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3.1 INTERNATIONAL BUSINESS

UNIT - IIntroduction and OverviewIntroduction and Overview : Introduction - The Globalization of the World Economy - The Changing Nature of International Business - Differences in International Business.

UNIT - IICountry FactorsNational Differences in Political Economy : Introduction - Political Systems - Economic Systems - Legal Systems -

The Determinants of Economic Development - States in Transition.Differences in Culture : Introduction - Social Structure - Religion - Language - Education - Culture and theWorkplace - Cultural Change - Cross-Cultural Literacy - Culture and competitive Advantage.

UNIT - IIIThe Global Trade and Investment EnvironmentInternational trade Theory : Introduction - An Overview of Trade Theory - Mercantilism - Absolute Advantage -Comparative Advantage - Heckscher-Ohlin Theory - The New Trade Theory - National Competitive Advantage -Porter's Diamond.The Revised Case for Free Trade - Development of the World - Trading System - WTO & development of Worldtrade - Regional grouping of countries and its impact.

UNIT - IVForeign Direct Investment : Introduction - Foreign Direct Investment in the World Economy - Horizontal ForeignDirect Investment - Vertical Foreign Direct Investment. Benefits and advantages to host and home countries.

The Global Monetary SystemThe Foreign Exchange Market : Introduction - The Functions of the Foreign Exchange Market.

UNIT - VThe Strategy and Structure of International BusinessThe Strategy of International Business : Introduction - Strategy and the Firm - Profiting from Global Expansion -Pressures for Cost Reductions and Local Responsiveness - Strategic ChoiceMode of Entry and Strategic Alliances : Introduction - Entry Modes - Selecting and Entry Mode - Strategic Alliances -Making Alliances Work.Exporting, Importing and Counter trade : Introduction - The Promise and Pitfalls of Exporting - Improving ExportPerformance - Export and Import Financing - Export Assistance - Counter trade.



3.1 INTERNATIONAL BUSINESS

UNIT - IIntroduction and Overview : Introduction - The Globalization of the World Economy - The Changing Nature ofInternational Business - Differences in International Business.

Globalization is not a new phenomenon either at the firm level or at the national/world .% economy level. Around1880,,the drocess of globalization of the economy and the firm , began. This was the recognition of comparativeadvantage. Many firms went global. They* ' included Ford, Singer, Gillette, National Cash Register, Otis andWestern Electronics. This was because of enjoyment of scale of economies due to the advancement of technology.In the interwar period, the thrust of globalization declined. But the post war period witnessed once again

tremendous growth of globalization. Let us learn some of the important forces of globalizations

Introduction and overview` The first phase of global trade began around 1870 and ended with the world war I (1914)` Started with industrial revolution in UK` Colonial empires were prevailing` The ratio of trade to GDP was as high as 22.1 in 1913` But later ctries started imposing trade barriers to protect their domestic trade and pdn, thus GDP ratio

reduced to 9.1 during 1930` Advanced ctries faced serious problems b/c of these trade barriers.` Added to this there was break down of gold standard also, which affected international trade` Thus world nations felt the need for international co-operations in global trade` This resulted in the establishment of International Monetary Fund(IMF) and International bank for

reconstruction and development(IBRD /WORLD BANK)` Advanced ctries faced serious problems b/c of these trade barriers.

` Added to this there was break down of gold standard also, which affected international trade` Thus world nations felt the need for international co-operations in global trade` This resulted in the establishment of International Monetary Fund(IMF) and International bank for

reconstruction and development(IBRD /WORLD BANK)

The globalization of the world economy

The impact of this level of globalization has undoubtedly led to economic growth. In specific terms, the effect ofglobalization are as follows:

y The major effect of globalization is that the global economy is,becoming more integrated day by day.y The volume of world trade has grown at a faster rate than the volume of worldy output.y There has been a trend of lowering the barriers to the free flow of goods, services and capital among

countries.

y Foreign direct investment has been playing an important role in the global economy. In order tobecome competitive, company have started investing in overseas operations.y Global operations have led to the emergence of Multilateral Trading Systems.y Imports are penetrating deeper into the world's largest economies as well.y The growth of world trade, foreign direct investment and imports leds to more foreign competition in

the domestic markets.y In order to compete with the foreign players, domestic firms are required to enbance the production

and distribution capabilities.y companies have started looking the wodd as a market for their products. .y Companies have started dispersing their manufacturing, marketing and research facilities around the

globe where cost and skill conditions are most favourable.y Opportunities have been increasing for the firms.y Innovations have started spreading faster.

Differences between International Trade and

Domestic Trade` Conducting and managing international business operations is more complex than undertaking domestic

business.` Differences in the nationality of parties involved, relatively less mobility of factors of production,

customer heterogeneity across markets, variations in business practices and political systems, variedbusiness regulations and policies, use of different currencies are the key aspects that differentiateinternational businesses from domestic business.

` Firms conducting trade internationally can withstand these situations and huge losses as their operationsare wide spread. Though they face losses in one area they may get profits in other areas, this provides forstabilizing during seasonal market fluctuations. Firms carrying business locally have to face this situationwhich results in low profits and in some cases losses too.

` International business provides for sharing of the latest technology that is innovated in various firmsacross the globe which in consequence will improve the mode and quality of their production.

` International business obviously improves the political relations among the nations which gives rise toCross-national cooperation and agreements. Nations co-operate more on transactional issues



UNIT - IICountry FactorsNational Differences in Political Economy : Introduction - Political Systems - Economic Systems - Legal Systems -The Determinants of Economic Development - States in Transition.Differences in Culture : Introduction - Social Structure - Religion - Language - Education - Culture and theWorkplace - Cultural Change - Cross-Cultural Literacy - Culture and competitive Advantage.

Political system` A political system is a system of politics and government. It is usually compared to the legal

system, economic system, cultural system, and other social systems.` who should have authority, how religious questions should be handled, and what the government's

influence on its people and economy should be.` A political system is a complete set of institutions, interest groups (such as political parties, trade

unions, lobby groups), the relationships between those institutions and the political norms and rules thatgovern their functions (constitution, election law).

` A political system is composed of the members of a social organization (group) who are in power.` A political system is a system that necessarily has two properties: a set of interdependent components

and boundaries toward the environment with which it interacts.Basic Forms of Political systems

` Anarchism (Rule by no one)` Democracy (Rule by the people)` Monarchy. (Rule by one person) Monarchies are one of the oldest political systems known, developing

from tribal structure with one person the absolute ruler.` Meritocracy (Rule by best)` Technocracy (Rule by scientist/intellectuals)` Republic (Rule by law) The first recorded republic was in India in the 6th century BC (BCE).` Sultanate (Rule by one person and Allah) an Islamic political structure combining aspects of monarchy and

theocracy



` Theocracy (Rule by God and his representatives) and other religions too; also can force convert other non-religious person in any type in this system

` Parliamentary democracy (rule by the people through parliament)` Feudalism (Rule by lord/king)` Fascism (Rule by a leader)` Oligarchy (Rule by a few)` Military government (Rule by military)` Aristocracy (Rule by nobles)` Plutocracy (Rule by money)` Communism (Rule by workers)

Economic system` An economic system is the combination of the various agencies, entities that provide the economic

structure that guides the social community. These agencies are joined by lines of trade and exchangealong which goods, money etc are continuously flowing. This affects Production, allocation of economicinputs, distribution of economic outputs, and consumption of goods and services in an economy. It is a setof institutions and their social relations

` . Alternatively, it is the set of principles by which problems of economics are addressed, such asthe economic problem of scarcity through allocation of finite productive resources.

` Economic systems can be divided by the way they allocate economic inputs (the means of production) andhow they make decisions regarding the use of inputs. A common distinction of great importance is thatbetween capitalism (a market economy) and socialism (a planned economy).

` In a capitalist economic system, production is carried out to maximize private profit, decisions regardinginvestment and the use of the means of production are determined by competing business owners in themarketplace; production is based on the process of capital accumulation.

` The means of production are owned primarily by private enterprises and decisions regarding production

and investment determined by private owners in capital markets.` In a socialist economic system, production is carried out to directly satisfy economic demand by producing

goods and services for use; decisions regarding the use of the means of production are adjusted to satisfyeconomic demand, investment (control over the surplus value) is carried out through a mechanism ofinclusive collective decision-making.

