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PAPER CODE: BBA-6003
Dr. Vineet Walia
Dr. Pradeep Tomar
FOUNDATIONS OF INTERNATIONAL BUSINESS
UNIT-I Types of international business; basic structure of international business environment; risk in international business; motives for international business; barriers to international business; global trading and financial system – an overview UNIT-II Foreign market entry modes; factors of country evaluation and selection; decisions concerning foreign direct and portfolio investment; control methods in international business UNIT-III Basic foreign manufacturing and sourcing decisions; product and branding decisions for foreign markets; approaches to international pricing; foreign channel and logistical decisions UNIT-IV Accounting differences across countries; cross cultural challenges in international business; international staffing and compensation decisions; basic techniques of risk management in international business
FOUNDATIONS OF INTERNATIONAL BUSINESS
PAPER CODE: BBA-6003
QUESTION-1. Define and explain the concept of Business. What are the significant characteristics of Business and Business Organizations? Answer: Business – Business is not a new or modern concept rather it is eras old. A Business is an
important institution in any society in any part of this world. Be it for the supply of goods or services, creation of employment opportunities, offer of better quality life, or contribution to the economic growth of a country, the role of business is crucial. So the first question arises in anyone’s mind is what really a business is? The following definition is an attempt to provide appropriate answer. “A Business is nothing more than a person or group of persons properly organized to produce or distribute goods or services. The study of business is the study of activities involved in the production or distribution of goods and services-buying, selling, financing, personnel and the like”. Practically the above said definition is true but in theoretical sense it is incorrect. Before any activities can be considered in the business, there must exist both the goal of profit and the risk of loss. Thus Business can be accurately defined by K. Ashwathapa as “Complex field of commerce and industry in which goods and services are created and distributed in the hope of profit within a framework of laws and regulations”. The Concept of Business: To understand any business the critical step is to explore all the factors related to business and properly judging its impact on the business. There are many factors and forces which have considerable impact on any business. All these forces come under one word called environment. Hence understanding the business means understanding its environment. Environment refers to all external forces which have a bearing on the functioning of business. From the micro point of view, a business is an economic institution, as it is concerned with production and/or distribution of goods and services, in order to earn profits and acquire wealth. Different kinds of organizations (i.e., sole trader ship, partnership, Joint Stock Company and co-operative organization) are engaged in business and are operating from small scale, as in case of grocery in a start, to large scale, as in case of Tata Iron and Steel Co., Bajaj Auto, Maruti Udyog, and Reliance Industries.
Characteristics of Business & Business Organizations
The characteristics of a business organization are very dynamic and versatile in nature. Whatever may be the nature, magnitude and scale of operations of a business activity, a business Organization must possess the following characteristics: 1. Dealings in Goods and Services: The first basic characteristic of a business is that it deals in goods and services. Goods produced or exchanged, may be consumers' goods, such as bread, rice, cloth, etc. or producers' goods such as machines, tools, etc. The consumer goods are meant for direct consumption, either immediately, or after undergoing some processes, whereas the producers' goods are meant for being used for the purposes of further production. Producers’ goods are also known as capital goods. Services include supply of electricity, gas, water finance, insurance, transportation, warehousing, etc. 2. Production and/or Exchange: Every business is concerned with production and exchange of goods and services for value. Thus, goods produced or purchased for personal consumption or for presenting to others as gifts do not constitute business, because there is no sale or transfer for value. For example, if a person cooks at home for personal consumption, it is not business activity. But, if he cooks for others in his 'dhaba', or restaurant and receives payment from them, it becomes his business. 3. Creation of form, time and place utility: All business activities create utilities for the society. Form utility is created, when raw materials are converted into finished goods and services. Place utility is created, when goods are transported from the place of production to the place of consumption. Storage of goods creates time utility. This helps in preserving the goods, when not required and making them available, when demanded by the consumers. 4. Regularity and Continuity in Dealings: Regularity of economic transactions is the essence of business. There should be continuity, or regularity of exchange of goods and services for money. An isolated transaction cannot be called a business. For example, if a person sells his flat and earns some profits, it cannot be called a business. But, if he purchases and sells flats regularly to earn his livelihood, it will be called his business. 5. Profit Motive: Another important feature of a business activity is its objective. The chief objective of a business is to earn reasonable profits or 'surplus' as it is called in case of public enterprises. The survival of a business depends upon its ability to earn profits. Every businessman wants to earn profits, to get return on his capital and to reward himself for his services. Actually, profit is the spur that helps in the continuation of the business. Profit is also essential for growth. Recreation clubs and religious institutions cannot be called business enterprises, as they have nothing to do with the profit motive.
Question -2. What is the meaning and concept of International Business? Why the business organizations decide to go international? What are various types of International Business? Answer : International Business
International business is a term used to collectively describe all commercial transactions (private and governmental, sales, investments, logistics,and transportation) that take place between two or more regions, countries and nations beyond their political boundary. Usually, private companies undertake such transactions for profit; governments undertake them for profit and for political reasons. It refers to all those business activities which involves cross border transactions of goods, services, resources between two or more nations. Transaction of economic resources include capital, skills, people etc. for international production of physical goods and services such as finance, banking, insurance, construction etc. A multinational enterprise (MNE) is a company that has a worldwide approach to markets and production or one with operations in more than a country. An MNE is often called Multinational corporation (MNC) or Transnational company (TNC). Well known MNCs include fast food companies such as McDonald's and Yum Brands, vehicle manufacturers such as General Motors, Ford Motor Company and Toyota, consumer electronics companies like Samsung, LG and Sony, and energy companies such as ExxonMobil, Shell and BP. Most of the largest corporations operate in multiple national markets. Areas of study within this topic include differences in legal systems, political systems, economic policy, language, accounting standards, labor standards, living standards, environmental standards, local culture, corporate culture, foreign exchange market, tariffs, import and export regulations, trade agreements, climate, education and many more topics. Each of these factors requires significant changes in how individual business units operate from one country to the next. The conduct of international operations depends on companies' objectives and the means with which they carry them out. The operations affect and are affected by the physical and societal factors and the competitive environment Why Business Organizations Go International? The basic question of “why do the businesses organizations of a country go to the other countries?” might have been in your minds. Therefore, we answer this question, before proceeding further. To achieve higher rate of profits Expanding the production capacities beyond the demand of the domestic country Severe competition in the home country Limited home market
Political stability vs. Political instability Availability of technology and managerial competence High cost of transportation Nearness to raw materials Availability of quality human resources at less cost Liberalization and Globalization To increase market share To avoid tariffs and import quotas
Types of International business
There are different ways through which we can invest in foreign countries. These modes of International business are as follows: 1. Exporting- Exporting is the simplest and widely used mode of entering foreign markets. There are three forms of exporting includes: indirect exporting, direct exporting, and intra-corporate transfers. Indirect exporting: Indirect exporting is exporting the products either in their original form or in the modified form to a foreign country through another domestic company. Various publishers in India including Himalaya Publishing House sell their products, i.e., books to UBS publishers of India, which in turn exports these books to various foreign countries. Direct Exporting: Direct exporting is selling the products in a foreign country directly through its distribution arrangements or through a host country’s company. Baskin Robbins initially exported its ice-cream to Russia in 1990 and later opened 74 outlets with Russian partners. Finally in 1995 it established its ice-cream plant in Moscow. Intracorporate transfers: Intra corporate transfers are selling of products by a company to its affiliated company in host country (another country). Selling of products by Hindustan Lever in India to Unilever in USA. This transaction is treated as exports in India and imports in USA.
2. Licensing- In this mode of entry, the domestic manufacturer leases the right to use its intellectual property, i.e., technology, work methods, patents, copy rights, brand names, trade marks etc. to a manufacturer in a foreign country for a fee. Here the manufacturer in the domestic country is called ‘licensor’ and the manufacturer in the foreign country is called ‘licensee.’ Licensing is a popular method of entering foreign markets. The cost of entering foreign markets through this mode is less costly. The domestic company need not invest any capital as it has already developed intellectual property. As such, the domestic company earns revenue
without additional investment. Hence, most of the companies prefer this mode of foreign entry. The domestic company can choose any international location and enjoy advantages without incurring any obligations and responsibilities of ownership, managerial, investment etc. Kirin Brewery- Japan’s largest beer producer entered Canada by granting license to Molson and British market by granting license to Charles Wells Brewery. 3. Franchising- Franchising is a form of licensing. The franchisor can exercise more control over the franchised compared to that in licensing to licensing. International franchising is growing at a fast rate. Under franchising, an independent organization called the franchisee operates the business under the name of another company called franchisor. Under this agreement the franchisee pays a fee to the franchisor. The franchisor provides the following services to the franchisee: Trade marks Operating systems Product reputations Continuous support systems like advertising, employee training, reservation services, and quality assurance programmes etc. Basic Issues in Franchising The franchisor has been successful in his home country. McDonald was successful in USA due to the popular menu and fast and efficient services. The factors for the success of the McDonald are later transferred to other countries. The franchiser may have the experience in franchising in the home country before going for international franchising. Foreign investors should come forward for introducing the product on franchising basis. 4. Contract Manufacturing Some companies outsource their part of or entire production and concentrate on marketing operations. This practice is called contract manufacturing or outsourcing. The advantages are as follows: International business can focus on the part of the value chain where it has distinctive competence. It reduces the cost of production as the host country’s companies with their relative cost advantage produce at low cost. Small and medium industrial units in the host country can also develop as most the production activities take in these units. The international company gets the locational advantages generated by the host country’s production.
The disadvantages are as follows: Host country’s companies may take up the marketing activities also, hindering the interest of the international company. Host country’s companies may not strictly adhere to the production design, quality standards etc. These factors result in quality problems, design problems and other surprises. The poor working countries in the host country’s companies affect the company’s image. For example, Nike has suffered a string of blows to its public image because of reports of unsafe and harsh working conditions in Vietnamese factories churning our Nike foot ware. 5. Management Contracts The companies with low level technology and managerial may seek the assistance of a foreign company. Then the foreign company may agree to provide technical assistance and managerial expertise. This agreement between these two companies is called the management contract. A management contract is an agreement between two companies, whereby one company provides managerial assistance, technical expertise and specialized services to the second company of the argument for a certain agreed period in return for monetary compensation. Monetary compensation may be in the form of: A flat fee or Percentage over sales and Performance bonus based on profitability, sales growth, production or quality measures. Management contracts are mostly due to governmental inventions. The Government of the Kingdom of Saudi Arabia nationalized Armco and requested the former owners to manage the company. Exxon and other former owner of Armco accepted the offer. Delta, Air France and KLM often provide technical managerial assistance to the small airlines companies owned by the Governments. Advantages Foreign company earns additional income without any additional investment, risks and obligations. Hilton Hotels provided these services to other hotels without additional investment and earned additional income. This arrangement and additional income allows the company to enhance its image in the investors and mobilize the funds for expansion. Management contract helps the companies to enter other business areas in the host country. Disadvantages:
Sometimes the companies allow the companies in the host country even to use their trade marks and brand name. The host country’s companies spoil the brand name, if they do not keep up the quality of product service. The host country’s companies may leak the secrets of technology.
6. Turnkey project Indonesia government during 1974 invited global tenders for construction of a sugar factory in the country. Indonesia Government received the tenders from the companies of USA, UK, France, Germany and Japan. One of the Japanese Company quoted highest price compared to all other companies. Indonesia Government was very much satisfied with the total package and invited the Japanese company to implement the project. The Japanese company and Indonesian Government entered an agreement for implantation of this project by Japanese company for a price. This project is called “Turnkey Project.” A turnkey project is a contract under which firm agrees to fully design, construct and equip a manufacturing/business/service facility and turn the project over the purchaser when it is ready for operation for a remuneration. The form of remuneration includes: A fixed price (firm plans to implement the project below this price) Payment on cost plus basis (i.e., total cost incurred plus profit) This form of pricing allows the company to shift the risk of inflation/enhanced costs to the purchaser. International turnkey projects include nuclear power plants, airports, oil refinery, national highways, railway lines etc. Hence, they are large and multiyear projects. International companies involve in such projects include: Bechtel, Brown and Root, Hyundai Group, Kennengen, Friedrich Krupp Gmb H. etc. 7. The Greenfield Strategy The term Greenfield refers to starting with a virgin green site and then building on it. Thus, Greenfield strategy is starting of the operations of a company from scratch in a foreign market. The company conducts the market survey, selects the location, buys or leases land, creates the new facilities, erects the machinery, remits or transfers the human resources and starts the operations and marketing activities. This strategy is followed by Fuji in locating its manufacturing facilities in South Carolina, by Mercedes-Benz in locating automobile assembly plant in Alabama and Nissan in locating its factory in Sunderland, England. Disney management faced the problems in building Disneyland in Paris. These problems include: Problems in dealing with French construction contractors. Communication difficulties with painters. Local contractors demanded $150 million extra at the time of opening and threatened the opening. Local employees resisted the firm’s attempt to impose its US work values.
Advantages: The company selects the best location from all view points. The company can avail the incentives, rebates and concessions offered by the host governments including local governments. The company can have latest models of the buildings, machinery and equipment technology. The company can also have its own policies and styles of human resource management. The company can have its gestation period to understand and adjust to the new culture of the host country. Thus, it can avoid the cultural shock. Disadvantages: This strategy results in a longer gestation period as the successful implementation takes time and patience. Some companies may not get the land in the location of its choice. The company has to follow the rules and regulations imposed by the host country’s Government in case of construction of the factory buildings. Host country’s Government may impose conditions that the company should recruit local people and train them, if necessary, to meet the company’s requirements.
8. Mergers and Acquisitions
Domestic companies enter international business though mergers and acquisitions. A domestic company selects a foreign company and mergers itself with the foreign company in order to enter international business. Alternatively, the domestic company may purchase the foreign company and acquires its ownership and control. Though mergers and acquisitions provide easy and instant entry to global business, it would be very difficult to appraise the cases of acquisitions and mergers. Sometimes it would be cheaper to a domestic company to have a green field strategy than by acquisitions. Sometimes mergers and acquisitions also result in purchasing the problems of a foreign company. Advantages: The company immediately gets the ownership and control over the acquired firm’s factories, employees, technology, brand names and distribution networks. The company can formulate international strategy and generate more revenues. If the industry already reached the stage of optimum capacity level or overcapacity level in the host country. This strategy helps the economy of the host country. Disadvantages: Acquiring a firm in a foreign country is a complex task involving bankers, lawyers, regulations, mergers and acquisition specialists from the two countries. This strategy adds no capacity to the industry.
Sometimes host countries imposed restrictions on acquisitions of local companies by the foreign companies. Labour problems of the host country’s company are also transferred to the acquired company.
Two or more firms join together to create a new business entity that legally separate and distinct from its parents. Joint ventures are established as corporations and owned by the funding partners in the predetermined proportions. American Motor Corporation entered into joint venture with Beijing Automotive Works called Beijing Jeep to enter Chinese markets by producing jeeps and other vehicles. Joint ventures involve shared ownership. Joint ventures are common in international business. Various environmental factors like social, technological, economical and political encourage the formation of joint ventures. Joint ventures provide required strengths in terms of required capital, latest technology required human talent etc. and enable the companies to share the risk in the foreign markets. Advantages: Joint ventures provide large capital funds. They are suitable for major products. Joint ventures spread the risk between or among partners. Different parties to the joint venture bring different kinds of skills like technical skills, technology, human skills, expertise, marketing skills or marketing networks. Joint ventures make large projects and turnkey projects feasible and possible. Joint ventures provide synergy due to combined efforts of varied parties. Disadvantages: Joint ventures are also potential for conflicts. They result in disputes between or among parties due to varied interests. For example, the interest of a host country’s company in developing countries would be to get the technology from its partner while the interest of a partner of an advanced county would be to get the marketing expertise from the host country’s company. The partners delay the decision-making once the dispute arises. Then the operations become unresponsive and inefficient. Decision-making is normally slowed down in joint ventures due to the involvement of a number of parties. Scope for collapse of a joint venture is more due to entry of competitors, changes in business in business environment in the two countries, changes in partners’ strengths etc. Life cycle of a joint venture is hindered by many causes of collapse.
Question-3 What is International Business Environment? What do you understand by the basic structure of International Business Environment? Answer :
Business Environment : It refers to all external forces which have a bearing on the functioning of the business. In fact Environment consists of factors that are largely if not totally, external and beyond the control of individual industrial enterprise and their managements. These are essentially the ‘givers’ within which firms and their management must operate in a specific country and they vary, often greatly, from country to country. Business environment can be defined as the process by which strategists monitor the economic, governmental, market, supplier, technological, geographic, and social settings to determine opportunities and threats to their firms. From the above definitions we can extract that business environment consists of factors that are internal and external which poses threats to a Business Organization or these provide opportunities for exploitation. In business all the activities are being organized and also carried out by the people to satisfy the needs of the consumers. So, it is an activity carried out by the people for the people which means people occupy a central place around which all the activities revolve. It means business is people and a human is always a dynamic entity who believes in change and it may be right to say that the only certainty today is change. It poses a huge challenge for today’s and especially tomorrow’s businessmen and managers to be aware of specific changes so as to keep themselves abreast with the latest happenings in the field of business to maintain their survival and sustainability in the market. Therefore, the study of business environment is of atmost importance for the managers and practitioners.
International Business Environment
International Business Environment can be defined as the environment in different sovereign countries, with factors exogenous to the home environment of the organization, influencing decision making on resource use and capabilities. This includes the social, Cultural, Technological, Economic, Politico-Legal or regulatory, tax, Global and Natural environments. As Business Organizations have no control over the external environment, their success depends upon how well they adapt to the external environment. A Business Organization's ability to design and adjust its internal variables to take advantage of opportunities offered by the external environment, and its ability to control threats posed by the same environment, determine its success.
Basic Structure of International Business Environment
The Basic structure of international Business environment is very complex, dynamic and multifarious in nature so it is very much significant to study, understand and conceptualize the structure of International Business Environment in a comprehensive manner. The structure of International Business Environment can be categorized in to some very significant categories which can be understood by a simple Word STEP IN as follows 1. S – 2. T – 3. E – 4. P – 5. I – 6. N – Socio Cultural Environment Technological Environment Economic Environment Politico-Legal Environment International Environment Natural Environment
Social and cultural factors in various countries of the globe affect the international business. These factors include attitude of the people to work, attitude to wealth, family, marriage, religion, education, ethics, human relations, social responsibilities etc. Social and Cultural Environment Religion- Religion is one of the most important social institutions influencing business. Religions play significant role in normal and ethical standards in production and marketing of goods and services. Most of the religions indicate in providing truthful and honest information. But most of the marketing practice deviates from these standards. Family Systems- In addition to religion, family system has its impact on international business. In most of the Islamic countries, women play less significant role in the economy and also in the family with limited rights. In Latin Americans countries, though the role of women is better compared to that in Islamic countries, women’s role is limited in economies and in families. But, women play a dominant role in European and North American countries. In addition, joint families are more prevalent in Islamic and Hindu religions. Joint family system reduces the demand for goods and service compared to nucleus families. Culture- Culture is, the thought and behaviour patterns that member of a society earns through language and other forms of symbolic interaction- their customs, habits , beliefs
and values, the common viewpoints which bind them together as an social entity… Cultures change gradually picking up new ideas and dropping old ones, but many of the cultures of the past have been so persistent and self contained that the impact of such sudden change has torn them apart, uprooting their people psychologically. Characteristics of culture: 1. Learned- culture is not inherited nor biologically based; it is acquired by learning and experience. 2. Shared- People as members of a group, organization, or society share culture; it is not specific to specific individuals. 3. Trans generational- Culture is correlative passed from one generation to the next. 4. Symbolic- culture is based on the human capacity to symbolize or use one thing to represent another. 5. Patterned- Culture has structure and is integrated; a change in one part will bring changes in another. 6. Adaptive- Culture is based on the human capacity to change or adapt, as opposed to the more genetically driven adaptive process of animals. Language and Culture Language is the foundation of any culture. It is an abstract system of word meanings and symbols for all aspects of culture. Language includes speech, written characters, numerals, symbols, and gestures of non-verbal communication. The interrelationship between language and culture is very strong and often the former determines the latter. Words provide the concepts for understanding the world. In an organization, different people related with different culture speak different languages. Sometimes this language creates communication barriers so we can say that there is close interrelationship between language and culture. Cultural Attitude and Organization Dressing habits, living styles, eating habits and other consumption patterns, priority of needs are dictated or influenced by culture. Some Thai and Chinese and Indians do not consume beef. Thailand and Chinese believe that consumption of beef is improper and Indians believe that eating beef is a sin because cow is sacred. On the other hand, Americans and European eats mostly non-vegetarian foods and also prefer beef. Similarly, dressing habit also vary from country to country based on their culture. For example an Indian woman wears ‘saree’ and the woman of Middle East wears burka, naqab aur parda. Education and culture In its broad sense, education is the lifelong process of learning through which members of a society acquire knowledge and develop skills, ideas, values, norms, and attitudes which
they share other members of the society Countries rich in educational facilities attract highwage industries. Educationally advanced countries such as England, France, and Germany are more likely to be markets for computers and high-tech equipment than are less educated countries such as Poland, the Czech Republic, and Romania.
“Technological Environment means the development in the field of technology which affects business by new inventions of productions and other improvements in techniques to perform the business work. Explanation We see that in 21st century, technology is changing fastly. Now, all work is done online and business shops are using machinery at high level. There are following technological environment factors which affects business. • New inventions to produce the products. • New inventions relating to marketing like BPO for selling online in international market. Among all the segments of environment, technological environment exerts considerable influence on business. Thus this section requires more devotion. J.K. Galbraith defines technology as a systematic application of scientific or other organized knowledge to practical tasks. During the last 150 years, technology has developed beyond anybody’s comprehensions. Year 1983 was particularly considered by scientists as the year of scientific success. In this year scientists put a billion dollars technology into space, produced the world’s first test-tube triplets and obtained evidence of another solar system. A major break through was achieved in the field of genetic engineering. to cure dwarfism. Technology, thus, is the most dramatic force shaping the destiny of people and business all over the world. Changes in the technological environment have had some of the most dramatic effects on business. A company may be thoroughly committed to a particular type of technology, and may have made major investments in equipment and training only to see a new, more innovative and cost-effective technology emerge.Indeed, the managing director of a multinational organisation manufacturing heavy machinery once said that the hardest part of his job had nothing to do with unions, pay or products, but with whether or not to spend money on the latest technologically improved equipment. Computer technology has had an enormous impact on education and health care, to name but two areas affected. The advancements in medical technology, for example, have contributed to longevity in many societies. In addition, the introduction of robots in many factories has reduced the need for labour, and the use of VCR's and microcomputers has become commonplace in many homes and businesses. Unfortunately, there is a negative side to technological progress. The introduction of nuclear weapons, for example, has made the destruction of the human race a frightening possibility. In addition, factories using modern technologies have polluted both air and water and contributed to various environmental and health-related problems.
