Nature of Inter-national Business

Environment
• The environment of inter-national business is
regarded as the sum total of all the external forces
working upon the firm as it goes about its affairs in
foreign & domestic markets.
• The environmental factors are divided into :
1. Political –legal
2. Economic
3. Cultural, &
4. Technological Groups
 International
Business

Environment of Inter-national Business

1. Political Environment

• Political environment refers to the influence of the

system of government & judiciary in a nation on
inter-national business
• The system of government in a nation wields
considerable impact on its business
• The type & structure of government prevailing in a
country decides, promotes, fosters, encourages,
shelters, directs, & controls the business of that
country
• A political system (another name for the type of
government) that is stable, honest, efficient, &
 dynamic & which ensures political participation to
the people, & assures personal security to the
citizens, is a primary factor for economic develop-
ment
• The developed economies of to-day owe their success
to a large extent to the political system they richly
enjoyed “there is to-day”, comments John Kenneth
Galbraith, “no country with a stable & honest
government that does not have or has not had a
reasonably satisfactory state of economic progress”
Democracy

• Two basic political systems are in existence all over

the world, namely, democracy & totalitarianism
• In its pure sense, democracy refers to a political
arrangement in which the supreme power is vested
in the people
• Democracy may manifest itself in any of two funda-
mental manners
• If each individual is given the right to rule & vote on
every matter, the result is pure democracy which is
not, however workable in a complex society with a
large constituency
• Hence the republican form of government follows
whereby the public, in a democratic manner, elect
their representatives who do the ruling.
• A representative democracy rests on the assumption
that should the elected representatives fail to
perform adequately they will be voted down at the
next election
• Democracies maintain stable business environments
primarily through laws protecting individual
property rights
• In theory, business prospers when the private sector
enjoys freedom to decide, freedom to earn, &
freedom to spend
• But in practice free markets, property rights, &
democracies do not guarantee economic growth
• India, for example, is the world’s largest democracy
yet experienced slow economic growth till recently
• Meanwhile, countries under near totalitarian
regimes achieved rapid economic growth
• The so-called Asian Tigers – Hong Kong, Singapore,
South Korea, & Taiwan – for example, built strong
market economies in the absence of democratic
practices.
Totalitarianism

• In totalitarianism, also called authoritarianism,

individual freedom is completely sub-ordinated to
the power of the authority of state & concentrated
in the hands of one person or in a small group,
which is not constitutionally accountable to the
people
• Societies ruled by pressure clique – political,
economic or military or by a dictator, plus most
oligarchies & monarchies – belong to this category
• The doctrines of fascism & erstwhile communism
are examples of totalitarianism
• During the First & Second World Wars, the
authoritarian governments began to appear in most
mature economies
• Even after the Second War, the totalitarian system
became most common in newly independent nations
• Administrative efficiency of the dictators was often
cited as an advantage for coping with the problems
of new-born states
• Surprisingly many nations are ruled by dictators
or monarchies even to-day
• Nazi Germany (under Adolf Hitler) & the former
Soviet Union under (under Joseph Stalin) are
historic examples of totalitarian governments
• To-day, Cambodia, Myanmar, China, Cuba, Congo,
& Iraq are prominent examples of totalitarian
governments
Types of Totalitarianism

Totalitarianism, in itself is of four types :

a) Theocratic Totalitarianism
b) Secular Totalitarianism
c) Tribal Totalitarianism
d) Right-Wing Totalitarianism
a) Theocratic Totalitarianism

• When a country’s religious leaders are also its

political leaders, its political system is called a
theocracy
• Religious leaders frame & enforce laws &
regulations that are based on religious beliefs
• A political system that is under the control of
religious leaders is theocratic totalitarianism
• Afghanistan, some Sheikhs of the Middle East &
Iran are the countries which have such political
dispensation
b) Secular Totalitarianism