` The means of production are either publicly owned, or are owned by the workers cooperatively.The basic and general economic systems are

` Market economy ("hands off" systems, such as pure capitalism)` Mixed economy (a hybrid that blends some aspects of both market and planned economies)` Planned economy ("hands on" systems, such as state socialism)` Traditional economy (a generic term for older economic systems)` Participatory economics (a system where the production and distribution of goods is guided by public

participation)` Gift economy (where an exchange is made without any explicit agreement for immediate or future

rewards)

` Barter economy (where goods and services are directly exchanged for other goods or services)

Legal systems` The legal systems of the world today are generally based on one of three basic systems: civil

law, common law, and religious law ² or combinations of these. However, the legal system of eachcountry is shaped by its unique history, and so incorporates individual variations.

Social structure` Social structure is a term used in the social sciences to refer to patterned social arrangements which

form the society as a whole, and which determine, to some varying degree, the actions of theindividuals socialized into that structure.

` The meaning of "social structure" differs between various fields of sociology.` On the macro scale, it can refer to the system of socioeconomic stratification (e.g., the class

structure), social institutions, or, other patterned relations between large social groups` On the meso scale, it can refer to the structure of social network ties between individuals ororganizations.

` On the micro scale, it can refer to the way norms shape the behavior of actors within the social system.

Definition and concepts` social structure is seen as comprising those cultural or normative patterns that define the expectations of

agents hold about each other's behaviour and that organize their enduring relations with each other` the relationship of definite entities or groups to each other,` enduring patterns of behaviour by participants in a social system in relation to each other, and` institutionalised norms or cognitive frameworks that structure the actions of actors in the social system.



Differences in cultureCulture is a society·s (or group·s) system of shared, learned values and norms; as a whole, these values and normsare the society·s (or group·s) design for living

y Values: abstract ideas about the good, the right, the desirabley Norms: social rules and guidelines; determine appropriate behavior in specific situations

y Folkways: norms of little moral significancey dress code; table manners; timeliness

y Mores: norms central to functioning of social lifey bring serious retribution: thievery, adultery, alcohol

National culturey ´Nationµ: is a useful way to bound and measure culture for conduct of business

y culture is a key characteristic of society and can differ significantly across national bordersy Can also vary significantly within national borders

y culture is both a cause and an effect of economic and political factors that vary across nationalborders

y laws are established along national linesSocial Structure and Culture

y Societies vary based on whether the unit of social organization is the individual or the groupy Society is often stratified into classes or castes

y High-low stratificationy High-low mobility between stratay

Individual vs Group Societal Characteristics

Religion, Ethics and Culturey Religion: system of shared beliefs about the sacredy Ethical systems: moral principles or values that shape and guide behavior; often products of religiony Major religious groups and some economic implications

y Christianity protestant work ethicy Islam Islamic fundamentalismy Hinduism anti-materialistic, socially stratifiedy Buddhism anti-materialistic, social equalityy Confucianism hierarchy, loyalty, honesty

y Major religious groups have significant sub-sets with distinct beliefs and varying economic implications

Language and Culturey Language, spoken

y ´privateµ does not exist as a word in many languagesy Eskimos: 24 words for snowy Words which describe moral concepts unique to countries or areas: ´faceµ in Asian cultures,

´filotimoµ in Greecey Spoken language precision important in low-context cultures

y Language, unspokeny Context... more important than spoken word in low context cultures



Education and Culturey Education

y Medium through which people are acculturatedy Language, ´myths,µ values, norms taughty Teaches personal achievement and competition

y Education is a critical element of national competitive advantagey Education system itself may be a cultural outcome

Culture and the Workplace (Geert Hofstede)y Hofstede groups national cultures along dimensions meaningful to business:

y Work related values not universaly National values may persist over MNC efforts to create culturey Local values used to determine HQ policiesy MNC may create unnecessary morale problems if it insists on uniform moral norms

y Starting point for understanding of business situations across-culturesy Effective international managers MUST understand own culture AND other culture(s)

Hofstede's dimensionsy Power Distance:

y degree of social inequality considered normal by peopley distance between individuals at different levels of a hierarchyy scale is from equal (small power distance) to extremely unequal (large power distance)

y Individualism versus Collectivism:y degree to which people in a country prefer to act as individuals rather than in groupsy the relations between the individual and his/her fellows

y Uncertainty Avoidance:y more or less need to avoid uncertainty about the future

y degree of preference for structured versus unstructured situationsy structured situations: have tight rules may or may not be written down

y Masculinity versus Femininity:y division of roles and values in a societyy Masculine values prevail: assertiveness, success, competitiony Feminine values prevail: quality of life, maintenance of warm personal relationships, service,

care for the weak, solidarityy Confucian Dynamism (or long-term orientation)

y Attitudes towards timey Persistencey Ordering by statusy Protection of ´faceµy Respect for traditiony Reciprocation of gifts and favors

Hofstede Research: Some Issues

y Hofstede's methodology: Study based on IBM: 64 national subsidiaries, 116,000 workers (not just managers), three world

regions Reports averages; does not describe exact individual situations Is valid for broader groups not individuals

y IBM values may overwhelm national values Yet, if IBM culture so overwhelming, differences across countries may be attributable to

´nationalµ culture...y Privileged groupy Researcher bias? Western stereotypes and culturally biased conclusions?y Many recent studies validate Hofstede·s dimensions

Cultural Change

y Culture is not a constant, but does evolve over time. What was acceptable behavior in the US in the 1960s

is now considered ´insensitiveµ or even harassment. Language and sensuality that was not allowed on

Indian TV in the 1960s is now commonplace. Changes are taking place all the time. As countries become

economically stronger and increase in the globalization of products bought and sold, cultural change is

particularly common.



y Cross cultural literacy:

Individuals and firms must develop cross-cultural literacy. International businesses that are ill

informed about the practices of another culture are unlikely to succeed in that culture. One way to

develop cross-cultural literacy is to regularly rotate and transfer people internationally.

One must also beware of ethnocentric behavior, or a belief in the superiority of one·s own

culture. Along with this superiority, they may develop contempt for all the other cultures. Some

people have been unable to find some of the obvious weaknesses in our own culture and

strengths of other cultures. Some people are unaware of the uniqueness of the culture. One good

example on the uniqueness of American culture is the second free cup of coffee. It is so commonin American restaurants, yet is unheard of in many European or Asian countries. People who have

traveled internationally can often identify many other examples.

y Culture and competitive advantage:

Cultural values can influence the costs of doing business in different countries, and ultimately

the competitive advantage of the country. The text suggests some positive and negative aspects

of US and Japanese culture than may have contributed to the economic success of these

countries. Understanding what countries may have a competitive advantage has implications

both for looking for potential competitors in world markets and for deciding where to undertake

international expansion.

The Determinants of Economic Development:

The major measures of economic development of courtiers are GDP, PPP, and HDI.

Different countries have dramatically different levels of development. GDP is often regarded as a good measure ofeconomic activity of a country. GDP measures the total value of the goods and services produced annually.GDP/capita is also a good yardstick of economic activity, as it measures average value of the goods andservices produced by an individual. (Refer map showing GDP / per capita).

Countries such as Switzerland, United States, Sweden, and Japan are among the richest with highest GDP, whilethe largest countries like China, India are the poorest. Japan·s GDP per head is $28,217, whereas China has only$379 and India $307. (1993). Sudan has the lowest with GDP per head as $55. The world·s richest Switzerland has$36,231.

However, GDP/capita does not consider the differences in costs of living. The UN·s PPP index -- shows the

differences in the standards of living of people in different countries. PPP index shows GDP per head for thecost of living. The index is set equal to 100 for the country in which PPP is the highest, which happens to be US.(Refer the graph showing PPP index of selected countries.) This graph shows that an average Indian citizen canafford to consume only 5 percent of the goods and services consumed by the average US citizen.

A problem with both GDP/capita and PPP is that they are static in nature. From an international businessperspective, it is good to look at the rate of growth in the economy as well as the status of its people. Map 2.3shows that some of the fastest growing countries economically are those have been slower to develop.

