportunities to earn extra profits.
262 CHApTER 10
For example, assume a competitor imports 50 percent of its inputs from overseas. If
the dollar depreciates, the cost of imported items increases and the competitor may
be forced to raise its prices. Alternatively, if the dollar appreciates, the cost declines
and the competitor may be able to lower prices.
PAYMENTS AND REcEIVABLES

Managers of multinationals have to consistently monitor changes in exchange rates
to ensure that their incoming receivables and outgoing payments are not affected
significantly. If exchange rates are expected to change, managers must take appropri-
ate action to offset potential losses. One example of a counteraction is termed “leads
and lags in payments.”
Take the case of a company that expects to receive £100,000 every three months
for exports of goods to a regular client. If the manager forecasts that the pound will
appreciate in the near future, that is, from the existing spot rate of US$1.50 / £1 to
US$1.75 / £1 to US$2 / £1, he or she may prefer to delay receiving the money. This
is termed “lagging the receivables.” The manager should collect the payments in
pounds and invest it in the United Kingdom in anticipation of the pound appreciation.
Alternatively, assume the company has to make a payment of £100,000 every three
months. If the pound is expected to appreciate, it would be better for the company to
“lead the payments,” that is, make them sooner rather than later.
If the dollar instead of the pound is expected to appreciate—say, from US$2.00 / £ to
US$1.75 / £ to US$1.50 / £—the reverse strategies should be adopted for the above
example. The company is better off leading the incoming receivables and lagging
the outgoing payments.
INVOIcING CENTERS
Perhaps the most vexing issue for multinationals is managing the multitude of trans-
actions among their own subsidiaries; multinationals are continuously making and
receiving payments between parent companies and subsidiaries. If the transactions are
in different currencies, not only are transaction costs high, but they are also exposed
to exchange rate risks. One of the ways to reduce these costs is to create an invoicing
center that can consolidate and net the payments and receivables from the various
subsidiaries, as shown in the example below.
Suppose a U.S. parent company has three subsidiaries, located in Belgium, Bra-
zil, and Japan. The companies purchase and sell among themselves raw materials,
intermediate goods, and finished products. Figure 10.2A shows the flows in all four
currencies. Payments and receivables are made between Japan and Belgium and
between the United States and Brazil (diagonally in the figure). In total, there can be
six inflows and six outflows in various currencies among the participants.
Assume that an invoicing center is set up in Luxembourg, as shown in Figure 10.2B.
All overseas payments are now channeled through the invoicing center, resulting in
savings not only in the number of transactions performed but also in the exposure to
foreign exchange.
Figure 10.2 Payments among Parent and Subsidiaries
A. Without an Invoicing Center B. With an Invoicing Center
All payments are routed

U.S. Belgian through the invoicing center Belgian
U.S. Parent
Subsidiary Belgium sends and receives Subsidiary Subsidiary
payments from the United States
in dollars and euros
B
p razi
Staaym l sen US pays in $ Æ BG pays in � Æ
tes ent ds
in s fr and
do om re
US recs in $ Å BG recs in � Å
lla th ce
rs e iv
an Un es
d r ite
ea d
ls
Invoicing center in
s Luxembourg
ive n
ce i
d re ium
n lg
s a Be
in reals and euros
in dollars and yens

nd m
n se t fro ls
a
payments from Belgium

pa en re JP pays in ¥ Æ BR pays in Reals Æ
Brazil sends and receives
Japan sends and receives

Ja aym nd
p na JP recs in ¥ Å BR recs in Reals Å
ye
payments from the United States

Japan sends and receives
payments from Brazil
Japanese in yen and reals Brazilian Japanese Brazilian
Subsidiary Subsidiary Subsidiary Subsidiary
263
264 CHAPTER 10
CHAPTER SUMMARY
This chapter provides an overview of the foreign exchange markets, defined as
the venue for purchasing and selling foreign currencies. Foreign exchange is re-
quired whenever a transaction takes place between residents of different countries
that do not share a common currency. The increased pace of industrialization
and trade in the twentieth century contributed to the foreign exchange market’s
development into one of the largest and most efficient in the world, approaching
$3 trillion per day.
A foreign exchange rate is defined as the price of a foreign currency. When paper
money replaced the gold and silver coins as a medium of exchange, the value of a
foreign currency was initially determined by the official rate set by each government
or nation-state. If the rates deviated from the fixed rate, then countries had to intervene
in the markets by purchasing or selling their currencies to maintain that rate. Since
the 1970s, more countries have opted for their exchange rates to float freely and be
determined by the demand and supply for the currency.
Foreign exchange is quoted in direct or indirect terms. If a foreign currency is
quoted as home currency per unit of foreign currency, it is defined as a direct quote.
When a currency is quoted in foreign currency per unit of home currency, it is termed
an indirect quote. Foreign currency is available for spot (immediate) exchange or
forward deliveries. Forward rates for many currencies are available for 30-, 60-, and
90-day deliveries.
If a country has to pay more for a foreign currency, we consider the home currency
to have depreciated or the foreign currency to have appreciated. When a home cur-
rency depreciates, goods in the home currency become cheaper because the foreign
purchaser pays less to acquire the home currency. As a result, a depreciating currency
will increase exports and reduce imports for the country. As exports continue to in-
crease, ceteris paribus, there will be an increase in demand for the home currency,
and eventually this will cause the rates to return to equilibrium.
The main determinants for the demand and supply for a foreign currency are exports,
imports, and the inflation and interest rate differentials between the countries. The
higher the relative inflation rates or interest in a country, the more likely its currency
will depreciate against the other currency.
The major players in the foreign exchange markets are the major international banks,
followed by nonbank brokers, central banks, and corporations and individuals. The
bulk of the trading takes place between the major banks, defined as wholesale trades.
Wholesale trades account for 85 percent of all foreign currency transactions.
Finally, understanding foreign exchange markets is important for managers of
multinational corporations. Managers need to be aware of the future direction of
foreign exchange rates in order to price goods for overseas markets and source raw
materials for production. Foreign exchange rates also affect pricing in domestic
markets because procuring raw materials at cheaper rates enables companies to sell
their output at competitive domestic rates. If foreign exchange rates are volatile, it
makes it much more difficult for the manager to make long-term decisions required
for successful business planning.
KEY CONCEpTS
Gold Standard
Fixed Exchange Rates
Floating Exchange Rates
Foreign Exchange Market
1. Define foreign exchange. What are the two ways that foreign exchange can
be quoted?
2. If the direct quote for the Norwegian krone in New York is US$0.1550 / NK1,
what is the indirect quote?
3. If the exchange rate of the dollar to the euro changes from US$1.55 / €1 to
US$1.65 / €1, did the dollar appreciate or depreciate? Is that good or bad for
U.S. exports?
4. What are some of the reasons that gold and silver became the accepted choice
of coins to serve as a medium of exchange?
5. Who are the major users of foreign exchange? Distinguish between market
makers and brokers in the foreign exchange markets.
6. What are some of the major factors affecting the price of a currency? If the
inflation rate in a country increases relative to that of another country, will
its exchange rate depreciate or appreciate?
7. What is the difference between fixed and floating exchange rate regimes?
What is managed float?
8. Why is it important to have an understanding of foreign exchange rates for
pricing a company’s products? Is it only relevant for the pricing of exported
goods?
9. Explain how an invoicing center can help reduce costs to a multinational.
AppLiCATiON CASE: DOLLARiZATiON AND THE CASE Of ECUADOR AND

EL SALVADOR
The euro and the dollar are the two most dominant currencies in the world. As of
2006, the value of euro notes in circulation exceeded that of the dollar. This can be
explained partly by a fall in the value of the dollar and partly by the preference for
Europeans to pay in cash for most transactions, in contrast to Americans who prefer
to use credit cards. In addition, more countries are qualifying to join the European
Union, requiring the European Central Bank to print more euro notes and coins.
The success of the euro indicates that it is possible for the world to eventually
adopt a single currency. The euro is successful because all countries using the euro
agree to a common monetary system. A country has to be accepted into the eurozone
in order to be a member of the monetary system. Another way for a country to attach
on to another currency, preferably a stronger one, is to officially “adopt” the currency
without being a member of the monetary system. The term for such official adoption
266 CHApTER 10
is “dollarization,” and the term arose because the dollar was the most likely currency
to be adopted in the past. Today, it could easily be called “euroization” or “rubliza-
tion” or “yuanization,” depending on the currency adopted.
Two countries that recently “dollarized” their currencies were Ecuador in 2000 and
El Salvador in 2001. Only five other independent nations in the past have adopted the
dollar as their official currency, East Timor, the Marshall Islands, Micronesia, Palau,
and Panama. This list excludes all U.S. territories and those countries that use the
dollar “unofficially” (as a result of a failure of their local currency).
It is not clear whether countries benefit when they adopt a stronger currency like
the dollar. In the case of Ecuador, the dollarization appears to have worked well;
however, the experience for El Salvador has been mixed. The success or failure may
depend more on the economic conditions that existed in the country both prior to and
after the currency’s adoption.
In Ecuador, inflation had reached over 100 percent in 1999, the year before dol-
larization, leading to a dramatic depreciation of their local currency, the sucre. In
1997, the sucre was selling at 3,500 per dollar; by 2000, its value had fallen to over
25,000 per dollar. A room at a top-rated hotel that normally cost US$50 in 1997
dropped to US$7 per room for an American tourist. The country’s financial markets
had collapsed, and adoption of the dollar was one of the few options available to the
government. The aftermath was very encouraging, as inflation fell to 10.7 percent in
2002 and continued its downward drift thereafter to 3.9 percent in 2007. The reason
for the drastic drop in inflation was obvious: local politicians could no longer print
money as needed, and instead dollars had to be earned by exports or obtained through
official borrowing.
The long-term results for Ecuador have also been encouraging. The U.S. State
Department estimates the average GDP in Ecuador increased to 4.6 percent since
2000, supported by the exports of oil and nontraditional items and by remittances
from abroad. Per capita income increased from US$1,296 in 2000 to approximately
US$3,270 in 2007, and the poverty rate fell from 51 percent in 2000 to 38 percent
in 2006. These statistics might have improved even more if not for the high level of
corruption and political tension that still exists in the country. The growth rate finally
slowed down in 2007. It is unclear how the global slowdown in 2008 will affect the
country’s economic progress in the coming years.
Conditions in El Salvador were different from Ecuador when they dollarized their
currency. There was no immediate financial crisis and inflation rates were low prior
to dollarization. A number of structural reforms had been initiated between 1998 and
2000, that including the privatization of banks, the strengthening of the tax code, and
the breaking up of the state monopolies in telecommunications and electricity. Dol-
larization was chosen deliberately as a means to prevent deterioration in the value
of their local currency.
The U.S. State Department reports that El Salvador’s economy grew at 4.7 percent
in 2007, and poverty has been reduced from 66 percent in 1991 to 30.7 percent in 2006.
However inflation increased from 2.3 percent in 2001 to nearly 3.6 percent since the
dollarization. Although the interest rate declined during this period, it did not manage
to attract foreign investments into the country, primarily because of low productivity
and overdependence on agriculture. When the dollar became strong in early 2000,
exports from El Salvador also suffered as Chinese imports into the country increased.
The recent decline in the dollar should help both countries increase their exports.
Most economists would agree that it does not make economic sense for every
country, and in particular small countries, to have their own currency. Currencies of
small economies are more susceptible to outside shocks that can have major impacts
on their income and employment. Yet the experiences of Ecuador and San Salvador do
not provide clear evidence of whether dollarization is a solution for small countries,
especially those with weak currencies. During the financial crisis of 2008, investors
throughout the world showed a preference to buy dollars, a term referred to as a “flight
to safety.” Whether the dollar will continue to be considered a safe haven will depend
on how the United States handles the crisis and its aftermath.
If the United States is unable to rein in its deficit spending, it will not only lose
value but also its reputation as the currency of choice for the world. In that event, the
world may end up with several dominant currencies—the euro, the dollar, the Russian
ruble, and the Chinese yuan are the more likely dominant currencies. This is probably
better than having the current system of over 200 currencies.
QUESTIONS
1. How does dollarization differ from the adoption of the euro as the national
currency?
2. What was the impact of dollarization in Ecuador and El Salvador?
11 International Marketing
The success of most companies depends on their ability to market goods and services to
potential customers in a competitive global environment.
LEARNiNG ObJECTiVES
• To understand the role of marketing in international operations
• To understand the marketing environment
• To understand the strategic variables in marketing
• To be familiar with critical international marketing activities
Goods and services are produced for eventual sale to consumers in a given market.
The marketing function generates revenues and is the source of company profits. Until
and unless consumers buy goods and services, there is no business to run. Therefore,
marketing plays an important role in a company’s day-to-day operations. Marketing’s
functions include selecting the target market, choosing the goods and services to offer
to the customers, packaging and labeling the product, setting the price, distributing
goods and services, promoting the product, applying customer relations management,
and establishing feedback mechanisms to obtain relevant information from the users
of the goods and services. In fact, among the various costs associated with producing
and selling goods and services, quite often marketing and selling expenses account
for a major portion of the total cost.
The American Marketing Association (AMA) defines marketing as “an organizational
function and a set of processes for creating, communicating, and delivering value to
customers and for managing customer relationships in ways that benefit the organization
and its stakeholders.” The key concepts in the definition of marketing are that marketing
is a process; it delivers value to the customers; it manages customer relationships; it
attempts to meet a firm’s organizational objectives, while at the same time providing
benefits to its stakeholders. Companies deal with two types of customers: they sell goods
and services to the final consumers, who purchase items for their own use or to be used
by others in a household setting; and they sell goods and services to business customers
(also called industrial or institutional customers), who further a product/service or in
some way add value to the product/service for resale to the final consumers.
268
INTERNATIONAL MARKETING 269
FiNAL AND INDUSTRiAL CONSUMERS

Final consumers buy essential and nonessential items on a regular basis as part of
their daily purchases. For example, when a member of the family buys food items,
appliances, or automobiles, he or she is buying these items to be used by the individual
and family and household members. The purchases by this group are referred to as
final consumption. If, however, individuals or companies buy goods and services that
are then used to make other products or services, this type of consumption is referred
to as industrial consumption. The purchase of raw materials such as crude oil, steel,
and plastic, and component parts such as tires, motors, and copper wires is normally
associated with industrial consumption. The individual or the company that buys these
goods and services does not consume them but makes something else out of them and
then sells that product or service to the final consumers. For example, Volkswagen’s
purchase of tires from Michelin to be mounted on the VW Jetta, a car model it as-
sembles in the thousands, is an industrial consumption. In contrast, an individual’s
purchase of the same tires as replacements for worn-out tires is final consumption.
Similarly, Unilever’s purchase of food for its employee cafeteria, or a fleet of cars for
its senior executives, is referred to as industrial consumption. Unilever’s purchases
are part of its operations, and they help the firm to produce soap, detergents, toilet-
ries, and so on. Hence, it is not the types of goods and services that determine if the
purchase qualifies as final or industrial consumption, but how the goods and services
are used after they are purchased.
Purchases by businesses tend to be larger in volume than purchases by final con-
sumers. Also, in industrial purchases, prices tend to be negotiated. Some companies,
such as the British retailer Marks & Spencer, sell goods and services only to final
consumers. At the same time, there are others that sell only to industrial consum-
ers; for example, the Indian-based Tata Iron & Steel Company sells steel and other
fabricated metals only to industrial consumers such as appliance manufacturers and
automobile manufacturers. There are also companies that sell goods and services to
both the final and industrial consumers; GE, IBM, Philips, Samsung, and Sony are
all international companies that deal with both final and industrial consumers. In the
case of GE, it sells household appliances to final consumers, but it also sells electric
turbines and aircraft engines to industrial customers. Similarly, Philips sells electric
bulbs to final consumers as well as to industrial consumers.
GOODS VS. SERViCES

In our discussion, we have stated that international companies sell goods and services.
These terms are most often used interchangeably, but there some key differences
between goods (also called products) and services. Products are tangible items that
are purchased by consumers for consumption either immediately or for later use. For
instance, a consumer may buy a box of cereal that he or she may consume in one sit-
ting or over a period of time. Among tangible products, there are other differences,
too. Products are classified as nondurables or durables. Durable products have a long
life and nondurables have a shorter life. Items such as milk and eggs are nondurable
270 CHApTER 11
items. Consumers buy these types of products often. Durable products are also tan-
gible, but they last longer. Products such as appliances, clothing, and automobiles
are considered durable products.
Services are intangible items that consumers purchase. Besides intangibility, ser-
vices have three key characteristics: inseparability, perishability, and heterogeneity.
Inseparability implies that services are consumed as they are transacted; perishability
implies that services cannot be stored, so they are consumed as the service is trans-
acted; and heterogeneity implies that the same service varies from vendor to vendor
in form, quality, and the time it takes to transact that particular service. Restaurants,
banks, and consulting are examples of services. Marketing principles apply equally
to goods and services.
MARKETiNG ACTiViTiES
An international marketer undertakes two broad-based activities. The first is manag-
ing the environment, and the second is managing the marketing variables (programs).
Marketing activities for domestic and international markets are similar in the sense that
all the individual activities associated with domestic marketing are also undertaken in
international markets. The critical difference between the two lies in the environment
within which the marketing programs are developed.
MARKETING ENVIRONMENT
The marketing environment is made up of all the forces that exert influence on and
shape consumer purchases and a company’s marketing programs. The environmental
variables include competition, a country’s economic activities, political stability, gov-
ernment laws and regulations, culture and its influences, societal influences, technology
and its impacts on consumers, geography as it influences marketing and consumption
of goods and services, and existing distribution structure (for international companies,
changing an existing distribution structure is difficult; hence, it is an uncontrollable
variable). Geographic considerations, especially climatic differences, may have to be
recognized in introducing products.1 Culture has been found to exert great influence
on the customer’s choice process, especially for products with significant cultural
content such as magazines and films. When a product is marketed internationally, the
cultural similarity between the country of origin and the country where the product is
marketed influences the rate of adoption in the new country.2 International marketers
do not control the environment in which the basic marketing activities are conducted
(environmental variables were discussed in detail in Chapters 2 through 4).
The environmental variables faced by domestic and international marketers are the
same; that is, both face economic, political, cultural, and other external variables, but
the differences lie in the level of complexity between the domestic and international
variables. The external environment exerts influences over a company’s operations
as well as on the consuming public. The domestic environment is easy to understand,
familiar to the managers, and easy to predict. Companies always have an advantage
when they are selling in a domestic marketing environment because both the company
and its consumers share the same environmental variables. In contrast, the international
environment is difficult to understand, unfamiliar to international managers, and dif-
ficult to predict. In addition, the countries in which international companies operate
are not all alike. Significant differences among the countries further complicate the
task of the international manager. That is, an international company has to evaluate,
understand, and influence individually each of the markets it is in. If there are simi-
larities among the different countries, the international company has an opportunity
to standardize some of its marketing strategies. For example, when Pepsi-Cola sells
its beverages in China as well as in Germany, it needs to understand that these two
countries have totally different environments, and strategies used in each have to be
planned carefully. In contrast, in marketing the same products in Canada and the United
States, Pepsi can easily standardize such strategies as packaging and advertising.
To be successful in overseas markets, international companies must thoroughly
analyze and understand the marketing environment. The external factors will also
shape how each firm develops its strategies. For example, in predominantly Muslim
countries such as Indonesia, Kuwait, and Saudi Arabia, products with pork as the main
ingredient, such as sausage, are not sold or marketed in any form. Similarly, countries
that are less developed and that are classified as low income do not provide many sales
opportunities for baby diapers, detergents, and household appliances. Therefore, it is
important that international companies evaluate the external environment thoroughly
before marketing goods and services to a particular country.
INTEGRATED MARKETING PROGRAM

An international company manages the following marketing variables:
• Products and services

• Branding and packaging
• After-sales services (warranties, returns, repairs, and complaints)
• Price
• Distribution (retail selection, channel management, logistics, and inventory
management)
• Communication (message content and medium—sales force, advertising, sales
promotion, and public relations)
An international marketing environment is mostly an uncontrollable variable,

whereas marketing variables are mostly under the international company’s control. It
is through these variables that an international company gains competitive advantage
and succeeds in the different countries in which it operates. In developing strategies
using marketing variables (also known as a marketing mix or marketing program),
both domestic and international companies have to coordinate the various marketing
activities to achieve synergy among the variables. Called the integrated marketing
approach, this strategy has helped companies achieve competitive advantages that
boost their success in a globally competitive environment.3 That is, in developing a
marketing program, the company must ensure that the philosophy and attributes of
272 CHApTER 11
the product or service are in harmony with consumer needs. In addition, the pack-
aging strategy, price, distribution, and communication must all be aligned with the
attributes of the product or service.
Collectively, all the marketing variables should send the same signal to consum-
ers; for example, moderately priced products that are typically distributed through
discount stores would not appeal to the affluent market just because they were ad-
vertised in a prestigious business magazine such as Fortune. In this case, consumers
would be confused, because they would not be sure if the product was meant for the
mass market or for the premium market. To achieve synergy, a moderately priced
product must be targeted to the general public (mass marketed) at a reasonable price
in retail stores that are frequented by the targeted group; furthermore, its availability
should be communicated through advertisements in general appeal magazines and
during television programs that are popular among mainstream shoppers. For ex-
ample, Timex watches targets middle-income consumers in many countries; priced
reasonably, Timex watches are marketed in department stores, superstores, discount
outlets, and specialty stores (in this case, stores that sell only watches and jewelry)
and are advertised through popular magazines, television, and billboards. In contrast,
luxury products such as Rolex watches are targeted to a few affluent consumers; are
priced high (more than $10,000); and are distributed through high-end retailers and
advertised through prestigious magazines (Vogue, Fortune, and similar publications),
premium television programs (golf tournaments), and select newspapers (Financial
Times, Wall Street Journal, and the like). The key component of success in developing
marketing programs is to make sure that all the variables are well orchestrated and
they all communicate the same philosophy.
Because international markets vary from country to country, developing synergies
across markets is not always possible. Due to differences in consumers’ purchasing
power and cultural variations, quite often what has worked in one market may not
work in another. Major appliances from manufacturers such as GE and LG Electronics,
automobiles from manufacturers such as Hyundai and Toyota, and cosmetic products
from Estée Lauder and Revlon are typically marketed to wealthy households in devel-
oping countries. These consumers are not price sensitive and view these products as
prestigious. These same brands are often targeted to the mass market in industrialized
countries. So, in marketing these products in overseas markets, international com-
panies may completely shift their strategy from mass-produced and mass-marketed
products to top-of-the-line brands, depending on the target market.
In some situations, international companies may be backed into different market
segments, even though that was not their primary intention. For example, when Pepsi-
Cola was first introduced in the former Soviet Union in the early 1970s, only politburo
officials could afford the soft drink, and it was also served at major banquets more as
a novelty drink than as a simple soda. The result was that Pepsi was never accepted
as a drink by the masses in the USSR. Hence, its distribution and pricing remained
as an exclusive product. But when Coca-Cola introduced its soft drinks into Russia
after the fall of communism in 1991, the public was ready for soft drinks. Similarly,
when McDonald’s opened its first restaurant in the United Kingdom in 1974, the
Duchess of Kent and her children were among the first to line up at the restaurant,
Figure 11.1 Integrated Marketing Program and Its External Environment
COMMUNICATION
Consumers
PRICE
Distribution
Brand name Products/Services Packagaing
EX TERNAL E NVI RONMENT
• Competition • Economy • Political • Cultural
• Legal • Societal • Technological • Geographic
which became a liability for McDonald’s; it took the company years to correct the
notion that McDonald’s was an exclusive restaurant.
Figure 11.1 presents the interrelationships among marketing activities.
BASiC STEpS iN INTERNATiONAL MARKETiNG

As with domestic marketers, companies operating in international markets also have
to follow some specific steps, including identifying target consumers and developing a
comprehensive marketing program. The program developed should include selecting
products and services with attributes that benefit the consumers, setting the appropri-
ate price, making the product or service available to consumers at their convenience
using existing distribution channels, providing the necessary information to educate
the consumers about the benefits of using a particular product, and, finally, setting
up a formal feedback system to evaluate the performance of the product or service
in the marketplace.
Recent developments in technology and communications have, in effect, made the
274 CHApTER 11
world smaller. Globalization—that is, the interweaving of national economies—and

the effect of it in the formation of a wider market that transcends national boundaries
is shifting companies’ strategic emphasis from a single-market approach to multiple-
market considerations. For example, online retailing has created a global market that
transcends national boundaries.4 The multiple-market approach makes it possible for
companies to standardize product offerings, creating a universal segment. Therefore,
international companies find consumers with similar needs that will buy the same
product regardless of their locations. Coca-Cola, for example, is very popular in many
countries and is sold in nearly 200 of them. Similarly, BMW automobiles, Colgate
toothpaste, Head & Shoulders shampoo, Philips light bulbs, and Sony television
sets are popular with customers all over the world. This approach, called universal
segmentation, is becoming a targeted strategy by many international companies. The
challenge facing international marketers today is to develop products and strategic
plans that are competitive in the intensifying global market.
Global competition and the large number of firms that operate in these markets
have forced international companies to develop sophisticated marketing strategies
that exploit the opportunities provided by the globalization of markets.
DEVELOpiNG AN INTERNATiONAL MARKETiNG STRATEGY

As in the development of domestic marketing strategies, international marketing
strategies also start with the consumer. In a consumer-driven marketplace, identify-
ing the right target group and determining its needs is essential for companies to
succeed. Basically, target market selection focuses on certain clearly defined groups
of consumers that are likely buyers/users of a specific product or service. In interna-
tional markets, target groups may vary from country to country. For example, in most
European countries, buyers of major appliances such as refrigerators, dishwashers,
and washing machines tend to be middle-class and lower-middle-class families. In
comparison, in some Asian countries, appliances are often purchased by families from
the upper and upper-middle classes.
Following are the basic steps in developing an international marketing strategy:
• Choose consumers and market—Which consumer groups should the company

target?
• Conduct marketing opportunity analysis and forecast sales—Does a substantial
market exist, and what are the potential sales in units?
• Decide on mode of entry—How should a company enter the overseas market?
Through exports, by way of joint venture, or by establishing a wholly owned
subsidiary?
• Determine product and service offerings—What specific product/service ben-
efits are desired by the target group? Do the existing product attributes meet
consumers’ needs?
• Establish price points—What should be the final price of the product?
• Select channels for distribution—Which channel of distribution should the
company use?
• Develop a comprehensive communication program—What message should the

company deliver to its consumers?
• Select media for reaching consumers—Which media should the company use in
delivering its message?
• Implement a customer relations program—What programs should the company
introduce to establish customer contact?
• Set up a feedback mechanism to evaluate the marketing program—What mecha-
nism should the company use to obtain market-related feedback?
The above steps may seem familiar to students who have taken an introductory
marketing course. As mentioned earlier, the basic steps in domestic marketing
and international marketing are the same. The difference is in the implementa-
tion of these strategies in the marketplace: some differences stem from whether
the target group is domestic or international; others stem from variations in the
external environment.
In developing a comprehensive international marketing strategy, companies
often use their experiences in other countries or markets as a starting point to
avoid costly mistakes. Companies that are entering an overseas market for the
first time need to be careful in making sure that they have studied the consumers
and markets carefully and have considered all possible scenarios. Following is a
discussion of the various steps that companies take in marketing goods/services
in foreign markets.
CHOOSE CONSUMERS AND SELEcT MARKET

Consumers as a Variable
Consumers are the focus of all marketing programs. Hence, it is critical that inter-
national marketers analyze customers to identify, learn about, and understand the
factors that affect their purchases. Consumers can be identified using many variables,
including demographic variables such as age, income, gender, education, occupation,
marital status, and family (household) size; benefits sought from a particular product;
quality preferences; purchase behavior, that is, their rate of consumption of a product
(usage rate); and how often they purchase the product. Some marketers also make
use of psychographic variables, especially consumers’ lifestyles. Values and lifestyles
are used wherever data on them is available to identify target markets. In the United
States, SRI International measures values and lifestyles (VALS) of individuals on an
ongoing basis, and the data is available to subscribers, who use them to target specific
consumer segments.5 In international marketing, psychographics are not used for
segmenting markets as often as it is done in the United States and other industrialized
countries. Availability of information and measurement issues are the main reasons
why psychographics are not used as often internationally to identify and understand
consumer groups.
To improve the effectiveness of marketing strategies, marketers have used con-
sumer segmentation as a possible approach to improve their earnings performance.
276 CHApTER 11
Segmentation offers companies with a group of consumers who may have similar
needs and wants and could be reached through similar marketing communications
and distribution channels. In segmenting markets, international marketers make
use of the consumer characteristics to group customers with similar characteristics.
Some of the characteristics used to segment markets are the same as the ones used to
analyze customers—demographic variables, buyer preferences, purchase behavior,
and psychographics. For example, a consumer segment for Chanel perfume could be
made up of females, age 25 to 45, single, living in metropolitan areas, with a college
degree, and earning between €25,000 and €50,000.
Segmentation assumes that international marketers are able to identify specific
groups that are different in their consumption behavior and that the groups are mea-
surable through certain characteristics. For example, in India, income has been used
as a segmentation factor based on clear response differences between groups in the
consumer market. Income was a variable that was easily measured, and the segment
was identified as the “premium segment.”6 If marketers are able to distinguish two
groups through certain characteristics but are not able to identify which group cor-
responds to the different purchase or consumption patterns, then segmentation is not
an appropriate marketing strategy.
International marketers use marketing mix strategies to influence consumers to
purchase specific brands of a product category. The factors that influence consumers
most are price, quality, availability, attribute-need (fit), recommendation of others,
and information.
Identifying Countries/Markets
In an ever-growing global market with a vast untapped potential, there are many
opportunities for international companies to market goods and services. Companies
such as Coca-Cola, IBM, Philips, Siemens, Sony, Thomson, and Unilever constantly
look for potential markets to reach new growth targets. Although some of these com-
panies operate or sell in more than 100 countries, their quest for newer markets is a
mainstay of their strategic direction. The task of selecting an appropriate new country
or market is made difficult by the divergent goals or the trade-offs between two goals
that companies face. On the one hand, the company has to identify a country with the
greatest potential; on the other hand, it has to consider a country with the least amount
of risk. Often, these two goals are not complementary. For example, Luxembourg is
often rated as one of the safest or least risky countries for foreign firms to invest in,
but Luxembourg has a small population, just over 450,000. Though the country is
safe for investment purposes, the size of the population does not provide an attrac-
tive opportunity for most goods and services. In selecting a new country for entry,
international companies analyze such factors as the number of potential consumers
for a given product or service, the consumers’ ability to purchase these products or
services, the competitive environment, various external risks (economic, political,
regulatory, and the like), and the companies’ ability to generate profits in these new
markets. Chapters 2 through 4 discuss some of the environmental factors and how
companies select countries for entry.
CONDUcT MARKETING OppORTUNITY ANALYSIS

Entry into a new market does not assume that all potential consumers in that market
are ready to buy a new product or service. Factors such as the specific needs of the
consumers in the new market, the level of competition, and the price of the product
or service offered are all factors that affect consumption rate in a given market. For
example, introducing SUVs in a country where the roads are narrow and the price of
gasoline is high may not fit the needs of the local consumers. Similarly, the introduc-
tion of compact cars by General Motors in Japan will definitely not succeed, as the
Japanese have some of the best made compact cars in the world.
To develop a viable international marketing strategy, companies need to conduct a
market opportunity analysis and forecast the potential sales in a new market. A critical
part of market opportunity analysis is estimating the size of the total market, that is,
the number of units that the market can absorb by all firms selling the product. Market
forecast is the number of units a company is able to sell in a given market for a specific
period of time. Market opportunity analysis involves (1) determining market potential,
(2) conducting a sales forecast, and (3) evaluating the overall opportunity.
Market potential is the maximum number of units of a particular product that can
be sold to a specific target group. This includes the opportunity by all firms serving
the market. The market potential is the upper limit of possible sales for a product in a
given market and may not always be achieved by a single company. Actual industry
sales (by all companies) are lower than the potential due to many reasons, including
a lack of interest among the consumers for the product, ineffective marketing strate-
gies, and the availability of substitutes that equally satisfy a similar consumer need.
For example, in introducing its Prell shampoo in India, Procter & Gamble as well as
other shampoo manufacturers were not able to reach the projected market potential,
as traditional homemade herbal concoctions served the needs of the consumers at
a much lower cost. Hence, in estimating market potential as well as in defining the
target market, it is important to incorporate criteria such as affordability.
A target market may be defined as a specific segment or segments within a potential
market (country) that is defined through a set of variables that can be identified and
reached and contains the most likely adopters of a given product or service that a firm
wants to pursue. The target market is the focus of most marketing programs. For example,
among the 6 million new car buyers in China, Ford may define its target market for its
Ford Explorer as predominantly male consumers ranging in age from 25 to 50 years,
in the top 10 percent of the socioeconomic income level, who consider themselves the
trendsetters in their society. This particular segment might encompass fewer than 50,000
consumers among the potential 6 million automobile buyers. But for Ford, this is the
target that they will concentrate on in developing their marketing strategy.
FOREcAST SALES FOR THE SELEcTED TARGET GROUp

The sales forecast is the expected unit sales for a given product in a given market within
the market potential. It can be calculated for the whole industry or for a single firm. A
sales forecast is the result of a detailed marketing program within a given marketing
278 CHApTER 11
environment. Therefore, it is important for companies to establish their potential sales

for a given time frame (typically one, two, or five years). There are many techniques
available to international companies for forecasting their sales. These include using
historic sales analysis of similar market introductions (comparative analysis), using
estimates made by the sales force, expert opinion, retailer/distributor estimates, time-
series analysis, and market research studies.
If the company is already in a country and would like to forecast future sales, it
would definitely make use of historic sales data in arriving at the target number. In this
situation, estimates by the sales force or the existing dealer network estimates may be
acceptable as well; however, quite often these figures are inaccurate and biased, as each
group may not state the true potential lest they be held responsible for the estimates.
In instances when the company has many years of data, it is appropriate to use time-
series analysis or regression analysis, as the forecast may be more objective.
When a company enters a new country/market for the first time, it is often difficult
to forecast sales accurately. The lack of information coupled with inexperience in the
country is often mentioned as the reason for not being able to forecast sales precisely.
For international companies that are attempting to enter foreign markets for the first
time, the problem of predicting sales accurately is even more difficult because such
companies do not have any prior experience in international marketing.
If the company is attempting to enter a new country and does not have any histori-
cal data to analyze, it can use a comparative-analysis approach, expert opinion, or
market research. In a comparative-analysis approach, the international company will
forecast the sales based on actual sales in a country where it had previously marketed
its product or service. For example, Adidas, the German-based sneaker manufacturer,
can use its sales figures for tennis shoes from a few years earlier in Japan to estimate
the sales for the same type of shoes in South Korea, making some adjustments for the
size of the target group (the population of Japan is more than 128 million, whereas
South Korea’s is just short of 49 million).
In using experts to predict sales, international companies rely on individuals who
are knowledgeable about the country in question. These may include individuals who
have had selling experience in the country, consultants, home country consular of-
ficials, and trade associations such as the National Automobile Dealers Association,
the International Chemical & Plastic Manufacturers Association, American Chambers
of Commerce Abroad, and other similar associations.
DEcIDE ON MODE OF ENTRY

As discussed in Chapter 6, companies enter international markets through exports,
licensing arrangements, strategic alliances, joint ventures, or wholly owned subsid-
iaries. Each of these approaches varies in the level of involvement and the level of
control exerted over the foreign operation. In exports, a firm has minimal control over
its marketing efforts in overseas markets. With a wholly owned subsidiary, a firm can
manage its foreign operations with total control. Whether a company enters a market
through exports or through a wholly owned subsidiary, its objectives are the same,
that is, to penetrate a new segment and expand its global markets.
The entry strategies of international companies are not static. Many companies
that start out as exporters eventually move into higher-order operations such as joint
ventures or fully owned subsidiaries. For example, when Japanese automobile manu-
facturers entered the U.S. market in the early 1960s, they first opted for exports (as
they did not have brand recognition in the United States), and only when they had
gained substantial market share did they decide to put up fully owned factories in the
United States. International companies may also use different entry strategies for dif-
ferent countries. For countries that have significant market potential, a company may
elect to enter through a fully owned subsidiary, as Nestlé did during the early stages
of its forays into overseas markets. For countries that are not fully developed but may
provide future opportunities for expansion, an international company may decide to
use exports to enter the market. For example, Nestlé entered many of the markets in
Africa through exports when it was exploring the market potential in the region.
DETERMINE PRODUcT AND SERVIcE OFFERINGS

In the final analysis, consumers purchase goods and services to satisfy specific needs.
The basic transaction between companies and consumers is in the exchange of goods
for payment. Therefore, the starting point of all marketing activities and the focus of
marketing strategy have to be about a product. In developing product strategies, an
international company considers two factors. The first is the stage of the product life
cycle (PLC), and the second is the product position in relation to competing brands.
Every product goes through a life cycle of various stages from introduction to
decline. Even though every product has its own life cycle, each may vary in length
of time. That is, the life cycles of some products such as designer clothes and toys
may be less than a year; some others such Bayer Aspirin and Coca-Cola have been
in the market for more than 100 years. Depending on the stage of a product’s life
cycle, different marketing strategies may be applied. For instance, in the introductory
stages, heavy communications strategies might be employed, whereas in the saturation
stage, the focus of marketing strategy may be to attain distribution in every possible
outlet. International marketers have the opportunity to extend the life of a product
by exploiting the differences in economic and market conditions among countries.
A product that is developed in an industrial country may be introduced in emerging
countries at a later time, making it possible for the product’s life to be extended. For
example, as Gillette, the maker of shaving items, introduces its Fusion Power razor
in the United States and a few other countries, it will introduce its previous model,
the Mach 3 Turbo, into Argentina, Brazil, and South Africa, thereby extending the
overall life of the Mach 3 and other razor products. In fact, it has been noted that there
are still some earlier models of razors that were introduced in the 1960s that remain
in the markets in some countries of the world.
Developing unique and/or distinctive product positions is part of the overall mar-
keting strategy. Product position refers to the perception of consumers of a particular
brand within a product category that distinguishes the brand on some attributes from
other competing brands. These attributes could be superior quality, higher price
value, ease of use, image, or any other feature that consumers may use in selecting a
280 CHApTER 11
particular product. International marketers make every attempt to attain a preferred

product position. For example, among credit card customers, American Express has
a position of prestige in comparison to MasterCard or Visa.
In international marketing, a factor that is often of some concern for companies
is the country-of-origin effect on consumers’ perception of the product. Country-of-
origin effects can be positive or negative: products made in some countries are well
known for their quality and value. It is possible that when the customer becomes
aware of the country of origin, it might affect the product’s image and, therefore,
its sales.7 For example, automobiles from Germany, electronics from Japan, and
watches from Switzerland all have positive images in most consumers’ minds. In
contrast, automobiles from Russia, designer clothing from Laos, and wines from the
Philippines have negative product images, as these countries are not known for the
manufacture of these products. Country-of-origin effects are product specific, not
brand specific. It also appears that there may be degrees of country-of-origin effects
among consumers from different countries. In a recent study, it was observed that
Japanese consumers were found to be more sensitive than American consumers to
the country-of-origin effect.8 International marketers that have positive country-
of-origin effects should leverage this benefit to their advantage in their marketing
strategies, while those that do not should design strategies that emphasize other
features to counter the negative product image. For example, in introducing Chilean
wines to the United States, the distributors who handled these wines emphasized
the value of the wines rather than the fact that they came from Chile, which is not
a traditionally strong wine-producing country.
Identify Specific Product/Service Benefits Desired by the Target Group
Consumers buy goods and services to derive predetermined benefits. Hence, a cus-
tomer buying a Volvo is attracted by the car’s reputation as one of the safest cars in the
market. In international markets, the benefits sought by consumers differ from country
to country. A consumer in one country may desire a particular brand of product for its
quality, whereas a consumer in another country may be interested in its convenience
factor. For instance, bicycles in China are used as a major mode of transportation
and are used by people who are mostly in the lower socioeconomic segment of the
population. For buyers in China, bicycles should be simple in design and relatively
inexpensive (under $25). In contrast, in the United States, bicycles are used mostly
as recreational vehicles, and buyers are willing to spend hundreds of dollars (if not
thousands) on each. Hence, these bicycles are equipped with all available gadgetry
and are technological marvels. For American bicycle manufacturers to be successful
in the Chinese market, they have to totally revamp their machines to suit the benefits
sought by the Chinese bicycle buyers.
While entering a new country/market, international companies need to conduct
market research to identify specific benefits that consumers seek in a given product
category. Information on consumers and markets may be gathered through interna-
tional market research. For international companies, their first attempt in gathering
consumer or market-related information may be through internal records. Reports such
as cost data, accounting reports, sales reports, inventory reports, annual advertising
expenditures, and consumer data (especially for service companies such as banks,
insurance companies, and other financial institutions) are all useful information in
understanding purchase patterns, media preferences, and so on that can be useful in
developing marketing programs. For international companies that operate in multiple
countries, comparing data across markets may shed some insights that may also be
applied in developing marketing strategy. Besides the internal sources of informa-
tion, international companies sometimes seek out other secondary data that may be
useful. Information from government agencies, international organizations such as
the International Monetary Fund, the United Nations, and the World Bank, and trade
publications and other published information can be useful in understanding markets
(Appendix 2 provides a summary of activities of the international agencies). Many of
these sources are relatively inexpensive (some of them may even be free), and with
modern technology such as Internet access they are easy to locate.
Many of the larger international companies monitor markets on a regular basis
and employ qualified staffs who from time to time conduct market-related research.
These companies also sometimes hire outside research suppliers to carry out specific
research studies. Companies such as VNU of the Netherlands, the Kantor Group of
the United Kingdom, and Information Resources of the United States are all research
suppliers that conduct a variety of studies and have operations in many countries of
the world. In fact, VNU has operations in 81 countries.
Determine If the Existing Product Attributes Meet International Consumers’ Needs
In the previous step, the international marketer was able to identify the specific
benefit(s) that a segment of consumers sought from a product category. At this stage,
the international marketer should evaluate its product or service offering to make
sure that the attributes of the offering match the benefits sought by its target group.
Product or service attributes are defined as features and characteristics that provide
specific benefits to consumers. For example, attributes of a personal computer may
be its overall quality, memory, speed, integrated audio capability, and so on. In in-
ternational marketing, due to influences of culture, consumers may seek more than
just physical attributes. Based on an individual consumer’s culture, preferences may
be influenced by taste, color, and form—attributes that are more psychological than
physical. Research has shown that consumer perceptions of quality vary from country
to country, and market-perceived quality is difficult to compare across cultures.9
Successful international marketers recognize that consumers seek total satisfac-
tion from a purchase. Total satisfaction implies that the marketers consider both the
physical and psychological satisfaction that consumers desire. For example, when
Heineken, a Dutch beer company, having experienced the surge in low-caloric light
beers in the United States, introduced its Amstel Light in some European countries,
many consumers rejected it. For these consumers, who enjoy their full-bodied beer,
the taste of light beer did not appeal to them. Although Amstel Light was success-
ful in the United States, it never caught on in Europe. Similarly, refrigerators in
many developing countries are viewed as a symbol of one’s wealth and success,
282 CHApTER 11
and, hence, are often exhibited in the living room, a practice not seen in European
and American homes.
In introducing products into foreign markets or developing new offerings, in-
ternational companies have to make sure that their products meet the physical and
psychological aspects of consumers’ needs. That is, if a group of consumers buys a
particular brand of shampoo for its medicinal qualities (such as removal of dandruff)
and at the same time the preferred color of the shampoo is blue, an international com-
pany has to determine if its product has such medicinal benefit as well as the color
sought by the consumers in that country. Similarly, Volvo automobiles are renowned
for their safety features, but traditionally their cars have been boxy and, according
to some observers, ungainly in shape and design. If, in a given market, a large seg-
ment of the population considers safety the single-most-critical physical attribute in
an automobile but also values attractiveness of design, then Volvo would appeal to
only a small segment of that market. (Recognizing this problem, Volvo did introduce
sleeker designs in the late 1990s.)
Product or service attributes, both physical and psychological, can offer an in-
ternational company unique competitive advantages. A company has a competitive
advantage in a brand of a particular product category (e.g., Arial is a brand within
the product category detergents) when it has greater value in benefits than competi-
tors’ products. Through exceptional quality, convenience, user friendliness, added
value, and cultural symbolism, international companies are able to gain competitive
advantage. Companies must first identify and understand the needs of consumers
and develop unique attributes that can retain customers and gain their confidence and
patronage. For example, Toyota, which is renowned for its quality, has a competitive
advantage over other automobile manufacturers that helps it outsell most competitors
in its class of vehicles (Corolla in the subcompact category and Camry in the four-
door sedan category). Similarly, Apple’s iPod, with its unique features and attractive
design, is the preferred brand of MP3 player among teenagers and adults alike all
around the world.
International Product Standardization
If the conditions are right, international companies prefer to market the exact same
product in all countries. This strategy, called standardization, offers unique advantages
to companies that can implement it. Some of the key advantages of standardization
are economies of scale in production, R&D efficiency, distribution effectiveness, and
strategic synergy, resulting in cost savings. Standardization also avoids duplication
of efforts and streamlines operations. Using a standardization strategy, international
companies are able to compete strongly with other global brands.
Standardization is the ultimate goal of most international companies. In fact, the
globalization process, as outlined by Theodore Levitt,10 assumes that companies
are able to standardize products and services as consumers seek the best products at
the lowest prices from anywhere in world. To achieve standardization, international
companies must find common ground in consumer segments that have similar pur-
chasing power, seek similar benefits, and are in countries that have similar external
environments. It is virtually impossible to find two exactly similar countries that

can adopt similar products. Country variations do exist, and, therefore, it is not easy
to standardize products. However, marketers have found ways to circumvent these
difficulties. One strategy is to offer products and services that marketers feel have
particularly strong consumer appeal and sell them as “what everyone wants” rather
than worry about the details of “what everyone thinks they might like.”11 When
Starbucks introduced its brand of coffee houses in China, it ignored the fact that the
Chinese are predominantly tea drinkers and instead believed that its brand of coffee,
which was appealing to the younger middle class all over the world, would succeed
in China, too. Similarly, when Kellogg’s and General Mills, two American-based
cereal companies, introduced Corn Flakes and Cheerios in India, they did not worry
about the fact that most Indians have a hot home-cooked breakfast each morning.
Instead, they felt that the convenience of just pouring milk into ready-made cereal
would appeal to busy executives, working women, and children, and they did succeed
in changing the breakfast habits of Indians in the metropolitan areas.
In Europe, where it is assumed that there are some similarities among the countries,
including their state of industrialization, efforts to standardize products have not always
been successful. To succeed in these countries, the practical approach has been not to stan-
dardize products and marketing programs across the region, but to find groups of countries
that have similar marketing characteristics. For example, the authors of a recent research
study found that companies can succeed through standardization by pairing countries such
as Germany and France, the United Kingdom and France, and others.12
Product Strategy When the Product Attributes Do Not Match Consumer Needs
If the product or service attributes do not match the specific benefits sought by a
target group, the international company has a few strategic options available. First,
it can consider whether consumers may be convinced through demonstrations, ex-
perts’ testimonials, or other communication techniques that the attribute its product
possesses is important and desirable. For example, Philips, a Dutch conglomerate
that sells fluorescent light bulbs to the industrial market, wanted buyers to change
the product emphasis from how much light bulbs cost and how long they last to the
total cost of buying the bulb, including the high disposal cost caused by toxic materi-
als in the bulbs. Philips had a new version of a light bulb that was environmentally
friendly and easy to dispose of but cost more than conventional bulbs. Instead of using
the traditional channel of convincing purchasing managers to buy the bulbs, Philips
pitched the new bulbs (Alto) directly to the CFOs, who understood the significance
of the overall cost. Through this strategy, Philips was able to capture 25 percent of
the industrial fluorescent lamp business in the United States.13 Similarly, Starbucks
was successful in China without adapting to the local tastes. The company did not
change any of its product offerings but relied on its marketing program to sell coffee
to a heavily tea-drinking population. Toyota has succeeded globally by emphasizing
the fuel efficiency of its cars and changing the mindset of consumers worldwide about
the most important attribute in a car even before the present oil crisis (especially in
the United States, where car buyers were less concerned about fuel efficiency).
284 CHApTER 11
International companies that feel they cannot convince foreign consumers of their
products’ merits have tried other approaches, including changing their products’ at-
tributes for the new market. For example, McDonald’s has been successful in many
countries by adapting to local tastes: in the Middle East, all the food is halal approved;
in Mexico, McDonald’s offers a chorizo (spicy sausage) platter of eggs, rice, and
beans; and in India, its menu includes a veggie burger.
Packaging and Branding
Packaging and branding go hand in hand. Brand names are typically placed on every
package. Consumers quite often recognize their favorite brands simply by looking
at the package. For example, Heineken beer is recognized worldwide by its distinc-
tive green bottle. Similarly, Citigroup is recognized by its logo (an umbrella over its
brand name). A strong global brand image is a definite competitive advantage for
companies that can achieve it. Studies have shown that consumers do not process
brand experience at a rational and conscious level, but rather through a complex
system of psychology and motivation.14 Developing global brands is probably the
most important strategic initiative that international companies can undertake.15 To
be recognized globally while standing for excellence, companies must (1) start with
a very good product or service, (2) develop unique competitive advantages, (3) be in
the public’s view, (4) sell to a large market, (5) have a distinctive name, and (6) be
marketed in many countries. In addition, global brand recognition is achieved through
heavy promotional activities that require financial resources. International companies
have also been successful through co-branding, or linking brands through relation-
ships with other brands.16 For example, many desktop computer companies such as
Dell and HP have successfully co-branded their products by linking with Intel. The
world’s 10 most recognizable brand names in 2007 were Coca-Cola, Microsoft, IBM,
GE, Intel, Nokia, Toyota, Disney, McDonald’s, and Mercedes-Benz.17
Most consumer products are packaged so as to protect the product as well as to
provide useful information. Consumers see the package before they see the product
inside, so packaging has significant marketing implications. If all other factors remain
the same, a consumer may select a brand simply because of the attractive features of
the packaging. Hence, cosmetic companies and packaged goods companies spend
a considerable amount of resources in developing package designs that are unique,
appealing, and create awareness.
In international markets, due to language differences, cultural tastes, and govern-
ment regulations, companies have to make changes to the packaging to adapt to
the host country’s needs. For example, the governments of many countries require
all weights and measurement to be in metric. Numerous other packaging problems
have been caused by a company’s failure to adapt to local conditions. Take the case
of Brugel, a German children’s cereal brand, which featured birds, dogs, and other
animals on the packaging to attract children’s attention. This product was placed in
the pet foods section of supermarkets in China based on its package features. If the
company had used some Chinese labeling, it could have avoided this problem. Since
Japanese companies spend a considerable amount of time and money on packaging,
foreign products that are marketed with poor packaging convey poor-quality products
to the Japanese. In Brazil, Coca-Cola’s Diet Coke ran into problems, as “diet” in that
culture implied medicinal use, and the product therefore required daily recommended
consumption on the label.
ESTABLISH PRIcE POINTS

Wherever consumers buy goods and services, the price of the item is a major consid-
eration in their choice of a brand because it is the most easily comparable measure.
Therefore, setting the price of goods and services is an important strategic step for
international companies. Price can be used to attract consumers, add value to a com-
pany’s offering, gain competitive advantage, maximize profits, and acquire and retain
distributors. The factors that affect prices are costs (direct and indirect), distribution
costs, break-even level, market size, demand estimates, price elasticity of demand,
competitors’ prices, local taxes, and the host country’s regulations.
In international marketing, setting a final price is complicated by the differences in
input costs, rates of inflation in the host country, exchange-rate fluctuations, differ-
ences in price elasticity of demand, different break-even levels, and the purchasing
power of the consumers in a given country. Hence, it is not unusual to find that the
price for the same product differs from country to country. For example, a package
of 100 Tylenol 500 mg tablets has a retail price of US$9 in the United States, P325
in the Philippines (the equivalent of US$6.50 at an exchange rate of P50 per dol-
lar), and Rs150 in India (the equivalent of US$3.00 at the exchange rate of Rs50 per
dollar). Similarly, the Canon PowerShot S3 IS digital camera sold for US$556.95 at
retail stores in the United States, for €546 in Germany (the equivalent of US$873),
and £238.00 in the United Kingdom (the equivalent of US$454).
From a strategic point of view, price is viewed as value gained by the consumer.
Value is defined as the ratio of the benefits derived from a product to its price. That is
Value = benefits/price. Therefore, the more benefits a customer derives from a given
product, the greater the value associated with it. International companies can charge
high prices if they can show that their products have high value. Many consumers are
willing to pay high prices for luxury goods such as Rolex watches and BMW cars,
as they perceive these as high-value brands. The value quotient can be increased by
increasing the benefits derived from a product, by decreasing its price, or by doing
both (combining an increase in benefits with a decrease in price).
International companies that enter a new country for the first time may have a dif-
ficult time deciding on the exact price to charge for their products because they lack
prior experience with that particular market. In such cases, companies have several
options: They may set the price based on their cost structure by computing all the costs
first and then adding a predetermined profit to arrive at the final price. For example,
if the direct and indirect cost associated with producing and marketing a product is
US$10, and if the company typically aims for a 10 percent profit over cost, the final
price would be US$11. Another common approach in pricing a product in a new mar-
ket is to set the price on the basis of a competitor’s price, assuming the competitor’s
products have similar attributes and are marketed to the same target group. In some
286 CHApTER 11
instances, when the company is not sure of a direct competitor, an average price for
the industry may be used as a benchmark.
If the international company has prior experience in other markets, it can use these
experiences as a guide in setting a final price. For example, Sony has little difficulty
in setting a price for its television sets in a new market: it uses its vast experience
and knowledge in determining the exact cost of producing and marketing television
sets all over the world.
In establishing the price points for a product or service, international companies
have to continuously monitor the environment. The actions of competitors, changes
in raw material costs, changes in rate of inflation, exchange-rate fluctuations, and
government regulations are just some of the factors that must be monitored. Any
change in a competitor’s price has to be considered seriously. An upward shift in
price may be a deliberate action by a competitor to change its image and the prestige
associated with its brand. If the target consumer group accepts this price change, it
may be willing to pay more for the competitor’s brand, resulting in a loss of sales for
the company. For example, if BMW raises its price by 5 percent on its 500 series of
cars, then Mercedes-Benz and Lexus may opt to raise their prices, too. Sometimes
companies may lower their prices to take market away from their competitors. Most
often these price reductions are quickly matched by all competitors in an attempt
to protect market share. If British Airways reduces its price on its London-to-New
York route, this move will be quickly replicated by Air India, American Airlines, and
others flying the same route. Unless a company has some unique cost benefits such
as lower production costs or advantages in distribution efficiencies, the window of
opportunity for a price advantage is small. Price is the easiest of all marketing strate-
gies to copy.
SELEcT CHANNELS FOR DISTRIBUTION

Distribution is the marketing activity that makes it possible for companies to reach their
consumers and complete a sale. Distribution activities include channel management,
logistics, transportation, and inventory management. Logistics is an integral part of
distribution and is a critical activity within the marketing function.18 Distribution is
divided into two categories: upstream and downstream. Upstream distribution man-
ages the flow of goods and services from various suppliers to the manufacturers or
service companies, basically for industrial consumption. For example, the distribution
of raw materials such as steel, tires, and batteries that are purchased by an automo-
bile manufacturer is considered upstream distribution. In contrast, distribution of
goods and services that reach retailers for consumption by final consumers is called
downstream distribution. What follows is a discussion of downstream distribution
in international markets.
Channels help companies move goods and services from manufacturer to con-
sumers. The major function of channels is to have products available where and
when the customers want them. Hence, channels fulfill the utilities of place and
time. Through retailers, companies reach consumers at various locations within the
country. In many countries, foreigners are barred from investing in retail activities
so as to protect national interests (distribution of staple items is considered vital to a

country’s security).19 Some of the other functions performed by channels are buying
and selling (transferring ownership from a company to a buyer), breaking the vol-
ume down, transporting goods and services, maintaining inventory levels, providing
information, and promoting goods and services to final consumers. In international
markets, the channel functions vary from country to country. For example, in Japan,
it is typical to use six to seven intermediaries in transferring a product from the source
(producer) to the final consumer. Therefore, some of the first-level channel members
in Japan may be just selling agents who do not actually buy the product but sell it for
a fee. In the United States, a typical channel for distributing consumer goods uses
three or four intermediaries, a much shorter channel compared to Japan’s distribution
system. Typically, the first level of channel members in the United States is made
up of wholesalers, who buy and sell goods and services. In industrial marketing, the
number of channel members is even fewer—at most one or two intermediaries—
because the volume of a purchase by each industrial consumer, shorter channels
are justified. For example, when Henkel, a German-based multinational company
that sells household items, buys toner cartridges for its photocopying machines, it
buys them in the hundreds; an individual consumer probably buys two or three toner
cartridges per purchase. Shorter channels are efficient when the products are bulky.
Costs of handling, loading, and unloading bulky products can add to overall costs,
and, hence, shorter channels are more practical in such cases. Also, shorter channels
are economical when order lots are larger.
Within the channels, each member or intermediary performs different functions.
A company may decide to carry out all the channel functions internally (direct chan-
nels), or have independent, outside businesses carry out the channel functions (indi-
rect channels). With indirect channels, companies use intermediaries to complete the
distribution function. Some companies use just one intermediary, and others may use
many. The number of intermediaries depends on the product, consumption rate, and
specific country in which the distribution is set up. In automobile distribution, for
instance, only one intermediary is used, as the product is bulky and consumers do not
buy this product that frequently; in contrast, toiletries are distributed through three
or four intermediaries, as they are purchased frequently by consumers. The number
of intermediaries used determines the length of the channel; when only one or two
are used they are referred to as short channels, and when three or more are used they
are referred to as long channels.
Companies that opt for direct channels sell their goods and services directly to
the final consumers. These companies undertake all the essential functions that are
necessary to have the product or service available to the user. There are definite ad-
vantages in opting for direct channels. Companies that perform their own channel
functions have direct access to their customers and hence come to know their needs
better. This helps them to improve their customer retention rate. This direct contact
also helps them to gather information that may be used to streamline strategies and
to help generate new product ideas. In addition, these companies have better control
of their distribution costs. On the downside, a direct channel is very expensive. A
company that decides to undertake all the channel functions by itself incurs the related
288 CHApTER 11
costs associated with them without the benefit of spreading these costs over many
product categories of many companies, which an independent distributor is able to
do. Doing one’s own distribution also implies assuming many unrelated activities
that may not be within a company’s core competencies.
In spite of the difficulties, a few international companies are involved with direct
channels, and they are more popular in industrial marketing, where order size justi-
fies shorter channels. Many manufacturers have started the use of virtual stores as a
direct distribution channel in addition to their existing indirect retail channels. When
manufacturers start their own direct channels, however, conflicts can arise with the
existing retail channel system. To avoid these conflicts, some manufacturers distribute
excess stock at retail stores through their direct online system.20 Companies that sell
door-to-door, mail-order companies, telephone-order companies, and Internet-based
sellers all use direct channels. For example, the Avon cosmetic company sells its
products through representatives in door-to-door sales; Amazon.com sells many vari-
eties of products through the Internet; and Dell Computers uses the telephone to take
customer orders. Some of the large industrial companies such as Boeing, Hyundai,
Mitsubishi Heavy Machinery, Philips, and SAP have their own sales offices in for-
eign countries that call on customers directly. Most service companies—commercial
banks, insurance companies, and investment banks—always use direct channels to
reach their customers. Hence, HSBC of the United Kingdom has branch offices in
different countries of the world. Similarly, the Swiss-based UBS AG, an investment
bank, has offices in many countries to serve the needs of its retail customers and
business clients.
Some service companies do use indirect channels to reach a wider geographic area
quickly. Through licensing and franchising arrangements, these companies are able
to provide their services to customers in many parts of the world with much lower
risks to the franchisor. Licensing is an arrangement whereby one company gives
rights to another for the use of a brand name or trademark for a predetermined fee.
Franchising is a similar arrangement, in which, for a fee (royalty), one company (the
franchisor) sells to another party (the franchisee) the use of a trademark that is the
essential asset for the franchisee’s business. As the franchisors themselves do not
invest directly in these operations and can assign the actual operational details to the
franchisee, the financial exposure to these companies is reduced. Some of the benefits
for international companies that use licensing or franchising systems are that they are
able to cover a territory with little investment and receive highly motivated business-
people to work for them without having to keep them on their payroll. Furthermore,
franchisees have local knowledge and expertise that can be leveraged to a competi-
tive advantage. Lack of knowledge of host country market conditions is a common
problem faced by most international companies. The franchisors are also guaranteed
income through licensing fees or royalties. On the downside, franchisors lose some
control over their brand names and management expertise to host country nationals
who may end up being future competitors. Also, the available market potential may
not be fully exploited by the franchisee.
International companies that sell their goods and services to final consumers usually
use indirect channels to distribute their products. These companies use a combination
of importers, agents, wholesalers, and retailers to sell their products to final consum-
ers. The type of channel members available and the level of services they provide in
each market may vary from country to country. For example, until China entered the
World Trade Organization (WTO) in 2001, distributors in China provided only basic
transportation and warehousing services. Since many of these distributors were state
designated, they operated under a monopoly. Therefore, many international companies
had to use fragmented, tiered, and rigid top-down distribution networks that were
expensive and inefficient. Because of the WTO-mandated guidelines, however, China
had to revamp its distribution system and open the business for private as well as
foreign-owned companies. These changes have led to improved services and a much
more efficient distribution system. Before China joined the WTO, the distribution
system was made up of three to four intermediaries, and now it is made up of just one
or two.21 Therefore, it is very important for international companies to study a host
country’s distribution channels and systems to develop a competitive strategy.
Distribution costs, if not controlled, may lead to unprofitable operations. Many
international companies continuously search for ways to streamline their distribution
systems to lower their costs. Some of these changes may include a total revamping
of not only the distribution system but other operational activities as well. A small
Ohio-based industrial parts company with distribution in more than six countries
established new channels by shifting its manufacturing to five locations around the
world with six major distribution centers. Before this shift in the manufacturing-
distribution matrix, all manufactured parts flowed through the company’s U.S.-based
manufacturing plant. After the revamped system, each manufacturing plant, through
its distribution centers, delivered parts to its customers at a faster rate, knocking 3
percent off the company’s distribution costs.22 Similarly, Dell Computers and Nokia
in China have improved their distribution systems through the removal of unneces-
sary layers of bureaucracy.23
Distribution systems in each country are often already established; hence, an in-
ternational company may be forced to adapt to the host country’s system. In some
countries, like Japan, the distribution system is complicated, and foreign companies,
even successful retail chains like Carrefour SA, have difficulty succeeding there.24
Most of the difficulties in Japan are attributed to the tradition-bound structure, which
is difficult for foreign companies to understand. Companies like Toys “R” Us have
taken on local partners in Japan to maneuver through an archaic system that is deeply
entrenched and functions effectively. Similarly, in the Philippines, food distribution
is handled first by large trading agents, followed by wholesalers, and then by food
brokers, finally reaching the end consumers through retailers. Nestlé’s entry into the
Philippine market has been greatly affected by the nation’s distribution chain. The
chocolate maker has very little choice but to use the existing distribution system. If it
wants to set up its own system, it may run into government regulations (in the Philip-
pines, food distribution cannot be handled by foreign-owned companies), as well as
increased investments in an activity in which the company has very little expertise,
and, more important, lacks geographic coverage. Nestlé may not be able to reach all
potential international consumers due to a lack of the wide network of retailers that
the independent businesses handling distribution are able to provide. International
290 CHApTER 11
Table 11.1
Types of Channel Members Used in Selected Countries
No. of Channel
Country Product Members Type of Channel Members
Australia Food items 1 to 2 Large food retailers buy direct. Small retail-
ers use a food distributor.
Brazil Food items; toiletries 2 to 4
China Nonfood items and 2 to 3 Dealer/distributor and retailer or Dealer/
prescription drugs distributor, wholesaler, and retailer
Denmark Food items; toiletries 1 to 3 For large chain retailers, just one; For
small retailers, broker and retailer
India Food items; toiletries 2 to 5
Japan Food items 5 to 6 Agent 1, Agent 2, distributors, wholesalers,
and retailers
New Zealand Food items; toiletries 2 to 4
Philippines Food items; toiletries 3 to 4 Brokers, distributors, and retailers
South Korea Food items; toiletries 1 to 2 For packaged items, direct to the retailer; For
fresh produce, wholesalers to retailers
Thailand Drugs 2 Wholesaler and retailer
United States Food items (meats); 3 Wholesalers, jobbers, and retailers
toiletries
marketers must get their goods into the hands of consumers, either by distributing
them themselves or by handing them to specialists who can do it more efficiently.25
Table 11.1 presents types of channel members used by selected countries in the dis-
tribution of various items.
Inventory management and warehousing are part of the distribution system. Through
inventory, companies are able to manage the uneven demand patterns that occur in the
marketplace. Because of distances and operating in different time zones, inventory
management in international marketing becomes even more critical than it is domesti-
cally. Inventory helps companies to regulate the flow of goods through distribution
channels. The advantage of maintaining an adequate inventory level is that consumers
will always be able to find the products they need (fulfilling the time utility function
of distribution), and retailers will not be out of stock of a particular brand of product.
Consumers may be willing to wait for items such as automobiles and even some appli-
ances, but for products such as milk, soap, detergent, and other household items, they
will not wait. If a particular brand is not available, consumers will switch brands.
The key decisions in inventory management are when to order and how much to
order. There are many costs associated with inventory management. Some of these
costs are storage (also called carrying) costs, ordering costs, handling costs, transpor-
tation costs, opportunity costs, insurance costs, allowances for breakage or spoilage,
and stock-out costs. Maintaining a large inventory is expensive, and marketers try to
control these costs. In industrial marketing, some manufacturers use the just-in-time
(JIT) manufacturing process. This inventory system is designed to minimize inven-
tories and their associated costs, and also to control waste. (Inventory management
and JIT are discussed in Chapter 8.)
DEVELOp A COMpREHENSIVE COMMUNIcATION PROGRAM