• A political system in which political leaders are

guided by military & bureaucratic power is called
secular totalitarianism
• In such a system, the military controls the govern-
ment & makes decisions which it deems to be in the
best interest of the country
• An example is Pakistan
• Until the early 1980’s secular totalitarianism were
common throughout Latin America
• They were also found in several Asian countries,
particularly South Korea, Taiwan, Singapore,
 & the Philippines
• Since the early 1980’s, however, this form of govern-
ment has been losing its ground
• The majority of Latin American countries are now
genuine democracies, while significant political
freedom has been granted to the political opposition
in countries such as South Korea, Taiwan & the
Philippines
c) Tribal Totalitarianism

• A third form of totalitarianism is the tribal

totalitarianism
• This exists principally in African countries, such as
Zimbabwe, Tanzania, Uganda, & Kenya
• Tribal totalitarianism occurs when a political party
that represents the interests of a particular tribe
monopolises power
d) Right-Wing Totalitarianism

• Here, private ownership of property is endorsed by

government, market forces are also allowed free
play, but political freedom are rarely granted
• Argentina, Brazil, Chile, & Paraguay were under
right-wing totalitarian governments in the 1980’s
• China is classic example of polity which though
communist by definition, is pursuing right-wing
policies
• The country is privatising state-owned enterprises,
attracting FDI, pursuing pro-business policies & is
registering a hefty growth rate
• The country appears to be an open & free society,
but is essentially totalitarian
• As between democracy & totalitarianism, which
political system is ideal for business growth is a
relevant question
• It may be stated that democracy does not guarantee
high rates of economic growth, nor does
totalitarianism drive a country to slow economic
growth
• Rate of growth – the increase in the amount of goods
& services produced by a nation – is influenced by
many variables other than political & civil liberties
• These include a country’s tax system, policy towards
foreign & domestic investment, political stability,
judiciary, & the like.
Political Risk

• Corporates face political risk when they conduct

business with the outside world
• Political risk is any governmental action or
politically motivated event that could adversely
affect the long-term profitability or value of a firm
• Political risk affects different firms in different ways
• It can threaten the market of an exporter, the
production facilities of a manufacturer, or the
ability of a firm to repatriate its profits from a host
country to its home country
Examples of Political Risks & their Impact on
International Business
A) Macro Risks
i) Expropriation of corporate
assets without prompt &
adequate compensation
ii) Barriers to repatriation of
profits
iii) Confiscation of properties
iv) Loss of technology or other
intellectual property
v) Campaigns against foreign
goods
Impact
Loss of future profits
No motivation to improve
efficiency
Loss of assets & future
profits
Loss of future profits
Loss of sales & increased
costs of public relations
campaigns
vi) Mandatory labour legislations
vii) Civil wars
viii) Inflation
ix) Currency devaluations
Increased operating costs
Destruction of property
loss of sales, increased
security costs, disrupted
production runs
Increased operating costs
Reduced values of
repatriated earnings

B) Micro Risks
i) Kidnappings, terrorist, Disrupted production,
threats, etc. higher security costs,
reduced productivity
ii) Increased taxation Reduced after tax profits
iii) Officials’ dishonesty Loss of business, increased
operating costs
Type of Risks

Distinction is often made between Macro & Micro risks:

A) Macro Political Risk

B) Micro Political Risk
A) Macro Political Risk

• A macro political risk affects all inter-national

businesses in the same way
• Expropriation, the seizure of privately owned assets,
as for example, a farm or a factory, by government
with little or no compensation to the owners, is a
macro political risk
• The taking of ownership of an entire industry that
had been generated privately, as a part of a plan to
restructure an entire economy, is called national-
isation, again a macro political risk
• Communist governments in eastern Europe &
China expropriated private firms following
 World War II
• Fidel Castro did the same in Cuba during 1958-59
• Recently, governments in Angola, Chile, Ethiopia,
Peru, & Zambia have expropriated private firms
• Field Marshall Ayub Khan nationalised four hotels
of M.S Oberoi without paying any compensation
• In all these cases, inter-national businesses were
hard hit
• Political boycotts also result in macro political risk
• Since 1955, a number of Arab countries have
boycotted firms with branches in Israel or
companies that have allowed the use of their trade
name there
• Macro political risk can also come about because of
indigenisation laws which bind inter-national
businesses to accept equity participation by local
citizens.
B) Micro Political Risk