A broader approach to assessing the overall quality of life in different countries is the Human Development Indexdeveloped by UN. This is based on life expectancy, literacy rates, and whether (based on PPP indices)incomes are sufficient to meet the basic needs of individuals. The map shows the Human Development Index.Notice that some of the worse off countries are heavily populated and have rapidly expanding populations. Thehuman development index is scaled from 0 to 100. Countries scoring less than 50 are classified as having low

human development; scoring 50 to 80 are classified as having medium human development while those countriesthat score above 80 are classified as having high human development. One of the reasons of low humandevelopment index is heavy and expanding population.

What is the relationship between political economy and economic progress? This is a difficult issue. One thing thatis generally accepted is that innovation is the engine of long-run economic growth. Innovation is the processthrough which people create new products, new processes, mew organizations, new management practices andnew strategies. Another thing is that a free market economy is better at stimulating innovation than a commandeconomy that does not have the same types of incentives for individual initiative.

Innovation also depends on a strong protection of property rights, as innovators and entrepreneurs need some levelof assurance that they will be able to reap the benefits of their initiative.

While it is possible to have innovation and economic growth in a totalitarian state, many believe that economicgrowth and a free market system will eventually lead a country to becoming more democratic.



Geography can also affect economic development. A landlocked country with an inhospitable climate, poor soil,few natural resources, and terrible diseases is unlikely to develop economically as fast as country with theopposite characteristics on each of these attributes.

While it can be hard to do much about unfavorable geography, education is something that governments canaffect. Numerous studies suggest that countries that invest more in the education of their young people developfaster economically. Examples include Japan, South Korea, and many Asian countries.

States in Transition

Since the late 1980s, there have been two major changes in the political economy of many of the world·s nations.First, a wave of democratic revolutions swept the world, and many of the previous totalitarian regimes collapsed.

Secondly, there has been a move away from centrally planned and mixed economies towards free markets.

Eastern Europe and Soviet Union:

Following the Second World War, Soviet backed Communist Governments took power in eight Eastern European

sates: Poland, Czechoslovakia, Hungary, Bulgaria, Albania, Romania, Yugoslavia and East Germany. This set the

scene for 40 years of ideological conflict between the Communist bloc, dominated by the Soviet Union and the

democratic west.

The conflict started melting in 1985 when Mikhail Gorbachev became General Secretary of the Soviet Communist

party and began his program of Glasnost and Perestroika. During 1989, communist governments fell globally. The

biggest change occurred in 1991 in the Soviet Union. By 1991, the USSR had already moved significantly down the

road toward political freedom, but not economic freedom. On January 1, 1992, the Union of Soviet Socialist

Republics passed into history, to be replaced by 15 independent republics, 11 of which elected to remain

associated as a commonwealth of independent states.

The post communist history has not been easy. The move toward greater political and economic freedom has often

been accompanied by economic and political chaos. These countries stated dismantling decades of price controls,

allowed private ownerships of businesses and permitted much greater competition and privatization of its sate

owned enterprises. But, most of these enterprises were inefficient and the private investors were not interested.

The new democratic governments continued supporting these loss making enterprises to save from massive

unemployment·s. the resulted subsidies resulted in budget deficits that was balanced by ´printing moneyµ. Along

with lack of price controls, this led to inflation. In 1993, the inflation rate was 21 percent in Hungary, 38 percent

in Poland, 841 percent in Russia and 10,000 percent in Ukraine. GDP also fell. However, there is improvement in

economic conditions in Poland, Czech etc.

The revolutions in the USSR and Eastern Europe have (in general) moved these countries towards democracy (away

from totalitarianism), towards individualism (away from collectivism), and towards mixed economies (away from

command). The transitions have been difficult, however, and economic progress has not been easy. Recent

elections have brought ´reformedµ communists back into power in some countries, and the economic problems

facing the people are significant.

There are three main reasons for the spread of democracy. First, many totalitarian regimes failed to deliver

economic progress to the vast bulk of their populations. Secondly, improved information technology limited the

ability of the government to control citizens· access to information. Thirdly, increases in wealth and the standard

of living have encouraged citizens to push for democratic reforms.

While there are general movements towards democracy and open economies, this does not mean that there is

necessarily going to be a homogenization of civilization. At the same time, we see a further definition and

development of both Islamic and Chinese civilizations.

Western Europe:

In Western Europe, there has been a general trend towards privatization of state owned companies and

deregulation of industry. In many western European countries, basic industries such as telecommunications, energy

production, airlines and railroads were often state owned, while many other sectors were protected with heavy

sate regulations.

Starting with Margaret Thatcher·s conservative government in Britain during the early 1980·s Britain has moved to

privatization of these state owned enterprises. Sate owned industries have been privatized(sold to private

investors) and restrictive regulations were lifted.



Asia:

During the 1980·s and early 1990·s a shift toward greater political democracy occurred in the Philippines,

Thailand, Taiwan and South Korea. In Vietnam, the ruling communist party removed many price controls and began

to shift toward a market economy. In North Korea, also situation is changing to better relations with South Korea,

which was their archrival. In India, in 1991, under the Government of P.V. Narasimha Rao, began a reform program

aiming to free market economy.

In China too, the communist government started the shift from a pure command economy to a mixed economy.

Private ownership was allowed. The most important of them was the creation of a number of special economic

zones in which free markets were allowed to operate without any restrictions, private ownership was allowed and

foreign companies were permitted to invest. China·s economy as a whole has been growing at over 10 percent peryear during 1990·s. Japan·s growth after Second World War also is phenomenal.

Latin America:

During the 1980s, most Latin American countries changed from being run by dictatorship to democratically elected

governments. While most countries previously had erected high barriers to imports and investment (to keep

multinationals from ´dominatingµ their economies), they now mostly are encouraging investment, lowering

barriers, and privatizing state owned enterprises.

The tide began to turn in the 1970·s in Chile, under the military dictatorship, shifted sharply in the direction of a

free market economy. The largest shift occurred in Mexico, then run by the civilian government of President

Salinas, moved toward free market economy. Under him, Mexico, privatized many state owned enterprises,

cancelled many of the laws that limited FDI, cut import tariffs to world levels, and in 1994, brought Mexico in to

North American Free Trade Agreement (NAFTA) with the US and Canada. Two Latin American giants, Argentinaand Brazil also followed Mexico to join NAFTA.

Africa

Africa is also moving toward more democratic modes of government and free market economies. Most African

countries gained their independence from colonial powers particularly Britain, France and Portugal in the 1950·s

and 1960·s.most of them became one party sates ruled by authoritarian leaders.

Today both socialism and totalitarianism are slowly ret4eraing form Africa. During 1994, South Africa, Malawi, and

Mozambique all held their first democratic elections and 1996 in Sierra Leone and Uganda.

But according to the world bank·s report, even of the African countries now achieve a 3 percent annual growth in

GDP, it will take 40 years before many return to the level of economic growth they were at the early 1970·s!!

Another report shows that foreign investors who are attracted to Africa because of cheap labor are deterred by theproblem s of doing business in countries where the rules of law is so weak that even simple contracts can be

difficult to enforce and they have to bribe poorly paid bureaucrats who can otherwise make business impossible.

The great hope for Africa is that the continent·s potential economic powers, which include Nigeria, Kenya, and

South Africa which might pull the rest of Africa along with them.



UNIT - III

The Global Trade and Investment Environment International trade Theory : Introduction - An Overview of TradeTheory - Mercantilism - Absolute Advantage - Comparative Advantage - Heckscher-Ohlin Theory - The New TradeTheory - National Competitive Advantage - Porter's Diamond. The Revised Case for Free Trade - Development ofthe World - Trading System - WTO & development of World trade - Regional grouping of countries and its impact.

Theories of International TradeEvolution of Trade Theories

Mercantilism Absolute advantage (Classical) Comparative advantage Factor Proportions Trade International Product Cycle New Trade Theory National competitive advantage

Mercantilism: mid-16th century A nation·s wealth depends on accumulated treasure

± Gold and silver are the currency of « trade theory holding that nations should accumulatefinancial wealth, usually in the form of gold (forget things like living standards or humandevelopment) by encouraging exports and discouraging imports trade

Theory says you should have a trade surplus. ± Maximize export through subsidies.