Communication programs are meant to inform current and potential consumers of the
benefits of using a company’s products and services. Well-organized and well-managed
communications should be able to (1) tell potential consumers why they should
use a particular brand of product, (2) persuade those customers that the company’s
brand is best by showing its advantages over competing brands, (3) build loyalty,
(4) serve as a champion for the company’s brands, and (4) inform consumers about
the company. In some industries such as cosmetics, household items, and toiletries,
communication costs are a major portion of the overall marketing costs. International
companies such as Nestlé, Procter & Gamble, and Unilever spend more than US$4
billion annually in communication-related activities. To achieve the various goals
of communication and at the same time be cost efficient, many companies develop
models to simulate scenarios and map outcomes. Some of the basic steps in most
communications strategies are:
• Identifying the target audience

• Setting communication goals
• Designing the message
• Selecting media
• Developing a promotional budget
• Evaluating communication programs
To be effective, a communications strategy should first identify the target audience,

which ranges from current users of a company’s products, to potential purchasers of
a company’s products, to those who may influence the purchase of the company’s
products, or any other group that may directly or indirectly help the company sell its
goods and services. As mentioned earlier, in international markets, the target audience
may differ from country to country, and, therefore, companies may have to adjust
their message to the audience targeted.
Once the target audience is identified, the next step is to develop a message that
conveys the reasons why a given target audience should consider using or buying a
company’s products. Message design should achieve the following: gain the audi-
ence’s attention, hold their interest, help them make a decision, and help them to recall
a specific brand when considering a purchase in a product category. In international
markets, it is important that message content be effective and be consistent with the
country’s cultural values. As explained in Chapter 2, “International Business Envi-
ronment: Culture,” numerous marketing campaigns have failed because of improper
usage of language or unintentional breaches of cultural norms.
To be successful, marketing communications have to be received by the selected
audience; therefore, selection of the right media vehicles helps companies reach their
target audience. The three basic vehicles to communicate with target audiences are
personal selling, advertising, and sales promotions. Despite their differences, all three
can be used together to attain improved synergy in communicating with the target
audience. Many domestic and international companies are developing integrated
292 CHApTER 11
marketing communication programs to attain maximum communication impact.26

An integrated marketing communication program is defined as a comprehensive plan
that evaluates the strategic roles of a variety of communication initiatives including
advertising, sales promotions, direct response, and public relations.
Personal Selling
Personal selling is a direct two-way communication that is possibly the most effec-
tive means of communicating with target consumers. As salespeople represent the
company, they are the final, but critical, link to consumers. Because of the direct
two-way communication, salespeople are able to answer questions, remove doubts,
customize the message to suit the consumer, and gather pertinent information that may
be useful in refining marketing strategies and introducing new products. Moreover,
personal selling is one of the few marketing activities that can be measured for its
effectiveness. Marketers are able to measure the effect of incremental spending on
the sales force in sales revenues or profits.
Even though personal selling has many benefits, one of its main drawbacks is its
cost. Because of salaries and fringe benefits, the cost for reaching 1,000 customers
through personal selling in comparison to reaching the same number of customers
through advertising is relatively very high. Assuming an average compensation pack-
age of $75,000 per salesperson, and assuming that each salesperson is able to reach
10 customers per day, it will cost a company $30,000 to reach 1,000 customers (10
customers × 250 days/year = 2,500 customers @ $75,000 = 75,000/2.5 = $30,000.00).
An advertisement during the Super Bowl cost only $5 to reach the same number of
customers, and in the case of most magazines, the cost to reach 1,000 customers ranges
from $3 to $35. In addition to its cost, developing a sales team is administratively
time-consuming, especially in the international marketing context. In some cases,
international companies cannot bring expatriates to the host country to be part of the
sales force. This may pose problems for international companies in industries such
as pharmaceuticals that deal with intellectual property items. Because of the above
reasons, personal selling is most often utilized in industrial marketing situations,
where it is important to customize communications and obtain feedback, and where
order size justifies the higher costs associated with this approach.
Advertising
Advertising is a nonpersonal communication approach that utilizes media vehicles

to reach a target audience. The objectives of advertising are the same as those of
the overall marketing communication program. Ads inform a given audience about
products, give reasons why customers should buy the products, tell where the
products are available, and provide information about the company that markets
the products. Many international companies use advertising as a communication
vehicle because of its cost efficiency and the variety of media that are available.
On the downside, advertising is a one-way communication vehicle; in addition,
most media are cluttered with hundreds of advertisements vying for viewers’ at-
Table 11.2
The World’s Ten Largest Advertisers, 2007 (US$ million)
Rank Company Country Advertising Expenditure

1 Procter & Gamble United States 8,190
2 Unilever Netherlands 4,272
3 General Motors United States 4,173
4 Toyota Japan 2,800
5 L’Oréal France 2,773
6 Ford Motors United States 2,645
7 Time Warner United States 2,479
8 Daimler Chrysler Germany 2,104
9 Nestlé Switzerland 2,033
10 Johnson & Johnson United States 1,968
Source: “Top 100 Global Marketers,” Advertising Age, November 19, 2007, p. 4.
tention, and the effectiveness of this type of communication is difficult to measure.

To improve advertising effectiveness, many companies use coordinated advertis-
ing campaigns to make their products popular.27 Creatively, it is very challenging
to develop messages to reach a culturally diverse audience.28 Some international
companies have tried to standardize their message content and/or media choice
in multiple countries if target audiences are found to be similar. But most often,
even with the same target audience within the same region, there are obstacles to
standardization due to minor variations among customers.29
International companies spend a considerable amount of money, time, and effort
in developing and placing advertisements. Total media spending for all companies
worldwide reached US$98 billion during 2007.30 That year, the leading advertiser
in the world was Procter & Gamble, with an annual expenditure of US$8.2 billion,
followed by Unilever with US$4.3 billion. Five of the top advertisers are American
companies. Four of the top advertisers are automobile companies. Table 11.2 presents
the world’s 10 largest advertisers. The total U.S. advertising expenditure at $47 bil-
lion alone is nearly half of all the advertising expenditures of the world. As a region,
Europe is the second largest advertiser in the world at US$31 billion. Table 11.3
presents advertising expenditures by region, and Table 11.4 presents the 10 leading
advertisers in the United States.
The actual development of an advertising campaign and the message design are
most often managed by advertising agencies. Advertising agencies offer an inter-
national company many services that are best handled by an outside supplier who
specializes in message design, creative input, artwork, media placement, market re-
search, publicity campaigns, and consulting. Not all advertising agencies offer every
service mentioned here; some offer just creative input, and a few others specialize
in media. Globalization of markets and the growth in international marketing have
been matched by the internationalization of advertising agencies. Most of the large ad
agencies, including Omnicom Group, WPP Group, Interpublic, Publicis, Dentsu, and
Havas, have offices in nearly 100 countries to match their clients’ operations. In some
294 CHApTER 11
Table 11.3
Advertising Expenditures by Region, 2007 (US$ million)
Rank Region Advertising Expenditure % of Total

1 United States 46,015 47.1
2 Europe 31,121 31.8
3 Asia 14,915 15.3
4 Africa, Latin America, and Middle East 3,616 3.7
5 Canada 2,093 2.1
6 Total 97,760 100.00
Source: “Top 100 AD Spending by Region,” Advertising Age, November 19, 2007, p. 7.
countries, international companies may hire local ad agencies for their knowledge of
the particular market, and in some instances, the host countries’ laws may require a
local partner, as in the case of Vietnam.
For advertising to reach its audience, it needs to use media vehicles. The major
advertising media are print (newspapers and magazines), broadcast (radio and televi-
sion), outdoor, direct mail, and electronic media.
Because of specific considerations, cultural influences, and regulations, all media
are not available for advertising in all countries. Television and radio in some coun-
tries are controlled by the government and, hence, not available for the placement of
advertisements. In Brazil, broadcast advertisements must appear just before or after
the start of a program or during station breaks; in Vietnam, space for advertisement
in print media is limited to only 10 percent. These restrictions and cultural influences
pose problems for international marketers in their attempts to reach their customers.
Therefore, it is essential that international companies plan ahead and develop alterna-
tives in case the preferred media are not available to them.
For international marketers, the decision to place advertising in one or more of
the seven available media vehicles is governed by two factors: which ones offer the
best chance of reaching the target audience and which are the most cost effective.
Most companies use a collection of media (called a media mix) to reach the various
segments of the market. Each medium has advantages and disadvantages.
Newspapers are relatively inexpensive, reach a wide audience, have high believ-
ability in most countries, and can be reviewed again and again. Since most newspapers
are printed in black and white, they are not useful in communication campaigns that
need to show vibrant colors such as cosmetics, clothing, food, and automobiles (in
some countries this problem has been overcome with special full-color advertising
inserts). Newspapers in some countries focus on just the news and have limited space
for advertising, as in Japan. For some advertisers, newspapers’ target audience may
be too broad.
Magazines reach a specific target segment, as there are many specialized magazines
that attract certain groups (Business Week, the Economist, and Vogue, are three good
examples). Magazines can also be geographically segmented through regional edi-
tions (Time magazine has an Asian edition and a European edition). Magazines have
high-quality reproduction, including color and a long life (people keep magazines
Table 11.4
The Ten Largest Advertisers in the United States, 2007 (US$ million)
Rank Company Advertising Expenditure

1 Procter & Gamble 5,230.1
2 AT&T 3,207.3
3 Verizon Communications 3,016.1
4 General Motors 3,010.1
5 Time Warner 2,962.1
6 Ford Motors 2,525.2
7 Glaxo Smith Kline 2,456.9
8 Johnson & Johnson 2,408.8
9 Walt Disney Co. 2,293.3
10 Unilever 2,245.8
Source: “Leading National Advertisers,” Advertising Age, June 5, 2008, p. 8.
for a long time), and have pass-along readership. On the negative side, magazines
are relatively expensive and have a long lead time (some magazines require at least
six months’ lead time to buy advertising space).
Radio is a good backup medium that is inexpensive and useful in reminding
a target audience about a company’s products. Radio has a wide reach in many
countries, as most people have radios. On the negative side, radio suffers from a
lack of visual presentation, and ads are usually very short. In addition, some of
the more popular stations that have a significant listener base may have too many
advertisements and hence more clutter (clutter is defined as greater number of
advertisements in a given time period). Studies have shown that respondents are
twice as likely to recall a particular advertisement among those that they were
exposed to low clutter compared to those who heard the same advertisements in
a high-clutter situation.31
Combining both audio and visual presentations, television is a popular medium
that the masses watch for news and entertainment. The audiovisual presentation im-
proves the attention rate of the audience, is appealing to their senses, and helps the
target audience recall the ad’s message. Placing advertisements on television is very
expensive (the cost of single minute of advertising during the 2006 Super Bowl was
$4 million). The television medium also suffers from clutter, as there are too many
ads, and each ad may be shown for only 15 to 30 seconds. In many countries, such
as China, advertising on television is strictly controlled. In Sweden, advertisements
focusing on children are restricted. Hence, this medium is not always available to
international companies.32
Outdoor advertising is a flexible medium that has high exposure and is inexpensive.
However, some countries have many regulations governing outdoor advertising, and
this type of advertising does not have audience selectivity; therefore, it is limited to
certain product categories.
Direct mail may be customized both in message content and in customer targets.
Hence, it is useful for certain product categories, such as financial services. Direct
296 CHApTER 11
mail assumes that the mail system in a country is efficient and that the target audi-
ence’s addresses can be located easily. But in many developing countries and also in
some industrialized countries, the postal system is not efficient, and finding addresses
is next to impossible.
The Internet has become a worldwide medium that is gaining popularity, especially
among the young. The Web is a low-cost medium (the cost is less than US$1 to reach 1,000
potential customers), and it is an interactive system that can help international companies
answer questions and gather relevant information from potential customers.
Sales Promotion
Sales promotions are a collection of communication initiatives that do not fall under
the personal selling or advertising categories. Any communication device that can
be creatively developed to inform a target audience about a product, a service, an
idea, or an organization is a sales promotion. In the United States, commonly used
sales promotion tools are sampling (giving out free samples), coupons, rebates,
low-interest financing, premiums, contests, and tie-ins. As the list of tools suggests,
it is difficult to categorize them under a single label. Internationally, common sales
promotion tools are price discounts, in-store demonstrations, coupons, sweepstakes,
games, and buy one, get one free (BOGO) specials. For example, during the 2006
World Cup, Bimbo, Mexico’s leading bakery, teamed up with Jorge Campos,
Mexico’s star soccer player, for a promotion campaign tied in to the World Cup
championship.
Sales promotions are useful for gaining attention because they are incentive laden.
Expected responses from successful sales promotion tools are brand switching, pur-
chase acceleration, stockpiling, product trials, and increased spending. Supermarkets
are heavy users of sales promotion devices.33
Because of regulations, a few sales promotion tools that are permissible in the
parent country may not be used in the host country. For example, in Belgium there is
a maximum limit on discounts (33 percent), and in many European Union countries,
games and sweepstakes tied to product purchases are banned.34 Similarly, in many
Asian countries, cash gifts are restricted by local laws.
IMpLEMENT A CUSTOMER RELATIONS PROGRAM

Customer relations management (CRM) is a powerful tool in the hands of marketers
that can be used to segment markets, preempt customers’ concerns, customize mar-
keting strategies, and evaluate current marketing programs. CRM systems integrate
pertinent customer information into a single location and help businesses use tech-
nology and human resources to gain insight into customers’ behavior. CRM offers
fast access to records of actual customer purchasing behavior. Through advances in
computer technology and database management, it has become easier and less expen-
sive for companies to set up CRM systems that provide unprecedented opportunities
to customize products and meet customers’ needs.35 Some international companies
hire consulting companies that specialize in CRM to develop their relationship pro-
grams. International CRM Solutions provides multilingual sales and service support
for clients throughout the world, including the Asia-Pacific region, Europe, Latin
America, and North America. Some financial service companies have successfully
implemented CRM in a few countries using their existing information technology
(IT) departments.36
SET Up A FEEDBAcK MEcHANISM TO EVALUATE THE MARKETING PROGRAM

Strategic marketing programs are dynamic and require adjustments during their imple-
mentation stage. Feedback systems should track the results and monitor changes taking
place in the marketing environment, especially competitive efforts. To fine-tune the
program, international marketers need information about the program’s success. The
type of information sought can be performance measures such as revenues, market
share, regional penetration, and dealer acceptance rate, and more specific consumer
information such as who purchased the product, where they purchased the product,
and the reasons why they purchased the product.
There are many techniques to track programs. Some are simple; others rely on
specialized data. Some are internally generated information, and others are obtained
from outside suppliers. Tracking sales data by customer and/or by region is useful
for understanding the direct effects of a marketing program. This adaptation can be
compared to using historical data for comparative analysis. International companies
also compare sales data across countries to identify patterns. In addition, compa-
nies can compare sales and other related data to preestablished benchmarks such
as industry averages or the dominant competitor’s performance. Information can
also be obtained from consumers through market research that may help companies
in evaluating their marketing programs. Distributors, as well, are a good source
of information that may help international companies identify problems with their
marketing programs.
Syndicated companies such as Nielsen and Ipsos Group S.A. conduct studies and
monitor sales of goods on a regular basis. The studies are available to subscribers for a
fee. These and other companies provide single-source data (data that allows research-
ers to link purchase behavior, household characteristics, and advertising exposure at
the household level) that is customer and market specific.
CHApTER SUMMARY
Marketing activities generate sales and in turn revenues and profits. Hence,
studying marketing activities is one of the most critical business functions for an
international company. The basic marketing activities for a domestic market and
an international market are the same, but the external environment in which an
international company operates is more challenging and difficult to predict. In
developing marketing programs for international markets, it is useful to know the
various regulations that govern some of these activities. The regulations vary across
countries, and international marketers may have to adapt their strategies to comply
with the regulations.
298 CHApTER 11
The primary focus of all marketing programs is the consumer. Strategic actions
such as product/service development and others are intended to influence purchases.
To understand the consumers’ needs and the benefits they seek from a product, inter-
national marketers obtain consumer- and market-related information. International
marketers deal with both final and industrial consumers. Final consumers purchase
goods and services for their personal consumption, whereas industrial consumers
purchase goods and services to make other goods and services and then sell them to
the final consumers.
Standardization of products and marketing programs is the ultimate goal of in-
ternational companies. Standardization reduces costs and improves efficiency. But
due to variations in the external environment, standardization is not always possible.
Therefore, international companies may end up adapting their products and marketing
programs to suit the host countries’ market conditions.
Strategic marketing variables include product, brand, packaging, price, distribution,
and communication. To be successful, an international marketer should coordinate
all the various marketing activities to benefit from the synergy that can be derived
from the interplay of the activities.
It is important for international marketers to assess their marketing programs to
identify and make any changes that may be necessary. Using internally available data,
companies can fine-tune their programs to improve their results.
KEY CONCEpTS
International Marketing Environment
Target Market
Marketing Variables
Standardization
Integrated Marketing Approach
Customer Relations
1. What are the differences between the domestic and international marketing
environments?
2. What are the differences between final and industrial consumers?
3. What are the differences between products and services?
4. What is standardization?
5. What are the benefits of standardization?
6. What are the key marketing activities?
7. Discuss international product life cycle (PLC).
8. What is product positioning?
9. Why is it difficult to standardize prices across markets?
10. Identify the critical issues in international distribution.
11. What is an integrated communication program?
12. What are the major challenges for international marketers in communicating
with a target audience?
13. What is customer relations management?

14. What are country-of-origin effects, and how can they be utilized to an inter-
national company’s advantage?
15. Why do international companies set up feedback systems?
AppLiCATiON CASE: NATURA—A BRAZiLiAN SUCCESS STORY

Natura was established in 1969 as a laboratory and retail store in São Paulo,
Brazil. Its first line of products consisted of men’s grooming items; in 1972,
the company added a women’s line of cosmetics. From its inception, Natura’s
business philosophy was to build relationships: the company fostered relation-
ships with its customers, suppliers, and employees while building its customer
base by providing innovative, high-quality products. In a shift from industry
norms at that time, Natura made a decision to sell through a well-organized sales
force—called consultants—directly to its customers, bypassing the established
distribution channels; this is the same practice used by Avon, a large, U.S.-based
multinational cosmetic company.
With its customer-focused business philosophy, its quality products, and its
system of direct distribution, Natura grew by leaps and bounds. In 1974, the com-
pany’s annual revenues were just over $5 million; it had revenues of $180 million
in 1990 and $350 million four years later. By 2006, the company had grown to be
a major player in the cosmetics and beauty care industry, with sales of more than
$2.7 billion, 5,125 employees, and about 568,000 consultants. Having captured
20 percent of the Brazilian cosmetics market, Natura was competing head-on with
such industry giants such as Max Factor (a division of Procter & Gamble), L’Oreal,
and Unilever.
Back in the 1990s, as the Brazilian economy grew, the government decided
to open its markets to foreign competition in many industrial sectors, including
cosmetics. At the same time, Natura decided to expand its operations into other
Latin American countries, including Argentina, Bolivia, Chile, Mexico, and Peru.
Through its well-trained sales consultants, Natura was able to do well in many of
these countries.
Besides its business philosophy and direct sales approach, Natura succeeded
through innovative product introductions that took advantage of its consultant net-
work’s extensive customer knowledge. Through R&D efforts and market research,
Natura identified attractive target segments in each of the countries it entered and
then developed products that solved unique customer-related beauty problems. For
example, by offering a three-in-one skin care product, the company was able to outsell
its competitors, who had three different products for the same purpose. The savings
were substantial, and the use of just one product instead of three made the Natura
cream a convenient, time-saving choice for customers. In addition, Natura used many
indigenous ingredients found in the Amazon jungles of Brazil that were less harsh on
the skin, especially in humid tropical climates.
Natura offers a full range of cosmetic, facial care, skin care, and hair care products
for men and women of all ages. In 2006 alone, Natura launched 213 new products.
300 CHApTER 11
The company has several lines that cater to specific target segments by addressing
their unique needs. For example, one of its successful product lines, called “Mamae e
Bebe” (translated as “Mom and Baby”) is aimed at mothers and infants and addresses
the needs of both. By concentrating on introducing new products and targeting dif-
ferent needs, Natura always seems to leave its rivals behind.
QUESTION
1. Enumerate and discuss the strategic actions that helped Natura, a small com-
pany, compete successfully with some of the large, foreign-owned cosmetic
companies.
International Human Resources
12 Management and
Organizational Structures
Of all the resources managed by an organization, the human resources are the most
critical of all. Organizational structures dictate the divisions of workforce and distribution
of roles to facilitate the orderly functioning of a firm.
LEARNiNG ObJECTiVES
• To explain the role of human resources in an international company
• To understand the various functions of human resources management
• To understand the differences between centralized and decentralized organizations
• To understand the differences between using local managers and using expatriate
managers
• To understand the importance of labor-management relations
• To distinguish and describe different types of organizational structures
• To discuss factors that affect organizational decision making in an international
firm
• To understand the role of divisional and departmental setups in organizing for
international business
Managing a modern-day international company with its dynamic competitive environment

requires a strong internal governance process that starts with the people that administer
it.1 As more and more companies embrace the resource-based view (RBV) of strategy, the
employees offer the core competencies for sustainable competitive advantage.2 Moreover,
research studies have shown that the companies most effective in conducting business
globally must excel in people management, among other factors.3 Human resources, also
referred to as human capital, are probably the most important resource that international
companies possess.4 The success of international companies in their human resources
development process has led government agencies of foreign countries to use those same
techniques in training their staff, especially in handling crisis situations.5
The people who manage an international company are part of human resources
management (HRM). The human resources management function in an international
company involves many activities, among them identifying staffing needs, writing
detailed job descriptions, and recruiting and hiring the right people. Each of these
301
302 CHApTER 12
activities is undertaken in a complex and challenging international environment. The

spread of globalization has forced international companies to staff multicountry opera-
tions with qualified people from all parts of the world rather than looking internally
for expatriates to manage operations.6 In an international company, human resources
managers become even more critical than in a domestic environment, as these people
play a key role in the overall international strategic planning process.7
International companies’ personnel include people from different countries; therefore,
a major challenge for an international company is to manage this diverse group of staff
with different cultural backgrounds and to encourage them to work as a team, interacting
with one another to achieve corporate goals. Running a modern globally oriented company
requires a highly specialized yet closely linked group of global managers, regional and
local managers, and worldwide functional managers.8 The task sounds challenging, and
it is; hence, the difficulties of managing a dispersed and disparate workforce in a glob-
ally oriented organization. Some large international companies have thousands of people
working for them in many different countries. For example, Unilever, the Anglo-Dutch
company based in the Netherlands, operates in 150 countries and employs 247,000 people
worldwide. Managing such a vast number of staff in different parts of the world requires a
well-organized human resources department that can react to varied requests from subsidiar-
ies. To make each subsidiary thrive, international companies have to successfully transfer
business practices from the parent company to local subsidiaries. A key to this diffusion,
or transfer, is the parent company’s human resources practices.9 By deploying staff from
corporate headquarters, international companies are able to transfer management skills to
a wide group of personnel across countries, thereby developing the capabilities of the staff
with the foreign assignment and becoming a training ground for career development.10
One of the primary questions international companies have to address is the issue of
how much control host-country managers should be given. This issue, the two sides of
which are broadly labeled “centralized” operations and “decentralized” operations, reflects
where the power and control of operations are vested. In a centralized organization, most
of the power and control are held at the company’s headquarters; the managers at the
company’s central location make decisions for the subsidiaries. In a decentralized orga-
nizational structure, many decisions are made by managers at the subsidiary levels. Large
international companies fear the loss of control in a totally decentralized organizational
setup. To ensure control in a decentralized organizational system, companies develop
formal strategic control processes that allow them to exert some form of control to achieve
broader corporate goals.11 Some international companies have developed a middle-of-the-
road approach, wherein the control and power do not reside at either extreme.
It is difficult to balance these two divergent systems. In industries where transfer
of technology or knowledge is critical, the more centralized form of organizational
structure is recommended.12 For example, setting retail prices, selecting media for
advertising, and making sales force management decisions in the local market may
be done by subsidiary managers. However, major investment decisions, budget allo-
cations for R&D, and selecting countries as targets for marketing goods and services
would be made at the headquarters level. Philips, the Netherlands-based electronics
company, has a centralized system for currency hedging but allows individual countries
to allocate the gains or losses resulting from these hedging actions.13 The relationship
INT’L HUMAN RESOURcES MGMT AND ORGANIZATIONAL STRUcTURES 303
between headquarters personnel and subsidiary personnel is critical in the success of

international companies. Headquarters personnel must be able to effectively coordinate
and control worldwide operations to improve efficiency and reduce duplication and
waste. Subsidiary managers and staff should be able to understand local conditions
and make smart decisions that have a positive impact on their local operations.
Human resources management is made up of many individual functions. These
functions collectively help an international company manage and coordinate the
activities of its staff in different countries.
MANAGiNG THE HUMAN RESOURCES FUNCTiON

The human resources functions in an international company are:
• Identifying the staffing needs of an international company

• Writing out detailed job descriptions
• Recruiting the right people
• Developing an adequate and fair compensation plan
• Instituting an evaluation process
• Setting up training programs to develop international managers
• Managing the placement of expatriate and host-country personnel
As companies grow, the need to staff this growth requires that an international
company recruit and train new employees. Many of the larger international companies
plan their staffing needs well in advance to coincide with their expansion plans into
overseas markets. In some companies, human resources needs are planned two to three
years in advance, as many American companies do. In contrast, Japanese companies
normally plan their future staffing needs nine to ten years in advance.
In identifying staffing needs, international companies have to complete the fol-
lowing steps:
• Determine the number of new employees to be hired for a specific time period
• Ascertain the functional department(s) to which the new employees will be
assigned
• Determine the time frame in which these new employees should be hired (for
instance, immediately, in the next 12 months, or in the next two years)
• Determine if the new positions could be staffed by current employees
• Determine if new staff should be hired for assignments at headquarters or at the
subsidiary level
• If the staff is required at the subsidiary level, determine the countries in which
these new staff will be employed
• Describe the job specification for each new position
• Identify the essential qualifications, including technical and language skills, of
the persons to be hired
• Identify financial considerations, including budget allocations (which budget the
staff will be assigned to)
304 CHApTER 12
• Determine whether the new position can be filled by a local staff member or must
be filled by an expatriate staff member
DETERMINE THE NUMBER OF NEW EMpLOYEES TO BE HIRED FOR A SpEcIFIc

TIME PERIOD
The request for new employees may come from many areas, including functional
departments within the organization, subsidiary operations, or HRM itself. In larger
international companies, procedures are set up so that each functional manager or
country manager requesting new staff has to submit paperwork for review by upper
management. The official procedure includes justifying the need for additional per-
sonnel, deciding on the applicants’ required qualifications and experience, estimating
the salary level for each open position, figuring out which budget will be charged
for paying the new staff, and establishing the date for the new staff to begin work.
In smaller organizations, procedures may be much more informal, but all staff addi-
tions must be justified. Whether the procedures are formal or informal, at the end of
the process, management must be able to determine the number of new employees
needed by the company for a given period of time.
In identifying staffing needs, some larger international companies periodically
conduct an inventory of their current personnel and their various skills. The items
included in the personnel database include educational background (degree[s] earned),
special skills, work experience, yearly performance evaluations, training programs
attended, and so on. Table 12.1 presents the skeletal framework of the matrix used in
an HRM personnel/skill inventory.
This information is stored in an HRM database and can be accessed whenever there
is a need to identify internally qualified staff. The personnel/skills inventory provides the
company with information about where it can locate a specific skilled person within the
company, if such a skill level is required. Most companies go to great lengths to find inter-
nally qualified people to fill an open position; only if they cannot find a qualified internal
candidate do they actively recruit from outside. There are many benefits for a company
in seeking internal candidates first, including that management knows the strengths and
weaknesses of its employees, these employees are familiar with the company’s products
and services, and, finally, internal hiring provides opportunities for staff to grow within
the organization. Additionally, internal hirings are excellent for motivating staff.
AScERTAIN THE FUNcTIONAL DEpARTMENT(S) TO WHIcH THE NEW EMpLOYEES WILL

BE ASSIGNED
In most instances, the request for new staff comes from a particular functional depart-
ment at the headquarters or subsidiary level. Typical functions in most organizations
are accounting, administration and legal, finance, HRM, information technology
(IT), marketing, production and operations management (POM), and research and
development (R&D). It is also possible that in some instances, based on future ex-
pansion plans, HRM and senior management may decide to add new staff to a new
functional area or add staff to fulfill the needs of a newly created department or even
Table 12.1
Skeletal Framework of the Matrix Used in HRM Personnel/Skill Inventory
Current No. of Years in No. of Years in Educational Additional Internal Language

Employee ID Position This Position the Company Background Certification Training Skills Other Factors
001
002
003
004
005
006
007
008
00n
305
306 CHApTER 12
a new division. For example, as customer relations management (CRM) became part
of business operations, many international companies added this function and were
compelled to add new staff independent of the existing departmental needs. Similarly,
many foreign-based companies in the United States, such as HSBC, Siemens, and
Nestlé, were forced to add compliance officers for improving internal controls and
audit trails in their subsidiaries, as required by the Sarbanes-Oxley Act of 2002.
DETERMINE THE TIME FRAME IN WHIcH THESE NEW EMpLOYEES SHOULD BE HIRED
Recruiting the right staff for a specific position is time-consuming and expensive. A
new employee who does not fit within the corporate culture or is not able to fulfill
the tasks assigned causes unnecessary delays, additional expenses, and an increased
workload for the existing staff—situations that may bring down the morale of the
employees. Therefore, many international companies plan ahead so that they can take
their time in identifying the right person and avoiding costly mistakes. International
companies usually start their hiring process six months to a year in advance. The
length of time needed depends on the availability of a pool of candidates, the level
of the position that is going to be filled (from a simple clerk to a technical manager),
the number of vacancies to be filled, host-country regulations, and the amount of
training needed to prepare the employee for taking the post.
In some instances, an international company will fill in a position with minimal plan-
ning due to an urgent need for a replacement or to fulfill a need brought on by shifts in
the marketplace in one of its subsidiary operations. For example, when Apple’s iPod
became an instant success, it had to hire additional marketing and sales staff in the United
States and many of its overseas operations to handle the unusually high demand.
DETERMINE IF THE NEW POSITIONS COULD BE STAFFED BY CURRENT EMpLOYEES

Once the number of new staff and the time within which they have to be hired are
determined, an international company normally looks for people within its organiza-
tion. As mentioned earlier, internal hiring provides opportunities for present employees
to advance and improves morale. This is especially true if the position to be filled
is of a sensitive nature, such as dealing with intellectual property rights or handling
confidential financial, technical, or R&D information. These positions are better filled
by people who have experience and who have been with the company for some time;
they provide an opportunity for a well-deserving employee to move up within the or-
ganization. If the position to be filled is not critical—a clerical position, for instance—
and is not at a level to which an existing employee can be promoted, international
companies may not spend too much time reviewing internal candidates.
DETERMINE IF NEW STAFF SHOULD BE HIRED FOR ASSIGNMENTS AT HEADqUARTERS

OR AT THE SUBSIDIARY LEVEL
Where new staff will be assigned depends on where the request for new employees
originated. If the request for a position comes from headquarters, then the new staff will
be placed at headquarters. If the request for a position comes from one of the subsidiaries,
then the new staff will be placed at that subsidiary. Requests for new employees may also
come from regional offices for assignments at either the regional office or in one of the
local operations. When operating in many countries, international companies often set
up regional offices to manage the disparate operations. Countries are often grouped by
geographic proximity. For example, Coca-Cola is divided into six geographic divisions:
(1) North America, (2) Africa, (3) East Asia, South Asia, and Pacific Rim, (4) European
Union, (5) Latin America, and (6) North Asia, Eurasia, and Middle East.
One of the decisions a company faces when placing new staff, whether at headquar-
ters or at the subsidiary level, is whether to use expatriates to fill the positions or to
hire host-country nationals. That is, the company must determine whether it is better
to send staff from its existing operations (headquarters, regional offices, or one of its
subsidiaries) to an operation in another country or to rely on local staff. In consider-
ing this issue, we need to define the term expatriate. Expatriates are noncitizens of
the country in which they are working. For instance, if Canon, a Japanese company,
sends one of its staff from Japan to work in China, that employee is considered an
expatriate (also called an “expat”). A more detailed discussion of expatriates versus
host-country citizens is presented later in this chapter.
IF THE STAFF IS REqUIRED AT THE SUBSIDIARY LEVEL, DETERMINE THE COUNTRIES IN

WHIcH THESE NEW STAFF WILL BE EMpLOYED
If the request for additional staff is from one of the subsidiaries, the question of where to
assign the new staff is quite simple. The subsidiary requesting the new staff either will
recruit locally or will be assigned a staff member from the regional office or headquarters.
In some instances, the decision to add a new staff member at the subsidiary level may come
from headquarters to improve the operation, in which case the new staff may be recruited
at the parent country and then assigned to the subsidiary in the host country.
DEScRIBE THE JOB SpEcIFIcATION FOR EAcH NEW POSITION

It is essential that the department, unit, or division requesting the new staff be able
to spell out exactly what the job entails. Called “job specification,” this explains in
detail the various tasks that the person hired should accomplish, to whom the new
staff member reports, with whom they have to interface, what qualifications they
need, and how their performance will be measured.
IDENTIFY THE ESSENTIAL QUALIFIcATIONS, INcLUDING TEcHNIcAL AND LANGUAGE

SKILLS, OF THE PERSONS TO BE HIRED
To recruit the right person for a particular job, the department, unit, or division re-
questing the new staff member must have a clear idea of the qualifications required
to undertake the assignment. Normally, the qualifications are an output of the job
specification. That is, if the accounting department is requesting an additional audi-
tor to monitor the various subsidiary operations, the basic qualification required may
308 CHApTER 12
include an undergraduate degree in accounting and a certification that qualifies the

individual to sign off on accounting reports, such as balance sheets. In the United
States, an auditor must have a certification of public accountancy (CPA) to be able
to sign off on accounting reports.
IDENTIFY FINANcIAL CONSIDERATIONS, INcLUDING BUDGET ALLOcATIONS

Before requesting approval for hiring a new employee, the requesting department or
unit should have the necessary funds. Budget allocations are necessary to keep control
of costs and to make sure that all expenditures are preapproved. Budgets are a detailed
forecast of all expected cash inflows and outflows by the international company for
all its activities and are prepared well in advance. Budgets have a specific time frame,
usually a year, but in some international companies they can be set for a longer time
period. If the control measures are not in place, there may be cost overruns that affect
the net earnings of the company.
DETERMINE WHETHER THE NEW POSITION CAN BE FILLED BY A LOcAL STAFF

MEMBER OR MUST BE FILLED BY AN EXpATRIATE STAFF MEMBER
Expatriates
In hiring staff for international operations, management has a choice of hiring local
staff or sending in personnel from other countries. Personnel from other countries
may include employees from headquarters, regional offices, or another subsidiary.
These outside staff members are referred to as expatriates. As explained earlier, expa-
triates are noncitizens of the country in which they are working: they may be home-
country nationals, that is, citizens of the country in which the international company
is headquartered, or third-country nationals, that is, citizens of neither the country in
which they are working nor the headquarters country. For example, a manager sent
by Mercedes-Benz from Germany to its operations in the United States is a home-
country national; however, a Chinese manager from Mercedes-Benz’s operations in
China who is sent to the United States is a third-country national. In both cases, the
managers deployed are considered expatriates.
Most often, if the new assignment is not critical (clerk, assembly line worker,
or technician, for example), it is not necessary for international companies to send
in personnel from other countries. These positions, if filled by expatriates, might
unnecessarily increase the cost of operations at the subsidiary level. In contrast,
if the position is a managerial or highly skilled position (chemist, IT specialist,
and the like), the decision to hire locally versus sending in an expatriate becomes
quite involved.
Compared to 20 or 30 years ago, when there were many expatriates working in
subsidiary operations, in recent years the numbers of these employees have been de-
clining. International companies have found competent local personnel with sufficient
skills; the cost of sending an expatriate has risen; some host-country governments
have regulations that prohibit excessive hiring of expatriates; the expatriate burnout
rate is high; and expatriates, especially those from the headquarters country, are often
not willing to relocate to operations in foreign countries.
Job burnout among expatriates is a major concern for international companies. In
some cases, expatriates have not been able to handle the strains of working overseas
and have either failed as managers or have left their jobs earlier than planned. Research
conducted on expatriate burnout has identified several reasons for this. In one study,
researchers found that the expatriates had difficulty adjusting to local cultures and busi-
ness practices.14 Other frequently mentioned reasons for expatriate burnout are lack of
job satisfaction,15 role conflicts,16 and the inability of most Western-based expatriates
who come from rule-based individualistic countries to adjust to the relationship-based
collectivistic countries that are mostly in their economic development stages.17
There are many compelling reasons why international companies rely on expatri-
ates to fill some positions in their subsidiary operations:
• International companies are not able to find qualified personnel in host countries.
• The nature of the position involves sensitive areas such as proprietary technology,
confidential operational procedures, complex mathematical models, and so on.
• Transfer of technology is involved. That is, when a company is starting up a new
operation, introducing a new product, making a major modification to a product,
or introducing a totally new production process, international companies use
expatriates to accomplish these tasks.
• A subsidiary operation needs to be controlled. A subsidiary is just a part of the
larger entity, and, hence, its activities need to be synchronized and coordinated
with the activities of all other subsidiaries. Having a person from headquarters
is of great help in this process.
• Host-country personnel need to be introduced to and educated about the com-
pany’s policies and procedures (so the subsidiary operates as headquarters
operates). This uniform application of policies and procedures is very useful in
managing vastly diverse operations.
• Managers must be provided with a training ground for understanding the complexi-
ties of managing across diverse environments in preparation for senior postings.18
There are disadvantages to sending expatriates to foreign countries:
• There are additional costs. Expatriate personnel are normally paid a premium
to accept positions in overseas subsidiaries. In addition, there are other costs,
such as moving expenses, housing allowances, educational allowances for
children, annual home leave, adjustments for host-country taxes, and household
help allowances.
• It takes time for the expatriate manager to get acclimated and to begin handling
the daily tasks.
• The expatriate’s family members may not adjust to local conditions, creating
tension at home and making the expatriate less productive.
• There may be resentment from local staff, as each incoming expatriate takes
away an opportunity for local personnel to move up within the organization.
310 CHApTER 12
• The reentry of expatriate managers back into their home country is not smooth.
During their absence, there may have been shifts in assignments and the
previously established network with other managers and staff may not exist
anymore.
• There may be legal restrictions in bringing foreign-born managers into the host
country.
A few countries (India, among others) have enacted laws that restrict the number of
foreign personnel that can work in a subsidiary. Host governments enact these laws to
force foreign companies to train local personnel in advanced technical and managerial
skills to improve the skills of local staff. In addition, host governments view expatri-
ates as an unnecessary financial drain (outflow of funds) on the economy.
Therefore, when determining whether to fill a position with an expatriate, inter-
national companies have to carefully weigh the pros and cons and decide whether
it is in the best interest of the company to send a foreign national as a manager to a
subsidiary operation.
A related issue concerning expatriates is whether to send a worker from the home
country or from a third country. If the international company’s desire is to have control
of subsidiary operations, protect intellectual property (or another sensitive area), and/
or introduce new products, procedures, and methods, it is always better to use home-
country nationals. Home-country nationals are more apt to have the required experi-
ence and related qualifications for this type of work than third-country nationals.
If the position at the subsidiary is not in a sensitive area and does not involve in-
troduction of products, procedures, or methods, it is best to send third-country nation-
als. Third-country nationals may have compatible qualifications in the nonbusiness
area, such as cultural or language similarities. For example, it is easier for Indian
expatriate managers to function in Bangladesh or Sri Lanka than it is for European
expatriate personnel because of the cultural similarities among India, Bangladesh,
and Sri Lanka.
The process of selecting expatriate personnel for overseas assignments has to be
handled carefully. Many of the problems attributed to expatriate failures can be traced
back to the selection of the wrong people for the job—people who did not want to
leave their home country, were not prepared for the complexities of working in a
different culture, did not know how to adjust to staff that had different skill levels,
and in some instances did not have the necessary technical competence to function
effectively.
As this discussion shows, international companies should consider the following fac-
tors critical when selecting an expatriate to fill a position with a foreign subsidiary.
Technical Competence. The person selected for overseas operations must have ad-
vanced technical knowledge of the position through education, training, and/or work
experience; remember that technical knowledge is frequently lacking at the subsidiary
level, so technical competence is the key reason why expatriates are needed in host
countries.19 For example, a person selected to head the finance department in a sub-
sidiary must have the necessary financial background to be effective. Research studies
have shown that technical competence, usually indicated by past domestic or foreign
job performance, is the greatest determinant of success in foreign assignments.
Cultural and Linguistic Adaptability. Individuals who come from cultural backgrounds
similar to that of the host country or know the host-country language seem to per-
form well as expatriates. Studies have shown that it is possible to select expatriate
staff using cross-cultural social intelligence tests that have proven to be effective.20
For example, an expatriate from Argentina who is sent to Chile would have a better
chance of succeeding because these two countries have similar cultures and Spanish
is the official language of both nations.
Willingness to Accept Foreign Assignment. Any expatriate must not only be competent
and adaptable but also be willing and eager to take the foreign assignment. Those who
view the foreign assignment as a challenge and adventure are more likely to succeed
than those who view it as just a job. Research studies have shown that expatriates from
Australia, the Netherlands, and the United Kingdom are more willing to be placed
overseas than the French, Germans, Italians, Spanish, and Swiss.21
Family Cooperation. It is equally important for the international company to ascertain

the willingness of the spouse (if the expatriate is married) and children to be in a
foreign country. Many expatriates have failed due to the inability of family members
to adjust to the local environment.22
Local Staff
If the international company’s business is affected by local environmental conditions

such as culture, language, business practices, laws, and established relationships, then
it is better for the company to hire local staff. The greater the need for local adapta-
tion, the better it is for the international company to use local managers because they
understand local conditions better than foreign nationals do. For example, if local
distributors are more likely to trust and work with locals, hiring a marketing manager
from a foreign country would create problems. Similarly, if government officials speak
only the local language, sending an expatriate with no knowledge of this language to
negotiate with the host government is bound to fail. In this circumstance, it is better
to hire a local to participate in the negotiations.
To a great extent, the importance of the decisions to be made, the experience of
the host-country managers, and the confidence of the upper management in the local
managers will influence the amount of control and decision making that will be trans-
ferred to the subsidiary level. Following are several other reasons to hire locals:
• Hiring local managers is less expensive than sending an expatriate to the sub-
sidiary. For starters, local managers are paid comparable local salaries that are
lower than the salaries paid to expatriates. The company does not have to pay
the various allowances (moving, educational, housing, and others) to the locals
that are commonly paid to expatriates.
312 CHApTER 12
• There may be political or diplomatic reasons why locals may be better suited for
the position than expatriates. For example, BP, a UK-based international company,
would be better served by appointing Argentinean managers to key posts rather
than having British managers attempt to deal with the local government and other
business entities in Argentina; territorial disputes and conflicts between the United
Kingdom and Argentina still exist over the Falkland Islands, which are located in
the southern Atlantic Ocean about 300 miles off the coast of Argentina.
• Hiring local managers may help establish better relationships with the subsidiary’s
workforce, which may enhance overall morale. Moreover, it is easier to recruit
experienced new local employees if the managerial positions are held by locals.
• International companies that have hired local managers have found that these
employees have some good ideas and initiatives that could help the international
company. In fact, research has shown that adequately trained local managers
reach high productivity levels and gain a critical knowledge base.23
Nonmanagerial Staff
Generally, a firm’s nonmanagerial staff, including accountants, clerks, factory work-

ers, technicians, and others, is hired locally. International companies have to address
some major issues in hiring nonmanagerial local staff:
Managing the Staff. The process of recruiting, training, motivating, and compensat-
ing local employees differs from country to country. As the international company
moves to different countries, it normally faces different hiring and training methods.
It is difficult to adapt one model of human resources guidelines across countries and
cultures. For example, in Japan it is customary to form teams to work on tasks. Be-
cause Japan is a collectivistic society, teamwork is part of the culture and is accepted
freely. When the same team orientation is introduced in individualistic countries, such
as Germany, it may not work.
Wages and Benefits. Compensation and associated benefits vary from country to coun-
try, so international companies have to set wages according to the prevailing rate in
the country in which they are operating. This can be beneficial for the international
company, as it often saves on costs. For example, an American automobile assembly
worker earns on average $28 per hour, whereas a similar Mexican worker earns the
equivalent of $5 an hour. Also, benefits, which in some cases are high, differ from
country to country. In the major industrialized countries of Canada, France, Germany,
Japan, and the United States, not only do workers receive wages, but they also receive
other benefits such as medical insurance, holidays, and pension plans. These costs can
become a competitive disadvantage for the company. In many developing countries,
including China, Indonesia, and the Philippines, international companies do not have
to pay into a health insurance system, saving the company worker-related expenses.
The wage and related compensation factors may be one of the critical reasons why
China is one of the largest low-cost manufacturing centers in the world. Table 12.2
presents average wage rates for selected countries.
Table 12.2
Average Hourly, Weekly, and Monthly Wage Rates in the Manufacturing Sector for
Selected Countries (US$), 2006
Country Hourly Wage Rate Weekly Wage Rate Monthly Wage Rate
1 Austria 19.38 —
2 Australia — 870.00 —
3 Canada 17.76 — —
4 Czech Republic — — 884.32
5 China — — 102.00a
6 Ireland 19.04 758.10 —
7 Japan — — 3569.10
8 Netherlands — 1,082.72 —
9 Philippines 5.32 — —
10 Romania — — 383.83
11 Singapore — — 2,364.70
12 South Korea — — 2,799.35
13 Spain 16.97 — 2,382.50
14 Taiwan — — 1,298.40
15 United Kingdom 19.25b — —
16 United States 16.50–25.00c — —
Source: ILO Statistics and Database, June 19, 2007. Available at http://www.ilo.org/.
Notes: The International Labor Organization (ILO) reports labor rates in hourly, weekly, and monthly
rates depending on how each country reports the data. The ILO reports rates in local currency. Rates have
been translated in U.S. dollars using the average exchange rate for the year.
aAs reported by China Labor Watch, July 2006, pp. 1–4.
bUK Statistics Authority, available at http://www.statistics.gov.uk/.
cU.S. Bureau of Labor Statistics, June 19, 2007. Available at http://www.bls.gove/oes.
In hiring local personnel, international companies need to understand local labor

laws. Each country has laws, rules, and guidelines that stipulate hiring requirements.
These may include minimum age requirements, minimum wage policies, hiring quotas
(among them, requirements to hire certain minorities), and minimum and maximum
hours that employees must work. For example, in Finland, workers are represented
through unions, and wages, benefits, and such are governed by law.
Labor unions are another factor that many international companies face in deal-
ing with workers in different countries. The labor movement and the unionization
of the workforce have lost some of their earlier strength, especially compared to
the influence they had at the turn of the twentieth century. In many countries, union
membership has declined considerably. For example, in the United States, only about
18 percent of the total present-day workforce is unionized, and in France less than
10 percent is. There are many reasons given for this decline, including improve-
ments in working conditions and labor laws that provide some level of protection
for workers. Even with the decline in worldwide union activity, though, unions are
active in many countries, including Sweden and Japan. Unions in different parts
of the world are organized differently. Some countries have national unions; others
have industry-based unions; and a few others, such as Japan, have unions that are
organized at the company level. For international companies, dealing with these
314 CHApTER 12
various types of union structure is difficult; therefore, they must approach each
situation differently. Wherever the union is a force, international companies should
exercise care in dealing with them. Unions have been known to target large multi-
national companies for wage and benefit increases, knowing that these companies
have the financial resources to support such raises and are averse to creating labor
discord in a foreign country.
ORGANiZATiONAL STRUCTURES
Organizational structures and human resource functions are key elements in organizing
for effective management of an international company. Most international business
failures can be traced to two key factors: people (managers making poor decisions)
and organizational structures (inadequate structures creating problems in coordina-
tion, communication, and management control).
Organizational structures (also called organizational designs) are used by inter-
national companies (or any organization) to arrange their business activities in an
orderly fashion among their various working units. Such structures show (1) where
the formal power in a company is vested, (2) what the lines of decision making look
like, and (3) who is responsible for certain activities. They also outline formal report-
ing arrangements. Organizational structures are even more critical for international
companies, as they need to coordinate, communicate with, and control many operations
that are geographically diverse. Having control of its operations helps an international
company ensure that each of its many subsidiaries is working toward a common goal.
Control is the ability of the parent company to guarantee the quality of its offerings
and coordinate the activities of all its units to meet corporate objectives. On the one
hand, excessive control by the home office might endanger the subsidiary decision-
making process, resulting in slower reactions to local competitive initiatives. On the
other hand, a lack of control might lead to duplication of effort, especially in areas
such as research and development, raw-material sourcing, financing, and promotional
campaigns. Duplication leads not only to inefficiencies in decision making but also
to cost increases. Organizational structures are greatly influenced by the external
environment in which they have to operate.
Organizational structures normally reflect where the level of authority and control
in a company is vested. When decision making is concentrated at headquarters and
the structure exerts tight control, the system is called centralization. If subsidiaries
are granted a high degree of autonomy and are subject to relatively loose controls,
the structure is referred to as decentralization. In the present business climate, with
dynamic shifts in the external environment, companies are usually neither totally
centralized nor totally decentralized. Some functions, such as research and develop-
ment, will be centralized, but the media planning for the local market and the final
price that a customer pays might be left to local managers.
The organizational structures of most companies are dynamic and evolving,
reflecting current trends and environmental conditions. For example, in a 10-year
span between the 1980s and 1990s, Coca-Cola transformed its organization from a
divisional structure to a geographic structure. In contrast, in early 2000, Procter &
Gamble transitioned from a geographic structure to a product structure in managing

its worldwide operations.
The driving forces in changing organizational structures are:
• To adapt to changes in the competitive environment

• To improve efficiency so as to reduce cost
• To improve decision making so that line managers can react faster to changing
market conditions
• To improve coordination among the various units (headquarters, regional offices,
and subsidiaries)
• To improve customer relations
• To facilitate innovation and introduce new products at a faster rate
Many companies entered foreign markets through exports. The management of

exports was normally assigned to a department within the organization. As their sales
and revenues grew, some international companies established joint ventures and/or
wholly owned subsidiaries in these markets. With increasing revenues from overseas
markets, many companies set up international divisions that managed the various
overseas operations. Many of the large international companies of the twenty-first
century derive more than half of their revenues and profits from international opera-
tions. In addition, the trend toward globalization has created a new set of challenges
for international companies, requiring them to view their organizational designs dif-
ferently than in the past.
The global design adopted by a firm must deal with the need to integrate three types
of knowledge to compete effectively: area knowledge, product knowledge, and func-
tional knowledge.24 Even with the trend toward globalization, international companies
have not adopted one single design that they feel is the most effective. Depending
on the industry, the size of the firm, and other factors, each company develops its
own design. In addition, an international firm may be an exporter, a licensee, a joint-
venture operator, or a wholly owned subsidiary. Each of these operations has unique
aspects that make the organizational setup different for different types of operations.
To compound the problem even further, some large international companies may be
involved in all the aforementioned activities. The organizational structures of inter-
national companies are a continuous experiment in arriving at an optimum level of
efficiency and improvements in decision making. Organizational research has identi-
fied six distinct organizational structures that international companies use:
1. Divisional structures
2. Product structures
3. Geographic structures
4. Functional structures
5. Matrix structures
6. Hybrid structures
A concise description of each of the six structures follows.

316 CHApTER 12
DIVISIONAL STRUcTURES
Divisional structures are one of the earliest forms of organizational designs found
among international companies. As mentioned earlier, they are an outgrowth of the
first forays of companies into foreign markets. In this structure, the international
operations and functions of a company are clearly separated from its domestic opera-
tions. The international division centralizes in one entity all of the responsibility for
international activities. Divisional structures are simple and easy to set up. Headed by
a senior executive, the international division is responsible for all international activi-
ties from identifying markets to recruiting personnel for international assignments.
These divisions exert full control over the company’s international operations. Over
the years, in some companies, sales by the international division eventually equaled
or surpassed those of the domestic operation in terms of size, revenues, and profits.
The focus of the divisional structure is the international operation’s separation
from domestic operations, which allows it to tap into various overseas markets and
grow without implications for the domestic operations. In divisional structures, the
management of international operations might be left in the hands of specialists. Be-
cause the problems encountered by foreign managers are unique to the international
arena, this setup has some merit. Foreign exchange transactions, for example, are
uniquely international, and therefore the person dealing with this function needs to
be a specialist in that area. These specialists then allocate and coordinate resources
for international activities under a single unit, the international division, providing a
better overall direction and enhancing the firm’s ability to respond quickly to market
opportunities. Moreover, the divisional design allows the firm to independently serve
international customers.
In those firms that had international divisional structures—for example, Ford Motors
and IBM, both of which operated for many years under the divisional structure—staff
members were able to focus the firm’s undivided attention on exploring the interna-
tional market.25 This autonomy allowed the division to be recognized as a profit center
and eliminated possible bias against international activities that may have existed with
international sales when they were handled under a domestic department. Figure 12.1
presents a divisional organizational structure.
As shown in Figure 12.1, the international division is totally independent of the
domestic division. In this example, the international division is organized around
regions and further segmented by countries. In some instances, a division may be
organized into functional units (finance, marketing, and production, for instance) or
even product divisions (cosmetics, detergents, paper products, and so on for a firm
like Procter & Gamble).
The primary emphasis in divisional structures is the independence of the inter-
national area from its domestic counterpart and the recognition that the overseas
environment is complex and different from the domestic environment. This allows
the division to be treated as a profit center with decision-making authority on how to
operate the business in foreign countries and foreign markets. Besides the independent
nature of the divisional structure, the other main advantage of the divisional design is
the locus of power at the divisional headquarters, which is useful in negotiations with
Figure 12.1 International Divisional Structure
CEO
President, President,
Domestic International
VP, Latin
VP, Asia VP, Europe
America
Country
Manager, Italy
Finance
Production
Marketing
Country
Manager, France
governments and other businesses, especially with potential joint-venture partners.