• A micro political risk affects specific foreign business

• Micro political risk include industry regulations,
taxes, kidnapping, & terrorist threats
• India’s decision in 1975 to reduce foreign equity to
40 per cent & Peru’s decision to nationalise its
copper mines are example of micro political risks
• The US decision to tax textile imports is another
instance
• Firms which have high visibility in host countries
are targets of micro political risk
• If agitations are caused by animosity between
factions in the host country & the government of a
foreign country, agitators may target only the most
visible companies from that foreign country, like
KFC.
Political Risk Assessment

• Inter-national business must conduct some form of

political risk assessment in order to manage risks
• Typically, managers in host countries assess the
potentially destabilising issues & evaluate their
future impact on the firm, making suggestions for
handling problems
• Top management at the head office will then
establish guidelines for each host country managers
to solve such problems
• Risk assessment by inter-national businesses usually
takes two forms
• One is through the use of experts or consultant
familiar with the host country or region under
consideration
• Such, consultants, advisors, or committees usually
monitor important indicators that may portend
political change
• They then assess the likelihood of political change
& develop several scenarios to describe alternative
political conditions in the future
• A second & increasingly common means of political
risk assessment used by inter-national businesses
is through the development of their internal staff
& in-house capabilities
• This type of assessment may be accomplished by
having staff assigned to foreign subsidiaries or
affiliates monitor local political activities or by
hiring people with expertise in the political &
economic conditions in regions critical to the firm’s
operations
• Whatever the method, timely information from the
people in the front line should not be missed
• Experts of consultants are no substitute for the line
managers in the foreign subsidiaries, many of whom
are host country nationals
• These managers represent the most important
resource for current information on the political
• environment & how it might affect their firm
because they are uniquely situated at the meeting
point of the firm & the host country
• Prudent inter-national businesses, however weigh
the subjectivity of these managers’ assessments &
also realise that similar events will have different
effects in different countries
• Some inter-national businesses try to quantify the
political risks associated with different countries
• Using these criteria countries are ranked as being
high or low in political risks
• The criteria generally used include the political-
economic environment, domestic economic
 conditions, & external economic relations
• Russia & Turkey rank high on risk &
Singapore & the Netherlands have very low risk
• Eurasia Group, a political & economic risk analysis
firm, has composed Global Political Risk Index
(GPRI)
• The index is a composite measure of the state of a
country’s government, security, society & economy
• All indicators are scored on a scale of 0 to 100
• The higher the number, the greater the political
stability
• Table (below) contains ranking of countries on
GPRI by Eurasia
• The ranking relates to 2006 & 2007
• The safest countries are Hungary, South Korea,
Poland & Bulgaria
• Pakistan, Nigeria, Venezuela & Iran are the
countries with least safety
• India stays at 62 both in 2006 & 2007
• China has improved its ranking from 61 in 2006 to
66 in 2007
 Table Composite Score

2006 2007
Hungary 78 77
S. Korea 76 75
Poland 74 72
Bulgaria 70 69
Mexico 67 67
China 66 61
Brazil 66 64
Turkey 65 64
Argentina 66 66
S. Africa 64 65
Russia 63 61
India 62 62
Thailand 61 60
Egypt 60 58
Algeria 59 59
Saudi Arabia 57 57
Indonesia 57 55
Colombia 56 55
Ukrain 56 57
Philippines 55 56
Iran 51 49
Venezuela 50 52
Nigeria 48 47
Pakistan 45 50
Managing Political Risks

• Inter-national businesses employ different methods

for managing political risks (see the Table under
Political Risk
• As the table shows, an MNC involves itself in each of
these either directly or indirectly. Similarly, its
actions can be defensive or proactive
1. Avoiding Investment
2. Adaptation
3. Threat
4. Lobbying
5. Terrorism Consultants
 Direct Indirect
1. Host operations 1. Risk insurance
dependent on home 2. Home country
Reactive control government
2. Diversification pressuring host
country government