± Minimize imports through tariff and quotas Flaw: restrictions, impaired growth « trade theory holding that nations should accumulate financial wealth, usually in the form of gold

(forget things like living standards or human development) by encouraging exports and discouragingimports

Theory of absolute advantage Adam Smith: Wealth of Nations (1776) argued:

± Capability of one country to produce more of a product with the same amount of input thananother country

± A country should produce only goods where it is most efficient, and trade for those goods whereit is not efficient

Trade between countries is, therefore, beneficial Assumes there is an absolute balance among nations

« destroys the mercantilist idea since there are gains to be had by both countries party to an exchange « questions the objective of national governments to acquire wealth through restrictive trade policies « measures a nation·s wealth by the living standards of its people

Output per one day of LabourProduct Japan India

Pens 10 20 Television 20 5

In Japan one day of labour can produce either10 pens or 20 T.V. In India one day of labour can produce either 20pens or 5 T.VJapan has an absolute advantage in producing T.V and India has abs. adv in producing Pens.

India and Japan entering in to trade with one another, then both will get advantage Suppose Japan agrees to exchange 10 T.V for 20 Pens

Number of days required to produce10 TV 20 Pen

Japan 0.5 2India 2 1Japan can save 1.5 days of Lab ( 2-0.5=1.5)India can save 1 day of lab ( 2-1=1)

Disadvantage of Absolute theory No Absolute Advantage: In reality most of the developing countries do not have absolute advantage in

producing any pdt at low cost Theory only deals with one resource, labour Failed to explain the situation where the country have cost advantage for both product



Theory of comparative advantage David Ricardo: Principles of Political Economy (1817)

± Extends free trade argument ± Efficiency of resource utilization leads to more productivity ± Should import even if country is more efficient in the product·s production than country from

which it is buying. ± Look to see how much more efficient. If only comparatively efficient, than import.

Makes better use of resources Trade is a positive-sum game

Assumptions of the Theory Full Employment Only cost of production is labour. And is subject to law of constant returns No trade barriers Trade is free from cost of production Trade takes place only between two countries only two products are traded No cost of transportation

Labour cost per hour1unit of A 1 unit of B

USA 80 90India 120 100USA got ab advt in both the goods than India.In this case we need to calculate opportunity cost to explain advt of trade.O.C: OC of A is the amt of B sacrificed to get one additional unit of A

Opportunity CostGood A Good B

USA 80/90 90/80India 120/100 100/120USA have lowest O.C in producing A, and India have lowest O.C in producing B.Thus USA have com.advt in producing AAnd India have com. Advt in producing BBoth the countries can produce and export those goods in which they have comp.advt

Comparative Advantage with Money One is better off specializing in what one does relatively best Produce and export those goods and services one is relatively best able to produce Buy other goods and services from people who are better at producing them

Disadvantages of Comparative theory Driven only by maximization of production and consumption Only 2 countries engaged in production and consumption of just 2 goods? What about the transportation costs? Only resource ² labour (that too, non-transferable)

Factor proportions theory Heckscher (1919) - Ohlin (1933) Theory Export goods that intensively use factor endowments which are locally abundant

± Corollary: import goods made from locally scarce factors Note: Factor endowments can be impacted by government policy - minimum wage

Patterns of trade are determined by differences in factor endowments - not productivity focus on relative advantage, not absolute advantage « trade theory holding that countries produce and export those goods that require resources (factors)

that are abundant (and thus cheapest) and import those goods that require resources that are in shortsupply

Example: ± Australia ² lot of land and a small population (relative to its size) ± So what should it export and import?

Factor Proportions Trade TheoryConsiders Two Factors of Production

y Laboury Capitaly A country that is relatively labour abundant ( or capital abundant) should specialize in the production

and export of that product which is relatively labour intensive ( or capital intensive)y Countries with capital abundance will be able to produce capital intensive products efficiently, and

countries with labour abundance will be able to produce labour intensive products efficiently.



Factor abundance in terms of factor prices (Pc/Pl)A < (Pc/Pl)B

C ² capital L ² LabourP ² prices A & B - Countries(Pc)A is cheaper than (Pc)B

Country A is abundant of Capital(Pl)B is cheaper than (Pl)A

Country B is abundant of Labour

Assumptions1. Perfect competition in commodity as well as factor market2. Factors of pdn are mobile within the country3. It it a 2x2x2 model; 2ctries,2commodities & 2 factors4. No transportation cost5. Free trade between two countries.6. There is no change in technology7. Homogeneous labour

The Leontief Paradox Wassily Leontief had made empirical testing of H-O theorem.

The Test:Could Factor Proportions Theory be used to explain the types of goods the United States imported and exported?

The Method:Input-output analysis

The Findings:The U.S. exported labor-intensive products and imported capital-intensive products.

The Controversy:Findings were the opposite of what was generally believed to be true!

Modern Firm-Based Trade Theories / The New trade theory Country Similarity Theory

Explains the phenomenon of intra industry trade Trade between two countries of goods produced by the same industry Japan exports Toyotas to Germany Germany exports BMWs to Japan Trade results from similarities of preferences among consumers in countries that are at the same

stage of economic development Most trade in manufactured goods should be between countries with similar per capita incomes

Product Life Cycle Theory Introduction Growth Maturity Decline

Global Strategic Rivalry Theory Firms struggle to develop sustainable competitive advantage Advantage provides ability to dominate global marketplace Focus: strategic decisions firms use to compete internationally Owning intellectual property rights Investing in research and development Achieving economies of scale or scope Exploiting the experience curve

Porter·s National Competitive Advantage Success in trade comes from the interaction of country and firm specific elements Factor conditions

Demand conditions Related and supporting industries Firm strategy, structure, and rivalry



The Revised Case for Free Trade

While strategic trade policy identifies conditions where restrictions on trade may provide economic benefits, there

are two problems that may make restrictions inappropriate: retaliation and politics.

Intervening to aid domestic firms will only be successful if other countries do not take similar actions that offset

the effects.

While it could be very difficult to identify situations where strategic intervention in trade is economically

appropriate, various interest groups will be certain to lobby that particular firms should be aided. Given the ease

with which special interest groups seem to be able to capture the attention of the government, it is more likely

that consumers will be harmed more needlessly than producers will. It is unreasonable to expect the government

to be completely fair and objective in ´targetingµ industries, when different industries, lobbies, and politicians all

have there own objectives for ´getting their paws in the honey potµ of governmental funds.

What Is the WTO? The World Trade Organization (WTO) is the only global international organization dealing with the rules of

trade between nations. WTO agreements are negotiated and signed by the trading nations and approved in their parliaments. The goal is to help producers of goods and services, exporters, and importers conduct and grow their

business. To improve the welfare of the peoples of the member countries. The WTO came into being in 1995 January 1st . The WTO is the successor to the General Agreement on Tariffs and Trade (GATT), established in the wake

of the Second World War.

Merchandise exports grew on average 6% annually Total trade in 1997 was 14 times the level of 1950 In 1997, 40 governments concluded negotiations for tariff free trade. We have seen what Ricardo had to say about comparative advantage, and the strong consensus among

those who seriously consider trade issues. Trade provides nearly 100% of an economy·s jobs. Global trade provides a large and growing share of

these jobs.Function of WTO

Administering WTO trade agreements Forum for trade negotiations Handling trade disputes Monitoring national trade policies Technical assistance and training for developing countries Cooperation with other international organizations



The Quad

Some of the most difficult negotiations have needed an initial breakthrough in talks among the fourlargest members

y Canaday Europeany Japany United States

Disadvantages of WTO The WTO undermines state sovereignty It undermines representative democracy

Member nations are prevented from protecting the environment Members are unable to uphold laws guaranteeing workers· rights The WTO is controlled by the larger nations The WTO represents the interests of large corporations and wealthy citizens Some protesters have arguments fully worthy of consideration. They deserve a better venue for hearing

than the streets. Nihilistic anarchists usually capture the legal protest, along with lugubrious labor Luddites trade terrorists, and the clueless

REGIONAL GROUPINGS : DEVELOPED AND DEVELOPING COUNTRIES

The main motivating force behind the trend towards regionalism in the industrial countries appears to be the needto reduce non-tariff barriers to trade and to diffuse trade tensions, which is perceived to be easier to achieve on a

regional than on a global basis. The expected gains are increased productive efficiency through the achievement ofeconomies of scale, the adoption of cost-reducing technologies, and a reduction in market segmentation whichcreates monopoly rents and imposes administrative costs.