Technology is a critical factor in economic development. Because of the advances of international communication, the increasing economic interdependence of nations, and the serious scarcity of vital natural resources, the transfer of technology has become an important preoccupation of both industrialised and developing countries. For many industrialised countries, the changes in the technological environment over the last 30 years have been immense particularly in such areas as chemicals, drugs, and electronics. It is vital that organisations stay abreast of these changes - not only because this will allow them to incorporate new and innovative designs into their products, but also because it will give them a firmer base from which to anticipate and counteract competition from other organisations. When the Gillette company developed a superior stainless steel razor blade, it feared that such a superior product might mean fewer replacements and sales. Thus, the company decided not to market it. Instead, Gillette sold the technology to Wilkinson, a British garden tool manufacturer, thinking that Wilkinson would use the technology only in the production of garden tools. When Wilkinson Sword Blades were introduced and sold quickly, Gillette understood the magnitude of its mistake.
International business is mostly and directly influenced by the economic environment of various countries. Global economy has undergone a sea change during the last 50 years. The change is revolutionary after1990. The results of these changes are emergence of global markets, establishment of World Trade organization, emergence o0f global business houses and global competitors rather than local competitors. The major changes include: Capital flow rather than trade or product flow across the globe. Establishment of production facilities in various countries Technological revolution delinked the relation between the size of production and level of employment. Primary products are delinked from the industrial economies. The macroeconomic factors of individual nations independently do not significantly control the global economic outcomes. The contest between ‘capitalism’ and ‘communism’ is over. Capitalism succeeded over communism/socialism as a model for the organization of economic activity. Economic Systems Economic system is an organization of institutions established to satisfy human needs/wants. There are three types of economic system, viz., capitalism, communism and mixed. These are as follows: i. Capitalism Economic Systems- Under this system, customer allocates resources. Customers’ choice for product/services decides what will be produced by whom. This economic system provides for economic democracy, thus giving the customer, his choice for products/services. This system emphasizes on the philosophy of individualism believing in private ownership of production and distribution facilities. The limitation of this economic system
made the governments to introduce the welfare state concept which includes: workmen’s compensation law, provision for social security, labour legislation for state and housing, agriculture, medical, food, transportation, communication, security, education, water, power supply etc. USA, Japan and UK are the examples of capitalistic countries. Most of the other countries like India, France, Italy and Malaysia have started shifting their economic system towards this economic system. ii. Mixed Economic System- Under this economic system, major factors of production and distribution are owned, managed and controlled by the state. The purpose is to provide the benefits to the public more or less on equity basis. The other factors of mixed economic system are development of strong public sector, agrarian reforms, control over private wealth, regulation of private investment and national self-reliance. This system does not distribute the existing wealth equally among the people, but advocates the egalitarian principle. It believes in full employment, suitable rewards for the workers’ efforts. This is also called ‘Fabian socialism.’ The trend that is taking place in the globe today is the move towards privatization i.e., move towards market allocation. UK, France, Holland and India, for example, have reduced their command sector after 1990. iii. Communistic Economic System- In this, economic system, private property and property rights to income are abolished. The state owns all the factors of production and distribution. Communism is also called Marxism. In communistic/command allocation countries, the resource allocation decisions are made by the government planners. The number of automobiles, shoes, shirts, television sets- their size, colour, quality, features etc., motor cycles, and scooters are determined by government planners. Under this system, consumers are free to spend their income on what is available. The major limitations of this system include: It reduces individual freedom of choice due to restrictions on items to be produced. It fails to get total commitment of people to work and country’s welfare. It failed to achieve significant economic growth. It could not achieve equality- the main plank of Marxism. The rules of this system did not set fine examples for the executors to follow or implement It has been obsessed with rights of workers. Cuba is an example of the last remaining predominantly communist country. Business Development Stages of business Development Different countries in the world are at different stages of development. Countries are segments based on GNP pr capita. World countries are divided into four categories, viz., Low-Income Countries, Lower-Middle- Income Countries, Upper-Middle Income Countries and High-Income Countries.
Low-Income Countries- These countries are also known as third world countries or preindustrial countries. They are also those with 1992 incomes of less than US $ 400 per capita. Characteristics of these countries include: Limited industrialization, and excessive dependency of population on agriculture High birth rates Low literacy rates Heavy reliance on foreign aid Political instability and unrest Concentrated in Africa, South of the Sahara Excessive unemployment and underemployment Technological backwardness Underutilization of natural resources Excessive dependency on imports Industrial development is characterized by consumer goods industries The vicious circle of poverty. Lower-Middle-Income Countries- These countries are also known as less developed countries. These countries are with a GNP per capita of US $ between 400 and 2000 (1992). Characteristics of these countries include: Early stages of industrialization Expansion of consumer markets. Availability of cheap and motivated human resources Domestic markets are dominated with the products like clothing, batteries, tires, building materials, packaged foods etc. Locations for production of standardized/mature products like clothing for exports. Pose threat to the rest of world in labour-intensive products due to cheap labour. Have competitive advantage in mature and labour intensive products. Upper-Middle-Income Countries- These countries are also known as industrializing countries. GNP per capita of these countries ranges between US $ 2,000 and 12,000. Characteristics of these countries include: Less dependency on agriculture. Occupational mobility of the people from agriculture to industry. People migrate from rural to urban areas which results in increased urbanization. Increase in literacy, formal education and increased wage rates. Low wage costs compared to advanced countries. Formidable competitors due to lower wage costs and with the capability of advanced countries. High exports and rapid economic development. High-Income Countries- These countries are also known as advanced countries, industrialized, post industrial or First World countries. The GNP per capita (1992) of these countries is more than US $ 12,000. The characteristics of these countries include:
Oil-rich countries are excluded from this category. Countries reached the income level of more than US $ 12,000 through the process of industrial growth are included in this category. Countries developed through the codification of theoretical knowledge rather than from random inventions are included in this category. Service sector contributes more than 50 percent to the GNP. Development of information sector. Development of intellectual Technology over machine technology. Domination of scientist and professionals over engineers and semi-skilled workers. Emphasis on future plans. Japan’s work culture (mainly co-operation and harmonious interaction) suits to the basic requirements of the post industrialized society. UK’s work culture (mainly distrust and absence of sound relations) is in contrast to the needs of rapid industrialization. High income countries mostly aim at building the information society. These countries face the problems like pollution, excessive urbanization, economic depression, increase in aged population etc. Deindustrialization is in the process in these countries. These countries shift to the information society. Product innovations are more prevalent in post industrial society compared to that in industrial society.
Politico-Legal environment factors also influence the operations of international business firms enormously. The influence of the political system of a country influences the business from multi-angles, viz., deciding, promoting, fostering, encouraging, sheltering, directing and controlling the business activities. The success and growth of international business depend upon the stable, dynamic, honest, people participative, secured political system in a country. Political Relations and International Business Political friendship/friendly diplomatic relations result in the growth of bilateral or multilateral trade. For example, the friendly diplomatic relations between India and the former USSR helped not only the Indian companies but also the MNCs operating in India to have close business linkages with the former USSR. Similarly, the friendly diplomatic relations between Pakistan and USA helped Pakistan companies to have close business linkages with USA. Hostilities between countries affect the international business among the companies of these countries. Arab countries did not prefer to carry on business with the business firms of Israel. In USA, the firms follow the policy of ‘maintenance of arm’s length’ with the competing firms. But in other countries, particularly in Europe and India, they come to an agreement among themselves regarding price, product design, division of markets etc.
Types of political systems: Appraisal of political systems helps us in having an idea of political systems and their impact on international business. Governments may be parliamentary (open) or absolutist (closed). In parliamentary governments people are consulted and are allowed to participate in decision-making on all important issues. Under absolutist government the ruling government dictates government policies, rules and regulations on all citizens without considering the latter’s needs or views. Though Saudi Arabia and North Korea claim that they are of parliamentary type political system, they do not allow the people to express their voice. Hence they are classified as monarchies and dictatorships. The business in these countries is completely based on government policies rather than the people’s needs. Government may also be classified as two-party system, multiparty, single party and oneparty dominated. Two-party system- Two major parties take turn of controlling the government under two-party system. USA and UK are the example of two-party system. Multiparty system- There would be many parties and no party is strong to gain the control of the Government in multiparty system. Germany, France, Israel, India (during 1996-2000) and Poland are examples for multiparty system. Single-party system- In this system only one dominant party almost gets the opportunity to control the government, though several parties exist. Egypt is the best example for it. Even in India, Congress party ruled the country until 1997. Thus a single party rules the Government during the early stages of development One-party dominated system- In this system, though there are more than one party, the dominant party rules the Government and it does not allow any opposition party to come up. The former USSR, Cuba, Libya are example of this system. Level of Economic Development and Political Stability: South Africa and Italy are economically developed countries. South Africa has been facing internal and external problems and Italy has been facing labour problems and internal dissension. Vietnam is politically stable but economically developing country. India is politically unstable and also a developing country. This is due to varied regional, ethnic, language, religious issues/problems. Political Risks- International business firms face political risks as and when there are changes in Government policies and /or changes in political parties in power. Risks are based on the host government’s actions like confiscation, expropriation, nationalization, domestication and creeping expropriation. Confiscation- The process of nationalization of a property without compensation is called confiscation. Chinese government’s seizure of US property in 1949 when Chinese communist party took power is an example of confiscation. Expropriation- Expropriation is the process of nationalization of a property with compensation. Indian Government nationalized commercial banks with compensation in July 1969.
Nationalization- Nationalization is the process of shifting the ownership of private property from private individuals or institution to the Government. Burma nationalized entire foreign trade. Poland and Czech communist nationalized n100 percent of their economy. Domestication- In domestication, foreign business firms relinquish control and owner ship in favour of domestic investors either partly or fully. For example, Indian Leaf Tobacco Development Company Ltd., in India, Pepsi, General Motors and Barclays Bank in South Africa. General Instability Risk- These risks are due to social, political, religious unrest in the host country like the recent coup in Fiji and problems due to Muslim rebels in Philippines. Operation Risk- These risks are due to the imposition of controls on the foreign business operation (like production levels, marketing, finance and human resource) by the host Government.
Indicators of Political Instability Political instability can be viewed from the social unrest, attitudes of nationals and policies of host Governments. Social unrest- Social unrest is caused by clashes between or among community groups, religious groups and ethnic groups. For example, Christian-Muslim conflict in Lebanon, Hindu-Muslim conflict in India, White-Black conflict in USA etc. Attitudes of nationals- The negative attitude of nationals towards foreign business and foreigners is a greater risk. These negative attitudes include exploitation, colonialism, repatriation, employment to foreigners etc. Policies of the Host Government- Host government’s policies affect the operation of international business firms directly and internally or externally. For example, janata Government in India asked Coca-Cola to leave the country in 1977 due to the policy of discouraging the multinationals. How to Minimize Political Risks? Political risks cannot be completely eliminated. However, they can be minimized by contributing to the change of the attitudes of the people and Government of the host country like as: Stimulation of the host’s country economy. Employment of Nationals. Sharing ownership Being civic minded Political neutrality Behind-the-scenes lobby Observation of political mood reduction of exposure
The International (or global) environment consists of all those factors that operate at the transnational, cross-cultural, and across-the-border level which have an impact on the business of an organization. Some of the important factors and influences operating in the international environment are as below: 1. Globalization, its process, content, and direction 2. Global economic forces, organizations, blocs, and forums. 3. Global trade and commerce, its process and trends. 4. Global financial system, source of financing, and accounting standards 5. Geopolitical situation, equations alliances, and strategic interest of nations 6. Global demographic pattern and shifts. 7. Global human resources- institutions, availability, nature and quality of skills63999and expertise, mobility of labor and other skilled personnel. 8. Global information systems, communication networks, and media. 9. Global technological and quality systems and standards 10. Global markets and competitiveness 11. Global legal system, adjudication and arbitration mechanisms 12. Globalization of management and allied disciplines, and the diffusion of management techniques in industry. The multinational environment constitutes a special class of the environmental sector. While the preceding seven sectors are largely limited and exclusive in nature, the multinational environment encompasses all the sectors, albeit in global context. What we mean to say is that while for instance, the political environment within a country could consist of certain factors related to national politics, the international environment would also have a geopolitical component including the political factors and influences at the global level.
Equally significant, but sadly ignored, are the factors like climate, minerals, soil, landform, rivers and oceans, coast lines, natural resources, flora and fauna etc. Which have considerable influence on the functioning of a business. It is the natural environment which decides the resources for any business. Manufacturing, which is one of the aspects of business, depends on physical environment for inputs like raw material, labour of various skills, water, fuel etc. Trade between two regions of a nation or between two nations is the result of geographic factors. Because of natural factors, certain areas are more suitable for production of certain goods and other areas are in need of such goods. Transportation and communication, the main prop of business, depend to a larger extent on geographic factors. Uneven landforms, desserts, oceans, forest, rivers etc. are barriers to develop this vital infrastructure. Some businesses like mining of coal and ores, drilling of oil and most important agriculture which depends most on nature. Thus the impact of natural environment can not be ignored moreover it should be given top priority for any successful business.
Question – 4. What are the prominent Risks in International Business and How these can be averted in International Business Organizations? or Question- Explain the major risks and challenges faced by a firm involved in International Business. July, 2010 Answer:
Risks in International Business Just as there are reasons to get into global markets, and benefits from global markets, there are also risks involved in locating companies in certain countries. Each country may have its potentials; it also has its woes that are associated with doing business with major companies. Some of the rogue countries may have all the natural minerals but the risks involved in doing business in those countries exceed the benefits. Some of the risks in international business are: (1) Strategic Risk (2) Operational Risk (3) Political Risk (4) Country Risk (5) Technological Risk (6) Environmental Risk (7) Economic Risk (8) Financial Risk (9) Terrorism Risk Strategic Risk: The ability of a firm to make a strategic decision in order to respond to the forces that are a source of risk. These forces also impact the competiveness of a firm. Porter defines them as: threat of new entrants in the industry, threat of substitute goods and services, intensity of competition within the industry, bargaining power of suppliers, and bargaining power of consumers. Operational Risk: This is caused by the assets and financial capital that aid in the day-today business operations. The breakdown of machineries, supply and demand of the resources and products, shortfall of the goods and services, lack of perfect logistic and inventory will lead to inefficiency of production. By controlling costs, unnecessary waste
will be reduced, and the process improvement may enhance the lead-time, reduce variance and contribute to efficiency in globalization. Political Risk: The political actions and instability may make it difficult for companies to operate efficiently in these countries due to negative publicity and impact created by individuals in the top government. A firm cannot effectively operate to its full capacity in order to maximize profit in such an unstable country's political turbulence. A new and hostile government may replace the friendly one, and hence expropriate foreign assets. Country Risk: The culture or the instability of a country may create risks that may make it difficult for multinational companies to operate safely, effectively, and efficiently. Some of the country risks come from the governments' policies, economic conditions, security factors, and political conditions. Solving one of these problems without all of the problems (aggregate) together will not be enough in mitigating the country risk. Technological Risk: Lack of security in electronic transactions, the cost of developing new technology, and the fact that these new technology may fail, and when all of these are coupled with the outdated existing technology, the result may create a dangerous effect in doing business in the international arena. Environmental Risk: Air, water, and environmental pollution may affect the health of the citizens, and lead to public outcry of the citizens. These problems may also lead to damaging the reputation of the companies that do business in that area. Economic Risk: This comes from the inability of a country to meet its financial obligations. The changing of foreign-investment or/and domestic fiscal or monetary policies. The effect of exchange-rate and interest rate make it difficult to conduct international business. Financial Risk: This area is affected by the currency exchange rate, government flexibility in allowing the firms to repatriate profits or funds outside the country. The devaluation and inflation will also impact the firm's ability to operate at an efficient capacity and still be stable. Most countries make it difficult for foreign firms to repatriate funds thus forcing these firms to invest its funds at a less optimal level. Sometimes, firms' assets are confiscated and that contributes to financial losses. Terrorism Risk: These are attacks that may stem from lack of hope; confidence; differences in culture and religious philosophy, and/or merely hate of companies by citizens of host countries. It leads to potential hostile attitudes, sabotage of foreign companies and/or
kidnapping of the employers and employees. Such frustrating situations make it difficult to operate in these countries. Although the benefits in international business exceed the risks, firms should take a risk assessment of each country and to also include intellectual property, red tape and corruption, human resource restrictions, and ownership restrictions in the analysis, in order to consider all risks involved before venturing into any of the countries. Dr. Sidney Okolo is a professor, consultant, strategist, and Africa expert. He is affiliated to several universities, the Managing Director of International Business Associates, a management consulting firm, and also the CEO of Global Education Support, an education assistance program. Among other things, he engages in all aspects of learning, knowledge, organization and human change. His focus is on leadership, management, entrepreneurship, profit engineering, human potential, excellence, achievement, business strategy, research and development. Product management, change management, conflict management, athlete management, marketing, business development and operations. He works with clients to adapt to change due to change in factors of production, technology, goods and services. He engages clients in training, retraining, development, skills enhancement, association, behavior modification, ways of thinking, and attitude adjustment. In addition to his work in the United States, his focus is also on developing countries in the continent of Africa, their leadership, culture, economic and market structure, community planning and development, and his created four letter word, "PIES", which stands for: poverty, instability, ethnicity, and sectarianism.
Question-5. What are the motives of entering in International Business? Or Question- What are the major reasons for getting engaged in International Business? Answer: Motives of International Business: All organizations, irrespective of their size,
are keen to enter in to international business. Established companies are expanding their business. Many countries encourage trade, and removal of strangulating trade barriers. It motivates companies to aggressively multiply their targets. The governments of various countries are also determined to make their economy grow through international business that has therefore become a inevitable part of their economic policy. The objective behind international business can be looked at: 1. From an individual company’s angle. 2. From the government angle.
From an individual company’s angle 1. Managing the product life cycle: All companies have products, which pass through different stages of their life cycles. After the product reaches the last stage of the life cycle called the declining stage in one country, it is important for the company to identify other countries where the whole cycle process could be encashed. For example, Enfield India reached maturity and declining stage in India for the 350 cc motorcycle. The company entered Kenya, West Indies, Mauritius and other destinations where the heavy engine two-wheeler became popular. The Suzuki 800 cc vehicle reached the last stage of its life cycle in Japan and entered India in the early 1980’s, where it is still doing good business today. HP laptops are moving all the developing countries the moment they reached maturity in the U.S. market. 2. Geographic expansion as a growth strategy: Even if companies expand their business at home, they may still look overseas for new markets and better prospects. For example, Arvind mills expanded their business by either setting up units or opening warehouses abroad. Ranbaxy’s growth is mainly attributed to geographic expansion every year to new territories. Arobindo Pharma, Cipla and Dr. Reddys follow the same. 3. The adventurous spirit of the younger generation The younger generation of business families has considerable International exposure. They are willing to take risks and challenges And also create opportunities for their business. Laxmi Mittal has Emerged as the steel king of the world and Vijay Mallya of the UB Group took a major risk in setting up operations in South Africa. Kumar Birla expands to Australia and Europe through acquisitions. 4. Corporate ambition: Every corporate in the country has strategic plans to multiply its sales turnover. In case some of the ventures fail, others will offset the losses because of multi-location operations. For example, Coco Cola is still to day not earning any profit in a number of countries. But this will not affect the company because more than a hundred countries are contributing to offset losses. Kellogge cannot think of profits in India for further five years. They are ambitious to be visible and then revenue. 5. Technology advantage: Some companies have outstanding technology through which they enjoy core competency. There is a need for such technology in all countries. Biocon, Infosys, Gharda chemicals are known for their core competency in biotechnology, IT and pesticides respectively and a huge demand exists throughout the world for their technology. Thermax, Ion Exchange, Bharat Heavy Electricals and Larsen & Toubro have marched ahead in International business. 6. Building a corporate image Prior to profits and revenue generation, many companies first build their corporate image abroad. Once the image is built, generating revenues is a comparatively easy task. Samsung and LG built their image in India for the first three years and generation of revenue and profits has been considerable, as they have expanded to semi-urban and rural India as well. Today their market share and penetration levels have gone far ahead of other players in India.
7. Incentives and business impact Companies, which are involved in international business, enjoy fiscal, physical and infrastructural incentives while they setup business in the host country. The Aditya Birla Group enjoyed such incentives in Thailand and Indonesia. All such incentives contribute to the company to enjoy multiple advantages like economies of scale, access to import inputs, competitive pricing and aggressive promotion. 8. Lobour advantage Many companies have a highly productive lobour force. Their unique skills may not be available throughout the world. Manufacturing units in India have consistently performed well, whether in a diamond industry, handicraft, woodwork or leather. Companies nurture the skills of the artisans and win world markets. Knitwear, handlooms, embroidery, metal ware, carpet weaving, cashew processing and seafood call for cost-effective lobour force. India is endowed with such skills. 9. New business opportunities Many companies have entered in to business abroad, seeing unlimited opportunities. National foreign trade policy emphasizes focus markets. Enormous amount of growth potential is untapped in Latin America, Sub-Saharan Africa, CIS countries and China. 10. Emergence of SEZ’S, EOU’S, AEZ Current approvals of Special economic zones, Agrizones and Technology parks by Ministry of Commerce & Industry give new dimensions to international business. The companies setting up units in SEZ’s enjoy innumerable benefits and competitiveness. From a Government Angle 1. Earning valuable foreign exchange Foreign exchange earning is necessary to balance the payments for imports. India imports crude oil, defense equipments, essential raw materials and medical equipments for which the payments have to be made in foreign exchange. If the exports are high and imports are low it indicates a surplus balance of payment. On the other hand if imports are high and exports are low it indicates an adverse balance of payment, which all economies would want to avoid. A vast majority of the nations in the world are facing adverse balance of payment. 2. Interdependency of nations From time immemorial, nations have depended on each other. Even during the era of Indus valley civilization, Egypt and the Indus Valley depended on each other for various items. Today, India depends on the Gulf regions for crude oil and in turn the Gulf region depends on India for tea, rice etc. Developed countries depend on developing countries for primary goods, whereas developing countries depend on developed countries for value added finished products. No single country is endowed with all the resources to survive on her own. 3. Trade theories and their impact The theories of absolute advantage, comparative advantage and competitive advantage, which have been propounded by classical economists, indicate that a few nations have certain advantages of resources. The resources may be in the form of labour or infrastructure or technology or even a proactive policy of the government. Such theories are remaining foundations till today, for international business practices with few changes and trends.