Additionally, the divisional structure is useful in exploring worldwide markets.
One of the disadvantages of divisional structures is that they are not very effective
if the international company is involved in many countries and sells a large number
of products. Too many products or markets overwhelm the capacities of the interna-
tional division; for example, it is difficult for employees to know the whole product
line. Similarly, it is difficult for employees in the international division to know or
understand the local needs of a large number of countries.
PRODUcT STRUcTURES
Many international organizations operate through product-based structures. These
companies focus on their product offerings as the basis for organizing into vari-
ous units. Take the case of Procter & Gamble and Kimberly-Clark, two diversified
American consumer packaged goods companies that formerly used a geographic
318 CHApTER 12
organizational design: both companies have recently adopted product-oriented orga-

nizational structures. Procter & Gamble was reorganized from four geographical units
into seven global business units responsible for each of its product areas worldwide.
In this setup, the various domestic product divisions are responsible for international
line and staff functions. Because the global product design forces managers to think
globally, it facilitates geocentric corporate philosophies. This is a useful mind-set
as firms work to develop greater international skills internally.26 Similarly, in 2004,
Kimberly-Clark, with sales in more than 150 countries, reorganized to form three
divisions to manage its three main product categories—personal care, consumer tis-
sues, and business-to-business items.27 In addition, it divided its business operations
into developed- and developing-market divisions to increase effectiveness and reflect
fundamental differences between these two types of countries.
Companies that operate with a product structure may have regional experts to assist
the product group. This type of structure is best suited for coordination of domestic
and international activities related to a product category. The goal with this structure
is to reduce duplication in such areas as product research, systems development, and
package design. When an organization has a product-based arrangement, the head
of the domestic product division is the most important post in the company. All the
international activities are coordinated from a product point of view. The international
activities are secondary to the product.
Product-based structures are set for greater control of international operations,
and the feedback from various countries is used to develop a strong overall product
strategy. For example, in 1991, IBM restructured its organization from a geographic
structure to an industry/product-based structure to better serve its global customers’
needs. The new structure is based around specific industries such as banking, insurance,
government, retail, and utilities. Since adopting the industry-based structure, IBM has
improved its bottom-line performance, and its customers are equally pleased with the
improved service that they have been receiving. Similarly, GE is organized around
its various businesses, including aircraft engines, consumer products, financials, and
industrial products. Each product group identifies investment opportunities and is
responsible for the marketing of any goods or services that are developed from the
investment. Figure 12.2 presents a product-based organizational structure.
In the product structure shown in Figure 12.2, specialists with some country or
regional expertise are assigned to assist the CEO. These specialists may be recruited
from each of the regions or may come from the parent organization. The divisional
head of each product exercises a greater role than the country managers in the func-
tion and management of the unit. Country managers are mostly administrators who
coordinate the activities of the various functional departments.
Business research in product-based organizations may be centralized at headquar-
ters, with each region or country assigned the task of conducting the research with
assistance from the central office. In some companies, the research function is totally
decentralized, with each country undertaking its own research and some coordination
at the regional or central level.
The advantages of the product-based structure are strong coordination across
functional areas to support the product group, improved customer service, and the
Figure 12.2 Product Structure
CEO
Product Division A Product Division B Product Division C
Country 1 Country 2
ability to manage products that are unique. For example, IBM has found that servic-
ing government orders across countries requires uniquely developed solutions to IT
problems that are different from solutions created for business customers.
A critical disadvantage of divisional structure is that, although this structure avoids
duplication in product development, it creates some confusion for the regional or
country managers, as they have to report to as many product heads as there are prod-
uct divisions. In addition, this type of design requires more personnel to manage the
international operations than other designs, thereby increasing the overall cost of
operations.
GEOGRApHIc STRUcTURES
In a geographic structure, responsibility for all international activities is in the hands
of a regional or country manager reporting directly to the chief executive officer or an
international divisional head. This type of organization simplifies the task of direct-
ing worldwide operations, as the person in charge is directly in contact with a senior
officer at the firm’s headquarters. In this case, the country operations become just
another division of the company for allocation of resources. Geographic structures
ensure that sufficient funds are made available to the country operations.
Besides the advantage of the allocation of resources, this structure helps local
managers to contribute considerably more to the decision-making process. With
their knowledge of the local market conditions, they are able to direct the company’s
efforts more effectively than if they were managed directly from headquarters. The
geographic structure leads to improved service to the firm’s customers and enables
international companies to develop a pool of local managers, adding diversity to the
management ranks.
Geographic structures are most often found in companies with diverse product
categories requiring a strong marketing approach. These structures also tend to be
320 CHApTER 12
Figure 12.3 Geographic Structure
CEO
VP, Asia VP, Europe VP, Latin America
Country Manager, Country Manager,

Brazil Chile
CFO
Production Manager
Marketing Director
used more by packaged goods companies such as Coca-Cola, Campbell’s, and RJR
Nabisco. The companies in these categories face intense competition, require constant
modifications to their strategies, and come under foreign government scrutiny. For
local governments, especially those in developing countries, some of these products
are not high-priority items (soft drinks, packaged food, and tobacco) and therefore do
not help in the country’s economic development programs. Geographic structures are
also favored by international companies that depend on their marketing capabilities
more than their manufacturing efficiency or technology. Companies such as Apple
computers and Heineken are market driven and have adopted a geographic organi-
zational design. Many financial institutions such as AIG and other global banks and
insurance companies have organized their operations around regions and countries.
On the negative side, geographic structures require each foreign operation to have
both product and functional specialists. Therefore, a geography-based international
organization requires more staff than other structures in the international division
to provide support to the geographic units. Studies have shown that in a few cases
the geographic structures have generated dissonance between the organization and
local staff.28 This type of structure also creates problems in terms of coordination
of the activities of the various product offerings. Figure 12.3 presents a geographic
organizational structure.
In the setup shown in Figure 12.3, the functional managers report to country heads.
These country managers are directly under regional managers. The regional manag-
Figure 12.4 Functional Structure
CEO
CFO VP, Manufacturing VP, Marketing
Regional VP, Asia Regional VP, Asia Regional VP, Asia
ers report either to the company CEO or to a high-ranking executive at corporate

headquarters.
FUNcTIONAL STRUcTURES
The philosophy behind the functional structure is that it is more efficient to have
functional expertise than product or country/regional expertise. In this type of struc-
ture, the senior executive responsible for each functional area—production, finance,
or marketing—is responsible for the same functions at the regional and country
levels. Function-based organizations are most often found among companies with
a limited product line, such as companies in the petroleum industry and industrial
product companies (office equipment) or those whose products are highly technical
(robotics). After its merger with Mobil, Exxon changed its organizational structure
from a geographically based design to a function-based structure. The company felt
that it could make better use of its expertise in refining (operations), marketing, and
financial capabilities through this structure. Function-based organizations are able to
manage individual departments very well. This leads to efficiency through economies
of scale. In those companies that have limited product lines, this type of design is
useful in developing successful strategies through effective coordination among the
various functions.
One of the disadvantages of the functional structure is the difficulty in coordinat-
ing activities among functional units both at headquarters and at the country level.
The coordination between various functional units is either left to the CEO at the
country level or handled by a senior executive at headquarters. Figure 12.4 presents
a function-based organizational structure.
As can be seen in Figure 12.4, the marketing executive coordinates the same activi-
ties in every country in which the company has operations. This is true for the other
company functions as well, such as manufacturing, finance, and so on.
322 CHApTER 12
MATRIX STRUcTURES
The previously identified organizational structures, though useful in specific situa-
tions, have deficiencies in coordinating and implementing the various activities of an
international firm. To reduce these problems, some international companies have tried
to combine the structures. Called matrix organizations, this type of structure blends
the product, geographic, and functional elements, while maintaining clear lines of
authority. Some large global companies have adopted a matrix organizational design,
including Boeing, the U.S.-based aerospace company; Nokia, the Finnish cellular
phone manufacturer; the New Zealand Dairy Board, New Zealand’s government-
sponsored dairy farmers cooperative; and the large Anglo-Dutch consumer goods
company Unilever.
In a matrix organizational structure, a subsidiary reports to more than one group
(functional, product, or geographic). This design is based on the theory that because
each group shares responsibility over foreign operations, the groups will become
more interdependent and exchange information and resources with one another.29 In
matrix organizations, the area and product managers have overlapping responsibili-
ties. A manufacturing manager in Japan will report not only to the vice president of
manufacturing but also to the regional manager for Asia at the world headquarters.
In this case, the lines of responsibility and resultant flow of communication occur
both horizontally and vertically across the main dimensions. Generally, in a matrix
organizational structure, it is customary to have staff personnel coordinate the various
lines of authority and communications, including the research function. However,
final responsibility for all activities and the decision-making authority rests with the
senior management.
The New Zealand Dairy Board, with sales in more than 120 countries, has found
the matrix structure to be effective in managing its global operations. The cooperative
is organized around geographic areas (Asia, Europe, and so on) that revolve around
specific products (such as powdered milk) with overlaid functional strategic business
groups (finance, marketing, and the like). The change from the board’s previous geo-
graphic organizational design involved developing pilot category teams, specialized
training for employees, and shifts in employee responsibilities. The matrix structure
is very flexible and allows management to pursue both global and local strategies
at the same time without difficulty. Matrix structures also encourage team decision
making, which is useful in building consensus and consequently improves programs
implementation.
Many international managers agree that the matrix structure is the most complex
form of international organizational design.30 Although matrix structures were
meant to take advantage of the merits of product, geographic, and functional forms,
in practice they create new problems of their own. Since matrix structures form
managerial teams with no single person in charge, the focus is on building team
consensus. This slows the decision-making process. Also, in instances of a lack
of consensus, top management has to step in to resolve conflicts, taking valuable
time from these senior executives. ING group, a large Dutch financial institution,
recently reorganized itself from a matrix structure to a product-based structure
Figure 12.5 Matrix Organization Structure
President and
Managem ent Board
Central Staffs
Domestic Appliances
Lighting and Personal Care Other Divisions
National
Subsidiary 1
SALES SALES
PRODUCTION
National
Subsidiary 2
PRODUCTION
National
Subsidiary n
because of difficulties in attaining coordination under the matrix structure. Figure

12.5 presents a matrix organizational structure.
As can be seen in Figure 12.5, the lines of communication tend to be quite com-
plex. The vertical and horizontal reporting systems can often cause delays in decision
making and sometimes lead to confusion. Overall, however, these designs do help in
opening multiple channels of communication.
HYBRID STRUcTURES
Hybrid structures are variant forms of matrix structures. In the hybrid structure, a
matrix form of structure exists at the senior level of management, and one of the
other forms of organization design (functional, geographic, or product) is adopted
at the other levels. Hybrid structures are designed to improve the organization’s ef-
fectiveness when it faces new challenges. These challenges may be the result of the
acquisition of a new company, the introduction of a new product line that is different
from its existing portfolio of products, or the process of becoming a major supplier
to a large single customer.
Hybrid structures are not seen as permanent organizational designs, but rather
temporary arrangements to address changes brought on by unexpected or unplanned
events. Figure 12.6 presents a hybrid organizational structure.
324 CHApTER 12
Figure 12.6 Hybrid Organization Structure
CEO
President President President

President
Domestic Domestic Domestic
International
Product 1 Product 2 Product 3
Area President President President

President Product 1 Product 2 Product 3
Country A Country 1 Country 1 Country 1
Country B Country 2 Country 2 Country 2
The advantages of the hybrid structure stem from the division of the activities of
managing an international company between senior managers and line managers.
Senior management is able to make decisions on broad-based corporate strategies and
be responsible for the upstream activities in the value chain. Meanwhile, line manag-
ers are able to concentrate on functional and local issues and are left to handle the
downstream activities in the value chain, which is their main concern. One drawback
to the hybrid structure is that, like the matrix structure, they are complex and difficult
to operate. In addition, this design offers no clear-cut responsibilities for controlling
costs and profits, and, hence, profitability of the company may suffer.
NEW DEVELOpMENTS IN ORGANIZATIONAL STRUcTURES

Besides the six organizational designs discussed above, from time to time, interna-
tional companies experiment with structures that improve their decision making and
give them a competitive advantage. International companies that build infrastructures
such as airports, oil-drilling platforms, highways, and bridges have successfully used
project-management systems that are organized around specific parts of the project.31
The customer-based organizational structure and the transnational network structure
are two systems that some international companies use. In the customer-based or-
ganizational design, the focus of senior management and the whole organization is
the customer. Resources and strategies are designed to acquire and retain customers.
Solectron Corporation, an electronic manufacturing service company, has set up its
organization around customers by merging various regional areas such as the account
Figure 12.7 Transnational Network Organization Structure
Italy Egypt
France
United
States NV Philips Kenya
Netherlands
UK
S.Korea
Japan
Taiwan
Source: Sumantra Ghosal and Christopher A. Bartlett, “The Multinational as an Interorganizational Net-
work,” Academy of Management Review 15, no. 4 (1990): 603–625.
management teams to provide customers with a more globalized support structure.

In some companies, customer-based structures are set up to improve the organiza-
tion’s effectiveness in servicing one large customer such as the government, or, in the
case of advertising agencies, in servicing a single client that has substantial billings
and for whose global advertising the agency is responsible.
The transnational network structure is designed to take advantage of the global
economies of scale that are available for an international company and at the same time
be responsive to the demands of the individual host countries in which the company
operates. As the name suggests, this design connects the various country operations
to the regional offices and headquarters. In transnational network structures, all the
subsidiaries are linked through a network arrangement that facilitates communica-
tions among all the subsidiaries and at the same time maximizes the utilization of
resources.32 The transnational structure is a complex organizational design that requires
multilevel communication networks that overlap functional, geographic, and product
levels within the organization. This structure is often used by companies that have a
vast number of products in many regions of the world. Figure 12.7 presents a partial
transnational network structure that is used by Philips of the Netherlands.
Philips’s three main regional offices—in Japan, the United Kingdom, and the
United States—are linked to headquarters in the Netherlands. Each regional office
is linked to subsidiaries in countries close to it. The headquarters in the Netherlands
administers the subsidiaries in the Middle East and Africa.
As observed from the previous discussion, there is no single organizational design
that fits all the requirements of an international company. Developing an effective
organizational structure is an evolving process due to the internal and external changes
326 CHApTER 12
that take place in an international company. It is one of the critical tasks of senior
management to adopt a design that helps the company to manage a vast variety of
products and services over a number countries spread across the world. It is important
that all the managers and key personnel perform their duties within the context of the
prevailing organizational structure. Table 12.3 presents the advantages and disadvan-
tages of using some of the organizational structures discussed here.
CHApTER SUMMARY
HUMAN RESOURcES
Human resources are among the most critical resources that an international company
manages. As a crucial function, human resources are central to an organization’s suc-
cess. The human resources management (HRM) functions are the activities that help
an international company to attract, develop, and maintain an efficient and productive
workforce.
Some of the specific tasks within attracting, developing, and maintaining a com-
petent staff include developing job specifications, recruiting qualified candidates,
developing training programs, administrating a compensation plan, instituting moti-
vational programs, setting up an evaluation system, and placing the staff in various
international operations.
The actual operations of HRM are a function of the degree of centralization ver-
sus decentralization of control an international company wants to exert. In central-
ized organizations, most of the power and control of the company is vested at its
headquarters. In a decentralized organization, much of the decision making is left
to country-level managers. The actual choice between centralized versus decentral-
ized operations depends to a large extent on the international company’s corporate
philosophy, the type of products and services it sells, the size of the company, and
the host government’s regulations. Technology-oriented international companies that
have proprietary products such as pharmaceuticals and whose managerial decisions
have long-term effects tend to prefer centralized forms of governance. In fast-paced
industries such as soft drinks that require immediate actions on the part of country
managers, a more decentralized approach may be adopted.
Another important consideration in international HRM is the hiring of local man-
agers versus sending in expatriates. Expatriate managers are faced with complex and
challenging external environments. As a result, they need the ability to adapt to host-
country cultures and business customs that are often unfamiliar to them. In addition,
they may be called upon to deal with government officials, a task that is not normally
assigned to line managers at headquarters. Expatriates are useful in maintaining cor-
porate polices and procedures, transferring technology, and controlling operations.
On the downside, expatriates are expensive, their local knowledge is often minimal,
and their presence hinders the development of talented local managers.
Labor-management relations and union issues are another set of concerns that the
HRM department has to deal with. Unions in different parts of the world are orga-
nized differently. In some countries, there are national unions; in others, there are
Table 12.3
Advantages and Disadvantages of Different Organizational Structures
Organizational
Structure Advantages Disadvantages Representative Organization
Divisional structure Useful in negotiations with joint-venture Not effective to operate in many IBM
partners and governments (experience) countries
Able to explore more effectively world- Not effective when selling a large variety of
wide markets products
Product structure Strong coordination across functional Not efficient due to duplication of Procter & Gamble
areas to support the group product strategies across countries
Useful when products are unique Needs more personnel to manage, increasing
the cost of operations
Geographic structure Serves customers’ unique needs Duplication of functional tasks Coca-Cola
Better control over regional markets Needs more personnel to manage, increasing
the cost of operations
Functional structure Efficient (economies of scale in each Difficult to coordinate the various functions, as ExxonMobil
function) they are separated from one another
Useful with few products or locations Not practical for companies with a large number
of product lines or operations in many countries
Matrix structure Is flexible enough to pursue global and Difficult to make decisions because of multiple New Zealand Dairy Board
local strategies layers and multiple reporting
Promotes team decision making Problematic because staff must deal
with multiple bosses
Hybrid structure By dividing the activities between senior Complex structure that is difficult to operate Xerox
management that handles most of the
upstream activities in a value chain
and the local managers that handle the
downstream activities, this design helps
companies develop focused strategies
It is able to improve coordination and be Also, it is not clear who controls the costs and
responsive to market factors. profits.
Transnational network Responsive to local situations at the Complex structure that is difficult to operate Philips
same time taking advantage of global
economies of scale
Combines functional, product, and Duplication of efforts, as subsidiaries
geographic areas, which may result in are independent of headquarters and can pursue
high-quality strategic decisions any area, including R&D
327
328 CHApTER 12
industry based unions; and in a few others, the unions are organized around individual
companies. Dealing with these different types of unions is difficult; international
companies have to approach each situation as unique and not attempt a broad strategy
that applies to all situations.
ORGANIZATIONAL STRUcTURES
Organizational structures are used by international companies to arrange their busi-
ness activities in an orderly fashion among their diverse working units. Organiza-
tional structures show where the formal power is vested and who is responsible for
certain activities. They assist an international company in improving coordination of
activities, decision making, controlling operations, and enhancing the communica-
tion process.
International companies use different types of organizational designs in managing
their global operations. There are six to eight different types of organizational designs
in use today. Use of a particular structure by an international company is an evolving
process. Factors such as the company’s focus, its product offerings, the number of
countries it has operations in, and changes in the external environment may dictate
a change in the company’s organizational structure.
The most commonly used organizational structures by international companies
are divisional structures, product structures, geographic structures, and functional
structures. It is critical that an organizational structure reflects a company’s strengths.
With the dynamic transformations that are constantly occurring in the business
environment, some large international companies are experimenting with newer
organizational designs such as matrix, hybrid, and transnational networks to react to
the rapid changes.
KEY CONCEpTS
Human Resource Functions
Human Resource Planning
Expatriates
Organizational Structures
1. What is the human resource function in an international company?
2. Why is the human resource function important for an international com-
pany?
3. Enumerate and discuss the various human resource functions.
4. Discuss the differences between centralized and decentralized organiza-
tions.
5. Identify the conditions or factors that influence the choice of centralized versus
decentralized organizations.
6. What is an expatriate?
7. Discuss the merits of sending expatriates to manage overseas operations.

8. When is it appropriate to hire local managers?
9. How does unionization affect international companies’ operations?
10. In general, are unions beneficial for employees? If so, why?
11. What is an organizational structure?
12. What is the purpose of an organizational structure?
13. Discuss the various organizational designs.
14. Discuss the contributing factors in a company’s choice of an organizational
design.
15. In your opinion, are there one or two organizational designs that are superior
to others?
AppLiCATiON CASE: CHibA INTERNATiONAL

Chiba International of Japan, maker of high-precision electronic parts, has its U.S.
operations in San Jose, California. The company’s electronics parts are used in the
final assembly of integrated circuits, particularly the expensive memory chips used
in computers and military hardware. Chiba International is a subsidiary of Chiba
Electronics Company and is rated as one of the most profitable companies in Japan
on the basis of “management earnings stability” and “overall performance” by the
Nihon Keizai Shimbun, Japan’s preeminent business paper.
Chiba started its U.S. operations in 1994 with a small sales office and later estab-
lished a manufacturing facility through the acquisition of an American competitor.
The company has been quite successful in the United States and currently employs
an American workforce in its manufacturing plant. Moreover, 14 out of the 24 top
executives and 65 of the 70 salespeople in the California plant are also Americans.
Chiba, like other Japanese companies, has an underlying philosophy that it preaches
and practices. In Japan, all employees have to memorize this philosophy and are
required to recite it at the morning assembly held each workday. The Japanese have
found that the recital and expression of the philosophy is fundamental to the success
of making each employee part of a work-based family and, therefore, is responsible
for the high morale exhibited by the company’s workforce.
To be successful in the United States, Ken Morikawa, the general manager of the
Chiba operations in San Jose, would like to have his American workforce feel a part
of the overall company family. He is convinced that the only way to achieve this is
by educating his American workforce in the Japanese system of human resources
management principles, including the practice of reciting the company’s philosophy
each day. The problem for Morikawa is how to go about implementing this practice.
First of all, he is not sure that American workers unfamiliar with the practice would be
willing to learn and recite the philosophy at an assembly each morning, so he wonders
whether he could introduce this concept piecemeal—slowly and carefully. Second, in
order to be useful, the philosophy needs to be translated into English. How accurately
would the translation reflect the company’s original philosophy? Morikawa’s plan
is first to give each employee a leaflet explaining the company philosophy; then the
employees will be given a few training sessions to explain the philosophy, and finally
330 CHApTER 12
Morikawa will have them recite it. The English translation of Chiba’s philosophy is
presented below:
As the sun rises brilliantly in the sky,
Revealing the size of the mountain, the market,
Oh, this is our goal.
With the highest degree of mission in
Our heart we serve our industry,
Meeting the strictest degree of customer
Requirement.
We are the leader in this industry and
Our future path
Is ever so bright and satisfying.
QUESTIONS
1. In your opinion, would the American workers adopt the philosophy?
2. If you were Mr. Morikawa, how would you go about implementing the com-
pany philosophy to the American workforce?
SOURcE
Part of this application case was developed from the work of Nina Hatvany and Vladimir Pucik, pub-
lished in John B. Cullen and K. Praveen Parboteeah, Multinational Management: A Strategic Approach,
4th ed. (Mason, OH: Thomson/South-Western Publishers, 2008), pp. 725–73.
13 International Financial
Management
LEARNiNG ObJECTiVES
• To understand the various financial transactions undertaken by a multinational
manager
• To recognize the various financial institutions that will be faced by an interna-
tional financial manager
• To be aware of the various methods of payment available to an international
financial manager
• To understand the role of stock markets and the Eurodollar currency markets in
international finance
• To recognize how regulatory agencies in the United States and overseas countries
can affect international financial decision making
INTERNATiONAL EXpANSiON
When a company expands its business beyond its national borders by exporting or
importing goods or services, the company’s financial manager has to deal with ad-
ditional variables such as exchange rates, tariffs, and regulatory, legal, and cultural
issues. The financial manager’s responsibilities increase further when the company
establishes subsidiaries abroad, as he or she must deal with additional issues such as
borrowing and lending in local markets and interacting with foreign governments,
agencies, and institutions.
The goal of this chapter is to provide an overview of the major decisions as well
as the elements of the financial environment that will be faced by international finan-
cial managers. These include the various institutions in the marketplace, including
banks and insurance companies, stock and debt markets, and regulatory agencies.
Understanding the roles and structures of these institutions, which are integral to
overseas business transactions, will help international financial managers appreciate
the decision-making challenges facing them.
We first identify the business variables that are important to financial managers when
they expand into international business activities. We then discuss the institutions that are
associated with the variables and the choices available to the multinational manager.
331
332 CHApTER 13
STAGE 1: EXpORTS AND IMpORTS
A company’s exposure to the overseas markets usually begins with the sale or purchase
of goods or services from other countries. The financial manager’s role in handling
the overseas activities of exports and imports requires dealing with the following.
Foreign Currency
A financial manager is responsible for the timely payment of bills and collection of receiv-
ables. If invoices to overseas customers are stated in dollars, there are no exchange-rate
issues, and the manager faces the same problems as domestic clients. If the invoices are
stated in foreign currencies, the manager needs to possess a good working knowledge of
the foreign exchange markets and the various international payment options available for
handling the monetary transactions. In many countries, a significant amount of paperwork
is also required prior to sending or receiving payments.
Tariffs
The financial manager needs to deal with the various tariffs imposed by different
countries, some of which are convoluted and complicated. Tariffs can affect the pric-
ing of goods and services directly or indirectly. If the tariffs are high, the company
may be forced to lower prices in order to make their products affordable to customers.
Similarly, if a company is purchasing goods, it will have to be aware of the duties
and fees imposed by U.S. customs authorities in order to determine the final cost of
the product and the price to charge locally.
Shipping
The financial manager has to evaluate the costs associated with the various ship-
ping options available for the export and import of goods. In most cases, the mode
of transportation is determined by the characteristics of the product, including size,
weight, durability, and other factors. The packaging of the goods is an additional
factor for consideration. Innovations in packaging can affect the mode of shipment
and, in turn, the pricing of the product.
Insurance
In international business, it is important to insure products shipped abroad for non-

delivery or delay. Unlike domestic shipments, the time lag for replacement is much
longer for overseas shipments. In addition, insurance for liability protection may also
be required in the event of a failure of the product or service. In the past, this was less
of a concern, as it was too cost prohibitive for an importer to pursue legal action for
noncompliance, especially for small companies. The process was also very cumbersome,
especially in Europe and Asia, where it could take years to settle a case. However, in
recent years, lawsuits against foreign companies have become routine, and the threat
INTERNATIONAL FINANcIAL MANAGEMENT 333
of overseas litigation has forced companies around the world to reconsider their insur-
ance options. For instance, three employees of the software company SAP, based in
China, sued the company on grounds of unlawful termination, something that would
have been unheard of a few years ago.1 In addition, various national governments are
playing a role in litigation. Microsoft, for example, continues to face legal challenges
from the European Union on its monopoly status of its operating software, in spite of
having reached an agreement with the U.S. Justice Department.
STAGE 2: ESTABLISHING A SUBSIDIARY

The second stage in a company’s overseas plan usually entails establishing an of-
fice or a subsidiary in a foreign country, which poses considerable challenges to a
financial manager. The following variables impact financial decision making in the
establishment of an overseas office.
Taxes
The financial manager has to be aware of the different types of taxes in a country and their
impact on payment flows between the parent company and the subsidiary. Reconciling
taxes can be challenging when the parent’s and the subsidiary’s statements of accounts
have to be consolidated in accordance with the local accounting standards.
Banking Relationships
Since a subsidiary is a separate freestanding incorporated company in a foreign coun-

try, it will usually establish its own financial relationship with a local bank. Although
the subsidiary can obtain loans from the parent company at lower interest rates, it
encounters exchange-rate risk when it is has to repay the money. In addition, there
is often substantial paperwork involved in overseas borrowing. A subsidiary usually
prefers to work with the local offices of major international banks, especially with
the branch office of the parent company’s bank.
Capital Markets
Larger subsidiaries usually have to access the local stock and debt markets to issue
stocks and bonds for their financing needs. If a subsidiary funds its long-range require-
ments by borrowing in local currency, it can be paid from its earnings in the local
market and avoid exchange-rate risks. Although the parent is able to issue shares and
bonds overseas on behalf of its subsidiary, exchange-rate volatility and paperwork may
make it more convenient to let the subsidiary raise the capital in the local markets.
STAGE 3: ESTABLISHMENT OF MULTIpLE SUBSIDIARIES

The final stage in the overseas expansion of multinationals is the creation of multiple
subsidiaries in several countries. Cash will flow not only between a subsidiary and
334 CHApTER 13
the parent but also among subsidiaries. The management and control of cash flows
among subsidiaries can become quite complex, requiring financial managers with
considerable expertise to manage the payments. For example, a subsidiary may choose
to provide credit to another subsidiary for purchase of its goods with the stipulation
that the payment be made directly to the parent, saving time and transaction costs.
Such payments have to be done carefully to ensure they do not violate the laws of
each country.
The next sections discuss the various institutions faced by financial managers when
completing international transactions.
INTERNATiONAL BANKS
The bank is a focal point for most international financial managers, as payments have
to be made to vendors and funds collected from customers throughout the year. In
the case of overseas operations, financial managers must deal with banks that have
expertise in foreign exchange and the facilities to offer foreign currency services.
There are several types of international banks that can assist multinational managers
in transferring payments from one country to another.
COMMERcIAL BANKS
Commercial banks are depository institutions that accept deposits from customers
and make loans to corporations and individuals. Smaller commercial banks usually
do not have a foreign exchange desk; instead, they use a larger commercial bank to
perform the international transactions on behalf of their clients. Large commercial
banks have their own foreign exchange traders, who buy and sell currencies and
hold inventories. A commercial bank still requires a correspondent associate in the
other country to make a payment on behalf of its client to an overseas customer.
The correspondent associate role can take the form of a commercial relationship
with a local bank in the country, or the commercial bank can choose to set up its
own affiliate or branch.
SUBSIDIARIES
Large commercial banks find it advantageous to set up their subsidiaries in major
financial markets. A subsidiary is usually an incorporated company in a foreign
country. When located in a foreign country, the subsidiary is a freestanding legal
entity separate from the parent company. It is treated as a domestic company by
the local authorities. The parent company’s ownership of the overseas subsidiary
may be less than 100 percent, but the parent still maintains control of management.
If management is shared, the arrangement is usually defined as a joint venture.
A subsidiary has to file taxes locally, prepare financial statements based on local
standards, and report to the monetary and taxing authorities of the country where
it is established. A banking subsidiary usually offers a full range of services in
the local country. Its presence overseas makes it very convenient for the parent
bank to offer a range of payment services to its multinational clients located in

that country.
BRANcH OFFIcES
A commercial bank also has the choice of setting up a branch office in a foreign
country to handle its overseas transfers and payments. A branch office is just a legal
extension of the parent company and is not treated as a separate corporate entity.
The branch office may or may not accept deposits from local customers. If it does
not take local deposits, it will lend to local customers using equity capital or loans
from the parent bank. A commercial bank will find it useful to set up a branch office
in a foreign country if its clients conduct regular business in that country. It will be
able to perform the transfers and payments of its clients more efficiently and with
less paperwork.
Foreign banks similarly set up branches in the United States to facilitate business
with their clients that have moved here to set up subsidiaries. In the United States,
all branches of foreign banks are regulated by the International Banking Act of 1978.
Branches are allowed to accept deposits from domestic residents only if they exceed
US$100,000 and therefore are not eligible for deposit insurance provided by the
Federal Deposit Insurance Corporation (FDIC).2 There is no minimum amount for
deposits accepted from foreigners.
CORRESpONDENT BANKS
It is not possible for a commercial bank to have subsidiaries or branches in every
country. Most commercial banks instead establish correspondent banking relationships
with banks in countries where they do not have a branch or subsidiary. A correspondent
bank will facilitate the transfer of payments for an overseas bank, and the relation-
ship is usually two-way. For example, if Citibank agrees to handle all payments and
transfers in the United States for Shanghai Pudong Development Bank, the latter will
perform similar services for Citibank in China.
A commercial bank usually maintains a deposit in the correspondent bank, which
serves as a means of payment for services received from the correspondent bank.
Maintaining a corresponding banking relationship is very important for banks that
have multinationals as their customers. A multinational makes and receives multiple
payments from around the world and usually prefers to have one bank handle its global
transactions. That bank must have the ability to provide services in every country.
REpRESENTATIVE OFFIcES
Many commercial banks also establish representative offices in foreign countries to
service the overseas subsidiaries of their domestic clients. A representative office does
not accept deposits, engage in lending, or offer other banking activities. Its sole role
is to act as a liaison between its client and the foreign banks located in the overseas
country. In the United States, the Foreign Bank Supervision Enhancement Act of
336 CHApTER 13
1991 requires that foreign banks wishing to set up representative offices in the United
States first obtain approval from the Federal Reserve Board, even though technically
a representative office does not perform any banking function.
OFFSHORE BANKS
Large multinationals and major banks also establish offshore banks, which are usu-
ally located in what are termed “tax-haven countries.” The offices are usually shell
entities with a minimal staff. These shell companies typically hold cash on behalf of
the parent bank and disburse the money when needed to different parts of the world.
The countries with the greatest number of offshore banks are the Bahamas, the Cay-
man Islands, Bahrain, Singapore, Luxembourg, Panama, and the Netherlands Antilles.
Offshore banks serve a useful function for banks that are engaged in international
transactions because they allow banks to park their cash for temporary periods as
they shift their resources globally. Multinationals also find it convenient to deposit
money in offshore banks for short-term periods.
Assume that a U.S. multinational has US$20 million from its UK operations that
it wishes to hold for six months before spending it on a planned investment in Spain.
If the multinational brings this money back to the United States, it will be subject to
corporate taxes. The multinational may choose to deposit the funds in a UK bank.
However, assume it also has the option of depositing the funds in an offshore bank
that pays a higher interest rate. Offshore banks are able to offer higher deposit rates
because they face fewer regulatory requirements. In this case, it is obvious that the
better choice is to deposit the funds with the offshore bank.
Offshore banks also enable multinationals to plan their cash inflows and outflows
on a global scale. For example, assume the amount of funds in the earlier case was
not sufficient for the multinational’s Spanish investment. The UK subsidiary may
request the parent bank to collect additional funds from its various subsidiaries. This
is best accomplished by the parent company pooling all the money in a central ac-
count at the offshore bank.
The growth of offshore banks led the Federal Reserve Board in 1981 to allow the
establishment of an international banking facility (IBF) in the United States. This al-
lows a commercial bank to create its own offshore unit within the United States. The
offshore unit can be lodged within the bank premises and for all purposes is legally
assumed to be an office located offshore. Deposits in the IBF are not subject to U.S.
banking regulations. An IBF is allowed to accept deposits only from foreigners. It can
perform all the functions of an offshore bank. The 1981 rule resulted in the establish-
ment of several IBFs by major banks in the United States and slowed the growth of
offshore banks overseas.
Table 13.1 lists the results of a survey undertaken by Global Finance, an online
magazine, which ranks the most popular banks by region for delivery of foreign
exchange services. The researchers interviewed corporate executives and industry
analysts covering 70 leading foreign exchange banks around the world. The ques-
tions were both objective and subjective in nature. Citigroup ranked among the best
for companies located in North and South America.
Table 13.1
World’s Best Foreign Exchange Banks in 2005
North America Citigroup

Latin America Citigroup
Western Europe Deutsche Bank (Honorable mention: BNP Paribas and UBS)
Central and Eastern Europe Bank Austria Creditanstalt
Scandinavia Nordea
Middle East National Bank of Kuwait
Africa Standard Bank
Asia-Pacific HSBC
Southeast Asia DBS (Singapore)
Source: Gordon Platt, “World’s Best Foreign Exchange Banks 2005, Global Finance Selects the Leaders
in the World’s Biggest Financial Market,” Global Finance, January 2005. Available at http://globalf.vwh.
net/content/?article_id=694 (accessed July 12, 2008).
INTERNATiONAL TRANSACTiONS
REcENT DEVELOpMENTS IN TRANSFERS AND PAYMENTS
Internet technology has revolutionized the way companies send and receive payments
in foreign currencies.
Most banks today offer Web-based programs for companies to send and receive
overseas payments from their corporate checking accounts. The most common method
of payment for corporate international transactions is through wire transfers, which
take between one and three days. Most programs also allow for scheduling of pay-
ments so that if a company has to make a periodic or recurring payment, the financial
manager can state the payment dates and amounts in advance and the program will
automatically make the payments.
Another improvement in international payments is in the clearing and settlement of
stocks and bonds purchased in overseas markets. The actual confirmation and delivery
for the purchase or sale of a stock or bond used to vary between three to seven days,
with the exception of transactions between the United States and Canada, which usually
was completed in a day. The terms used in the market are T + 3 for three days and T + 7
for seven days for actual receipt of payments. Today, the purchase or sale of securities
and receipt of payment for a majority of countries can be concluded in T + 1 days.
TERMS OF PAYMENT IN INTERNATIONAL TRANSAcTIONS

There are four terms of payment for export and import of goods, and they offer dif-
ferent benefits and risks to the seller (exporter) and buyer (importer).
Advance Payment
A seller may demand an advance payment prior to shipping any goods.

338 CHApTER 13
• This provides full security to the exporter, who will not have to worry about
nonpayment.
• In advance payment, the risk is borne completely by the buyer or importer who
is now exposed to nondelivery of goods, delay, or unacceptable quality.
• The importer also incurs an additional interest expense because the payment is
made prior to receiving the goods. Most advance payment transactions are done
when the two parties are unfamiliar with each other or the importing country is
politically unstable.
• Advance payments in international business are not common. On the contrary,
the terms of payment for most international transactions are on credit with pay-
ments made only after the delivery of the goods.
Letters of Credit
A letter of credit (LC) is a document issued by a bank that guarantees a bank will
pay the specified amount on a specified date when an exporter completes his or her
contractual agreement of shipping the goods and presenting all documents specified
in an export agreement. It allows an exporter to safely ship goods on credit as long
as he or she receives a letter of credit from the importer’s bank. The usual terms of
payments are 30, 60, or 90 days after the shipment of goods.
• The importing bank is obligated to make the payment as long as the documents,
usually a bill of lading from the shipping company and insurance papers, are in
order.
• The importing bank does not require verification of the goods unless specified in
the agreement. In that case, a customs document may also have to be included
to ensure that the goods are in accordance with the terms of the contract.
• The LC is the most common form of payment in international transfers of goods.
This is partly because the exporter’s agreement is with the importer’s bank and
not with the importer. The payment should be guaranteed as long as the importer’s
bank is in good standing.
• An LC is usually irrevocable, which means that if any changes have to made, they
require the agreement of the exporter, the importer, and the importer’s bank.
• An LC can be confirmed by the exporter’s bank for a small fee. This will provide
a double guarantee in that if the importing bank is unable to make the payments
for any reason, the exporting bank is obligated to make the payments. It is recom-
mended that the exporter get an LC confirmed if the importing bank is located
in a country that is politically unstable or has foreign exchange problems.
Documentary Collections
A documentary collection, or DC, is a transaction in which the title of goods is exchanged

when the importer’s bank accepts the documents sent by the exporter’s bank. The im-
porter’s bank will make a payment immediately if the document sent by the exporter’s
bank is a document against payment (D/P), or will agree to make the payment on the
specified due date if the document is a document against acceptance (D/A). A DC is

similar to an LC except that neither of the banks provides any guarantee of payment.
• A DC is commonly used when the parties have a well-established relationship

or the transactions are between parties in countries where the legal system is
reliable for enforcement of nonpayment.
• Using a DC is less expensive than using an LC.
• A DC is often used with shipments by sea because it is easier to maintain owner-
ship of goods until the documents are accepted. It is more difficult to maintain
ownership of goods with air or road shipments because of the potential delay
that may occur for the document to reach the foreign bank on time.
Open Revolving Account
In an open revolving account, an exporter sends the documents after shipping directly
to the importer, who will make the payments based on the terms and conditions of the
agreement. Usually an open purchase order (P.O.) is requested from the importer, against
which the exporter will invoice after each shipment. For example, a German company
will issue a €1 million P.O. valid for two years, against which the exporter is asked to ship
goods worth €20,000 per month. Each month, the exporter will ship goods and send an
invoice for €20,000 for payment. When the amount left in the P.O. is low, the companies
may choose to add an additional amount to the old P.O. or issue a new P.O.
• In an open revolving account, the risk of payment is borne completely by the

exporter.
• Open revolving accounts are usually undertaken by companies with longstand-
ing relationships and in transactions where the importer is considered to have a
strong financial standing.
• An open revolving account is a very strong selling tool for the exporter because it
shows confidence that the exporter will meet the quality required by the importer
and does not expect any rejection of delivery.
METHODS OF PAYMENT
Wire Transfer
Wire transfer is the most common form of payment in international transactions. Most
banks today offer Web-based programs to directly transfer money from a company’s
checking account to a client’s bank, with fees ranging from US$12 to US$20 per wire
transfer for high-volume customers.
The following information is usually required for wire transfers.
SWIFT Number. All banks use a messaging system to notify the recipient bank of the
arrival of funds. The most popular service is provided by the Belgium-based Society for
Worldwide Interbank Financial Telecommunication (SWIFT), with bank customers in
340 CHApTER 13
208 countries. To identify a bank, SWIFT uses an eight- and eleven-letter bank identifier
code (BIC), based on ISO (International Standards Organization) standard 9362.3 For
example the code BNPAFRPP stands for BNP-Paribas, located in Paris, France. The first
four characters, BNPA, stand for BNP-Paribas. The next two letters, FR, stand for France,
and the last two, PP, stand for Paris, the location of their headquarters. The eleven-digit
code adds a three-letter identifier for the branch. For example BNPAFRPPMAR would
route the message to the Marseilles branch (MAR) of BNP-Paribas. The last five digits
of the code are alphanumeric, meaning they can be numbers or letters.4
Routing Number. In addition to the messaging number sent by SWIFT, all banks require
routing numbers for the actual delivery of the payment. The routing numbers vary for dif-
ferent countries, although efforts are being made to consolidate them to a single format.
ABA Number. In the United States, the routing number is known as the ABA number,
so termed because it was created by the American Banking Association in 1910.
The components of the nine-digit code are as follows: the first four digits represent
one of the 12 Federal Reserve districts, with the first two identifying the city. For
example, 01 is Boston and 02 is New York. The next four digits are a unique bank
identifier code, and the last digit is a check digit that is used to verify the accuracy
of the routing number.
IBAN Number. In Europe, the international bank account number (IBAN) is used as
the routing number. It is an alphanumeric code that can be as long as 34 characters.
It is based on ISO standard 13616–1:2007 and consists of the following components:
the first two characters identify the country, the next two are check digits to ensure
that all the numbers are in order, the next four are letters that identify the bank, and
the last component is a six-digit number for the branch. The rest of the numbers
represent the customer’s account number.
Other Countries. Most countries have their own unique identifier code for routing
numbers. Canada has an eight-digit number for checks and a nine-digit routing num-
ber for electronic delivery, assigned by the Canadian Payments Association. India
recently introduced the Indian Financial System Code (IFSC), which will be applied
to all branches in the near future. The Reserve Bank of India (the equivalent of the
Federal Reserve Board) issues the IFSC. It is made up of four letters to identify the
bank and a digit for future use, followed by six digits to identify the branch.
Credit Cards
The use of credit cards as a method of payment for international transactions is in-
creasing as transactions over the Internet increase in volume. The three major card
companies that dominate the market are American Express, Visa, and MasterCard.
The seller usually has to pay a discount of between 2 and 4 percent based on the
card and the agreement terms. American Express issues its own cards, while Visa
and MasterCard issue cards through banks and other financial institutions. Payments
through credit cards in international business are usually made by customers for small
transactions and do not apply to large corporate transactions.
Paper Checks
The use of paper checks as a means of payment has declined considerably over the
years, as the cost of this method of payment has increased relative to wire transfers.
Not only is check payment expensive, but it also takes a long time for the payment
to clear. The importer has to first send the check via mail to the exporter who then
deposits in his or her bank. The exporting bank has to mail the check to the foreign
bank on which it has been drawn. The money is then transferred via correspondent
banks before being credited to the exporter’s account. Even with the use of Internet
technology that allows checks to be scanned and sent electronically to another bank,
the time delay is still significant, somewhere between two and four weeks.
INTERNATiONAL SHippiNG
The financial manager must often evaluate the various delivery options available to a
company and the financial impact of each option. The major forms of transportation
to overseas markets are by sea and air, with sea shipments accounting for more than
80 percent of the total. Some goods are limited in the type of transportation that can
be used to ship them.
1. If the product is bulky or heavy, it cannot be shipped by air. For example,

cars and trucks have to be shipped by sea transport. Although in theory a car
can be shipped by air, it is prohibitively expensive.
2. If the goods are perishable, they must be transported by air. For example, fresh
flowers from countries in South America have to be shipped by air in order to
reach customers in Europe or the United States by the following morning.
3. Hydrocarbons, such as oil and gas, must be transported via ships because they
need to be enclosed in special tanks or bulk containers.
SHIpMENT BY SEA
There are three types of global shipping:
1. Dry Bulk: These carriers transport mostly dry raw materials or food, such as
stones, steel, iron, wheat, rice, and maize, which must be transported in bulk
and require a significant amount of space.
2. Wet Bulk: These carriers transport mostly raw materials such as hydrocarbons
(oil and liquefied gas), as well as several kinds of wet chemicals.
3. Tanker: These carriers transport mostly finished products that are shipped
in containers. The container sizes are standardized—usually 20 or 40 feet in
length—so they can be loaded from ships directly to trains and trucks.
342 CHApTER 13
Table 13.2
The Top Five Airports for Transport of Air Cargo
City Country Tonnage Comments

1 Memphis United States 3,840,574 Hub for Federal Express
2 Hong Kong China 3,772,673 Asian hub for many companies
3 Anchorage United States 2,826,499 Major transit for transpacific routes
4 Seoul South Korea 2,555,582 Major hub for Air Korea
5 Shanghai China 2,494,808 UPS China base
Source: “The World’s Top 50 Cargo Airports,” Air Cargo World, July 2008. Available at http://www
.aircargoworld.com (accessed July 12, 2008).
SHIpMENT BY AIR
The use of air cargo has been increasing consistently over the past three decades as
larger and more fuel efficient planes have been developed to carry products over long
distances. Air cargo volume fell in 2008 because of a spike in oil prices, but most analysts
are forecasting that the growth of air cargo will continue for the foreseeable future. The
Official Airline Guide (OAG) has estimated that air cargo growth between 2008 and
2011 will average 5.6 percent. In addition, the 2008 report estimates that air freight will
increase from 152.1 billion FTKs (freight tonne kilometers) to 274.1 billion FTKs by
2017.5 The top five airports for transport of air cargo are listed in Table 13.2. The next
five busiest air cargo airports are in Paris, Tokyo, Frankfurt, Louisville, and Miami.
For goods that can be sent either by sea or by air freight, a financial manager must
perform a cost-benefit analysis after considering all factors that can affect pricing. Air
shipment is preferable if costs of holding inventory are very high. When goods are
sent by ship, a company is usually required to hold a significant amount of inventory
because of the delay incurred when goods are transported from the seaport to the final
destination. However, sea shipment is preferred if the product is combustible or not
suitable to extreme temperatures.
REcENT DEVELOpMENTS IN OVERSEAS SHIppING

Sea shipments will continue to increase in volume as countries develop and engage
in more exporting and importing of goods. Current technology does not foresee
breakthroughs in air technology that will make it cheaper to send all goods by air.
However, in some industries such as publishing and engineering services, advances
in Internet technology have made it unnecessary to ship goods at all.
Publishing
In the publishing industry, the ability to send complete books overseas electronically
for either download or professional publication eliminates the need to send books
physically across borders. In the documents-processing industry, the availability of
software to authenticate signatures allows formal documents, including contracts,

invoices, architectural drawings, and the like, to be sent electronically. Banks are
now able to send scanned checks electronically to their overseas counterparts for
verification prior to making payments to their clients.
Engineering
The development of 3D technology has enabled engineers to create products first on

the computer and to test them completely before producing a prototype for physical
testing. Three-dimensional models of mechanical parts can be sent overseas electroni-
cally to be reproduced using special prototyping machines. This process not only elimi-
nates the need to send prototype models but also allows for multiple configurations
to be tested based on the availability of local materials and processes. Innovations in
robotic technology are expected to develop additional new ways of producing goods
and services remotely and reduce the demand for transportation.
INTERNATiONAL INSURANCE
Multinational managers have to be familiar with the insurance coverage required for
manufacture and delivery of goods and services to their overseas customers. In the case of
overseas customers, additional coverage is required for political risk. Political risk refers
to the risk of loss due to changes in political structure or government policies that affect,
directly or indirectly, the conduct of business transactions in the foreign country.
SHIpMENT INSURANcE
All shipments, domestic or international, require insurance coverage in the event of
nondelivery of goods or services. The reasons can vary from damage to shipments to
lost shipments to bureaucratic delays or theft. Most of the major insurance companies
around the world and some shipping companies provide a range of insurance services
for international shipments. Shipments by sea are covered by marine cargo insurance,
while shipments by air may be covered by both marine and air cargo insurance, which
is also offered by air carriers. The usual coverage for export insurance is 110 percent
of CIF, defined as the total of cost (of product), insurance, and freight.
In the United States, the government also offers insurance to encourage exports
of goods and services and assists companies in short-term financing and protection
against nonpayment. The services are provided by the Export-Import Bank of the
United States, usually called the Ex-Im Bank. The Ex-Im Bank does not compete
with the private sector. It provides insurance services only if companies are unable
to obtain financing or insurance from private financial institutions.6
POLITIcAL RISK INSURANcE

Perhaps the most difficult insurance to obtain is political risk insurance, especially for coun-
tries that have unstable governments or weak corporate governance. The major political
344 CHApTER 13
risk is the nationalization or appropriation of a company’s assets that leads to a complete

blockage of its funds. In the United States, political risk insurance is obtained from the
Overseas Private Investment Corporation (OPIC), a government agency, and from the
Multilateral Investment Government Agency (MIGA), an affiliate of the World Bank.
OPIC
The Overseas Private Investment Corporation, an independent U.S. government
agency, was established in 1951 to encourage private companies to export by providing
financing and political risk insurance. It also makes funds available for investment in
countries that are currently not attractive to the private sector. Political risk insurance
protects firms against expropriation, currency inconvertibility, political violence, and
stand-alone terrorism.7
MIGA
The Multilateral Investment Government Agency is an affiliate of the World Bank,
and its goal is to encourage foreign direct investment (FDI) to developing countries
to stimulate growth and reduce poverty. MIGA protects investors and lenders against
expropriation, currency inconvertibility, war, civil disturbances, and breach of con-
tract. It covers only new investments and does not exceed US$420 million to any
one country. It also provides insurance for financial institutions that provide financial
support for equity or debt instruments.8
STOCK EXCHANGES AND MARKETS

Financial managers of large multinationals often have to go to the public markets
to obtain financing in the form of stocks and bonds. Until the 1980s, there were few
well-developed financial markets in the world. The major markets were located in
New York, London, Tokyo, Frankfurt, and Paris. In the 1980s, countries around the
word began to liberalize their financial markets and develop their stock and debt
markets. Today, most of the large companies overseas issue stocks and bonds in the
local markets to meet their long-term financing needs. This practice replaced their
main form of financing, loans through local commercial banks.
New York and London continue to dominate the stock markets. Large foreign
companies prefer to list their stocks in these two markets because of their established
reputation, experience in handling large trades, deep pool of investors, and strict rules
that protect minority shareholders. These factors, termed corporate governance, were
weak in many of the newly emerging stock exchanges in the early years of develop-
ment. Insider trading, which can be disadvantageous to small and overseas investors,
was the biggest problem in most of these countries.
This landscape has changed in the past decade as more countries have clamped
down on stock market abuses and tightened corporate governance rules. As a result,
there has been significant growth in the listing of overseas shares in stock markets
around the world. These developments have led to a wave of consolidations among
stock exchanges. The largest stock exchanges continue to be in New York and London;
a discussion of three of the world’s major exchanges follows.
NYse-EURONEXT
The merger of the New York Stock Exchange, one of the largest in the world, and
Euronext, an Amsterdam-based Pan-European exchange, led to the creation of NYSE-
Euronext, the largest exchange in the world in terms of listed firms.
The NYSE opened in 1792, with 24 members, and the first stock listed was the Bank
of New York. In 1972, the NYSE incorporated itself as a not-for-profit organization,
and in 2006, it became a for-profit company. It is only one of the exchanges listed
in the S&P 500 index. For most of its existence it traded through open pits, where
traders bought from and sold to each other through hand signals and shouting at the
pits. Although it offered electronic trading through its SuperDot system in 1984, it did
not expand its services until recently. The NYSE ARCA electronic trading platform
now handles most of the daily trades. In 2007, the NYSE was trading more than 5
billion shares per day.
Euronext was formed on November 22, 2000, when the stock exchanges of Am-
sterdam, Paris, and Brussels merged to create a Pan-European exchange. In 2002,
Euronext merged with the Portuguese stock exchange and the London International
Financial Futures Exchange. In 2008, NYSE-Euronext merged with the American
Stock Exchange (AMEX) to consolidate its leading position in the world. It now
boasts a total of 5,600 listed companies.9
NasdaQ omX
NASDAQ OMX also considers itself one of the largest exchanges in the world. Al-
though the listed companies total only 4,400 firms in 2008, the exchange provides
trading support for more than 60 exchanges located in 40 countries. NASDAQ was
one of the first companies to offer electronic trading when it introduced the small-order
execution system in 1984. It continued to grow by listing stocks that were unable to
meet the requirements of the NYSE and AMEX, then the two leading exchanges. As
electronic exchange became better established, NASDAQ was in the enviable posi-
tion of having a strong lead in the delivery of automated trades. In 2007, it merged
with OMX—a derivatives exchange that began in 1985 and grew by merging with
several Nordic exchanges, including the Stockholm, Copenhagen, and Iceland ex-
changes. OMX was well known in the market for its use of advanced technology in
the creation of trading platforms.
LONDON STOcK EXcHANGE

The London Stock Exchange, or LSE, is considered one of the oldest exchanges in the
world, beginning its activities around 1698. Most of the trading was informal and took
place at Jonathan’s Coffee House in Change Alley. In 1751, 150 brokers officially formed
a club to buy and sell shares at the coffee house.10 In 2007, the LSE merged with Italian
346 CHApTER 13
Borsa to form the largest stock exchange in Europe. In June 2008, the exchange had more
than 3,200 stocks listings, including the Alternate International Market (AIM), which
caters to smaller companies and demands lower requirements to list their stocks.
AMERIcAN AND GLOBAL DEpOSITORY REcEIpTS

When companies list their stocks in overseas markets, the shares are usually traded
by investors in the local economy. It is difficult for a U.S. investor, for example, to
trade stocks of a company traded on the Australian stock exchange. The U.S. investor
also faces exchange-rate risk because the stock will be priced in Australian currency.
To encourage U.S. investors to purchase foreign stocks, a bank can purchase foreign
shares and place them in a trust. It then issues new shares that are valued in Ameri-
can dollars. The prices are based on the prices traded in the home market. The new
shares are called American depository receipts (ADRs) and have become a popular
instrument for U.S. investors wishing to hold foreign shares.
Assume that a German company, called AKR GmbH, has 1 million shares trading
in the German stock market at €10 each. The current exchange rate is US$2/€1. An
American bank could purchase 100,000 shares of AKR in Germany and put them in a
trust. The bank then creates AKR ADRs and sells shares in the United States for US$20
each. These shares can be traded on either the NYSE or the NASDAQ by American
investors. For example, assume that the price of the AKR share in Germany increases
to €20. The price for AKR ADRs will increase to US$40, assuming the exchange rate
stays the same at US$2/€1. The American investor can now sell the ADR to another
buyer at a purchase price of US$40. Any dividends paid by the company in Germany
will also be paid to the American investor in U.S. dollars.
ADRs have been growing in popularity for the past 20 years. Foreign companies have
found it beneficial to list their stocks this way for two reasons: to increase their inves-
tor base and to raise capital in the United States. The deep market in the United States
allows foreign companies to raise capital less expensively than in their home country.
The recent development of stock exchanges around the world has led companies to
seek and list ADRs in other countries, too. If a depository receipt is trading on more
than one stock exchange, it is called a global depository receipt (GDR). Between
2002 and 2004, among all new depository receipts in the world, ADRs accounted
for 64 percent and GDRs for 36 percent of the total issued. In the period between
2004 and 2006, the ratio stood at 55 percent for GDRs as opposed to 45 percent for
ADRs.11 J.P. Morgan introduced the American depository receipt in 1927 for a British
retailer, Selfridges & Co. Today, more than 2,000 companies from 80 countries have
issued depository receipts. What was once an American phenomenon has become a
global one.
EURODOLLAR MARKETS
A financial manager of a multinational must be knowledgeable not only about inter-
national stock markets but also about debt markets. Most subsidiaries abroad borrow
from local commercial banks to satisfy their financing needs. However, because of
the financial market liberalization around the world, multinational managers are find-
ing that they can go directly to the local public markets, with or without the help of
investment banks, to obtain debt financing. In addition, parent companies can satisfy
their financing needs by tapping the Eurocurrency market, where currency instruments
are traded outside the borders of the respective countries
The Eurocurrency market can be best explained by the development of the Eurodol-
lar market in the 1950s. The original Eurodollar can be traced to Russia and the Eastern
European countries that formed the Soviet bloc after World War II. Fearing that their
dollar deposits in U.S. banks would be confiscated by the U.S. authorities, they moved
their dollar deposits to European banks, where they opened dollar accounts. The banks
found a ready market for dollars in U.S. multinationals and European companies. The
banks lent the money in dollars for repayment in dollars, though they were located in
Europe. The person or corporation that borrowed the money would, in turn, deposit
the dollars in another bank. As a result of the multiplier effect, the dollar deposits
grew in volume. They were not subject to local banking laws because they were not
in the currency of the country. Over time, companies began to issue bonds and other
instruments in dollars, and eventually this led to the rapid development of the dollar
market outside of the United States. All dollars that are traded outside the United
States became known as Eurodollars. It does not matter if the dollars are deposited
in a bank account in Singapore or Japan; they are still termed Eurodollars.
The success of the Eurodollar market also led other currencies, such as the German
deutsche mark, French franc, and Japanese yen, to be deposited outside their countries.
They were called Euromarks, Eurofrancs, and Euroyen, respectively. Multinationals
such as IBM could borrow Euroyen to finance their Japanese operations and Euromarks
for investment in Germany. Approximately two-thirds of the Eurocurrency market
is still dominated by the Eurodollar. London is the largest center for dollar deposits,
estimated at US$1.86 trillion, approximately 25 percent of the total. The next largest
repository of U.S. dollar deposits is in the Cayman Islands.12
REGULATORY AGENCiES
A major concern for managers of multinationals is the myriad of regulatory agencies
that must be dealt with in the course of conducting overseas business. Companies
that engage in exporting, invest in overseas ventures, and set up joint ventures or
subsidiaries are all likely to face the following kinds of regulators, both in the United
States and around the world.
U.S. Customs and Border Protection, formerly the U.S. Customs and now part of
the Department of Homeland Security, monitors both exports and imports of goods.
A company that imports goods to the United States faces different schedules of du-
ties. If the country is classified as developing, it may be subject to lower rates than
the general rates. Countries that do not have normal trade relations with the United
States, such as Cuba and North Korea, may have rates higher than the general rates.
In addition, user fees are applied based on mode of entry. The harbor processing fee
is charged for goods entering by ship, while a merchandise processing fee is applied
for most other imports.13
348 CHApTER 13
The Office of Foreign Assets Control, a part of the U.S. Department of the Treasury,
monitors international financial transactions. The office ensures that investments are
not undertaken in countries where investment is prohibited by law. Today, all over-
seas investments, including manufacturing of goods and delivery of services, have
to abide by the controls put in place by Congress, mostly to combat terrorism-related
activities.
The International Trade Administration, a division of the U.S. Department of Com-
merce, promotes U.S. trade and investment, ensures that fair trade is implemented
among countries, and monitors companies to ensure that they are complying with
trade laws and agreements. The Bureau of Industry and Security (BIS), another divi-
sion of the Commerce Department, monitors the export and licensing of goods that
are restricted by law, requiring multinationals to seek its assistance in verifying that
they are compliant with the laws.
The U.S. Internal Revenue Service (IRS), part of the Department of the Treasury,
monitors the reporting of foreign-exchange earnings and the associated tax impli-
cations. Multinationals have to pay taxes on income repatriated from their foreign
subsidiaries to the parent company. In addition, they have to consolidate the income
statements and balance sheets of all their subsidiaries and compute the net taxes
owed. This often entails getting interpretations and clarifications as to whether certain
transactions meet the definitions of the local accounting standards, requiring frequent
consultations with the IRS.
The customs authority of the foreign country, with the exception of countries located
in economic unions or free trade areas, subjects all exports to that foreign country to
customs duties. There are no customs duties within countries in the European Union.
The North American Free Trade Agreement has also eliminated a majority of tariffs
among Mexico, Canada, and the United States. There are many other free trade areas
around the world where duties are not assessed for the member countries. Free trade
areas can make a big difference to financial strategies. Assume, for example, that a
multinational plans to open a subsidiary in or near Europe to service the European
Union market. Assume that the multinational must choose between opening the sub-
sidiary in Spain or in Morocco, where the labor rates are much lower. A cost-benefit
analysis must be done to determine if the benefits of having zero tariffs within the
EU offsets the gains of cheaper production in Morocco.
The taxing authority of the foreign country charges taxes for income earned by a
multinational in that foreign country. All multinationals have to deal with a number
of taxing authorities under different tax laws. Tax treaties between countries also
determine the amount of taxes to be paid by subsidiaries of foreign corporations. If
the foreign taxing authority charges a tax rate higher than the U.S. corporate tax rate,
the IRS will issue a credit for the extra taxes paid. There are attempts to harmonize
taxes within economic unions and free trade zones, but the goal for a unified global
taxation is still quite far from fruition.
The monetary authorities of the foreign country, the equivalent of similar agen-
cies in the United States, are also entities faced by U.S. multinationals when they do
business overseas. Handling some government agencies can be challenging because
of the prevalence of bribes and other unofficial payments expected by government
officials in some countries. The United States has a strict policy of not making any
illegal payments overseas under the Foreign Corrupt Trade Practices Act of 1977,
explained in the next section. In addition, financial managers have to keep abreast of
new laws passed by host governments that are implemented by the various branches
of their monetary authorities.
Other agencies that can impact trade include the consumer protection offices of
both the exporting and importing countries, local taxing authorities, social agencies,
and sometimes even political lobby groups. From a financial perspective, they either
add to the direct costs of doing business overseas or increase the risk of doing busi-
ness in that country. If the risk is increased, the investment has to generate more than
sufficient returns as additional compensation.
THE FOREiGN CORRUpT TRADE PRACTiCES ACT Of 1977

In 1977, the United States passed the Foreign Corrupt Practices Act (FCPA), the first of
its kind in the world. It explicitly forbids companies to make payments to any foreign
official to obtain new business or renew existing business. The law also forbids making
unauthorized payments through intermediaries. Since the term “foreign official” was
considered too broad, the Foreign Trade Act in 1988 clarified the category of persons
that would be considered recipients of bribery. Recipients are defined as government
officials that may directly or indirectly influence the outcome of a business order. The
law excludes payments to facilitate or expedite routine government actions such as
obtaining permits and licenses, providing power and water supply, expediting mail
services, or providing police protection. In other words, it allows “grease” payments
considered essential to maintain the continuity of business as a result of economic
rigidities in the local country.
For financial managers, deciding whether payments do or do not constitute bribery
will always remain a delicate issue. This issue becomes important when multinationals
acquire foreign companies. Multinational managers need to ensure that the FCPA is
included in their due diligence when they acquire companies, especially from countries
with weak corporate governance. The U.S. Department of Justice will allow a time
extension for complying with FCPA due diligence if a company does not have time
to conduct such diligence prior to making a bid, especially if there is competition to
acquire the target company.14
THE FiNANCiAL CRiSiS Of 2008