A different set of reasons seems to underly the trend towards preferential trading among developing countries.Tariffs continue to be more important than non-tariff barriers in these countries. The elimination of tariffs amonga group of partner countries is thus viewed as a means of achieving industrialization through regional importsubstitution by "swapping" markets for each other's products. Regional integration among developing countries hasalso sometimes aimed at economizing on foreign exchange by setting up clearing accounts for infra-area trade.Such internal clearing accounts exist for most regional trading groups among developing countries, including theLatin American Integration Association, the Central American Common Market, and the Caribbean Community. Thisobjective also underlies recent integration initiatives in Africa. Most recently, there has been increased focus onopening markets in a broader way and thus integrating members of preferential trading arrangements into theglobal trading system.



UNIT ² IV

Foreign Direct Investment : Introduction - Foreign Direct Investment in the World Economy - Horizontal ForeignDirect Investment - Vertical Foreign Direct Investment. Benefits and advantages to host and home countries.The Global Monetary SystemThe Foreign Exchange Market : Introduction - The Functions of the Foreign Exchange Market.

Foreign Direct Investment Foreign direct investment (FDI) happens when a firm invests directly in facilities in a foreign country A firm that engages in FDI becomes a multinational enterprise (MNE)

± Multinational = ´more than one countryµ Factors which influence FDI are related to factors that stimulate trade across national borders Involves ownership of entity abroad for

± production ± Marketing/service ± R&D ± Raw materials or other resource access

Parent has direct managerial control ± The degree of direct managerial control depends on the extent of ownership of the foreign entity

and on other contractual terms of the FDI ± No managerial involvement = portfolio investment

Forms of FDI ± Purchase of existing assets

Quick entry, local market know-how, local financing may be possible, eliminatecompetitor, buying problems

± New investment No local entity exists or is available for sale, local financial incentives may encourage,

no inherited problems, long lead time to generation of sales or other desired outcome ± Participation in an international joint-venture

Shared ownership with local and/or other non-local partner

Alternative Modes of Market Entry FDI

± FDI - 100% ownership ± FDI < 100% ownership, International Joint Venture

Majority, Equal Share, Minority Participation Strategic Alliances (non-equity) Franchising Licensing Exports

± Direct vs IndirectWhy FDI?

FDI over exporting ± High transportation costs, trade barriers

FDI over licensing or franchising ± Need to retain strategic control ± Need to protect technological know-how ± Capabilities not suitable for licensing/franchising

Government Policy and FDI The radical view: inbound FDI harmful; MNEs

± Are an instrument of imperialist domination ± Exploit host to the advantage of home country ± Extract profits from host country; give nothing back ± Keep LDCs backward/dependent for investment, technology and jobs

The free market view: FDI should be encouraged ± Adam Smith, Ricardo, et al: international production should be distributed according tocomparative advantage

± The MNE increases the world economy efficiency because it brings to bear unique ownershipadvantages on the local economy·s comparative advantages



Host Country Effects of FDI Benefits

± Resource -transfer ± Employment ± Balance-of-payment (BOP)

Import substitution Source of export increase

Costs ± Adverse effects on the BOP

Capital inflow followed by capital outflow + profits Production input importation

± Threat to national sovereignty and autonomy Loss of economic independence

Home Country Effects of FDI Benefits

± BOP current account adversely affected by inward flow of foreign earnings ± Positive employment effect from increased exports of raw materials / assemblies to the overseas

subsidiary ± Repatriation of skills and know-how

Costs ± BOP trade position is negatively affected (lower finished goods exports) ± Loss of employment to overseas market

Government Policy and FDI Home country

± Outward FDI encouragement Risk reduction policies (financing, insurance, tax incentives)

± Outward FDI restrictions National security, BOP

Host country ± Inward FDI encouragement

Investment incentives Job creation incentives

± Inward FDI restrictions Ownership extent restrictions (national security; local nationals can safeguard host

country·s interests

Greenfield Strategy Starting with a virgin green site and then building on it. The company conducts the market survey, selects the location, buys or leases the land, creates facilities,

starts mkting operations etc.FDI: Horizontal vs. Vertical

Horizontal vs. Vertical Direct Investment ± Horizontal

Investment in the ´sameµ industry as a firm operates in at home ± Examples:

» Starbucks and its international expansion» MacDonald·s and its international expansion

± Vertical Investment in a downstream supplier (backward) or upstream purchaser (forward) as

compared to the business that the firm operates in its home country ± Examples:

» Backward: Volkswagon + SAIC + FAW to produce gearbox (an input toVolkswagon·s home operation)

» Forward: Less common. Volkswagon·s acquisitions of dealers in the US(Volkswagon ´soldµ cars to the dealers in the US. I.e., Volkswagon

sold the output of its home country operations to the US dealers thatit acquired)Advantages Horizontal FDI?

Transportation Costs Market Imperfections

± Impediments to exporting ± Impediments to Sale of Know-How

Strategic Behavior Product Life Cycle Location Specific Advantages

Advantages Vertical FDI? Strategic Behavior Market Imperfections

± Impediments to Know-How ± Investment in Specialized Assets



Exchange Rates and the Foreign Exchange Market` Exchange rates are important because they enable us to translate different counties· prices into

comparable terms.` Exchange rates are determined in the same way as other asset prices.` The general goal of this chapter is to show:

How exchange rates are determined The role of exchange rates in international trade

Exchange Rates and International Transactions

` An exchange rate can be quoted in two ways: Direct

x

The price of the foreign currency in terms of dollars Indirect

x The price of dollars in terms of the foreign currency

` Domestic and Foreign Prices If we know the exchange rate between two countries· currencies, we can compute the price of

one country·s exports in terms of the other country·s money.x Example: The dollar price of a £50 sweater with a dollar exchange rate of $1.50 per

pound is (1.50 $/£) x (£50) = $75.Two types of changes in exchange rates:

x Depreciation of home country·s currencyx A rise in the home currency prices of a foreign currencyx It makes home goods cheaper for foreigners and foreign goods more expensive

for domestic residents.x Appreciation of home country·s currency

x A fall in the home price of a foreign currencyx It makes home goods more expensive for foreigners and foreign goods cheaper

for domestic residents.x Exchange Rates and Relative Prices

x Import and export demands are influenced by relative prices.x Appreciation of a country·s currency:

x Raises the relative price of its exportsx Lowers the relative price of its imports

x Depreciation of a country·s currency:x Lowers the relative price of its exportsx Raises the relative price of its imports

The Foreign Exchange Market` Exchange rates are determined in the foreign exchange market.

The market in which international currency trades take place` The Actors The major participants in the foreign exchange market are:

x Commercial banksx International corporationsx Nonbank financial institutionsx Central banks

` Characteristics of the Market The worldwide volume of foreign exchange trading is enormous, and it has ballooned in recent

years. New technologies, such as Internet links, are used among the major foreign exchange trading

centers (London, New York, Tokyo, Frankfurt, and Singapore). The integration of financial centers implies that there can be no significant arbitrage.

x The process of buying a currency cheap and selling it dear. Vehicle currency

x A currency that is widely used to denominate international contracts made by partieswho do not reside in the country that issues the vehicle currency.

Interbank tradingx Foreign currency trading among banksx It accounts for most of the activity in the foreign exchange market.

` Spot Rates and Forward Rates Spot exchange rates

x Apply to exchange currencies ´on the spotµ Forward exchange rates

x Apply to exchange currencies on some future date at a prenegotiated exchange rate Forward and spot exchange rates, while not necessarily equal, do move closely together.

` Foreign Exchange Swaps Spot sales of a currency combined with a forward repurchase of the currency. They make up a significant proportion of all foreign exchange trading.

` Futures and Options



Futures contractx The buyer buys a promise that a specified amount of foreign currency will be delivered

on a specified date in the future. Foreign exchange option

x The owner has the right to buy or sell a specified amount of foreign currency at aspecified price at any time up to a specified expiration date.