4. Diplomatic relations Diplomacy and trade always go hand in hand. Many sovereign nations send their diplomatic representatives to other countries with a motive of promoting trade besides maintaining cordial relations. Indian diplomats in Latin America have done a remarkable job of promoting India’s business in the 1990’s. Indian embassies and high commissions in all the countries around theworld play a catalytic role of promoting trade and investment. 5. Core competency of nations Many countries are endowed with resources, which are produced at an optimum level. Such countries can compete well anywhere in the world. Rubber products from Malaysia, knitwear from India, rice from Thailand and wool from Australia are a few illustrations. Competing with a focused competency in any major resource or technology gives core competency status. India’s core competency in IT is known throughout the world. 6. Investment for infrastructure Over the years all countries have invested huge amounts of money on infrastructure by building airports, seaports, economic zones and inland container terminals. If the trade activities do not increase, the country cannot recover the amounts invested. Hence, the government fixes targets for every infrastructure unit and time frame to achieve it. Economies like Mauritius, Hong Kong, Singapore, Malta and Cyprus invest in trade related infrastructure in order to elevate themselves to be foreign trade oriented economies. Infrastructure and international business are the two eyes of a growing economy. 7. National image A new era has emerged from conquering countries by sword to winning it by trade. A businessman gives priority to the image of the country he belongs to. We come across products with labels such as “made in China” and “Japan” & “made in India”. Businessmen from India, China and Japan bring credentials to their country. When L.N.Mittal operates in Indonesia or Kazakhstan or Trinidad he is perceived by the people as Indian. The stigma cannot be detached. 8. Foreign trade policy and targets All developing countries announce their trade policies. A clear road map is drafted and given to promotional bodies so that timely implementation is possible. Every trade policy in India, in the past had its agenda and action plans right from import control order in 1947. All the trade policies had three fold objectives in their agenda- production promotion and competitiveness. 9. National targets By the year 2010, India aims to have a 2% share of the global market from the current level of 1.5 %. By the year 2009-10, our trade status was expected to cross $ 500 billion. The global melt down and its impact on low consumption around the world has limited the target unachievable for India. 10. WTO and international agencies The apex body of world trade, the WTO, a free, transparent and regulatory body upholds provisions related to the elimination of tariffs and non-tariff barriers. The International Bank for Reconstruction and Development (IBRD), popularly called the World Bank extends financial assistance on a soft loan basis in order to assist developing countries in their infrastructure and industrial development. The International Monetary Fund (IMF) maintains currency stability in various countries through regulatory mechanisms. Many more organizations like International Maritime Organization, International Standard
Organization, International Telecommunication Union, International Civil Aviation Organization are major catalysts to promote trade between nations. Over the past few years their role in promotion of trade, especially amongst developing economies is unprecedented.
Question -6. What do you mean by Trade barriers? What are the different barriers to International Trade? Or Question. Give arguments for and against protection. July 2010 Answer:
Trade Barriers Trade barriers are government-induced restrictions on international trade. By international trade we mean the exchange of goods and/or services. This exchange usually takes place between two parties from different countries or between two countries located anywhere on the globe. If the international trade takes place between two parties, it is known as bilateral trade and if the trade takes place between more than two parties, it is known as multi-lateral trade. There are basically three barriers to international trade that are used by countries. The barriers can take many forms, including the following:
Tariffs Barriers- This is barrier is in the form of duties, taxes, quotas etc. Because of this barrier, imports decrease and price of imported products increase which results in the fall in the demand giving boost to domestic products. Tariffs refer to the tax imposed on imports. Tariffs are of two types, viz., specific tariffs and ad valorem tariffs. Specific tariffs are levied as a fixed charge for each unit of the product imported. For example, a tariff of Rs. 1000 on each TV imported. The tariff levied as a proportion of the value of the imported goods is called ‘ad valorem’ tariff. For example, imposition of 30 per cent tax on the value of computers imported.
Parties gaining from Tariffs The following parties gain from the tariffs: Government of the importing country: Government of the importing country gets the revenue in the form of import duties. Industry of the importing country: The products of the importing country would find market as the cost of imported goods is higher than that of domestic goods. Jobs in the domestic country are saved. Business for the ancillary industry, serving, market intermediation etc. is also protected. However, the following parties are adversely affected by the tariffs:
Consumers of the domestic country lose as they have to pay higher price. Thus, the customers pay for the inefficiency of the domestic industry. The industry of the exporting country loses the demand for its product, sales and profit. Ultimately, a tariff enhances the efficiency of some countries and curtails the growth of the most efficient countries. Thus tariffs reduce the efficiency of world economies. This process results in inefficient utilization of all kinds of resources. The purpose of tariffs is to protect the domestic industry by increasing the cost of imported goods. Government of India imposed tariffs to protect domestic automobile industry, sugar industry, cement industry and steel industry.
Non-Tariff Barriers - Usually this type of barrier is imposed by a country on imports so that the quantity of imported items is restricted. Due to this, the availability of the imported item or items is restricted in the domestic market and the price too is very high. A second category of government intervention on international trade relates to nontariff barriers. Any government regulation, or procedure other than a tariff that has the effect of restricting international trade, or affecting overseas investment, becomes a non-tariff barrier. Import licenses- An import license is a document issued by a national government authorizing the importation of certain goods into its territory. Import licenses are considered to be non-tariff barriers to trade when used as a way to discriminate against another country's goods in order to protect a domestic industry from foreign competition.
Export licenses- An export license is a document issued by the appropriate licensing agency after which an exporter is allowed to transport his product in a foreign market. The license is only issued after a careful review of the facts surrounding the given export transaction. Export license depends on the nature of goods to be transported as well as the destination port. Import quotas- Import quota is direct restriction on the quantity of goods which are imported into a country. These restrictions are imposed by issuing import licenses to certain firms and individuals to import certain quantity of the goods. Subsidies- In order to encourage domestic production or to protect the domestic producer from the foreign competitors, government pays to domestic producer by reducing operation cost. Such payments are called subsidies. Subsidies are in different forms. They are cash grants, loans and advances at low rate of interest, tax holidays, and government procurement of output at a higher rate, equity participation and supply of inputs at lower prices. Subsidies help the domestic procedures in the following ways:
Acquire the character of a low cost producer and have all the advantages of a low cost producer like high profit margin or fixing the price at lower level. Compete with a foreign producer in the domestic market. Enter the foreign markets.
Voluntary Export Restraints- A voluntary export restraint (VER) or voluntary export restriction is a government imposed limit on the quantity of goods that can be exported out of a country during a specified period of time. Typically VERs arise when the import-competing industries seek protection from a surge of imports from particular exporting countries. VERs are then offered by the exporter to appease the importing country and to deter the other party from imposing even more explicit (and less flexible) trade barriers. Local content requirements- Local content requirement is a popular government policy in developing countries to regulate foreign direct investment. Administrative Policies - Governments in addition to the quotas and other restrictions, use formal and informal policies to restrict imports and boost exports. Administrative policies are bureaucratic rules and procedures which are formulated to make it difficult to imports to enter the country. Formal trade barriers like tariffs and quotas are lowest in Japan. Japan mostly uses the administrative policies. Currency devaluation –Devaluation of currency is a reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged. In common modern usage, it specifically implies an official lowering of the value of a country's currency within a fixed exchange rate system, by which the monetary authority formally sets a new fixed rate with respect to a foreign reference currency
Voluntary Constraints- This is a type of international trade barrier wherein a country voluntarily restricts or stops imports from coming in. This is usually used to limit the competition that domestic industries will face with the coming in of imported goods. Whenever a country starts international trade with another country, these three barriers to international trade are
always taken into account.It has been seen that lower developed countries and developing countries tend to favour these three barriers to international trade as the countries can earn foreign exchange by introducing tariff and non-tariff barrier. The local industries are protected from competition by foreign companies and industries and as less imported goods are available in the country, consumers tend to buy local products giving the local industries a boost. A voluntary export restraint is the opposite form of import quotas. A voluntary export restraint is a quota on exports of the domestic firm imposed by the exporting country. Exporting country imposes such restriction, mostly at the request of the importing country. For example, Japanese automobile exporters had such restraint in 1981 due to the request of the US government. Foreign exporters mostly accept for the voluntary export restraint as its violation leads to imposition of import tariffs, import quotas etc. Import quotas and voluntary export restraints help the domestic firms by providing protection from the foreign competitors. These enhance the prices of import goods and make the domestic goods cheap. Most trade barriers work on the same principle: the imposition of some sort of cost on trade that raises the price of the traded products. If two or more nations repeatedly use trade barriers against each other, then a trade war results. Economists generally agree that trade barriers are detrimental and decrease overall economic efficiency, this can be explained by the theory of comparative advantage. In theory, free trade involves the removal of all such barriers, except perhaps those considered necessary for health or national security. In practice, however, even those countries promoting free trade heavily subsidize certain industries, such as agriculture and steel. Trade barriers are often criticized for the effect they have on the developing world. Because rich-country players call most of the shots and set trade policies, goods such as crops that developing countries are best at producing still face high barriers. Trade barriers such as taxes on food imports or subsidies for farmers in developed economies lead to overproduction and dumping on world markets, thus lowering prices and hurting poorcountry farmers. Tariffs also tend to be anti-poor, with low rates for raw commodities and high rates for labor-intensive processed goods. The Commitment to Development
Index measures the effect that rich country trade policies actually have on the developing world. Another negative aspect of trade barriers is that it would cause a limited choice of products and would therefore force customers to pay higher prices and accept inferior quality.
Question-7. What do you understand by Global Trading and Financial System and how these can be coordinated at Global Scenario? Give an overview. or Question-What is meant by Exchange rate? Explain various factors affecting exchange rates. Answer:
The global trading and financial system is the financial system consisting of institutions and regulators that act on the international level, as opposed to those that act on a national or regional level. The main players are the global institutions, such as International Monetary Fund and Bank for International Settlements, national agencies and government departments, e.g., central banks and finance ministries, private institutions acting on the global scale, e.g., banks and hedge funds, and regional institutions, e.g., the Eurozone. Deficiencies and reform of the GFS have been hotly discussed in recent years. Euro Currency Market Another component of international financial markets is the Eurocurrency market. Originally called the Eurodollar market, the Eurocurrency market first made its appearance in the early 1950s when the communist-controlled governments of Central and Eastern Europe needed dollars to finance their international trade but feared that the US government would confiscate or block their holdings of dollars in the US banks for political reasons. These governments solved their problem by using European banks that were willing to hold their dollar accounts for them. In this way, the Eurodollar was born-US dollar deposited in the European bank accounts. As other currencies became stronger in the post-war era- particularly the yen and the Deutsche mark-the Eurocurrency market broadened to include Europounds, Euroyen, Euromarks, and other currencies. Today, a Eurocurrency is defined as a currency on deposit outside of its country of issue. Obviously, the terms Eurocurrency is a misnomer because a Eurocurrency can be created anywhere in the world; the persistent Euro-prefix reflects only the European origin of the market. Eurocurrency markets serve two valuable purposes: 1. Eurocurrency deposits are an efficient and convenient market device for holding surplus cash; and 2. Eurocurrency market is a major source of short-term bank loans to finance corporate working capital needs, including the financing of imports and exports.
The unique feature of the Eurocurrency market is the relatively low cost of borrowings. The Eurocurrency market loans are low cost because of three reasons1. Firstly, the loans are free from costly government banking regulations, such as revenue requirements, that are designed to control the domestic money supply but which push up lending costs. 2. Secondly, these loans involve large transactions, so the average cost of making the loan is less. 3. Thirdly, since the most creditworthy borrowers avail the loans, the risk premium that lenders charge is also less. Exchange Rate In finance, an exchange rate (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in terms of another currency. For example, an interbank exchange rate of 91Japanese yen (JPY, ¥) to the United States dollar (US$) means that ¥91 will be exchanged for each US$1 or that US$1 will be exchanged for each ¥91. Exchange rates are determined in the foreign exchange market, which is open to a wide range of different types of buyers and sellers where currency trading is continuous: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday until 22:00 GMT Friday. The spot exchange rate refers to the current exchange rate. Theforward exchange rate refers to an exchange rate that is quoted and traded today but for delivery and payment on a specific future date. In the retail currency exchange market, a different buying rate and selling rate will be quoted by money dealers. Most trades are to or from the local currency. The buying rate is the rate at which money dealers will buy foreign currency, and the selling rate is the rate at which they will sell the currency. The quoted rates will incorporate an allowance for a dealer's margin (or profit) in trading, or else the margin may be recovered in the form of a "commission" or in some other way. Different rates may also be quoted for cash (usually notes only), a documentary form (such as traveller's cheques) or electronically (such as a credit card purchase). The higher rate on documentary transactions is due to the additional time and cost of clearing the document, while the cash is available for resale immediately. Some dealers on the other hand prefer documentary transactions because of the security concerns with cash. Exchange Rate Determination The transactions in the foreign exchange market, viz., buying and selling foreign currency take at a rate, which is called ‘exchange rate’. Exchange rate is the price paid in the home currency for a unit of foreign currency. The exchange rate can be quoted in two ways, viz., One unit of foreign money to a number5 of units of domestic currency. A certain number of units of foreign currency to one unit of domestic currency. For example, 1 US $ = Rs. 50 or Re. 1 = US $ 0.02 Exchange rate in a free market is determined by the demand for and the supply of exchange of a particular country. The equilibrium exchange rate is the rate at which
demand for foreign exchange and the supply of foreign exchange are equal. Ragnar Nurske defined the equilibrium exchange rate as, “that rate which over a certain period of time keeps the balance of payments in equilibrium.” Equilibrium exchange rate can be determined by two methods: The exchange rate between US dollars and Indian Rupees can be determined by demand for and supply of US dollars in India or by Indians. The price of US $ is fixed in Indian Rupees. The exchange rate between Indian Rupees and US dollars can also be determined by demand for and supply of Indian Rupees by Americans or in USA. The price of Indian Rupee is determined in US dollars. The prices are the same in both these methods. Determinants of Exchange Rates Numerous factors determine exchange rates, and all are related to the trading relationship between two countries. Remember, exchange rates are relative, and are expressed as a comparison of the currencies of two countries. The following are some of the principal determinants of the exchange rate between two countries. Note that these factors are in no particular order; like many aspects of economics, the relative importance of these factors is subject to much debate. 1. Differentials in Inflation As a general rule, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies. During the last half of the twentieth century, the countries with low inflation included Japan, Germany and Switzerland, while the U.S. and Canada achieved low inflation only later. Those countries with higher inflation typically see depreciation in their currency in relation to the currencies of their trading partners. This is also usually accompanied by higher interest rates. 2. Differentials in Interest Rates Interest rates, inflation and exchange rates are all highly correlated. By manipulating interest rates, central banks exert influence over both inflation and exchange rates, and changing interest rates impact inflation and currency values. Higher interest rates offer lenders in an economy a higher return relative to other countries. Therefore, higher interest rates attract foreign capital and cause the exchange rate to rise. The impact of higher interest rates is mitigated, however, if inflation in the country is much higher than in others, or if additional factors serve to drive the currency down. The opposite relationship exists for decreasing interest rates - that is, lower interest rates tend to decrease exchange rates.
3. Current-Account Deficits The current account is the balance of trade between a country and its trading partners, reflecting all payments between countries for goods, services, interest and dividends. A deficit in the current account shows the country is spending more on foreign trade than it is earning, and that it is borrowing capital from foreign sources to make up the deficit. In other words, the country requires more foreign currency than it receives through sales of exports, and it supplies more of its own currency than foreigners demand for its products. The excess demand for foreign currency lowers the country's exchange rate until domestic goods and services are cheap enough for foreigners, and foreign assets are too expensive to generate sales for domestic interests. 4. Public Debt Countries will engage in large-scale deficit financing to pay for public sector projects and governmental funding. While such activity stimulates the domestic economy, nations with large public deficits and debts are less attractive to foreign investors. The reason? A large debt encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off with cheaper real dollars in the future. In the worst case scenario, a government may print money to pay part of a large debt, but increasing the money supply inevitably causes inflation. Moreover, if a government is not able to service its deficit through domestic means (selling domestic bonds, increasing the money supply), then it must increase the supply of securities for sale to foreigners, thereby lowering their prices. Finally, a large debt may prove worrisome to foreigners if they believe the country risks defaulting on its obligations. Foreigners will be less willing to own securities denominated in that currency if the risk of default is great. For this reason, the country's debt rating (as determined by Moody's or Standard & Poor's, for example) is a crucial determinant of its exchange rate. 5. Terms of Trade A ratio comparing export prices to import prices, the terms of trade is related to current accounts and the balance of payments. If the price of a country's exports rises by a greater rate than that of its imports, its terms of trade have favorably improved. Increasing terms of trade shows greater demand for the country's exports. This, in turn, results in rising revenues from exports, which provides increased demand for the country's currency (and an increase in the currency's value). If the price of exports rises by a smaller rate than that of its imports, the currency's value will decrease in relation to its trading partners. 6. Political Stability and Economic Performance Foreign investors inevitably seek out stable countries with strong economic performance in which to invest their capital. A country with such positive attributes will draw investment funds away from other countries perceived to have more political and
economic risk. Political turmoil, for example, can cause a loss of confidence in a currency and a movement of capital to the currencies of more stable countries. The exchange rate of the currency in which a portfolio holds the bulk of its investments determines that portfolio's real return. A declining exchange rate obviously decreases the purchasing power of income and capital gains derived from any returns. Moreover, the exchange rate influences other income factors such as interest rates, inflation and even capital gains from domestic securities. While exchange rates are determined by numerous complex factors that often leave even the most experienced economists flummoxed, investors should still have some understanding of how currency values and exchange rates play an important role in the rate of return on their investments. Demand for Foreign Exchange The demand for foreign exchange is determined by the country’s: Import of goods and service. Investment in foreign countries (flow of capital to other countries), i.e., establishment of an industry by Indians in USA. Other payments involved in international transactions like payment of Indian Government to various foreign governments for settlement of their transactions. Other types of outflow of foreign capital like giving donations etc. The demand curve indicates the amount of foreign exchange demanded (for example, US dollars). Supply of Foreign Exchange Supply of foreign exchange of a particular country (i.e., US dollars) indicates the availability of foreign currency of a particular country to the country concerned (i.e., India) in its foreign exchange market. The supply of foreign exchange includes: Country’s exports of goods and services to foreign countries. Inflow of foreign capital. Payments made by the foreign governments to Indian government for settling their transactions. Other types of inflow of foreign capital like remittances by the Non-Resident Indians, donations received etc. The supply curve of foreign exchange is shown by ‘SS’.The equilibrium exchange rate is determined at ‘P’ where the demand curve ’DD’ intersects the supply curve ‘SS’. Both the supply of foreign exchange and demand for foreign exchange is ‘OQ’ and the exchange rate is ‘OP’. If the demand for foreign exchange is in excess of supply, i.e., the demand is at the point of ‘b’ on the demand curve and the supply is ‘a’ on the supply curve (demand>supply), the exchange rate is fixed at ‘OP2’. In contrast, if the demand is less than the supply, i.e. , demand is at point ‘c’ on demand curve and the supply is at point ‘d’ on the supply curve (demand< supply), the exchange rate is fixed at ‘OP1’. Thus the excess demand over supply results in the exchange rate higher than the equilibrium exchange rate and vice versa is true if the demand is less than the supply.
Foreign Exchange Market Mechanism The subject of foreign exchange is, in the words of H.E. Evitt, “that section of economic science which deals with the means and methods by which rights to wealth in one country’s currency are converted into rights to wealth in terms of another country’s currency.” As he further observes, it “involves the investigation of the method by which the currency of one country is ex changed for that of another, the causes which render such exchange necessary, the forms which such exchange may take, and the ratios or equivalent values at which such exchanges are effected.” There are different interpretations of the term foreign exchange, of which the following two are important and common: 1. Foreign exchange is the system or process of converting one national currency into another, and of transferring money from one country to another. 2. Secondly, the foreign exchange is used to refer to foreign currencies. For example, the Foreign Exchange Regulation Act, 1973 (FERA) defines foreign exchange as foreign currency and includes all deposits, credits and balance payable in any foreign currency and any drafts, travellar’s cheques, letters of credits and bills of exchange, expressed or drawn in Indian currency, but payable in any foreign currency. Functions of Foreign Exchange Market The foreign exchange market is a market in which foreign exchange transactions take place. In other words, it is a market for sale and purchase of different currencies. A foreign exchange market performs three important functions: 1. Transfer of Purchasing Power- The primary function of a foreign exchange market is the transfer of purchasing power from one country to another and from one currency to another. The international clearing function performed by foreign exchange market plays a very important role in facilitating international trade and capital movements. 2. Provision of Credit- the credit function performed by foreign exchange markets also plays a very important role in the growth of foreign trade, for international trade depends to a great extent on credit facilities. Exporters may get pre-shipment and post-shipment credit. Credit facilities are available also for importers. The Eurodollar market has emerged as a major international credit market. 3. Provision of Hedging Facilities- The other important function of the foreign exchange market is to provide hedging facilities. Hedging refers to covering of export risks, and it provides a mechanism to exporters and importers to guard themselves against losses arising from fluctuations in exchange rates.
Question-8. How can a domestic Business Organization make an effort to enter Foreign Market? What are the various foreign market entry modes? Explain Answer:
Every domestic Business Organization likes to go for expansion through Internationalization if there is favorable and conducive environment for Global Business. There are different ways through which we can invest in foreign countries. These modes of International business are as follows: 1. Exporting- Exporting is the simplest and widely used mode of entering foreign markets. There are three forms of exporting includes: indirect exporting, direct exporting, and intra-corporate transfers. Indirect exporting: Indirect exporting is exporting the products either in their original form or in the modified form to a foreign country through another domestic company. Various publishers in India including Himalaya Publishing House sell their products, i.e., books to UBS publishers of India, which in turn exports these books to various foreign countries. Direct Exporting: Direct exporting is selling the products in a foreign country directly through its distribution arrangements or through a host country’s company. Baskin Robbins initially exported its ice-cream to Russia in 1990 and later opened 74 outlets with Russian partners. Finally in 1995 it established its ice-cream plant in Moscow. Intracorporate transfers: Intra corporate transfers are selling of products by a company to its affiliated company in host country (another country). Selling of products by Hindustan Lever in India to Unilever in USA. This transaction is treated as exports in India and imports in USA.
2. Licensing- In this mode of entry, the domestic manufacturer leases the right to use its intellectual property, i.e., technology, work methods, patents, copy rights, brand names, trade marks etc. to a manufacturer in a foreign country for a fee. Here the manufacturer in the domestic country is called ‘licensor’ and the manufacturer in the foreign country is called ‘licensee.’ Licensing is a popular method of entering foreign markets. The cost of entering foreign markets through this mode is less costly. The domestic company need not invest any capital as it has already developed intellectual property. As such, the domestic company earns revenue without additional investment. Hence, most of the companies prefer this mode of foreign entry.