The financial crisis of 2008 affected the global financial markets throughout the world.
It began with the low interest rate environment fostered by the U.S. Federal Reserve
Board (the Fed) after the crash of the Internet bubble in 2001. Financial institutions
offered mortgages at very low interest rates, luring individuals to purchase homes in
record numbers. As the real estate sector boomed and home prices soared, financial
institutions began creating a variety of investment securities such as Mortgage-Backed
Securities (MBS) and Collateralized Debt Obligations that used mortgages as collat-
eral. When the Fed began to raise interest rates in June 2004, a trend that continued
350 CHApTER 13
until 2007, it increased the burden of payments to mortgage holders. This eventually
led to record defaults and foreclosures that affected not only the real estate market
but also the holders of the newly created financial instruments. Unfortunately, these
instruments were not just held by investors in the United States but throughout the
world.
The financial crisis impacted companies globally as banks reduced their lending
sharply, forcing the governments of many countries to step in and provide emergency
credit in the market. Companies that had relied on banks to finance short-term credit
found themselves paying higher interest rates. Companies that relied on letters of
credit for imports were forced to offer more collateral. Many shipping companies
have been hurt by the crisis as a result of banks’ reluctance to issue letters of credit.
The Baltic Dry Index, a measure of shipping costs for commodities, fell by 11 percent
to 2,221 on October 10, 2008, which was 81 percent lower than it was five months
earlier, reflecting the impact of the crisis.15 Pascal Lamy, director-general of the
World Trade Organization (WTO), reported that trade finance cost had increased to
300 basis points above LIBOR (London Interbank Offered Rate) for several develop-
ing countries, while HSBC—a large international bank—reported that the cost for
guaranteeing a letter of credit had doubled since the financial crisis began16. Thus, a
financial crisis that began in the United States had managed to affect trade patterns
throughout the globe.
CHApTER SUMMARY
This chapter focuses on the different financing issues that face a multinational manager
when engaged in overseas business. In particular, an international financial manager
has to be knowledgeable in exchange rates and the different foreign institutions and
government agencies around the world. This chapter describes the various stages of
a multinational as it progresses from a domestic company to a full-fledged multina-
tional with multiple subsidiaries. The various institutions it will face in the course of
expanding its overseas business are also explained.
Different international banks are available to a multinational manager. Commercial
banks can set up subsidiaries or branches overseas to offer full-fledged services to
their clients that have moved overseas. Alternatively, they can establish correspon-
dent or representative offices to provide services indirectly. Financial managers also
need to be knowledgeable about the kinds of insurance coverage they must have to
protect their shipments and foreign activity abroad. The most difficult insurance to
obtain is coverage for political risk. In the United States, political risk insurance is
obtained from the Overseas Private Investment Corporation (OPIC), a government
agency, and from the Multilateral Investment Government Agency (MIGA), an af-
filiate of the World Bank.
This chapter also examines the three major stock exchanges in the world and
explains the role of American depository receipts, which allow U.S. investors to
purchase foreign stocks in U.S. dollars. The growth in the stock markets has allowed
companies to raise capital in several countries through the issue of global deposi-
tory receipts. Companies can also borrow debt through the Eurocurrency markets,
where they have the choice of borrowing in the currency of their choice, such as the
Eurodollar or the Euroyen.
Finally, financial managers also have to deal with government authorities both in
the United States and abroad. In the United States, the four major government agen-
cies that affect international business are the Office of Foreign Assets Control and the
Internal Revenue Service (in the Department of the Treasury); the International Trade
Administration (in the Department of Commerce); and the U.S. Customs and Border
Protection (in the U.S. Department of Homeland Security). The chapter concludes
with a discussion of the Foreign Corrupt Practices Act of 1977, which forbids U.S.
companies from bribing foreign government officials in order to obtain new business
or renew business orders.
KEY CONCEpTS
Subsidiary vs. Branch
International Shipping
Political Risk
American Depository Receipts
Stock Exchanges
Eurodollar
1. What issues face a financial manager when his or her company forays into
the world of international business by exporting or importing goods and
services?
2. What issues face a financial manager when his or her company establishes a
subsidiary overseas?
3. What is the difference between a subsidiary and a branch?
4. What is the difference between a correspondent bank and a representative
bank? What purpose do they serve for commercial banks?
5. What are international banking facilities (IBFs) and how do they operate?
Why and when do multinationals prefer to use offshore banks?
6. What are the different terms of payments in international transactions? Who
bears the risk when the terms require an advance payment? Who bears the
risk in an open revolving account?
7. What is the difference between a letter of credit and a documentary collec-
tion?
8. What are the three methods of payment, and which is the most popular?
9. What is the difference between the SWIFT number and the routing number?
How are the numbers determined?
10. What are the different modes of shipping for overseas customers? What impact
do advances in Internet technology have on the mode of transportation?
11. What is political risk and how do companies protect themselves from political
risk?
352 CHApTER 13
12. What is the Eurocurrency market and why is it advantageous for a company
to borrow from this market?
13. What should international financial managers be aware of regarding the vari-
ous stock exchanges in the world? How can American depository receipts
help a multinational financial manager?
14. What four agencies in the United States impact the foreign operations of U.S.
companies? What impact can they have on the finances of a company?
AppLiCATiON CASE: ICELAND 2008—CONCERN fOR EXpORTERS

AND IMpORTERS
Exporters and importers have to worry about the creditworthiness of their overseas
clients as well as the macroeconomic conditions of the foreign countries in which
they engage in business. The case of Iceland in 2008 provides an example of how a
country’s economic condition can change rapidly to affect the overseas transactions
of multinationals. In November 2007, Iceland was voted by the United Nations as one
of the best countries to live in the world, surpassing Norway for the first time. With
a population of only 313,000, the country boasted a per capita income of $54,100 in
2007 and was ranked ninth by the World Bank. S&P rated its sovereign foreign debt
at A+ in 2007. Then, within a span of a year, its currency had devalued by over 100
percent and inflation increased by 10 percent. In October 2008 S&P reduced its rat-
ings to BBB and the country was nearly bankrupt. What caused the country that was
booming in 2007 to deteriorate so rapidly in a span of a year?
The problem began as early as 2003, when Iceland experienced strong economic
growth. Among the industries they attracted were many aluminum producers to take
advantage of the clean and plentiful energy derived from their underground steams.
Aluminum and marine life together accounted for over 70 percent of total exports in
2007. Unfortunately, during the boom period, several Icelandic banks began to borrow
aggressively from the international debt markets to invest in a variety of projects, includ-
ing real estate in Britain and retail businesses in Europe. Local Icelanders also borrowed
heavily to invest in domestic real estate and increase overall consumption. By 2008, the
total debt of banks increased to 11 times the GDP of Iceland, approximately $14 billion.
When the property market collapsed in Britain and the economy slowed in Europe, the
market value of the assets of banks went into a downward spiral.
The banks not only borrowed overseas from the wholesale market but also from
small savers, primarily from Britain. Icesave, a subsidiary of the second largest bank
in Iceland, Landsbanki, became one of the fastest growing Internet banks in Northern
Europe through its aggressive selling tactics. By offering attractive interest rates, it
managed to draw over 300,000 small savers, primarily from Britain, and deposits
grew to over $7.5 billion. When the Icelandic government announced on October 7,
2008, that it was putting Landsbanki into receivership because of its deteriorating
balance sheet, the extent of the country’s banking problem was revealed. Eventually,
the government was forced to take over the remaining two large banks in Iceland,
Kaupthing and Glitnir. The country was also forced to borrow from the IMF and other
countries to prevent it from defaulting on its debt obligations.
Among the contentious issues during the crisis was the obligation of the Icelandic
government to deposit holders of Landsbanki’s Internet subsidiary bank, Icesave,
in Britain. The Financial Services Compensation Scheme, an agency of the British
government, normally guaranteed £50,000 of deposits, of which the first £16,317
would have had to come from the Icelandic government. Unfortunately, the Icelandic
guarantee fund only had £88 million in total to cover over £13 billion in deposits.
A furor erupted when the Icelandic government announced it would fully repay
depositors in Iceland but only the minimum amount of €16,317 to its overseas deposi-
tors. The British government took the unprecedented step of freezing Landsbanki’s
assets in Britain under a provision in a newly created antiterrorism law. After some
acrimonious exchanges, the British government agreed to lend Iceland the sum of £3
billion, so the country could pay off the minimum €16,317 owed to British depositors.
The British government also made an exception and allowed the Financial Services
Compensation Scheme to fully repay all deposits held at Icesave. Unfortunately,
British depositors who saved at offshore banks of Landsbanki, primarily in the Isle
of Man and Channel Islands, were not included in the bailout. Approximately 2,000
depositors are expected to receive only 30 percent of their savings.
Many Icelandic importers were also affected because overseas banks refused to
accept letters of credit from their banks. Even if importers were willing to pay cash,
they could not find dealers to exchange their currencies because nobody wanted to
hold Icelandic krona as it continued to depreciate during the crisis. Multinationals
and even local governments in Britain found that their deposits held in the foreign
subsidiaries of Icelandic banks remained frozen while the country searched desper-
ately for loans.
QUESTIONS
1. What caused Icelandic banks to default in 2008?
2. What lessons does the Icelandic crisis teach multinational financial managers
who have to deposit money throughout the year in several different countries?
14 International Accounting
LEARNiNG ObJECTiVES
• To recognize the challenges posed to multinational corporations when they in-
tegrate their overseas businesses
• To understand how exchange rates affect the valuation of a company’s overseas
assets and liabilities
• To appreciate the effort involved in designing a global accounting standard
• To recognize the importance of instituting strong accounting standards by study-
ing some recent corporate scandals
• To understand the various taxes faced by multinational corporations when they
undertake overseas business
All companies prepare financial statements to keep track of their business activities and
the inflow and outflow of cash. Financial statements are used internally to evaluate and
improve business decisions. They allow management to identify costs and revenues in
detail and fine-tune the company’s operations. If the company is a publicly traded entity,
financial statements assist shareholders and creditors in evaluating the firm’s performance.
Finally, financial statements are prepared to assess the company’s tax liabilities.
The methods and formats used to prepare financial statements are determined by
the accounting standards board of each country. The standards vary from country to
country because they are based on each nation’s history of commercial activities, its
political system, and its cultural and social nuances.
When a company goes global, the accounting method and the preparation of fi-
nancial statements must address two additional issues:
1. Convert (or translate, in accounting terminology) the financial statements

from one currency to another, and
2. Reconcile the different accounting standards and formats between the two
countries.
The field of international accounting has grown steadily more complex over the
years, partly due to the heavy increases in trade and foreign investments and partly
due to firms engaging in creative and innovative forms of cross-border partnerships.
International accountants require significantly more expertise than their domestic
354
INTERNATIONAL AccOUNTING 355
counterparts because they need to have a strong background and knowledge of the
local customs and business culture of the countries in which their firms do business.
The accounting rules of most countries have adapted over hundreds of years. Culture,
more than geographic proximity, seems to play an important role in the development
of accounting standards. Take, for example, the Anglo-Saxon countries of the United
Kingdom, the United States, Australia, and New Zealand. Even though the countries
are geographically far-flung, their accounting standards have more in common with
one another than they do with those of continental Europe or Canada.
Accounting rules are complex not only for companies but also for individuals
working in different countries, such as global executives and staff. Most companies
prefer to send their own executives and staff to work at their overseas subsidiaries.
A foreign executive or staff member, termed an expatriate, usually earns income
that falls under the jurisdiction of two or more taxing authorities. An executive of
a Dutch company may be transferred in the middle of the year from a subsidiary in
Accra, Ghana, to another in Sydney, Australia. He or she may have to files taxes in
three countries for that year: the Netherlands, Ghana, and Australia. An international
accountant will have to determine how to apportion the income, deductions, and
exemptions among the three countries. This will depend on the accounting standards
of the three countries. Accountants specializing in expatriate personal taxes have to
be knowledgeable in the accounting laws of several countries and must be able to
reconcile them in a manner that satisfies the various taxing authorities.
In this chapter we ignore personal taxes and focus only on accounting issues as
they relate to multinational corporations. For our purposes, the multinational parent
company is assumed to be located in the United States (unless otherwise specified)
and has subsidiaries located in several countries that manufacture goods and provide
services. As noted in earlier chapters, a subsidiary is a fully incorporated company
located in another country. It may or may not be 100 percent owned, but we assume
the parent has managerial control over its activities.
BASiCS Of INTERNATiONAL ACCOUNTiNG

International accounting differs from domestic accounting primarily in two areas: (1)
it has to take into account the impact of exchange rates, and (2) it has to reconcile the
different formats used in different countries.
REcORDING FOREIGN EXcHANGE TRANSAcTIONS

We begin with an introduction on how firms record foreign exchange transactions,
both for the purchase and sale of goods and services. The procedure applies to all
companies, whether they are domestic companies or multinationals with multiple
subsidiaries. This is because all transactions at the end of the year are recorded, con-
solidated, and reconciled in the home country, and the rules for recording are based
on domestic accounting standards.
When a company places an order to sell or purchase a good from another country,
it has the option of invoicing the bill in the local currency or in the foreign currency.
356 CHApTER 14
If it is invoiced in the local currency, the transaction is no different than a domestic

transaction. However, if the bill is invoiced in a foreign currency, it is still necessary
to record the transaction in the home currency after converting it from the foreign
currency. If there is a time lag between the order date and payment date, the company
will have to account for foreign exchange differences when the payment is settled.
Assume a U.S. company imports A$1 million worth of merchandise from an Austra-
lian company, to be paid in 90 days. By U.S. generally accepted accounting principles
(GAAP), the order will be recorded in U.S. dollars on the date of the order. The company
will have to first convert the value of the order from Australian dollars to U.S. dollars.
That amount depends on the prevailing exchange rate on the order date.
Assume the exchange rate on the order date is A$1.25/US$1. The U.S. company
will record the order as A$1,000,000/US$1.25 = US$800,000, and this amount will
be credited to accounts payable.
The next stage is to record the payment 90 days later. Assume the exchange rate
on the date of payment is A$1/US$1. The U.S. company will need US$1,000,000 to
purchase A$1,000,000, an increase of US$200,000 from the date of order. The account-
ing rules in the United States require a payment of US$800,000 be recorded to offset
the US$800,000 in accounts payable. Separately, the company will have to record
US$200,000 as an exchange loss. If the exchange rate was A$1.50/US$1 on the date
of payment, the U.S. company needs only US$666,666.67 to make the payment of
A$1,000,000. The company will continue to record a payment of $800,000 to offset the
accounts payable but will separately record an exchange gain of US$133,333.33.
An alternative approach is to record a foreign sale or purchase in one transaction by
waiting for the payment to be completed. The company can then record the activity
based on the actual value of the payment. Although this one-step procedure is simpler
than the two-step procedure described above, it does have one drawback. If a com-
pany is engaged in multiple foreign sales and purchases, it will find itself with many
transactions valued at different exchange rates. This becomes problematic when the
company has to consolidate transactions at the end of each month, quarter, or year.
The two-step procedure also has an advantage in that it provides a clear picture of
whether the company’s profits or losses are the result of exchange-rate movements.
If they are due to exchange-rate changes, management is better off spending time
managing exchange-rate risks. Accounting rules in most countries require companies
to follow the two-step procedure when recording overseas sales and purchases.
BALANcE SHEET
A company’s balance sheet provides information about its total assets and liabilities. If
a company has several subsidiaries, the assets and liabilities of the various subsidiaries
have to be consolidated at the end of the fiscal year into the parent’s balance sheet. Most
countries use December 31 as the year-end closing of their books. However, this date
is not uniform across the globe. Some countries use March 31, while others use June
30 as their year-ends. Although year-ends are usually not mandated by country, it is
normal for companies to choose dates that are common across firms in their industry.
Table 14.1 (p. 358) provides the year-ends that are popular in most countries.
REcORDING TRANSLATION GAINS OR LOSSES

For a company with overseas subsidiaries, the act of consolidation becomes problem-
atic as a result of fluctuations in exchange rates. Although the mechanics of convert-
ing or translating overseas assets and liabilities to U.S. dollars is an easy process,
the impact on the financial performance of the overall firm is not clear. An example
(below) highlights the issue.
Assume that Company A is a parent company located in the United States and Com-
pany B is its subsidiary located in the United Kingdom. Both parent and subsidiary
are 100 percent equity financed, that is, the firms have no debt, and the spot exchange
rate is US$2/£1. The balance sheets of both companies are shown below.
Company A (parent) Company B (subsidiary)

Assets Equity Assets Equity
US$100 million US$100 million £50 million £50 million
In dollars, the balance sheet of Company US$100 million US$100 million
B will be converted at the spot exchange
rate of US$2.00/£1.
The consolidated balance sheet of the parent and subsidiary will be:
Consolidated AB
Assets Equity
US$200 million US$200 million
Assume that the exchange rate changes overnight from US$2/£1 to US$1.50/£1.
What impact does it have on the consolidated balance sheet? First, the value of the
assets and equity of the overseas subsidiary will decrease to US$75 million instead
of US$100 million.
As a result, the consolidated balance sheet of the parent and subsidiary will now be:
Consolidated AB
Assets Equity
US$175 million US$175 million
What does this decline in the value of the overseas assets mean to the parent com-
pany? Is it a loss that affects shareholders of the parent company? The answer depends
on whether the parent company intends to sell or liquidate the subsidiary. If it plans to
sell the subsidiary, then it is a real loss to the parent. If it intends to continue the firm’s
operations, it may not be a real loss. The exchange rate could go back to US$2/£1 the
following period, and the value of the subsidiary will go back up to US$100 million.
Accounting bodies used to treat such changes as real gains or losses. Today they are
treated as unrealized gains and losses, as explained in the next section.
358 CHApTER 14
Table 14.1
Fiscal Year-ends in Selected Countries
Country Year-end Comments

New Zealand March 31 Public companies use June 30 to match Australia
Japan March 31
India March 31
Australia June 30 Mandatory
United States December 31
Europe December 31
China December 31 For companies with foreign investments
United Kingdom Mixed Based on month of setup, majority use December 31
CURRENcY TRANSLATION
In the United States, the standards for financial accounting and reporting are deter-
mined by the Financial Accounting Standard Boards (FASB), an independent orga-
nization that represents the industry and the public.1 The Securities and Exchange
Commission (SEC), which regulates all publicly traded companies in the United States,
has usually accepted the guidelines established by the FASB. In the United Kingdom,
the Accounting Standards Board (ASB) of the Financial Reporting Council (FRC)
took over the tasks from the Accounting Standards Committee in 1990, and sets the
standards for UK companies.2 Similarly, other countries have their own accounting
standards boards that define the reporting standards for companies operating within
their jurisdictions.3
For American companies with international operations, the change in the value of the
asset or liability of a subsidiary used to be treated as a real gain or loss under FASB #8. In
the earlier example, the company would have had to report a real loss of US$25 million the
year when the exchange rate moved to US$1.50/£1. If in the following year the exchange
rate moved back to US$2/£1, the company would report a real gain of US$25 million.
A number of companies complained that this rule was not only unfair but it did
not make economic sense. If a business is an ongoing entity and the overall business
operations are unaffected by exchange-rate changes, it is inappropriate to claim them
as real losses or gains. Exchange-rate volatility rarely affects the day-to-day opera-
tions of most companies.
After several hearings, FASB #8 was replaced by FASB #52, which allowed com-
panies to record changes in the balance sheet of their subsidiaries as unrealized losses
or gains. They are recorded as real gains or losses only when the subsidiary is sold.
The unrealized losses and gains are instead adjusted in a separate equity account.
Outside investors can see the amount of unrealized losses or gains by examining the
“Adjustments for Currency Translation” in the equity account.
Many countries had laws similar to FASB #8 but have now changed them to allow
companies to record the gains and losses as unrealized on their balance sheets. The
new global accounting standards, known as the International Financial Reporting
Standards (IFRS), also consider gains and losses related to exchange-rate changes
as unrealized till the company is sold.
CHOIcE OF EXcHANGE RATE: CURRENT VS. TEMpORAL

Another issue related to the translation of the income statement and balance sheet
of a subsidiary is whether market or historical exchange rates should be used. Most
companies acquire assets and liabilities at different dates. Assume that a U.S. company
purchased equipment for 1 million reals at the beginning of the year in Brazil, when the
exchange rate was 2 reals/US$1. In dollars, the value of the purchase was US$500,000.
At the end of the year, assume the exchange rate comes down to 1.25 reals/US$1 (ap-
preciation of the Brazilian real). The value of the asset using this exchange rate became
US$800,000. Should the assets be translated at the old or new rate? Does the parent
company have the right to claim that it made an instant US$300,000 gain, or should it
translate the value of the asset at the rate in effect at the time of the purchase?
The accounting standards have generally used either of the following two methods.
Current Method
Under the current method, all assets and liabilities are translated at the exchange rates
on the date of translation. For the above example, the parent will value the assets at
US$800,000 at year-end. One problem with this approach is that it may be incompat-
ible with the parent company’s balance sheet because the parent company is more than
likely to value its assets at historical cost. Most accounting standards allow domestic
assets and liabilities to be translated at historical costs. It is too cumbersome for a
domestic company to change the value of its assets every year.
Assume that a company purchases a car valued at US$10,000 and plans to use it for
five years. One way of reporting the value of its assets each year is to depreciate it by
US$2,000 per year over five years. The value of the car will be US$8,000 at the end of year
one, US$6,000 at the end of year two, and so on. At the end of year five, the book value
of the car will be zero. This assumes that the historical price of US$10,000 remains the
same over the five years. If the current method is used, the company must revalue the car
and report the market value of the car at the end of each year—a cumbersome process.
Temporal Method
Under the temporal method, monetary accounts such as cash, accounts receivables,
and debt are translated at the current exchange rate. Longer-term assets such as plant
and equipment are translated at historical rates. Long-term assets are translated at
historical rates, making the process both compatible to domestic accounting standards
as well as less cumbersome.
The new IFRS has also adopted the temporal approach. Before we examine the
IFRS, a brief history of the evolution of accounting standards is discussed.
HiSTORY Of ACCOUNTiNG
It is now generally accepted that the double-entry system of bookkeeping was used
extensively by the Italians in Genoa around 1400 C.E. A few scholars have claimed
360 CHApTER 14
Table 14.2
The “Big Four”: Revenues and Number of Employees
Company Revenues Date Employees Countries/Offices

PricewaterhouseCoopers US$25.2 billion June 30, 2007 146,000 150 countries
Deloitte Touche Tohmatsu US$23.1 billion May 31, 2007 150,000 142 countries
Ernst and Young US$21.1 billion 2007 130,000 140 offices
KPMG US$19.81 billion September 30, 2007 146,000 146 countries
that the double-entry system was developed even earlier. For example, B.M. Lall
Nigam asserts that the double-entry system existed in India thousands of years earlier.4
This claim is not accepted universally and has been refuted by several new studies.5
Similarly, Omar Abdullah Zaid argues that Muslim societies engaged in double-entry
bookkeeping systems well before the Italians, although clear evidence is still lack-
ing.6 The first major book credited to the description of double-entry bookkeeping
is Luca Pacioli’s Summa de Arithmetica, Geometria, Proportioni et Proportionalita
in 1494 C.E.
The earliest book published in England that refers to accountants and bookkeep-
ing is by Hugh Oldcastle: “A Profitable Treatyce Called the Instrument or Boke to
Learn to Know the Good Order of the Keepying of the Famouse Reconynge Called in
Latyn, Dare and Habdare, and in English, Debitor and Creditor.” In Modern English
it is translated as “A Profitable Treatise Called the Instrument or Book to Learn to
Know the Good Order of the Keeping of the Famous Reconciliation called in Latin,
Dare and Habdare, and in English, Debtor and Creditor.”
The oldest continuously functioning accounting firm can be traced to Josiah Wade
in 1780 in Bristol, England, who specialized in auditing the accounting of merchants.
The company became Tribe, Clark and Company in 1871 and finally merged with
Deloitte in 1969.7
In 1989, there were eight large accounting firms, but this number has gradually been
reduced to four, which today are referred to as the “Big Four”: PricewaterhouseCoo-
pers, Deloitte Touche Tohmatsu, Ernst and Young, and KPMG. Three of the “Big
Eight” merged, while the fourth, Arthur Anderson, was disbanded as a result of a
major accounting scandal in 2002 involving an energy company, Enron, and will be
discussed later. The remaining four firms are truly global firms because they operate
in nearly all countries, mostly through local affiliates. Their revenues and total number
of employees for 2007 are listed in Table 14.2.
TOWARD A GLObAL ACCOUNTiNG SYSTEM

INTERNATIONAL AccOUNTING STANDARDS BOARD
As discussed previously, operating a business in another country requires the integra-
tion of the local accounting system. This can be a cumbersome, unwieldy, and some-
times impossible process. The recent spurt in globalization of commerce and trade
has forced many countries to seriously coordinate their accounting systems and to
cooperate with other governing bodies. The work toward integrating global accounting
standards began as early as June 1973, when the International Accounting Standards
Committee (IASC) was formed. Its mission was to create international standards that
are “capable of rapid acceptance and implementation world-wide.”8
Unfortunately, the IASC struggled for many years to deal with the intransigence of
various accounting boards to relinquish their authority to a global body. In the end,
globalization has forced the issue to the forefront, and the new global standards are
finally being adopted through the offices of the International Accounting Standards
Board (IASB), an independent, privately funded accounting-standard setter based in
London. Its parent organization is the International Accounting Standards Committee
Foundation, formed in March 2001 and incorporated in Delaware.
The big boost for the adoption of IFRS came from the European Union, when it
announced on June 2, 2002, that all companies within its jurisdiction would have
to adopt IFRS as of January 1, 2005. In September 2002, a further boost was given
when the U.S. FASB and IASB announced the Norwalk Agreement, whereby they
pledged their best efforts to reconcile the two standards and reach common platforms.
Today, more than 100 countries either have adopted IFRS or are changing their local
standards to be compatible with IFRS standards. The future for IFRS seems very
promising and is coming at an appropriate time, as cross-border business is expected
to continue its rapid growth for the foreseeable future.
AccOUNTING ScANDALS
The push for a common accounting standard has been partly spurred by a number of
corporate scandals at the turn of this century. Top-rated companies such as Enron,
Parmalat, WorldCom, Royal Ahold, Computer Associates, and Tyco International, to
name a few, were caught in what have been termed “creative accounting” manipula-
tions. These events have cast doubt on the ability of accounting firms to certify the
books of corporations, especially those of multinationals. The lack of coordination
among various accounting boards may have also contributed to some of the abuses.
We begin with a review of some of the more notable scandals.
Enron
Enron started as the Northern Natural Gas Company and after a series of mergers
became a multifaceted energy company in 2001 with over 20,000 employees. It spe-
cialized in electricity and gas transmission, pipelines, power plants, refineries, and
energy trading. In August 2000, Enron’s stock was trading at $90, and it was one of
the most admired companies among investors. Fortune magazine named it the “most
innovative company” six years in a row, while CEO magazine named its board one
of the top five in the country. Unfortunately, very few analysts bothered to examine
in detail the dramatic increases in reported revenues, from $40 billion in 1999 to
more than $100 billion in 2000.9 When they began to scrutinize them in earnest in
early 2001, it became apparent that the company was not honest in their claims. By
362 CHApTER 14
December 2, 2001, the company had declared bankruptcy, leaving all its employees
without jobs and with losses on their retirement portfolios. In addition, investors in
Enron lost billions of dollars.
When the truth emerged, it showed a company that was engaged in the classic fraud
of overstating revenues and profits and understating losses. In the case of Enron, the
company also managed to show an amazingly upbeat and positive face to the public.
In reality, many officers were involved in creating shell companies to hide their bad
debts and loss-making units.
An important question that always arises in cases of corporate fraud is the role of
accounting firms. Did Arthur Anderson, then one of the Big Five accounting firms,
know of these phony accounts set up by Enron? After an investigation, several Arthur
Anderson employees were indicted for destroying documents. On June 15, 2002, the
company itself was indicted for obstruction of justice related to the shredding of the
documents. This indictment was overturned by the U.S. Supreme Court in 2005, but
by then the damage had been done and the company had only 200 employees left.
The original Big Eight had been reduced to the Big Four. The question of whether
the accounting firm was complicit in the fraud was never established.
The Enron episode is still considered one of the most notable accounting scandals
for this period, although there were many that followed with even greater losses.
One reason for its prominence is the high-profile approach used by management to
dazzle and woo the media and investors, even when they knew their revenues were
far below their claims. A numbers of executives were convicted, including CEO Jef-
frey Skilling, sentenced to 25 years in prison, and CFO Andrew Fastow, sentenced
to six years in prison. The case also gained notoriety because it dragged a major
accounting company down with it. Finally, the company’s demise was instrumental
in Congress passing the Sarbanes-Oxley Act (commonly termed SOX), which sig-
nificantly tightened corporate governance standards in the United States. The SOX
has also generated much criticism because some if its provisions are deemed too
burdensome by corporate executives.
WorldCom
An equally large scandal that erupted soon after the Enron episode was the declara-
tion of bankruptcy by WorldCom on July 21, 2002, with assets of $107 billion. The
company had accumulated a total debt of $41 billion. WorldCom was founded by
Bernie Ebbers in 1983 as LDDS, a provider of long-distance telephone and data
services. In 1998, Ebbers acquired MCI for $37 billion, making it the second largest
telephone operator in the company. In 2000, Ebbers tried to take over another large
long-distance phone company, Sprint, and failed. Although the telecommunications
industry was entering one of its most competitive periods, the company continued to
report significant increases in revenues, $7.6 billion in 1998, $17.6 billion in 1998,
and $35.9 billion in 1999. Neither investors nor the board of directors took the time
to examine WorldCom’s claims of revenue growth.
It was later revealed that WorldCom had also engaged in the traditional fraud of
overstating revenues and understating expenses. In this case, the fraud was discovered
in 2002 by the company’s internal auditors. When the accounts were rectified, the
discrepancy in revenues was estimated at $3.8 billion, and the assets were overstated
by $11 billion. Bernie Ebbers was convicted in July 2005 and sentenced to 25 years
in prison for accounting fraud along with several other executives.
Parmalat
The accounting scandals of the late 1990s and early 2000s were taking place not only
in the United States but also across the globe. The boom in the U.S. stock market
of the 1980s led to massive investments in Europe and Asia. In response, financial
markets were liberalized in many countries, and firms worldwide were engaging
in significant expansions and mergers and acquisitions. It was inevitable that some
companies would also end up committing fraud.
In Europe, the biggest scandal took place at Parmalat, a large food company from
Italy, which was ranked fourth in Europe at that time. Parmalat’s troubles began in
1999, when the company went on an acquisition spree in North and South America;
some of these purchases turned out to be less-than-profitable ventures. In addition,
founder and CEO Calisto Tanzi bought the local soccer club, Parma, and also created
Parmatour, a tourism company, both of which ran into heavy losses. With the aid of
several major international banks, Parmalat set up several shell companies to engage
in risky derivatives trading and issue bonds using fake collateral as guarantees; ulti-
mately, Parma released false financial statements.
On December 9, 2003, the company temporarily defaulted on a US$150 million
bond, which sent the first signal to the market that something was amiss. This was
followed by an announcement on December 15 by Bank of America that the company
did not hold liquid assets worth US$3.9 billion, as claimed by Parmalat.10 The price
of its stock immediately tumbled, and investors’ estimated loss after the dust settled
was approximately €18 billion. Once again, it was the same fraudulent scheme of
overstating revenues, understating costs, and falsifying documents while keeping a
positive public face.
In the case of Parmalat, the company still exists and has now recovered from liq-
uidation. However, the civil cases that followed the scandal continue today (2008)
because Parmalat countersued the banks. The company claims that the banks were
equally involved in helping them set up the false accounts. In some instances, the
banks have been found guilty of complicity.
Several more scandals were to follow, and the period between 1997 and 2005 may
be recorded as one of the worst in recent corporate history, with cases including Royal
Ahold (2003), Tyco International (2002), and more recently AIG (2005). It is and
will continue to be difficult to detect fraud, especially when committed by insiders.
If insiders choose to engage in creative accounting, they can evade the scrutiny of
both the accountants and the analysts who follow their stocks. When a company has
subsidiaries overseas, it makes it even more complicated to detect fraud.
Will the adoption of the IFRS reduce this problem? It is interesting to note that
for most of the fraud cases described above, managers had to create overseas shell
companies to hide their losses. IFRS is expected to make it simpler to integrate the
364 CHApTER 14
various overseas units and make it more transparent. Perhaps this is the first step in
curtailing global fraudulent activities.
HOW DIFFERENT ARE THE IFRS AND GAAP?

The accounting standards in each country can have a big impact on the way financial
figures are reported. For example, on May 2, 2008, United Microelectronics Corpora-
tion (UMC) from Taiwan announced that it had to restate its net profits of T$16.96
billion, using Taiwanese accounting standards, to a loss of T$9.06 billion (or US$304
million) when using U.S. GAAP accounting standards.11
Similarly, OmniVision, based in Sunnyvale, California, makers of imaging sensors,
provided two sets of statements for the year 2007. Net income using U.S. GAAP for
the fourth quarter of 2007 was US$9.1 million. However, when non-GAAP method-
ology was used, the reported net income for the fourth quarter of 2007 was US$14.3
million.12
A study by Citigroup found that when comparing 73 European companies that used
both U.S. GAAP and IFRS standards, 82 percent using IFRS had higher net income and
70 percent had lower book values, implying a higher return on equity.13 Profits under
IFRS were on average 23 percent higher for the sampled companies, with a median of
6 percent higher than under U.S. GAAP accounting. For example, Bayer, a major Ger-
man chemical company, saw its profits under IFRS go up by 525 percent compared to
its profits under U.S. GAAP. Similarly, a major UK bank, Lloyds TSB, reported profits
that were 54.4 percent higher when it used IFRS than when it used U.S. GAAP.
In the Citigroup study, the discrepancies arose because of differences in the treat-
ment of taxes (60 companies), pensions (55 companies), goodwill and intangible
assets (53 companies), and financial instruments (40 companies). The data for the
study were for the periods 2005 and 2006.
The major difference between the two standards can be summarized as follows:
IFRS is more principles based, while U.S. GAAP is more rules based. A principles-
based approach is more conceptual in that it expects companies to provide reliable
and accurate reports based on specific objectives and intent of the disclosure. The
methods to achieve the objectives can vary, and hence different rules can be applied.
In a rules-based approach, although the objectives may be the same, the procedures
and methodology are rigidly defined. A problem with such an approach is that com-
panies can always find loopholes enabling them to follow the rules but not meet the
intended objective.
Even FASB usually begins as a principles-based system. The problem occurs when
the FASB issues guidelines and provides examples on how to treat each principle
or objective. Due to litigation worries, U.S. accountants request numerous clarifica-
tions, and as a result, the FASB ends up issuing more guidelines, pronouncements,
and clarifications, making it more like a rules-based approach.14
For example, take the case of royalty payments sent from subsidiaries to their parent
companies. Under a new bilateral treaty agreed to on December 28, 2007, between
the United States and Finland, cross-border royalty payments are no longer subject
to withholding taxes. Withholding taxes are additional taxes imposed by countries
when subsidiaries repatriate money to their parent companies. Both countries still
charge 5 percent withholding tax on any dividend income sent back to the parent, as
long as the parent has less than 80 percent ownership. With 80 percent ownership or
above, there are no withholding taxes on dividend payments.
A problem with the above taxation structure is that subsidiaries may be tempted to
send more money as royalties rather than as dividends. In the rules-based approach
used by U.S. GAAP, it is easier to use this loophole than in the principles-based ap-
proach used by IFRS.
Appendix 14.1 (see pp. 377–379) lists some of the differences between IFRS and
U.S. GAAP, as published by PricewaterhouseCoopers in October 2007. It shows that
several of the principles are compatible with existing rules-based guidelines, although
there is still much work required for full convergence between the two systems.
TRANSITION TO IFRS
More than 100 countries have already made plans to move toward the IFRS, and
there is optimism that a single global accounting standard can be achieved within the
next decade. With the agreement by the United States to conform to IFRS, a major
stumbling block has been removed. Following are examples of some other countries
that are taking steps to implement IFRS directly or indirectly.
China
In 2007, China took a big step in its evolution of modernizing its financial markets
by announcing a new set of accounting standards. For China, this is a significant
transition. Until 1993, it had been using the old Soviet-style centrally planned ac-
counting system. Then it moved on to a very rules-based approach. The new stan-
dards, termed the Accounting Standards for Business Enterprises, are in many ways
similar to the principles-based approach of the IFRS. These new standards will mean
a bigger change for the domestic companies in China. Although surveys have found
that Chinese companies are looking forward to these new standards, it will still be
challenging for a large country such as China to move away from the old and rigid
accounting mind-set. The biggest change will be in reporting fair or market values
for assets. This will be very difficult because most of China’s industries still lack free
market prices to make effective comparisons.15
India
In March 2007, the Institute of Chartered Accountants of India announced the con-
vergence of Indian accounting standards to IFRS by April 1, 2010. In the beginning,
the standards will be adopted by listed companies and other large entities, including
banking and insurance firms. Thereafter, separate guidelines will be issued for small
and medium-sized enterprises, with attempts to follow the principles of the IFRS as
closely as possible.
This news was well received by many of the Indian companies that were listed on
366 CHApTER 14
overseas stock markets, particularly in the United States and Europe. The European
Union is currently investigating whether the Indian accounting standards are compa-
rable to the IFRS, since the EU requires their own companies to adopt IFRS standards.
There are currently about 80 Indian companies listed in the European markets. If the
EU finds there is no likelihood of convergence taking place between the Indian ac-
counting standards and IFRS before 2011, then all Indian companies listed in Europe
will be mandated to adopt IFRS as of 2009.16
Russia
Russia, like China, had to dramatically change its accounting standards as it moved
from a centrally planned economy to a free and open market system. In the late 1990s,
the country was somewhat in a chaos as it moved to deregulate prices and sell many
of its government-owned entities. The Russian Duma (or parliament; duma is the
Russian word for “deliberation”) passed a bill in 1997 approving the transition to a
new accounting system that was based on the principles of the IFRS. It was expected
to be adopted by most of the country’s large enterprises. Unfortunately, however,
Russia experienced a ruble crisis in 1998, when investors sold the Russian currency
in a panic. The value of the ruble plummeted from R6/US$1 in August to about R22/
US$1 by the end of December. It was apparent that the transition to a free market
economy was not going to be successful unless major structural reforms took place
in the corporate and legal environment, with enhanced corporate governance and
accounting standards.
The crisis forced the Duma to attempt on many occasions to make IFRS manda-
tory for Russian firms. As of 2008, this change had not yet been implemented. In the
meantime, Russian accounting standards have been modified to meet the principles
of IFRS. A December 2007 survey by the European Union of more than 2,300 ac-
counting professionals in Russia yielded the following results17:
1. Sixteen percent of the respondents stated that their company used IFRS.
A majority of the firms were in the financial sector. Excluding firms in the
financial sector, the percentage was not much lower: 12 percent.
2. Thirty-two percent of the organizations reported using accounting standards
that are in compliance with IFRS, suggesting the transition is slowly but surely
taking place.
3. Sixty-seven percent of those using IFRS said it was beneficial, while 20
percent said it was not beneficial.
4. Thirty-two percent responded that the major barrier to the implementation of
IFRS is lack of a mandate by the government requiring firms to adopt it.
5. However, nearly 75 percent expect that most firms will be reporting according
to IFRS standards by 2010.
The three countries profiled above illustrate the slow but steady acceptance of
IFRS. Most countries are either adopting IFRS fully or modifying their accounting
standards to comply with its principles. Clearly, there are benefits associated with
Table 14.3
Benefits Countries Would Gain by Adopting IFRS
Benefits for Companies

• Improved management information for decision making
• Better access to capital, including from foreign sources
• Reduced cost of capital
• Ease of using one consistent reporting standard in subsidiaries from different countries
• Facilitated mergers and acquisitions
• Enhanced competitiveness
Benefits for Investors
• Better information for decision making
• More confidence in the information presented
• Better understanding of risk and return
• Companies can be compared to a peer group of companies
Benefits for Policy Makers
• Strengthened and more effective Russian [and emerging market countries] capital market
• Better access to the global capital markets
• Promotion of cross-border investment
Benefits for National Regulatory Bodies
• Improved regulatory oversight and enforcement
• A higher standard of financial disclosure
• Better information for market participants to underpin disclosure-based regulation
• Better ability to attract and monitor listings by foreign companies
Benefits for Other Stakeholders
• Greater credibility and improved economic prospects for the accounting profession
• Enhanced transparency of companies through better reporting
• Better reporting and information on new and different aspects of the business
Source: Directorate for Financial and Enterprise Affairs, OECD, “Implementing International Financial
Reporting Standards (IFRS) in Russia: The Russian Corporate Governance Roundtable,” May 2005. Avail-
able at http://www.oecd.org/document/22/0,3343,fr_2649_34795_35686358_1_1_1_1,00.html (accessed
July 23, 2008).
the establishment of a single accounting standard globally. The Organisation for

Economic Co-operation and Development (OECD), an influential public group in
Europe comprised of 30 country representatives, released a list of benefits a country
like Russia would gain by adopting IFRS. This list, as shown in Table 14.3, can be
extended to firms in all countries, especially those in emerging markets.
INTERNATiONAL ACCOUNTiNG AND TAXES

Multinationals are faced with the daunting problem of managing cash flows between
subsidiaries and between a parent and a subsidiary. Taxes play an important role in
international accounting since the transfer of cash flows usually overlaps two, if not
more, taxing authorities. The taxation of cash flows between countries is typically
governed by bilateral treaties between countries. These treaties enable multinationals
to reduce some of the disparities in the taxing systems between countries.
There are two kinds of direct taxes that affect business operating across borders:
corporate taxes and withholding taxes. Another is the indirect tax, which can also have
an impact on cash flows across borders, and all three taxes are discussed next.
368 CHApTER 14
CORpORATE TAXES
With the exception of a few tax-haven countries such as the Cayman Islands or
Bahrain, most countries impose corporate taxes on companies’ profits, whether
they are domestic or foreign owned. As long as business is being conducted in a
country, the taxing authority reserves its right to impose taxes on profits gener-
ated by the firm. The issue for most multinationals is not the taxes they have to
pay in the foreign country; the issue is whether the income will be taxed again
when the profits are repatriated back to the home country, a phenomenon known
as double taxation.
Corporations do not conduct business overseas for tax benefits alone. They have
to consider various other factors including transportation, the level of skilled workers
in the host country, and availability of materials, among others. Whenever a com-
pany conducts business overseas, there is an impact on the domestic economy, most
notably a loss in jobs. Home-country governments cannot change the conditions in
foreign countries that draw companies overseas (the low wages, favorable tax rates,
and lower labor standards); however, they do have the ability to tax the profits that
will eventually be repatriated back to the home country.
By and large, most countries have avoided the double taxation of profits from
companies that conduct business overseas. Still, many countries have rules that en-
sure companies that have gone abroad will pay taxes at least equal to those of their
domestic counterparts. Other countries have taken a more liberal approach and do
not tax any of the profits that are repatriated to the home country.
No Additional Taxes
The approach in which no additional taxes are levied on repatriated corporate profits
recognizes that capital should flow to regions where owners can maximize their returns.
Different tax rates in another country should not be a factor in taxing a company’s
profits. This approach accepts the right of regions to use taxes as incentives for busi-
nesses. Just as the different states in the United States have different tax rates, some
of which are enacted deliberately to attract businesses, national borders should not
be a factor when locating plants or services abroad.
Playing-Field Taxes
The approach known as “playing-field taxes” adopts the stance that all businesses in
a country, whether they operate domestically or overseas, should face the same level
of minimum taxation. If a business chooses to go overseas to a lower tax environ-
ment, its profits will be subject to additional taxes up to the amount that would be
paid by their domestic counterparts. If the business pays more taxes overseas than its
domestic counterparts, it should receive a tax credit when its profits are repatriated
to the home country. This approach essentially states that location is not a relevant
factor; tax rates should be uniform.
The United States taxes the dividends of companies that have gone overseas on
the principle of leveling the playing field. The European Union had similar taxation
laws but 10 years ago abolished the tax equalization law. Its corporations are now
allowed to repatriate dividends free of income tax. Some multinationals have com-
plained that this gives the European companies an advantage over U.S. companies
in locating their plants overseas. The United States taxes dividends only when they
are actually repatriated to the United States. If a U.S. corporation chooses to leave
its money overseas in the form of retained earnings, they will not be subject to ad-
ditional U.S. taxes.
WITHHOLDING TAXES
Whenever a company repatriates income to its home country, the foreign country
usually imposes an additional tax, termed the “withholding tax.” The income may
consist of the following:
1. Dividends, which are profits distributed to the shareholders. In the case of

multinationals, the dividends are sent back to cover the original investment
made by the parent company.
2. Interest income, usually paid for loans and bonds. In the case of multination-
als, the interest is for loans made by the parent to their subsidiaries.
3. Royalties, which are payments made by subsidiaries to their parent for use
of a particular technology or process that is owned by the parent company.
Withholding tax rates are usually determined by bilateral treaties signed between
countries. Over the years, withholding taxes have been reduced among countries.
For example, the United States does not levy any withholding taxes on the interest
income of foreign investors, but it continues to impose withholding taxes on royalties
and dividends. On March 13, 2003, the U.S. Senate ratified a treaty with Australia
that agreed to the following:
• A zero rate of dividend withholding tax on dividends paid to an eligible entity

holding 80 percent or more of the voting shares
• A 5 percent rate of dividend withholding tax on dividends paid to an eligible
entity holding at least 10 percent of the voting shares
• Interest withholding tax would not be levied on interest paid to eligible financial
institutions
• The withholding tax rate on royalties would be reduced from 10 percent to 5
percent
EXAMpLE OF IMpAcT OF CORpORATE AND WITHHOLDING TAX

Assume that a company has a subsidiary in Brazil and at the end of the year it reports
the following profits in Brazilian reals. It will repatriate all the profits to the parent
company. Assume that the corporate tax rate in Brazil is 20 percent and the with-
holding tax is 5 percent.
370 CHApTER 14
Sales 10,000 reals

Variable cost 4,000 reals
Profits before taxes 6,000 reals
Taxes of 20 percent 1,200 reals
Profits after taxes 4,800 reals
Withholding tax of 5 percent 240 reals
Net profits repatriated to parent 4,560 reals
How much tax will have to be paid by the parent company when it receives the
4,560 reals? This will depend on the whether the home country exempts overseas
remittances from taxes or whether it applies taxes to level the playing field with
domestic companies.
If a Country Requires No Additional Taxes
In this case, the amount available to shareholders of the parent company is the full
amount of 4,560 reals. If the parent company is located in an EU country and the
exchange rate is 3 reals/€1, the amount available on the date of payment is €1,520.
If a Country Applies Playing-Field Taxes
It will depend on the tax rate of the home country. Assume the parent company is
in the United States and the corporate tax rate is 34 percent. Also assume that the
current exchange rate is 2 reals/US$1. Since the Brazilian corporate tax rate is 20
percent, the money sent back to the parent will be subject to additional taxes. The
Internal Revenue Service (IRS) will first estimate the grossed-up income in order
to determine the equivalent taxes that will paid by a domestic company. Grossed-up
income is defined as the net dividends received plus the taxes paid on the income.
In this case:
Grossed-Up Income
Amount repatriated 4,560 reals
Corporate taxes paid in Brazil 1,200 reals
Withholding taxes paid 240 reals
Total 6,000 reals
At an exchange rate of 6,000 reals/US$2 US$3,000
A U.S. company would pay corporate taxes of US$1020

US$3,000 × 0.34
The company has already paid corporate taxes in US$600 (1,200 reals/2)
Brazil
The company already paid withholding taxes US$120 (240 reals/2)
Balance to be paid to the IRS US$300
When the company pays US$300 in taxes to the IRS, the amount available to U.S.
shareholders is 4,560 reals/2 = US$2,280–US$300 = US$1,980.
VALUE ADDED TAX AND GENERAL SALES TAX

Another tax that most companies face overseas is the value added tax (VAT) or the
sales tax, both of which are termed indirect taxes. While VATs are usually imposed
at the federal level, sales tax is usually imposed at the state and county levels. In
some countries, such as Canada, sales tax is collected by both the federal and state
governments. The biggest difference between the two forms of indirect taxation is
the way they are collected.
A sales tax is collected at the end of the product cycle or at the final stage of deliv-
ery of the goods or services. When an item is purchased at a retail store, it represents
a final purchase by the consumer, and a one-time tax is imposed on the purchase. In
the United States, sales tax is collected at the state and county levels. During the pro-
duction of the goods, no taxes are collected. At each stage of the production process,
the seller is exempt from collecting taxes as long as it is clear that the purchases are
intended for resale. In the United States, this can be achieved by requesting a resale
certificate from the purchaser.
In the case of VAT, taxes are collected at every stage of the production process
as well as from the final customer. The amount of tax collected depends on the net
added value at each stage of production. The amount of tax collected at the end under
both tax systems, VAT and sales tax, is the same. An example below highlights the
differences in these two taxes.
Example
Assume that the manufacture and sale of a small toaster oven passes through three
stages.
1. Stage 1 occurs at a steel fabricator that sells steel sheets to a toaster manu-
facturer at a price of US$5 per toaster.
2. Stage 2 is the assembly of the toaster using the steel sheets and other materi-
als; the toaster is then shipped to Wal-Mart at a price of US$15.
3. Wal-Mart sells the toaster to a customer at a price of US$20.
Assume one country imposes a VAT at the rate of 5 percent and another country
imposes a sales tax of 5 percent.
In the case of the country with sales tax:
1. The steel fabricator invoices US$5 to the toaster manufacturer and does not
charge any tax but requests a resale certificate.
2. The toaster manufacturer charges Wal-Mart US$15 and does not charge any
sales tax but requests a resale certificate. The net profit for the toaster manu-
facturer is US$10.
3. Wal-Mart charges the customer US$20 plus a sales tax of 5 percent. The cus-
tomer pays a total of US$20 + US$1 tax. Wal-Mart remits US$1 to the state
taxing authority. The net profit for Wal-Mart is US$5 (US$20–US$15).
372 CHApTER 14
In the case of the country with VAT:
1. The steel fabricator charges US$5 to the toaster manufacturer and 5 percent
VAT equal to US$0.25, and remits US$0.25 to federal taxing authority. The
net proceeds for the steel fabricator are US$5, while the cost to the toaster
manufacturer is US$5.25.
2. The toaster manufacturer charges Wal-Mart US$15 plus VAT of US$15 × .05
= US$0.75. The toaster manufacturer remits only US$0.50 (US$0.75–US$0.25
paid earlier) to the federal taxing authority. The net proceeds for the toaster
manufacturer are US$10 (US$15.75–US$5.25–US$0.50). The cost to Wal-
Mart is US$15.75.
3. Wal-Mart charges the customer US$20 plus VAT of US$20 × .05 = US$21.
Wal-Mart remits US$0.25 (US$1.00–US$0.75) to the federal taxing authority.
The net proceeds for Wal-Mart are US$5 (US$21–US$15.75–US$0.25).
As shown above, the total proceeds under the VAT and sales tax regimes are the
same. The total proceeds received by the taxing authority are also the same. The only
difference is in the collection process, where every manufacturer at each stage of the
production process has to make payments to the taxing authority.
GLOBAL TAXES
The assorted taxes described above—corporate, withholding, and indirect—vary
significantly around the globe. The trend toward globalization has led to significant
changes in taxation policies around the world.
The biggest change has been the lowering of taxes throughout the world. One
reason for the decline has been the desire of many countries to lure foreign direct
investment. This is especially true for emerging market countries.
Within countries in a regional bloc, there has been a tendency toward convergence
and harmonization of taxes. An example is the European Union, where directives are
being issued to level the playing field and work toward a common taxation policy.
The Andean pact countries of Bolivia, Columbia, Ecuador, and Peru agreed in 2004
to a common VAT, but it has yet to be implemented.18 The Mercosur bloc countries
of Argentina, Brazil, Paraguay, and Uruguay are also attempting to harmonize their
taxation policies.
One concern that was highlighted in a 2007 KPMG report is that countries may
lower corporate taxes to lure businesses but increase indirect taxes to offset the loss
in revenues. Critics point out that this amounts to a consumption tax, which affects
the poor more than the rich. Unfortunately, it is difficult to measure the costs and
benefits of such an approach; attracting business does increase employment, which
in turn generates more jobs and tax revenue, and this has to be evaluated against the
burdens imposed by the increases in indirect taxes.
Appendix 14.2 lists the corporate taxes for 2005 to 2007 and indirect taxes for
2007 for 103 countries, as compiled by KPMG.19 Europe as a bloc in 2008 has one
of the lowest corporate tax rates, averaging about 24 percent, with Bulgaria having
the lowest at 10 percent, followed by Romania and Hungary at 16 percent. The high-
est tax rate in Europe is Germany’s, at 38.36 percent. In contrast the U.S. corporate
tax averages 40 percent, and Japan’s averages 40.69 percent, making them the two
highest in the world.
As Appendix 14.2 (pp. 380–381) shows, corporate taxes in Asia have also been
reduced in the recent past. India has reduced its taxes to 34 percent, South Korea to
27.4 percent, and Fiji to 31 percent. Singapore and Taiwan continue to offer the lowest
corporate taxes at 20 percent and 25 percent, respectively. Bahrain and the Cayman
Islands have no corporate or personal taxes, although Bahrain imposes some taxes for
those engaged in the mining and extraction industries. The next lowest are in Paraguay,
Bulgaria, and Cyprus at 10 percent, followed by Macau and Oman at 12 percent.
CHApTER SUMMARY
A country’s accounting rules determine how its financial reports are prepared for
record keeping, for internal management, and to satisfy the tax authorities. For com-
panies that are publicly traded, financial reports have to be accurate, transparent, and
meaningful for outside shareholders and creditors so they can evaluate the company’s
performance. When a company conducts business internationally, the record-keeping
procedure has to include transactions that are denominated in another currency. If a
company has subsidiaries abroad, the complexities increase because income state-
ments and balance sheets denominated in several currencies have to be consolidated
into one grand income statement and balance sheet.
The most challenging aspect of international accounting is consolidating the income
statements and balance sheets of the various overseas subsidiaries. Not only do accoun-
tants have to worry about incorporating exchange rates but they must also reconcile the
various accounting standards. The problem with reconciliation is that there are many
approaches to consolidating balance sheets. Among the more common approaches are
the temporal method and the current method. Most countries now use the temporal ap-
proach when consolidating the balance sheets of various subsidiaries.
The trend toward globalization has led to the creation of International Financial
Reporting Standards (IFRS), coordinated by the International Accounting Standards
Board. Although the first push for a global accounting standard began as early as 1973,
it was not until 2002, when the European Union mandated that companies adopt IFRS,
that the movement started gathering steam. It has also been helped by the announcement
from the Financial Accounting Standards Board (FASB), an independent body that helps
sets U.S. standards, that they too will attempt to converge toward IFRS standards. More
than 100 countries have now signed on to move to the IFRS standards.
International accounting is further complicated by the various taxes imposed by
countries on the profits of firms. Three of the most common taxes are corporate taxes,
withholding taxes, and indirect taxes such as value added tax (VAT) and sales tax.
Multinationals are not concerned about paying taxes on profits they have earned.
However, they are concerned about double taxation. One example of double taxation
is when a U.S. subsidiary pays taxes on the profits it repatriates to the United States.
Most countries have bilateral treaties that eliminate double taxation. They either do not
374 CHApTER 14
tax any of the repatriated profits or they tax them only if the multinational companies
pay lower taxes than a comparable domestic company. This additional tax levels the
playing field so companies conducting business overseas do not have an advantage
over domestic firms.
KEY CONCEpTS
Translation Gain and Losses
International Financial Reporting Standards (IFRS)
Generally Accepted Accounting Principles (GAAP)
Value Added Taxes
1. Why is international accounting more challenging than domestic accounting?
2. Explain how and why accounting for personal taxes of global executives and
staff can become complicated.
3. Assume a U.S. company purchases goods worth €1,500,000 from a Ger-
man company and has to make payment in 60 days. The exchange rate is
US$1.50/€1. When the payment is made 60 days later, the exchange rate is
US$1.25/€1. How would the company record the transaction on the order
date and the payment date?
4. Why is the two-step procedure to record foreign exchange transactions better
than the one-step procedure?
5. The balance sheet of a U.S. company has US$200 million in assets and US$200
million in equity. Its subsidiary in Belgium has assets and equity valued at
€100 million. The exchange rate today is US$1.50/€1. At the end of the year,
the exchange rate changes to US$1.25/€1. Do they report an unrealized loss
or gain, and how much?
6. Explain the current and temporal methods of translating the asset and liabilities
of a subsidiary.
7. What common theme runs through the scandals of Enron, WorldCom, and
Parmalat?
8. Compare principles-based versus rules-based accounting standards for finan-
cial reporting.
9. What is major difference between IFRS and U.S. GAAP? Under which system
is it easier to use loopholes?
10. What benefits may a company obtain if it adopts the IFRS, according to the
OECD report?
11. Distinguish between corporate taxes, withholding taxes, and indirect taxes.
12. What approaches have countries used when taxing the repatriated profits of
companies that conduct business overseas?
13. An aluminum manufacturer sells the equivalent of US$5 per sheet to a manu-
facturer of aluminum trays. The aluminum-tray manufacturer in turn delivers
finished trays to a major retailer for US$10 per tray. The retailer sells it to a final
customer for US$15. If the VAT and sales tax is 6 percent, show how the total
taxes paid to the taxing authorities are the same under both indirect taxes.
AppLiCATiON CASE: THE FANNiE MAE ACCOUNTiNG SCANDAL

The gap between the average salary of a chief executive officer (CEO) and that of a
rank-and-file worker in the United States has been increasing steadily over the years.
A study by the Institute of Policy Studies in Washington, D.C., estimated that the
gap in total compensation increased from 40 times in 1980 to 364 times in 2007. In
Europe, the gap is estimated at 32 times higher; in Japan, it is 17 times higher. Studies
have also shown that CEO compensation in the United States is unrelated to perfor-
mance; they continue to increase even when profits and share prices decline. One such
executive recently in the news was Rick Wagoner, CEO of General Motors (GM),
who was paid millions of dollars in bonuses beginning in 2000. His compensation in
2006 alone was in excess of $9 million. Two years later, GM was near bankruptcy
and was pleading with the U.S. Congress for a bridge loan. (Wagoner later agreed to
a $1 salary during GM’s restructuring.) What is astonishing is that during the same
period, the top executives of Japanese car companies earned less than $1 million per
year, even as they outperformed GM throughout the globe.
A major portion of executive compensation in the United States is in the form of
stock options. From a shareholder’s point of view, offering stock options is an ef-
fective way to align the interests of the CEO with that of the shareholders; both will
benefit when stock prices are maximized. Unfortunately, a weakness in the model is
that it also encourages CEOs to focus on short-term profits. This is particularly true
when one considers that the average tenure of CEOs in the United States is just five
years. This provides strong incentives to CEOs to postpone critical decisions that can
benefit the company in the long run, such as retooling, replacing, or repairing essential
equipment to accommodate new technology and foster employee productivity.
In some cases, it also encourages CEOs to engage in accounting manipulations.
A large number of corporate scandals in recent years have been the result of ac-
counting manipulations that inflate earnings in order to boost share prices. A recent
example was the case of Fannie Mae, one of the institutions that played a major role
in the collapse of the financial markets in 2008. Fannie Mae was created in 1938
as the Federal National Mortgage Association by the U.S. government. Its mission
was two-fold: to encourage home ownership by making funds available to mortgage
lenders, and to purchase mortgages from banks. Privatized in 1968 with an implicit
backing from the U.S. government, it increased lending successfully over the years
to become one of the largest mortgage institutions in the United States. Fannie Mae’s
efforts allowed U.S. home ownership to reach a record 69 percent of households in
2004, the highest in the world.
Fannie Mae also generated significant profits during this growth period and awarded
large bonuses to their top executives. Franklin Raines, the CEO of Fannie Mae, earned
over $90 million between 1998 and 2003. In 2003, federal regulators began to ques-
tion some of the accounting practices used by Fannie Mae to report their earnings.
An investigation by the accounting firm of PWC (PricewaterhouseCoopers) led to a
376 CHApTER 14
restatement of earnings by about $6.3 billion. A criminal investigation initiated by

the U.S. Department of Justice in 2004 did not find evidence of willful manipulation
of earnings. However, federal regulators decided to press civil charges against the
top management.
In 2008, the top management reached a settlement with the regulators. Franklin
Raines, by this time Fannie Mae’s former CEO, agreed to pay a total of $24.7 million
back, including $2 million in fines; J. Timothy Howard, former chief financial officer,
agreed to pay back $6.4 million; and Leanne Spencer, former controller, agreed to pay
back $645,000. Fannie Mae also paid $400 million in fines as part of the settlement
for misstating the revenues.
Financial misreporting was one issue, but the other was the quality of decisions
made by the executives to deserve such large bonuses. In the third quarter of 2008,
Fannie Mae reported losses of $29.1 billion. This single quarter loss exceeded the
total profits of $28.1 billion earned between 2002 and 2006. It is now apparent that the
millions of dollars earned in bonuses between 1995 and 2006 ignored the high risks
incurred by Fannie Mae. These risks were finally realized in 2007 and 2008, when
loan after loan began to default in a cascading manner. This is yet another example
of executives making decisions that trigger far-reaching, catastrophic effects on a
company well after their tenure is over.
How did Fannie Mae underestimate the risks and quality of the mortgages they
purchased from the various banks? Mortgages are originally written by banks, but
they are supposed to follow the strict guidelines issued by Fannie Mae. If Fannie
Mae had checked the documents carefully prior to their purchase, they would have
found evidence of paperwork that indicated incorrect or forged statements. Did the
executives foster a culture that ignored their own strict risk management guidelines?
These are questions yet to be answered. What we do know is that, in the end, the lack
of effective oversight led Fannie and its sister institution, Freddie Mac, to become
insolvent, forcing the U.S. government to nationalize both institutions. Taxpayers
ended up paying for the mismanagement of executives who had left the company
years earlier.
QUESTIONS
1. What are some of the unique characteristics of executive compensation in the
United States?
2. What suggestions can you offer to ensure that CEOs who collect multimillion-
dollar bonuses make the right long-term decisions for a company?
Appendix 14.1
Summary of Some Similarities and Differences between IFRS and U.S. GAAP
Subject IFRS US GAAP

Accounting framework
Historical cost or valuation Generally uses historical cost, but intan- No revaluations except for certain types
gible assets, property, plant and equip- of financial instrument.
ment (PPE) and investment property
may be revalued to fair value. Deriva-
tives, certain other financial instruments
and biological assets are revalued to
fair value.
Financial statements
Components of financial state- Two years’ balance sheets, income Similar to IFRS, except three years
ments statements, cash flow statements, required for SEC registrants for all
changes in equity and accounting poli- statements except balance sheet.
cies and notes. Specific accommodations in certain cir-
cumstances for foreign private issuers
that may offer relief from the three-year
requirement.
Balance sheet Does not prescribe a particular format. Entities may present either a classified
A current/non-current presentation of or nonclassified balance sheet. Items
assets and liabilities is used unless a on the face of the balance sheet are
liquidity presentation provides more rel- generally presented in decreasing order
evant and reliable information. Certain of liquidity. SEC registrants should fol-
minimum items are presented on the low SEC regulations.
face of the balance sheet.
Income statement Does not prescribe a standard format, Present as either a single-step or
although expenditure is presented in multiple-step format. Expenditures are
one of two formats (function or nature). presented by function. SEC registrants
Certain minimum items are presented should follow SEC regulations.
on the face of the income statement.
Consolidated financial statements

Consolidation model Based on control, which is the power A bipolar consolidation model is used,
to govern the financial, and operating which distinguishes between a variable
policies. Control is presumed to exist interest model and a voting interest
when parent owns, directly or indirectly model. The variable interest model is
through subsidiaries, more than one discussed below. Under the voting inter-
half of an entity’s voting power. Control est model, control can be direct or indi-
also exists when the parent owns half rect and may exist with less than 50%
or less of the voting power but has ownership. “Effective control,” which is a
legal or contractual rights to control, or similar notion to de facto control under
de facto control (rare circumstances). IFRS, is very rare if ever employed in
The existence of currently exercisable practice.
potential voting rights is also taken into
consideration.
Presentation of jointly controlled Both proportional consolidation and Equity method required except in spe-
entities (joint ventures) equity method permitted. cific circumstances.
(continued)
378 CHApTER 14
Appendix 14.1 (continued)
Subject IFRS US GAAP

Business combinations
Types: Acquisitions or mergers All business combinations are acquisi- Similar to IFRS.
tions; thus the purchase method is
the only method of accounting that is
allowed.
Purchase method—fair Assets, liabilities, and contingent liabili- There are specific differences to IFRS.
values on acquisition ties of acquired entity are fair valued. Contingent liabilities of the acquiree
Goodwill is recognized as the residual are recognized if, by the end of the al-
between the consideration paid and the location period: • their fair value can be
percentage of the fair value of the busi- determined, or • they are probable and
ness acquired. In-process research and can be reasonably estimated. Spe-
development is generally capitalized. cific rules exist for acquired in-process
Liabilities for restructuring activities are research and development (generally
recognized only when acquiree has an expensed). Some restructuring liabilities
existing liability at acquisition date. Li- relating solely to the acquired entity
abilities for future losses or other costs may be recognized if specific criteria
expected to be incurred as a result of about restructuring plans are met.
the business combination cannot be
recognized.
Purchase method—intangible Capitalized but not amortized. Goodwill Similar to IFRS, although the level of
assets with indefinite useful and indefinite-lived intangible assets are impairment testing and the impairment
lives and goodwill tested for impairment at least annually test itself are different.
at either the cash-generating unit (CGU)
level or groups of CGUs, as applicable.
Business combinations involving Not specifically addressed. Entities Generally recorded at predecessor cost;
entities under common control elect and consistently apply either pur- the use of predecessor cost or fair value
chase or pooling-of-interest accounting depends on a number of criteria.
for all such transactions.
Revenue recognition
Revenue recognition Based on several criteria, which require Similar to IFRS in principle, although
the recognition of revenue when risks there is extensive detailed guidance for
and rewards and control have been specific types of transactions that may
transferred and the revenue can be lead to differences in practice.
measured reliably.
Expense recognition
Interest expense Recognized on an accruals basis Similar to IFRS.
using the effective interest method.
Interest incurred on borrowings to con- Similar to IFRS with some differences in
struct an asset over a substantial the detailed application.
period of time are capitalized as
part of the cost of the asset.
Assets
Property, plant and equipment Historical cost or revalued amounts Historical cost is used; revaluations are
are used. Regular valuations of entire not permitted.
classes of assets are required when
revaluation option is chosen.
Inventories Carried at lower of cost and net realiz- Similar to IFRS; however, use of LIFO
able value. FIFO or weighted average is permitted. Reversal of write-down is
method is used to determine cost. LIFO prohibited.
prohibited. Reversal is required for sub-
sequent increase in value of previous
write-downs.
Financial assets—measurement Depends on classification of invest- Similar accounting model to IFRS, with
ment—if held to maturity or loans some detailed differences in application.
and receivables, they are carried at
amortized cost; otherwise at fair value.
Gains/losses on fair value through profit
or loss classification (including trading
instruments) is recognized in income
statement. Gains and losses on avail-
able for-sale investments, while the
investments are still held,
are recognized in equity.
Liabilities
Provisions—general Liabilities relating to present obligations Similar to IFRS. However, probable is a
from past events recorded if outflow of higher threshold than “more likely than
resources is probable (defined as more not.”
likely than not) and can be
reliably estimated.
Financial liabilities versus equity Capital instruments are classified, Application of the U.S. GAAP guidance
classification depending on substance of issuer’s may result in significant differences to
contractual obligations, as either IFRS, for example, certain redeemable
liability or equity. Mandatory instruments are permitted to be classi-
redeemable preference shares fied as “mezzanine equity” (i.e., outside
are classified as liabilities. of permanent equity but also separate
from debt).
Equity instruments
Capital instruments—purchase Show as deduction from equity. Similar to IFRS.
of own shares
Derivatives and hedging

Derivatives Derivatives not qualifying for hedge Similar to IFRS. However, differences
accounting are measured at fair value can arise in the detailed application.
with changes in fair value recognized in
the income statement. Hedge account-
ing is permitted provided that certain
stringent qualifying criteria are met.
Other accounting and

reporting topics
Functional currency definition Currency of primary economic environ- Similar to IFRS.
ment in which entity operates.
Source: Published by PriceWaterhouseCoopers, October 2007.