1. Joint venture 1. Lobbying home &

2. Licensing host governments
Proactive agreements 2. Corporate
3. Promote host goals citizenship
in host country

Managing Risks
1. Avoiding Investment

• The simplest way to manage political risks is to

avoid investing in a country ranked high on such
risks
• Where investment has already been made, plants
may be wound up or transferred to some other
country which is considered to be relatively safe
• This may be a poor choice as the opportunity to do
business in a country will be lost
2. Adaptation

• Another way of managing political risk is adaptation

• Adaptation means incorporating risk into business
strategies
• MNCs incorporate risk by means of the following
three strategies:
a) Local Equity & Debt
b) Development Assistance
c) Insurance
a) Local Equity & Debt

• This involves financing subsidiaries with the help of

local firms, trade unions, financial institutions, &
government
• As partners in local businesses, these groups ensure
that political developments do not disturb operations
• Localisation entails modifying operations, product
mix, or any such activity to suit local taste & culture
• When McDonald’s commenced franchisee
operations in India, it ensured that sandwiches did
not contains any beef.
b) Development Assistance

• Offering development assistance allows an inter-

national business to assist the host country in
improving its quality of life
• Since the firm & the nation become partners, both
stand to gain
• In Myanmar, for instance, the US oil company
Unocal & France’s Total have invested billions of
dollars to develop natural gas fields & also spent
$ 6 million on local education, medical care, & other
improvements.
c) Insurance

• This is the last means of adaptation

• Companies buy insurance against the potential
effects of political risk
• Some policies protect companies when host
government restrict the convertibility of their
currency into parent country currency
• Other insure against losses created by violence
events including war & terrorism
• Most developed countries have created agencies to
ensure the firms against risks
• These agencies are generally state owned/sponsored
• The Overseas Private Investment Corporation
(OPIC) for instance, insures US overseas
investments against nationalisation, revolutions &
foreign exchange inconvertibility
• Similarly, the Multilateral Investment Guarantee
Agency (MIGA), a subsidiary of the World Bank,
provides insurance against political risks
• Private insurance firms, such as Lloyd's of London,
also underwrites political risk insurance
3. Threat

• Political risks can also be managed by trying to

prove to the host country that it cannot do without
the activities of the firm
• This may be done by trying to control raw materials,
technology & distribution channels in the host
country
• The firm may threaten the host country that the
supply of materials, products, or technology would
be stopped if its functioning is disrupted.
4. Lobbying

• Influencing local politics through lobbying is another

way of managing political risks
• Lobbying is the policy of hiring people to represent
a firm’s business interest as also its views on local
political matters
• Lobbyists meet with local public officials & try to
influence their position on issues relevant to the firm
• Their ultimate goal is getting favourable legislation
passed & unfavourable ones rejected
• Lobbyists render variety of services for fees
• Whether brokering a deal relating to merger or
acquisition, obtaining a refund from government
developments or getting clearances to start new
projects, services of lobbyists are always available
• Several sectors of the economy are not thrown open
to FDI
• Such sectors offer plenty of scope for lobbying

Lobbyists come from different hues as exhibit

(below) shows
 The Lobbyist Universe
Types Individuals Modes of Operand Effectiveness
Owner- From Ratan Meet key policy Very high since
Promoters Tata, to Mukesh makers personally, they bring a lot of
Ambani, to N.R drum up popular personal cred-
Naraynan Murthy, support via media ibility & the heft
to Azim Prem Ji of their business
to Sunil Mittal, empires to weigh
everyone has on the issues they
lobbied for, champion.
variously, better
policies in
telecom, oil &
gas, education
retail.
Consultants Typically, retired They work the ‘old High, since they
bureaucrats boys’ network have know how the
themselves better access than system works,
 such as Pradip employee- & which the
Baijal, former lobbyists, & levers to pull.
TRAI chairman, know the lay of
& C.M Vasudeva, the land better
former Expenditure than most.
Secretary in the
Ministry of Finance
PR firms Increasingly being They work Medium to
used to do more through in- low, because
than just public formal channels they have
relations, PR firms & media. Limited
offer ‘back office’ access to
support Perfect both the
Relations, Genesis bureaucracy
& IPAN are some & the media.
such firms.
Professional Reliance Industries’ Mostly interact High, since
Employees Shankar Adawal, with key they know
ITC’s K. S Vidya- bureaucrats, the innards
nathan, Renbaxy or lobby via of their
laboratories’ industry industries &
Ramesh Adige, are associations. can make
some senior compelling,
executives who have fact-based
extensive domain arguments.
knowledge &
champion specific
issues.
Politicos Usually, members They try to Medium,
of Parliament or appeal to the they are
those embedded party high typically
 in the organisational commands or the used in
machinery. concerned addition to
S. Gurumurthy & ministers direct- other
Salman Khurshid ly. Lobbyists.
are two examples.
Agents Dime a dozen, They keep Medium,to