The domestic company can choose any international location and enjoy advantages without incurring any obligations and responsibilities of ownership, managerial, investment etc. Kirin Brewery- Japan’s largest beer producer entered Canada by granting license to Molson and British market by granting license to Charles Wells Brewery. 3. Franchising- Franchising is a form of licensing. The franchisor can exercise more control over the franchised compared to that in licensing to licensing. International franchising is growing at a fast rate. Under franchising, an independent organization called the franchisee operates the business under the name of another company called franchisor. Under this agreement the franchisee pays a fee to the franchisor. The franchisor provides the following services to the franchisee: Trade marks Operating systems Product reputations Continuous support systems like advertising, employee training, reservation services, and quality assurance programmes etc. Basic Issues in Franchising The franchisor has been successful in his home country. McDonald was successful in USA due to the popular menu and fast and efficient services. The factors for the success of the McDonald are later transferred to other countries. The franchiser may have the experience in franchising in the home country before going for international franchising. Foreign investors should come forward for introducing the product on franchising basis. 4. Contract Manufacturing Some companies outsource their part of or entire production and concentrate on marketing operations. This practice is called contract manufacturing or outsourcing. The advantages are as follows: International business can focus on the part of the value chain where it has distinctive competence. It reduces the cost of production as the host country’s companies with their relative cost advantage produce at low cost. Small and medium industrial units in the host country can also develop as most the production activities take in these units. The international company gets the locational advantages generated by the host country’s production. The disadvantages are as follows: Host country’s companies may take up the marketing activities also, hindering the interest of the international company. Host country’s companies may not strictly adhere to the production design, quality standards etc. These factors result in quality problems, design problems and other surprises.
The poor working countries in the host country’s companies affect the company’s image. For example, Nike has suffered a string of blows to its public image because of reports of unsafe and harsh working conditions in Vietnamese factories churning our Nike foot ware.
5. Management Contracts The companies with low level technology and managerial may seek the assistance of a foreign company. Then the foreign company may agree to provide technical assistance and managerial expertise. This agreement between these two companies is called the management contract. A management contract is an agreement between two companies, whereby one company provides managerial assistance, technical expertise and specialized services to the second company of the argument for a certain agreed period in return for monetary compensation. Monetary compensation may be in the form of: A flat fee or Percentage over sales and Performance bonus based on profitability, sales growth, production or quality measures. Management contracts are mostly due to governmental inventions. The Government of the Kingdom of Saudi Arabia nationalized Armco and requested the former owners to manage the company. Exxon and other former owner of Armco accepted the offer. Delta, Air France and KLM often provide technical managerial assistance to the small airlines companies owned by the Governments. Advantages Foreign company earns additional income without any additional investment, risks and obligations. Hilton Hotels provided these services to other hotels without additional investment and earned additional income. This arrangement and additional income allows the company to enhance its image in the investors and mobilize the funds for expansion. Management contract helps the companies to enter other business areas in the host country. Disadvantages: Sometimes the companies allow the companies in the host country even to use their trade marks and brand name. The host country’s companies spoil the brand name, if they do not keep up the quality of product service. The host country’s companies may leak the secrets of technology. 6. Turnkey project Indonesia government during 1974 invited global tenders for construction of a sugar factory in the country. Indonesia Government received the tenders from the companies of USA, UK, France, Germany and Japan. One of the Japanese Company quoted highest price compared to all other companies. Indonesia Government was very much satisfied with the total package and invited the Japanese company to implement the project. The Japanese company and Indonesian
Government entered an agreement for implantation of this project by Japanese company for a price. This project is called “Turnkey Project.” A turnkey project is a contract under which firm agrees to fully design, construct and equip a manufacturing/business/service facility and turn the project over the purchaser when it is ready for operation for a remuneration. The form of remuneration includes: A fixed price (firm plans to implement the project below this price) Payment on cost plus basis (i.e., total cost incurred plus profit) This form of pricing allows the company to shift the risk of inflation/enhanced costs to the purchaser. International turnkey projects include nuclear power plants, airports, oil refinery, national highways, railway lines etc. Hence, they are large and multiyear projects. International companies involve in such projects include: Bechtel, Brown and Root, Hyundai Group, Kennengen, Friedrich Krupp Gmb H. etc. 7. The Greenfield Strategy The term Greenfield refers to starting with a virgin green site and then building on it. Thus, Greenfield strategy is starting of the operations of a company from scratch in a foreign market. The company conducts the market survey, selects the location, buys or leases land, creates the new facilities, erects the machinery, remits or transfers the human resources and starts the operations and marketing activities. This strategy is followed by Fuji in locating its manufacturing facilities in South Carolina, by Mercedes-Benz in locating automobile assembly plant in Alabama and Nissan in locating its factory in Sunderland, England. Disney management faced the problems in building Disneyland in Paris. These problems include: Problems in dealing with French construction contractors. Communication difficulties with painters. Local contractors demanded $150 million extra at the time of opening and threatened the opening. Local employees resisted the firm’s attempt to impose its US work values. Advantages: The company selects the best location from all view points. The company can avail the incentives, rebates and concessions offered by the host governments including local governments. The company can have latest models of the buildings, machinery and equipment technology. The company can also have its own policies and styles of human resource management. The company can have its gestation period to understand and adjust to the new culture of the host country. Thus, it can avoid the cultural shock. Disadvantages: This strategy results in a longer gestation period as the successful implementation takes time and patience. Some companies may not get the land in the location of its choice. The company has to follow the rules and regulations imposed by the host country’s Government in case of construction of the factory buildings.
Host country’s Government may impose conditions that the company should recruit local people and train them, if necessary, to meet the company’s requirements.
8. Mergers and Acquisitions
Domestic companies enter international business though mergers and acquisitions. A domestic company selects a foreign company and mergers itself with the foreign company in order to enter international business. Alternatively, the domestic company may purchase the foreign company and acquires its ownership and control. Though mergers and acquisitions provide easy and instant entry to global business, it would be very difficult to appraise the cases of acquisitions and mergers. Sometimes it would be cheaper to a domestic company to have a green field strategy than by acquisitions. Sometimes mergers and acquisitions also result in purchasing the problems of a foreign company. Advantages: The company immediately gets the ownership and control over the acquired firm’s factories, employees, technology, brand names and distribution networks. The company can formulate international strategy and generate more revenues. If the industry already reached the stage of optimum capacity level or overcapacity level in the host country. This strategy helps the economy of the host country. Disadvantages: Acquiring a firm in a foreign country is a complex task involving bankers, lawyers, regulations, mergers and acquisition specialists from the two countries. This strategy adds no capacity to the industry. Sometimes host countries imposed restrictions on acquisitions of local companies by the foreign companies. Labour problems of the host country’s company are also transferred to the acquired company.
9. Joint Ventures:
Two or more firms join together to create a new business entity that legally separate and distinct from its parents. Joint ventures are established as corporations and owned by the funding partners in the predetermined proportions. American Motor Corporation entered into joint venture with Beijing Automotive Works called Beijing Jeep to enter Chinese markets by producing jeeps and other vehicles. Joint ventures involve shared ownership. Joint ventures are common in international business. Various environmental factors like social, technological, economical and political encourage the formation of joint ventures. Joint ventures provide required strengths in terms of required capital, latest technology required human talent etc. and enable the companies to share the risk in the foreign markets. Advantages: Joint ventures provide large capital funds. They are suitable for major products. Joint ventures spread the risk between or among partners. Different parties to the joint venture bring different kinds of skills like technical skills, technology, human skills, expertise, marketing skills or marketing networks. Joint ventures make large projects and turnkey projects feasible and possible.
Joint ventures provide synergy due to combined efforts of varied parties.
Disadvantages: Joint ventures are also potential for conflicts. They result in disputes between or among parties due to varied interests. For example, the interest of a host country’s company in developing countries would be to get the technology from its partner while the interest of a partner of an advanced county would be to get the marketing expertise from the host country’s company. The partners delay the decision-making once the dispute arises. Then the operations become unresponsive and inefficient. Decision-making is normally slowed down in joint ventures due to the involvement of a number of parties. Scope for collapse of a joint venture is more due to entry of competitors, changes in business in business environment in the two countries, changes in partners’ strengths etc. Life cycle of a joint venture is hindered by many causes of collapse.
Question-9 While deciding for the destination for the entry in foreign markets for international business, what are the factors of country evaluation and selection? Answer:
In International Business, the country evaluation and selection process determines the geographical opportunities Business Organizations choose to pursue. We first discuss the challenges of marketing and production site location. It goes on to carefully examine the process by describing the choice and weighting of variables used for opportunity and risk analysis as well as the inherent problems associated with data collection and analysis. Then we introduce the use of grids and matrices for country comparison purposes, discuss resource allocation possibilities, and concludes by noting the different factors considered as part of start-up, acquisition, and expansion decisions. Business Organizations lack the resources to take advantage of all international opportunities they identify, so they must determine both the order of country entry as well as the rates of resource allocation across countries. In choosing geographic sites, a firm must determine both where to market and where to produce. The answer can be one and the same place if transportation costs are high and/or government regulations make local production a necessity. In many industries, facilities must be located near foreign customers; in others, market and production sites are continents away. Developing a site location strategy that helps a firm maximize its resources and competitive position is very challenging, given that many estimates and assumptions about factors such as future costs and prices and competitors’ reactions must be made. There are some major steps international business managers must take in making these decisions.
SCANNING AND DETAILED EXAMINATION COMPARED Scanning is useful insofar as a company might otherwise consider either too few or too many possibilities. Through the use of scanning, decision makers can perform a detailed analysis of a manageable number of geographic locations. Managers can usually complete the scanning process without having to incur the expense of visiting foreign countries. Instead they rely on analyzing information found on the Internet and other publicly available sources, as well as communicating with people familiar with the foreign countries they are interested in. The more time and money companies invest in examining an alternative, the more likely they are to accept it regardless of its merits—a phenomenon known as escalation of commitment. Companies should be careful about taking forced actions based on peer and/or media pressure and should instead carefully weigh important variables when comparing countries of interest.
II. WHAT INFORMATION IS IMPORTANT? Environmental climate—the external conditions in a host country that could significantly affect an enterprise’s success or failure—reveals both opportunities and risk whose combination should determine what actions to take. A. Opportunities Opportunities are determined by competitiveness and profitability factors. Variables weighing heavily on the selection of market and production sites would include market size, ease and compatibility of operations, costs, resource availability and red tape. 1. Market Size. Market size is determined by sales potential. In some instances, past and current sales for either an existing product or a similar or complementary product are available on a country-by-country basis. In addition, data such as GNP, per capita income, population, income distribution, economic growth rates, and levels of economic development will also be useful. Other important economic variables pertaining to market size include: • Obsolescence and leapfrogging of products. Consumers in some emerging economies skip entire generations of technology in favor of more recent technologies, such as Chinese consumers going from having no telephones to using cellular phones almost exclusively. • Prices. The relative prices of essential and non-essential good can have a significant impact on consumption patterns. Higher prices for necessary goods leave less discretionary income for non-essentials. • Income elasticity. Market potential can be calculated by dividing the percentage of change in product demand by the percentage of change in income in a give country. Income elasticity varies by product and income level, with demand for necessities being less elastic than demand for luxuries. • Substitution. Depending on local conditions, consumers in some countries may be more willing to substitute some products or services for others.
For example, people in high population density areas typically substitute mass transit for automobiles. • Income inequality. Even in areas where per capita incomes are low, there may be middle- and upper-income people with substantial income to spend due to income inequality. • Cultural factors and taste. Countries with similar income levels may exhibit different demand patterns based on differences in cultural values and tastes. • Existence of trading blocs. Countries with small populations and/or low per capita incomes may have a much larger market due to participation in a regional trading block. 2. Ease and Compatibility of Operations. Companies are naturally attracted to countries that are located nearby, share the same language and offer market conditions similar to those in their home countries. Beyond that, proposals may then be limited to those countries that offer, among other factors, the appropriate plant size, the local availability of resources, an acceptable percentage of ownership and the sufficient repatriation of profits. 3. Costs and Resource Availability. Costs are a critical factor in productionlocation decisions. Productivity-related factors include the cost of labor, the cost of inputs, tax rates, and available capital, utilities, real estate, and transportation. When companies move into emerging economies because of labor cost differences alone, their advantages may be short-lived. Competitors often follow leaders into low-wage areas, there is little first-in advantage for low-labor cost production migration, and the costs can rise quickly as a result of pressure on wage or exchange rates. The quality of a country’s infrastructure can be very important in location decisions. Firms often need to locate in an area that will allow them to move supplies and finished products very efficiently. If a given production site will be used to serve multiple markets, the cost and ease of moving materials and products in and out the country will be especially important. 4. Red Tape and Corruption. Red tape includes the difficulty of getting permission to operate, bringing in expatriate personnel, obtaining licenses to produce and market goods and satisfying government agencies on matters such as taxes, labor conditions and environmental compliance. Government corruption may include requirements of payments to win a contract or receive government services, such as mail delivery or visa issuance. Although not always a directly measurable cost, red tape and corruption increase the cost of doing business. B. Risks Is it ever rational for a firm to invest in a country with high economic and political risk ratings? Such questions must be carefully weighed when making international capital-investment decisions. 1. Risk and Uncertainty. Firms usually experience higher risk and uncertainty when they operate abroad. Firms use a variety of financial techniques to compare potential investments, including discounted cash flows, economic
value added, payback period, net present value, return on sales, return on equity, return on assets employed, internal rate of return and the accounting rate of return. Given the same expected return, most decision makers prefer a more certain outcome to a less certain one. Companies may reduce risk or uncertainty by insuring, however, insuring against things such as nonconvertibility of funds or expropriation is likely to be costly. As part of a feasibility study, the degree of acceptable risk should be determined so a firm does not incur unacceptable costs. Liability of Foreignness. The liability of foreignness refers to the fact that foreign firms have a lower rate of survival than local firms for the initial years after the start of operations. However, those foreign firms that manage to overcome their initial problems have long-term survival rates comparable to those of local firms. Competitive Risk. A firm’s innovative advantage may be short-lived. When pursuing a strategy known as imitation lag, a firm moves first to those countries most likely to adapt and catch up to the advantage. In some instances firms may seek those countries where they are least likely to confront significant competition; in others they may gain advantages by moving into countries where competitors are already present. By being the first major competitor in a market, companies can more easily gain the best partners, best locations, and best suppliers—a strategy to gain first mover advantage. Companies may also reduce risk by avoiding overcrowded markets, or conversely, they may purposely crowd a market to prevent competitors from gaining advantages therein that they can use to improve their competitive positions elsewhere, a situation known as oligopolistic reaction. Firms may also seek “clusters” like Silicon Valley that attract multiple suppliers, customers and highly trained personnel in order to gain access to new products, technologies, and markets. Monetary Risk. If a firm’s expansion occurs through foreign-direct investment, foreign-exchange rates and access to investment capital and earnings are key considerations. Liquidity preference refers to the theory investors want some of the holdings to be in highly liquid assets on which they are willing to take a lower return. Firms must carefully evaluate a country’s present capital controls, recent exchange-rate stability, balance-of-payments account, inflation rate, and level of government spending. Political Risk. Political risk reflects the expectation the political climate in a given country will change in such a way that a firm’s operating position will deteriorate. It relates to changes in political leaders’ opinions and policies, civil disorder, and animosity between a home and host country. When evaluating political risk, decision makers refer to past patterns in a given country, expert opinions and country analysts. They also look for economic and social conditions that could lead to political instability, but there is no consensus as to what constitutes dangerous instability or how it can be predicted.
Geographical Issue Natural disasters have a huge impact on people and property every year, often hitting the poorest nations of the world hardest. Companies should take the risk of natural disasters and their potential impact into account when choosing locations for doing business. The United Nations Development Program is developing a Disaster Risk Index that could be used as a tool for companies to compare and prepare for disaster risk. Natural disasters can also trigger outbreaks of disease, which should also be considered when choosing locations for global operations. III. COLLECT AND ANALYZE DATA Firms perform research to reduce uncertainties in their decision processes, to expand or narrow the alternatives they consider and to assess the merits of their existing programs. The costs of data collection should always be weighed against the probable payoffs in terms of revenue gains or cost savings. A. Problems with Research Results and Data Numerous countries have agreed to standards for collecting and publishing various categories of national data. However, the lack, obsolescence and inaccuracy of data on other countries can make research difficult and expensive to undertake. Further, data discrepancies further increase uncertainty in decision-making. 1. Reasons for Inaccuracies. For the most part, incomplete or inaccurate data result from the inability of governments to collect the needed information. Both economic and educational factors will affect the quantity and quality of available data. Of equal concern, however, is the publication of false or purposely misleading information, as well as the non-reporting or underreporting of information people wish to hide or distort. 2. Comparability Problems. Comparability problems result from definitional differences across countries (e.g., family categories, literacy levels, accounting rules), differences in base years, distortions in foreign currency conversions, the measurement of investment flows, the presence of black market activities, etc. B. External Sources of Information Both the specificity and cost of information will vary by source. 1. Individualized Reports. Market research and business consulting firms conduct country studies for a fee. The fact that a firm can specify the information it wants may make the cost worthwhile. 2. Specialized Studies. Certain research organizations generate specific studies about countries, regions, industries, issues, etc., that they make available for general purchase. The price is much lower than for an individualized study.
3. Service Companies. Most international service-related firms publish reports that are usually geared toward either the conduct of business in a given country or region or about some specific subject of general interest, such as tax or trademark legislation. 4. Government Agencies. Governments and their agencies publish tomes of information designed to stimulate business activity both at home and abroad. 5. International Organizations and Agencies. The UN, the WTO, the IMF, the OECD, and the EU are but a few of the multilateral organizations and agencies that collect and disseminate data. Many of the international development banks even help fund investment feasibility studies. 6. Trade Associations. Many trade associations collect, evaluate, and disseminate a wide variety of data dealing with competitive and technical factors in their industries. Their reports may or may not be available to nonmembers. 7. Information Service Companies. Certain companies offer informationretrieval services; they maintain databases from hundreds of sources from which they will access data for a fee, or sometimes for free at public libraries. Objectives of studying the factors of country evaluation and selection • • • • • • • To grasp company strategies for sequencing the penetration of countries To see how scanning techniques can help managers both limit geographic alternatives and consider otherwise overlooked areas To discern the major opportunity and risk variables a company should consider when deciding whether and where to expand abroad To know the methods and problems when collecting and comparing information internationally To understand some simplifying tools for helping to decide where to operate To consider how companies allocate emphasis among the countries where they operate To comprehend why location decisions do not necessarily compare different countries’ possibilities
Question-10 What do you understand by Foreign Direct Investment? What are the major decisions concerning foreign direct investment? or Question- Explain the basic motives and determinants of Foreign Direct Investment. July, 2010. Answer:
Foreign Direct Investment Foreign direct investment (FDI) plays an extraordinary and growing role in global business. It can provide a firm with new markets and marketing channels, cheaper production facilities, access to new technology, products, skills and financing. For a host country or the foreign firm which receives the investment, it can provide a source of new technologies, capital, processes, products, organizational technologies and management skills, and as such can provide a strong impetus to economic development. Foreign direct investment, in its classic definition, is defined as a company from one country making a physical investment into building a factory in another country. The direct investment in buildings, machinery and equipment is in contrast with making a portfolio investment, which is considered an indirect investment. In recent years, given rapid growth and change in global investment patterns, the definition has been broadened to include the acquisition of a lasting management interest in a company or enterprise outside the investing firm’s home country. As such, it may take many forms, such as a direct acquisition of a foreign firm, construction of a facility, or investment in a joint venture or strategic alliance with a local firm with attendant input of technology, licensing of intellectual property, In the past decade, FDI has come to play a major role in the internationalization of business. Reacting to changes in technology, growing liberalization of the national regulatory framework governing investment in enterprises, and changes in capital markets profound changes have occurred in the size, scope and methods of FDI. New information technology systems, decline in global communication costs have made management of foreign investments far easier than in the past. The sea change in trade and investment policies and the regulatory environment globally in the past decade, including trade policy and tariff liberalization, easing of restrictions on foreign investment and acquisition in many nations, and the deregulation and privitazation of many industries, has probably been been the most significant catalyst for FDI’s expanded role. For small and medium sized companies, FDI represents an opportunity to become more actively involved in international business activities. In the past 15 years, the classic definition of FDI as noted above has changed considerably. This notion of a change in the classic definition, however, must be kept in the proper context. Very clearly, over 2/3 of direct foreign investment is still made in the form of fixtures, machinery, equipment and buildings. Moreover, larger multinational corporations and conglomerates still make the overwhelming percentage of FDI. But, with the advent of the Internet, the increasing role of technology, loosening of direct investment restrictions in many markets and decreasing communication costs means that newer, non-traditional forms of investment will play an important role in the future. Many governments, especially in industrialized and
developed nations, pay very close attention to foreign direct investment because the investment flows into and out of their economies can and does have a significant impact. State and local governments watch closely because they want to track their foreign investment attraction programs for successful outcomes. It is nowadays accepted that Foreign Direct Investment plays a crucial role in industrial development of the developed and developing countries alike and can help in boosting economic growth through, for example, total factor productivity growth. FDI increasingly comprises sets of inter-connected operationalized business decisions by multinational enterprises (MNEs) in response to changing global and regional competitive, strategic considerations and factor conditions . As such, Foreign Direct Investment Policy Instruments, which have analytical and regulatory dimensions, are required to manage the landscape of MNEs’ FDI operations in order to maximize positive externalities accruing to the host location, as well as optimizing the allocative efficiencies involved in Foreign Direct Investment. The policy framework for Foreign Direct Investment is a crucial part of the overall national strategy for industrialization. As the ratio of inward Foreign Direct Investment to GDP is, in general, relatively high for developing countries in comparison to industrialized countries, the role of well-designed Foreign Direct Investment Policy Instruments in economic development cannot be overestimated. From the outset, one needs to appreciate that when reference is made to the advantages and disadvantages of FDI PIs, it is in terms of the relative merits of the policy tools. It is also important to indicate that, from a policy perspective, the pros and cons of Policy Instruments are framed by considerations of who (interest groups) gains or loses. This is not a trivial issue, depending not only on the demographic structure of employment distribution of the labour force in the economy, but also on the changing nature of the relative balance of competitive advantage between countries. These two influences move at two very distinct ‘policy speeds’ – the first, in generational terms, the second, in business cycle terms. In many cases, large companies still play a dominant role in investment activities in small, high tech oriented companies. However, unlike in the past, these larger companies are not necessarily acquiring smaller companies outright. There are several reasons for this, but the most important one is most likely the risk associated with such high tech ventures. In the case of mature industries, the products are well defined. The manufacturer usually wants to get closer to its foreign market or wants to circumvent some trade barrier by making a direct foreign investment. The major risk here is that you do not sell enough of the product that you manufactured. However, you have added additional capacity and in the case of multinational corporations this capacity can be used in a variety of ways. High tech ventures tend to have longer incubation periods. That is, the product tends to require significant development time. In the case of software and other intellectual property type products, the product is constantly changing even before it hits the marketplace. This makes the investment decision more complicated. When you invest in fixtures and machinery, you know what the real and book value of your investment will be. When you invest in a high tech venture, there is always an element of uncertainty. Unfortunately, the recent spate of dot.com failures is quite illustrative of this point.