380 CHApTER 14
Appendix 14.2
Global Corporate and Indirect Taxes, 2007 (in percent)
Corporate Tax VAT or GST

Country Jan. 1, 2005 Jan. 1, 2006 Jan. 1, 2007 Jan. 1, 2007
Albania 23 20 20 20
Argentina 33 21
Aruba 35 35 28 3
Australia 30 30 30 10
Austria 25 25 25 20
Bahrain 0 0
Bangladesh 30 30 30 15
Barbados 30 25 25 15
Belgium 33.99 33.99 33.99 21
Belize
Bolivia 25 25 25 13
Bosnia & Herzegovina 17
Botswana 25 25 25 10
Brazil 34 34 34 Vary
Bulgaria 15 15 10 20
Canada 36.1 36.1 36.1 6
Cayman Islands 0 0 0
Chile 17 17 17 19
China 33 33 33 17
Colombia 35 35 34 16
Costa Rica 30 30 30 13
Croatia 20.32 20.32 20 22
Cyprus 10 10 10 15
Czech Republic 26 24 24 19
Denmark 28 28 28 25
Dominican Republic 25 30 29 16
Ecuador 25 25 25 12
Egypt 20 20 10
El Salvador
Estonia 24 23 22 18
Fiji 31 31 31 12.5
Finland 26 26 26 22
France 33.83 33.33 33.33 19.6
Germany 38.31 38.34 38.36 19
Greece 32 29 25 19
Guatemala 12
Honduras 30 30 30 12
Hong Kong 17.5 17.5 17.5 0
Hungary 16 16 16 20
Iceland 18 18 18 24.5
India 36.5925 33.66 33.99 12.5
Indonesia 30 30 30 10
Ireland 12.5 12.5 12.5 21
Israel 34 31 29 15.5
Italy 37.25 37.25 37.25 20
Jamaica 33.33 33.33 33.33 16.5
Japan 40.69 40.69 40.69 5
Kazakhstan 30 30 30 14
Korea, Republic of 27.5 27.5 27.4 10
(continued)
Appendix 14.2 (continued)
Corporate Tax VAT or GST

Country Jan. 1, 2005 Jan. 1, 2006 Jan. 1, 2007 Jan. 1, 2007
Kuwait 55
Latvia 15 15 15 18
Lithuania 15 15 15 18
Luxembourg 30.38 29.63 29.63 15
Macau 12 12 12 0
Malaysia 28 28 27 10
Malta 35 35 35 18
Mauritius 25 25 22.5 15
Mexico 30 29 28 15
Montenegro 17
Mozambique 32 32 32 17
Netherlands 31.5 29.6 25.5 19
Netherlands Antilles 34.5 34.5 34.5 3–5
New Zealand 33 33 33 12.5
Norway 28 28 28 25
Oman 12 12 12 0
Pakistan 35 35 35 15
Panama 30 30 30 5
Papua New Guinea 30 30 30 10
Paraguay 10 10
Peru 30 30 30 17
Philippines 32 35 35 12
Poland 19 19 19 22
Portugal 27.5 27.5 25 21
Qatar 35
Romania 16 16 16 19
Russia 24 24 24 18
Saudi Arabia 20 20 0
Serbia 18
Singapore 20 20 20 5
Slovak Republic 19 19 19
Slovenia 25 25 23 20
South Africa 37.8 36.9 36.9 14
Spain 35 35 32.5 16
Sri Lanka 32.5 32.5 35 15
Sweden 28 28 28 25
Switzerland 21.3 21.3 21.3 7.6
Taiwan 25 25 25 5
Thailand 30 30 30 7
Tunisia 35 35 30 18
Turkey 30 30 20 18
Ukraine 25 25 25 20
United Arab Emirates 55 55 55 0
United Kingdom 30 30 30 17.5
United States 40 40 40 Vary by state
Uruguay 30 30 30 23
Venezuela 34 34 34 11
Vietnam 28 28 28 10
Zambia 35 35 35 17.5
Source: KPMG.
Appendix 1
Regional Economic Integrations
Regional economic integrations are efforts by groups of countries to assist one another
in attaining economic and political stability. Most regional economic integrations
are formed among countries that are geographically close (within the same region).
Geographic proximity is a sound basis for these agreements for the following rea-
sons: the people in these countries may have similar consumption habits; they may
share a common history; and because of their proximity, they may also benefit from
shorter distances traveled in the distribution of goods and services. The impetus to
form economic cooperation among countries came about after the devastation of
World War II, which economically crippled most of the Asian and European coun-
tries. Basically, regional economic integration is a political and economic agreement
among countries that give preferences in trade and economic cooperation to member
countries with the aim to assist one another through cooperation and collective ef-
forts. For international and global companies, these regional agreements provide an
opportunity to serve a large market base. For example, the European Union is made
up of 500 million consumers, whereas the number of consumers in a single country
in Europe does not exceed 83 million.
Regional economic integrations vary in scope, and each type of integration focuses
on specific economic and trade aspects of the member countries. The four forms of
integrations are:
1. Free trade area

2. Customs union
3. Common market
4. Economic union
Table A1.1 presents the four different types of integrations and their key differences.
As evident from the table, forming a free trade area is much simpler than forming an
economic union. As countries move from free trade agreements to an economic union,
the level of integration becomes progressively more comprehensive and complete.
In a free trade area, the member countries agree on just one condition—removal of
internal tariffs. In contrast, in an economic union, in addition to removing tariffs,
member countries also agree on common tariffs with the rest of the world, permit free
mobility of production factors, and harmonize their economies, including agreeing to
382
REGIONAL EcONOMIc INTEGRATIONS 383
Table A1.1
Distinctions among Types of Economic Integration
Type of Integration Conditions Examples

Free trade area Free trade among member countries North American Free Trade Agreement
Each country has individual trade ar- (NAFTA); member countries include
rangements with the rest of the world Canada, Mexico, and the United States
Customs union Free trade among member countries Mercosur; member countries include
Member countries have common Argentina, Brazil, Paraguay, and
external tariffs with the rest of the world Uruguay; a common external tariff has
been adopted, and Mercosur is on its
way to becoming a customs union
Common market Free trade among member countries Although there are many unions with
Member countries have common the term “common market” in them,
external tariffs with the rest of the world such as the Common Market for East-
ern and Southern Africa (COMESA)
Free mobility of production factors such and the Common Market of the South
as labor and capital (Mercosur), these organizations have
yet to attain the goals of a common
market. The only successful common
market was the European Common
Market, the predecessor of the Euro-
pean Union (EU)
Economic union Free trade among member countries European Union (EU); member coun-
Member countries have common tries include Austria, Belgium, Britain,
external tariffs with the rest of the world Cyprus, Czech Republic, Denmark,
Estonia, Finland, France, Germany,
Free mobility of production factors such Greece, Hungary, Ireland, Italy, Latvia,
as labor and capital Lithuania, Luxembourg, Malta, Neth-
Adoption of common economic policies erlands, Poland, Portugal, Slovakia,
including common currency and the es- Slovenia, Spain, and Sweden
tablishment of a common central bank
have a single currency. It is much easier to form a free trade area than an economic
union; hence, there is only one economic union in existence.
BENEfiTS Of INTEGRATiON
Theoretically, regional integrations benefit member countries through improved ex-
changes in cultural and social activities, a better understanding of each member’s political
system, and achievement of economic growth. From an economic standpoint, the three
benefits of integration are: (1) trade creation, (2) trade diversion, and (3) economies of
scale. Trade creation and trade diversion are called the “static effects” of integration,
and economies of scale are referred to as the “dynamic effects” of integration.
TRADE CREATION
Regional integration forces the shifting of resources from inefficient companies to
companies that are more efficient. Efficient companies, with their cost advantage,
are able to market goods and services at much lower prices than unproductive ones.
384 AppENDIX 1
As more and more consumers buy goods and services from efficient companies, the
inefficient companies lose market share and are either forced to improve or leave the
industry. Because of the removal of trade barriers, efficient companies from other
countries that could not have competed before the integration are able to export goods
and services and compete for market share.
TRADE DIVERSION
Because of regional integration, trade shifts from nonmember countries to member
countries. This shift helps member countries to have more trade between them than
they did before integration.
EcONOMIES OF ScALE
Because of trade creation and trade diversion, the size of the market within the member
countries grows substantially, reducing the cost of production for companies within
the group through economies of scale.
ACTiViTiES AND OpERATiONS Of NAFTA AND THE EUROpEAN UNiON

Two of the most successful regional integrations are NAFTA, a free trade agreement
among Canada, Mexico, and the United States, and the European Union (EU) made
up of 25 European countries. Following is a brief description of the activities and
operations of NAFTA and the European Union.
THE NORTH AMERIcAN FREE TRADE AGREEMENT

The North American Free Trade Agreement (NAFTA) is a regional agreement among
the governments of Canada, Mexico, and the United States. The objectives of this
agreement are stated in Article 102 of the agreement, as follows:
1. Eliminate barriers to trade in, and facilitate the cross-border movement of

goods and services between, the territories of the Parties.
2. Promote conditions of fair competition in the free trade area.
3. Increase substantially investment opportunities in the territories of the Parties.
4. Provide adequate and effective protection and enforcement of intellectual
property rights in each Party’s territory.
5. Create effective procedures for the implementation and application of this
Agreement, for its joint administration and for the resolution of disputes; and
6. Establish a framework for further trilateral, regional, and multilateral coop-
eration to expand and enhance the benefits of this Agreement.
In June 1990, President Carlos Salinas de Gortari of Mexico and President George
Bush of the United States announced their intention to negotiate a free trade agree-
ment between their countries. The next year, Canada joined the process, and in June
1991, formal negotiations began among the three countries on a North American
Free Trade Agreement.1 The proposed agreement was negotiated in the midst of a
recession in the United States. The initial reaction from some sectors of the U.S.
economy, including labor organizations and the environmentalist movement, was
very negative to the proposed agreement. Organized labor argued that NAFTA
would result in hundreds of U.S. companies relocating to Mexico to take advantage
of cheap labor, which would result in a loss of jobs in the United States. At the
same time, corporate America and its leaders supported the agreement because of
the potential lower production costs that would be derived through the agreement.
After a lengthy debate, the U.S Congress approved the treaty in November 1993.
On January 1, 1994, the North American Free Trade Agreement was activated by
Canada, Mexico, and the United States.
After the inauguration of U.S. president Bill Clinton, he proposed side arrangements
to the NAFTA which resulted in the formation of the North American Agreement
on Environmental Cooperation (NAAEC), the North American Development Bank
(NADB), the Border Environmental Cooperation Commission (BECC), and the North
American Agreement on Labor Cooperation (NAALC). Through its Commission for
Environmental Cooperation, the NAAEC was formed in response to environmentalists’
concerns that the United States would lower its pollution and emissions standards if
the three countries did not achieve consistent environmental regulation. The NADB
was organized for financing investments to reduce pollution in the region. The BECC
and the NADB are programs for funding specific projects that elevate environmental
problems, especially those affecting water resources. The North American Agreement
on Labor Cooperation (NAALC) was formed to resolve labor problems and to foster
greater cooperation among labor unions within the member countries.
NAFTA went into effect on January 1, 1994. The implementation of NAFTA super-
seded the U.S.–Canada Free Trade Agreement (FTA), signed by the two countries on
January 1, 1989. Since its implementation, NAFTA has been examined many times
to determine whether it has achieved its stated objectives. Research on the success
of NAFTA has focused on four critical issues: economic growth, employment rates,
FDI flows, and impact on the environment.
Many researchers who have studied NAFTA feel that the overall results of the
agreement have been positive.2 Economic growth has been achieved by the intensified
competition in domestic markets and at the same time the agreement has promoted
investment from both domestic and foreign sources. The increased competition has
led U.S. companies to operate more efficiently. Prior to the recession of 2008, the
economies of Canada and the United States have performed well during the NAFTA
era, growing by an average annual rate of 3.3 percent and 3.6 percent, respectively.3
However, Mexico’s economy grew at an annual rate of only 2.7 percent between
1994 and 2003. This rate is considered to be well below Mexico’s potential growth,
despite its sharp recession after the 1995 peso crisis.
In the area of trade, NAFTA seems to have benefited the member countries. U.S.
trade with Mexico substantially increased after NAFTA, especially in vehicles,
machinery, and steel and iron. The agreement has also increased trade between the
countries more rapidly than between these two countries and the rest of the world.
386 AppENDIX 1
In terms of the volume of trade, Mexico seems to have gained more than the United
States has.4 In 1998, Mexico replaced Japan as America’s second-largest trading
partner. The U.S.–Mexico Chamber of Commerce reported that trade between the
two countries doubled between 1993 and 1997, increasing from US$80 billion to
US$160 billion a year. NAFTA seems to have had positive results on the flows of
goods, capital, and labor.5
According to the Office of the U.S. Trade Representative web site, in the first de-
cade of NAFTA, U.S. manufacturing output soared, U.S. employment grew, and U.S.
manufacturing wages increased dramatically. Income gains and tax cuts from NAFTA
were worth up to US$930 each year for the average U.S. household of four. Wages
in export-related industries of Mexico were 37 percent higher than in the rest of its
economy. Mexican wages and employment tend to be higher in states with higher
foreign investment and trade, and migration from those states is lower. Wages are also
higher in sectors with more exposure to imports or exports. Two-way agricultural trade
between the United States and Mexico increased more than 125 percent since NAFTA
went into effect, reaching US$14.2 billion in 2003 compared to US$6.2 billion in 1993.
Merchandise exports from Canada to the United States increased by 250 percent since
1989 and account for 87.2 percent of Canada’s total merchandise exports. Foreign
direct investment (FDI) from Canada into Mexico has also shown dramatic increases,
especially in the financial sector, accounting for 36 percent of Canadian FDI in Mexico
in 2001, compared to no measurable investments in this sector just a few years back.
This trend continued until early 2007, just before the economic crisis.
NAFTA has also had some negative effects on the three countries.6 Although
NAFTA succeeded in its core goal of removing trade and investment barriers, it was
not as successful in decreasing unemployment and increasing wages. Although the
figures for all three countries improved in the initial post-NAFTA years, they did not
reach the levels that were forecast when the agreement was first proposed. Also, it
is not clear whether these increases were the result of the agreement or simply time-
related growth. Between 1993 and 2007, U.S. employment rose from 110 million to
137 million,7 in Canada it grew from 12.9 million to 16.9 million,8 and in Mexico,
jobs increased from 32.8 million to 40.6 million.9 However, some researchers have
argued that NAFTA has had only a small impact on these numbers, since this growth
was the normal growth expected over time.
The member countries are also concerned about environmental issues. The Mexican
government estimates that pollution damages since the mid-1990s have exceeded $36
billion per year.10 According to some estimates, NAFTA might have directly contrib-
uted to about a 2 percent increase in annual gross emissions of carbon monoxide and
sulfur dioxide. In addition, the free trade agreement has increased the air pollution
levels at the border between Mexico and the United States because of the increased
truck traffic used for hauling goods from Mexico to countries up north. NAFTA has
not affected the friendly relationship between Canada and the United States. Although
from time to time there have been some disagreements on specific issues, in general
they have been settled quickly. For example, the Canada–U.S. softwood lumber
dispute has been raised on and off for about a quarter century.11 It has gone through
four rounds, the last two with the FTA/NAFTA in place. When the U.S. Congress
demanded a 15 percent duty on Canadian lumber exports, Canada challenged them

at the multilateral trade body, GATT. However, the pressure of negatively affecting
the free trade relations pushed Canada into opting for a settlement that replaced the
U.S. duty with a 15 percent Canadian lumber export tax.
Through the efforts of the NAAEC, all three countries have benefited from coor-
dination and cooperation, which is increasing the effectiveness of North American
conservation efforts by:
• Developing common priorities for the protection of certain species

• Developing North American Conservation Action Plans for three shared
marine species
• Providing tools, such as a map of terrestrial ecoregions, which management
agencies are using in their programs
• Setting out common mechanisms for planning and monitoring bird conserva-
tion programs
In conclusion, the primary focus of NAFTA was to reduce barriers to investment

and trade, and it has succeeded in that goal. The agreement brought the continent
closer to a free trade, which improved the quality of life in North America. Although
the objectives have not all been reached, the agreement has worked for all three
countries in terms of being a building block for future agreements.
THE EUROpEAN UNION

The largest and most comprehensive of the regional integrations is the European
Union.12 Although the EU was formed in January 1993, its creation was preceded
by modest integration efforts among some of the European countries dating back to
the 1950s.
In 1950, Robert Schuman—the chief architect of the European Unity and then-
French foreign minister—proposed integrating the coal and steel industries of
Western Europe. Schuman’s idea was inspired by the work of French-born European
integrationist Jean Monnet. Because energy and steel production were two com-
ponents essential for economic success, Schuman reasoned that it was important
to establish a mechanism of collective cooperation among countries to solve some
of the endemic problems associated with these industries. As a result, in 1951, the
European Coal and Steel Community (ECSC) was set up to include Belgium, West
Germany, Luxembourg, France, Italy, and the Netherlands. The power to make de-
cisions about the coal and steel industry in these countries was placed in the hands
of an independent, supranational body called the High Authority. Monnet was its
first president.
Building on the success of ECSC, these same six countries decided to go further
and integrate other sectors of their economies. In 1957, they signed the Treaty of
Rome, creating the European Atomic Energy Community (EURATOM) and the
European Economic Community (EEC). The member states agreed to first remove
trade barriers among them and at a later date to form a common market. In 1967, the
388 AppENDIX 1
institutions of the three European communities—ECSC, EURATOM, and EEC—

were merged, establishing a single commission and a single Council of Ministers as
well as the European Parliament. The European Economic Community was made up
of 12 countries—Austria, Belgium, Denmark, France, Ireland, Italy, Luxembourg,
Norway, Portugal, Spain, Sweden, and the United Kingdom. The EEC member
countries agreed to:
• Eliminate all trade barriers between members

• Establish a common external tariff
• Introduce a common agricultural and transport policy
• Create a European Social Fund
• Establish a European Investment Bank
• Develop closer relations between member countries
The Treaty of Maastricht (1992) creating the European Union added new forms
of cooperation among the member states, including the introduction of a single Eu-
ropean currency managed by a European Central Bank. The single currency—the
euro—became a reality on January 1, 2002, when euro notes and coins replaced
national currencies in 12 of the 15 countries of the European Union: Belgium, Ger-
many, Greece, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria,
Portugal, and Finland.
The European Union has grown in size from its first attempt at a regional integra-
tion with six European countries to its present membership of 25 countries. Denmark,
Ireland, and the United Kingdom joined the original six countries in 1973, followed
by Greece in 1981, Spain and Portugal in 1986, and Austria, Finland, and Sweden
in 1995. The membership totaled 25 after 10 new countries joined the European
Union in 2004: these 10 new countries include Cyprus, the Czech Republic, Estonia,
Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia. Bulgaria and Ro-
mania followed in 2007. Croatia and Turkey are in the process of becoming member
states, but they have yet to be approved by the European Parliament. To ensure that
the expanded European Union can continue to function efficiently, it needs a more
streamlined system for making decisions. That is why the Treaty of Nice lays down
new rules governing the size of the EU institutions and the ways in which they work.
The treaty went into effect on February 1, 2003, but was replaced three years later
by the new EU Constitution.
The countries that make up the European Union (its “member states”) remain inde-
pendent sovereign nations, but they pool their sovereignty in order to gain a strength
and world influence none of them could have on their own. Pooling sovereignty
means, in practice, that the member states delegate some of their decision-making
powers to shared institutions they have created, so that decisions on specific matters
of joint interest can be made democratically at the European level.
The European Union is composed of the European Parliament, the Council of
the European Union, and the European Commission as the decision-making bod-
ies; the Court of Justice and the Court of Auditors as the other main institutions;
the European Economic and Social Committee and the Committee of the Regions
Figure A1.1 The European Union
THE EUROPEAN
UNION (E U)
Main decision-making bodies European Union’s executive body
EUROPEA N COUNCIL OF THE EUROPEA N

PARLIAMENT EUROPEA N UNION* COMMISSION**
732 Members
COURT OF JUSTICE COURT OF

25 Judges AUDITORS
25 Members
Ensures that the EU member Ensures that EU funds are

states and institutions do what collected properly and spent
the law requires; has the legally, economically, and for
power to settle legal disputes the intended purpose; has the
power to audit any person or
organization handling EU
funds.
*The council is made up of the ministers of the member states.

**The commission is independent of national governments. It represents and upholds the interests of the
European Union as a whole.
as the consultative bodies; and the European Central Bank and the European
Investment Bank as the financial bodies. (See Figure A1.1). In addition, specific
institutions have the responsibility for managing some of the key agencies, in-
cluding the European Ombudsman, the European Data Protection Supervisor, the
Office for Official Publications of the European Communities, and the European
Communities Personnel Selection Office.
The European Parliament
The European Parliament (EP) is elected every five years by the citizens of the Euro-
pean Union to represent their interests. Its origins go back to the 1950s and the found-
ing treaties, and since 1979 its members have been directly elected by the people they
represent. The present parliament, elected in June 2004, has 732 members from all
25 EU countries. Nearly one-third of the members (222) are women. Members of the
European Parliament (MEPs) do not sit in national blocs, but in seven European-wide
political groups. Among them, they represent all views on European integration, from
the strongly pro-Federalist to the openly Eurosceptic. In 2007, Hans-Gert Pöttering
was elected president of the European Parliament.
The European Parliament has its offices in Brussels, Belgium; Luxembourg;
and Strasbourg, France. Luxembourg is home to the administrative offices, the
390 AppENDIX 1
General Secretariat. Parliamentary meetings, called “plenary sessions,” take place

in Strasbourg and sometimes in Brussels. Committee meetings are also held in
Brussels.
The European Parliament has three main roles:
1. Passing Laws. The most common procedure for adopting (that is, passing) EU
legislation is codecision. This procedure places the European Parliament and
the Council of the European Union on equal footing and applies to legislation
in a wide range of fields. In some fields, including agriculture, economic policy,
visas, and immigration, the council alone legislates through consultations with
the parliament. However, the parliament’s assent is required for certain im-
portant decisions, such as allowing new countries to join the European Union.
The parliament also initiates new legislation for the European Union.
2. Democratic Supervision. The parliament exercises democratic supervision over

the other European institutions in several ways. When a new commission takes
office, its members are nominated by the EU member-state governments, but they
cannot be appointed without the parliament’s approval. The parliament interviews
each nominee individually, including the prospective commission president, and
then votes on whether to approve the commission as a whole. Throughout its term
of office, the commission remains politically accountable to the parliament, which
can pass a “motion of censure” calling for the commission’s mass resignation.
More generally, the parliament exercises control by regularly examining
reports sent to it by the commission. These reports include the annual general
report and reports on the implementation of the budget. Moreover, MEPs
regularly ask the commission questions about their operations that the com-
missioners are legally required to answer.
The parliament also monitors the work of the council: MEPs frequently ask
questions of the council, and the president of the council attends the parlia-
ment’s plenary sessions and takes part in important debates. The parliament
can exercise further democratic control by examining petitions from citizens
and setting up committees of inquiry.
Finally, the parliament provides input at every EU summit (the European
Council meetings). At the opening of each summit, the president of the parlia-
ment is invited to express the parliament’s views and concerns about topical
issues and the items on the European Council’s agenda.
3. The Power of the Purse. The European Union’s annual budget is decided
jointly by the parliament and the Council of the European Union. The parlia-
ment debates the budget in two successive readings, and the budget does not
come into force until it has been signed by the president of the parliament.
The parliament’s Committee on Budgetary Control (COCOBU) monitors how
the budget is spent, and each year the parliament decides whether to approve
the commission’s handling of the budget for the previous financial year. This
approval process is technically known as “granting a discharge.”
The Organization of the European Parliament. The parliament’s work is divided into
two main stages:
• Preparing for the plenary session. Preparing for the plenary session is done by the
MEPs in the various parliamentary committees that specialize in particular areas
of EU activity. The issues for debate are also discussed by the political groups.
• The plenary session itself. Plenary sessions are normally held in Strasbourg (one
week per month) and sometimes in Brussels (two days only). At these sessions,
the parliament examines proposed legislation and votes on amendments before
coming to a decision on the text as a whole.
Other items on the agenda may include council or commission “communications,”

or questions about what is going on in the European Union or the wider world.
The Council of the European Union
The council is the European Union’s main decision-making body. Like the European
Parliament, the council was set up by the founding treaties in the 1950s. It represents
the member states, and its meetings are attended by one minister from each of the
EU’s national governments.
The EU’s relations with the rest of the world are dealt with by the General Af-
fairs and External Relations Council (GAERC). The GAERC is responsible for
general policy issues, so its meetings are attended by whichever minister or state
secretary each government chooses. There are nine different GAERC subcommit-
tees or configurations:
1. General Affairs and External Relations

2. Economic and Financial Affairs (ECOFIN)
3. Justice and Home Affairs (JHA)
4. Employment, Social Policy, Health, and Consumer Affairs
5. Competitiveness
6. Transport, Telecommunications, and Energy
7. Agriculture and Fisheries
8. Environment
9. Education, Youth, and Culture
Each minister in the council is empowered to commit his or her government. More-
over, each minister in the council is answerable to his or her national parliament and
to the citizens that the parliament represents. This ensures the democratic legitimacy
of the council’s decisions.
Up to four times a year, the presidents and/or prime ministers of the member states,
together with the president of the European Commission, meet as the “European
Council.” These summit meetings set overall EU policy and resolve issues that could
not be settled at a lower level, that is, by the ministers at normal council meetings.
The European Council has six key responsibilities:
392 AppENDIX 1
1. Legislation. Much of EU legislation is adopted jointly by the council and the

parliament. As a rule, the council acts only on a proposal from the commis-
sion, and the commission normally has responsibility for ensuring that EU
legislation, once adopted, is correctly applied.
2. Coordination of the policies of member states. The EU countries have de-
cided that they want an overall economic policy based on close coordination
of their national economic policies. Such coordination is carried out by the
economics and finance ministers, who collectively form the Economic and
Financial Affairs (ECOFIN) Council.
This council also wants to create more jobs and to improve the European
Union’s education, health, and social protection systems. Although each EU
country is responsible for its own policies in these areas, the member states
can agree on common goals and learn from one another’s experience what
works best. This process is called the “open method of coordination,” and it
takes place within the council.
3. Concluding international agreements. Each year the council “concludes” a
number of agreements between the EU and non-EU countries, as well as with
international organizations.
4. Approving the EU budget. The EU’s annual budget is decided jointly by the
council and the European Parliament.
5. Common Foreign and Security Policy. The member states of the European
Union are working to develop a Common Foreign and Security Policy (CFSP).
But foreign policy, security, and defense are matters over which the individual
national governments retain independent control. Hence, the parliament and
the European Commission play only a limited role in this area. However, the
EU countries have much to gain by working together on these issues, and
the council is the main forum in which this intergovernmental cooperation
takes place. To enable it to respond more effectively to international crises,
the European Union has created a Rapid Reaction Force. This is not a Euro-
pean army: the personnel remain members of their national armed forces and
under national command, and their role is limited to carrying out humanitar-
ian, rescue, peacekeeping, and other crisis-management tasks. In 2003, for
example, the EU conducted a military operation (code named Artemis) in the
Democratic Republic of Congo, and in 2004 it began a peacekeeping opera-
tion (code named Althea) in Bosnia and Herzegovina.
6. Freedom, security, and justice. EU citizens are free to live and work in whichever
EU country they choose, so they should have equal access to civil justice every-
where in the European Union. Freedom of movement within the European Union
is of great benefit to law-abiding citizens, but it is also exploited by international
criminals and terrorists. To tackle cross-border crime requires cross-border coop-
eration among the national courts, police forces, customs officers, and immigration
services of all EU countries. These security and justice issues are dealt with by
the Justice and Home Affairs Council, that is, the ministers for justice and of the
interior. The aim of this council is to create a unified and uniform approach to
freedom, security, and justice within the European Union’s borders.
The Organization of the Council of the European Union
Permanent Representatives Committee (COREPER). In Brussels, each EU member

state has a permanent team, called a Permanent Representatives Committee (COREP-
ER), that represents it and defends its national interest at the EU level. The head of
each representative committee is, in effect, his or her country’s ambassador to the
European Union. These ambassadors (known as “permanent representatives”) meet
weekly within the COREPER. The role of this committee is to prepare the work of
the council, with the exception of most agricultural issues, which are handled by the
Special Committee on Agriculture. The COREPER is assisted by a number of work-
ing groups, made up of officials from the national administrations.
Council Presidency. The presidency of the council rotates every six months: each
EU country in turn takes charge of the council agenda and chairs all the meetings for
a six-month period, promoting collaborative legislative and political decisions and
brokering compromises among the member states.
General Secretariat. The president is assisted by the General Secretariat, which pre-
pares and ensures the smooth functioning of the council’s work at all levels. Javier
Solana is the current secretary-general of the council. He is also high representative
for the Common Foreign and Security Policy (CFSP), and in this capacity helps
coordinate the European Union’s actions on the world stage. Under the new consti-
tutional treaty, the high representative would be replaced by an EU foreign affairs
minister. The secretary-general is assisted by a deputy secretary-general in charge of
managing the General Secretariat.
Qualified Majority Voting. Decisions in the council are taken by vote. The number
of votes allotted to each country is based on its population, but the numbers are also
weighted in favor of the less populous countries. In some particularly sensitive areas
such as Common Foreign and Security Policy, taxation, asylum, and immigration
policy, council decisions have to be unanimous. In other words, each member state
has the power of veto in these areas. In addition, a member state may ask for con-
firmation that the votes in favor represent at least 62 percent of the total population
of the European Union. If this is found not to be the case, the decision will not be
adopted.
The European Commission
The commission is independent of national governments. Its job is to represent and

uphold the interests of the European Union as a whole. It drafts proposals for new
European laws, which it presents to the parliament and the council. It is also the
European Union’s executive arm, responsible for implementing the decisions of the
parliament and the council.
Like the parliament and council, the European Commission was set up in the 1950s
under the European Union’s founding treaties. The term “commission” is used in two
394 AppENDIX 1
senses. First, it refers to the team of men and women—one from each EU country—
appointed to run the institution and make its decisions. Second, the term “commission”
refers to the institution itself and to its staff. Informally, the appointed members of the
commission are known as “commissioners.” They have all held political positions in
their countries of origin, and many have been government ministers, but as members
of the commission they are committed to acting in the interests of the European Union
as a whole and not taking instructions from national governments.
A new commission is appointed every five years, within six months of the elec-
tions to the European Parliament. The present commission’s term of office runs until
October 31, 2009. Its president is José Manuel Barroso, from Portugal. The com-
mission remains politically accountable to the parliament, which has the power to
dismiss the whole commission by adopting a motion of censure. Individual members
of the commission must resign if asked to do so by the president, provided the other
commissioners approve.
The commission attends all the sessions of the parliament, where it must clarify
and justify its policies. It also replies regularly to written and oral questions posed
by MEPs.
The day-to-day running of the commission is done by its administrative officials,
experts, translators, interpreters, and secretarial staff. There are approximately 25,000
staff members and civil servants. The “seat” of the commission is in Brussels, Bel-
gium, but it also has offices in Luxembourg, representatives from all EU countries,
and delegations in many capital cities around the world.
The European Commission has four main roles:
1. Proposing new legislation. The commission has the “right of initiative.” In other
words, the commission alone is responsible for drawing up proposals for new Euro-
pean legislation, which it presents to the parliament and the council. These proposals
must aim to defend the interests of the European Union and its citizens, not those of
specific countries or industries.
Before making any proposals, the commission must be aware of new situations
and problems developing in Europe, and it must consider whether EU legislation is
the best way to deal with them. That is why the commission is in constant touch with
a wide range of interest groups and with two advisory bodies—the Economic and
Social Committee and the Committee of the Regions. It also seeks the opinions of
national parliaments and governments.
2. Implementing EU policies and the budget. As the European Union’s executive
body, the commission is responsible for managing and implementing the EU bud-
get. Most of the actual spending is done by national and local authorities, but the
commission is responsible for supervising it—under the watchful eye of the Court
of Auditors. Both institutions aim to ensure good financial management. Only if it
is satisfied with the Court of Auditors’ annual report does the European Parliament
grant the commission discharge for implementing the budget. The commission also
has to manage the policies adopted by the parliament and the council, such as the
Common Agricultural Policy.
3. Enforcing European law. The commission acts as “guardian of the treaties.”
This means that, together with the Court of Justice, the commission is responsible
for making sure EU law is properly applied to all the member states. If it finds that
an EU country is not applying an EU law, and therefore not meeting its legal obliga-
tions, the commission takes steps to put the situation right.
4. Representing the European Union on the international stage. The European
Commission is an important mouthpiece for the European Union on the international
stage. It enables the member states to speak “with one voice” in international forums
such as the World Trade Organization.
The Organization of the European Commission. It is up to the commission president to

decide which commissioner will be responsible for which policy area, and to reshuffle
these responsibilities during the commission’s term of office. The commission meets
once each week, usually on Wednesdays, in Brussels. Each item on the agenda is
presented by the commissioner responsible for that policy area, and the whole team
then makes a collective decision on it.
The commission’s staff is organized into departments, known as “directorates-
general” (DGs) and “services” (such as the Legal Service). Each DG is responsible
for a particular policy area and is headed by a director-general who is answerable to
one of the commissioners. Overall coordination is provided by the secretariat-general,
which also manages the weekly commission meetings. It is headed by the secretary-
general, who is answerable directly to the president. The DGs actually devise and
draft legislative proposals, but these proposals become official only when adopted
by the commission at its weekly meeting. If at least 13 of the 25 commissioners ap-
prove the proposal, the commission will adopt it, and it will have the whole team’s
unconditional support. The document will then be sent to council and the European
Parliament for their consideration.
The Court of Justice. The Court of Justice of the European Communities, often re-
ferred to simply as “the court,” was set up under the ECSC Treaty in 1952. Its job
is to make sure that EU legislation is interpreted and applied uniformly in all EU
countries. Based in Luxembourg, the court ensures that national courts do not give
different rulings on the same issue. It also makes sure that EU member states and
institutions do what the law requires. The court has the power to settle legal disputes
between EU member states, EU institutions, businesses, and individuals.
The court is composed of one judge per member state, so that all 25 of the Eu-
ropean Union’s national legal systems are represented. For the sake of efficiency,
however, the court rarely sits as the full court. It usually sits as a “grand chamber” of
just 13 judges, or in chambers of five or three judges. The court is assisted by eight
advocates-general. Their role is to present reasoned opinions on the cases brought
before the court. They must do so publicly and impartially.
The judges and advocates-general are people whose impartiality is beyond doubt.
They have the qualifications or competence needed for appointment to the highest
judicial positions in their home countries. They are appointed to the Court of Justice
by joint agreement between the governments of the EU member states. Each is ap-
pointed for a term of six years, which may be renewed.
To help the Court of Justice cope with the large number of cases brought before it,
396 AppENDIX 1
and to offer citizens better legal protection, a Court of First Instance was created in
1989. This court is responsible for giving rulings on certain kinds of cases, particularly
actions brought by private individuals, companies, and some organizations, and cases
relating to competition law.
The Court of Justice and the Court of First Instance each have a president, chosen
by their fellow judges to serve for a renewable term of three years. Vassilios Skouris,
from Greece, is the president of the Court of Justice and Bo Vesterdorf, from Denmark,
is president of the Court of First Instance.
A new judicial body, the European Civil Service Tribunal, has been set up to ad-
judicate disputes between the European Union and its civil service. This tribunal is
composed of seven judges and is attached to the Court of First Instance.
The Court of Auditors. The Court of Auditors was set up in 1975. It is based in Luxem-
bourg. The court’s job is to check that EU funds, which come from the taxpayers, are
properly collected and that they are spent legally, economically, and for their intended
purpose. Its aim is to ensure that the taxpayers get maximum value for their money,
and it has the right to audit any person or organization handling EU funds. The court
has one member from each EU country, appointed by the council for a renewable term
of six years. The members elect the president for a renewable term of three years.
Hubert Weber, from Austria, was elected president in January 2005.
The Court of Auditors has approximately 800 staff members, including transla-
tors, administrators, and auditors. The auditors are divided into audit groups. They
prepare draft reports on which the court makes decisions. To carry out its tasks, the
court frequently carries out on-the-spot checks, investigating the paperwork of any
person or organization handling EU income or expenditures. Its findings are writ-
ten up in reports that bring any problems to the attention of the commission and EU
member-state governments. To do its job effectively, the Court of Auditors must
remain completely independent of the other institutions but at the same time stay in
constant touch with them.
One of the court’s key functions is to help the European Parliament and the council
by presenting them with an annual audit report on the previous financial year. The
parliament examines the court’s report in detail before deciding whether or not to
approve the commission’s handling of the budget.
Finally, the Court of Auditors gives its opinion on proposals for EU financial legisla-
tion and for EU action to fight fraud. The court itself has no legal powers of its own. If
auditors discover fraud or irregularities, they inform the European Anti-Fraud Office.
The European Economic and Social Committee. Founded in 1957 under the Treaty of
Rome, the European Economic and Social Committee (EESC) is an advisory body
representing employers, trade unions, farmers, consumers, and the other interest
groups that collectively make up the organized civil society. It presents their views
and defends their interests in policy discussions with the commission, the council
and the European Parliament. The EESC is a bridge between the European Union
and its citizens, promoting a more participatory, more inclusive, and therefore more
democratic society in Europe.
The EESC is an integral part of the European Union’s decision-making process. It

must be consulted before decisions are made on economic and social policies. On its
own initiative, or at the request of another EU institution, it may also give its opinion
on other matters. The EESC has 317 members—the number from each EU country
roughly reflecting the size of its population. The members are nominated by the EU
governments, but they work in complete political independence. They are appointed
to four-year terms and may serve more than once.
The European Economic and Social Committee meets in Plenary Assembly, and
its discussions are prepared by six subcommittees known as sections. Each of these
sections deals with a particular policy area. It elects its president and two vice presi-
dents for two-year terms. Anne-Marie Sigmund, from Austria, became president of
the EESC in October 2004.
The EESC has three main roles:
1. To advise the council, commission, and European Parliament, either at their

request or on the committee’s own initiative;
2. To encourage civil society to become more involved in EU policy making;
and
3. To bolster the role of civil society in non-EU countries and to help set up
advisory structures.
The Committee of the Regions. Set up in 1994 under the Treaty on European Union,
the Committee of the Regions (CoR) is an advisory body composed of representatives
of Europe’s regional and local authorities. The CoR has to be consulted before EU
decisions are taken on matters such as regional policy, the environment, education,
and transportation, all of which concern local and regional governments.
The CoR has 317 members. The number from each member state approximately
reflects its population size. The members of the CoR are elected municipal or re-
gional politicians, often leaders of regional governments or city mayors. They are
nominated by the EU governments but they work in complete political independence.
The Council of the European Union appoints them for four years, and they may be
reappointed. They must also have a mandate from the authorities they represent
or be politically accountable to them. The CoR chooses a president from among
its members, for a term of two years. Peter Straub, from Germany, was elected
president in February 2004.
The role of the CoR is to put forward the local and regional points of view on EU
legislation. It does so by issuing opinions on commission proposals.
The commission and the council must consult the CoR on topics of direct relevance
to local and regional authorities, but they can also consult the CoR whenever they
wish. For its part, the CoR can adopt opinions on its own initiative and present them
to the commission, the council, and the parliament.
The European Central Bank. The European Central Bank (ECB) was set up in 1998,
under the Treaty on the European Union, and it is based in Frankfurt, Germany. Its
job is to manage the euro, the European Union’s single currency. The ECB is also
398 AppENDIX 1
responsible for framing and implementing the European Union’s economic and
monetary policy.
To carry out its role, the ECB works with the European System of Central Banks
(ESCB), which covers all 27 EU countries. However, only 12 of these countries have
so far adopted the euro. The 12 collectively make up the euro area/region, and their
central banks, together with the European Central Bank, make up what is called the
Eurosystem.
The ECB works in complete independence. Neither the ECB, nor the national
central banks of the Eurosystem, nor any member of their decision-making bod-
ies can ask for or accept instructions from any other body. The EU institutions and
member-state governments must respect this principle and not seek to influence the
ECB or the national central banks.
The ECB, working closely with the national central banks, prepares and implements
the resolutions made by the Eurosystem’s decision-making bodies—the Governing
Council, the Executive Board, and the General Council. Jean-Claude Trichet, from
France, became president of the ECB in November 2003.
One of the ECB’s main tasks is to maintain price stability in the euro region, so
that the euro’s purchasing power is not eroded by inflation. The ECB aims to ensure
that the year-on-year increase in consumer prices is less than 2 percent. It does this
in two ways:
1. By controlling the money supply. If the money supply is excessive compared

to the supply of goods and services, inflation will result. Controlling the
money supply involves, among other things, setting interest rates throughout
the euro region.
2. By monitoring price trends and assessing the risk they pose to price stability
in the euro area.
The European Investment Bank. The European Investment Bank (EIB) was set up in
1958 by the Treaty of Rome. Its job is to lend money for major infrastructure projects,
such as rail and road links, airports, and environmental schemes. The EIB undertakes
projects particularly in the less developed regions within member countries as well as
the developing world. It also provides credit for small businesses. Philippe Maystadt,
from Belgium, is the president of the EIB.
The EIB is nonprofit organization and gets no money from savings or current accounts,
nor does it use any funds from the EU budget. Instead, the EIB is financed through
borrowing on the financial markets and by the bank’s shareholders, that is, the member
states of the European Union. The EU countries subscribe jointly to its capital, each
country’s contribution reflecting its economic weight within the union. This backing by
the member states gives the EIB the highest possible credit rating (AAA) on the money
markets, where it can therefore raise very large amounts of capital on very competitive
terms. This in turn enables the EIB to invest in projects of public interest that would
otherwise not get the money or would have to borrow it more expensively.
The projects the EIB invests in are carefully selected according to the following
criteria:
• Projects must help achieve EU objectives, such as making European industries and
small businesses more competitive; creating trans-European networks (transport,
telecommunications, and energy); boosting the information technology sector;
protecting the natural and urban environments; and improving health and educa-
tion services.
• Projects must chiefly benefit the most disadvantaged regions.
• Projects must help attract other sources of funding.
The EIB also supports sustainable development in countries of Africa, Asia, the
Caribbean, and Latin America. An autonomous institution, it makes its own borrow-
ing and lending decisions purely on the merits of each project and the opportunities
offered by the financial markets.
The European Ombudsman. The position of European Ombudsman was created by

the Treaty on the European Union. The ombudsman acts as an intermediary between
the citizens and the EU authorities. He or she is entitled to receive and investigate
complaints from EU citizens, businesses, and organizations, and from anyone resid-
ing in or having their registered office in an EU country. The ombudsman is elected
by the European Parliament for a renewable term of five years, which corresponds
to the parliament’s legislative term. Nikiforos Diamandouros, the former national
ombudsman of Greece, took up the post of European Ombudsman in April 2003 and
was reelected in January 2005 for a five-year term.
The ombudsman helps to uncover “maladministration” in the European Union’s
institutions and bodies. Maladministration, or failed administration, occurs “when
an institution fails to act in accordance with the law, or fails to respect the principles
of good administration, or violates human rights.” Some examples of maladminis-
tration are unfairness, discrimination, abuse of power, lack of or refusal to provide
information, unnecessary delay, and incorrect procedures. The ombudsman carries
out investigations in response to a complaint or based on his or her own initiative.
Operating independently and impartially, the ombudsman does not request or accept
instructions from any government or organization.
The European Data Protection Supervisor. The position of European Data Protec-
tion Supervisor (EDPS) was created in 2001. The responsibility of the EDPS is to
make sure that all EU institutions and bodies respect people’s right to privacy when
processing their personal data.
“Processing” covers many activities, including collecting information, recording
and storing it, retrieving it for consultation, making it available to other people, and
also blocking, erasing, or destroying data. Strict privacy rules govern these activities.
For example, EU institutions and bodies are not allowed to process personal data that
reveals racial or ethnic origin, political opinions, religious or philosophical beliefs,
or trade-union membership, nor may they process data on a citizen’s health or sex
life, unless the data is needed for health care purposes. Even then, the data must be
processed by a health professional or another person who is sworn to professional
secrecy. The EDPS works with the Data Protection Officers in each EU institution or
400 AppENDIX 1
body to ensure that the date privacy rules are applied. In 2004, Peter Johan Hustinx
was appointed European data protection supervisor with Joaquin Bayo Delgado as
the assistant supervisor.
The Office for Official Publications of the European Communities. The Office for
Official Publications of the European Communities acts as the publishing house for
the EU institutions, producing and distributing all official EU publications on paper
and in digital form.
The European Personnel Selection Office. The European Personnel Selection Office
(EPSO) became operational in January 2003. Its task is to set competitive examina-
tions for recruiting staff to work in all the EU institutions. The office was established
to be efficient and cost saving. Previously, all recruiting was handled by individual
institutions. The EPSO, with an annual budget of roughly €21 million, spends 11
percent less than the individual institutions used to spend on recruitment.
The European Union: Success or Failure
The European Union was formed as the European Economic Community (EEC) in
1958 and known as such until 1992. The people who drafted the Treaty of Rome
set the following task for the European Economic Community: “By establishing a
common market and progressively approximating the economic policies of member
states, to promote throughout the Community a harmonious development of economic
activities, a continuous and balanced expansion, an increase in stability, an accelerated
raising of the standard of living and closer relations between the States belonging to
it.” There have been many debates about whether the EU has achieved its goals. In
general, it has achieved most of its goals—if not fully then at least partially.13 The EU
has brought stability, modernization, and prosperity to old as well as new members.
It has also benefited from an integrated market of the kind that can be found in the
United States. As a group, the EU has encouraged world trade and has been a force
behind the formation of the WTO. These initiatives have provided great benefits to
the European Union’s member countries.
The introduction of a single European currency, the euro, is another major achieve-
ment of the European Union; it has been a positive force throughout the region.14
From an economic standpoint, the European Union has helped its member countries to
weather the financial problems in Asia and has also successfully fought off inflationary
pressures. The European Central Bank has acted forcefully to maintain price stability
without having to build any additional uncertainty premium into interest rates.
The introduction of the euro had its own set of challenges. The success of the euro
depended on how well the European Union’s leaders were able to settle their dif-
ferences in political philosophies, economic principles, and sovereignty concerns.15
However, the real challenge appeared to be in having the general population accept
the new currency. The people in countries with strong currencies, such as Germany
and the United Kingdom, were uneasy about giving up their known, low-inflation
currencies for an unknown and untested euro. In the early years, the euro did fall in
value against some of the major currencies, especially the U.S. dollar, and this decline
caused economic problems for some of the European countries.16
One of the goals of the EU was to be competitive in the knowledge-based indus-
tries by the year 2010. Although the EU has achieved some measure of success in
this area, it has been more successful in providing a system of rules and guidelines
through the union’s competition authorities, thereby helping European companies
compete in the world markets.17
On the negative side, the defeat of the proposed EU Constitution in referendums in
France and the Netherlands in mid-2005 not only brought to a halt plans to strengthen
the European Union through the creation of more coherent institutions, procedures,
and rules, but also exposed a severe division within the union on economic, social, and
external trade policies.18 The constitutional treaty’s defeat was largely motivated by
worries that welfare achievements of the French social model were threatened by an
EU policy impetus toward the removal of market barriers, both within the European
Union and with the outside world. The rejection by two founding members of the
union has almost certainly ended not only the constitution, but also the entire drive
toward deeper European integration. For decades, this process has proceeded through
a succession of treaties, most of which handed over more power from national to
European institutions. Now, and for the foreseeable future, new treaties will have to
be put to voters.
Appendix 2
Worldwide Organizations and
International Agencies
Worldwide organizations, also called international agencies, were established to serve

as intermediaries among nations to promote peace, resolve disputes, build economies,
aid countries in financial crisis, and so on. Organizations such as the United Nations,
the International Bank for Reconstruction and Development, also called the World
Bank, the International Monetary Fund, and others have evolved over the years in
scope and practices paralleling the internationalization process. Following is a brief
description of a few of these organizations: the International Monetary Fund, the
Organisation for Economic Co-operation and Development, the United Nations, and
the World Bank.1
THE INTERNATiONAL MONETARY FUND

The International Monetary Fund, also known as the IMF, was conceived at a United
Nations conference convened in Bretton Woods, New Hampshire, in July 1944. The 45
governments represented at that conference sought to build a framework for economic
cooperation that would avoid a repetition of the disastrous economic policies that had
contributed to the Great Depression of the 1930s. Headquartered in Washington, D.C.,
the IMF is governed by its almost global membership of 184 countries.
The IMF’s main responsibilities include:
• Promoting international monetary cooperation

• Facilitating the expansion and balanced growth of international trade
• Promoting exchange stability
• Assisting in the establishment of a multilateral system of payments
• Making its resources available (under adequate safeguards) to members experi-
encing balance-of-payments difficulties
More generally, the IMF is responsible for ensuring the stability of the international
monetary and financial system, which is the system of international payments and ex-
change rates among national currencies that enables trade to take place between countries.
The IMF seeks to promote economic stability and prevent crises; to help resolve crises
when they do occur; and to promote growth and alleviate poverty. It employs three main
tactics to meet these objectives: surveillance, technical assistance, and lending.
402
WORLDWIDE ORGANIZATIONS AND INT’L AGENcIES 403
SURVEILLANcE
Surveillance is the regular dialogue and policy advice that the IMF offers to each of
its members. Generally once a year, the IMF conducts in-depth appraisals of each
member country’s economic situation. It discusses with the country’s authorities
the policies that are most conducive to stable exchange rates and a growing and
prosperous economy. Members have the option to publish the IMF’s assessment,
and the overwhelming majority of countries opt for transparency, making extensive
information on bilateral surveillance available to the public. The IMF also combines
information from individual consultations to form assessments of global and regional
developments and prospects.
TEcHNIcAL ASSISTANcE
Technical assistance and training are offered (mostly free of charge) to help mem-
ber countries strengthen their capacity to design and implement effective policies.
Technical assistance is offered in several areas, including fiscal policy, monetary and
exchange-rate policies, banking and financial system supervision and regulation, and
statistics.
In the event that member countries do experience difficulties financing their balance
of payments, the IMF is also a fund that can be tapped for help in recovery.
LENDING
Financial assistance is available to give member countries the breathing room they
need to correct balance-of-payments problems. A policy program supported by
IMF financing is designed by the national authorities in close cooperation with the
IMF, and continued financial support is conditional on effective implementation
of this program.
The IMF is also actively working to reduce poverty in countries around the globe,
independently and in collaboration with the World Bank and other organizations.
The IMF’s resources are provided by its member countries, primarily through pay-
ment of quotas that broadly reflect each country’s economic size. The total amount of
the quotas is the most important factor determining the IMF’s lending capacity. The
annual expenses of running the IMF are met mainly by the difference between interest
receipts (on outstanding loans) and interest payments (on quota “deposits”).
The IMF is accountable to the governments of its member countries. At the apex of
its organizational structure is its Board of Governors, which consists of one governor
from each of the IMF’s 184 member countries. All governors meet once each year at
the IMF–World Bank Annual Meetings; 24 of the governors sit on the International
Monetary and Finance Committee (IMFC) and meet twice each year. The day-to-day
work of the IMF is conducted at its Washington, D.C., headquarters by its 24-mem-
ber Executive Board; this work is guided by the IMFC and supported by the IMF’s
professional staff. The managing director is head of the IMF staff and chairman of
the Executive Board, and is assisted by three deputy managing directors.
404 AppENDIX 2
The Board of Governors
The Board of Governors, the highest decision-making body of the IMF, consists of
one governor and one alternate governor for each member country. It usually meets
once a year at the annual meetings of the IMF and the World Bank. The governor is
appointed by the member countries and is usually the minister of finance or the gov-
ernor of the central bank. All powers of the IMF are vested in the Board of Governors,
which may delegate to the Executive Board all except certain reserved powers.
Key policy issues relating to the international monetary system are considered
twice-yearly in the IMFC (known until September 1999 as the Interim Committee).
A joint committee of the Boards of Governors of the IMF and World Bank—called
the Development Committee—advises and reports to the governors on development
policy and other matters of concern to developing countries.
The Executive Board
The Executive Board consists of 24 executive directors, with the managing director
as chairman. The Executive Board usually meets three times a week, in full-day ses-
sions, and more often if needed, at the organization’s headquarters in Washington,
D.C. The IMF’s five largest shareholders (the United States, Japan, Germany, France,
and the United Kingdom), along with China, Russia, and Saudi Arabia, have their
own seats on the board. The other 16 executive directors are elected for two-year
terms by groups of countries known as constituencies.
The documents that provide the basis for the board’s deliberations are prepared
mainly by IMF staff, sometimes in collaboration with the World Bank, and presented
to the board with management approval, but some documents are presented by execu-
tive directors themselves.
Unlike some international organizations that operate under a one-country, one-vote
principle (such as the United Nations General Assembly), the IMF has a weighted
voting system: the larger a country’s quota in the IMF (determined broadly by its
economic size), the more votes it has. But the board rarely makes decisions based
on formal voting; rather, most decisions are based on consensus among its members
and are supported unanimously.
The Executive Board selects the managing director, who besides serving as the
chairman of the board is the chief of the IMF staff and conducts the business of the
IMF under the direction of the board. Appointed for a renewable five-year term, the
managing director is assisted by a first deputy managing director and two other deputy
managing directors.
IMF employees are international civil servants whose responsibility is to the IMF,
not to national authorities. The organization has about 2,800 employees recruited from
141 countries. About two-thirds of its professional staff are economists. The IMF’s 26
departments and offices are headed by directors who report to the managing director.
Most staff work in Washington, although about 90 resident representatives are posted
in member countries to advise on economic policy. The IMF maintains offices in Paris,
France, and Tokyo, Japan, for liaison with other international and regional institutions,
Figure A2.1 The International Monetary Fund
THE INTERNATIONAL
MONETA RY FUND (IMF)
BOARD OF GOVERNORS*
184 Governors
EXECUTIVE BOARD**
24 Members
RODRIGO DE RATO
Managing Director and
Chairman of Executive Board
ANNE O. KRUE GER AGUSTIN CA RSTENS TAKATOSHI KATO