Geographical Extent of the Foreign Exchange Market` Global currency trading is a 24-hour-a-day process.` Many large international banks operate trading rooms in major trading center on a round-the-clock basis.` Some currency trading is conducted on an ofÀcial trading Áoor by open bidding but most of it is done

through dealers

Functions of the Foreign Exchange Market` The foreign exchange market is the mechanism by which a person of firm transfers purchasing power form

one country to another, obtains or provides credit for international trade transactions, and minimizesexposure to foreign exchange risk

` Transfer of purchasing power is necessary because international transactions normallyinvolve parties in countries with different national currencies. Each party usually wants to deal in its own

currency, but the transaction can be invoiced in only one currency` Provision of Credit:` Because the movement of goods between countries takes time, inventory in transit must be financed.` Minimizing Foreign Exchange Risk:` The foreign exchange market provides "hedging" facilities for transferring foreign exchange risk to

someone else.

Hedgingy A risk management strategy used in limiting or offsetting probability of loss from fluctuations in

the prices of commodities, currencies, or securities. In effect, hedging is a transfer of risk withoutbuying insurance policies.

` Hedging employs various techniques but, basically, involves taking equal andopposite positions in two different markets(such as cash and futures markets). Hedging is usedalso in protecting one's capital against effects of inflation through investing in high-yield financial instruments (bonds, shares), real estate, or precious metals.

`



UNIT - V

The Strategy of International Business : Introduction - Strategy and the Firm - Profiting from Global Expansion -Pressures for Cost Reductions and Local Responsiveness - Strategic Choice.Mode of Entry and Strategic Alliances : Introduction - Entry Modes - Selecting and Entry Mode - Strategic Alliances -Making Alliances Work.Exporting, Importing and Counter trade : Introduction - The Promise and Pitfalls of Exporting - Improving ExportPerformance - Export and Import Financing - Export Assistance - Counter trade.

The Strategy of International Businessy Wal-Mart moved into other countries for three Reasons

Growth opportunities at home were becoming constrainedIt thought it could create value by transferring its business model to foreign marketsIt wished to preempt other retailers that were also starting to expand globally

Wal-Mart initially treated foreign markets much like the US; it did discover that this was not the correct approachy To succeed abroad, Wal-Mart has had to customize its offering to local conditions while keeping its core

strategies and operations the same in every marketGoing global has yielded additional benefits as well

Enhanced bargaining power with suppliersThe ability to transfer valuable ideas from one country to another

Strategy and the Firmy Strategy can be defined as the actions that managers must take to attain the goals of the firm

-For most firms, the preeminent goal is to maximize the value of the firm for its ownersProfitability can be defined as the rate of return that the firm makes on its invested capital (ROIC), which is

calculated by dividing the net profits of the firm by total invested capital

Profit growth is measured by the percentage increasein net profits over time

Value Creation The way to increase the profitability of a firm is to create more value

-The amount of value a firm creates is measured by the difference between its costs of production and the valuethat consumers perceive in its products

Michael Porter states that there are two basic strategies for creating value and attaining a competitiveadvantage in an industry

-Low-cost strategy suggests that a firm has high profits when it creates more value for its customers and does soat a lower cost

-Differentiation strategy focuses primarily on increasing the attractiveness of a product



Strategic Positioning It is important for a firm to be explicit about its choice of strategic emphasis with regard to value

creation-Management must decide where the company wants to be positioned with regard to value and costA central tenet of the basic strategy paradigm is: To maximize its profitability, a firm must do three things-Pick a position on the efficiency frontier that is viable in the sense that there is enough demand to support that

choice-Configure internal operations so that they support that position-Make sure that the firm has the right organization structure in place to execute its strategy

The Value Chain Any firm is composed of a series of distinct value creating activities -Primary activities

Research & developmentProductionMarketing & salesService

-Support ActivitiesMaterials management or logistics

Human resource

Information systemsCompany infrastructure

Global Expansion, Profitability,and Profit Growth Expanding globally allows firms to increase their profitability and rate of profit growth in ways not

available to purely domestic enterprises Firms that operate internationally are able to

-Expand the market for their domestic products-Realize location economies by dispersing individual value creation activities-Realize greater cost economies-Earn a greater return by leveraging any valuable skills developed in foreign operations

Cost Pressures and Pressures for Local Responsiveness Firms that compete in the global marketplace

typically face two types of competitive pressure -Pressures for cost reductions -Pressures to be locally responsive

Pressures for Cost Reductions Pressures for cost reduction can be particularly intense in industries producing commodity-type products

-Universal needs exist when the tastes and preferences of consumers in different nations are similar if notidentical

Pressures for cost reductions are also intense-In industries where major competitors are based in low-cost locations-Where there is persistent excess capacity-Where consumers are powerful and face low switching costs



Pressures for Local Responsiveness Differences in consumer tastes & preferences

-North American families like pickup trucks while in Europe they are viewed as a utility vehicle for firms Differences in infrastructure & traditional practices

-Consumer electrical system in North America is based on 110 volts; in Europe on 240 volts Differences in distribution channels

-Germany has few retailers dominating the food market, while in Italy it is fragmented Host-Government demands

-Health care system differences between countries require pharmaceutical firms to change operatingprocedures

The Evolution of Strategy / Strategic choice An international strategy may not be viable in the long-term so firms need to shift toward a global

standardization strategy or a transnational strategy in advance of competitors As competition intensifies

-International and localization strategies tend to become less viable-Managers need to orient their companies toward either a global standardization strategy or a transnational

strategy

Foreign market entry modesForeign market entry modes differ in degree of risk they present, the control and commitment of

resources they require and the return on investment they promiseThere are two major types of entry modes: equity and non-equity modes. The non-equity modes categoryincludes export and contractual agreements. The equity modes category includes: joint venture and wholly ownedsubsidiaries

ExportingExporting is the process of selling of goods and services produced in one country to other countries.

There are two types of exporting: direct and indirect.

Direct exportsDirect exports represent the most basic mode of exporting, capitalizing on economies of scale in

production concentrated in the home country and affording better control over distribution. Direct export worksthe best if the volumes are small. Large volumes of export may trigger protectionism.

Types of Direct Exporting.Sales representatives represent foreign suppliers/manufacturers in their local markets for an established

commission on sales. Provide support services to a manufacturer regarding local advertising, local salespresentations, customs clearance formalities, legal requirements. Manufacturers of highly technical services orproducts such as production machinery, benefit the most form sales representation.

Importing distributors purchase product in their own right and resell it in their local markets to

wholesalers, retailers, or both. Importing distributors are a good market entry strategy for products that arecarried in inventory, such as toys, appliances, prepared food.

Advantages of direct exporting:y Control over selection of foreign markets and choice of foreign representative companiesy Good information feedback from target markety Better protection of trademarks, patents, goodwill, and other intangible propertyy Potentially greater sales than with indirect exporting.

Disadvantages of direct exporting:y Higher start-up costs and higher risks as opposed to indirect exportingy Greater information requirementsy Longer time-to-market as opposed to indirect exporting. y Indirect exportsy Indirect exports is the process of exporting through domestically based export intermediaries. The

exporter has no control over its products in the foreign market.

Types of indirect exporting:Export trading companies (ETCs) provide support services of the entire export process for one or more

suppliers. Attractive to suppliers that are not familiar with exporting as ETCs usually perform all the necessarywork: locate overseas trading partners, present the product, quote on specific enquiries, etc.

Export management companies (EMCs) are similar to ETCs in the way that they usually export forproducers. Unlike ETCs, they rarely take on export credit risks and carry one type of product, not representingcompeting ones. Usually, EMCs trade on behalf of their suppliers as their export departments[8].

Export merchants are wholesale companies that buy unpackaged products from suppliers/manufacturersfor resale overseas under their own brand names. The advantage of export merchants is promotion. One of thedisadvantages for using export merchants result in presence of identical products under different brand names andpricing on the market, meaning that export merchant·s activities may hinder manufacturer·s exporting efforts.



Confirming houses are intermediate sellers that work for foreign buyers. They receive the productrequirements from their clients, negotiate purchases, make delivery, and pay the suppliers/manufacturers. Anopportunity here arises in the fact that if the client likes the product it may become a trade representative. Apotential disadvantage includes supplier·s unawareness and lack of control over what a confirming house does withtheir product.

Nonconforming purchasing agents are similar to confirming houses with the exception that they do notpay the suppliers directly ² payments take place between a supplier/manufacturer and a foreign buyer[9].

Advantages of indirect exporting:y Fast market accessy Concentration of resources for productiony

Little or no financial commitment. The export partner usually covers most expenses associated withinternational salesy Low risk exists for those companies who consider their domestic market to be more important and for

those companies that are still developing their R&D, marketing, and sales strategies.y The management team is not distractedy No direct handle of export processes.