Therefore, the expanded role of technology and intellectual property has changed the foreign direct investment playing field. Companies are still motivated to make foreign investments, but because of the vagaries of technology investments, they are now finding new vehicles to accomplish their goals. Consider the following: 1.Licensing and technology transfer. Licensing and tech transfer have been essential in promoting collaboration between the academic and business communities. Ever since legal hurdles were removed that allowed universities to hold title to research and development done in their labs, licensing agreements have helped turned raw technology into finished products that are viable in competitive marketplaces. With some help from a variety of government agencies in the form of grants for R&D as well as other financial assistance for such things as incubator programs, once timid college researchers are now stepping out and becoming cutting edge entrepreneurs. These strategic alliances have had a serious impact in several high tech industries, including but not limited to: medical and agricultural biotechnology, computer software engineering, telecommunications, advanced materials processing, ceramics, thin materials processing, photonics, digital multimedia production and publishing, optics and imaging and robotics and automation. Industry clusters are now growing up around the university labs where their derivative technologies were first discovered and nurtured. Licensing agreements allow companies to take full advantage of new and exciting technologies while limiting their overall risk to royalty payments until a particular technology is fully developed and thus ready to put new products into the manufacturing pipeline. 2 .Reciprocal distribution agreements. Actually, this type of strategic alliance is more trade-based, but in a very real sense it does in fact represent a type of direct investment. Basically, two companies, usually within the same or affiliated industries, agree to act as a national distributor for each other’s products. The classical example is to be found in the furniture industry. A U.S.-based manufacturer of tables signs a reciprocal distribution agreement with a Spanish-based manufacturer of chairs. Both companies gain direct access to the other’s distribution network without having to pay distributor support payments and other related expenses found within the distribution channel and neither company can hurt the other’s market for its products. Without such an agreement in place, the Spanish manufacturer might very well have to invest in a national sales office to coordinate its distributor network, manage warehousing, inventory and shipping as well as to handle administrative tasks such as accounting, public relations and advertising. 3.Joint venture and other hybrid strategic alliances. The more traditional joint venture is bi-lateral, that is it involves two parties who are within the same industry who are partnering for some strategic advantage. Typical reasons might include a need for access to proprietary technology that might tip the competitive edge in another competitor’s favor, desire to gain access to intellectual capital in the form of ultra-expensive human resources, access to heretofore closed channels of distribution in key regions of the world. One very good reason why many joint ventures only involve two parties is the difficulty in integrating different corporate cultures. With two domestic companies from the same country, it would still be very difficult. However, with two companies from different cultures, it is almost impossible at times. This is probably why pure joint ventures have a fairly high failure rate only five years after inception. Joint ventures
involving three or more parties are usually called syndicates and are most often formed for specific projects such as large construction or public works projects that might involve a wide variety of expertise and resources for successful completion. In some cases, syndicates are actually easier to manage because the project itself sets certain limits on each party and close cooperation is not always a prerequisite for ultimate success of the endeavor. 4.Portfolio investment. Yes, we know that you’re paying attention and no we’re not trying to trip you up here. Remember our definition of foreign direct investment as it pertains to controlling interest. For most of the latter part of the 20th century when FDI became an issue, a company’s portfolio investments were not considered a direct investment if the amount of stock and/or capital was not enough to garner a significant voting interest amongst shareholders or owners. However, two or three companies with "soft" investments in another company could find some mutual interests and use their shareholder power effectively for management control. This is another form of strategic alliance, sometimes called "shadow alliances". So, while most company portfolio investments do not strictly qualify as a direct foreign investment, there are instances within a certain context that they are in fact a real direct investment.
Importance of Foreign Direct Investment for any consideration of going global? It is very clear that making a direct foreign investment allows companies to accomplish several tasks: 1 Avoiding foreign government pressure for local production. 2.Circumventing trade barriers, hidden and otherwise. 3.Making the move from domestic export sales to a locally-based national sales office. 4.Capability to increase total production capacity. 5.Opportunities for co-production, joint ventures with local partners, joint marketing arrangements, licensing, etc; A more complete response might address the issue of global business partnering in very general terms. While it is nice that many business writers like the expression, “think globally, act locally”, this often used cliché does not really mean very much to the average business executive in a small and medium sized company. The phrase does have significant connotations for multinational corporations. But for executives in SME’s, it is still just another buzzword. The simple explanation for this is the difference in perspective between executives of multinational corporations and small and medium sized companies. Multinational corporations are almost always concerned with worldwide manufacturing capacity and proximity to major markets. Small and medium sized companies tend to be more concerned with selling their products in overseas markets. The advent of the Internet has ushered in a new and very different mindset that tends to focus more on access issues. SME’s in particular are now focusing on access to markets, access to expertise and most of all access to technology.
Basic Requirements for Business Organizations considering a foreign investment? Depending on the industry sector and type of business, a foreign direct investment may be an attractive and viable option. With rapid globalization of many industries and vertical integration rapidly taking place on a global level, at a minimum a firm needs to keep abreast of global trends in their industry. From a competitive standpoint, it is important to be aware of whether a company’s competitors are expanding into a foreign market and how they are doing that. At the same time, it also becomes important to monitor how globalization is affecting domestic clients. Often, it becomes imperative to follow the expansion of key clients overseas if an active business relationship is to be maintained. New market access is also another major reason to invest in a foreign country. At some stage, export of product or service reaches a critical mass of amount and cost where foreign production or location begins to be more cost effective. Any decision on investing is thus a combination of a number of key factors including: i. assessment of internal resources, ii. competitiveness, iii.market analysis iv. market expectations. From an internal resources standpoint, does the firm have senior management support for the investment and the internal management and system capabilities to support the set up time as well as ongoing management of a foreign subsidiary? Has the company conducted extensive market research involving both the industry, product and local regulations governing foreign investment which will set the broad market parameters for any investment decision? Is there a realistic assessment in place of what resource utilization the investment will entail? Has information on local industry and foreign investment regulations, incentives, profit retention, financing, distribution, and other factors been completely analyzed to determine the most viable vehicle for entering the market (greenfield, acquisition, merger, joint venture, etc.)? Has a plan been drawn up with reasonable expectations for expansion into the market through that local vehicle? If the foreign economy, industry or foreign investment climate is characterized by government regulation, have the relevant government agencies been contacted and concurred? Have political risk and foreign exchange risk been factored into the business plan? Project Portfolio Management Project portfolio management is a term used by project managers and project management organizations, or PMOs, to describe methods for analyzing and collectively managing a group of current or proposed projects based on numerous key characteristics. The fundamental objective of PPM is to determine the optimal mix and sequencing of proposed projects to best achieve the organization's overall goals - typically expressed in terms of hard economic measures, business strategy goals, or technical strategy goals - while
honouring constraints imposed by management or external real-world factors. Typical attributes of projects being analyzed in a PPM process include each project's total expected cost, consumption of scarce resources (human or otherwise) expected timeline and schedule of investment, expected nature, magnitude and timing of benefits to be realized, and relationship or inter-dependencies with other projects in the portfolio. Some commercial vendors of PPM software emphasize their products' ability to treat projects as part of an overall investment portfolio. PPM advocates see it as a shift away from one-off, ad hoc approaches to project investment decision making. Most PPM tools and methods attempt to establish a set of values, techniques and technologies that enable visibility, standardization, measurement and process improvement. PPM tools attempt to enable organizations to manage the continuous flow of projects from concept to completion. Treating a set of projects as a portfolio would be, in most cases, an improvement on the ad hoc, one-off analysis of individual project proposals. The relationship between PPM techniques and existing investment analysis methods is a matter of debate. While many are represented as "rigorous" and "quantitative", few PPM tools attempt to incorporate established financial portfolio optimization methods like modern portfolio theory or applied information economics, which have been applied to project portfolios, including even non-financial issues.
Question -11 What do you mean by Control Methods? What are the various control methods in International Business? Answer :
Control Methods Control Methods are the important functions because these control methods help to check the errors and to take the corrective action so that deviation from standards are minimized and stated goals of the organization are achieved in desired manner. According to modern concepts, control is a foreseeing action whereas earlier concept of control was used only when errors were detected. Control in management means setting standards, measuring actual performance and taking corrective action. Thus, control comprises these three main activities. The four basic elements in a control method — (1) the characteristic or condition to be controlled, (2) the sensor, (3) the comparator , and (4) the activator — occur in the same sequence and maintain a consistent relationship to each other in every system. The first element is the characteristic or condition of the operating system which is to be measured. We select a specific characteristic because a correlation exists between it and how the Control method is performing. The characteristic may be the output of the system during any stage of processing or it may be a condition that has resulted from the output of the system. For example, it may be the heat energy produced by the furnace or the temperature in the room which has changed because of the heat generated by the furnace. In an elementary school system, the hours a teacher works or the gain in knowledge demonstrated by the students on a national examination are examples of characteristics that may be selected for measurement, or control. The second element of control,
the sensor, is a means for measuring the characteristic or condition. The control subsystem must be designed to include a sensory device or method of measurement. In a home heating system this device would be the thermostat, and in a quality-control system this measurement might be performed by a visual inspection of the product. The third element of control method, the comparator, determines the need for correction by comparing what is occurring with what has been planned. Some deviation from plan is usual and expected, but when variations are beyond those considered acceptable, corrective action is required. It is often possible to identify trends in performance and to take action before an unacceptable variation from the norm occurs. This sort of preventative action indicates that good control is being achieved. The fourth element of control, the activator, is the corrective action taken to return the system to expected output. The actual person, device, or method used to direct corrective inputs into the operating system may take a variety of forms. It may be a hydraulic controller positioned by a solenoid or electric motor in response to an electronic error signal, an employee directed to rework the parts that failed to pass quality inspection, or a school principal who decides to buy additional books to provide for an increased number of students. As long as a plan is performed within allowable limits, corrective action is not necessary; this seldom occurs in practice, however. Information is the medium of control, because the flow of sensory data and later the flow of corrective information allow a characteristic or condition of the system to be controlled. To illustrate how information flow facilitates control, let us review the elements of control in the context of information.
Control in International Business
'There is a need for control in International Business Operations. One of the key requisites to successfully manage the risks associated with running a business is to have a sound and effective control framework. The existence of such a framework in an organization encourages a sound control environment in which the business operates. With the increasing levels of corporate governance, the CFO and the CEO are being held accountable for the effectiveness and efficiency of their control environment. There should be some minimum controls that have to be in place to ensure that key strategic, operational and financial risks of the company are managed. The areas for discussion are: Control Environment General Accounting control Revenue Cycle control Expenditure Cycle control Bank and Cash control Fixed Assets Management control Inventory, Logistic and Distribution control Control Environment of a business organization is segregated into the following categories: General, Delegation of Duties, Risk Management, Management Information Systems.
Control Environment 1. General In the Control Environment, generally, certain minimum key salient features should at least be there: there should be a champion at the director level within the organization who strongly and clearly supports a strong control culture and environment, a clear policy statement on controls should be issued to all staff, there should be a company-wide framework of policies and procedures documented in a comprehensive manual, there should be clear policies and procedures in place to ensure that staffs fully declare all related party transactions and potential conflict of interest situations on a periodic basis. 2. Delegation of Authority (DOA) an overall delegation of authority guideline should be documented for all functions and operations, in particular, delegation of authority guidelines must be documented for the following: - Appointment and dismissal of members of top management team - Awarding of salary, bonuses, benefits for all staff - Setting terms and conditions for all staff - Debt and Capital restructuring - Investment functions - Treasury functions - Issuing of guarantees - Issuing of charges on assets - Acquisition or disposal of investments, businesses and commercial rights - Establishment of exclusive and/or special types of arrangements 3..Risk Management There should be a mechanism in place to ensure that all significant operational risks are identified and recorded on an ongoing basis. Procedures should be established to ensure that suitable action plans are implemented to address all the risks that have been identified. The action plans should be measurable to assess whether the identified risks have been successfully managed. There should be an effective system or process (e.g. Internal Audit checks) to ensure that adequate controls are in place to address identified Operational and Financial risks. Adequate insurance coverage should be undertaken for both the company’s assets. 4. Management Information The Management Information System (MIS) should be able to generate explanatory management reports, incorporating the usage of comprehensive graphs and schedules, on a timely basis. In particular, the management reports should include the following: - Profit and loss account - Balance sheet - Cash-flow statement - Aged debtor listings
- Creditor listings - Inter-company balance/transaction report - Foreign exchange exposure report - Contingent liabilities and other commitments report - Action plan report - Operational risk report - Division sales report - Division inventory report - Stock category month stock trend with comparison between stock holding vs prior month - Commentaries on the followings: (a) Sales/GP – on a current month versus budget, current month versus prior month and actual YTD versus budget YTD basis (b) Expenses – in terms of Staffing, Selling and General Expenses on a current month versus budget, current month versus prior month and actual YTD versus budget YTD basis (c) Other Income – explain and indicate the nature and comparison of current month versus budget and prior month , and current YTD versus budget YTD (d) Profit before Tax – comments in summary what caused the change in PBT (e) Cash Flow- Capital Expenditure and other significant items (f) Assets Management – in terms of AR and Stock turnover, ageing etc - Month end borrowing position (amount utilised versus facilities provided, interest rate) Comprehensive documented period end procedures should be in place to facilitate timely preparation of the management reports. Management reports should be reconciled to underlying accounting records and all reconciling items should be addressed promptly. Major variances against budget should be analysed monthly as part of management reporting. Provisions for taxation, both current and deferred, should be checked quarterly to ensure accuracy and compliance with local regulations. Control methods in international business Factors like distance, culture, language and practices create barriers to effective control. Yet without control over international operations, the degree to which they have or have not been successful cannot be judged. Plans are the prerequisite to control, yet these are developed in the midst of uncertain forces both internal and external to the firm. Basically control involves the establishment of standards of performance, measuring performance against standards and correcting deviations from standards and plans. In international marketing the ability to control is disturbed by the distance, culture, political and other factors. In well developed international operations headquarters may seek to achieve control over subsidiaries by three types of mechanism - data management mechanisms, merge
mechanisms, which shift emphasis from subsidiary to global performance, and conflict resolution mechanisms that resolve conflicts triggered by necessary trade-offs. The method of export control in many less developed countries takes the form of direct organisation by government. The appendix note at the end of this section describes the types of control imposed. Formal control methods in International Business Planning and budgeting Planning and budgeting are the main formal control methods. The budget spells out the objectives and necessary expenditures to achieve these objectives. Control consists of measuring actual sales against expenditures. If there is tolerable variance then no action is usually taken. Evaluating performance Performance is evaluated by measuring actual against planned performance. The problem is setting a performance standard. Usually it is based on historical performance with some kind of industry average. Problems of international comparison inevitably occur like how does one plan in an environment where exchange rates fluctuate quite often during the budget period. Influences on marketing budgets In preparing a budget or plan, the following factors are important: a) Market potential - how large, can it be tested? b) Competition - what is the competitive level? c) Impact of substitute products - packaging can be substituted in many ways d) Process - headquarters may impose an "indicative planning" method or guidance. Other performance measures Other measures of performance include share of market, image, position or corporate acceptance. Often these are difficult to obtain where data or data collection is difficult. Informal control method When staff are transferred from market to market, they often take their standards of performance with them and these can be assessed. Other methods include face-to-face contact and evaluation. Variables influencing control A number of factors may influence the control methods. These include: a) Domestic practices and values of standardization - these may not be appropriate b) Communication systems - have a heavy influence on control mechanisms - electronic control measures may not always be available c) Distance - the greater the distance, the bigger the physical and psychological differences
d) The product - the more technological the product the easier it is to implement uniform standards e) Environmental differences - the greater the environmental differences the greater the delegation of responsibility and the more limited the control process f) Environmental stability - the greater the instability in a country the less relevance a standardised measure of performance has g) Subsidiary performance - the more a subsidiary does, or reports, a non variance, the less likely is there to be headquarters interference h) Size of international operators - the bigger and greater the specialisation of headquarters staff the more likely will extensive control be applied. Obviously the ability to control any international operation, whether it be very sophisticated or relatively unsophisticated, the process will break down without adequate face-to-face and/or electronic communications.
Question-12. How Governments can influence on International Trade and Investment? What are the prominent Regional Trade Blocks at global scenario? or Question- Write notes on i. EEC ii. NAFTA iii. ASEAN iv. SAARC Answer :
Government Influence on trade and Investment Traditionally, it had been viewed that government is the custodian of the nation including industry and business. Consequently, business has become inefficient due to heavy protection provided by the government. The other school of thought is that the business can run efficiently and creatively in order to give more value to the customer’s money, when it is free from the government intervention and protection. Political Arguments for Government Intervention Politicians argue for government intervention from the point of view of national security, protecting industries, protecting jobs etc. National Security- Strategic industries from the point of view of national security should be run by the government. These industries include: defence, aerospace, electronics, semiconductors, posts, railways and the like. Government runs these industries even in earlier market economies like USA and Japan. Even after liberalization and globalization of
Indian economy, Government in India reserved eight strategic industries (from the national security point of view) for exclusive public sector operation. Protecting Industries- One of the major objectives of the government is to protect the domestic industry from the foreign competitors. This can be done only if the government runs the industry as the foreign competitors easily kill the private industry or business. This is clearly evident from the Indian experience. Most of the sick small-scale industrial units have become mortal and the healthy small and medium industries have become sick after the entry of foreign industries. This is more so, after the entry of cheap products from China and East Asian countries (like Thailand, South Korea and Malaysia) into Indian market. Therefore, politicians argue that government should interfere in the business. Protecting Jobs- The economic liberalization in India led to the closure of many small industries, downsizing of the large industries, outsourcing of employees, privatization (or disinvestment) of public sector units etc. This in turn reduced the number of jobs in the country. This case is true with all other countries which liberalized and globalize their economies. Hence politicians argue that the government should interfere in business in order to protect the basic right of the people, i.e., right for job. Retaliation- The foreign businesses need to be threatened and should be dealt with a ‘tough approach.’ Only governments can deal with a ‘tough approach and attitude’ with the foreign businesses. Governments can do this due to the power to take tough decisions and availability of machinery to implement the decisions. Otherwise, the foreign businesses control the domestic business firms. As such, the politicians argue for the government in business. Economic Arguments for Government Intervention Economic arguments include infant industry argument and strategic trade policy. Infant Industry Argument- When the industry is in the infant stage of its lifecycle, it needs protection from the foreign competitors. In fact, Indian government protected our industry during 1947 to 1990. Private industrialists cannot invest heavily during infant stage. Therefore, government should interfere in business to provide capital and infrastructural facilities. Strategic Trade Policy- According to the strategic trade policy, the government intervention is essential in the form of subsidies. The government should provide subsidies to certain domestic firms which have competitive advantage. These firms with low cost advantage will move to the foreign markets and get the first mover advantages. Thus, government should use subsidies to support promising firms those are dynamic in newly emerging markets. Foreign competing firms may create entry barriers to the domestic firms even in the home country. Then the government intervention is necessary to provide the entry to the domestic firms in the domestic market. US government played this role to provide the entry to the domestic firms when Japanese automobile firms created entry barriers. However, it is criticized that the strategic trade policy looks nice in theory, but it may be unworkable in practice. They suggest for global trading system. Global trading System Despite the arguments for protectionalism, there are strong arguments for free global trade. In fact, the protectionalism and the government intervention practically led to the inefficiency of both public and private sector industrial units. Consequently, the customers in the protected economies had to pay high price for low quality products. And sometimes,
the customers were denied of the supply of the product due to regulated production and distribution. These realities suggest for the free global trade. Adam Smith and David Ricardo long back suggested for free trade. Smith to the Great Depressions: David Ricardo as a Member of Parliament could influence the British Government to go for free trade in 1846.b Added to this the crop failure in Britain during the same period made the government to opt for free trade. But the great depression of 1929-33 reversed the position. The US and UK governments followed the protectionalism consequent upon the depression in order the protect domestic industry and jobs. Implications for Business- Why should international business managers care the political factors? What are the implications of these political factors on international business? The answer is that the trade barriers have direct impact on a company’s strategy. Trade barriers and company’s strategy: It would be better for the international firms to produce and market the products in the foreign markets other than those specified for national security. International firms should have the strategy of producing certain components or parts of the products in the host country and exports the products to other foreign countries. The international firm should have the strategy of locating the manufacturing facilities in the host country rather than exporting the products. This strategy also helps the foreign company to avoid the voluntary export restraints. Japanese automobile firms employed this strategy by locating their manufacturing facilities in USA. This strategy helped them to co0mpete the US firms on equal footing. Location of manufacturing facilities in host country even when trade barriers do not exist reduces the threat of imposing trade barriers in future. These strategies though enhance costs, help to have competitive advantages over other foreign companies and also the firms of the host country.
Regional blocks and trading agreement
In business there are many trading blocks comes in it. The most important trade blocks include: EEC, NAFTA, ASEAN, and SAARC.