First Deputy Managing Deputy Managing Deputy Managing
Director Director Director
*The Board of Governors is the highest decision-making body of the IMF and meets once a year.
**The Executive Board carries out the day-to-day work of the IMF and usually meets three times
a week.
and with organizations of civil society; it also has offices in New York City and Geneva,
Switzerland, mainly for liaison with other institutions in the UN system. Figure A2.1
presents the IMF’s organizational structure.
Resources of the IMF
The IMF’s resources come mainly from the quota (or capital) subscriptions that
countries pay when they join the IMF, or following periodic reviews in which quotas
are increased. Countries pay 25 percent of their quota subscriptions in Special Draw-
ing Rights (SDRs), or major currencies, such as U.S. dollars or Japanese yen; the
IMF can call on the remainder, payable in the member’s own currency, to be made
available for lending as needed. Quotas determine not only a country’s subscription
payments, but also the amount of financing that it can receive from the IMF and its
share in SDR allocations. Quotas also are the main determinant of countries’ voting
power in the IMF.
Quotas are intended broadly to reflect members’ relative size in the world economy:
the larger a country’s economy in terms of output, and the larger and more variable its
trade, the higher its quota tends to be. The United States, the world’s largest economy,
406 AppENDIX 2
contributes most to the IMF, 17.5 percent of total quotas; Palau, the world’s smallest
economy, contributes 0.001 percent. The most recent (eleventh) quota review came
into effect in January 1999, raising IMF quotas (for the first time since 1990) by about
45 percent to SDR 212 billion (about US$300 billion).
If necessary, the IMF may borrow to supplement the resources available from its
quotas. The IMF has two sets of standing arrangements to borrow if needed to cope
with any threat to the international monetary system:
• General Arrangements to Borrow (GAB), set up in 1962, which has 11 participants

(the governments or central banks of the Group of Ten industrialized countries
and Switzerland)
• New Arrangements to Borrow (NAB), introduced in 1997, with 25 participating
countries and institutions
Under the two arrangements combined, the IMF has up to SDR 34 billion (about
US$50 billion) available to borrow.
The IMF holds 103.4 million ounces of gold at designated depositories. Its total
gold holdings are valued on its balance sheet at SDR 5.9 billion (about US$9 billion)
on the basis of historical cost. As of February 2008, the IMF’s resources amounted to
US$362 billion. The IMF acquired virtually all its gold holdings through four main
types of transactions under the original Articles of Agreement. First, the original ar-
ticles prescribed that 25 percent of initial quota subscriptions and subsequent quota
increases were to be paid in gold. This represented the largest source of the IMF’s gold.
Second, all payments of charges (that is, interest on members’ use of IMF credit) were
normally made in gold. Third, a member wishing to purchase the currency of another
member could acquire it by selling gold to the IMF. The major use of this provision
was sales of gold to the IMF by South Africa in 1970–71. And finally, members could
use gold to repay the IMF for credit previously extended.
THE IMF: SUccESS OR FAILURE

The International Monetary Fund has been assisting the governments of many countries
in their recovery from poor economic conditions. Although the IMF applies the same
programs of economic recovery to all countries it helps, the results have not been the
same in all situations. In some cases, its efforts have resulted in full recovery of the
economy; in other cases, they have led to marginal results. Following are a few examples
of the successes and failures of the economic recovery programs initiated by the IMF.
In Bangladesh, the IMF’s efforts led to a decrease in the country’s poverty levels.
In addition, the country was able to maintain economic stability through the assistance
of the IMF.2 It has been argued that although the country’s growth rate is below 6
percent, the original target of the recovery program, this can still be considered an
achievement under admittedly difficult circumstances.
In recent surveys of the Bosnian economy, the IMF has highlighted the hazards
that arise from the country’s complex fiscal architecture.3 The country has achieved
some success in the field of indirect taxation with the establishment of shared
administration. However, IMF proposals for further unification may be politically

unacceptable.
Timothy Adams, former undersecretary for international affairs of the U.S. Trea-
sury, pushed the IMF to play a bigger role in monitoring the US$1.9 trillion-per-day
currency market.4 Adams criticized the IMF’s failure to push China to make its cur-
rency, the yuan, more flexible and was quoted as saying that the IMF was “asleep
at the wheel” on currencies. The Bush administration opened this new front in its
campaign to pressure China to raise the value of its currency, demanding that the IMF
crack down on countries that engage in currency manipulation.5 Adams, who issued
this demand, criticized the IMF for failing to enforce its own rules that bar member
nations from maintaining artificially cheap currencies.
Between 2001 and 2003, the Dominican Republic’s growth rate dropped by about
5 percent annually. The main reason for the decline was poor performance in two of
the key sectors of the economy—tourism and agriculture.6 But the economy picked
up after it began its IMF austerity program.
Reports on the outlook of the economy in Peru show signs that the government is suc-
ceeding in meeting and even exceeding the fiscal targets set by the IMF under the terms
of its “stand-by arrangement” with the country.7 Continued growth in international mining
prices will allow the government to use the tax revenues for additional debt repayments.
In 2001, Turkey faced a severe economic downturn. The IMF had to intervene
to stabilize the economy and maintain a steady currency.8 Turkey has successfully
rebounded from its economic problems: inflation has fallen, the economy has main-
tained a steady growth rate, and the Turkish currency has appreciated for the first time
in decades. In addition, Turkey’s privatization program had a remarkably successful
2005.9 Revenue from sales within the privatization program have reached around
US$9.7 billion since January 2005, with a further US$3 billion coming from sales
outside the program. This belated success is a tribute to the determination of Turkey’s
Justice and Development Party government to meet targets agreed to with the IMF
and the World Bank.
At the urging of the IMF, the Ukrainian parliament approved the government’s
revised 2005 budget, cutting the deficit target to 1.6 percent of GDP from the 2.2 per-
cent set by the outgoing administration. As recommended by the IMF, the Ukrainian
parliament removed tax breaks that were frequently criticized by the IMF.10 The easy
parliamentary passage of the financial plan represents a key success for the govern-
ment in its relations with the traditionally recalcitrant chamber.
Serbia’s economic progress, with guidance from the IMF, has been impressive
in recent years.11 According to Business Monitor International (BMI), tight fiscal
discipline and strong export growth are two success stories so far for the year 2005.
However, it is also important for the country to successfully complete the IMF loan
deal to implement further reforms to pensions and the energy sector, which are highly
vulnerable to political interference.
According to an article by Graham Bird in World Economy, one way of assessing the
impact of IMF programs is to see whether performance and policy targets are achieved.12
In the article, Bird asked whether “a failure to hit targets mean that the programs have been
unsuccessful, or could it be that targets have been too ambitious?” He analyzed political-
408 AppENDIX 2
economic factors that stymie government efforts. Some of the under-achievement of the
IMF initiatives might be due to the high goals (overoptimism) set by the agency. Bird
concludes that if the IMF eliminates overoptimism in its targets, the agency’s psychology
of failure surrounding its programs could be significantly reduced or even broken.
There is also concern among some economists that the IMF follows outdated
economic models that do not take into account current economic realities.13 These
economists think that the IMF’s intervention in economic crises in Latin America,
East Asia, and Russia worsened their situations.
THE ORGANiSATiON fOR ECONOMiC CO-OpERATiON AND DEVELOpMENT

The Organisation for Economic Co-operation and Development (OECD) is a unique
forum where the governments of 30 market democracies work together to address
the economic, social, and governance challenges of globalization as well as to exploit
its opportunities. The OECD provides a setting where governments can compare
policy experiences, seek answers to common problems, identify good practice, and
coordinate domestic and international policies.
The OECD grew out of the Organisation for European Economic Cooperation
(OEEC), which was set up in 1947 with support from the United States and Canada
to coordinate the Marshall Plan for the reconstruction of Europe after World War II.
Created as an economic counterpart to the North Atlantic Treaty Organization (NATO),
the OECD took over from the OEEC in 1961. The OECD’s mission has been to help
governments achieve sustainable economic growth and employment and raise standards
of living in member countries. At the same time, the OECD tries to maintain financial
stability among member countries so as to contribute to the development of the world
economy. Its founding convention also calls on the OECD to assist sound economic
expansion in member countries and other countries that would lead to growth in world
trade on a multilateral, nondiscriminatory basis. In recent years, the OECD has moved
beyond a focus on its 30 member countries to offer its analytical expertise and accumu-
lated experience to more than 70 developing and emerging market economies.
Globalization has seen the scope of the OECD’s work move from examining each
policy area within each member country to analyzing how various policy areas interact
with one another, between countries, and beyond the OECD area. This is reflected in
its work on issues such as sustainable development, bringing together environmental,
economic, and social concerns across national frontiers for a better understanding of
the problems and the best way to tackle them together.
The OECD provides a setting for reflection and discussion, based on policy research
and analysis, that helps governments shape their own internal policies. The goal is for
these discussions to eventually lead to formal agreements among member governments
or to be acted on in domestic or other international arenas. Unlike the World Bank or
the International Monetary Fund, the OECD does not dispense money.
The OECD’s way of working consists of a highly effective process that begins with
data collection and analysis and moves on to a collective discussion of policy, then de-
cision making and implementation. Mutual examination by governments, multilateral
surveillance, and peer pressure to conform or reform are at the heart of OECD effec-
tiveness. The OECD has achieved success in areas such bribery, technology, and trade.
Through its efforts, many formal agreements and policy initiatives have been reached,
including the Convention on Combating Bribery in International Business Transactions,
a resolution to use technology as a means for economic growth, the introduction of
programs to reduce unemployment, and agreements to increase multilateral trade.
Discussions at the OECD sometimes evolve into negotiations during which OECD
countries agree on the rules of the game for international cooperation. They can culminate
in formal agreements, for example on combating bribery, on export credits, or on capital
movements; or they may produce standards and models for international taxation or recom-
mendations and guidelines covering corporate governance or environmental practices.
ORGANIZATIONAL STRUcTURE
The staff of the OECD Secretariat in Paris carries out research and analysis at the
request of the OECD’s 30 member countries. Representatives of member countries
meet and exchange information in committees devoted to key issues. Decision-making
power lies with the OECD Council.
The OECD Council
The OECD Council is made up of one representative from each member country, plus a
representative from the European Commission. The council meets regularly at the level
of ambassadors to the OECD, and decisions are taken by consensus. The council meets
at the ministerial level once a year to discuss key issues and set priorities for OECD
work. The work mandated by the council is carried out by the OECD Secretariat.
Committees
Representatives of the 30 member countries meet in specialized committees to advance

ideas and review progress in specific policy areas such as economics, trade, science,
employment, education, or financial markets. There are about 200 committees, work-
ing groups, and expert groups in all.
Some 40,000 senior officials from national administrations come to OECD com-
mittee meetings each year to request, review, and contribute to work undertaken by
the OECD Secretariat. Once they return home, the national officials have online ac-
cess to OECD documents and can exchange information through a special network
(OLISnet).
The OECD Secretariat
Some 2,000 OECD Secretariat staff members in Paris work to support the activities
of the committees. They include about 700 economists, lawyers, scientists, and other
professionals, mainly based in a dozen substantive directorates, who provide research
and analysis.
The secretariat is headed by a secretary-general, who is assisted by four deputy
410 AppENDIX 2
secretaries-general. The secretary-general also chairs the council, providing the crucial
link between national delegations and the secretariat.
The OECD works in two official languages: English and French. Staff members are
citizens of OECD member countries but serve as international civil servants with no
national affiliation during their OECD posting. There is no quota system for national
representation; there is simply an equal opportunity policy of employing highly quali-
fied men and women with a cross-section of experience and nationalities.
The work of the secretariat parallels the work of the committees, with each direc-
torate servicing one or more committees, as well as committee working parties and
subgroups. Increasingly, however, OECD work is cross-disciplinary.
The OECD’s work on sustainable development, and its International Futures Program,
which aims at identifying emerging policy issues at an early stage, are multidisciplinary.
Work on population aging has brought together macroeconomic specialists with experts
on taxes, enterprises, health, the labor market, and social policy analysis.
The environment and economic issues can no longer be examined in isolation. Trade
and investment are inextricably linked. Biotechnology concerns affect policy issues
in agriculture, industry, science, the environment, and economic development. The
overall effects of globalization draw in virtually every field in developing policies.
The 30 member countries of the OECD are Australia, Austria, Belgium, Canada,
the Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland,
Ireland, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, New Zealand,
Norway, Poland, Portugal, the Slovak Republic, Spain, Sweden, Switzerland, Turkey,
the United Kingdom, and the United States. Figure A2.2 presents OECD’s organi-
zational structure.
THE OECD: SUccESS OR FAILURE

Under Article 1 of the convention that was signed in Paris on December 14, 1960,
and took effect on September 30, 1961, the OECD policies are designed for the fol-
lowing purposes:
• To achieve the highest sustainable economic growth and employment and a ris-
ing standard of living in member countries, while maintaining financial stability,
and thus contributing to the development of the world economy
• To contribute to sound economic expansion in member as well as nonmember
countries in the process of economic development
• To contribute to the expansion of world trade on a multilateral, nondiscriminatory
basis in accordance with international obligations
In many areas outlined in its charter, the OECD has achieved success, including
in advancing multilateral trade, in reducing unemployment among OECD countries,
and in its attempts to standardize tax policies across countries. In a few other areas
such as helping nations of the world to achieve economic growth and in dealing with
tax haven countries, the OECD did not fully achieve its goals.
In the area of trade, efforts by the OECD to liberalize multilateral trade have been
Figure A2.2 The Organisation for Economic Co-operation and Development
THE ORGANISATION FOR

ECONOMIC CO-OPERATION
AND DEVELOPMENT
(OECD)
THE COUNCIL*
Oversight and Strategic
Direction
The work mandated by the council

is carried out by the Secretariat.
The Secretariat works to support

THE OECD the activities of committees. COMMITTEES***
SECRETARIAT** Discussion and
Analysis and Proposals Implementation
*The council is made up of one representative per member country, plus a representative from the Eu-
ropean Commission.
**The secretariat is headed by the secretary-general, who also chairs the council and is assisted by four
deputy secretaries-general.
***Representatives of member countries and countries with “observer” status meet in specialized
committees.
successful. According to a study comparing the effects of three multilateral organiza-

tions—the World Trade Organization (WTO), the International Monetary Fund, and the
OECD—on the international trade levels of the member countries, the results indicate
that the OECD membership has had a consistently large positive effect on trade, while
accession to the WTO also increases trade.14 Similarly, in bringing nations together to
draw up a policy on tax to facilitate globalization, the OECD has achieved reasonable
results. The OECD committee on fiscal affairs has been able to harmonize transfer
pricing guidelines and the model tax convention on income and on capital.15 In the
area of the economy, specifically as it relates to achieving stable growth rates among
the OECD’s member countries, the organization has partially succeeded in attaining
reasonable growth rates, at the same time achieving full employment. This growth has
been realized under some adverse conditions, including rising energy costs and spiraling
inflation.16 Finally, in the area of labor reform, the OECD did take a leadership role in
creating and disseminating liberal welfare reform and labor market policy proposals
between 1994 and 2001. These attempts resulted in the European Union adopting some
of the guidelines in its European Employment Strategy.17
The OECD has not succeeded in its efforts to stimulate the world’s economy
412 AppENDIX 2
through policy initiatives that direct its member countries to work with poorer na-
tions of the world. In spite of its efforts, the OECD has not evenly affected economic
growth among nations of the world and, in some instances, even among its members.18
Similarly, in dealing with tax haven countries, the OECD has had no consequential
effects. A study reported on the failure of the OECD to satisfy tax haven countries
when it released the progress report on harmful tax practices in December 2001.19
In this area, the OECD is in a no-win situation. If it comes on strong on this issue, it
is accused of being overbearing and not listening, but when it does make changes in
response to criticism, it is accused of compromising its principles.
Finally, the OECD seems to have little influence when it comes to controlling
its relief efforts when disasters strike. Through its member countries, the OECD
is able to quickly raise funds and supplies for relief efforts, but once it sends this
aid to stricken areas, it does not seem to be able to distribute it efficiently or effec-
tively. A case in point is in the aftermath of the Indian Ocean tsunami: the European
Commission and 22 OECD countries pledged US$5 billion in humanitarian aid.20
But as of September 2005, an OECD study says, only 41 percent of the money had
been spent.
THE UNiTED NATiONS

In 1945, representatives of 50 countries met in San Francisco at the United Nations
Conference on International Organization to draw up the UN Charter. The organization
officially came into existence on October 24, 1945, when the charter had been ratified by
China, France, the Soviet Union, the United Kingdom, the United States, and a majority
of other signatories. United Nations Day is celebrated each year on October 24. Today,
nearly every nation, 191 in all, belongs to the United Nations. The UN Charter is the
constituting instrument of the United Nations, setting out the rights and obligations of
member states and establishing the organization’s organs and procedures.
The purposes of the United Nations, as set forth in the charter, are to maintain
international peace and security; to develop friendly relations among nations; to
cooperate in solving international economic, social, cultural, and humanitarian
problems and in promoting respect for human rights and fundamental freedoms;
and to be a center for harmonizing the actions of nations in attaining these
ends.
The six principal organs of the United Nations are the General Assembly, the
Security Council, the Economic and Social Council, the Trusteeship Council, the
International Court of Justice, and the Secretariat.
THE GENERAL ASSEMBLY

The General Assembly is the main deliberative organ of the United Nations. It is
composed of representatives of all member states, each of which has one vote. Deci-
sions on important questions—peace and security, admission of new members, and
budgetary matters, for instance—require a two-thirds majority. Decisions on other
questions are by simple majority.
Under the charter, the functions and powers of the General Assembly include:
• Considering and making recommendations on the principles of cooperation in

the maintenance of international peace and security, including the principles
governing disarmament and arms regulation
• Discussing any question relating to international peace and security and, except
where a dispute or situation is being discussed by the Security Council, making
recommendations on it
• Discussing and, with the same exception as above, making recommendations on
any question within the scope of the charter or affecting the powers and functions
of any organ of the United Nations
• Initiating studies and making recommendations to promote international political
cooperation, the development and codification of international law, the realization
of human rights and fundamental freedoms for all, and international collaboration
in economic, social, cultural, educational, and health fields
• Making recommendations for the peaceful settlement of any situation, regardless
of origin, that might impair friendly relations among nations
• Receiving and considering reports from the Security Council and other United
Nations organs
• Considering and approving the UN budget and apportioning the contributions
among members
• Electing the nonpermanent members of the Security Council, the members of
the Economic and Social Council, and additional members of the Trusteeship
Council (when necessary); electing jointly with the Security Council the judges
of the International Court of Justice; and, on the recommendation of the Security
Council, appointing the secretary-general
The General Assembly’s regular session usually begins each year in September
and ends in December. Beginning with its sixty-first regular session (2006–2007),
the assembly opens on Tuesday of the third week in September, counting from the
first week that contains at least one working day. The election of the president of the
assembly, as well as its 21 vice presidents and the chairpersons of the assembly’s six
main committees, take place at least three months before the start of the regular ses-
sion. To ensure equitable geographical representation, the presidency of the assembly
rotates each year among five groups of states: African, Asian, Eastern European, Latin
American and Caribbean, and Western European and other states.
In addition, the assembly may meet in special sessions at the request of the Security
Council, a majority of member states, or one member if the majority of members
concur. Emergency special sessions may be called within 24 hours of a request by
the Security Council on the vote of any nine council members, or by a majority of the
United Nations members, or by one member if the majority of members concur.
At the beginning of each regular session, the assembly holds a general debate,
often addressed by heads of state and government, in which member states express
their views on the most pressing international issues.
When the assembly is not meeting, its work is carried out by its six main com-
414 AppENDIX 2
mittees, other subsidiary bodies, and the UN Secretariat. The UN’s committees are
as follows:
• Disarmament and International Security

• Economic and Financial
• Social, Humanitarian, and Cultural
• Special Political and Decolonization
• Administrative and Budgetary
• Legal
Some issues are considered only in plenary meetings, while others are allocated
to one of the six main committees. All issues are voted on through resolutions
passed in plenary meetings, usually toward the end of the regular session, after
the committees have completed their consideration of them; these draft resolu-
tions are then submitted to the plenary assembly. Voting in committees is by a
simple majority. In plenary meetings, resolutions may be adopted by acclama-
tion, without objection or without a vote, or the vote may be recorded or taken
by roll call. While the decisions of the Assembly have no legally binding force
for governments, they carry the weight of world opinion, as well as the moral
authority of the world community.
The work of the United Nations during a given year derives largely from the deci-
sions of the General Assembly—that is to say, the will of the majority of the members
as expressed in resolutions adopted by the assembly. That work is carried out:
• by committees and other bodies established by the assembly to study and report
on specific issues, such as disarmament, peacekeeping, development, and human
rights
• in international conferences called for by the assembly
• by the Secretariat of the United Nations—the secretary-general and his staff of
international civil servants
THE SEcURITY COUNcIL

The UN Charter gives the Security Council primary responsibility for maintaining
international peace and security. It is organized so as to be able to function continu-
ously, and a representative of each of its members must be present at all times at UN
headquarters.
When a complaint concerning a threat to peace is brought before it, the council’s
first action is usually a recommendation that the parties to try to reach an agreement
by peaceful means. In some cases, the council itself undertakes investigation and
mediation. It may appoint special representatives or request that the secretary-general
do so; it may also set forth principles for a peaceful settlement.
When a dispute leads to a war, the council’s first concern is to bring it to an end
as soon as possible. On many occasions, the council has issued cease-fire direc-
tives, which have been instrumental in preventing wider hostilities. It also sends UN
peacekeeping forces to help reduce tensions in troubled areas, keep opposing forces
apart, and create conditions of calm in which peaceful settlements may be sought.
The council may decide on enforcement measures, economic sanctions (such as trade
embargoes), or collective military action.
In the case of a member state against which preventive or enforcement action has
been taken by the Security Council, the General Assembly (on the recommendation
of the Security Council) may suspend the member country’s exercise of the rights and
privileges of membership in the UN. A member state that has persistently violated the
principles of the charter may be expelled from the United Nations by the assembly
on the council’s recommendation.
A state that is a member of the United Nations but not of the Security Council
may participate, without a vote, in its discussions when the council considers that the
interests of that particular country are affected. Members of the United Nations and
nonmembers—if they are parties to a dispute being considered by the council—are
invited to take part, without a vote, in the council’s discussions; the council sets the
conditions for participation by a nonmember state.
The Security Council has 15 members: five permanent members and 10 elected
by the General Assembly for two-year terms. The presidency of the council ro-
tates monthly, according to the English alphabetical listing of its member states.
Each council member has one vote. Decisions on procedural matters are made by
an affirmative vote of at least nine of the 15 members. Decisions on substantive
matters require nine votes, including the concurring votes of all five permanent
members. This is the rule of “great power unanimity,” often referred to as the
“veto” power.
Under the charter, all members of the United Nations agree to accept and carry out
the decisions of the Security Council. While other organs of the United Nations make
recommendations to governments, the council alone has the power to take decisions
that member states are obligated under the charter to carry out.
Under the charter, the functions and powers of the Security Council are:
• To maintain international peace and security in accordance with the principles

and purposes of the United Nations
• To investigate any dispute or situation that might lead to international friction
• To recommend methods of adjusting such disputes or the terms of settlement
• To formulate plans for the establishment of a system to regulate armaments
• To determine the existence of a threat to the peace or act of aggression and to
recommend what action should be taken
• To call on members to apply economic sanctions and other measures not involv-
ing the use of force to prevent or stop aggression
• To take military action against an aggressor
• To recommend the admission of new members
• To exercise the trusteeship functions of the United Nations in “strategic areas”
• To recommend to the General Assembly the appointment of the secretary-general
and, together with the assembly, to elect the judges of the International Court of
Justice
416 AppENDIX 2
EcONOMIc AND SOcIAL COUNcIL

The UN Charter established the Economic and Social Council (ECOSOC) as the prin-
cipal organ to coordinate the economic, social, and related work of the 14 UN special-
ized agencies, 10 functional commissions, and five regional commissions. ECOSOC
also receives reports from 11 UN funds and programs, and it serves as the central
forum for discussing international economic and social issues, and for formulating
policy recommendations addressed to member states and the United Nations system.
It is responsible for promoting higher standards of living, full employment, and eco-
nomic and social progress; identifying solutions to international economic, social, and
health problems; facilitating international cultural and educational cooperation; and
encouraging universal respect for human rights and fundamental freedoms. ECOSOC
has the power to make or initiate studies and reports on these issues. It also has the
power to assist in the preparation and organization of major international conferences
in the economic and social and related fields and to facilitate a coordinated follow up
to these conferences. With its broad mandate, ECOSOC’s purview extends to more
than 70 percent of the human and financial resources of the entire UN system.
In the Millennium Declaration, heads of state and government declared their resolve
to further strengthen ECOSOC, building on its recent achievements, to help it fulfill
the role ascribed to it in the UN Charter. In carrying out its mandate, ECOSOC con-
sults with academics, business sector representatives, and more than 2,100 registered
nongovernmental organizations. ECOSOC holds a four-week substantive session each
July, alternating between New York and Geneva. The session includes a high-level
segment, at which national cabinet ministers, chiefs of international agencies, and
other high officials focus their attention on a selected theme of global significance. In
2005, a high-level segment took place in New York to address the following theme:
“Achieving the internationally agreed development goals, including those contained
in the Millennium Declaration, as well as implementing the outcomes of the major
United Nations conferences and summits: progress made, challenges and opportuni-
ties.” ECOSOC is expected to adopt a ministerial declaration on the theme of the
high-level segment, which will provide policy guidance and recommendations for
action. The ministerial declaration, together with the outcome of the discussions of
the coordination segment addressing the theme of “achieving internationally agreed
development goals, including those contained in the Millennium Declaration,” pro-
vided an important input to the 2005 General Assembly plenary event.
ECOSOC has taken a lead role in key policy areas in recent years. Its 1999 high-
level segment issued a “Manifesto on Poverty,” which in many respects anticipated
the formulation of the Millennium Development Goals that were approved at the UN
Millennium Summit in New York. The ministerial declaration of the high-level seg-
ment in 2000 proposed specific actions to address the digital divide, leading directly
to the formation in 2001 of the Information and Communication Technologies (ICT)
Task Force. The consideration of African development at the 2001 high-level segment
resulted in the first formal international endorsement of the New Partnership for Af-
rica’s Development (NEPAD). In 2002, the high-level segment adopted an innovative
resolution on the contribution of human resources to development, particularly in the
areas of health and education. The 2003 high-level segment focused on the promotion
of an integrated approach to rural development in developing countries; the segment
helped concentrate attention on the issues of poverty eradication and sustainability
and led to the launch of a related initiative on Madagascar. In 2004, the high-level
segment focused on least developed countries (LDCs) and resources mobilization
and an enabling environment for poverty eradication. The high-level dialogue of the
council helped to highlight the specific problems of LDCs. It also led to the launch
of a rural initiative in Benin.
Outside of the substantive sessions, ECOSOC initiated in 1998 a tradition of meet-
ing each April with finance ministers heading key committees of the Bretton Woods
institutions (the World Bank and IMF). These consultations initiated interinstitutional
cooperation that paved the way for the success of the International Conference on
Financing for Development, which was held in March 2002 in Monterrey, Mexico,
and which adopted the Monterrey Consensus. At that conference, ECOSOC was
assigned a primary role in monitoring and assessing follow up to the Monterrey
Consensus. These ECOSOC meetings have been considered important for deepen-
ing the dialogue between the United Nations and the Bretton Woods institutions, and
for strengthening their partnership for achieving the development goals agreed upon
at the global conferences of the 1990s. Participation in the meetings has broadened
since the initial meeting in 1998. In addition to the chair of the Development Com-
mittee of the World Bank and the chair of the International Monetary and Financial
Committee of the International Monetary Fund, the General Council of the World
Trade Organization and the Trade and Development Board of UNCTAD are now also
participating in the meeting.
The council’s 54 member governments are elected by the General Assembly for
overlapping three-year terms. Seats on the council are allotted based on geographical
representation, with 14 allocated to African states, 11 to Asian states, six to Eastern
European states, 10 to Latin American and Caribbean states, and 13 to Western Eu-
ropean and other states.
The Bureau of the Economic and Social Council is elected by the council at large
at the beginning of each annual session. The bureau’s main functions are to propose
the agenda, draw up a program of work, and organize the session with the support of
the United Nations Secretariat.
THE TRUSTEESHIp COUNcIL

The Trusteeship Council was established to provide international supervision for 11
trust territories administered by seven member states and ensure that adequate steps
were taken to prepare the territories for self-government or independence. It suspended
operation on November 1, 1994, with the independence of Palau, the last remaining
United Nations trust territory, on October 1, 1994. By a resolution adopted on May
25, 1994, the council amended its rules of procedure to drop the obligation to meet
annually and agreed to meet as occasion required, by its decision or the decision of
its president, or at the request of a majority of its members or the General Assembly
or the Security Council.
418 AppENDIX 2
In setting up an International Trusteeship System, the charter established the

Trusteeship Council as one of the main organs of the United Nations and assigned
to it the task of supervising the administration of trust territories placed under the
system. Major goals of the system were to promote the advancement of the inhabit-
ants of trust territories and their progressive development toward self-government or
independence. The Trusteeship Council is made up of the five permanent members
of the Security Council: China, France, the Russian Federation, the United Kingdom,
and the United States.
The aims of the Trusteeship System have been fulfilled to the extent that all trust
territories have attained self-government or independence, either as separate states
or by joining neighboring independent countries.
Under the charter, the Trusteeship Council is authorized to examine and discuss
reports from the administering authority on the political, economic, social, and edu-
cational advancement of the peoples of trust territories and, in consultation with the
administering authority, to examine petitions from and undertake periodic and other
special missions to trust territories.
THE INTERNATIONAL COURT OF JUSTIcE
The International Court of Justice, also known as the World Court, is the principal
judicial organ of the United Nations. Its seat is at the Peace Palace in The Hague
(Netherlands). The World Court began work in 1946, when it replaced the Permanent
Court of International Justice, which had functioned in the Peace Palace since 1922.
It operates under a statute similar to that of its predecessor, which is an integral part
of the Charter of the United Nations. The court has a dual role: to settle in accor-
dance with international law the legal disputes submitted to it by states, and to give
advisory opinions on legal questions referred to it by duly authorized international
organs and agencies.
The court is composed of 15 judges elected to nine-year terms of office by the UN
General Assembly and Security Council sitting independently of each other. It may
not include more than one judge of any nationality. Elections are held every three
years for one-third of the seats, and retiring judges may be reelected. The members
of the court do not represent their governments but are independent magistrates.
The judges must possess the qualifications required in their respective countries
for appointment to the highest judicial offices or be jurists of recognized competence
in international law. In addition, the composition of the court must reflect the main
forms of civilization and the principal legal systems of the world. When the court does
not include a judge possessing the nationality of a state that has a case in the court,
that state may appoint a person to sit as a judge on an ad hoc basis for the purpose
of the specific case.
THE SEcRETARIAT
The Secretariat is the arm of the UN that carries out the day-to-day work of the or-
ganization. It is made up of an international staff working in duty stations around the
world. It services the other principal organs of the United Nations and administers
the programs and policies laid down by them. At its head is the secretary-general,
who is appointed by the General Assembly on the recommendation of the Security
Council for a five-year renewable term. The current secretary-general is Ban Ki Moon
of South Korea.
The duties carried out by the Secretariat are as varied as the problems dealt with by
the United Nations. These range from administering peacekeeping operations to medi-
ating international disputes, from surveying economic and social trends and problems
to preparing studies on human rights and sustainable development. Secretariat staff
also inform the world’s communications media about the work of the United Nations;
organize international conferences on issues of worldwide concern; and interpret
speeches and translate documents into the organization’s official languages.
The Secretariat has a staff of about 8,900 under the regular budget drawn from some
170 countries. As international civil servants, the staff members and the secretary-
general answer to the United Nations alone for their activities, and they take an oath
not to seek or receive instructions from any government or outside authority. Under
the charter, each member state undertakes to respect the exclusively international
character of the responsibilities of the secretary-general and the staff and to refrain
from seeking to influence them improperly in the discharge of their duties.
The United Nations, while headquartered in New York, maintains a significant
presence in Addis Ababa, Bangkok, Beirut, Geneva, Nairobi, Santiago, and Vienna,
and has offices all over the world.
Some of the issues on the UN agenda in 2008 included climate change, human rights
abuses, terrorism, HIV/AIDS and other deadly diseases, and the importance of stimulat-
ing economic development. Figure A2.3 presents the UN’s organizational structure.
THE UNITED NATIONS: SUccESS OR FAILURE

The UN, whose primary purpose is maintaining international peace and security,
has profound effects on many aspects of global life. With its six main bodies and
all the commissions connected to them, the organization works to promote respect
for human rights, protect the environment, fight disease, and reduce poverty. Over
the years, the UN has played a major role in helping to defuse international crises
and resolve protracted conflicts. It has undertaken complex operations involving
peacemaking, peacekeeping, and humanitarian assistance in Africa, Serbia, Kosovo,
Cambodia, Vietnam, Algeria, Palestine, and the Middle East. After a conflict, it has
increasingly undertaken action to address the root causes of war and lay the founda-
tion for durable peace.
However, like many other international organizations, the UN has also been criti-
cized for some of the actions it has taken. Ralph Greer, writing in the Vancouver Sun,
stated that both the failures and the successes of the UN belong to its most powerful
members, as they constitute the majority of the Security Council, which makes all
important decisions.21 Also, UN officials talked about the successes and failures of the
UN during the fiftieth-anniversary commemoration of the signing of the UN Charter.
The officials pointed out that, despite the failures, the organization had 16 active
420
Figure A2.3 The United Nations
THE UNITED NATIONS
Maintenance of international
Main deliberative organ peace and security
General Assembly receives and considers reports

GENERAL ASSEMBLY (GA) primarily from Security Council and other UN organs SECURITY COUNCIL (S C)
*191 Members **15 Members
The secretary-general is The judges of the International

The members of the Economic and
appointed by the GA on the Court of Justice are jointly
Social Council and additional
recommendation of the SC elected by the GA and the SC.
members of the Trusteeship
Council are elected by the GA.
ECONOMIC AND SOCIAL TRUSTEES HIP COUNCIL SECRETARIAT INTERNATIONAL COURT OF

COUNCIL 5 Members JUSTICE
54 Members SECRETARY -GE NERAL 15 Judges
The primary organ to coordinate the Provides international supervision Serves to the other principal organs The principal judicial organ of the
economic, social, and related work for eleven trust territories and of the UN and administers the UN; settles legal disputes between
of United Nations ensures that adequate steps are programs and policies laid down by states and gives advisory opinions
taken to prepare the territories for them. The secretary-general is the to the UN and its agencies
self-governance or independence “chief administrative officer” of the
organization
*The General Assembly is composed of representatives of all member states, each of which has one vote.
**The Security Council has five permanent members (China, France, Russia, the United Kingdom, and the United States); the other ten members are
elected by the General Assembly for two-year terms.
peacekeeping operations and had helped negotiate settlements in at least 172 regional
conflicts from the Iran-Iraq war to the civil war in El Salvador. Further, they added
that the United Nations had played a role in supervising elections, promoting human
rights, curbing nuclear proliferation, fighting epidemics, and promoting development.
Boutros Boutros-Ghali, a former secretary-general of the UN, said he believed the main
accomplishments of the organization in its first half century were the roles it played in
decolonizing the third world, promoting international cooperation between rich and
poor countries, and increasing awareness of environmental problems. However, the
UN has had limited success in its efforts in the human rights area. Unfortunately for
the UN Commission on Human Rights (CHR), six of its human rights commission
members—China, Cuba, Eritrea, Saudi Arabia, Sudan, and Zimbabwe—were among
the most repressive regimes in the world as of 2005.22
Settling disputes between warring parties is another area in which the UN has had
very little success. For example, the UN failed to settle the disputes between Croatia
and Serbia. After waiting for the UN to help Serbia get back the disputed Krajina,
Serbia took matters into its own hands. Similarly, the UN was not initially success-
ful in bringing the Iran-Iraq war to an end. Only after the intervention of Sir John
Thompson, the United Kingdom’s representative to the UN, did the peace settlement
between the two countries end in a peace accord.23 Thompson’s initiative marked a
turning point in the Security Council’s approach to conflict resolution. The change
was underscored when Mikhail Gorbachev, in a departure from previous Soviet posi-
tions, called in 1987 for broader uses of UN peacekeeping forces.24
Charles W. Yost, who was the U.S. ambassador to the United Nations in 1970,
described the UN’s inability to keep the peace as “the central and critical failure”
of the world organization. He said, “It was created to keep the peace and if it can’t
keep the peace, any other successes it may have are likely to be overshadowed and
neglected.” He also stated that new kinds of international peacekeeping efforts were
needed for any Middle East settlement.
On the urging of some Security Council members, former Secretary-General Kofi
Annan embarked on reforming the UN to be more sensitive to some of the critical
world issues. While in office, he proposed and implemented numerous changes to
bring the organization’s management in line with best international practices. His
initiatives include the Brahimi recommendations for comprehensive changes to United
Nations peace operations, the 2002 Agenda for Further Change, the 2004 overhaul of
the staff security system, improved coordination of humanitarian assistance, as well
as a host of important budget, personnel, and management reforms. The current phase
of reform comes at a particularly crucial time for the UN. The organization has faced
an unprecedented series of challenges to meet the demands of member states, and yet
its operations continue to need updating to be able to handle these tasks.
As UN secretary-general, Kofi Annan assumed direct responsibility for imple-
menting reforms in a short time frame, as elaborated in his Implementation Report
(A/60/430). This update provided a status report on specific reforms agreed to by the
member states at the summit, as well as the ongoing reform measures previously initi-
ated under the secretary-general’s own authority. The task of continuing this reform
was then passed on to Ban Ki Moon.
422 AppENDIX 2
“The United Nations is the only hope of the world,” said Winston Churchill back
in 1944. Now, with the UN in crisis, attention should be given to his words and all
possible support from each member country should be given to the UN rather than
watching hope die.
THE WORLD BANK

The World Bank is a vital source of financial and technical assistance to developing
countries around the world. It is not a bank in the common sense. It is made up of two
unique development institutions owned by 184 member countries: the International
Bank for Reconstruction and Development (IBRD) and the International Develop-
ment Association (IDA). Each institution plays a different but supportive role in the
bank’s mission of global poverty reduction and the improvement of living standards.
The IBRD focuses on middle-income and creditworthy poor countries, while the IDA
focuses on the poorest countries in the world. Together, they provide low-interest
loans, interest-free credit, and grants to developing countries for education, health,
infrastructure, communications, and many other purposes.
Organized after the Bretton Woods, New Hampshire, meetings in July 1944, the
World Bank has expanded from a single institution to a closely associated group of
five development institutions. Their mission evolved from the IBRD as facilitator of
postwar reconstruction and development to the present-day mandate of worldwide
poverty alleviation in conjunction with their affiliate, the IDA.
The World Bank Group is made up of the following five organizations:
1. International Bank for Reconstruction and Development. The International

Bank for Reconstruction and Development provides loans and development
assistance to middle-income countries in Latin America, Asia, Africa, and
Eastern Europe. The IBRD gets most of its funds by selling bonds in inter-
national capital markets.
2. International Development Association. The International Development
Association plays an important role in the World Bank’s mission to reduce
poverty. Its support is focused on the poorest countries, to which it provides
interest-free loans and grants. The IDA depends on contributions from its
wealthier member countries for most of its financial resources.
3. International Finance Corporation. The International Finance Corporation
(IFC) promotes growth in the developing world by financing private sector
investments and providing technical support and advice to governments and
businesses. In partnership with private investors, the IFC provides loans and
equity finance for business ventures in developing countries.
4. Multilateral Investment Guarantee Agency. The Multilateral Investment
Guarantee Agency (MIGA) encourages foreign investment in developing
countries by providing guarantees to foreign investors against loss caused
by noncommercial risks. The MIGA also provides technical support to help
developing countries promote investment opportunities and uses its legal
services to reduce possible barriers to investment.
5. International Centre for the Settlement of Investment Disputes. The Interna-

tional Centre for the Settlement of Investment Disputes (ICSID) provides
facilities for settling investment disputes between foreign investors and their
host countries.
The World Bank is like a cooperative, where its 184 member countries are share-
holders. The shareholders are represented by the Board of Governors, which is the
ultimate policy maker at the World Bank. Generally, the governors are member
countries’ ministers of finance or ministers of development. They meet once a year
at the Annual Meetings of the Boards of Governors of the World Bank Group and the
International Monetary Fund. Because the governors meet only annually, they del-
egate specific duties to 24 executive directors, who work onsite at the bank. The five
largest shareholders—France, Germany, Japan, the United Kingdom, and the United
States—appoint an executive director, while other member countries are represented
by 19 executive directors.
THE BOARD OF GOVERNORS

One governor and one alternate governor in accordance with the Bank’s Articles of
Agreement are appointed for the Board of Governors by each member country. The
governor and alternate each serve a five-year term and may be reappointed. If the
member of the bank is also a member of the IFC or IDA, the appointed governor of
the bank and his or her alternate also serve as ex-officio governor and alternate on
the IFC and IDA Boards of Governors. MIGA governors and alternates are appointed
separately. Generally, these governors are government officials, such as ministers of
finance or ministers of development.
Under the articles, all powers of the bank are vested in the Board of Governors.
Pursuant to the bank’s bylaws adopted by the Board of Governors, the governors have
delegated to the executive directors all the powers that are not expressly reserved to
the governors under the articles.
The governors admit or suspend members, increase or decrease the authorized
capital stock, determine the distribution of net income, review financial statements
and budgets, and exercise other powers that they have not delegated to the executive
directors. The Board of Governors meets once a year at the bank’s annual meetings.
The meetings are traditionally held in Washington two years out of three and, in order
to reflect the international character of the institutions, every third year in a different
member country.
THE EXEcUTIVE DIREcTORS

The executive directors are responsible for the conduct of the general operations of the
bank and exercise all the powers delegated to them by the Board of Governors. Regular
elections of executive directors are held every two years, normally in connection with
the bank’s annual meetings. Over the years, it has been customary for election rules
to ensure that wide geographical and balanced representation be maintained on the
424 AppENDIX 2
Board of Executive Directors. Increases in the number of elected executive directors

require a decision of the Board of Governors by an 80 percent majority of the total
voting power. Before November 1, 1992, there were 22 executive directors, 17 of
whom were elected. In 1992, in view of the large number of new members that had
joined the bank, the number of elected executive directors was increased to 19. The
two new seats, Russia and a new group around Switzerland, brought the total number
of executive directors to its present level of 24.
The executive directors function in continuous sessions at the bank and meet as often
as the bank’s business requires. Executive directors consider and decide on IBRD loan
and guarantee proposals and IDA credit, they grant and guarantee proposals made by
the president, and they decide on policies that guide the bank’s general operations.
They are also responsible for presenting to the Board of Governors, at the annual
meetings, an audit of accounts, an administrative budget, and an annual report on the
bank’s operations and policies, as well as other matters. In shaping bank policy, the
Board of Executive Directors takes into account the evolving perspectives of member
countries on the role of the bank group as well as the bank’s operational experience.
In addition to attending regular board meetings twice a week, the executive directors
also serve on one or more of five standing committees: the Audit Committee, Budget
Committee, Committee on Development Effectiveness (CODE), Personnel Commit-
tee, and Committee on Governance and Executive Directors’ Administrative Matters.
The committees help the board discharge its oversight responsibilities through in-
depth examinations of policies and practices. Figure A2.4 presents the World Bank’s
organizational structure.
THE WORLD BANK: SUccESS OR FAILURE?

The World Bank, in its role as one of the world’s leading development lending agen-
cies, has had some successes as well as some failures. An area where the World Bank
has done quite well is in pursuing privatization policies, especially among the less
developed countries. Privatization seems to encourage local investments and that, in
turn, stimulates the economy. A case in point is the success of the privatization poli-
cies in Bangladesh.25 Research has shown that when countries undertake deregula-
tion and liberalization of formerly state-run industries, they can improve economic
performance.26 Recently, the World Bank has played a role in forcing the Group of
Eight to agree on aid and debt relief to low-income countries and middle-income
countries.27
The influence of the World Bank and its affiliates in shaping the economy of
South Africa is considered a success story.28 Survey findings from Asian execu-
tives on the achievements of the World Bank and the IMF in Asia show that
the institutions are believed to have adequately responded to financial crises in
Thailand and the Philippines and had influence in improving the region’s envi-
ronmental conditions.29
In 2002, the World Bank issued a US$300 million loan to Mexico to finance an
education reform project.30 The loan was the second phase of a three-part Adaptable
Program Loan (APL). These loans have influenced the Mexican government to take
Figure A2.4 The World Bank Group
THE WORLD BANK

GROUP
International WORLD BANK International Centre

International Finance Multilateral Investment
Development International Bank for for the Settlement of
Corporation Guarantee Agency
Association Reconstruction and Investment Disputes
(IFC) (MIGA)
(IDA) Development (IBRD) (ICSID)
IDA supports poorest IFC promotes growth in MIGA encourages foreign ICSID provides facilities for
countries by providing the developing world by investment in developing settling investment
interest-free loans and financing private sector countries by providing disputes between foreign
grants. investments and providing BOARD OF guarantees to foreign investors and their host
technical support and GOVERNORS investors against loss countries.
advice to governments and 184 Governors caused by noncommercial
businesses. risks.
EXECUTIVE
DIRECTORS
24 Members
Robert Zoellick
President
425
426 AppENDIX 2
steps toward modernization, decentralization, and democratization. The project is

considered a success for the World Bank as long as it takes the cultural needs of the
indigenous peoples into account.
In its efforts to reduce income inequality within and among countries, it appears
that the World Bank has not succeeded.31 The main causes of the rise in world in-
come inequality are attributed to the failure of the World Bank and the IMF to deal
effectively with the broader economic structural issues.32 One of the UN reports
criticizes the World Bank for failing to foster diversification. More than half of the
countries in Africa still depend on one or two commodities for 70 percent or more
of their export earnings.
Appendix 3
The Internet in International
Business
THE INTERNET AND BUSiNESS

The Internet has revolutionized the way businesses operate in the twenty-first
century. Beginning in 1990, Internet technology began to be used not only in
production processes but also in marketing, finance, human resources, and nearly
all other administrative functions. Today, few businesses can survive without a
Web page of their company that prominently provides detailed information for
consumers and investors. All companies recognize that they will be at a competi-
tive disadvantage if they do not keep up with the latest technological advances at
both the back and front room operations. These include the ability to implement
automatic ordering processes for raw materials, maintain lean inventory, and
run back-office services cost effectively. The term to describe the use of Internet
technology in business functions is defined as e-commerce, a word that did not
exist two decades ago.
E-commerce can be defined as business activity that usually involves trading a
service or product between two parties through the use of computers. The process
can be categorized into the following:
1. Electronic retailing or e-tailing, where online catalogs or a virtual mall with

multiple online catalogs are made available to customers to purchase goods and
services. This form of e-retailing is also called B2C or business-to-consumer
services.
2. B2B or business-to-business electronic transactions form another major
component of e-commerce and cover all activities between businesses over
the Internet. Activities include procurement and supply chain management,
delivery and sales of business information, and portals for exchange of
goods.
3. B2G is a new term to denote the business-to-business electronic transactions
that take place between businesses and government. Most governments ac-
count for a significant proportion of spending in an economy, roughly 20
percent of GDP for the United States, and therefore B2G is an important
component for growth in technological applications in the future.
427
428 AppENDIX 3
THE INTERNET AND INTERNATiONAL BUSiNESS

This appendix highlights the role of the Internet as it relates to business applications
and functions in the course of international activity. The use of the Internet continues
to evolve in the marketplace as innovations improve productivity and efficiency in
the workplace. We examine the innovations in technology in the three major areas
of finance, marketing, and production in international business.
INTERNATIONAL FINANcE
The use of computers in banking goes back a far as 1959, when Bank of America
ordered 32 ERMA (Electronic Recording Method of Accounting) computing machines
from General Electric to perform their accounting functions and checking handling.
It was based on the Magnetic Ink Character Reading (MICR) technology that is still
used today in checks.1 Similarly, the Automated Teller Machine (ATM) was originally
designed by Luther Simjian in 1939 and field tested by a bank that later became Cit-
ibank. However, they discontinued the use citing a lack of demand. It was not until
1967 that Barclays Bank installed the first machine in London.2
The progress in electronic transactions was already in motion by the 1990s, with
the use of telex that transmitted text messages across telephone lines. The advent of
fax transmission further increased the speed of sending instruction for cross-border
transactions. However, these were only messaging systems; the actual transfer of funds
was usually done by another set of staff of the banks in both countries. Today, with
Internet technology, the complete transaction of transferring funds can be executed
from one location. As a result, depositing money at a teller of a local bank is a real-
time transaction: it updates the client’s account as well as all other departments that
require notification of the transaction. At the end of the day, the total cash inflows
and outflows for the whole bank is available to senior management.
Transactions among financial institutions in 2008 exceeded a quadrillion trades per
year, and the speed of processing is now measured in milliseconds. The major institu-
tions that process these trades are the Fedwire Funds Services, TARGET, Automated
Clearing House (ACH), and the Depository Trust and Clearing Corporation (DTCC).
Real-Time Gross Settlement System (Fedwire and Target)
The Federal Reserve Board (the Fed) in the United States adopted the use of the
Internet in its payments system early on by developing the Fedwire and the ACH
systems. All banks in the United States use the Fedwire to transmit large value pay-
ments among themselves by having an account with the Fed. When Citibank decides
to send $10 million on behalf of a client to Wachovia Bank, it sends instructions via
the Internet, and the Fed debits the $10 million to Citibank’s deposit and credits the
same amount to Wachovia’s account. The payment is in real-time, irrevocable, and
final.3 In Europe, the same system is called TARGET (Trans-European Automated
Real-Time Gross Settlement Express Transfer system); it has recently been upgraded
to TARGET2 and went live on November 19, 2007.
THE INTERNET IN INTERNATIONAL BUSINESS 429
Automated Clearing Houses
The Federal Reserve also developed the Automated Clearing House in the 1970s,
enabling the transfer of small payments between private groups and generating sig-
nificant savings by reducing the flow of paper checks. ACH payments enable direct
deposits of payroll and payments related to social security, insurance, mortgages,
loans, federal and state taxes, business-to-business payments, and other entitlements
of the U.S. government. Over the years, several private clearing houses have also been
established that provide the same services as ACHs. They work under the rules devel-
oped by the National Automated Clearing House Association (NACHA), which are
similar to those established by the Fed. Among the largest is the Electronic Payments
Network that operates mainly in the Northeast sector of the United States. NACHA has
recently developed rules for cross-border payments to comply with the requirements
of the Office of Foreign Assets Control of the Department of the Treasury. Named
the International ACH Transaction (IAT), it must be implemented by all financial
institutions by March 2009, and will provide more information on the originator and
receiver of payments, especially when it goes through correspondent banks.
Depository Trust and Clearing Corporation
When an individual purchases a stock or bond today, there is rarely physical delivery
of the stock or bond certificates. Instead a book-entry takes place where the seller
receives payment directly into his or her bank account and the stock certificate number
is transferred from the seller to the buyer electronically. The U.S. government was
the first to issue government bonds and notes in paperless form (“dematerialized”).
Today, many companies also issue stocks or bonds in electronic form and it is expected
to become the norm throughout the world. All trades are then channeled through the
Depository Trust and Clearing Corporation (DTCC), which handles nearly all of the
securities trading in the United States. The DTCC is a not-for-profit organization that
is owned and controlled by all member institutions that provide trading services such
as the large commercial banks, investment banks, and mutual funds. The company
was started in the 1970s by the New York Stock Exchange (NYSE), American Stock
Exchange (AMEX), and other exchanges looking for ways to reduce the paperwork
associated with the sales of stocks.
As early as 1961, the NYSE with 15 member banks had begun book-entry trading
for 31 securities. This format then led to the creation of seven clearing and settlement
groups by the rest of the stock exchanges in the country. The two largest were the Na-
tional Securities Clearing Corporation (NSCC) and the Depository Trust Corporation
(DTC), owned by the NYSE, AMEX, and NASDAQ. Eventually the rest were merged
into the NSCC and DTC, and they in turn merged in 1999 to form the DTCC.4
Reuters and Bloomberg
All traders around the globe have either a Reuters or Bloomberg terminal on their
desk. These terminals receive a large volume of information from financial markets
430 AppENDIX 3
worldwide and are processed via algorithms to provide meaningful charts and analysis
to the traders. Reuters was providing such data even before Bloomberg began its ser-
vices, but Bloomberg managed to capture a larger market share in the United States
by providing data that was deemed relevant to traders and more user friendly than
their competitors. Although Reuters has an overall edge globally, both companies are
tied neck and neck in the supply of financial information to global markets.
INTERNATIONAL MARKETING
In the field of marketing, Internet technology has been useful to companies in two
areas, advertising and sales.
Advertising
The Internet has changed the world of advertising by slowly replacing print, radio,
and television advertisements as the dominant media to reach customers worldwide.
As mentioned earlier, it is necessary today for all companies to have a Web site that
effectively displays information about the company and their products and services.
Research shows that consumers with Internet access research products online even if
they intend to purchase them in stores. A Web site alone, however, is not sufficient for
a company to improve its sales, domestic or international. It has to ensure that traffic on
the Internet is directed to their Web site, which is difficult when one considers that in
2008 there were more than 250 billion pages available on the World Wide Web. The two
keys ways to ensure the flow of traffic to a company’s Web site are discussed next.
Paid Advertisements (Pay per Click)
Companies can pay to have their Web sites appear on the pages of major search engines,
which include Google, Yahoo, and MSN. The terms of payments are “pay per click”
(PPC), and the cost depends on the number of clicks made by potential clients when
visiting the Web pages. Companies may contract directly with the search engines or deal
with advertising companies that specialize in placing ads online around the globe.
As an example, Google will display a company’s advertisement as a sponsored link
on key search words. If a company in Indonesia provides tourism packages, and a
U.S. customer types “travel and Indonesia” in Google, the company’s advertisement
will appear as part of a sponsored link. Google also offers what is called “contextual
targeting technology,” in which companies can place their advertisements in sites
related to their business. A company that writes blogs on travel, for instance, can
have travel advertisements directed to their site. The payments are usually based on
the number of clicks on the advertisement.
Search Engine Optimization (SEO)
The other method is for the company to ensure through the development of its Web
site that online traffic is maximized to its page. All major search engines keep their
policy of selecting pages to display in response to keywords a carefully guarded secret.