these are largely track of bids, high, this is

fixers & do not file status, an ‘ever-
have the domain work through green’
knowledge or the lower level species.
credibility of other bureaucracy
lobbyists. & grease palms.
5. Terrorism Consultants

• To manage terrorism risk, MNCs hire consultants in

counter-terrorism to train employees to cope with
the threat of terrorism.
Bargaining & Integrative Approaches

• The five strategies of managing political risk which

have been discussed above fall under two broad
approaches :
i) Relative Bargaining Power, &
ii) Integrative as well as Protective &
Defensive Techniques
i) Relative Bargaining Power

• This theory is simple – an MNC has more

bargaining power than the host country
• In other words, the firm has the power & position to
do business in a host country on its own terms &
conditions
• Initiating investment in a host country, possessing
proprietary technology, & owning critical raw
materials will enable a firm to enjoy high bargaining
power
ii) Integrative as well as Protective & Defensive
Techniques

• Another means by which an international business

seeks to avoid political risk is by integration & the
implementation of protective & defensive techniques
• Integrative techniques are designed to help the
subsidiary to become one with the host country’s
needs & culture
• The adaptation strategies discussed earlier belong to
this category
• Protective & defensive techniques are designed to
discourage the host government from interfering in
 operations
• In contrast to the interactive techniques, these
actually encourage non-integration of the subsidiary
in the host country environment
Examples Include :
1) Doing as little local manufacturing as possible &
conducting all research & development outside the
host country ;
2) Limiting the responsibility of local personnel &
hiring only those who are vital to the operation ;
3) Raising capital from local banks & the host
government as well as outside sources ;&
4) Dispersing production of the product among a
 number of countries
• When should a firm use integrative techniques &
when should it use protective & defensive strategies?
• Answers to these questions depend on the technology
being used, expertise & skills, logistics, & labour
transmission of the MNC
• In all, four basic types of firms are said to use these
techniques
• The first type comprises dynamic, high technology
MNCs which possess the unique knowledge that the
host country needs
• Computer companies are a good example
• As seen from Fig.(below), these firms may not use
 integrative techniques
• They keep distance from host country governments
& rely heavily on protective & defensive techniques
• The second type consists of MNCs with low or stable
technology
• These firms use relatively unsophisticated
technology
• Steel companies are one such example
• As seen from Fig.(below), these MNCs use both high
integration & high protective & defensive strategies,
although they tend to rely more on integration than
on defensive approach
• The third type consists of inter-national businesses
whose managers need to be highly skilled
• For example, food production firms require
advanced marketing & management skills to be
competitive
• These firms typically use a balanced approach of
integration & protective & defensive techniques, but
they are less concerned with either than low or
stable technology companies do
• The last type comprises firms characterised by
highly labour-intensive products, high value in
relation to weight &/or volume, & need for a strong
global marketing systems for selling the product
• Firms manufacturing sewing machines are an
appropriate example
• Companies in this category tend to rely more
heavily on protective & defensive measures than any
of the other three groups & employ only a moderate
concern for integrative techniques
 Fig. Use of Integrative & Protective & Defensive
High 20 Techniques by Firms in Select
Industries

(11, 14) •
Low or stable technology

Moderate • Unified logistic

10 (7, 10) labour transmission
Integrative Advanced management (16, 6)
techniques skill •
(14, 3) •
Dynamic high
technology
Low 1
1 10 20
Low Moderate High
Protective/ defensive techniques