European Economic Community (EEC)
The successful functioning of European Coal and Steel Community (ECSC) stimulated the member countries to extend this facility to all commodities by Treaty of Rome in 1957. This Treaty gave birth to European Economic Community (EEC). The European Economic Community is also known as European Common market. Originally six countries, viz., France, Federal Republic of Germany, Italy, Belgium, Netherlands and Luxembourg formed into the European Economic Community (EEC) by the Treaty of Rome, 1957. It came into being on 1st January 1958. The number of member countries of the EEC increased from six to nine on January 1, 1973 as United Kingdom, Ireland and Denmark joined the community. Greece joined the EEC in 1981 and Portugal
and Spain joined in 1984. Austria, Finland and Sweden joined the community on January 1, 1986. Now the EEC has 15 members. The requirements for joining the EEC as members are (1.) the country must be European country and (2.) it must be a democratic country. Objectives EEC consists of three organizations, viz., the European Coal and Steel Community (ECSC), the European Economic Community (EEC) and the European Atomic Energy Community (Euratom). ECSC functions for 50 years and the EEC and Euratom function for unlimited time duration. The main objective of the EEC according to Article of the Rome Treaty of 1957 is: “The community shall have its task, by setting up a common market. To promote throughout the community a harmonious development by economic activities, a continuous and balanced expansion, an increase in stability and accelerated raising of the standard of living and closer relations between the Member States belonging to it.” Activities of the EEC The activities of the EEC based on the objectives are: Elimination of customs duties, quantitative restrictions with regard to exports and imports of goods among member countries. Establishment/formulation of a common customs tariff and common commercial policy with regard to non-member countries. Abolition of all obstacles for movement of persons, services and capital among member countries. Formulation of common policy in the area of agriculture. Formulation of common policy in the area of transport. Establishment of a system which would ensure competition among member countries. Application of procedures and programmes to control the disequilibrium in the balance of the payments of member countries. Application of programmes in order to coordinate the economic policies of the member countries. Approximation of legislation of the member governments to the extent required for the proper functioning of the commo0n market. Establishment of European Social Fund with a view to enhance the employment opportunities for workers and to improve their living standards. Establishment of European Investment bank for mobilization of fresh resources and to contribute to the economic development of the community. Development of association with foreign countries to promote jointly the economic and social development of the EEC. Organization of EEC European Council is the main administrative body of the EEC. Each member country is represented by a minister in this council. Each member country holds the presidency of the council for six-monthly period by rotation. A committee of permanent representatives acts as the secretariat of the council. This committee is also called, “Corper”. The Corper makes all important decisions. The Corper is the link between the EEC and member Governments. European Council European Council acts as the executive agent of the EEC in Making routine decisions.
Formulating rules of conduct. Preparing new legislations. Enabling members to carry out the provisions of the Treaty. European Commission The European Commission assists the Council. This is the executive body of the EEC. The members of this commission are appointed for5 a period of four years which can be renewed. One or more EEC policies are entrusted to each commissioner. Each commissioner is assisted by a chief of cabinet of his country. These assistants take decisions on behalf of their commissioners. Court of Justice There is a court of justice to adjudicate disputes relating to agriculture, social security for migrants among the member countries and competition policy. The court also adjudicates disputes between the member countries brought by the commission against the council or commission reported by a person or a company. Court of Auditors Court of auditors was appointed as a part of the EEC by amending the Treaty of Rome. The activities of the court of auditors include: Auditing the EEC budget. Monitoring the EEC’s expenditure. Laying down improved procedures for collection of duties and levies. European Parliament The European Commission should consult the Parliament before a final decision is taken. The parliament acts through the Parliamentary Committee. The activities of the European parliament include: Provide consultation and information to the Commission. Approve or reject the draft budget prepared by the Commission. Dismiss the Commission, if necessary. Advisory Committees: There are several advisory committees to advise the European Commission. These committees include: Economic and Social Committee Monetary Committee Consultative Committee on Coal and Steel industry Economic and Social Committee This committee represents the activities like employers, employee unions, farmers, retail traders, liberal professions and public. European commission appoints the members on this committee. Monetary Committee This committee examines the monetary problems, problem of the balance of payments and suggests measures to overcome them. Consultative Committee on coal and Steel Industry: This committee studies the problem of coal and steel industries and offers suggestions. Functioning of the EEC
Complete customs union became reality among the member countries of the EEC by July 1, 1968. We study the functioning of the EEC under the following aspects: Common agricultural policy, Common fisheries policy, European Monetary Union, Factor mobility, Regional development policy, and Common transport policy. Different member countries of the EEC were following different agricultural policies before the formati0on of EEC. For example, the then West Germany and Italy fixed high support prices due to the inefficiency of their agricultural sector. The vice versa was true in case of France and Netherlands. The treaty favoured common agricultural policy.
North American Free Trade Agreement (NAFTA)
The North American Free Trade Agreement (NAFTA) came into being on January 1, 1994. The most affluent nations of the world, i.e., USA and Canada along with Mexico- a developing country joined together to form a trade bloc. A free trade agreement was signed by USA and Canada in 1989. This was extended to Mexico in 1994. NAFTA is expected to eliminate all the tariffs and trade barriers among these countries by 2009. However, internal tariffs on a large number of product categories were removed already. NAFTA has a population of 363 million and hence it is one of the significant trading areas in the globe. Objectives The objectives of the NAFTA include: To create new business opportunities particularly in Mexico. To enhance the competitive advantage of the companies operating in USA, Canada and Mexico in wider international markets. To reduce the prices of the products and services by enhancing the competition. To enhance industrial development and thereby employment throughout the region. To provide stable and predictable political environment for the investors. To develop industries in Mexico in order to create employment and to reduce migration from Mexico to USA. To assist Mexico in earning additional foreign exchange to meet its foreign debt burden To improve and consolidate political relationship among member countries. Measures The measures as per the agreement of NAFTA include: Opening up of Government procurement markets in each member country of NAFTA. Resident of NAFTA countries can invest in any other NAFTA countries freely. Protection of intellectual property rights of the NAFTA member countries. Simplification and harmonization of product standards in all the member countries of NAFTA. Free-flow of employees and business people from one member country to another. Prevention of non-Mexican firms assembling goods in Mexico.
Avoidance of re-export of the products imported by any member country from the third party. This condition is not applicable, in case certain percentage of manufacturing costs is incurred in the importing country. This percentage is 50 in case of USA and Canada and 80 in case of Mexico. Pollution control along the USA-Mexico border. Critical Appraisal It was felt that the emergence of NAFTA enables for the further development of USA and Canada and for the significant development of Mexico. Further, the free flow of capital and human resources enables for achieving equilibrium in the regional development. However the formation of NAFTA is criticized on the following grounds: Most of the US industries will shift to Mexico as Mexico has less stringent environmental protection and health and safety legislation than USA. NAFTA agreement is implemented without prior preparations,. Therefore, Mexican economy may face adjustment and assimilation problems than USA and Canada. Despite these criticisms, the emergence of NAFTA helps all the three member countries in the area of industrial development, increase in employment opportunities, incomes and living standards of the people. However, this trade block is a major hurdle for the globalization of the business as two major developed countries are involved in this agreement.
The Association of South-East Asian Nations (ASEAN)
A group of six countries, Singapore, Brunei, Malaysia, Philippines, Thailand and Indonesia, agreed in January 1992 to establish a Common Effective Preferential Tariffs (CEPT) plan. This plan helped to create an association of South-East Asian Nations (ASEAN) free trade area in 15 years with effect from January 1993. The CEPT allows for tariffs cut ranging from 0.50 per cent to 20.00 per cent beginning with 15 products. The emergence and successful operation of EEC and NAFTA gave impetus for the forming of ASEAN. The ASEAN member countries have developed economically at a fast rate in the globe. Their strength is well educated and skilled human resources. This strength enabled them to achieve faster industrialization. Further the ASEAN member countries are rich in oil, mineral resources, agricultural goods and modern industrial products. These countries invite and allow the free-flow of foreign capital. The formation of ASEAN enables the member countries to have close cohesiveness, share their economic and human resources and achieves synergy in the development of their agricultural sectors, industrial sectors and service sectors. The common historical and cultural background made the member countries to maintain their unity and solidarity by establishing a trade block. ASEAN countries have the determination to develop south-east Asia a nuclear weapons free area and a zone of peace, freedom and neutrality.
Asian Free Trade Area (AFTA)
The ASEAN countries are vigilant of the developments in the international environment like the formation NAFTA, SAARC and the introduction of Euro. In view of these developments, the ASEAN countries formed the Asean Free Trade Area (AFTA) in September 1994. The AFTA initially set to function for 10 years in order to develop inter ASEAN trade. The objectives of the AFTA are: To encourage inflow of foreign investment into this region. To establish free trade are in the member countries. To reduce tariff of the product produced in ASEAN countries. 40% value addition in the ASEAN countries to the product value is treated as manufactured in ASEAN countries.
European Free Trade Association (EFTA)
The European Free Trade Association (EFTA) was formed in 1959. The member countries of EFTA include: Norway, Portugal, Sweden and Switzerland. The associate member countries are: Finland and Iceland, Great Britain and Denmark. The objectives of EFTA are: To eliminate almost all tariffs among member countries. To abolish trade restrictio0ns regarding imports and exports of goods among member countries. To enhance economic development, employment, incomes and living standards of the people of the member countries. To enable free trade in Western Europe. The EFTA achieved most of its objectives during its 40 years of existence. EFTA does not regulate the agriculture and economy of the member countries and members’ trade outside the EFTA. The EFTA is managed by a council. Each member country is represented by its representative to the EFTA Council makes policy decisions of the organization. SecretaryGeneral implements the policies.
Latin American Integration Association (LAIA)
Latin American Free Trade Association (LAFTA) on the lines of EFTA was formed in 1960. The countries signed the LAFTA agreement were Argentina, Brazil, Chile, Mexico, Paraguay, Peru, Uruguay, Colombia, Ecuador, Venezuela and Bolivia. Later the Latin American Integration Association (LAIA) replaced LAFTA. Objectives The objectives of LAIA are: To eliminate restrictions on trade among the member countries and To reduce the customs and tariffs and eliminate them gradually.
Organization Structure: LAIA is managed by a Council of Ministers. Foreign Ministers of the member countries represent the council. The Council of Ministers is assisted by a conference of contracting parties which makes discussions on issues requiring a joint resolution of the members and a permanent Executive Committee. Executive Committee Implements the Treaty. The Executive Committee is assisted by a secretariat. Operations: Members prepare a list of goods on which they consider duty reductions. Member countries negotiate once in three years for complete exemption of tariffs and decide the list of products eligible for complete exemption of tariffs. In fact, they include all the products which are traded in the region in the list. More favourable terms are granted for the less developed countries of the region. Critical Appraisal: The performance of the LAIA is only modest. The reasons for modest performance include: Delay and negative approach of the members in preparing common list. High cost of transportation. Contentment of the members with the sheltered markets. Forces of nationalism.
South Asian Association for Regional Cooperation (SAARC)
The successful performance of EEC, NAFTA and other trade blocks in the economic development of the member countries and in improving the employment opportunities, incomes and living standards of the people of the region gave impetus for the formation of South Asian Association for Regional Cooperation (SAARC). India, Bangladesh, Bhutan, Pakistan, The Maldives and Sri Lanka adopted a declaration on SAARC in August 1983. The charter of the SAARC was formally adopted in December 1985 by the heads of the member countries. Objectives The objectives of the SAARC are: To improve the quality of life and welfare of the people of the SAARC member countries. To develop the region economically, socially and culturally. To provide the opportunity to the people of the region to live in dignity and to exploit their potentialities. To enhance the self-reliance of the member countries jointly. To provide conducive climate for creating and enhancing mutual trust, understanding and application of one another’s issues. To enhance the mutual assistance among member countries in the areas of economic, social cultural, scientific and technical fields. To enhance the co-operation with other developing economies. To have unity among the member countries regarding the issues o common interest in the international forums. To extend co-operation to other trade blocks.
Organization Structure The Council of the SAARC is the highest policy making body. The Council is represented by the heads of the Government of the member countries. The Council meets once in two years. This council is assisted by the ‘Council of Ministers.’ The Council of Ministers is represented by the foreign ministers of member governments. It formulates policies, reviews the functioning and decides the new areas of co-operation, establishes additional mechanism, decides the issues of general interests to the SAARC member countries. The Council meets twice a year and more times, if necessary. The Council of Ministers is assisted by the standing committee. Standing committee consists of foreign secretaries of member governments. The functions of the standing committee include: Monitoring and coordinating the programmes. Determining inter-sectoral priorities. Mobilizing co-operation within and outside the region. Formulating the modalities of financing. Standing committee is expected to meet as and when necessary and submits the report to the Council of Ministers. This committee sets up action committee for the project implementation. The standing committee is assisted by the programming committee. Programming committee includes the senior officials of the member governments. The functions of the programming committee are: Scrutinizing the budget of the secretariat. Finalizing the annual schedule of the secretariat. Carrying out the activities assigned by the standing committee. Analyzing the reports of the technical committees and SAARC regional centers and submitting them to the standing committee along with its comments. Technical committees comprise the representatives of all member countries. Their functions Formulating projects and programmes in their respective areas. Monitoring and implementing the projects. Submitting the reports to the standing committee through the programme committee. The technical committees of SAARC include: Agriculture Communications Environment Health and Population Activities Rural Development Science and Technology Tourism and Transport All the secretarial work is done by the SAARC secretariat, which is located in Nepal. The activities of the secretariat include: Co-ordinating, monitoring and implementing SAARC and other international forums. Servicing the meetings of the SAARC. Serving as communication link between SAARC and other international forums.
The Secretary-General is the chief of the secretariat. He/She is appointed by the Council of Ministers on rotation basis among members for a period of three years. He is assisted by seven Directors (one from each member country) and general service staff. SAARC Preferential trading Arrangement (SAPTA) The Council of Ministers has signed the SAARC Preferential Trading Arrangement agreement on April 11, 1993. Objectives of SAPTA are: To gradually liberalize the trade among member countries of SAARC. To eliminate trade barriers among SAARC countries and reduce or eliminate tariffs. To promote and sustain mutual trade and economic co-operation among member countries. Administration of SAPTA: SAARC Preferential Trading Arrangement agreement would be administered on the following lines: The benefits to the member countries would be accorded on equitable basis of reciprocity and mutuality. The Agreement would be improved step by step through mutual negotiations. The Agreement has taken the special needs of the less developed countries into consideration. Product Areas: All raw materials, semi-finished products and finished products are3 included for mutual concessions. Tariffs: Concessions would be given in tariffs, Para-tariffs, non-tariffs and trade measures. Special treatment for the least developed countries would be provided in the following ways: Providing technical assistance, establishment of industrial and agricultural projects in order to boost up their exports. Enhancing their exports by eliminating non-tariff and para-tariff barriers, providing duty free access etc. Establishing training facilities in the areas of export trade. Providing export credit insurance and market information. Entering into long-term contracts. Balance of Payments If the concessions enhance the imports resulting in serious balance of payments problem, the importing country can suspend the concessions. Provision for information, consultation and dispute settlement are provided. Extension of concessions: The concessions would be extended to all member countries (expect those meant for least developed countries). Committee of participants: Committee of participants would review the implementation of this agreement and distribution of the benefits among member countries equitably. Non-application of the provision: If the benefits similar to those stated in the provisions of this agreement, the provisions in this agreement are not applicable to the same case distribution of benefits among member countries equitably. Modification and withdrawal of concessions: Concessions provided under this agreement can be withdrawn or modified through the mutual consultations and
agreement of the countries concerned after three years. However, Committee on Economic Cooperation (CEC) will monitor these aspects. Withdrawal from SAPTA: Member countries by giving six months’ notice to SAARC Secretariat and committee on Economic Cooperation can withdraw from the SAPTA.
Question-13 What are the basic foreign manufacturing and sourcing decisions? Answer:
Then, the sourcing or manufacturing group gets some prices and adds in the costs of international transportation, tariffs, taxes and one-time investments, etc. And, if they’re more thorough than most, they remember to include an allowance for increased in-transit inventory. After they add up all the numbers, if international trumps domestic sourcing by more than 20%, they may pull trigger and go overseas. Before we get back to the story, and the punch line, I need to make three caveats: First, I am by no means an international sourcing expert. I’m well aware that I have just oversimplified the decision making process—I hope. Second, while St. Onge Co. does plenty of work for manufacturing folks, personally, I work more with distribution and supply chain personnel and am therefore perhaps overly sympathetic to their cause. Third, I am by no means suggesting companies that decide to source internationally have made the wrong decision. Sometimes, they have, but most times, they have not. The problem is, no matter how sound the decision, more times than not, managers fail to take into account the implications to the downstream domestic supply chain. In too many instances, no one consults U.S. distribution personnel—except perhaps to help with a transportation rate or two. Sourcing, of course, is not their area of expertise. They know little about the international playing field and, in some manufacturing-centric companies, they’re viewed as little more than a necessary evil. Tangential side note number one: Regardless of how the Council of Supply Chain Management Professionals, American Production and Inventory Control Society, or anyone else may choose to define it, for most manufacturers, “supply chain management” does not include manufacturing or sourcing.
In my experience, the major item many fail to account for is an increase in domestic inventory and reduction in domestic service levels—almost always the result of a move to foreign sourcing. Secondarily, those who move offshore rarely consider the implications to the domestic distribution network itself. When major sourcing changes occur, addressing these issues almost always occurs in a reactive manner and almost always by domestic supply chain personnel responding to a decision rather than collaborating with their sourcing counterparts. This is unfortunate. Both network and inventory optimization tools exist to provide valuable insights and cost estimates to the decision making process. Tangential side note number two: Other, less quantifiable considerations that are frequently downplayed or disregarded include sales benefits of the 'Made In USA' label, supplier reliability, intellectual capital considerations and valuation changes in the Chinese yuan. And, don’t forget the risk of product flow disruption due to work stoppages, natural disaster, political turmoil, or God forbid, another terrorist attack. Heaven help us if anything happens to the Port of Long Beach. Luckily, hurricanes don’t hit the West Coast, but how quickly we forget Sept. 11, longshoremen strikes and the fact that China is a communist country. Now, back to the lighter and more mundane topics of networks and inventory. First, let’s look at the domestic distribution network. I’ll keep it simple. If one day, I’m sourcing most of my product from the Northeast, and the next day, I’m sourcing it from the West Coast (i.e., China) or south Texas (i.e., Mexico), I might come to realize that my distribution centers are in the wrong place or are now the wrong size due to inbound freight and other considerations. Long story short, it would sure be nice to know about any sourcing decision before I sign a five-year lease renewal on my Ohio distribution center, decide to downsize my West Coast distribution center or commit 60% of my outbound shipment volume to a Northeast-centric carrier. With the aid of internal distribution experts and perhaps a little network modeling, you can make better sourcing decisions, avoid overflow warehouse space and minimize customer-service disruptions. Finally, the punch line: inventory. Almost without exception, when I ask domestic supply chain managers if the inventory impact of foreign sourcing was properly anticipated and planned for, the answer is “no.” As mentioned earlier, that’s because it does not make the strategic-sourcing radar screen. It’s also because it’s difficult to quantify without the use of more sophisticated analytical tools. Fortunately, those tools now exist. Unfortunately, few people are aware of them. Even fewer use them. Generally speaking, here’s what happens. In addition to in-transit inventory, which is easy to quantify, domestic safety stock must increase if you expect to maintain current service levels. This is because, with few exceptions, foreign sourcing brings with it less favorable
replenishment parameters, such as longer lead times, larger order minimums and, most importantly, greater lead-time variability. St. Onge Co. has done significant analysis to show that the latter—lead-time variability—is the biggest culprit. If a domestic supplier is having a bad day, the usual seven-day lead time turns into eight or nine days. If the foreign supplier, or more likely, the foreign supply chain, is having a bad “day” (missed sailings, port congestion, customs holds, etc.), the usual 90-day lead time turns into 120 or 180 days. This brings with it cost, which can rear its ugly head in a number of areas: increased inventory, diminished fill rates, expedited shipping, outside warehousing, double handling of product and more. For most companies, the lesser of these evils is increased inventory carrying cost, which brings with it increased warehousing cost. While less than an exact science, it is possible to estimate and anticipate these costs legitimately as part of the sourcing decision and planning process. Just remember, when planning the foreign, don’t forget the domestic.
Question-14 What is the concept of Global or International Marketing? or Question- Define and Explain Global Marketing. How does the shift from domestic marketing to global markrting can be understood? Answer:
Global marketing can be defined as marketing on a worldwide scale reconciling or taking commercial advantage of global operational differences, similarities and opportunities in order to meet global objectives. Here are three reasons for the shift from domestic to global marketing. Worldwide Competition One of the product categories in which global competition has been easy to track in U.S.is automotive sales. The increasing intensity of competition in global markets is a challenge facing companies at all stages of involvement in international markets. As markets open up, and become more integrated, the pace of change accelerates, technology shrinks distances between markets and reduces the scale advantages of large firms, new sources of competition emerge, and competitive pressures mount at all levels of the organization. Also, the threat of competition from companies in countries such as India, China, Malaysia, and Brazil is on the rise, as their own domestic markets are opening up to foreign competition, stimulating greater awareness of international market opportunities and of the need to be internationally competitive. Companies which previously focused on protected domestic markets are entering into markets in other countries, creating new sources of competition, often targeted to price-sensitive market segments. Not only is competition intensifying for all firms regardless of their degree of global market involvement, but the basis for competition is changing. Competition continues to be market-based and ultimately relies on delivering superior value to consumers. However, success in global markets depends on knowledge accumulation and deployment.
Evolution to Global Marketing Global marketing is not a revolutionary shift, it is an evolutionary process. While the following does not apply to all companies, it does apply to most companies that begin as domestic-only companies. Domestic marketing A marketing restricted to the political boundaries of a country, is called "Domestic Marketing". A company marketing only within its national boundaries only has to consider domestic competition. Even if that competition includes companies from foreign markets, it still only has to focus on the competition that exists in its home market. Products and services are developed for customers in the home market without thought of how the product or service could be used in other markets. All marketing decisions are made at headquarters. The biggest obstacle these marketers face is being blindsided by emerging global marketers. Because domestic marketers do not generally focus on the changes in the global marketplace, they may not be aware of a potential competitor who is a market leader on three continents until they simultaneously open 20 stores in the Northeastern U.S. These marketers can be considered ethnocentric as they are most concerned with how they are perceived in their home country. exporting goods to other countries. loosener Rhett International marketing If the exporting departments are becoming successful but the costs of doing business from headquarters plus time differences, language barriers, and cultural ignorance are hindering the company’s competitiveness in the foreign market, then offices could be built in the foreign countries. Sometimes companies buy firms in the foreign countries to take advantage of relationships, storefronts, factories, and personnel already in place. These offices still report to headquarters in the home market but most of the marketing mix decisions are made in the individual countries since that staff is the most knowledgeable about the target markets. Local product development is based on the needs of local customers. These marketers are considered polycentric because they acknowledge that each market/country has different needs. Global marketing specialization Global marketing is a field of study When it comes to global marketing strategies, the Internet plays a highly significant role as the most powerful business weapon in today's globalized business world. Elements of the global marketing mix The “Four P’s” of marketing: product, price, placement, and promotion are all affected as a company moves through the five evolutionary phases to become a global company. Ultimately, at the global marketing level, a company trying to speak with one voice is faced
with many challenges when creating a worldwide marketing plan. Unless a company holds the same position against its competition in all markets (market leader, low cost, etc.) it is impossible to launch identical marketing plans worldwide. Product A global company is one that can create a single product and only have to tweak elements for different markets. For example, Coca-Cola uses two formulas (one with sugar, one with corn syrup) for all markets. The product packaging in every country incorporates the contour bottle design and the dynamic ribbon in some way, shape, or form. However, the bottle or can also includes the country’s native language and is the same size as other beverage bottles or cans in that same country. Price Price will always vary from market to market. Price is affected by many variables: cost of product development (produced locally or imported), cost of ingredients, cost of delivery (transportation, tariffs, etc.), and much more. Additionally, the product’s position in relation to the competition influences the ultimate profit margin. Whether this product is considered the high-end, expensive choice, the economical, low-cost choice, or something in-between helps determine the price point. Placement How the product is distributed is also a country-by-country decision influenced by how the competition is being offered to the target market. Using Coca-Cola as an example again, not all cultures use vending machines. In the United States, beverages are sold by the pallet via warehouse stores. In India, this is not an option. Placement decisions must also consider the product’s position in the market place. For example, a high-end product would not want to be distributed via a “dollar store” in the United States. Conversely, a product promoted as the low-cost option in France would find limited success in a pricey boutique. Promotion After product research, development and creation, promotion (specifically advertising) is generally the largest line item in a global company’s marketing budget. At this stage of a company’s development, integrated marketing is the goal. The global corporation seeks to reduce costs, minimize redundancies in personnel and work, maximize speed of implementation, and to speak with one voice. If the goal of a global company is to send the same message worldwide, then delivering that message in a relevant, engaging, and costeffective way is the challenge. Effective global advertising techniques do exist. The key is testing advertising ideas using a marketing research system proven to provide results that can be compared across countries. The ability to identify which elements or moments of an ad are contributing to that success is how economies of scale are maximized. Market research measures such as Flow of Attention, Flow of Emotion andbranding moments provide insights into what is working in an ad in any country because the measures are based on visual, not verbal, elements of the ad.