However, some minimum requirements must be met in the design of Web pages in
order to have them selected for front page display. Professional companies or search
engine optimization (SEO) programmers must continuously monitor the traffic and
tweak the meta tags (words that are searched by search engines to determine content)
used in a Web page to increase its chances of being selected for the first few pages
of browsing. Research has shown that most users do not go past a few pages when
searching on the Internet.
Companies that optimize their Web pages (defined as organic search Web sites)
are generally trusted more than companies using paid advertisements. Customers are
somewhat skeptical of sponsored Web sites. Organic Web sites are cheaper because
advertisement are free; however, these sites require effort and finesse to ensure they
end up on the front pages of the top search engines. For international business, this
will require interacting with the local search engines in the relevant countries.
Sales
The Internet has proved to be a major tool for companies to boost their international
sales. The ability to contact firms globally via the Web has created a new industry that
specializes in packaging global data for companies planning their global marketing
strategy. Most companies have also set up Web pages for orders to be placed directly
to their portal for delivery of goods through their international sales offices.
INTERNATIONAL PRODUcTION AND OpERATIONS

Perhaps the biggest benefits of Internet technology are those related to improving
efficiency in international production and operations. The two most important pro-
ductivity advances involve:
1. The use of Internet technology to design efficient allocation of resources between

subsidiaries and the parent. The integration of workflow processes between sub-
sidiaries and the parent has to be fully optimized in order to achieve efficiency
throughout the company. This requires software that can evaluate the inventory
levels and requirements of all subsidiaries and provide the information to one
central location, thereby assisting in the procurement of resources as well as
the allocation of the output from the various subsidiaries.
2. The use of Internet technology to design efficient allocation of resources
between companies and external stakeholders. External stakeholders include
(1) the clients whose success hinges on an efficient delivery method, and
(2) the suppliers whose costs decrease when the most efficient method of
procurement is used.
The major improvements in the efficiency of these services have taken place through
the implementation of software for managing information effectively between the
various stakeholders and their respective units. The three popular software programs
432 AppENDIX 3
that support these activities include Oracle, SAP, and Sage Software. These programs
usually cover different functional areas and different phases of the workflow process
of an organization. They include the following areas:
1. Product life cycle (PLC) management

2. Enterprise resource planning
3. Supply-chain management
4. Human resource management
5. Customer relationship management
6. Electronic commerce
7. Real estate management
8. Environment, health, safety, and other regulatory issues
Electronic Data Interchange (EDI)
Electronic Data Interchange is the delivery of standardized forms of messages be-

tween companies, mostly in the area of sales and purchase management. This was
among the earliest vehicles used by companies to automate the purchase and sales
processes. EDI is a subset of e-commerce in that it only pertains to the transmission
of information between two business entities. The information allows for Company
A to purchase from Company B by inputting just the information relevant to the sale,
which then can be transmitted electronically; the order recording, shipment informa-
tion, and confirmation of payment can all be accomplished electronically. Wal-Mart,
for example, expects its suppliers to be fully compliant with their EDI requirements.
Goods have to be shipped and confirmed within very tight schedules. If goods do not
reach the central docks on time, suppliers miss their opportunity to transport them to
the various stores; suppliers will then end up paying for the missed deliveries.
There are currently three standards in place for designing EDI protocols.
1. ISO/IEC 14662:1997 was established by the International Organization

of Standardization (ISO), along with the International Electrotechnical
Commission, to make EDI standards uniform across the world. It uses an
open-edi approach to make it much simpler for companies to develop protocols
for interacting with diverse companies.
2. ANSI ASC X12 (American National Standards X12) is the standard used in
the United States and is applicable to all kinds of business documents, in-
cluding invoices and purchase orders. The Accredited Standards Committee
X12 was given the task of designing the standards that initially began with
the Transportation Data Coordination Committee in 1975, followed by the
implementation in other industries, such as financial services, in 1986, and
the insurance and health care industries in 1991.5
3. UN/EDIFACT or United Nations/Electronic Data Interchange for Administra-
tion Commerce and Transport was adopted by the United Nations and is still
used in Europe. The Accredited Standards Committee of the United States is
attempting to makes its standards converge toward the EDIFACT design.
There are many companies that offer global EDI packages that make it easy to
communicate between different industries in different countries. The programs are
basically written to make them compatible across the three standards.
AppENDiX 3 SUMMARY
Internet technology has greatly impacted the way business is conducted globally. As
in domestic business, it has changed the mode of operations in all areas of business,
including finance, marketing, production, and administration.
In finance, the biggest impact has been on the way payments are transferred between
companies and financial institutions in different countries. They have reached an ef-
ficiency level where payments across countries can be cleared and settled in one day.
In additional, financial information is available instantly across the globe via computer
for traders, eliminating price discrepancies and opportunities to arbitrage.
In marketing, the biggest change has taken place in the world of advertising,
where the Internet is expected to replace print, TV, and radio as the dominant media.
Companies have the option of paying to have their Web pages accessible to potential
customers, or they can optimize their Web sites to ensure their pages are selected when
specific words are keyed in by customers. The latter is termed an “organic search,”
and customers usually trust organic search results over paid or sponsored links. In
international marketing, companies have to be aware of not only targeting globally
recognized search engines such as Google, MSN and Yahoo but also the local search
engines popular in each country or region.
In production, there have been rapid advances in the use of Internet technology to
improve efficiency and speed in the global operations of companies. Internet technol-
ogy has reduced the distances between subsidiaries and the parent company. Software
by SAP and Oracle, for example, can link the production and operation schedules of
many factories into a single database and coordinate activities simultaneously.
Notes
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435
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January 10, 2007 pp. 1, C5.
3. Enrico Giovannini, “Statistics and Politics in a ‘Knowledge Society,’” Social Indicators Research
86, no. 2 (2008): 177–200.
440 NOTES
4. Paul M. Vaaler, “How Do MNCs Vote in Developing Country Elections,” Academy of Manage-
ment Journal 51, no. 1 (2008): 21–43.
5. R.J. Rummel and David A. Heenan, “How Multinationals Analyze Political Risk,” Harvard
Business Review 56, no. 1 (178): 67–76.
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tinational Firms—An Assessment,” International Journal of Management 6, no. 1 (1989): 18–28.
9. Jean J. Boddewyn and Thomas L. Brewer, “International Business Political Behavior: New
Theoretical Direction,” Academy of Management Review 19 no. 1 (1994): 119–43.
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13. Ivar Kolstad and Espen Villanger, “Determinants of FDI in Services,” European Journal of
Political Economy 24, no. 2 (2008): 518–33.
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ments and Operations, 11th ed. (Upper Saddle River, NJ: Prentice Hall, 2007), p. 91.
15. Gabriel A. Almond and G. Bingham Powell, Jr., eds., Comparative Politics Today: A World View,
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16. Stephen B. Tallman, “Home Country Political Risk and Foreign Direct Investment in the United
States,” Journal of International Business Studies 19, no. 2 (1988): 219–34.
17. Gardiner Morse, “Doing Business in a Dangerous World,” Harvard Business Review 80, no. 4
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NOTES 441
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NOTES TO CHApTER 5
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2. Tarini J. Carr, “The Harappan Civilization,” Archeology Online. Available at http://www.archae-
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Quarterly Journal of Economics 80 (1966): 190–207.
4. Directorate for Financial and Enterprise Affairs, OECD, “Foreign Direct Investment for Devel-
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5. John Dunning, “The Eclectic (OLI) Paradigm of International Production: Past, Present, and
Future,” International Journal of the Economics of Business 8, no. 2 (July 2001): 173–90.
6. ALCOA, “Alcoa Announces Cooperation Agreement with Vietnam on Development of Bauxite
Mining and Alumina Refineries,” news release, June 24, 2008. Available at http://www.alcoa.com/global/
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8. David Barboza, “U.S. Group Accuses Chinese Toy Factories of Labor Abuses,” New York Times,
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NOTES TO CHApTER 6
1. Richard Harris and Qian Cher Li, “Evaluating the Contribution of Exporting to U.K. Productivity
Growth: Some Microeconomic Evidence,” World Economy 31, no. 2 (2008): 212–35.
442 NOTES
2. Luis Filipe Lages, Sandy D. Jap, and David A. Griffin, “The Role of Past Performance in Ex-
port Ventures: A Short-Term Reactive Approach,” Journal of International Business Studies 39, no. 2
(2008): 304–25.
3. Ven Sriram, James P. Neelankavil, and Russell Moore, “Export Policy and Strategy Implications
for Small-to-Medium-Sized Firms,” Journal of Global Marketing 3, no. 2 (1989): 43–61.
4. T.K. Das and Bing-Sheng Teng, “A Resource-Based Theory of Strategic Alliances,” Journal of
Management 26, no. 1 (2000): 31–61.
5. Richard C. Hoffman and John F. Preble, “Global Diffusion of Franchising: A Country Level
Examination,” Multinational Business Review 9, no. 1 (2001): 66–76.
6. John Tozzi, “Is It Time to Buy a Franchise?” Business Week, March 10, 2008, p. 12.
7. “Merck Signs Licensing Agreement with Sol-Gel,” Soap, Perfumery & Cosmetics, Febru-
ary 2008, p. 8.
8. Kyuho Lee, Mahmood A. Khan, and Jae-Youn Ko, “Outback Steakhouse in Korea,” Administra-
tion Quarterly 49, no. 1 (2008): 62–72.
9. Tony Dignam, “Franchising a Structured Plan Is the Key to Success,” Accountancy Ireland 40,
no. 1 (2008): 54–55.
10. Destan Kandemir and G. Tomas Hult, “A Conceptualization of an Organizational Learn-
ing Culture in International Joint Ventures,” Industrial Marketing Management 34, no. 5 (2005):
440–46.
11. Mike W. Peng and Oded Shenkar, “Joint Venture Dissolution as Corporate Divorce,” Academy
of Management Executive 16, no. 2 (2002): 92–105.
12. Arvind Parkhe, “Building Trust in International Alliances,” Journal of World Business 33, no.
4 (1998): 417–37.
13. “Motorola Joins Two India Joint Ventures,” United Press International (UPI) News Brief, July
25, 2006.
14. Anne-Wil Harzing, “Acquisitions versus Greenfield Investments: International Strategy and
Management of Entry Modes,” Strategic Management Journal 23, no. 3 (2002): 211–27.
15. Charles W.L. Hill, Peter Hwang, and Chan W. Kim, “An Eclectic Theory of the Choice on
International Entry Mode,” Strategic Management Journal 11, no. 2 (1990): 117–28.
16. Ashish Arora and Andrea Fosfuri, “Wholly Owned Subsidiary versus Technology Licensing in the
Worldwide Chemical Industry,” Journal of International Business Studies 31, no. 4 (2000): 555–72.
NOTES TO CHApTER 7
1. Tim Brown, “Design Thinking,” Harvard Business Review 89, no. 6 (2008): 84–92.
2. Jay R. Galbraith, Designing Organizations: An Executive Guide to Strategy Structure and Process
(San Francisco: Jossey-Bass, 2002).
3. Cliff Edwards, “Shaking Up Intel’s Insides,” Business Week, January 31, 2005, p. 35.
4. Danny Miller, Russell Eisenstat, and Nathaniel Foote, “Strategy from the Inside Out: Building
Capability-Creating Organizations,” California Management Review 44, no. 3 (2002): 37–54.
5. Mohanbir Sawhney, “Don’t Homogenize, Synchronize,” Harvard Business Review 79, no. 7
(2001): 100–108.
6. Julian Birkinshaw, Neil Hood, and Stefan Jonsson, “Building Firm-Specific Advantages in
Multinational Corporations,” Strategic Management Journal 19, no. 3 (1998): 221–41.
7. Sergio Olavarrieta and Roberto Friedmann, “Market Orientation, Knowledge-Related Resources
and Firm Performance,” Journal of Business Research 61, no. 6 (2008): 623–30.
8. Claudio Carpano and Manzur Rahman, “Information Technology, International Marketing and
Foreign Subsidiaries Market Share,” Multinational Business Review 6, no. 1 (1998): 36–43.
9. David Cray, “Control and Coordination in Multinational Corporations,” Journal of International
Business Studies 15, no. 2 (1984): 85–98.
10. Peter Drucker, The Practice of Management (New York: Harper & Row, 1954).
NOTES 443
11. Paul Evans, Vladimir Pucik, and Jean-Louis Barsoux, The Global Challenge: Frameworks for
International Human Resource Management (Boston: McGraw-Hill, 2002).
12. John Child and Rita Gunther McGrath, “Organizations Unfettered: Organizational Form in an
Information-Intensive Economy,” Academy of Management Journal 44, no. 6 (2001): 1135–48.
13. Ting-Ping Liang and Mohan Tanniru, “Customer-Centric Information Systems,” Journal of
Management Information Systems 23, no. 3 (Winter 2007): 9–15.
14. Indranil Bardhan, Jonathan Whitaker, and Sunil Mithas, “Information Technology, Production
Process Outsourcing, and Manufacturing Plant Performance,” Journal of Management Information
Systems 23, no. 2 (Fall 2006): 13–40.
15. Jules Duga and Tim Studt, “Globalization Distributes More of the R&D Wealth, R&D Magazine
49, no. 9 (2007): G3–18.
16. Barry Jaruzelski, Kevin Dehoff, and Rakesh Bordia, “A Select Set of Companies Sustain Su-
perior Financial Performance While Spending Less on R&D Than Their Competitors,” Booz Allen
Hamilton’s Annual Study of the World’s 1,000 Largest Corporations R&D Budgets, November 13,
2006, pp. 1–21.
17. “Spending by Semiconductors,” Electronic News 52, no. 30 (2006): 29.
18. Jaruzelski, Dehoff, and Bordia, “A Select Set of Companies Sustain Superior Financial Perfor-
mance While Spending Less on R&D Than Their Competitors.”
19. K. Kim, J-H Park, and J.E. Prescott, “The Global Integration of Business Functions: A Study
of Multinational Business in Integrated Global Industries,” Journal of International Business Studies
34, no. 4 (2003): 327–44.
20. Paul Larson, “An Empirical Study of Inter-organizational Functional Integration and Total
Costs,” Journal of Business Logistics 15, no. 1 (1994): 153–69.
21. George S. Day, “Aligning the Organization with the Market,” Sloan Management Review 48,
no. 1 (2006): 41–49.
22. Vijay Govindrajan, “A Contingency Approach to Strategy Implementation at the Business-Unit
Level: Integrating Administrative Mechanisms with Strategy,” Academy of Management Journal 31,
no. 4 (1988): 828–53.
NOTES TO CHApTER 8
1. Xiaofeng Ma and Marcel Dissel, “Rapid Renovation of Operational Capabilities by ERP
Implementation: Lessons from Four Chinese Manufacturers,” International Journal of Manufacturing
Technology and Management 14, no. 3–4 (2008): 431–47.
2. David A. Aaker, “Creating a Sustainable Competitive Advantage,” California Management
Review, Winter 1989, pp. 91–106.
3. Theodore Levitt, “Marketing Intangible Products and Product Intangibles,” Harvard Business
Review, May−June 1981, pp. 94–102.
4. M. Bachlaus, M.K. Tiwari, and R. Shankar, “Cost Management and Time Management in Lean
Manufacturing,” International Journal of Production Research 46, no. 12 (2008): 3387–413.
5. Matthias Zimmermann, Lars Zschom, Joachim Kaschel, and Tobia Teich, “A Conceptual Model
and an Information Tool for the Establishment of Production Networks Based on Small and Smallest
Enterprises,” International Journal of Manufacturing Technology and Management 14, no. 3–4 (2008):
342–58.
6. Shawnee K. Vickery, Cornelia Droge, and Robert E. Markland, “Production Competence and
Business Strategy: Do They Affect Business Performance?” Decision Sciences 24, no. 2 (1993):
435–55.
7. Robert N. Mefford, “Determinants of Productivity Differences in International Manufacturing,”
Journal of International Business Studies, Spring 1986, pp. 63–82.
8. David Woodruff, “Why Mercedes Is Alabama Bound,” Business Week, October 11, 1993, pp.
138–39.
444 NOTES
9. City Mayors, “The World’s Top Cities Offering the Best Quality of Life,” March 7, 2009. Avail-
able at http://www.citymayors.com/features/quality_survey.html; “The World’s Most Expensive Big
Cities,” March 7, 2009. Available at http://www.citymayors.com/features/cost_survey.html.
10. Richard Chacon, “Managing the Crisis BankBoston Sticks to Latin Expansion Strategy; Despite
Global Breakdown and Investor Jitters,” Boston Globe, September 30, 1998, p. E1.
11. Grit Walther, Thomas Spengler, and Dolores Queiruga, “Facility Location Planning for Treat-
ment of Large Household Appliances in Spain,” International Journal of Environmental Technologies
and Management 8, no. 4 (2008): 405–25.
12. Paul M. Swamidass, “A Comparison of the Plant Location Strategies of Foreign and Domestic
Manufacturers in the U.S.,” Journal of International Business Studies 21, no. 2 (1990): 301–17.
13. For a detailed discussion of these two methods, refer to Jay Heizer and Barry Render, Production
and Operations Management (Upper Saddle River, NJ: Prentice Hall, 1996), pp. 352–53.
14. Manoj K. Malhotra and Larry P. Ritzman, “Resource Flexibility Issues in Multistage Manufac-
turing,” Decision Sciences 21, no. 4 (1990): 673–90.
15. Steven C. Wheelwright and Robert H. Hayes, “Competing through Manufacturing, Harvard
Business Review, January–February 1985, pp. 99–109.
16. K.R. Harrigan, Strategies for Vertical Integration (Lexington, MA: D.C. Heath, 1983).
17. S.K.M. Ho, “TQM and Organizational Change,” International Journal of Organizational Analysis
7, no. 2 (1999): 169–81.
18. “How Manufacturers Drive Improvement,” Industrial Engineer 36, no. 3 (2004): 1. For ad-
ditional information on TQM, see E.A. Anderson and Adams A. Dennis, “Evaluating the Success of
TQM Implementations: Lessons from Employees,” Production and Inventory Management Journal
38, no. 4 (1997): 1–6; A.M.Y. Chan, Fangus Wai-Wa Chu, and Chi Kwong Yuen, “A Successful TQM
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Zhang, “Developing a Model of Quality Management Methods and Evaluating Their Effects on Busi-
ness Performance,” Total Quality Management 11, no. 1 (2000): 129–37.
19. Dennis Sester, “Motorola: A Tradition of Quality,” Quality 40, no. 10 (2001): 30–34.
20. General Electric, “Making Customers Feel Six Sigma Quality.” Available at http://www.ge.com/
sixsigma/makingcustomers.html (accessed August 5, 2004).
21. “How Manufacturers Drive Improvement,” Industrial Engineer 36, no. 3 (2004): 1.
22. Fataneh Taghaboni-Dutta and Keith Moreland, “Using Six-Sigma to Improve Loan Portfolio
Performance,” Journal of American Academy of Business, Cambridge 5, no. 1–2 (2004): 15–21.
23. iSixSigma, “Ask the Expert. The Topic: Six Sigma and Business Strategy.” Interview with Joe
Valasquez, Senior Vice President, Bank of America. Available at http://www.isixsigma.com/library/
content/a040823a.asp (accessed June 2008).
24. Will Wade, “The Tech Scene: B of A Touts Six Sigma’s Bottom-Line Benefits,” American Banker
169, 144 (July 28, 2004): 1–2.
25. John P. Shewchuk, “Worker Allocation in Lean U-Shaped Production Lines,” International
Journal of Production Research 46, no. 13 (2008): 3485–502.
26. Gerald R. Aase, John R. Olson, and Marc J. Schniederjans, “U-Shaped Assembly Layouts and
Their Impact on Labor Productivity: An Experimental Study,” European Journal of Operations Re-
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27. E.P. Hibbert, “Global Make-or-Buy Decisions,” Industrial Marketing Management 22, no. 2
(1993): 67–77.
28. Song Huang, Yujin Hu, and Chenggang Li, “A TCPN Based Approach to Model the Coordination in
Virtual Manufacturing Organizations,” Computers and Industrial Engineering 47, no. 1 (2004): 61–77.
29. Jamie Flinchbaugh and James J. Benes, “In Search of Waste,” American Machinist 148, no. 6
(2004): 56–58.
30. Drew Lathin and Ron Mitchell, “Learning from Mistakes,” Quality Progress 34, no. 6 (2001):
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31. “How Manufacturers Drive Improvement,” Industrial Engineer 36, no. 3 (2004): 1.
NOTES 445
32. Scott McMurray, “Ford’s F-150: Have It Your Way,” Business Week, March 2004, pp. 53–55.
33. Shigeo Shingo, Non-Stock Production: The Shingo System for Continuous Improvement (Cam-
bridge, MA: Productivity Press, 1988), p. 36.
34. Robert D’Avanzo, “The Reward of Supply Chain Excellence,” Optimize, December 2003, p.
68.
35. Timothy Aeppel, “Manufacturers Cope with Costs of Strained Global Supply Lines,” New York
Times, December 8, 2004, p. 1A.
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37. “E. China City Becomes Auto Part Export Giant,” Xinhua, May 26, 2004, p. 1.
38. Masaaki Kotabe and Glenn S. Omura, “Sourcing Strategies of European and Japanese Multina-
tionals: A Comparison,” Journal of International Business Studies, Spring 1989, pp. 113–30.
39. George S. Day, Understand CRM (London: Financial Times, 2000), pp. 10–13.
NOTES TO CHApTER 9
1. “Sourcing Global Talent: Europe’s Place in a Globalised Economy—Interview with Mark Spelman,
Chairman of the American Chamber of Commerce’s Executive Committee in Brussels,” New Europe,
June 16, 2008. Available at http://www.neurope.eu/articles/87848.php (accessed August 28, 2008).
2. U.S. Department of Labor, Bureau of Labor Statistics, Table of Civilian Unemployment Rate,
1974–2007. Available at http://www.federalreserve.gov/boarddocs/hh/2007/february/figure34.htm
(accessed August 28, 2008).
3. Cédric Tille and Kei-Mu Yi, “Curbing Unemployment in Europe: Are There Lessons from Ireland
and the Netherlands?” Current Issues in Economics and Finance 7, no. 5 (May 2001).
4. Neil Shister, “Executive Overview: Near-Sourcing,” World Trade, January 3, 2008. Available at
http://www.worldtrademag.com/Articles/Column/BNP_GUID_9–5-2006_A_10000000000000226880
(accessed August 28, 2008).
5. “Big 6 ‘Switch’ to Bigger Deals, Corner 2.4% of Global Work,” Economic Times, June 13, 2008.
Available at http://economictimes.indiatimes.com/articleshow/msid-3124559,prtpage-1.cms (accessed
August 28, 2008).
6. E-Business Strategies (EBS), “Offshore Outsourcing Failure Case Studies.” Available at http://
www.ebstrategy.com/Outsourcing/cases/failures.htm (accessed August 28, 2008).
7. Dell, “Dell Commences Manufacturing in India for Large, Growing Number of Indian Cus-
tomers,” July 30, 2007. Available at http://www.dell.com/content/topics/global.aspx/corp/pressoffice/
en/2007/2007_07_30_in_000?c=us&1 =en&s=corp.
8. NASSCOM, “NASSCOM-McKinsey Report 2005: Extending India’s Leadership in the Global IT
and BPO Industries,” news release, December 13, 2007. Available at http://www.nasscom.in/Nasscom/
templates/NormalPage.aspx?id=2599.
9. Denise Dubie, “Gartner: Top 30 Offshore Locations for 2008,” Network World, May 20,
2008. Available at http://www.networkworld.com/news/2008/052008-gartner-top-offshore-locations.
html?page=1.
10. Rachelle Jackson, “Wage Rates—China’s Rising Costs Make Buyers Think Twice,” Ethical Cor-
poration, March 10, 2008. Available at http://www.ethicalcorp.com/content.asp?ContentID=5768.
11. Enrico Benni and Alex Peng, “China’s Opportunity in Offshore Services,” McKinsey Quarterly,
May 2008.
12. Government Accountability Office, “Offshoring of Services: An Overview of the Issues,” Report
to Congressional Committees, December 29, 2005. Available at http://www.gao.gov/new.items/d065.
pdf (accessed August 28, 2008).
13. Wal-Mart Watch, “That Was Then, This Is Now.” Available at http://walmartwatch.com/pages/
that_was_then_this_is_now.
14. D. Monga and C. Chakravarty, “Barclays to Set Up Captive BPO in India,” Economic Times, May
10, 2008. Available at http://economictimes.indiatimes.com/articleshow/msid-3026165,prtpage-1.cms.
446 NOTES
15. Sudin Apte, “Shattering the Offshore Captive Center Myth,” Forrester Research, April 30, 2007.
Available at http://www.forrester.com/Research/Document/Excerpt/0,7211,42059,00.html.
16. “Captive BPO Centres Begin to Pay Off,” Economic Times, September 26, 2007. Available at
http://economictimes.indiatimes.com/Infotech/ITeS/Captive_BPO_centres_begin_to_pay_off/article-
show/2402877.cms.
17. Marianne Kolbasuk McGee, “Vast Majority of U.S. Companies Don’t Offshore IT Work,” In-
formationWeek, January 23, 2008. Available at http://www.informationweek.com/news/management/
outsourcing/showArticle.jhtml?articleID=205917099.
18. “Off-Shoring: How Big Is It?” A Report of the Panel of the National Academy of Public Ad-
ministration for the U.S. Congress and the Bureau of Economic Analysis, October 2006. Available at
http://www.bea.gov/papers/pdf/NAPASecondOff-ShoringReport10–31–06.pdf.
19. Procurement Leaders Network, “European Offshoring Spend Set to Soar in 2008,” December
17, 2007. Available at http://www.procurementleaders.com/learninggroups/global-sourcing/global-
sourcing-news/european-offshoring-soar-2008/.
20. Alice Lipowicz, “Most States Offshore Human Services Tech Support,” Government Computer
News, March 3, 2006. Available at http://www.gcn.com/online/v011_n01/40274–1.html#.
21. Linda Tucci, “PWC Study: Majority of Top Executives Bullish on Outsourcing,” CIO News, May 24,
2007. Available at http://searchcio.techtarget.com/news/article/0,289142,sid182_gci1256272,00.html.
22. “KPO sector to be worth $10 billion by 2012,” Economic Times, June 17, 1008. Available at http://
economictimes.indiatimes.com/Infotech/ITeS/KPO_sector_to_be_worth_10_billion_by_2012_As-
socham/articleshow/3137959.cms (accessed November 21, 2008).
23. Jamie Liddell, “Sourcing Superstars: Alok Aggarwal & Marc Vollenweider, Evalueserve,”
Articlebase, September 26, 2008, available at http://www.articlesbase.com/outsourcing-articles/
sourcing-superstars-alok-aggarwal-marc-vollenweider-evalueserve-579083.html (accessed November
21, 2008).
NOTES TO CHApTER 10
1. Testimony of Chairman Alan Greenspan before the Committee on Financial Services, U.S. House
of Representatives, February 11, 2004, Federal Reserve Board’s semiannual Monetary Policy Report
to Congress. Available at http://www.federalreserve.gov/boarddocs/hh/2004/february/testimony.htm
2. China may have begun to mint coins even prior to 600 B.C., although they were made of base
metals as opposed to silver or gold. See Glyn-Davies, History of Money from Ancient Times to the
Present Day, 3rd ed. (Cardiff: University of Wales Press, 2002). Excerpts available at http://www.ex.ac.
uk/~RDavies/arian/amser/chrono.html (access May 18, 2008).
3. Bank of England, “History and Timeline.” Available at www.bankofengland.co.uk (accessed
July 18, 2008).
4. Triennial Central Bank Survey, “Foreign Exchange and Derivatives Market Activity in 2007,”
December 2007, p. 9. Available at www.bis.org (accessed June 16, 2008).
NOTES TO CHApTER 11
1. Philip M. Parker and Nader T. Tavassoli, “Homeostasis and Consumer Behavior across Cultures,”
International Journal of Research in Marketing 17, no. 1 (2000): 33–53.
2. C. Samuel Craig, William H. Greene, and Susan P. Douglas, “Culture Matters: Consumer Ac-
ceptance of U.S. Firms in Foreign Markets,” Journal of International Marketing 13, no. 4 (2005):
80–103.
3. Musa Pinar and Paul S. Trapp, “Creating Competitive Advantage through Ingredient Branding
and Brand Ecosystem: The Case of Turkish Cotton and Textiles,” Journal of International Food and
Agribusiness Marketing 20, no. 1 (2008): 29–56.
NOTES 447
4. Lenita Davis, Sijun Wang, and Andrew Lindridge, “Culture Influences on Emotional Response
to On-Line Store Atmospheric Cues,” Journal of Business Research 61, no. 8 (2008): 806–12.
5. Wagner A. Kamakura, “Lifestyle Segmentation with Tailored Interviewing,” Journal of Market-
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7. Svein Ottar Olsen and Ulf H. Olsson, “Multientity Scaling and the Consistency of Country-of-
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8. Zeynep Gurhan-Canli and Durairaj Maheswaran, “Cultural Variations in Country of Origin Ef-
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9. Terrence Witkowski and Mary Wolfinbarger, “Comparative Service Quality: German and American
Ratings of Five Different Service Settings,” Journal of Business Research, November 2002, 875–81.
10. Theodore Levitt, “The Globalization of Markets,” Harvard Business Review 61, no. 3 (1983):
92–101.
11. Levitt, “The Globalization of Markets.”
12. Henry F.L. Chung, “An Investigation of Cross-Market Standardization Strategies: Experiences
in the European Union,” European Journal of Marketing 39, no. 11–12 (2005): 1345–71.
13. W. Chan Kim and Renée Mauborgne, “Creating New Market Space,” Harvard Business Review,
January–February 1999, pp. 83–93.
14. Chris Barnham, “Instantiation,” International Journal of Market Research 50, no. 2 (2008):
203–20.
15. Susan P. Douglas, C. Samuel Craig, and Edwin J. Nijssen, “Integrating Branding Strategy
across Markets: Building International Brand Architecture,” Journal of International Marketing 9, no.
2 (2001): 97–114.
16. Shirley Leitch and Sally Davenport, “Corporate Brands and Social Brands,” International Stud-
ies of Management and Organization 37, no. 4 (2008): 45–63.
17. “The 100 Top Brands,” Business Week, August 6, 2007, pp. 59–63.
18. J. Lynch and L. Whicker, “Do Logistics and Marketing Understand Each Other? An Empirical
Investigation of the Interface Activities between Logistics and Marketing,” International Journal of
Logistics Research and Applications 11, no. 3 (2008): 167–78.
19. “Unshackling the Chain Stores,” Economist, May 31, 2008, pp. 69–70.
20. Ralf W. Seifert, Ulrich W. Thonemann, and Marcel A. Sieke, “Integrating Direct and Indirect
Sales Channels under Decentralized Decision-Making,” International Journal of Production Econom-
ics 103, no. 1 (2006): 209–29.
21. Francis Bassolino and Sean Leow, “FICE and the Liberalization of Distribution in China,” China
Business Review 33, no. 4 (2006): 16–30.
22. “Establish New Channels of Distribution to Reduce Our Export Costs,” Controller’s Report,
March 2006, p. 10.
23. Patrick Bryne, “Supply Chain Mastery: One Key Success in China,” Logistics Management 45,
no. 7 (2006): 30–32.
24. Yoshinobu Sato, “Some Reasons Why Foreign Retailers Have Difficulty in Succeeding in the
Japanese Market,” Journal of Global Marketing 18, no. 1–2 (2004): 21–44.
25. Alex Rialp, Catherine Axinn, and Sharon Thach, “Exploring Channel Internationalization among
Spanish Exporters,” International Marketing Review 19, no. 2–3 (2002): 133–55.
26. Jerry Kliatchko, “Towards a New Definition of Integrated Marketing Communications,” Inter-
national Journal of Advertising 24, no. 1 (2005): 7–34.
27. Claudia Penteado, “InBev Aggressive Marketer with a Diverse Portfolio,” Advertising Age,
June 2, 2008, p. 45.
28. Gillian Rice and Mohammed Al-Mossawi, “The Implications for Islam for Advertising Messages:
The Middle Eastern Context,” Journal of Euro-Marketing 11, no. 3 (2002): 71–96.
29. Charles R. Taylor and Shintaro Okazaki, “Comparison of U.S. and Japanese Subsidiaries’
448 NOTES
Advertising Practices in the European Union,” Journal of International Marketing 14, no. 1 (2006):
98–120.
30. “Leading National Advertisers,” Advertising Age, June 5, 2008, p. 8.
31. Erica Riebe and John Dawes, “Recall of Radio Advertising in Low-Clutter and High-Clutter
Formats,” International Journal of Advertising 25, no. 1 (2006): 71–86.
32. Sunil Erevelles, Fred Morgan, Ilkim Burke, and Rachel Nguyen, “Advertising Strategy in China:
An Analysis of Cultural and Regulatory Factors,” Journal of International Consumer Marketing 15,
no. 1 (2002): 91–123; Suzanne Bidlake, “Survey Results Used in Fight to Resist Restrictions on Ads,”
Advertising Age International, June 2000, pp. 1–2.
33. Yi-Zheng Shi, Ka-Man Cheung, and Gerard Prendergast, “Behavioral Response to Sales Promo-
tions Tools,” International Journal of Advertising 24, no. 4 (2005): 467–86.
34. “Doing Business in Europe,” European Business Journal 14, no. 1 (2002): 54–56.
35. Leo Y.M. Sin, Alan C.B. Tse, and Frederick H.K. Yim, “CRM: Conceptualization and Scale
Development,” European Journal of Marketing 39, no. 11–12 (2005): 1264–90.
36. Lynette Ryals and Adrian Payne, “Using IT in Implementing Relationship Marketing Strategies,”
Journal of Strategic Management 9, no. 1 (2001): 3–27.
NOTES TO CHApTER 12
1. C.K. Prahalad and Jan P. Oosterveld, “Transforming Internal Governance: The Challenge for
Multinationals,” Sloan Management Review, Spring 1999, pp. 31–41.
2. Alan Clardy, “The Strategic Role of Human Resource Development in Managing Core Compe-
tencies,” Human Resource Development International 11, no. 2 (2008): 183–97.
3. Mark A. Royal and Melvyn J. Stark, “Why Some Companies Excel at Conducting Business
Globally,” Journal of Organizational Excellence 25, no. 4 (2006): 3–10.
4. Cristina McEachey, “A Revolutionary Renovation,” Wall Street and Technology, June 2008,
pp. 32–37.
5. Carol A. Rusaw and Michael F. Rusaw, “The Role of Human Resource Development in Inte-
grated Crisis Management: A Public Sector Approach,” Advances in Developing Human Resources
10, no. 3 (2008): 380–96.
6. Paul R. Sparrow, “Globalisation of HR at Function Level: Four UK-Based Case Studies of the
International Recruitment and Selection Process,” International Journal of Human Resource Manage-
ment 18, no. 5 (2008): 845–67.
7. Randall S. Schuler, John R. Fulkerson, and Peter J. Dowling, “Strategic Performance Measure-
ment and Management in Multinational Corporations,” Human Resource Management 30, no. 3 (1991):
365–92; Catherine Truss and Lynda Gratton, “Strategic Human Resource Management: A Conceptual
Approach,” International Journal of Human Resource Management 5, no. 3 (1994): 663–86.
8. Christopher A. Bartlett and Sumantra Ghoshal, “What Is a Global Manager?” Harvard Business
Review, August 2003, pp. 101–8.
9. Valeria Pulignano, “The Diffusion of Employment Practices of U.S.-Based Multinationals in
Europe: A Case Study Comparison of British and Italian-Based Subsidiaries,” British Journal of In-
dustrial Relations 44, no. 3 (2006): 497–518.
10. Michael Dickman and Noeleen Doherty, “Exploring the Career Capital Impact of International
Assignments within Distinct Organizational Contexts,” British Journal of Management 19, no. 2
(2008): 145–61.
11. Michael Goold, “Strategic Control in the Decentralized Firm,” Sloan Management Review 32,
no. 2 (1991): 69–81.
12. Kevin DeSouza and Yukika Awazu, “Emerging Tensions of Knowledge Management Control,”
Singapore Management Review 28, no. 1 (2006): 1–13.
13. Richard F. Meyer, “N.V. Philips Electronics: Currency Hedging Policies,” Harvard Business
Review Interactive Case Study, October 13, 1994, p. 1. Available at http://harvardbusinessonline.hbsp.
NOTES 449
harvard.edu/b02/en/common/item_detail.jhtml;jsessionid=Y4N341PRGZB5WAKRGWCB5VQBKE
0YOISW?id=295055&referral=2340 (accessed December 7, 2008).
14. Bob Lewis, “Send the Right People to the Right Places,” People Management 12, no. 14
(2006): 85–86.
15. Hung-Wen Lee and Ching-Hsiang Liu, “Determinants of the Adjustment of Expatriate Managers
to Foreign Countries: An Empirical Study,” International Journal of Management 23, no. 2 (2006):
302–11.
16. Ramudu Bhanugopan and Alan Fish, “An Empirical Investigation of Job Burnout among Ex-
patriates,” Personnel Review 35, no. 4 (2006): 449–68.
17. Steven D. Maurer and Shaomin Li, “Understanding Expatriate Managers’ Performance: Effects
of Governance Environment on Work Relationships in Relation-Based Economies,” Human Resource
Management Review 16, no. 1 (2006): 29–46.
18. Hal B. Gregersen, “The Right Way to Manage Expats,” Harvard Business Review, March–April
1999, pp. 52–61.
19. Phyllis Tharenou and Michael Harvey, “Examining the Overseas Staffing Options Utilized
by Australian Headquartered Multinational Corporation,” International Journal of Human Resource
Management 17, no. 6 (2006): 1095–1114.
20. Ma. Evelina Ascalon, Deidra J. Schleicher, and Marise Ph. Born, “Cross-Cultural Social Intel-
ligence: An Assessment for Employees Working in Cross-National Contexts,” Cross-Cultural Manage-
ment 15, no. 2 (2008): 109–30.
21. Robert Taylor, “Companies Cut Back Overseas Transfer Benefits,” Financial Times, July 18,
1996, p. 1.
22. Karen Dawn Stuart, “Teens Play a Role in Moves Overseas,” Personnel Journal, March 1992,
pp. 72–78.
23. Charles M. Vance and Yongsun Paik, “Forms of Host-Country National Learning for Enhanced
MNC Absorptive Capacity,” Journal of Management Psychology 20, no. 7 (2005): 590–606.
24. Anil K. Gupta and Vijay Govindarajan, “Knowledge Flows within Multinational Corporations,”
Strategic Management Journal 21, no. 4 (2000): 473–96.
25. “Building a Competitive Organization for the 1990s,” Business International, June 11, 1990, p. 190.
26. Tarun Khanna and Krishna Palepu, “The Right Way to Restructure Conglomerates in Emerging
Markets,” Harvard Business Review, July–August 1999, pp.125–34.
27. Sarah Ellison “Kimberly-Clark to Reorganize: High-Ranking Official to Retire,” Wall Street
Journal, January 20, 2004, p. A3.
28. Marlynn L. May and Ricardo B. Contreras, “Promotor(a)s, the Organizations in Which They
Work, and an Emerging Paradox: How Organizational Structure and Scope Impact Promotor(a)s’ Work,”
Health Policy 82, no. 2 (2007): 153–66.
29. John W. Hunt, “Is Matrix Management a Recipe for Chaos?” Wall Street Journal, January 12,
1998, p. 10.
30. Christopher A. Bartlett and Sumantra Ghoshal, “Matrix Management: Not a Structure, a Frame
of Mind,” Harvard Business Review, July–August 1990, pp. 138–45.
31. Irja Hyväri, “Project Management Effectiveness in Project-Oriented Business Organizations,”
International Journal of Project Management 24, no. 3 (2006): 216–25.
32. “Corporate Networking Increases Organizational Choices,” Business International, July 9,
1990, p. 225.
NOTES TO CHApTER 13
1. Peter Bachman, “Former Managers Threaten SAP with Legal Action,” China Business News,
August 20, 2008. Available at http://www.bizchina-update.com/content/view/1239/2/.
2. As a result of the financial crisis of 2008, Congress has temporarily increased the deposit insur-
ance from $100,000 to $250,000 until December 31, 2009.
450 NOTES
3. For more about the International Standards Organization, see http://www.iso.org.

4. For more about the SWIFT organization, see http://www.swift.com.
5. “Global Air Freight Forecast to Return to Strong Growth, says OAG,” Official Airline Guide
press release, May 21, 2008. Available at http://www.oag.com/oagcorporate/pressreleases/08+OAG+
Air+Freight+Forecast+May08.html (accessed July 14, 2008).
6. For more about the Ex-Im bank, see http://www.exim.gov.
7. For more about the Overseas Private Investment Corporation, see http://www.opic.gov.
8. For more about the Multilateral Investment Guarantee Agency, see http://www.miga.org.
9. For more about the New York Stock Exchange, see http://www.nyse.com/.
10. For more about the London Stock Exchange, see http://www.londonstockexchange.com.
11. JPMorgan, Global Depository Receipts: Reference Guide (New York: JPMorgan Chase &
Co., 2008). Available at http://www.adr.com/pdf/ADR_Reference_Guide.pdf (accessed July 16,
2008).
12. Patrick McGuire, “A Shift in London’s Eurodollar Market,” BIS Quarterly Review, September
2004, pp. 67–77. Available at http://econpapers.repec.org/article/bisbisqtr/0409g.htm (accessed July
16, 2008).
13. For more about the Office of Foreign Assets Control, see http://www.cbp.gov.
14. Gibson, Dunn, & Crutcher LLP, “FCPA Opinion Procedure Release 2008–02,” in 2008 Mid-Year
FCPA Update, July 7, 2008. Available at http://www.gibsondunn.com/Publications/Pages/2008Mid-
YearFCPAUpdate.aspx (accessed July 17, 2008).
15. Robin Wright and Alan Beattie, “Shipping Suffers as Credit Dries Up,” Financial Times, Oc-
tober 13, 2008.
16. Carl Mortished, “Commerce Becalmed over Letters of Credit,” London Times, November 3,
2008. Available at http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/
article5069065.ece (accessed November 11, 2008).
NOTES TO CHApTER 14
1. For more about the Financial Accounting Standards Board, see http://www.fasb.org (accessed
March 18, 2008).
2. For more about the Financial Reporting Council, see http://www.frc.org.uk/ (accessed March
18, 2008).
3. For more details about other countries’ accounting boards, see http://www.asb.or.jp/ for Japan;
http://www.minefi.gouv.fr/directions_services/CNCompta/ for France; http://www.acsbcanada.org/ for
Canada; http://www.standardsetter.de/drsc/news/news.php for Germany; and http://www.aasb.com.
au/ for Australia.
4. B.M. Lall Nigam, “Bahi-Khata: The Pre-Pacioli Indian Double-Entry System of Bookkeeping,”
Abacus 22, no. 2 (September 1986): 148–61.
5. See Michael Scorgie, “Indian Imitation or Invention of Cash-Book and Algebraic Double-Entry,”
Abacus 26, no. 1 (March 1990): 63–70; and Christopher Nobes and Edward Elgar, International Ac-
counting and Comparative Financial Reporting: Selected Essays of Christopher Nobes (Cheltenham,
UK: Edward Elgar, 1999).
6. Omar Abdullah Zaid, “Accounting Systems and Recording Procedures in the Early Islamic
State,” Accounting Historians Journal 31, no. 2 (December 2004).
7. Peter Boys, “What’s in a Name: Firms’ Simplified Family Trees on the Web,” Institute of Char-
tered Accountants in England and Wales (ICAEW) Online. Available at http://www.icaew.com/index.
cfm?AUB=TB2I_36747 (accessed July 20, 2008).
8. See www.iasb.org/ for additional details.
9. The income in the prior years was $31 billion in 1998, $20 billion in 1997, and $13 billion in
1996. Source: Annual reports, Enron.
10. Claudio Celani, “The Story behind Parmalat’s Bankruptcy,” Executive Intelligence Review,
NOTES 451
January 16, 2004. Available at http://www.larouchepub.com/other/2004/3102parmalat_invest.html

11. “UMC Has $304 Million Net Loss in 2007 on U.S. Standard,” Reuters, May 2, 2008.
Available at http://www.reuters.com/articlePrint?articleId=USTP6654220080502 (accessed July
23, 2008).
12. “OmniVision Reports Financial Results for Fourth Quarter and Fiscal 2008,” Barron’s, May
29, 2008. Available at http://online.barrons.com/article/PR-CO-20080529–906291.html (accessed
July 23, 2008).
13. See David Jetuah, “Citigroup Lays Out IFRS-US GAAP Gulf,” Accountancy Age, August
30, 2007.
14. Rebecca Toppe and Mark Myring, “Defining Principles-Based Accounting Standards,” CPA
Journal, August 2004. Available at http://www.nysscpa.org/cpajournal/2004/804/essentials/p34.htm
15. Don Durfee, “The Great Experiment: China Is Attempting Its Biggest Accounting Change since
the Abandonment of Soviet-Style Bookkeeping,” CFOAsia.com, May 2007. Available at http://www.
cfoasia.com/archives/200705–02.htm (accessed July 23, 2008).
16. “Indian Firms Listed in Europe May Have to Adopt IFRS Standards,” The Economic Times,
April 20, 2008. Available at http://economictimes.indiatimes.com/News/News_By_Industry/Services/
Consultancy__Audit/Indian_firms_listed_in_Europe_may_have_to_adopt_IFRS_standards/rssarticle-
show/2965694.cms (accessed July 23, 2008).
17. Romir Monitoring Group, “Accounting Reform IFRS Survey Results,” survey, September–
October 2007. Available at http://www.accountingreform.ru/en/about/view (accessed July 23, 2008).
18. Daniel Drosdoff, “Andean Countries Forge Historic Tax Pact,” IDB America, May 2005. Avail-
able at http://www.iadb.org/idbamerica/index.cfm?thisid=3517 (accessed July 23, 2008).
19. KMPG International, “KMPG’s Corporate and Indirect Tax Rate Survey 2007.” Available at
http://www.kpmg.com.om/PDF/KPMG%27s%20Corporate%20&%20Indirect%20Tax%20rate%20
survey%202007.pdf (accessed July 23, 2008).
NOTES TO AppENDiX 1
1. Maxwell A. Cameron, “North American Free Trade Agreement Negotiations: Liberalization
Games between Asymmetric Players,” European Journal of International Relations 3, no. 1 (1997):
105–39.
2. Office of the U.S. Trade Representative, “NAFTA: A Strong Record of Successes,” March
2006. Available at http://www.ustr.gov/assets/Document_Library/Fact_Sheets/2006/asset_upload_
file242_9156.pdf (accessed June 2008).
3. National Center for Policy Analysis, “Economic Benefits of NAFTA,” June 2008. Available at
http://www.ncpa.org/pd/trade/pdtrade/pdtrade1.html.
4. S. Sarkar and H.Y. Park, “Impact of the North American Free Trade Agreement on the U.S.
Trade with Mexico,” International Trade Journal 15, no. 3 (Fall 2001): 269–92.
5. Raymond Robertson, “Wage Shocks and North American Labor-Market Integration,” American
Economic Review 90, no. 4 (September 2000): 742–64.
6. Office of the U.S. Trade Representative, “NAFTA: A Strong Record of Successes.”
7. U.S. Department of Labor, Bureau of Labor Statistics, “Current Employment Statistics,” 2007.
Available at http://www.bls.gov/ces.
8. Statistics Canada, “Employment by Industry and Sex,” 2007. Available at http://www40.statcan.
ca/101/cst01/labor10a.htm.
9. Secretaria del Trabajo y Prevision Social, “Encuesta Nacional de Empleo,” 2004. Available at
http://www.stps.gob.mx/.
10. Scott Vaughan, “How Green Is NAFTA? Measuring the Impacts of Agricultural Trade,” Envi-
ronment 46 (March 2004): 26–42.
452 NOTES
11. Bruce Campbell, “Time to Draw a Line in the Sand: NAFTA and the Softwood Lumber Dispute,”
Briefing Paper 6, no. 1 (March 2005).
12. Tristan Garel-Jones, “Anatomy of a Good Deal,” New Statesman, October 29, 2007, p. 12.
13. “A Few More Smiles Wouldn’t Hurt,” Economist 377, no. 8447 (October 2005): 64.
14. Hans-Eckart Scharrer, “The Euro’s Start-Up Phase Is a Success,” Intereconomics 35, no. 1
(January 2000): 1.
15. Jerome Sheridan, “The Consequences of the Euro,” Challenge 42, no. 1 (January–February
1999): 43–54.
16. Jörg Bibow, “The Euro: Market Failure or Central Bank Failure?” Challenge 45, no. 3 (May–
June 2002): 83–99.
17. “1992 Going on 2010,” European Business Forum, no. 12 (Winter 2002): 1.
18. “Economic Policy Outlook,” Country Report, European Union, no. 4 (December 2005):
10–11.
NOTES TO AppENDiX 2
1. The basic information on the workings and organizational structures of the four international
agencies was obtained from their individual Web sites: http://www.imf.org; http://www.oecd.org; http://
www.un.org; and http://www.worldbank.org (all accessed December 27, 2007).
2. “Bangladesh: Progress, Yes, Substantial Success, No,” Market: Asia Pacific 14, no. 12,
(December 2005): 1–2.
3. “Risk Summary: Bosnia-Herzegovina,” Emerging Europe Monitor: South East Europe Moni-
tor 12, no. 9 (September 2005): 11.
4. “Citigroup Economist Moving to Treasury; Shakers; Marketplace by Bloomberg,” International
Herald Tribune, February 13, 2006, p. 17.
5. Curtis J. Hoxter, “U.S. Raps China’s Yuan Exchange Rate as Far Out of Line with Market
Levels,” Caribbean Business 33, no. 39 (October 2005): 8.
6. “Layoffs of Government Workers (DOMINICA),” Caribbean Update 22, no. 1 (February
2006): 1.
7. “A Success Story,” Latin America Monitor: Andean Group Monitor 22, no. 9 (September 2005):
6.
8. Jon Gorvett, “Turkey Turns a Corner,” Middle East, no. 345 (May 2004): 54–55.
9. “Going, Going, Gone,” Business Middle East 13, no. 16 (January 2005): 6–7.
10. “Risk Summary: Ukraine,” Emerging Europe Monitor: Russia & CIS 9, no. 5 (May 2005): 5.
11. “On the Right Path,” Emerging Europe Monitor: South East Europe Monitor 12, no. 9 (Sep-
tember 2005): 1–10.
12. Graham Bird, “Over-optimism and the IMF,” World Economy 28, no. 9 (September 2005):
1355–73.
13. Joseph Stiglitz, “The Insider,” New Republic 222, no. 16–17 (April 2000): 56–59.
14. Andrew Rose, “Which International Institutions Promote International Trade?” Review of
International Economics 13, no. 4 (September 2005): 682–98.
15. Robert Couzin, “Fighting for Harmony, Not Balance,” International Tax Review 11, no. 6
(June 2000): 17.
16. W.W. Rostow, “Working Agenda for a Disheveled World Economy,” Challenge 24, no. 1
(March–April 1981): 5.
17. Jörg Michael Dostal, “Campaigning on Expertise: How the OECD Framed EU Welfare and
Labor Market Policies—and Why Success Could Trigger Failure,” Journal of European Public
Policy 11, no. 3 (June 2004): 440–60.
18. Jean-Philippe Cotis, “Statistics-Knowledge and Policy,” OECD World Forum on Key Indicators,
November 2004, p. 1.
NOTES 453
19. “OECD Compromises Fail to Satisfy Havens,” International Tax Review 13, no. 1 (December
2001–January 2002): 4.
20. Matthew Swibel, “Watch What’s Done, Not Said,” Forbes, January 2006, p. 32.
21. Ralph Greer, “UN Is Only as Effective as Biggest Members Want It to Be,” Vancouver Sun
(British Columbia), editorial, March 16, 2004, p. A13.
22. Arnold Beichman, “UN Human Rights and Wrongs,” Washington Post, May 8, 2005, p. 1.
23. Paul Lewis, “Security Council Pursuing Its Broader World Peace Mission,” New York Times,
January 21, 1990, p. 1.
24. Mikhail S. Gorbachev, “Secure World,” Foreign Broadcast Information Service—Soviet Union,
September 17, 1987, pp. 23–28.
25. Shahzad Uddin and Trevor Hopper, “Accounting for Privatization in Bangladesh: Testing
World Bank Claims,” Critical Perspectives on Accounting 14, no. 7 (October 2003): 739.
26. Zoë Chafe, “World Bank Involvement in Economic Reform: ‘A Warning Flag’?” World
Watch 18, no. 6 (November–December 2005): 9.
27. Tom Buerkle, “Who’s Afraid of the Big, Bad Wolfowitz?” Institutional Investor 39, no. 9
(September 2005): 52–62.
28. David Wessel, “South Africa Is a Success Story at World Bank,” Wall Street Journal, Eastern
ed., October 6, 1994, p. A15.
29. “Asian Executives Poll,” Far Eastern Economic Review 160, no. 40 (October 1997): 34.
30. Jayson W. Richardson, “Toward Democracy: A Critique of a World Bank Loan to the United
Mexican States,” Review of Policy Research 22, no. 4 (July 2005): 473–82.
31. Robert Hunter Wade, “The Rising Inequality of World Income Distribution,” Finance and
Development 38, no. 4 (December 2001): 37.
32. “Whose Land Reform?” Multinational Monitor 22, no. 6 (June 2001): 7; “Remembering Africa,”
Economist 320, no. 7722 (August 1991): 33.
NOTES TO AppENDiX 3
1. Both technologies were developed by SRI International. See SRI International, “ERMA and
MICR: The Origins of Electronic Banking.” Available at http://www.sri.com/about/timeline/erma-micr.
html (accessed July 30, 2008).
2. Mary Bellis, “Automatic Teller Machines—ATM. The ATM Machine of Luther George Simjian,”
About.com: Inventors. Available at http://inventors.about.com/od/astartinventions/a/atm.htm (accessed
July 30, 2008).
3. The Fed offers three services: Fedwire Fund Services for cash payments, Fedwire Securities
Services for transfer of securities, and National Settlement Services for private clearing houses to
settle payments at the end of the day. See http://www.federalreserve.gov/paymentsystems/ for more
details.
4. Depository Trust and Clearing Corporation, “An Introduction to DTCC: Services and Capa-
bilities,” April 2008. Available at http://www.dtcc.com/about/business/index.php (accessed July 28,
2008).
5. More information is available from “The Creation of ASC X12,” available at http://www.x12.0rg/
x120rg/about/X12History.cfm (accessed August 28, 2008).
Glossary
Absolute advantage: A theory proposed by Adam Smith which states that because
some countries can produce certain goods more efficiently than others, they should
specialize in and produce enough of these goods for their own consumption and for
exports, and they should import certain goods from other countries that might have
more efficient production factors.
Accounting: The process of identifying, recording, and interpreting cost and financial
data.
Acquisition: The purchase of a company by a group of investors or another company.
American Depository Receipt (ADR): A negotiable certificate issued by a U.S bank.

in the United States to represent the underlying shares of a foreign corporation’s stock
held in trust at a custodian bank in the foreign country.
Arbitrage: Buying and selling currencies or other commodities at a profit by making

use of price discrepancies between markets.
Balance of payments: A statement that summarizes all trade and economic transac-
tions between a given country and the rest of the world.
Bank for International Settlements: A bank in Basel, Switzerland, that facilitates

financial transactions among central banks.
Bill of lading: A document that is issued to a shipper by a carrier, listing the goods
received for shipment.
Black market: Market for goods and services that lies outside the official market.
Brand: A product that is identified with a company by means of a name, symbol, or logo.
Business ethics: The accepted principles of right or wrong governing the conduct of
businesses and the people running them.
455
456 GLOSSARY
Capital account: Transactions involving previously existing assets.
Capitalism: An economic system based on the free market approach.
Central bank: A government bank responsible for a country’s money supply.
Centralization: An organizational structure in which all decisions are made at a

company’s headquarters.
Certificate of origin: A shipping document that determines the origin of products

and is validated by an external source.
Command economy: An economic system in which resources are allocated and

controlled by the government.
Commercial invoice: A bill of goods from the buyer to the seller.
Comparative advantage: A trade theory suggesting that there may still be global ef-
ficiency gains from trade if a country specializes in those products that it can produce
more efficiently than other products.
Copyright: A legal concept giving the creator of an original work exclusive rights
to it, usually for a limited time. It can also be defined as the legal right to reproduce,
publish, distribute, and license an original work exclusively.
Corporate social responsibility (CSR): The idea that businesspeople should consider
the social consequences of economic actions when making business decisions, and
that there should be a presumption in favor of decisions that have both good economic
and social consequences.
Country-of-origin effect: The positive effects gained by the quality and reputation
of products originating from one country.
Cross-border trade: If countries trade freely, consumers benefit from cheaper goods
and services and higher quality goods because of allocation of the most efficient
resources and competition.
Cross rate: An exchange rate between two currencies computed from the exchange
rate of each currency in relation to the U.S. dollar.
Cultural influences: The forces that affect the communication and interaction pat-
terns of various groups. For instance, the media can be viewed as a cultural influence
on members of society.
Culture: The value system of a society that guides its beliefs, customs, knowledge,
and morals.
GLOSSARY 457
Culture shock: The negative feelings and/or anxiety that an individual feels when
relocating to another culture or country. This may manifest itself as a sense of disgust
for every aspect of the new society. Many people suffer from reverse culture shock—
the feeling of culture shock upon return to their home culture.
Customization (or local adaptation): Adapting a global marketer’s products/brands so

that they are best suited to the culture and consumer demands of a single target country.
Decentralization: The opposite of centralization; decisions are made at the lower

levels of the management.
Democracy: A political system in which the people of the country elect officials to
govern the affairs of the nation.
Devaluation: A reduction in the value of one currency in relation to another currency.
Downstream: Management of the supply of finished goods and services to the market.
Dumping: The selling of goods in a foreign market at a price below their cost of
production or “fair” market value, using profits from a company’s home market to
subsidize prices. This is often done to unload excess production or to drive out exist-
ing competition in a market.
Economic factors: All of the factors that contribute to the growth/decline of an

economy. These include gross domestic product (GDP) = the total of all domestic
economic activity of a country; inflation = a condition where consumer prices are
rising; balance of payments (BOP) = a statement that summarizes all economic
transactions between one country and the rest of the world; and external debt = the
amount of money borrowed by one country from all banks.
Economic integration: The removal of all trade barriers and factor mobility between
countries to facilitate growth. NAFTA is an example of a free trade agreement, which
is one form of economic integration.
Economies of scale: The effect of optimal production capacities that reduces total
cost by lowering unit cost as output increases through reduction in fixed costs.
Ethnocentric behavior: The belief that one’s own culture is superior to that of other
cultures. A related concept called consumer ethnocentrism is the belief that one should
purchase domestically produced goods, not imported ones.
Ethnocentrism: A belief that one’s own values are superior to others.
Exchange market: The system through which transactions in various currencies

take place.
458 GLOSSARY
Exchange rate: The price of one currency against another currency.
Expatriates: A citizen of one country who is working abroad in a firm’s subsidiary.
First-mover advantage: Advantages gained by moving into a foreign market ahead

of competitors.
Foreign Corrupt Practices Act (FCPA): A U.S. law that penalizes American com-
panies who engage in bribery.
Foreign direct investments (FDI): The flow of investments from overseas companies
that enable them to control operations in a foreign country or a company. FDI flows
are influenced by opportunities offered by foreign operations.
Forward rate: A foreign exchange rate quoted today for future delivery (typically
30, 60, or 90 days ahead).
Franchising: Similar to licensing, except it requires a longer commitment. In franchis-

ing, the franchiser not only sells intangible property to the franchisee, but also insists
that the franchisee abide by the rules of the business. In some cases, the franchiser
also assists the franchisee in running the business. The franchiser receives a royalty
payment that is usually a percentage of the franchisee’s revenues.
GAAP: Generally accepted accounting principles. The accounting standard followed

by U.S. companies and set by the Financial Accounting Standards Board (FASB).
Globalization: The process or trend toward a more integrated and interdependent

world economy. Through this process, companies are more likely to compete any-
where, source their raw material or R&D anywhere, and produce their products
anywhere.
Gray market: The selling of goods through unofficial distributors.
Greenfield investments: Starting foreign operations from scratch. Greenfield invest-

ments give the foreign firm a greater ability to build the kind of subsidiary it wants
in terms of operations and management philosophy. However, these ventures are
slower to establish than acquisitions; therefore, the firm has the possibility of being
preempted by other competitors in the market.
Gross domestic product (GDP): The total output of all economic activity in a
country.
Gross national income (GNI): New name for GNP.
Gross national product (GNP): The total incomes earned by residents of a country.
GLOSSARY 459
Home country: The country in which an international company is headquartered.
Horizontal integration: Entry by a firm into other businesses.
Host country: Any foreign country in which an international company operates.
Intellectual property rights: Ownership rights to intangible assets.
International agencies (World Trade Organization [WTO], United Nations

[UN], International Monetary Fund [IMF], World Bank): Significant players or
organizations in the global economy.
International business: Any firm that engages in international trade or investment.
International companies: International companies are identified by various names

depending on the extent of their operations. In general terms, an international company
is any company operating in at least one country; a multinational enterprise (MNE)/
multinational corporation (MNC) is a company that operates in many countries and
is involved in all types of international operations; a transnational company (TNC) is
a company owned by and managed by nationals in different countries (TNC is also a
term used by the United Nations to refer to an MNE/MNC); and a global company is
a company that integrates its operations and has a vast network of operations in many
parts of the world.
International Financial Reporting Standards (IFRS): New global standards

in accounting that are being adopted throughout the world and replacing existing
local standards.
International Monetary Fund (IMF): An international agency created to promote

international monetary cooperation after World War II.
Inventory management: A management function critical to the continuous flow of

supplies and goods that minimizes the cost of maintaining a safe volume of stock.
In international business, because of distances between suppliers and markets, this
function takes on an added importance.
Joint ventures: Contractual agreements that require direct investments in which two
or more companies share the ownership. Joint ventures can take the form of a minority
partnership, a 50/50 partnership, or a majority partnership, where each firms owns a
percentage of the business and its corresponding profits.
Just-in-time: An inventory system in which deliveries of inputs are made as they

are needed.
Legal systems: Legal systems are often characterized as being based on common law
460 GLOSSARY
(tradition, precedent, and custom-based), civil law (highly organized into codes with
less flexibility than common law), and theocratic law (based upon a religion).
Letter of credit: A guarantee to the exporter that the importer’s bank will make pay-
ment for the goods upon presentation of the bill of lading.
Licensing: An arrangement whereby a company (licensor) grants the rights to intan-

gible property like patents, inventions, formulas, processes, designs, copyrights, and
trademarks to another company (licensee) for a specified period of time. The licensor
receives a royalty fee from the licensee.
London Inter-Bank Offered Rate (LIBOR): The interest rate for large interbank
loans of Eurocurrencies.
Mixed economy: An economic system characterized by a mix of market and com-

mand economies.
Nationalization: The transfer of ownership to the state.
Nontariff barriers: Trade barriers other than tariffs such as quotas and administra-
tive controls.
Offshoring: The process of shifting production to a foreign country.
Outsourcing: The practice of using outside suppliers to perform functions that are
executed more efficiently by the outside firms.
Political risk: Exposure of losses to an international company due to changes in the

political environment of a host country.
Political systems: Can be characterized as either democratic or totalitarian. Demo-

cratic systems have elected officials and typically guarantee individuals various
freedoms (speech, media, religion, etc.); totalitarian systems are characterized by one
group or political party having power over the society and citizenry.
Polycentrism: Accepting differences in cultural systems.
Purchasing-power parity (PPP): An equalization process in incomes, exchange

rates, and household spending based on differences in purchasing power.
Quality: Meeting or exceeding the expectations of a customer.
Quota: A limit on the quantity of a product allowed to be imported or exported.
Services: Nongoods and intangible items that are bought and sold.
GLOSSARY 461
Six Sigma: A sophisticated system of quality control that uses data and statistical
analysis to achieve close to zero defects.
Special drawing rights (SDR): A unit of account issued to countries by the IMF to
help them to manage their reserves.
Spot rate: An exchange rate quoted for immediate delivery on a transaction that oc-
curs within two business days.
Standardization: A strategy adopted by international companies; standardization of-

fers similar products using a similar marketing mix to a similar target market across
multiple target countries.
Strategic alliances: Cooperative agreements between potential or actual competitors

that can range from formal joint ventures to short-run contractual agreements.
Strategy: Actions by companies to achieve objectives.
Subsidiary: Individual operations of companies in foreign countries.
Supply chain: The management of materials, semifinished goods, and finished goods
from supplier to the marketplace.
Target market: Refers to the selection of a homogeneous segment within a single

country, or alternatively across multiple countries.
Tariff: Tax levied on imported goods.
Total quality management: A system of quality control that checks quality at every
step of the process and is customer driven.
Trade creation: Shifting of production to more efficient countries because of com-

parative advantage.
Trade diversion: In trade diversion, exports shift to a less efficient country because
of trade barriers.
United Nations: An international organization whose goals are to promote world

peace and security.
Value added tax: A tax that is a percentage of the value added to a product at each
stage of the process.
Vertical integration: Entry by a firm into a different stage of productions in its own
industry.
462 GLOSSARY
Wholly owned subsidiaries: In a wholly owned subsidiary, the firm owns 100% of
the stock of the subsidiary. Wholly owned subsidiaries can be established in a foreign
country in two ways. A firm can set up new operations in the foreign country from
the ground up (greenfield) or it can acquire a firm and promote its products through
that firm (acquisition).
World Bank: A multilateral lending institution that aids developing countries through
loans and investment capital.
World Trade Organization (WTO): A voluntary organization through which groups

of countries negotiate trading agreements.
Name Index
Italic page references indicate charts and graphs. Ghosal, Sumantra, 325
Greenspan, Alan, 245
Adam, Timothy, 406 Greer, Ralph, 419
Aggarwal, Alok, 243–244
Anan, Kofi, 420 Half, Robert, 238
Hall, Edward T., 56–57
Barroso, José Manuel, 394 Hampden-Turner, Charles, 59–60
Bartlett, Christopher A., 325 Heckscher, Eli, 121
Behrman, Jack, 97 Henry VIII, 250
Bird, Graham, 407‑408 Hofstede, Gert, 48–52
Boutros-Ghali, Boutros, 420 Holliday, Charles, 26
Bush, George H.W., 384 Hoppe, M.H., 51
Howard, J. Timothy, 376
Carroll, Archie B., 18 Hume, David, 118
Chávez, Hugo, 95
Clinton, Bill, 385 Ishikawa, Kaoru, 202–203, 203
Croesus of Lydia, 250
Crosby, Philip B., 202, 203
Juran, Joseph M., 202–203, 203
Cullen, John B., 20
Delgado, Joaquin Bayo, 400 Kang, Jong Woo, 131

Deming, W. Edwards, 202–203, 203 Kluckhohn, Florence, 48, 52–55
Diamandouros, Nikiforos, 399
Dill, William R., 22 Lamy, Pascal, 350
Dodd, E. Merrick, Jr., 22 Leontief, Wassily, 121
Donaldson, Thomas, 21 Levitt, Theodore, 282
Dubie, Denise, 231 Lutz, Robert, 26
Dunning, John, 129, 131
Marco Polo, 251
Ebbers, Bernie, 362 Mathur, Anil, 51
Eicher, Theo, 131 Mauro, Paulo, 32
Mayer-Foulkes, David, 138, 138
Fastow, Andrew, 362 Maystadt, Philippe, 398
Freeman, Edward R., 22 Menem, Carlos, 144
Friedman, Milton, 26 Minow, Newton, 107
Monnet, Jean, 387
Galbreath, Jeremy, 26 Moon, Ban Ki, 419–420
463
464 NAME INDEX
Morikawa, Ken, 329–330 Simjian, Luther, 428

Skilling, Jeffrey, 362
Neelankavil, James P., 35, 51, 485 Smith, Adam, 118–119, 122
Nero, 250 Sondergraad, M., 51
Newtown, Sir Isaac, 252 Spelman, Mark, 221
Nigam, B.M. Lall, 360 Stevenson, William J., 203
Nixon, Richard M., 254 Straub, Peter, 397
Nunnenkamp, Peter, 138, 138 Strodtbeck, Fred, 48, 52–55
Ohlin, Bertil, 121 Tanzi, Calisto, 363