Disadvantages of indirect exporting:y Higher risk than with direct exportingy Little or no control over distribution, sales, marketing, etc. as opposed to direct exportingy Inability to learn how to operate overseasy Wrong choice of market and distributor may lead to inadequate market feedback affecting the

international success of the companyy Potentially lower sales as compared to direct exporting, due to wrong choice of market and distributors

by export partners.y Those companies that seriously consider international markets as a crucial part of their success would

likely consider direct exporting as the market entry tool. Indirect exporting is preferred by companieswho would want to avoid financial risk as a threat to their other goals.

LicensingAn international licensing agreement allows foreign firms, either exclusively or non-exclusively to

manufacture a proprietor·s product for a fixed term in a specific market.Summarizing, in this foreign market entry mode, a licensor in the home country makes limited rights or resourcesavailable to the licensee in the host country. The rights or resources may include patents, trademarks, managerialskills, technology, and others that can make it possible for the licensee to manufacture and sell in the host countrya similar product to the one the licensor has already been producing and selling in the home country withoutrequiring the licensor to open a new operation overseas. The licensor earnings usually take forms of one timepayments, technical fees and royalty payments usually calculated as a percentage of sales.As in this mode of entry the transference of knowledge between the parental company and the licensee is strongly

present, the decision of making an international license agreement depend on the respect the host governmentshow for intellectual property and on the ability of the licensor to choose the right partners and avoid them tocompete in each other market. Licensing is a relatively flexible work agreement that can be customized to fit theneeds and interests of both, licensor and licensee.

Following are the main advantages and reasons to use an international licensing for expanding internationally:

y Obtain extra income for technical know-how and servicesy Reach new markets not accessible by export from existing facilitiesy Quickly expand without much risk and large capital investmenty Pave the way for future investments in the markety Retain established markets closed by trade restrictionsy Political risk is minimized as the licensee is usually 100% locally ownedy Is highly attractive for companies that are new in international business.

On the other hand, international licensing is a foreign market entry mode that presents some disadvantages andreasons why companies should not use it as:

y Lower income than in other entry modesy Loss of control of the licensee manufacture and marketing operations and practices dealing to loss of

qualityy Risk of having the trademark and reputation ruined by a incompetent partnery The foreign partner can also become a competitor by selling its production in places where the parental

company is already in.



FranchisingThe Franchising system can be defined as: ´A system in which semi-independent business owners

(franchisees) pay fees and royalties to a parent company (franchiser) in return for the right to become identifiedwith its trademark, to sell its products or services, and often to use its business format and system.µCompared to licensing, franchising agreements tends to be longer and the franchisor offers a broader package ofrights and resources which usually includes: equipments, managerial systems, operation manual, initial trainings,site approval and all the support necessary for the franchisee to run its business in the same way it is done by thefranchisor. In addition to that, while a licensing agreement involves things such as intellectual property, tradesecrets and others while in franchising it is limited to trademarks and operating know-how of the business.

Advantages of the international franchising mode:

y Low political risky Low costy Allows simultaneous expansion into different regions of the worldy Well selected partners bring financial investment as well as managerial capabilities to the operation.

Disadvantages of the international franchising mode:y Franchisees may turn into future competitorsy Demand of franchisees may be scarce when starting to franchise a company, which can lead to making

agreements with the wrong candidatesy A wrong franchisee may ruin the company·s name and reputation in the markety Comparing to other modes such as exporting and even licensing, international franchising requires a

greater financial investment to attract prospects and support and manage franchisees[14].Turnkey projects

A turnkey project refers to a project in which clients pay contractors to design and construct new

facilities and train personnel. A turnkey project is way for a foreign company to export its process and technologyto other countries by building a plant in that country. Industrial companies that specialize in complex productiontechnologies normally use turnkey projects as an entry strategy[15].

One of the major advantages of turnkey projects is the possibility for a company to establish a plant and earnprofits in a foreign country especially in which foreign direct investment opportunities are limited and lack ofexpertise in a specific area exists.

Potential disadvantages of a turnkey project for a company include risk of revealing companies secrets to rivals,and takeover of their plant by the host country. By entering a market with a turnkey project proves that acompany has no long-term interest in the country which can become a disadvantage if the country proves to be themain market for the output of the exported process[16].

Wholly owned subsidiaries (WOS)

A wholly owned subsidiary includes two types of strategies: Greenfieldinvestment and Acquisitions. Greenfield investment and acquisition include both advantages and disadvantages. Todecide which entry modes to use is depending on situations.

Greenfield investment is the establishment of a new wholly owned subsidiary. It is often complex and potentiallycostly, but it is able to full control to the firm and has the most potential to provide above averagereturn.[17] ´Wholly owned subsidiaries and expatriate staff are preferred in service industries where close contactwith end customers and high levels of professional skills, specialized know how, and customization arerequired.µ[18] Greenfield investment is more likely preferred where physical capital intensive plants areplanned.[19] This strategy is attractive if there are no competitors to buy or the transfer competitive advantagesthat consists of embedded competencies, skills, routines, and culture.

Greenfield investment is high risk due to the costs of establishing a new business in a new country. A firm mayneed to acquire knowledge and expertise of the existing market by third parties, such consultant, competitors, orbusiness partners. This entry strategy takes much time due to the need of establishing new operations, distribution

networks, and the necessity to learn and implement appropriate marketing strategies to compete with rivals in anew market.

Acquisition has become a popular mode of entering foreign markets mainly due to its quick access Acquisitionstrategy offers the fastest, and the largest, initial international expansion of any of the alternative.Acquisition has been increasing because it is a way to achieve greater market power.The market share usually isaffected by market power. Therefore, many multinational corporations apply acquisitions to achieve their greatermarket power require buying a competitor, a supplier, a distributor, or a business in highly related industry toallow exercise of a core competency and capturecompetitive advantage in the market.Acquisition is lower risk than Greenfield investment because of the outcomes of an acquisition can be estimatedmore easily and accurately.[25] In overall, acquisition is attractive if there are well established firms already inoperations or competitors want to enter the region.



Disadvantages and problems in achieving acquisition success.y Integrating two organizations can be quite difficult due to different organization cultures, control system,

and relationships.[26] Integration is a complex issue, but it is one of the most important things fororganizations.

y By applying acquisitions, some companies significantly increased their levels of debt which can havenegative effects on the firms because high debt may cause bankrupt.[27]

y Too much diversification may cause problems.[28] Even when a firm is not too over diversified, a high levelof diversification can have a negative effect on the firm in the long term performance due to a lack ofmanagement of diversification.

Joint venture

There are five common objectives in a joint venture: market entry, risk/reward sharing, technology sharing andjoint product development, and conforming to government regulations. Other benefits include politicalconnections and distribution channel access that may depend on relationships.Such alliances often are favourablewhen:

y The partners' strategic goals converge while their competitive goals divergey The partners' size, market power, and resources are small compared to the Industry leadersy Partners are able to learn from one another while limiting access to their own proprietary skillsy The key issues to consider in a joint venture are ownership, control, length of agreement, pricing,

technology transfer, local firm capabilities and resources, and government intentions. Potential problemsinclude

y Conflict over asymmetric new investmentsy Mistrust over proprietary knowledgey Performance ambiguity - how to split the piey Lack of parent firm supporty C

ultural clashesy If, how, and when to terminate the relationship

Strategic alliance

y A strategic alliance is a term used to describe a variety of cooperative agreements between differentfirms, such as shared research, formal joint ventures, or minority equity participation. The modern formof strategic alliances is becoming increasingly popular and has three distinguishing characteristics

o 1. They are frequently between firms in industrialized nationso 2. The focus is often on creating new products and/or technologies rather than distributing

existing oneso 3. They are often only created for short term durations

Advantages of a strategic alliance

Technology Exchange

This is a major objective for many strategic alliances. The reason for this is that many breakthroughs and major

technological innovations are based on interdisciplinary and/or inter-industrial advances. Because of this, it is

increasingly difficult for a single firm to possess the necessary resources or capabilities to conduct their own

effective R&D efforts. This is also perpetuated by shorter product life cycles and the need for many companies to

stay competitive through innovation. Some industries that have become centers for extensive cooperative

agreements are:

Telecommunications

Electronics

Pharmaceuticals

Information technology

Specialty chemicals



Global competition

There is a growing perception that global battles between corporations be fought between teams of

players aligned in strategic partnerships [35]. Strategic alliances will become key tools for companies if

they want to remain competitive in this globalized environment, particularly in industries that have

dominant leaders, such as cell phone manufactures, where smaller companies need to ally in order to

remain competitive.