Advantages and Disadvantages of Global Marketing
Advantages of Global Marketing The advantages of global market we can introduce our product by using advertising Economies of scale in production and distribution Lower marketing costs Power and scope Consistency in brand image Ability to leverage good ideas quickly and efficiently Uniformity of marketing practices Helps to establish relationships outside of the "political arena" Helps to encourage ancillary industries to be set up to cater for the needs of the global player Benefits of eMarketing over traditional marketing Reach
The nature of the internet means businesses now have a truly global reach. While traditional media costs limit this kind of reach to huge multinationals, eMarketing opens up new avenues for smaller businesses, on a much smaller budget, to access potential consumers from all over the world. Scope Internet marketing allows the marketer to reach consumers in a wide range of ways and enables them to offer a wide range of products and services. eMarketing includes, among other things, information management, public relations, customer service and sales. With the range of new technologies becoming available all the time, this scope can only grow. Interactivity Whereas traditional marketing is largely about getting a brand’s message out there, eMarketing facilitates conversations between companies and consumers. With a two way communication channel, companies can feed off of the responses of their consumers, making them more dynamic and adaptive. Immediacy Internet marketing is able to, in ways never before imagined, provide an immediate impact. Imagine you’re reading your favorite magazine. You see a double-page advert for some new product or service, maybe BMW’s latest luxury sedan or Apple’s latest iPod offering. With this kind of traditional media, it’s not that easy for you, the consumer, to take the step from hearing about a product to actual acquisition. With eMarketing, it’s easy to make that step as simple as possible, meaning that within a few short clicks you could have booked a test drive or ordered the iPod. And all of this can happen regardless of normal office hours. Effectively, Internet marketing makes business hours 24 hours per day, 7 days per week for every week of the year. By closing the gap between providing information and eliciting a consumer reaction, the consumer’s buying cycle is speeded up and advertising spend can go much further in creating immediate leads.
Demographics and targeting Generally speaking, the demographics of the Internet are a marketer’s dream. Internet users, considered as a group, have greater buying power and could perhaps be considered as a population group skewed towards the middle-classes. Buying power is not all though. The nature of the Internet is such that its users will tend to organize themselves into far more focused groupings. Savvy marketers who know where to look can quite easily find access to the niche markets they wish to target. Marketing messages are most effective when they are presented directly to the audience most likely to be interested. The Internet creates the perfect environment for niche marketing to targeted groups. Adaptivity and closed loop marketing Closed Loop Marketing requires the constant measurement and analysis of the results of marketing initiatives. By continuously tracking the response and effectiveness of a campaign, the marketer can be far more dynamic in adapting to consumers’ wants and needs. With eMarketing, responses can be analyzed in real-time and campaigns can be tweaked continuously. Combined with the immediacy of the Internet as a medium, this means that there’s minimal advertising spend wasted on less than effective campaigns. Maximum marketing efficiency from eMarketing creates new opportunities to seize strategic competitive advantages. The combination of all these factors results in an improved ROI and ultimately, more customers, happier customers and an improved bottom line. Disadvantages of Global Marketing
Differences in consumer needs, wants, and usage patterns for products Differences in consumer response to marketing mix elements Differences in brand and product development and the competitive environment Differences in the legal environment, some of which may conflict with those of the home market Differences in the institutions available, some of which may call for the creation of entirely new ones (e.g. infrastructure) Differences in administrative procedures Differences in product placement. Differences in the administrative procedures and product placement can occur
Question-14. What is the concept of Product and Brand? What are the Product and Branding decisions concerning International markets? Or Question . How are products designed for foreign markets in International business? July 2010 Answer:
Product- A product can be defined as a collection of physical, service and symbolic attributes which yield satisfaction or benefits to a user or buyer. A product is a combination of physical attributes say, size and shape; and subjective attributes say image or "quality". A customer purchases on both dimensions. As cited earlier, an avocado pear is similar the world over in terms of physical characteristics, but once the label CARMEL, for example, is put on it, the product's physical properties are enhanced by the image CARMEL creates. In "post-modernization" it is increasingly important that the product fulfills the image which the producer is wishing to project. This may involve organisations producing symbolic offerings represented by meaning laden products that chase stimulation-loving consumers who seek experience - producing situations. So, for example, selling mineral water may not be enough. It may have to be "Antarctic" in source, and flavoured. This opens up a wealth of new marketing opportunities for producers. A product's physical properties are characterised the same the world over. They can be convenience or shopping goods or durables and nondurables; however, one can classify products according to their degree of potential for global marketing: i) Local or Domestic Products - seen as only suitable in one single domestic market. ii) International Products - seen as having extension potential into other markets. iii) Multinational Products - Products adapted to the perceived unique characteristics of national markets. iv) Global Products - Products designed to meet global segments. Quality, method of operation or use and maintenance (if necessary) are catchwords in international marketing. A failure to maintain these will lead to consumer dissatisfaction. This is typified by agricultural machinery where the lack of spares and/or foreign exchange can lead to lengthy downtimes. It is becoming increasingly important to maintain quality products based on the ISO 9000 standard, as a prerequisite to export marketing. Consumer beliefs or perceptions also affect the "world brand" concept. World brands are based on the same strategic principles, same positioning and same marketing mix but there may be changes in message or other image. World brands in agriculture are legion. In fertilizers, brands like Norsk Hydro are universal; in tractors, Massey Ferguson; in soups, Heinz; in tobacco, BAT; in chemicals, Bayer. These world brand names have been built up over the years with great investments in marketing and production. Few world brands, however, have originated from developing countries. This is hardly surprising given the lack of resources. In some markets product saturation has been reached, yet surprisingly the same product may not have reached saturation in other similar markets. Whilst France has long been saturated by avocadoes, the UK market is not yet, hence raising the opportunity to enter deeper into this market.
One of the fundamental decisions for successful international marketing relates to product policy and planning. It can be argued that product. decisions are probably the most crucial as the product is the very epitome of marketing planning. Errors in product decisions can include the imposition of a global standardised product where it is inapplicable and the attempt to sell products into a country without cognisance of cultural adaptation needs. An international marketer has the option of exporting ',the home market product to foreign markets, adapting the home market product to meet the needs of the foreign customers more closely, or developing new products to meet the specific needs of the customers in foreign markets. The selection process needs a careful analysis of the foreign market needs, appraisal of the market opportunity and detailed product planning. Decisions regarding the product, price, promotion and distribution channels are decisions on the elements of the "marketing mix". Many product decisions lie between the two extremes i.e. whether to sell globally standardised or adapted products. Product design Changes in design are largely dictated by whether they would improve the prospects of greater sales, and this, over the accompanying costs. Changes in design are also subject to cultural pressures. The more culture-bound the product is, for example food, the more adaptation is necessary. Most products fall in between the spectrum of "standardisation" to "adaptation" extremes. The application the product is put to also affects the design. In the UK, railway engines were designed from the outset to be sophisticated because of the degree of competition, but in the US this was not the case. In order to burn the abundant wood and move the prairie debris, large smoke stacks and cowcatchers were necessary. In agricultural implements a mechanised cultivator may be a convenience item in a UK garden, but in India and Africa it may be essential equipment. As stated earlier "perceptions" of the product's benefits may also dictate the design. A refrigerator in Africa is a very necessary and functional item, kept in the kitchen or the bar. In Mexico, the same item is a status symbol and, therefore, kept in the living room. Factors encouraging standardisation are: i) economies of scale in production and marketing. ii) consumer mobility - the more consumers travel the more is the demand iii) technology iv) image, for example "Japanese", "made in". The latter can be a factor both to aid or to hinder global marketing development. People found the "made in USA" image has lost ground to the "made in Japan" image. In some cases "foreign made" gives advantage over domestic products. In Zimbabwe one sees many advertisements for "imported", which gives the product advertised a perceived advantage over domestic products. Often a price premium is charged to reinforce the "imported means quality" image. If the foreign source is negative in effect, attempts are made to disguise or hide the fact through, say, packaging or labelling. Mexicans are loathe to take
products from Brazil. By putting a "made in elsewhere" label on the product this can be overcome, provided the products are manufactured elsewhere even though its company maybe Brazilian. Factors encouraging adaptation are: i) Differing usage conditions. These may be due to climate, skills, level of literacy, culture or physical conditions. Maize, for example, would never sell in Europe rolled and milled as in Africa. It is only eaten whole, on or off the cob. In Zimbabwe, kapenta fish can be used as a relish, but wilt always be eaten as a "starter" to a meal in the developed countries. ii) General market factors - incomes, tastes etc. Canned asparagus may be very affordable in the developed world, but may not sell well in the developing world. iii) Government - Taxation, import quotas, non tariff barriers, labelling, health requirements. Non tariff barriers are an attempt, despite their supposed impartiality, at restricting or eliminating competition. A good example of this is the Florida tomato growers, cited earlier, who successfully got the US Department of Agriculture to issue regulations establishing a minimum size of tomatoes marketed in the United States. The effect of this was to eliminate the Mexican tomato industry which grew a tomato that fell under the minimum size specified. Some non-tariff barriers may be legitimate attempts to protect the consumer, for example the ever stricter restrictions on horticultural produce insecticides and pesticides use may cause African growers a headache, but they are deemed to be for the public good. iv) History. Sometimes, as a result of colonialism, production facilities have been established overseas. Eastern and Southern Africa is littered with examples. In Kenya, the tea industry is a colonial legacy, as is the sugar industry of Zimbabwe and the coffee industry of Malawi. These facilities have long been adapted to local conditions. v) Financial considerations. In order to maximise sales or profits the organisation may have no choice but to adapt its products to local conditions. vi) Pressure. Sometimes, as in the case of the EU, suppliers are forced to adapt to the rules and regulations imposed on them if they wish to enter into the market.
Production Decisions concerning Foreign Markets
In decisions on producing or providing products and services in the international market it is essential that the production of the product or service is well planned and coordinated, both within and with other functional area of the firm, particularly marketing. For example, in horticulture, it is essential that any supplier or any of his "outgrower" (sub-contractor) can supply what he says he can. This is especially vital when contracts for supply are finalised, as failure to supply could incur large penalties. The main elements to consider are
the production process itself, specifications, culture, the physical product, packaging, labelling, branding, warranty and service. Production process The key question is, can we ensure continuity of supply? In manufactured products this may include decisions on the type of manufacturing process - artisanal, job, batch, flow line or group technology. However in many agricultural commodities factors like seasonality, perishability and supply and demand have to be taken into consideration. Quantity and quality of horticultural crops are affected by a number of things. These include input supplies (or lack of them), finance and credit availability, variety (choice), sowing dates, product range and investment advice. Many of these items will be catered for in the contract of supply. Specification Specification is very important in agricultural products. Some markets will not take produce unless it is within their specification. Specifications are often set by the customer, but agents, standard authorities (like the EU or ITC Geneva) and trade associations can be useful sources. Quality requirements often vary considerably. In the Middle East, red apples are preferred over green apples. In one example French red apples, well boxed, are sold at 55 dinars per box, whilst not so attractive Iranian greens are sold for 28 dinars per box. In export the quality standards are set by the importer. In Africa, generally, that there are no consistent standards for product quality and grading, making it difficult to do international trade regionally. Culture Product packaging, labeling, physical characteristics and marketing have to adapt to the cultural requirements when necessary. Religion, values, aesthetics, language and material culture all affect production decisions. Effects of culture on production decisions have been dealt with already in chapter three. Physical product The physical product is made up of a variety of elements. These elements include the physical product and the subjective image of the product. Consumers are looking for benefits and these must be conveyed in the total product package. Physical characteristics include range, shape, size, color, quality, quantity and compatibility. Subjective attributes are determined by advertising, self image, labelling and packaging. In manufacturing or selling produce, cognisance has to be taken of cost and country legal requirements. Again a number of these characteristics is governed by the customer or agent. For example, in beef products sold to the EU there are very strict quality requirements to be observed. In fish products, the Japanese demand more "exotic" types than, say, would be sold in the UK. None of the dried fish products produced by the Zambians on Lake Kariba, and sold into the
Lusaka market, would ever pass the hygiene laws if sold internationally. In sophisticated markets like seeds, the variety and range is so large that constant watch has to be kept on the new strains and varieties in order to be competitive. Packaging Packaging serves many purposes. It protects the product from damage which could be incurred in handling and transportation and also has a promotional aspect. It can be very expensive. Size, unit type, weight and volume are very important in packaging. For aircraft cargo the package needs to be light but strong, for sea cargo containers are often the best form. The customer may also decide the best form of packaging. In horticultural produce, the developed countries often demand blister packs for mangetouts, beans, strawberries and so on, whilst for products like pineapples a sea container may suffice. Costs of packaging have always to be weighed against the advantage gained by it. Increasingly, environmental aspects are coming into play. Packaging which is nondegradable - plastic, for example - is less in demanded. Bio-degradable, recyclable, reusable packaging is now the order of the day. This can be both expensive and demanding for many developing countries. Labelling Labelling not only serves to express the contents of the product, but may be promotional. The EU is now putting very stringent regulations in force on labelling, even to the degree that the pesticides and insecticides used on horticultural produce have to be listed. This could be very demanding for producers, especially small scale, ones where production techniques may not be standardised. Government labelling regulations vary from country to country. Bar codes are not widespread in Africa, but do assist in stock control. Labels may have to be multilingual, especially if the product is a world brand. Translation could be a problem with many words being translated with difficulty. Again labelling is expensive, and in promotion terms non-standard labels are more expensive than standard ones. Requirements for crate labelling, etc. for international transportation will be dealt with later under documentation. Branding and trademarks As mentioned in chapter four, it is difficult to protect a trademark or brand, unless all countries are members of a convention. Brand "piracy" is widespread in many developing countries. Other aspects of branding include the promotional aspects. A family brand of products under the Zeneca (ex ICI) label or Sterling Health are likely to be recognised worldwide, and hence enhance the "subjective" product characteristics. Warranty
Many large value agricultural products like machinery require warranties. Unfortunately not everyone upholds them. It is common practice in Africa that if the original equipment has not been bought through an authorised dealer in the country, that dealer refuses to honour the warranty. This is unfortunate, because not only may the equipment have been legitimately bought overseas, it also actually builds up consumer resistance to the dealer. When the consumer is eventually offered a choice, the reticent. dealer will suffer. For example when new dealers spring up.
Service In agricultural machinery, processing equipment and other items which are of substantial value and technology, service is a prerequisite. In selling to many developing countries, manufacturers have found their negotiations at stake due to the poor back-up service. Often, this is no fault of the agent, distributor or dealer in the foreign country, but due to exchange regulations, which make obtaining spare parts difficult. Many organisations attempt to get around this by insisting that a Third World buyer purchases a percentage of parts on order with the original items. Allied to this problem is the poor quality of service due to insufficient training. Good original equipment manufacturers will insist on training and updating as part of the agency agreement. In order to illustrate the above points, cotton can be used as an example. Cotton is a major foreign exchange earner for Zimbabwe. In 1990/91, 52,000 tonnes were sold overseas at a value of Zim$ 238 million. As the spinners, particularly those in the export market, are in a highly competitive industry, it is essential that the raw material is as clean as possible. Also today's spinning equipment is highly technical and the spinner wishes to avoid costly breakdowns by all means.
There are five major product strategies in international marketing. Product communications extension This strategy is very low cost and merely takes the same product and communication strategy into other markets. However it can be risky if misjudgments are made. For example CPC International believed the US consumer would take to dry soups, which dominate the European market. It did not work. Extended product - communications adaptation If the product basically fits the different needs or segments of a market it may need an adjustment in marketing communications only. Again this is a low cost strategy, but
different product functions have to be identified and a suitable communications mix developed. Product adaptation - communications extension The product is adapted to fit usage conditions but the communication stays the same. The assumption is that the product will serve the same function in foreign markets under different usage conditions. Product adaptation - communications adaptation Both product and communication strategies need attention to fit the peculiar need of the market. Product invention This needs a totally new idea to fit the exclusive conditions of the market. This is very much a strategy which could be ideal in a Third World situation. The development costs may be high, but the advantages are also very high. The choice of strategy will depend on the most appropriate product/market analysis and is a function of the product itself defined in terms of the function or need it serves, the market defined in terms of the conditions under which the product is used, the preferences of the potential customers and the ability to buy the product in question, and the costs of adaptation and manufacture to the company considering these product - communications approaches. Product decisions epitomise marketing planning and are the manifestation of marketing strategy. These decisions are not to be taken lightly. The end consumer and channel considerations have to be taken into account and the product extended or adapted accordingly.
Branding Decisions for International Markets
Global brand A global brand is one which is perceived to reflect the same set of values around the world. Global brands transcend their origins and create strong enduring relationships with consumers across countries and cultures. They are brands sold in international markets. Examples of global brands include Facebook, Apple, Pepsi, McDonald's, Mastercard, Gap, Sony and Nike. These brands are used to sell the same product across multiple markets and could be considered successful to the extent that the associated products are easily recognizable by the diverse set of consumers.
Benefits of global branding In addition to taking advantage of the outstanding growth opportunities, the following drives the increasing interest in taking brands global: Economies of scale (production and distribution) Lower marketing costs Laying the groundwork for future extensions worldwide Maintaining consistent brand imagery Quicker identification, recognition and integration of innovations (discovered worldwide) Preempting international competitors from entering domestic markets or locking you out of other geographic markets Increasing international media reach (especially with the explosion of the Internet) is an enabler Increases in international business and tourism are also enablers Possibility to charge premium prices Internal company benefits such as attracting and retaining good employees, and cohesive company culture Global brand variables
The following elements may differ from country to country:
Corporate slogan Products and services Product names Product features Positionings Marketing mixes (including pricing, distribution, media and advertising execution)
These differences will depend upon:
Language differences Different styles of communication Other cultural differences Differences in category and brand development Different consumption patterns Different competitive sets and marketplace conditions Different legal and regulatory environments Different national approaches to marketing (media, pricing, distribution, etc.)
Generic or No Brand: The first decision regarding branding is whether to brand or not. The trend towards non-branding products is increasing world-wide. In fact, the scales of nonbranded products is increasing particularly in retail stores. The increase in demand for non-brand products is due to the availability of these products at less price. In addition,
non-brand products are available - In a number of sizes and models. Branded Products: Most of the global companies go for branding. The customers of different countries find it easy to identify the branded products and they are aware of the ingredients and utility of the branded products. For example" the customers throughout the world are aware of the products of Colgate-Palmolive, Pepsi or Coke etc. The global company can get better price and profits through branded products. Private Brand: Most of the exporting companies go for dealer's brand or private brand. The advantages of private branding include: easy in giving dealer's acceptance, possibility of getting larger market share, less promotional expenses etc. Private branding is more appropriate for the small companies who export to various foreign countries. Manufacturer's Brand: The manufacturer sells the products in his own brand. The advantages of manufacturer's brand include: better control of products and features, better price due to more price inelectricity, retention of brand loyalty and better bargaining power. •Single Brand: The global company go for a single brand for all its exports to the same country (or Single Brand): The advantages of single brand in single market include: better impact on marketing ,permittmg more focussed marketing, brand receives full attention, reduction in cost of promotion etc. Multiple Brands: The marketing conditions and the features of the customers vary wIdely from one region to the other, in the same country. Therefore, the exporter uses multiple branding decisions in such cases. Multiple branding enables the exporter to meet the needs of all segments. Theother advantages of multiple branding include: creation of excitement among employees, gaining of more shelf space, avoidance of negative connotation of existing brand etc. Local Brands: Global companies have started widely using the local brands in order to give the impression of cultural compatibility of the local market. The advantages of local branding include: elimination of difficulty in pronunciation, elimination of negative connotations, avoidance of taxation on international brand etc. Global brands or World Wide Brand: Exporters normally go for global brand. The advantages of global brand include: reduction of advertising costs, elimination of brand confusion, better marketing impact and focus, status for prestigious brands and for wellknown designs etc.
Strategies for Branding Decisions
(1) If the product has production consistency and salient attributes which can be differentiated, then it would be better for the manufacturer to go for branding otherwise better to sell the product without any brand .
(2) If the manufacturer is least dependent person, it would be feasible to go for the manufacturer's own brand otherwise, it would be feasible to go for a private brand . (3) If there are intermarket differences like demographic and psychological, it would be feasible for having a local brand. Otherwise, it would be better to go for global brand . (4) If there are intermarket differences like demographic and psychological, it would be feasible for multibrands. Otherwise it would be feasible to go for single brand.