Otellini, Paul, 173 Thompson, James D., 22
Thompson, Sir John, 420
Pacioli, Luca, 360 Trichet, Jean-Claude, 398
Parboteeah, K. Praveen, 20 Trompenaars, Fons, 59–60
Platt, Gordon, 337
Vollenweider, Marc, 243–244
Raines, Franklin, 375–376
Ricardo, David, 119–122 Wagoner, Rick, 375
Ronen, Simcha, 57–59, 58 Weber, Hubert, 396
Rúa, Fernando de la, 144 Welch, Jack, 170
Salinas de Gortari, Carlos, 384 Yost, Charles, W., 420

Schuman, Robert, 387
Schwartz, Mark S., 18 Zaid, Omar Abdullah, 360
Schwartz, S.H., 59–60 Zeglis, John, 6
Seko, Mobutu Sese, 100 Zhang, Yong, 51
Shenkar, Oded, 57–59, 58
Subject Index
Italic page references indicate charts and graphs. Air shipments, 341–342, 342
Alcoa Corporation, 130, 208
ABA and ABA number, 340 Algeria, 231, 231
Absolute advantage theory, 118–120 AMA, 268
Absolutism, 19 American Banking Association (ABA), 340
Accounting firms, 360, 362, 375–376 American depository receipts, 345–346
Accounting American Market Association (AMA), 268
application case, 375–376 American Stock Exchange (AMEX), 345, 429
basics, 355–359 Amstel Light, 281
certified public accountant and, 308 Anticorruption laws, 33, 348–349
as control mechanism, 182 Antitrust laws, 112
foreign currency transactions and, 183 APL, 424, 426
functional integration, 172, 182–183 Application cases
historical perspective, 359–360 accounting, 375–376
IFRS versus GAAP, 364–365 cultural environment, 65
International Accounting Standards Board and, 360–361 economy and economic variables, 92–93
overview, 354–355, 373–374 entry strategies, 170–171
reports and, developing, 182 financial management, 352–353
scandals, 361–364, 375–376 foreign direct investment, 144–145
standards, different, 183 foreign exchange market, 265–267
taxes and functional integration, 187–188
corporate, 368–370, 373 human resources management, 329–330
general sales, 371–372 legal environment, 115
management, 182 marketing, 299–300
overview, 367 offshoring, 243–244
value-added, 371–372 political environment, 115
withholding, 369–370 production and operations management, 219–220
transition to IFRS and, 365–367 trade, 144–145
Accounting Standards Board (ASB), 358 Appreciation of currencies, 247–248
ACHs, 429 Appropriability theory, 168
Activity orientation, 54, 56 Area knowledge, 315
Adaptable Program Loan (APL), 424, 426 Argentina, 144–145
Advance payment, 337–338 Arthur Anderson, 360, 362
Advertising, 57, 292–296, 293, 294, 295, 430 Artifacts, 47
Aesthetics, 47 ASB, 358
African countries, 13 Asian countries, 46–47. See also specific name
Agreements, drawing up, 159 Asian economic crisis (1997), 68
465
466 SUBJEcT INDEX
Ask price, 259 Brownfield investments, 127–128

ATM, 428 Brugel, 284–285
Attitudes, cultural, 46 Buddhism, 45
Authoritarianism, 100, 114 Bureau of Industry and Security (BIS), 348
Automated clearing houses (ACHs), 429 Business corruption, 29, 29. See also Corruption
Automated Teller Machine (ATM), 428 Business knowledge offshoring (BKO), 239
Automobile industry, 86, 87, 130 Business Monitor International (BMI), 407
Autonomy, 59 Business process offshoring (BPO), 221, 225–230, 237,
Avon Cosmetics, 179 243
Business-to-business (B2B) transactions, 427
B2B transactions, 427 Business-to-consumer (B2C) transactions, 427
B2C transactions, 427 Business-to-government (B2G) transactions, 427
B2G transactions, 427 Buy decision, 199–200
Back-office services, 227–228 Buy one, get one free (BOGO) specials, 296
Balance of payments, 71 Buy price, 259
Balance sheet, 356–357
Baltic Dry Index, 350 CAD (computer-aided design), 88
Bank for International Settlements, 256 Cadbury Schweppes, 86
Bank of England, 252–253 CAFTA-DR, 225
BankBoston, 195 Call centers, 229–230
Banking relationships with subsidiary, 333 Canada, 385–386
Banks, 256, 258–259, 334–336, 337. See also specific Capital, 125, 176
name Capital account, 71
Barclays Bank, 237, 428 Capital markets, 333
Bartering, 159, 250 Capital structure, 177
Batch process, 199 Capitalism, 99–100, 114
Bayer, 279, 364 Captive units, 236
BECC, 385 Cargo airports, 342, 342
“Big Eight” accounting firms, 360, 362 Caribbean countries, 9
“Big Four” accounting firms, 360, 362 Carrefour SA, 289
Bill of lading, 153 Central banks, 259
Bimetallic standard, 253 Central Intelligence Agency, 72
BIS, 348 Centralization, 302, 314
BKO (business knowledge offshoring), 239 Centrally planned economy, 77–78, 77, 91
Bloomberg services, 429–430 Certificate of origin, 155, 157
BMW, 86, 187–188 Certified public accountant (CPA), 308
Board of Governors (IMF), 403–404 Ceteris paribus, 257
Board of Governors (World Bank), 423 CFSP, 392–393
Boeing, 209 Channels, 155, 158, 179
Border Environmental Cooperation Commission (BECC), Checks, paper, 340–341
385 Chiba International, 329–330
BOT (build, operate, and trade) concept, 237 China
BP, 160 aesthetics in, 47
BPO, 221, 225–230, 237, 243 BMW in, 187
Branch offices, bank, 335 cultural environment in, 40
Branding and brand names, 284–285 dollarization and, 260
Brazil, 4, 19, 32, 128, 151, 231, 231, 299–300 foreign direct investment in, 9, 92–93
Bretton Woods, 253, 402, 421 as manufacturing base of world, 73
Bretton Woods system, 253–254, 259 mode of entry laws in, 109
British Petroleum (BP), 160 Motorola in, 5
Brokers, 259 as offshoring country for United States, 231–232, 231
SUBJEcT INDEX 467
China (continued) Competitive environment, 84–86, 87, 92

offshoring in, 234 Computers, 88, 132
ownership laws in, 109 Conseco, 230
religion in, 44 Conservatism, 59, 100, 114
research and, 11 Consularization, 155
research and development in, 185 Consumers
Starbucks in, 283 choosing, 275–276
trade and, 4 country-of-origin effects on, 280
trade surplus of, 9, 71 final, 269
transition to IFRS and, 365 industrial, 269
wage rates in, 5, 5 needs of, understanding, 178
Wal-Mart and, 235 as variable, 275–276
World Trade Organization and, 289 Consumption tax, 372
Christianity, 44–45 Continental Congress (U.S.), 252
Citibank, 335 Continuous improvement systems, 217–218
Citicorp, 197 Continuous process, 199
Citigroup, 284, 364 Convergence, cultural, 8, 61
City Mayors group survey, 89, 89 CoR, 397
Civil law, 107 Core services, 232
Class, social, 44, 234 COREPER, 393
Clayton Act, 112 Corporate social responsibility (CSR), 18–19, 20
Clearing and settlement process, 247 Corporate taxes, 368–370, 373
CLS (Continuously Linked Settlement) Group, 247 Corporations, 259. See also specific name
Coca-Cola, 19, 39, 81, 86, 160–161, 208, 272, 279, 285, Correspondent banks, 335
314 Corruption
COCOBU, 390 actors in, 29–30, 30
Codes of conduct, 33–34 agent of, 29, 30
Coins, 250–251 business, 29, 29
Cold War, 102 client of, 29, 30
Collateralized Debt Obligations, 349 countries with least corruption and, 30, 31
Collectivism, 48–49, 52, 54, 60 countries with most corruption and, 32
Commercial banks, 256, 258–259, 334–335 defined, 29, 31
Commercial invoice, 153, 154 effects of, 28, 30–32
Committee of the Regions (CoR), 397 as factor in political environment, 102
Committee on Budgetary Control (COCOBU), 390 foreign direct investment and, 31–32
Common Foreign and Security Policy (CFSP), 392–393 grand, 29
Common law, 107 index of, 30, 32
Common market, 382, 383 influence peddling, 29
Communication, 41–43, 56, 179 occurrences, 28–29
Communication program, developing petty, 29
advertising, 292–296, 293, 294, 295 political, 29, 29
overview, 291–292 principal of, 29, 30
personal selling, 292 reducing, prescription for, 32–34
sales promotions, 296 regulations against, 33, 348–349
Communism, 100, 114 types of, 29, 29
Communitarianism, 48–49, 52, 54, 60 Corruption Perception Index (CPI), 30, 32
Comparative advantage theory, 119–121, 125 Cost-push inflation, 71
Compensation, 4–5, 5, 181, 312, 313 Costs
Competencies, cultural, 60 advertising, 293, 294
Competition, 4, 7, 84–86, 87, 160 distribution, 289
Competitive advantage, 85 holding, 212
468 SUBJEcT INDEX
Costs (continued) CSR, 18–19, 20

in industrial countries, rising, 4–5, 5 Cultural environment
input, 193 application case, 65
insurance, 212 changes in, 40
inventory, 208, 212, 213, 225 in China, 40
logistics, 225 competencies in, 60
opportunity, 212 components of
ordering, 212 aesthetics, 47
reducing, 161 artifacts, 47
research, 13 attitudes, 46
setup, 212 customs, 46–47
spoilage/breakage/obsolescence, 212 language and communication, 41–43
stock-out, 212 overview, 41, 63
transportation, 161, 212 religion, 44–45
Council Presidency (EU), 393 social structure, 43–44
Country development classifications, 73 values, 45–46
Country governments. See also Political environment; convergence and, 8, 61
specific country cross-cultural management and, 47
anticorruption regulation and, 33 customer’s choice process and, 270
customs authority of, 348 defined, 41, 63
fiscal year-ends in selected, 358 framework for classifying
foreign direct investment and polices of, 139–141 Hall’s low-context-high-context framework,
incentives, local, 194–195 56–57
monetary authorities of, 348–349 Hofstede’s cultural dimension, 48–52, 52
regulations, local, 194 Kluckhohn and Strodtbeck’s value orientations,
research and development and, 185 52–55, 56
stable, 98 other, 59–60
taxing authority of, 348 overview, 47–48
unstable, 98, 100–101 Ronen and Shenkar’s cluster approach, 57–59, 58
Country-of-origin effects, 161, 280 generalization and, 60–61
Country Risk Analysis importance of recognizing, 63–64
economy and economic variables in Japan, 40
competitive environment, 84–86, 87 orientation and, 62–63
Euromoney approach to, 15, 81–82, 82, 83, 84, 91 overview, 38–39, 63–64
infrastructure, 87, 91 pitfalls in negotiating, 65
overview, 81 shock and, 61–62
quality of life, 88–90, 89, 90, 92 Currencies
technology, 87–88, 91 appreciation of, 247–248
underground economies, 84, 85, 91 controls, 111
in export/import strategy, 150 depreciation of, 247–248
free research studies and, 15 expansion internationally and, foreign, 332
political environment, 102–104, 104, 105 transactions of foreign, 183
Country selection for export/import strategy, 150 translations, 358
Court of Auditors, 396 world, 249–250, 249
Court of Justice of the European Communities, Current account, 71
395–396 Current method, 359
CPA, 308 Customer relations, 179, 268, 296–297
CPI, 30, 32 Customer relations management (CRM), 179, 217,
Credit cards, 340 296–297
CRM, 179, 217, 296–297 Customer service support center, 228
Cross-cultural management, 47 Customers, 208. See also Consumers
SUBJEcT INDEX 469
Customs authority, 348 Dubai Ports World, 140

Customs, cultural, 46–47 DuPont, 26
Customs union, 382, 383 Duties, avoiding, 161–162
Dyadic relationship between stakeholders and company,
DB, 80 23–24, 25
DC, 338–339
Debasement, 250–251 e-commerce, 427. See also Internet, in international
Debt, external, 71–72, 72 business
Debt policies, 176 e-tailing, 427
Decentralization, 302, 314 ECB, 265, 397–398
Decision analysis, 195–196, 196 Economic and Financial Affairs (ECOFIN) Council, 392
Dell Computers, 128, 179, 199, 201, 230 Economic and Social Council (ECOSOC) (UN), 416–417
Demand for goods and services, 7 Economic development, 72–74, 76
Demand-pull inflation, 71 Economic effects of corruption, 30–31
Democracy, 96, 99–100 Economic growth, 7
Deontological philosophy, 21 Economic integration, 8
Dependency model, 98 Economic order quantity (EOQ), 213–214, 213
Depository receipts, 345–346 Economic systems, 76–78, 77
Depository Trust and Clearing Corporation (DTCC), 429 Economic union, 382, 383
Depository Trust Corporation (DTC), 429 Economies of scale, 384
Depreciation of currencies, 247–248 Economist Intelligence Unit, 89
Design and technology issues, 175 Economy and economic variables
Deutsch Bahn (DB), 80 Iceland, 352–353
Deutsche Bank, 115, 151, 208 mortgage crisis and, 375–376
Developing countries, 73, 111 Economy and economical variables
Development, economic, 72–74, 76 application case, 92–93
Diffuseness, 60 Asian crisis, 68
Direct democracy, 96 balance of payments, 71
Direct exporting, 155 centrally planned economy, 77–78, 77, 91
Direct investments. See also Foreign direct investment (FDI) changes in, considering, 68
benefits of, 160–161 country risk analysis
joint ventures, 164–167, 169 competitive environment, 84–86, 87, 91
licensing and franchising, 162–164, 169 Euromoney approach, 81–82, 82, 83, 84, 91
overview, 160, 169 infrastructure, 87, 91
reasons for, 161–162 overview, 81
wholly owned subsidiaries, 167–170 quality of life, 88–90, 89, 90, 92
Direct third-party vendors, 237–238 technology, 87–88, 91
Distribution channels, selecting, 179, 286–290, 290 underground economies, 84, 85, 91
Distribution costs, 289 development, 72–74, 76
Diversification, 8, 161 evaluating, 68–69
Divisional structures, 316–317, 317 external debt, 71–72, 72
Documentary collections (DC), 338–339 gross domestic product, 4, 67–70
Dollarization, 260, 265–267 gross national income, 68, 74, 75, 76, 90
Domain expertise, 232 gross national product, 69–70
Domestic environment, 270–271 inflation, 70–71, 70, 236, 236, 257, 266
Domestic markets, saturation of, 7, 15 international business and, 78–81
Dominican Republic-Central America-United States Free market-based economy, 76–77, 77, 91
Trade Agreement (CAFTA-DR), 225 mixed economy, 77, 78, 91
Double taxation, 368, 373–374 overview, 67, 90–92
Dry bulk shipments, 341 in past 20 years, 67–68
DTCC, 429 U.S. credit crisis, 5–6, 68, 349–350
470 SUBJEcT INDEX
ECOSOC (UN), 416–417 Engineering, 342–343

ECSC, 387 English language, 42
Ecuador, 265–267 Enron, 361–362
EDI, 432–433 Entry strategies. See also Export/Import strategy
EDPS, 399–400 application case, 170–171
EEC, 387, 400 comparison of various, 168–169, 169
EESC, 396–397 direct investments
Egalitarianism, 59 benefits of, 160–161
EIB, 398–399 joint ventures, 164–167, 169
EITI, 138, 138 licensing and franchising, 162–164, 169
El Salvador, 265–267 overview, 160, 169
Electronic data interchange (EDI), 432–433 reasons for, 161–162
Electronic Payments Network, 429 wholly owned subsidiaries, 167–170
Electronic retailing, 427 mode of entry and, 278–279
Electronic trading, 255 overview, 146–147, 169
Electrum, 250 Environment. See also Cultural environment; Legal
Embeddedness, 59 environment; Political environment
Emerging economies, 7 competitive, 84–86, 87, 92
Employees. See also Labor domestic, 270–271
adaptability of, cultural and linguistic, 311 external, 38–39
availability of skilled, 193 marketing, 270–271
compensating, 4–5, 5, 181, 312, 313 EOQ, 213–214, 213
corruption-reducing prescriptions for, 33–34 EP, 389–391
expatriate, 111–112, 181, 308–311 EPSO, 400
family cooperation and, 311 ESCB, 398
foreign assignments and, willingness to accept, 311 Ethical issues
human resources management functions and absolutism and, 19
ascertaining department to be assigned to, 304, 306 accounting scandals and, 361–364, 375–376
describing job specifications for, 307 complexity of, 19
determining countries in which new staff will be conflicts and, 19
employed, 307 corporate social responsibility and, 18–19, 20
determining if new positions can be filled by local defined, 17–18
staff or expatriate member, 308–314 deontological philosophy and, 21
determining if new positions could be staffed by European Union and, 22
current employees, 306 factors affecting, 19–20
determining number of new employees, 304, 305 moral language approach and, 21
determining time frame of hiring, 306 regulations and self-regulation, 21–22
determining where new staff will be assigned, theories, 21
306–307 Ethnocentrism, 62
determining who new positions should be staffed by, EU. See European Union
306 EURATOM, 387
identifying essential qualifications for, 307–308 Euro, 249–250
identifying financial considerations for, 308 Eurodollar markets, 346–347
overview, 301–304 Euromoney, 81–82, 82, 83, 84, 91
labor unions and, 313–314 Euronext, 344–345
local, 311–312 European Atomic Energy Community (EURATOM),
nonmanagerial, 312–314 387
performance reviews of, 181 European Central Bank (ECB), 265, 397–398
recruiting, 180–181 European Coal and Steel Community (ECSC), 387
technical competence of, 310–311 European Commission, 393–400
training and developing, 181 European Data Protection Supervisor (EDPS), 399–400
SUBJEcT INDEX 471
European Economic and Social Committee (EESC), Exports. (continued)

396–397 direct, 155
European Economic Community (EEC), 387, 400 document requirements in, 153, 154, 155, 156, 157
European Investment Bank (EIB), 398–399 expansion internationally and, 332–333
European Ombudsman, 399 foreign exchange rates and, 257–258
European Parliament (EP), 389–391 foreign markets and, 8–9
European Personnel Selection Office (EPSO), 400 Iceland in 2008 and, 352–353
European System of Central Banks (ESCB), 398 indirect, 155
European Union (EU) operation of, 8–9
antitrust laws in, 112 process of, 149–150, 149
components of, 388–389, 389 productivity and, 148
council of, 391–392 by region, 123, 123
creation of, 386–387 External debt, 71–72, 72
ethical regulations and, 22 External environment, 38–39
European Coal and Steel Community and, 387 Extractive industry, 135, 138, 138
European Commission and, 393–400 Extractive Industry Transparency Initiative (EITI), 138, 138
European Parliament and, 389–391 ExxonMobil Corporation, 199, 209, 321
evaluation of, 400–401
members of, 123, 124 Family units, 43
organization of, 393 Fannie Mae, 375–376
overview, 387–389, 389 FASB, 183, 358, 364, 373
taxes in, 369 FBA, 235
trade in, 123 FDI. See Foreign direct investment
Treaty of Maastricht and, 388 FDIC, 335
Treaty of Rome and, 387 the Fed, 252, 259–260, 349, 428
Evaluation of markets, 179–180 Federal Banking Agencies (FBA), 235
Evalueserve, 243–244 Federal Deposit Insurance Corporation (FDIC), 335
Everest Research Group, 238 Federal National Mortgage Association, 375
Executive directors (World Bank), 423–424 Federal Open Market Committee, 260
Expansion internationally, 331–334 Federal Reserve Act (1913), 252
Expatriate employees and issues, 111–112, 181, 308–311 Federal Reserve Board (the Fed), 252, 259–260, 349, 428
Expenditure method, 69 Fedwire, 428
Export-Import Bank (Ex-Im Bank), 343 Feedback, obtaining, 179–180, 297
Export/import strategy Fidelity Investments, 186
agreements, drawing up, 159 Finance, 172, 176–177, 428–430. See also Financial
changes to product/service/packaging/label, 152–153 management
country risk analysis, 150 Financial Accounting Standard Boards (FASB), 183, 358,
country selection, 150 364, 373
document requirements, understanding, 153, 154, 155, Financial crisis (2008), 5–6, 68, 349–350
156, 157 Financial decisions, 16
export process and, 149–150, 149 Financial institutions, 227. See also specific name
importer selection, 158–159 Financial management. See also Shipping
market potential, 151 application case, 352–353
overview, 147–149, 149, 169 banks and, 334–336, 337
payment arrangements, 159 expansion internationally and, 331–334
regulations, understanding, 152 financial crisis of 2008 and, 349–350
terms of sale, 159 insurance and, 343–344
type of exporting channels, 155, 158 overview, 331, 350–351
Exports. See also Export/import strategy regulation and, 347–349
channels, 155, 158 stock exchanges and markets and, 344–347
country selection for, 150 transactions and, 337–341
472 SUBJEcT INDEX
Financial Reporting Council (FRC), 358 Foreign exchange

Financing, 176 delivery of services, 336, 337
Fiscal year-ends in selected countries, 358 risk, managing, 177
Fixed-position layouts, 206–207 shortage of, 131
Fixed-rate regimes, 260 transactions
Flexible manufacturing, 210–211 recording, 355–356
Floating-rate regimes, 260 traded in U.S. dollars, 255, 256
FOB, 153 Foreign exchange market. See also Foreign exchange
Food and Agriculture Organization (UN), 135 rates
Ford Motor Company, 86, 211, 316 application case, 265–267
Forecast sales, 277–278 appreciation of currencies, 247–248
Foreign Bank Supervision Enhancement Act (1991), depreciation of currencies, 247–248
335–336 determination of foreign exchange rates and,
Foreign banks, 335 256–258
Foreign Corrupt Trade Practices Act (1977), 145, 348–349 dollarization and, 260, 265–267
Foreign currency transactions, 183 exchange rate regimes and, 259–260
Foreign direct investment (FDI) history of, 250–255
application case, 144–145 multinational companies and, 260–262, 263
from Canada, 386 overview, 245–246, 264
in China, 9, 92–93 participants in, 258–259
corruption and, 31–32 size of, 255–256
cost and benefits of, 132–135 world currencies in, 249–250, 249
country governments and policies of, 139–141 Foreign exchange rates. See also Foreign exchange
defined, 9, 126 market
in extractive industry, 135, 138, 138 choice of current versus temporal, 359
forms of, 127–128 defined, 246–247
government policies and, 139–141 determination of, 256–258
horizontal, 128 exports and, 257–258
inward, 127 fluctuations in, 16
in manufacturing industry, 133–134 imports and, 257–258
in Mexico, 386 inflation and, 257
motives for, 128–132 market turnover, 255, 256
Multilateral Investment Government Agency and, 343–344 near-shoring and, 225
multinational corporation and, 126 regimes, 259–260
OLI paradigm and, 129 U.S. versus foreign countries, 254
operation of, 9 Foreign markets, 7–9
outward, 127 Foreign Trade Act (1988), 349
overseas portfolio investment versus, 126 Formalizing strategies, 17
overview, 126–127, 142–143 Forrester Research study, 237
ownership restrictions, 140–141 France, 40
political environment and, 98, 138–139 Franchisor, 162, 288
private equity and, 141–142 Francisee, 162, 288
regulation, 140 FRC, 358
in selected countries, 9, 10 Freddie Mac, 376
in services industry, 134–135 Free-floating exchange rate systems, 254–255, 257
stable governments and, 98 Free market, 138–139, 141
statistics, 136–137, 136, 137 Free on board (FOB), 153
trade and, 142 Free trade, 120, 138–139
trends in, 132 Free trade area, 225, 382, 383
U.S. classification of, 126–127 Front-office services, 228–230
vertical, 128, 130 FTA, 385
SUBJEcT INDEX 473
Functional integration Globalization (continued)

accounting, 172, 182–183 international business and, 5–6
application case, 187–188 markets and, 274
finance, 172, 176–177 OECD and, 408
global, 174 offshoring and, 232–233
human resources, 172, 180–182 of production and operations management, 191–192
importance of, 172–173 research and, 11
linkages, 172, 173 taxes and, 372–373, 377–378
management information system, 172–173, 183–184 GM, 42, 130, 161, 375
marketing, 172–173, 177–180 GNI, 68, 74, 75, 76
overview, 172–174, 173, 185–186 GNP, 69–70
production and operations management and, 172–176 Gold and gold standard, 118, 252–254
research and development, 172–173, 184–185 Goods
Functional knowledge, 315 demand for, 7
Functional structures, 321, 321 purchasing of, 245–246
services versus, 269–270
GAAP, 356, 364–365, 377–379 Google, 430
GAERC, 391 Grand corruption, 29
Gains, recording translation, 357–358 Greece, 250
GAO report on offshoring (2006), 235, 239 Greenbacks, 252
Gartner survey of offshoring, 230, 239 Greenfield investments, 127, 167
GATT, 121, 124–125, 221 Gross domestic product (GDP), 4, 67–70
GCI, 4 Gross national income (GNI), 68, 74, 75, 76, 90
GDP, 4, 67–70 Gross national product (GNP), 69–70
GE, 22, 88, 170–171, 185 Groupism, 54
General Affairs and External Relations Council Guatemala, 231, 231
(GAERC), 391
General Agreement on Trade and Tariffs (GATT), 121, H-O model, 121
124–125, 221 Hall’s low-context-high-context framework, 56–57
General Assembly (UN), 412–414 Hampden-Turner and Trompenaars’s framework,
General Electric (GE), 22, 88, 170–171, 185 59–60
General Mills, 12, 283 Harmony, 59
General Motors (GM), 42, 130, 161, 375 Heckscher-Ohlin (H-O) model, 121
General Secretariat (EU), 393 Heineken, 281, 284
Generalization, cultural, 60–61 Help desk, 228
Generally accepted accounting principles (GAAP), 356, Henkel, 287
364–365, 377–380 Heterogeneity of product/services, 270
Geocentrism, 63 Hewlett-Packard (HP), 4
Geographic diversification, 161 Hierarchy, 59
Geographic structures, 319–320, 320 Hilton, 128
Germany, 40, 248, 253 Hinduism, 45
Gillette, 178 Hitachi Corporation, 11
Glitnir, 352 Hofstede’s cultural dimensions framework, 48–52, 52
Global company, 10–11 Holding costs, 212
Global Competitiveness Index (GCI), 4 Holiday Inn, 162
Global competitors, 85 Hong Kong International Airport (HKIA), 87
Global depository receipts, 345–346 Horizontal foreign direct investment, 128
Global Finance survey, 336, 337 Hospitals, 227–228
Global functional integration, 174 Hostilities in host country, traditional, 101
Globalization Households, 44
defined, 6 HP, 4
474 SUBJEcT INDEX
HRM. See Human resources management Hyperinflation, 253

HSBC (Hong Kong Shanghai Bank Corporation), 115, Hyundai, 86
350 Hyundai Capital, 171
Human nature dimension, 53, 56
Human relationship, 54 IASB, 360–361
Human resources IASC, 361
compensation and, 181 IBAN number, 340
decisions, 215 IBF, 336
expatriate issues and, 181 IBM, 186, 316, 318
functional integration, 172, 180–182 IBRD, 253–254, 421. See also World Bank
performance review and, 181 Iceland, 352–353
planning, 180–181 Icesave, 352
recruiting and selection, 180–181 ICJ, 108, 418
training and development and, 181 ICRG, 103–104, 104
Human resources management (HRM) ICSIDm, 144–145
application case, 329–330 IDA, 421
functions Ideology, political, 99, 114
ascertaining function departments to which new IFDI, 127
employees will be assigned, 304, 306 IFRS, 358, 363–367, 367, 373, 377–380
describing job specification for new positions, 307 IFSC, 340
determining countries in which new staff will be ILO, 5, 108
employed, 307 IMF. See International Monetary Fund
determining if new position can be filled by local IMFC, 403–404
staff or expatriate member, 308–314 Imports. See also Export/import strategy
determining if new positions should be staffed by barriers to, 130–131
current employees, 306 expansion internationally and, 332–333
determining if new staff should be hired for foreign exchange rates and, 257–258
assignments at headquarters or at subsidiary foreign markets and, 8–9
level, 306–307 Iceland in 2008 and, 352–353
determining number of new employees to be hired, operation of, 8–9
304, 305 selecting importer, 158–159
determining time frame in which new employees Income method, 69
should be hired, 306 India, 4, 187–188, 234, 243–244, 365–366
identifying essential qualifications, 307–308 Indian Financial System Code (IFSC), 340
identifying financial considerations, 308 Indirect exporting, 155
overview, 301–304 Indirect third-party vendors, 238
organizational structures Individualism, 48–49, 52, 54, 60
advantages of, 326, 327 Individuals, 259
defined, 314 Industry. See specific type
disadvantages of, 326, 327 Infant industries, 141
divisional, 316–317, 317 Inflation, 70–71, 70, 236, 236, 257, 266
functional, 321, 321 Influence peddling, 29
geographic, 319–320, 320 Infrastructure, 87, 92
hybrid, 323–324, 324 ING, 322–323
matrix, 322–323, 323 Input costs, 193
new developments in, 324–326, 325 Inseparability of product/services, 191, 270
overview, 314–315 Inshoring, 224. See also Offshoring
product, 317–319, 319 Institute of Chartered Accountants of India, 365
overview, 301–303, 326, 328 Insurance, 155, 212, 332–333, 343–344
as people-driven, 180 Insurance companies, 227
Hybrid structures, 323–324, 324 Intangibility of product/services, 191, 270
SUBJEcT INDEX 475
Integration. See also Functional integration International companies. (continued)

decision toward full, 199–200 defined, 10
defined, 199 as factor in political environment, 102
of marketing program, 271–273, 273 largest, 6, 6
regional economic layouts and, 207
benefits of, 383–384 purchasing decisions and, 208–209, 209
defined, 382 Six Sigma program and, 204–205, 205
European Union and, 384, 384, 387–401 International Country Risk Guide (ICRG), 103–104,
forms of, 382, 383 104
NAFTA and, 384–387 International Court of Justice (ICJ), 108, 418
overview, 382–383 International CRM Solutions, 297
technology and, 200–201 International Development Association (IDA), 421
vertical, 199, 200 International Financial Reporting Standards (IFRS), 358,
Intel Corp., 9, 173 363–367, 367, 373, 377–380
Intellectual property rights (IPR), 109 International Labor Organization (ILO), 5, 108
Interest rates, 70, 257 International Monetary and Finance Committee (IMFC),
Internal Revenue Service (IRS), 348, 370 403–404
International Accounting Standards Board (IASB), 360–361 International Monetary Fund (IMF)
International Accounting Standards Committee (IASC), 361 Board of Governors, 403–404
International ACH Transactions (IAT), 429 corruption-reducing prescriptions for, 33–34
International bank account number (IBAN), 340 economic development and, 73
International Bank for Reconstruction and Development evaluation of, 406–408
(IBRD), 253–254, 421. See also World Bank Executive Board, 404
International Banking Act (1978), 335 lending and, 253–254, 403
International banking facility (IBF), 336 organization of, 404–405, 405
International banks, 334–336, 337 resources of, 405
International business. See also specific components of responsibilities of, 402
costs in industrial countries and, rising, 4–5, 5 surveillance and, 403
defined, 3 technical assistance and, 403
economic development and, 72–74, 76 International organizations, 33–34. See also specific
economy and economic variables and, 78–81 name
globalization and, 5–6 International Trade Administration, 347–348
growth of, 7–8 Internet
Internet in credit card use via, 340
financing, 427–430 English language and, 42
marketing, 430–431 in international business
overview, 427, 433 financing, 427–430
production and operations management, 431–433 marketing, 430–431
management, 4 overview, 427, 433
in new world order, 3–4 production and operations management, 431–433
operations, 8–10 in marketing, 430–431
organizational labels in, 10–11 payments, 340, 428
overview, 3–7, 35–37 production and operations management and,
trade and, 3–4 431–433
volatility in, 12 sales, 431
wage rates and, 4–5, 5 technology, 221–222, 225–230, 243
International Center for the Settlement of Investment technology offshoring, 226
Disputes (ICSID), 144–145 Inventory
International companies. See also Organizational costs, 208, 212, 213, 225
structures of international companies; specific name decisions, 211–215, 213
anticorruption regulations and, 34, 35 management, 176
476 SUBJEcT INDEX
Investments, 133–135, 176. See also Direct investments; Learning-curve effect, 174
Foreign direct investment (FDI) Least developed countries (LDCs), 417
Invoicing centers, 262, 263 Legal environment
Inward foreign direct investment (IFDI), 127 application case, 115
IPR, 109 aspects of business affected by
IRS, 348, 370 antitrust laws, 112
Islam, 44–45 currency controls, 111
expatriates issues, 111–112
Japan labor laws, 111
automobile advertising in, 57 mode of entry, 109
combined rail and road bridge in, 87 overview, 108, 114
cultural environment in, 40 ownership, 108–109
keiretsu in, 214 price controls, 112
product liability laws in, 113 product liability, 112–113
research and development in, 185 repatriation of profits, 113
trade surplus in, 71 tariffs and other nontariff barriers, 113
values in, 45 taxation, 109–110, 110
wage rate in, 5, 5 judicial systems, 107–108, 114
Japanese Bar Association, 113 legal constraints and, avoiding, 161
Jenny Craig, 86 mediation institutions and, 108
JIT systems, 210, 214–215, 290 overview, 107–108, 114
Job based process, 199 political environment and, 94–95
Joint ventures, 164–167, 169, 236–237 tribal, 107–108
Judicial systems, 107, 114 types of, 107–108
Just-in-time (JIT) systems, 210, 214–215, 290 various, 107
Legalization, 155
Kaupthing, 352 Less-developed countries, 73
Keiretsu, 214 Letter of credit (LC), 159, 338
Kellogg’s, 283 Levi Strauss & Co., 19, 46
Kimberly-Clark, 317–318 Lexus, 86
Kluckhohn and Strodtbeck’s value orientations Liberalism, 100, 114
framework, 52–55, 56 Licensee, 162
Knowledge for effective competition, 315 Licensing and franchising agreements, 9, 128, 162–164,
Knowledge process outsourcing (KPO), 243–244 169, 288
KPMG, 372–373, 377–378 Licensor, 162
KPO, 243–244 Line process, 199
Loans, subsidized, 140
Label changes, 152–153 Local competitors, 85
Labor. See also Employees Local employees, 311–312
laws, 111 Location decisions, 192–196, 196, 197
low-cost, 4–5, 5, 7 Logging in Amazon forests, 19
movement of, 125 Logistics, 194, 216–217, 225
relations, 182 London Stock Exchange (LSE), 345
unions, 313–314 Long-term/short-term orientation, 50–51, 52
Landsbanki, 352–353 Losses, recording translation, 357–358
Language, 41–43, 56 LSE, 345
Layout and layout decisions, 175, 206–207
LC, 159, 338 Magnetic Ink Character Reading (MICR) technology, 428
LDCs, 417 Make-or-buy decision, 208–209, 209
Lead time and research, 14 Maladministration, 399
Lean manufacturing, 210–211, 219–220 Malaysia, 115, 151
SUBJEcT INDEX 477
Management. See also Financial management; Human Marketing (continued)

resources management (HRM); Production and industrial consumers and, 269
operations management (POM) integrated program, 271–273, 273
cross-cultural, 47 Internet in, 430–431
foreign exchange risk, 177 overview, 268, 297–298
international business, 4 steps in, basic, 273–274
inventory, 176 strategy, developing
of suppliers, 217 choose consumers and select market, 275–276
supply-chain, 215–218 conduct marketing opportunity analysis, 277
taxes, 182 decide on mode of entry, 278–279
technology, 88 determine product and service offerings,
working capital, 176 279–285
Management information systems (MIS), 172–173, develop comprehensive communication program,
183–184 291–296
Manufacturing establish price points, 285–286
facilities, setting up, 174–175 forecast sales for selected target group, 277–278
flexible, 210–211 implement customer relations program, 296–297
foreign direct investment in, 133–134 overview, 274–275
industry, 73, 133–134, 190–191 select channels for distribution, 286–290, 290
just-in-time systems and, 210, 214–215 set up feedback mechanism to evaluate marketing
lean, 210–211, 219–220 program, 297
plant location decisions, 16–17 target group and, 277–278, 280–281
processes, newer developments in, 210–211 Marketing opportunity analysis, 277
wage rates for selected countries, 312, 313 Marketing program or mix, 271
Market. See also Foreign exchange market Masculinity-femininity, 50, 52
capital, 333 Mass customization, 210
common, 382, 383 Massachusetts Bay Colony, 251–252
distance to, 194 Mastery, 59
domestic, saturation of, 7, 15 Matrix structures, 322–323, 323
Eurodollar, 346–347 Matsushita Company (now Panasonic), 16–17, 55
evaluation of, 179–180 MBS, 349
foreign, 7–9 McDonald’s Corporation, 178, 197, 284
free, 138–139, 141 McKinsey study of offshoring, 230, 232
identifying, 276 Members of the European Parliament (MEPs), 389,
knowledge, 160, 167 394
penetration, 240 Mercantilism, 118
potential, 15–16, 151 Mercedes-Benz, 86
research, 178 Mercer Consulting, 89
selecting, 275–276 Mexico, 65, 117, 384–387
size, 208 Michelin, 207, 269
turnover, 255, 256 Middle Eastern countries, 13
Market-based economy, 76–77, 77, 91 MIGA, 343–344
Market makers, 258–259 Milken Institute, 31–32
Marketing Millennium Declaration, 416
activities, 270–273 MIS, 172–173, 183–184
application case, 299–300 Mixed economy, 77, 78, 91
customer relations and, 268 MNC. See Multinational corporation
environment, 270–271 MNE, 10, 97–98
final consumers and, 269 Mode of entry laws, 109
functional integration, 172–173, 177–180 Modified gold standard, 253–254
goods versus services and, 269–270 Monetary authorities, 348–349
478 SUBJEcT INDEX
Money. See specific type North American Free Trade Agreement (NAFTA), 117,
Monitoring systems, anticorruption, 33 384–387
Moral language approach, 21 Northern Ireland, 230, 231
Morocco, 231, 231 NYSE, 344–345, 429
Mortgage-Backed Securities (MBS), 349
Mortgage crisis, 375–376 Obligation, theory of, 21
Motorola, 5, 193, 204 OECD, 32, 127, 367, 408–411, 412
Multicountry research, 15 OFDI, 127
Multilateral Investment Government Agency (MIGA), Office for Official Publications of the European
343–344 Communities, 400
Multinational corporation (MNC). See also specific Office of Foreign Assets Control, 347
name Office of the U.S. Trade Representative, 386
foreign direct investment and, 126 Official Airline Guide (OAG), 341
foreign exchange market and, 260–262, 263 Offshore banks, 336, 337
operations of, 7 Offshoring
trade and, 125–126 advantages of, 233–236
Multinational enterprise (MNE), 10, 97–98 application case, 243–244
Mutual fund, 126 business knowledge, 239
business process, 225–230, 237, 243
NAAEC, 385 in China, 234
NAALC, 385 companies engaging in, 238–239
NADB, 385 countries for United States and, 230–232, 231
NAFTA, 117, 384–387 defined, 224
NASDAQ OMX, 345 disadvantages of, 233–236
NASSCOM (trade group), 230 disparity in income and class, 234
National Academy of Public Administration, 238 future of, 230–232, 231
National Automated Clearing House Association GAO report on (2006), 235, 239
(NACHA), 429 globalization and, 232–233
National Securities Clearing Corporation (NSCC), 429 inflation and, 236, 236
Nationalism, 100 inshoring and, 224
Natura Cosmetics, 151, 299–300 Internet technology, 226
Nature of product, 131–132 near-shoring and, 224–225
Nature, relationship to, 54, 56 organizational structure of, 236–238
Near-shoring, 224–225. See also Offshoring outsourcing and, 223, 243–244
Neomercantilism model, 98 overview, 221–223, 241–242
Nestlé, 72, 289 reasons for, 239–240
New world order, 3–4 reasons not to, 240–241
New York Stock Exchange (NYSE), 344–345, 429 receiving country and, 233–234
New Zealand Dairy Board, 322 sending country and, 234–236
Newly industrialized country (NIC), 4, 221 of services, 225–230, 232–233
Nielsen and Ipsos Group S.A., 297 studies, 230, 232, 237–239
Nonbank brokers, 259 technology, 226
Noncommercial banks, 258–259 OLI paradigm, 129
Nonmanagerial employees, 312–314 One-party states, 96–97
Nontariff barriers, 113 Open revolving account, 339
Nonverbal language, 42 Operations, 8–10, 162
North American Agreement on Environmental Operations management. See Production and operations
Cooperation (NAAEC), 385 management (POM)
North American Agreement on Labor Cooperation OPIC, 343–344
(NAALC), 385 Opportunity costs, 212
North American Development Bank (NADB), 385 Ordering costs, 212
SUBJEcT INDEX 479
Organisation for Economic Co-operation and Pinnacle Foods Group, Inc., 199
Development (OECD), 32, 127, 367, 408–411, 412 PLC theory, 121–122, 129–130, 279
Organizational labels, 10–11 Political corruption, 29, 29
Organizational structures of international companies Political effects of corruption, 32
advantages of, 326, 327 Political environment
defined, 314 application case, 115
disadvantages of, 326, 327 changes in, 6
divisional, 316–317, 317 corruption as factor in, 102
functional, 321, 321 country risk assessment and, 102–104, 104, 105
geographic, 319–320, 320 factors in
hybrid, 323–324, 324 corruption, 102
matrix, 322–323, 323 hostilities, traditional, 101
new developments in, 324–326 ideology, 99–100, 114
overview, 314–315 international companies, 102
product, 317–319, 319 nationalism, 100
Outsourcing, 199, 223, 243–244. See also Offshoring overview, 98–99
Outward foreign direct investment (OFDI), 127 public sector enterprises, 101
Overseas portfolio investment, 126 stable governments, 98
Overseas Private Investment Corporation (OPIC), terrorism, 101
343–344 unstable governments, 98, 100–101
Ownership laws, 108–109 foreign direct investment and, 98, 138–139
Ownership restrictions in foreign direct investment, international business and, 114
140–141 legal environment and, 94–95
models for analyzing relationships between company
Packaging, 152–153, 284–285 and host government, 97–98
Packaging slip, 153 overview, 94–95, 114
Panasonic, 16–17, 55 political systems, 96–97
Paper checks, 340–341 strategic actions and, 104, 106–107, 114
Paper money, 251–252 Political risk insurance, 343–344
Parallel economies, 84, 85, 91 Political Risk Services, 103, 104
Parmalat, 363–364 Political systems, 96–97
Particularism, 60 Polycentrism, 62–63
Partners, 163, 165–166 POM. See Production and operations management
Pay per click (PPC), 430 Portfolio investments, 9–10, 126
Payments Power Curbers, 4
advance, 337–338 Power distance, 49, 52
arrangements, 159 PPC, 430
balance of, 71 PPP, 74, 90
Internet, 340, 428 Price
methods, 339–341 ask, 259
and receivables, 262, 263 buy, 259
royalty, 364 controls, 112
transfers and, 337–339 points, establishing, 285–286
People’s Republic of China. See China of products, 261
Pepsi-Cola Corporation, 42, 86, 160, 271 of raw material, 261–262
Performance, 201 setting, 178
Performance reviews, 181 Price-specie-flow mechanism, 118, 253
Perishability of product/services, 191, 270 PricewaterhouseCoopers (PWC), 375–376, 377–380
Personal selling, 292 Primary research data, 14
Petty corruption, 29 Private equity, 141–142
Philips, 17, 283, 302, 325 Privatization, 424
480 SUBJEcT INDEX
Process-based layouts, 206 Production and operations management (POM)

Process decisions, 197–201, 200 (continued)
Process technology, 88 Internet and, 431–433
Procter & Gamble, 88, 277, 314–315, 317–318 in manufacturing versus services, 190–191
Product overview, 189–190, 218
branding, 284–285 supply-chain management and, 215–218
changes to, making, 152–153 Productivity, 148, 193
declining period of, 122 Profits, repatriation of, 113
determining offering of, 279–285 Project based process, 199
developing, 178 Protestant work ethic, 45
growth stage of, 122 Public sector enterprises, 101
heterogeneity of, 270 Publishing industry, 342
inseparability of, 270 Purchasing decisions, 208–209, 209
intangible, 270 Purchasing power parity (PPP), 74, 90
introductory stage of, 122 Purdue, 199
knowledge, 315 PWC, 375–376, 377–380
liability laws, 112–113
mature stage of, 122 Quality control, 175
nature of, 131–132 Quality decisions, 201–206, 203, 205
packaging, 284–285 Quality of life, 88–90, 89, 90, 92, 195
perishability of, 270 Quality of research data, 14
price of, 261
of raw material, 261–262 R&D functional integration, 172–173, 184–185
selecting for export, 151–152 Raw material, pricing of, 261–262
standardization, 282–283 Real interest rates, 70
strategy, 283–284 Real-Time Gross Settlement system, 428
structures, 317–319, 319 Recruiting employees, 180–181
tangiblity of, 269–270 Regulations
technology, 88 anticorruption, 33, 348–349
type of, 208 antitrust, 112
Product-based layouts, 206 customs, 348
Product decisions, 196–197 ethics and, 21–22
Product life cycle (PLC) theory, 121–122, 129–130, 279 in export/import strategy, analyzing and understanding,
Production, 121–122 152
Production and operations management (POM) financial, 347–349
application case, 219–220 foreign direct investment and, 140
decisions in local, 194
human resources, 215 monetary, 348
inventory, 211–215, 213 taxes, 348
layout, 206–207 Relative advantage, 120
location, 192–196, 196, 197 Reliability, 201
newer developments in manufacturing processes, Religion, 44–45
210–211 Repatriation of profits, 113
overview, 193, 218 Representative offices, 335–336
process, 197–201, 200 Republic, 96
production, 196–197 Reputation, 201
purchasing, 208–209, 209 Research
quality, 201–206, 203, 205 China and, 11
scheduling, 207–208 complexity of, 14–15
functional integration, 172–176 costs of, 13
globalization of, 191–192 free research studies and, 15
SUBJEcT INDEX 481
Research (continued) Services (continued)

globalization and, 11 core, 232
importance of, 11–13 demand for, 7
lead time and, 14 determining offering of, 279–285
multicountry, coordinating, 15 developing, 178
primary data, 14 foreign direct investment in, 134–135
quality of data and, 14 front-office, 228–230
secondary data availability and, 13 goods versus, 269–270
time pressures and, 14 heterogeneity of, 270
uses of, 15–17 industry, 134–135, 190–191
Research and development (R&D) functional integration, inseparability of, 191
172–173, 184–185 intangibility of, 191
Reserve Bank of New York, 260 offshoring of, 225–230, 232–233
Resource-based view (RBV) of strategy, 301 operations management in, 190–191
Resource utilization, 208 perishability of, 191
Reuters services, 429–430 Reuters, 429–430
Risk, 160, 177, 251 selecting for export, 151–152
Robinson-Patman Act, 112 telemarketing, 229–230
Ronen and Shenkar’s cluster approach, 57–59, 58 variability of, 191
Routing number, 340 Setup costs, 212
Royal Dutch Shell, 18 Shadow economies, 84, 85, 91
Royalty payments, 364 Shareholders. See Stakeholders
Russia, 366–367 Sharp (electronics company), 17
Sherman Act, 112
S&P 500, 4 Shipper’s export declaration, 155, 156
Sale, terms of, 159 Shipping
Sales by air, 341–342, 342
calls, 229–230 developments in, recent, 341–343
forecast, 277–278 dry bulk, 341
Internet, 431 expansion internationally and, 332
promotions, 296 insurance, 343
tax, general, 371–372 by sea, 341–342
Sarbanes-Oxley Act (SOX), 362 selection of method of, 341
Scalability, 232 tanker, 341
Scandals, accounting, 361–364, 375–376 wet bulk, 341
Scenario analysis, 79–81, 91 Shock, culture, 61–62
Scheduling decisions, 207–208 Siemens AG, 144–145, 228
Schwartz’s framework, 59 Six Sigma principles, 204–205, 205
Sea shipments, 341–342 Social class, 44
Search engine optimization (SEO), 430–431 Social effects of corruption, 32
SEC, 358 Social structure, 43–44
Secondary research data availability, 13 Socialism, 100, 114
Secretariat (UN), 418–419 Society for Worldwide Interbank Financial
Securities and Exchange Commission (SEC), 358 Telecommunication (SWIFT), 339
Security Council (UN), 414–415 Solectron Corporation, 324–325
Self-regulation, 21–22 Sourcing, 174, 216
SEO, 430–431 South Africa, 231
Services South Korea, 4
back-office, 227–228 South Vietnam, 95
Bloomberg, 429–430 Southwest Airlines, 80
changes to, making, 152–153 Sovereignty at bay model, 97
482 SUBJEcT INDEX
SOX Act, 362 Taxes

Space, concept of, 55, 56 accounting and
SPC, 202 corporate, 368–370, 373
Specialization, 120, 160, 174 general sales, 371–372
Specificity, 60 management, 182
Spoilage/breakage/obsolescence costs, 212 overview, 367
SQC, 202, 204 value-added, 371–372
Stable governments, 98 withholding, 369–370
Stakeholders authorities regulating, 348
balanced approach to relationship with company and, consumption, 372
26–28 corporate, 368–370, 373
corporate social responsibility and, 18–19, 22 double taxation and, 368, 373–374
defined, 22–23 in European Union, 369
dyadic relationship with company and, 23–24, 25 general sales, 371–372
interests of, 18, 23, 24 globalization and, 372–373, 377–378
symbiotic relationship with company and, 23–24, 25, incentives, 110
26 laws, 109–110, 110
theory of, 23 in legal environment, 109–110, 110
Standard & Poor’s 500 stock index (S&P 500), 4 levels, 109–110
Standardization, 175, 282–283 local, 193
Starbucks, 283 no additional taxes approach and, 368, 370
Statistical process control (SPC), 202 playing-field taxes approach and, 368–369, 370
Statistical quality control (SQC), 202, 204 rates, 110, 110
Stock exchanges and markets, 344–347 subsidiary and, establishing, 333
Stock-out costs, 212 treaties, 110
Strategic actions, 104, 106–107 types, 110
Strategic industries, 140–141 value added, 371–372
Strategy-formulation process, 79–81 withholding, 139, 364–365
Submerged economies, 84, 85, 91 Technical competence, 310–311
Subsidiary, 333–335 Technology
Subsidized loans, 140 advances in, 8
SuperDot system, 345 country risk analysis of economy and, 87–88, 91
Suppliers, 194, 217 integration and, 200–201
Supply-chain management, 215–218 Internet, 221–222, 225–230, 243
Supply-side inflation, 71 issues, 175
Sweden, 44, 46 Magnetic Ink Character Reading, 428
SWIFT number, 339–340 management, 88
SWITCH, 226–227 management information systems, 172–173,
Symbiotic relationship between stakeholders and 183–184
company, 23–24, 25, 26 process, 88
three-dimensional, 342–343
Taiwan, 4 transfer of, 88, 133–135
Tangibility of product/services, 269–270 Y2K crisis and, 226
Tanker shipments, 341 Telemarketing, 229–230
Target group, 277–278, 280–281 Teleological philosophy, 21
Target markets, selecting, 177 Temporal method, 359
TARGET (Trans-European Automated Real-Time Gross Terms of payments, 337–339
Settlement Express Transfer) system, 428 Terms of sale, 159
Tariffs, 113, 161–162, 332 Terrorism, 101
Tata Iron & Steel Company, 269 Theocracy, 97
“Tax-haven countries,” 336 Theocratic law, 107
SUBJEcT INDEX 483
Theories Trademark, 162

absolute advantage, 118–119 Training and development of employees, 181
appropriability, 168 Transactions, 159, 337–341. See also Foreign exchange
comparative advantage, 119–121, 125 Transfer of technology, 88, 133–135
ethical, 21 Transfers and payments, 337–339
of obligation, 21 Transnational corporation (TNC), 10, 126. See also
product life cycle, 121–122, 129–130, 279 specific name
stakeholder, 23 Transparency International (TI), 30, 32–34
Third-party vendors, 237–238 Transportation costs, 161, 212
Third world countries, 73 Treaty of Maastricht (1992), 388
TI, 30, 32–34 Treaty of Rome, 387
Time orientation, 55, 56 Trust, 252–253
Time pressures on research, 14 Trusteeship Council (UN), 417–418
Time zone and near-shoring, 225 Tunisia, 231, 231
TNC, 10, 126. See also specific name Turkey, 406
Toshiba, 39
Total quality management (TQM), 202–204, 214 UMC, 364
Total SA of France, 128 UN. See United Nations
Toyota Motors, 88, 185, 202, 208–209, 219–220, 283 UN Conference on Trade and Development (UNCTAD),
Toyota Production System (TPS), 219–220 135
TPS, 219–220 Uncertainty avoidance, 49–50, 52
TQM, 202–204, 214 Underdeveloped countries, 73
Trade Underground economies, 84, 85
absolute advantage theory and, 118–120 Unilever, 196–197, 302
application case, 144–145 Unions, labor, 313–314
bartering and, 159, 250 United Microelectronics Corporation (UMC), 364
changes in, 125–126 United Nations (UN)
China and, 4 corruption-reducing prescriptions for, 33–34
comparative advantage theory and, 119–121 country development classifications of, 73
defined, 118, 142 creation of, 411
electronic, 255 Economic and Social Council, 416–417
in European Union, 123 evaluation of, 419–421
foreign direct investment and, 142 Food and Agriculture Organization, 135
free, 120, 138–139 General Assembly, 412–414
in future, 125–126 human rights issues and, 420
General Agreement on Trade and Tariffs and, 124–125 International Court of Justice, 108, 418
Heckscher-Ohlin model and, 121 Millennium Declaration and, 416
historic perspective, 3–4, 142 purposes of, 412
international business and, 3–4 Secretariat, 418–419
mercantilism, 118 Security Council, 414–415
multinational corporations and, 125–126 Trusteeship Council, 417–418
NAFTA and, 117 “World Investment Report” (2006), 136, 136, 137
overview, 117–118, 142 United States. See also specific government departments
product life cycle theory and, 121–122 and regulations in
relative advantage and, 120 credit crisis (2008), 5–6, 68, 349–350
statistics, 122–124, 123 foreign exchange rates of, 254
World Trade Organization and, 117, 121, 124–125, 221 Free Trade Agreement with Canada and, 385
Trade barriers, 8 mortgage crisis in, 375–376
Trade creation, 383–384 North American Free Trade Agreement and, 117,
Trade surplus, 9, 71 384–387
Trade diversion, 384 offshoring countries for, 230–232, 231
484 SUBJEcT INDEX
Universalism, 60 WEF, 4, 82
Unstable governments, 98, 100–101 Weight Watchers, 86
UNZ & CO., 157 Wet bulk shipments, 341
U.S. Bureau of Labor Statistics, 5, 236, 236 Whirlpool, 161
U.S.-Canada Free Trade Agreement (FTA), Wholly owned subsidiaries, 167–170
385 Wire transfer, 339–340
U.S. Chamber of Commerce, 98, 132 Withholding taxes, 139, 364–365
U.S. Customs and Border Protection, 347 Working capital management, 176
U.S Department of Commerce, 154 World Bank
U.S. Department of Justice, 349 Board of Governors, 423
U.S. Department of the Treasury, 260 components of, 421, 423, 425
U.S. Internal Revenue Service, (IRS), 348 corruption-reducing prescriptions for, 33–34
Utilitarian philosophy, 21 economic development and, 73
Utilities, availability of, 194 evaluation of, 424, 426
executive directors, 423–424
VALS, 275 function of, 421
Value added concept, 190 gross national income and, 73–74, 75, 76, 90
Value added tax (VAT), 371–372 lending and, 253–254
Values and lifestyles (VALS), 275 underground economies and, 85
Values, cultural, 45–46, 275 World Court, 108, 418
Variability of services, 191 World Economic Forum (WEF), 4, 82
VAT, 371–372 World Trade Organization (WTO)
Vendors, 232–233, 237–238 China and, 289
Venezuela, 95 exports by region and, 123, 123
Verizon Communications, 95 mediation in legal environment and, 108
Vertical foreign direct investment, 128, 130 trade and, 117, 121, 124–125, 221
Vertical integration, 199, 200 World War I, 253
Vietnam, 130 WorldCom, 362–363
Volkswagen, 269 Worldwide Quality of Living Survey, 89
WTO. See World Trade Organization
Wage rates, 4–5, 5, 193, 312, 313
Wal-Mart, 235 Y2K crisis, 226
About the Authors
James P. Neelankavil is the Robert E. Brockway Distinguished Professor of Market-

ing and International Business at the Zarb School of Business at Hofstra University.
He received his doctoral degree in international business from the Stern School of
Business at New York University (NYU) and his MBA with distinction from the Asian
Institute of Management in Manila, the Philippines. Prior to joining the Zarb School
of Business, Dr. Neelankavil taught at NYU’s Stern School of Business.
Recently, Dr. Neelankavil was awarded a Fulbright Senior Specialist fellowship to
the Philippines. He has held visiting professorships at Rotterdam School of Manage-
ment in the Netherlands; at Bocconi University in Milan, Italy; and at NYU’s Stern
School of Management. His teaching interests include corporate strategy, global
business strategy, and international marketing.
Dr. Neelankavil has published over 25 articles and seven books in the area of in-
ternational business, corporate strategy, and cross-cultural studies. His research has
appeared in many leading business journals, including the Journal of International
Business Studies and the Journal of Business Research. His primary research interests
are in the areas of cross-cultural management, strategic management, and R&D and
innovation.
Anoop Rai received his Ph.D. from Indiana University. He is a professor of finance
at the Zarb School of Business at Hofstra University. His current research focuses
on international financial markets and institutions, and he has published papers in
the Journal of Banking and Finance, the Journal of Economics and Business, the
Journal of Risk and Insurance, the Journal of Futures Markets, and the Journal of
International Financial Markets. Professor Rai has taught at several other institutions
as a visiting or adjunct professor, including the Rotterdam School of Management
in the Netherlands, the University of Catania in Sicily, Italy, and Rutgers University
in Singapore. He has also conducted seminars on risk management for bankers from
Russia and its newly independent states and for the Netherlands Antilles.
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Basics of

James P. Neelankavil and Anoop Rai

First published 2009 by M.E. Sharpe

Published 2015 by Routledge

Routledge is an imprint of the Taylor & Francis Group, an informa business

Copyright © 2009 Taylor & Francis. All rights reserved.

No part of this book may be reprinted or reproduced or utilised in any form or by

Product or corporate names may be trademarks or registered trademarks, and

Library of Congress Cataloging-in-Publication Data

ISBN 13: 9780765623928 (pbk)

PREFAcE AND AcKNOWLEDGMENTS ix

The Legal Environment 107

Chapter Summary 218

13. INTERNATiONAL FiNANCiAL MANAGEMENT 331

1. An introduction and overview of international business

a. Culture and its effects on businesses and customers

3. Discussion of entry strategies

a. Production and operations management

7. Global outsourcing and its role in international operations

Dr. Sandip Dutta, Southern Connecticut University

We would like to extend a special thanks to Harry M. Briggs, executive editor of

International business involves understanding the external environment,

makes global expansion attractive to international firms. For example, Motorola, a

The World’s Ten Largest International Corporations Ranked by Revenues, 2007

Revenues Net Earnings Total Assets Employees In # of

REASONS fOR GROWTH iN INTERNATiONAL BUSiNESS

• Saturation of domestic markets. In many of the industrialized countries, market

• Diversification attempts by international companies to reduce risk. One benefit

TYpES Of INTERNATiONAL OpERATiONS

LIcENSING AND FRANcHISING AGREEMENTS

FOREIGN DIREcT INVESTMENTS

FDI Flows to a Few Selected Countries, 2006

# Country FDI flows (US$ hundred millions)

ORGANIZATIONAL LABELS FOR INTERNATIONAL COMpANIES

• International company—a company of any size that participates in any form of

INTERNATiONAL BUSiNESS RESEARCH AND THE NEED fOR INfORMATiON

by the human resources departments of international companies to assess managers’

AVAILABILITY OF SEcONDARY DATA

COMpLEXITY OF INTERNATIONAL RESEARcH

variables present in foreign markets, and the unfamiliarity of international managers

COORDINATING MULTIcOUNTRY RESEARcH

Determining Market Potential

Manufacturing Plant Location Decisions

Production facilities are located to take advantage of such factors as inexpensive

High-quality information is essential for developing strategies. By understanding

ETHiCAL CONSiDERATiONS iN INTERNATiONAL BUSiNESS

International Companies: Areas of Ethical and Social Responsibility Concerns

Affected Stakeholder Ethical/CSR Issues Situations

REGULATIONS AND SELF-REGULATIONS TO COMBAT ETHIcAL BEHAVIOR

STAKEHOLDER THEORY AND CORpORATE SOCiAL RESpONSibiLiTY

WHO ARE STAKEHOLDERS?

INTERESTS AND CONcERNS OF VARIOUS STAKEHOLDERS

STAKEHOLDERS’ DYADIc VS. SYMBIOTIc RELATIONSHIp WITH THE COMpANY

Interests, Needs, and Concerns of Major Stakeholders

COMpLEXITY AND PROBLEMS WITH AcHIEVING SUccESS WITHIN A

REASONS FOR A BALANcED AppROAcH TO SATISFYING STAKEHOLDERS’ INTERESTS

WHAT IS A BALANcED AppROAcH TO DEALING WITH STAKEHOLDER’S INTERESTS?

• The first step in developing a comprehensive stakeholder strategy is to develop a

ADDITIONAL REcOMMENDATIONS AND CONcLUSIONS

# Type of Corruption Examples Predominantly found in