Industry convergence

As industries converge and the traditional lines between different industrial sectors blur, strategic

alliances are sometimes the only way to develop the complex skills necessary in the time frame required.

Alliances become a way of shaping competition by decreasing competitive intensity, excluding potential

entrants, and isolating players, and building complex value chains that can act as barriers[36].

Economies of scale and reduction of risk

Pooling resources can contribute greatly to economies of scale, and smaller companies especially can

benefit greatly from strategic alliances in terms of cost reduction because of increased economies of

scale.

In terms on risk reduction, in strategic alliances no one firm bears the full risk, and cost of, a joint activity.

This is extremely advantageous to businesses involved in high risk / cost activities such as R&D. This is also

advantageous to smaller organizations whom are more affected by risky activities.

Alliance as an alternative to merger

Some industry sectors have constraints to cross-border mergers and acquisitions, strategic alliances prove

to be an excellent alternative to bypass these constraints. Alliances often lead to full-scale integration if

restrictions are lifted by one or both countries.

Disadvantages of strategic alliances

The risks of competitive collaboration

Some strategic alliances involve firms that are in fierce competition outside the specific scope of the specific

scope of the alliance. This creates the risk that one or both partners will try to use the alliance to create an

advantage over the other. The benefits of this alliance may cause unbalance between the parties, there are

several factors that may cause this asymmetry:

The partnership may be forged to exchange resources and capabilities such as technology. This may cause

one partner to obtain the desired technology and abandon the other partner, effectively appropriating all

the benefits of the alliance.

Using investment initiative to erode the other partners competitive position. This is a situation where one

partner makes and keeps control of critical resources. This creates the threat that the stronger partner

may strip the other of the necessary infrastructure.



Strengths gained by learning from one company can be used against the other. As companies learn from

the other, usually by task sharing, their capabilities become strengthened, sometimes this strength

exceeds the scope of the venture and a company can use it to gain a competitive advantage against the

company they may be working with.

Firms may use alliances to acquire its partner. One firm may target a firm and ally with them to use the

knowledge gained and trust built in the alliance to take over the other.

The Promise and Pitfalls of Exporting

The potential benefits from exporting can be great. Regardless of the country in which a firm has its base. The restof the world is a much larger market than the domestic market. While larger firms may be proactive in seeking outnew export opportunities, many smaller firms are reactive and only pursue international opportunities when thecustomer calls or knocks on the door.

Many new exporters have run into significant problems when first trying to do business abroad, souring them onfollowing up on subsequent opportunities.

Common pitfalls include poor market analysis, poor understanding of competitive conditions, lack of customization

for local markets, poor distribution arrangements, bad promotional campaigns, as well as a generalunderestimation of the differences and expertise required for foreign market penetration.

If basic business issues were not enough, the tremendous paperwork and formalities that must be dealt with canbe overwhelming to small firms.

Improving Export Performance

National differences in the governmental and business infrastructure available for supporting exporting varyconsiderably. German and Japanese firms have relatively easy access to information and assistance. While US firmsare not left totally to their own devices, the amount of direct and indirect assistance to them is much lessdeveloped.

One of the biggest impediments to exporting is ignorance of foreign market opportunities.The best way of overcoming ignorance is to collect more information. In the USA, there are a number of

institutions, most importantly the US Department of Commerce, which can assist firms in the informationgathering and matchmaking process.

Business and trade associations can also provide valuable assistance to firms.

One way for first-time exporters to identify opportunities and help avoid pitfalls is to hire an Export ManagementCompany. A good EMC will have a network of contacts in potential markets, will have multilingual employees, willhave knowledge of different business mores, and will be fully conversant with the ins and outs of the exportingprocess and with local business regulations.

One drawback of relying on EMCs is that the company fails to develop its own exporting capabilities.

The probability of exporting successfully can be improved by utilizing an EMC or export consultants, focusing ononly one or a few markets at first and get them working effectively, starting out on a small scale, having realisticexpectations about the time and commitment required, developing good relations with local distributors, andhiring local personnel. The example of 3M helps illustrate one firm·s approach.

Export and Import Financing: Procedure:

Firms engaged in international trade face a problem -- they have to trust someone who may be very difficult totrack down if they default on an obligation.

Due to the lack of trust, each party to an international transaction has a different set of preferences regarding theconfiguration of the transaction.

Firms can solve the problems arising from a lack of trust between exporters and importers by using a third partywho is trusted by both - normally a reputable bank.

A bank issues a letter of credit, abbreviated as L/C at the request of an importer. It states that the bank promises

to pay a beneficiary, normally the exporter, upon presentation of documents specified in the letter of credit.



A draft (bill of exchange) is the instrument normally used in international commerce to effect payment. It is anorder written by an exporter instructing an importer, or an importer·s agent, to pay a specified amount of moneyat a specified time. Drafts fall into two categories -- sight drafts and time drafts. Time drafts are negotiableinstruments.

The bill of lading is issued to the exporter by the common carrier transporting the merchandise. It serves threepurposes; it is a receipt, a contract, and a document of title.

The entire 14-step process for conducting an export transaction is summarized. Take for example an Indianimporter and US exporter.

Step1: The Indian importer places an order with the US exporter and asks the American if he would be willing toship under a letter of credit.Step 2: the US exporter agrees to ship under a letter of credit and specifies relevant information such as price anddelivery terms.Step 3: the Indian importer applies to (e.g.) State bank of India for a letter of credit to be issued in favor of theUS exporter fro the merchandise the importer wishes to buy.Step 4: the state bank of India issues a letter of credit in the Indian importer·s favor and sends it to the USexporter·s bank, the bank of New York.Step 5: the bank of New York advices the US exporter of the opening of a letter of credit in his favour.Step 6: the US exporter ships the goods to the Indian importer on a common carrier. An official of the carrier givesthe exporter a bill of lading.Step 7: the US exporter presents a 90 day-time draft (bill of exchange) drawn on the State Bank of India, inaccordance with its letter of credit and the bill of lading to the bank of New York. The US exporter endorses thebill of lading so title of goods is transferred to the Bank of New York.

Step 8: the bank of New York sends the draft and the bill of lading to the State Bank of India. The State Bank ofIndia accepts the draft, taking possession of the documents and promising to pay the now accepted draft in 90days.Step 9: State Bank of India returns the accepted draft to the bank of New York.Step 10: the bank of New York tells the US exporter that it has received the accepted bank draft, which is payablein 90 days.Step 11: the exporter sells the draft to the bank of New York at a discount from its face value and receives thediscounted cash value of the daft in return.Step 12: State Bank of India notifies the Indian importer of the arrival of the documents. He agrees to pay theState Bank of India in 90 days. State Bank of India releases the documents so the importer can take possessions ofthe shipment.Step 13: in 90 days, the State Bank of India receives the importer·s payment, so it has funds to pay the maturingdraft.Step 14: in 90 days the holder of the matured acceptance ie, bank of New York presents it to the State Bank ofIndia fro payment. The State Bank of India pays.

Export Assistance

Exporters in the India can draw upon two types of government-backed assistance to help finance their exports; theExport-Import bank and Export Credit Guarantee Corporation (ECGC)

The Export-Import Bank (EXIM BANK) is a public sector financial institution established in January 1, 1982. it wasestablished by an act of parliament fro the purpose of financing, facilitating, and promoting foreign trade in India.Export Credit Guarantee Corporation (ECGC): this institution covers the exporter against various risks. It alsoprovides guarantees to the financing banks to enable them to provide adequate finances to exporters.

Counter trade

Counter trade is a term that covers a whole range of barter like agreements. It is primarily used when the firm is

exporting to countries whose currency is not freely convertible, and who may lack the foreign exchange reservesrequired to purchase the imports. By some estimates, counter trade accounted for 20% of world trade by volume in

1998There are five distinct types of countertrade -- barter, counter purchase, offset, switch trading, and buy

back.

ib notes final

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