Question-15. What is International Pricing? What are various approaches and strategies for International Pricing? or Question. Explain various factor affecting pricing decisions in international business. July 2010 Answer:
Pricing Pricing is the process of determining what a company will receive in exchange for its products. Pricing factors are manufacturing cost, market place, competition, market condition, and quality of product. Pricing is also a key variable in microeconomic price allocation theory. Pricing is a fundamental aspect of financial modeling and is one of the four Ps of the marketing mix. The other three aspects are product, promotion, and place. Price is the only revenue generating element amongst the four Ps, the rest being cost centers. Pricing is the manual or automatic process of applying prices to purchase and sales orders, based on factors such as: a fixed amount, quantity break, promotion or sales campaign, specific vendor quote, price prevailing on entry, shipment or invoice date, combination of multiple orders or lines, and many others. Automated systems require more setup and maintenance but may prevent pricing errors. The needs of the consumer can be converted into demand only if the consumer has the willingness and capacity to buy the product. Thus pricing is very important in marketing. A well chosen price should do three things:
achieve the financial goals of the company (e.g., profitability) fit the realities of the marketplace (Will customers buy at that price?) support a product's positioning and be consistent with the other variables in the marketing mix
price is influenced by the type of distribution channel used, the type of promotions used, and the quality of the product
price will usually need to be relatively high if manufacturing is expensive, distribution is exclusive, and the product is supported by extensive advertising and promotional campaigns a low price can be a viable substitute for product quality, effective promotions, or an energetic selling effort by distributors
From the marketer's point of view, an efficient price is a price that is very close to the maximum that customers are prepared to pay. In economic terms, it is a price that shifts most of the consumer surplus to the producer. A good pricing strategy would be the one which could balance between the price floor (the price below which the organization ends up in losses) and the price ceiling (the price beyond which the organization experiences a no demand situation). Whether the orientation is towards control over end prices or over net prices, company policy relates to the net price received. Cost and market considerations are important as a company cannot sell goods below cost of production and remain in business and it sells goods at a price unacceptable in the marketplace. Firms unfamiliar with overseas marketing and firms producing industrial goods orient their pricing solely on a cost basis. Firms that employ pricing as part of the strategic mix, however, are aware of such alternatives as market segmentation from country to country or market to market competitive pricing in the marketplace and other market oriented pricing factors including cultural differences in perceptions of pricing. Full-cost versus Variable-Cost Pricing: Firms that orient their thinking around cost must determine whether to use variable cost or full cost in pricing the goods. In variable –cost pricing, the firm is concerned only with the marginal or incremental cost of producing goods to be sold in overseas markets. Such firms regard foreign sales and assume that any return over their variable cost makes a contribution to net profit. These firms may be able to keep a price most competitively in foreign markets but because they are selling products abroad at lower net prices than they are selling them in the domestic market they may be subject to charge to dumping . In that case they open themselves to anti dumping tariff penalties that take away from their competitive advantage. Nevertheless variable cost (or marginal cost) pricing is a practical approach to pricing when a company has high fixed costs and unused production capacity. Any contribution to fixed cost after variable costs are covered is profit for the company. On the one hand companies following the full cost pricing philosophy insist that no unit of a similar product is different from any other unit in terms of cost and that each unit must bear its full share of the total fixed and variable cost. This approach is suitable when a company has high variable costs relative to its fixed costs. In such cases prices are often set on a cost plus basis, that is, total costs plus profit margin. Both variable costs and full cost policies are followed by international markets. Skimming versus penetration pricing:
Firms must also decide when they follow a skimming or a penetration pricing policy. Traditionally the decisions of which policy to follow depends on the level of competition, the innovativeness of the product market, characteristics and company characteristics. A company uses skimming when the objective to reach a segment of the market that is relatively price insensitive and thus wiling to pay premium price for the value received. If limited supply exists, a company may follow skimming approach in order to maximize revenue and to match demand to supply. When a company is the only seller of a new or innovative product, skimming price may be used to maximize profits until competition forces a lower price. Skimming often is used in markets with only two income levels the wealthy and the poor . Costs prohibit setting a price that will be attractive to the lower income market, so the marketer charges a premium price and directs the product to the high income, relatively price insensitive segment. Apparently this was the policy of Johnson & Johnson ‘s pricing of diapers in Brazil before the arrival of P&G. Today such opportunities are fading away as the disparity in income levels is giving way to growing middle income market segments. The existence of larger markets attracts competition and as is often the case the emergence of multiple product lines, thus leading to price competition. Influences on pricing for international marketing. The cost of manufacturing, distributing and marketing your product. The physical location of production plants might influence price. For example, Toyota have plants in their European market, in the United Kingdom and Turkey. Of course fluctuations in foreign currencies affect pricing. Many companies are benefiting from a relatively low US Dollar price during the 2010s. This make imports to the United States expensive, but exports relatively cheap to other nations. However fluctuations make it very difficult for companies to make long-term decisions - such as building large factories in global markets i.e. costs of production are cheap today, but could be expensive in the future, impacting upon the price that your business is forced to charge. The price that the international consumer is willing to pay for your product. Your own business objectives will influence price. For example, large international companies such as Starbucks may operate at a loss in some locations but still need a local presence in order to maintain their economies of scale, as well as their reputation as a global player. The price that competitors in international markets are already charging. Business environment factors such as government policy and taxation. Grey Markets A business can expect problems with grey markets where it trades across national boundaries. So if Company Y is English it will trade in Stirling or Pound notes. If it trades in the United States during the 2010s, to be competitive it will need to sell at a reduced price in the US. However, there is little to stop an entrepreneur from traveling to the US, filling up a transport container with products, which have been exported from Company Y in England, then returning them back to England and marketing the same product at a lower
price than Company Y is willing to trade. This is an example of parallel trade, which is legal - just. Therefore it is known as grey marketing. International Pricing Approaches Export Pricing - a price is set for by the home-based marketing managers for the international market. The pricing approach is based upon a whole series of factors which are driven by the influences on pricing listed above. Then mainstream approaches to pricing may be implemented - see below. Non-cash payments - less and less popular these days, non-cash payments include counter-trade where goods are exchanged for goods between companies from different parts of the World. Transfer Pricing - prices are set in the home market, and goods are effectively sold to the international subsidiary which then attaches its own margin based upon the best price that local managers decide that they could achieve. Then mainstream approaches to pricing may be implemented - see below. Standardization versus adaptation - do you use a standard, common approach to pricing in each market, or do you decide to adapt the price to local conditions? Generic Marketing Approaches to Pricing There are many ways to price a product. Let's have a look at some of them and try to understand the best policy or strategy in various situations.
1. Premium Pricing. 2. Penetration Pricing. 3.Economy Pricing. 4. Price Skimming. 5. Psychological Pricing. 6. Product Line Pricing. 7. Optional Product Pricing. 8. Captive Product Pricing. 9. Product Bundle Pricing. 10. Promotional Pricing. 11.Geographical Pricing. 12. Value Pricing. Premium Pricing. Use a high price where there is a uniqueness about the product or service. This approach is used where a a substantial competitive advantage exists. Such high prices are charge for luxuries such as Cunard Cruises, Savoy Hotel rooms, and Concorde flights.
Penetration Pricing. The price charged for products and services is set artificially low in order to gain market share. Once this is achieved, the price is increased. This approach was used by France Telecom and Sky TV. Economy Pricing. This is a no frills low price. The cost of marketing and manufacture are kept at a minimum. Supermarkets often have economy brands for soups, spaghetti, etc. Price Skimming. Charge a high price because you have a substantial competitive advantage. However, the advantage is not sustainable. The high price tends to attract new competitors into the market, and the price inevitably falls due to increased supply. Manufacturers of digital watches used a skimming approach in the 1970s. Once other manufacturers were tempted into the market and the watches were produced at a lower unit cost, other marketing strategies and pricing approaches are implemented. To watch the full Pricing Models video please register FREE here Premium pricing, penetration pricing, economy pricing, and price skimming are the four main pricing policies/strategies. They form the bases for the exercise. However there are other important approaches to pricing. Psychological Pricing. This approach is used when the marketer wants the consumer to respond on an emotional, rather than rational basis. For example 'price point perspective' 99 cents not one dollar. Product Line Pricing. Where there is a range of product or services the pricing reflect the benefits of parts of the range. For example car washes. Basic wash could be $2, wash and wax $4, and the whole package $6. Optional Product Pricing. Companies will attempt to increase the amount customer spend once they start to buy. Optional 'extras' increase the overall price of the product or service. For example airlines will charge for optional extras such as guaranteeing a window seat or reserving a row of seats next to each other. Captive Product Pricing Where products have complements, companies will charge a premium price where the consumer is captured. For example a razor manufacturer will charge a low price and recoup its margin (and more) from the sale of the only design of blades which fit the razor. Product Bundle Pricing. Here sellers combine several products in the same package. This also serves to move old stock. Videos and CDs are often sold using the bundle approach.
Promotional Pricing. Pricing to promote a product is a very common application. There are many examples of promotional pricing including approaches such as BOGOF (Buy One Get One Free). Geographical Pricing. Geographical pricing is evident where there are variations in price in different parts of the world. For example rarity value, or where shipping costs increase price. Value Pricing. This approach is used where external factors such as recession or increased competition force companies to provide 'value' products and services to retain sales e.g. value meals at McDonalds.
Question-16 What are International Channels and Logistic decisions? Or Question- How do the logistic decisions and marketing channels influence the business at international scenario? Answer:
International Logistics International marketing is becoming more important to companies as the worldshifts from distinct national markets to linked global markets. Globalization bringshomogenization of consumer needs, liberalization of trade, and competitiveadvantages of operating in global markets. Companies are forced to think and actglobally in order to survive in such a dynamic environment. All these elements havea deep impact on the development and the positioning of companies on internationalmarketplaces where competition is cruel. Furthermore, another significant changeconcerns the customers since they are more demanding in term of quality, lead timeand order fulfilment. In this context, firms must be more and more flexible andreactive to anticipate and to adapt to such changes. This quest for flexibility and reactivity affects the conception and the management of firms and more generally their logistic systems and contributes to the development of partnership relations, to the emergence of mergers or strategic alliances between companies. As a result, a Business Organization can no longer be considered as an isolated entity but as a component of a wider supply network. International Firms have begun to implement various strategies in order to remain competitive in world market. Logistics is one of the key areas in the process of international marketing as the delivery of goods to the buyer is as important as any other activity in business and marketing. Quite often, the most crucial part in International trade is the timely delivery of goods at a reasonable cost by the exporter to the importer. In fact, the prospective buyer may be willing to pay even higher price for timely supplies. The emergence of logistics as an integrative activity, with the movement of raw materials from their sources of supply to the production line and ending with the movement of finished goods to the customer has gained special importance. Earlier on, all the functions comprising logistics were not viewed as components of a single system. But, with emergence of logistic as an important part of corporate strategy due to certain developments in the field of international marketing has gained special significance. Before discussing the various aspects of logistics, let us look at its definition “Logistics is the process of planning, implementing and controlling the efficient, effective flow and storage of goods, services and related information from point of origin to point of consumption for the purpose of conforming the customer requirement”. This definition clearly points out the inherent nature of logistics and it conveys that Logistics is concerned with getting products and services where they are needed whenever
they are desired. In trade Logistics has been performed since the beginning of civilization: it’s hardly new. However implementing best practice of logistics has become one of the most exciting and challenging operational areas of business and public sector management. Logistics is unique, it never stops! Logistics is happening around the globe 24 hours a days Seven days a week during fifty-two weeks a year. Few areas of business involve the complexity or span the geography typical of logistics CONCEPT OF INTERNATIONAL MARKETING LOGISTICS Word, ’Logistics’ is derived from French word ‘loger’, which means art of warpertaining to movement and supply of armies. Basically a military concept, it isnow commonly applied to marketing management. Fighting a war requires thesetting of an object, and to achieve this objective meticulous planning is needed sothat the troops are properly deployed and the supply line consisting, interalia,weaponary, food, medical assistance, etc. is maintained. Similarly, the plan shouldbe each that there is a minimum loss of men and material while, at the same time, itis capable of being altered if the need arises. As in the case of fighting a war in thebattle-field, the marketing managers also need a suitable logistics plan that iscapable of satisfying the company objective of meeting profitably the demand of the targeted customers. From the point of view of management, marketing logistics or physical distribution has been described as ‘planning, implementing and controlling the process of physical flows of materials and final products from the point of origin to the pointof use in order to meet customer’s needs at a profit. As a concept it means the art of managing the flow of raw materials and finished goods from the source of supply to their users. In other words, primarily it involves efficient management of goods from the end of product line to the consumers and in some cases, include the movement of raw materials from the source of supply to the beginning of the production line. These activities include transportation warehousing, inventory control, order processing and information monitoring. These activities are considered primary to the effective management of logistics because they either contribute most to the total cost of logistics or they are essential to effective completion of the logistics task. However, the firms must carry out these activitiesas essential part of providing customer with the goods and services they desire. SIGNIFIGANCE OF MARKETING LOGISTICS The important of a logistics systems lies in the fact that it leads to ultimate consummation of the sales contract. The buyer is not interested in the promises of the seller that he can supply goods at competitive price but that he actually does so. Delivery according to the contract is essential to fulfilling the commercial and legal requirements. In the event of failure to comply with the stipulated supply of period, the seller may not only get his sale amount back, but may also be legally penalized ,if the sales contract so specifies. There is no doubt that better delivery schedule is a good promotional strategy when buyers are reluctant to invest in warehousing and keeping higher level of inventories. Similarly, better and/or timely delivery helps in getting repeat orders through creation of goodwill for the supplier. Thus, as effective logistics system contributes immensely to the achievements of the business and marketing objectives of a firm. It creates time and place utilities in the products and thereby helps in maximizing the value satisfaction to consumers. By ensuring
quick deliveries in minimum time and cost, it relieves the customers of holding excess inventories. It also brings down the cost of carrying inventory, material handling, transportation and other related activities of distribution. In nutshell, an efficient system of physical distribution/logistics has a great potential for improving customer service and reducing costs. Logistics has gained importance due to the following trends •Raise in transportation cost. •Production efficiency is reaching a peak •Fundamental change in inventory philosophy •Product line proliferated •Computer technology •Increased use or computers •Increased public concern of products Growth of several new, large retailchains or mass merchandise with large demands & very sophisticated logistics services, by pass traditional channel & distribution. •Reduction in economic regulation •Growing power of retailers •Globalization As a result of these developments, the decision maker has a number of choices to work out the most ideal marketing logistics system. Essentially, this system implies that people at all levels of management think and act in terms of integrated capabilities and adoption of a total approach to achieve pre-determined logistics objectives. Logistics is also important on the global scale. Efficient logistics systemsthroughout the world economy are a basis for trade and a high standard of living forall of us. Lands, as well as the people who occupy them, are not equally productive.That is, one region often has an advantage over all others in some productionspecialty. An efficient logistics system allows a geographical region to exploit itsinherent advantage by specializing its productive efforts in those products in whichit has been an advantage by specializing its productive to other regions. The systemallows the products’ landed cost (production plus logistics cost) and quality to becompetitive with those form any other region. Common examples of this specialization have been Japan’s electronics industry, the agricultural, computer and aircrafts industries of United States and various countries dominance in supply in graw materials such as oil, gold, bauxite, and chromium. Further more Logistics has gained importance in the international marketing with the following reasons: 1.Transform in the customers attitude towards the total cost approach rather than direct cost approach. 2.Technological advancement in the fields of information processing and communication. 3.Technological development in transportation and material handling. 4.Companies are centralizing production to gain economies of scale. 5.Most of the MNC organizations are restructuring their production facilities on a global basis. 6. In many industries, the value added by manufacturing is declining as the cost of materials and distribution climbs.
7.High volume data processing and transmission is revolutionizing logistics control systems. 8.With the advancement of new technologies, managers can now update sales and inventory planning faster and more frequently, and factories can respond with more flexibility to volatile market conditions. 9.Product life cycles are contracting. Companies that have gone all out to slash costs by turning to large scale batch production regularly find themselves saddled with obsolete stocks and are unable to keep pace with competitors’ new-product introductions. 10.Product lines are proliferating. More and more product line variety is needed to satisfy the growing range of customer tastes and requirements, and stock levels in both field and factory inevitably rise. 11.The balance of power in distribution chain is shifting from the manufacturers to the trader. iii) - OBJECTIVES OF MARKETTING LOGISTICS The General objectives of the logistics can be summarized as: 1.Cost reduction 2.Capital reduction 3.Service improvement Thespecific objectives of an ideal logistics system is to ensure the flow of supply to the buyer, the: •right product •right quantities and assortments • right places •right time •right cost / price and, •right condition This implies that a firm will aim at having a logistics system which maximizes the customer service and minimizes the distribution cost. However, one can approximate the reality by defining the objective of logistics system as achieving a desired level of customer service i.e., the degree of delivery support given by the seller to the buyer. Thus, logistics management starts with as curtaining customer need till its fulfillment through product supplies and, during this process of supplies, it considers all aspects of performance which include arranging the inputs, manufacturing the goods and the physical distribution of the products. However, there are some definite objectives to be achieved through a proper logistics system. These can be described as follows:
1. Improving customer service: As we know, the marketing concept assumes that the sure way to maximize profits in the long run is through maximizing the customer satisfaction. As such, an important objective of all marketing efforts, including the physical distribution activities, is to improve the customer service. An efficient management of physical distribution can help in improving the level of customer service by developing an effective system of warehousing, quick and economic transportation, all maintaining optimum level of inventory. But, as discussed earlier, the level of service directly affects the cost of physical distribution. Therefore, while deciding the level of service, a careful analysis of the customers’ wants and the policies of the competitors is necessary. The customers may be interested in several things like timely delivery, careful handling of merchandise, reliability of inventory, economy in operations, and so on. However, the relative importance of these factors in the minds of customers may vary. Hence, an effort should be made to ascertain whether they value timely delivery or economy in transportation, and so on. One the relative weights are known, an analysis of what the competitors are offering in this regard should also be made. This, together with an estimate about the cost of providing a particular level of customer service, would help in deciding the level of customer service. Scope of International Marketing Logistics The development of interest in logistics after industrial revolution and world war II contributed to the growth in scope of logistical activities. The following areas are the major scope of logistics: •Demand forecasting •Distribution communication •Inventory Control •Material Handling •Order Processing •Part & Service Support •Plant and Warehouse side selection •Procurement •Packaging •Salvage & scrap disposal •Traffic & transportation •Warehousing & Storage •Time & Place Utility •Efficient Movement to Customer •Return goods handling •Customers Service
• The Network of partners in the value chain that cooperate to bring products from producers to ultimate consumers
• Imagine Nike again • All those who help in bringing shoes to the consumer from the factories (or is it sweatshops ?) in Indonesia are the channel members (except transporters) • These include wholesalers, retailers, agents, brokers etc • They are called intermediaries, middlemen, dealers, resellers or distributors • However, the prevailing view is that channel members are more than just middlemen • They are comrade-in-arms • They are marketer’s first customers and partners; they add value to the marketer’s offer • What are some functions that channel members perform? Functions of Channel Members Making Products Available • This is the most obvious and first function • Retailers are critical here • As also wholesalers in rural marketsInformation • Retailers are a great source of information • Why is this so? • What makes the retailer good here? • The retailer is closest to the consumer • Hence knows more than you, the marketer • Which models are liked? Which models are moving fast, slow and so on? • Also very useful for certain institutional purchases like hotels for tiles Promotion • Channel members also indulge in sales promotion and advertising
• Deals, flyers, cooperative advertising Transfer of Title • If ITC sells 100 packets of Aashirwad aata to Nilgiris, the title is now transferred • Ownership is transferred Physical possession • Thus “your” goods are now possessed by Nilgiris • Imagine what would happen if retailers did not take physical possession? Financing • Now that Nilgiris owns it, they need to finance the inventory • Inventory always has carrying costs Risk Taking • Now the onus is on Nilgiris to sell • What if they are unable to sell? • They are stuck with the product • Hence perishables always carry a large margin e.g. vegetables • What are some other risks? • What if a kid breaks some bottles of jam in the st
Question-17. What is International accounting and how International Accounting Standards are set by different International Organizations? Or Question- What do you understand by Accounting Difference across countries? Answer: International Accounting
Comparable, transparent, and reliable financial information is fundamental for the smooth functioning of capital markets. In the global arena, the need for comparable standards of financial reporting has become paramount because of the dramatic growth in the number, reach, and size of multinational corporations, foreign direct investments, cross-border purchases and sales of securities, as well as the number of foreign securities listings on the stock exchanges. However, because of the social, economic, legal, and cultural differences among countries, the accounting standards and practices in different countries vary widely. The credibility of financial reports becomes questionable if similar transactions are accounted for differently in different countries. To improve the comparability of financial statements, harmonization of accounting standards is advocated. Harmonization strives to increase comparability between accounting principles by setting limits on the alternatives allowed for similar transactions. Harmonization differs from standardization in that the latter allows no room for alternatives even in cases where economic realities differ. The international accounting standards resulting from harmonization efforts create important benefits. Investors and analysts benefit from enhanced comparability of financial statements. Multinational corporations benefit from not having to prepare different reports for different countries in which they operate. Stock exchanges benefit from the growth in the listings and volume of securities transactions. The international standards also benefit developing or other countries that do not have a national standard-setting body or do not want to spend scarce resources to undertake the full process of preparing accounting standards. The most important driving force in the development of international accounting standards is the International Accounting Standards Committee (IASC), an independent privatesector body formed in 1973. The broad objective of the IASC is to further harmonization of accounting practices through the formulation of accounting standards and to promote their worldwide acceptance.
International Accounting Standards initially tended to be too broad, allowing many alternative accounting treatments to accommodate country differences. This was a serious weakness in achieving the objective of comparability. To gain acceptability of its standards, in 1989 the IASC undertook a project (called the Comparability Project) aimed at enhancing comparability of financial statements by reducing the alternative treatments. An important part of this effort was its work plan to produce a comprehensive core set of high-quality Standards (Core Standards project). The IASC has completed its Core Standards project, and the revised standards are a significant improvement over the earlier ones. Many other organizations also play an important role in the march toward international accounting standards. Among the more important are those discussed below. IFAC.- The International Federation of Accountants is a worldwide association formed in 1977 to develop the accounting profession, harmonize its auditing practices, and reduce differences in the requirements to qualify as a professional accountant in its member countries. It currently has a membership of one hundred and forty-three national professional organizations in one hundred and four countries representing more than 2 million accountants. The IFAC issues International Standards on Auditing (ISA) aimed at harmonizing auditing practices globally. The IFAC Council also appoints country representatives on the IASC Board (thirteen in total). UN.- Several organizations within the United Nations have been involved in international accounting standards. Its Group of Experts prepared a four-part report in 1976, "International Standards of Accounting and Reporting for Transnational Corporations." The report listed financial and nonfinancial items that should be disclosed by multinational corporations to host governments. More recently, it has worked to promote the harmonization of accounting standards by discussing and supporting best practices in a variety of areas, including environmental disclosures. OECD.- The Organization for Economic Cooperation and Development formed in 1960 currently has twenty-nine of the world's developed, industrialized countries as its members. A valuable contribution of the OECD is its surveys of accounting practices in member countries and its assessment of the diversity or conformity of such practices. Its Working Group on Accounting Standards supports efforts by regional, national, and international bodies promoting accounting harmonization. In 1998, the OECD issued "Principles of Corporate Governance" that support the development of high-quality, internationally recognized standards that can serve to improve the comparability of information between countries. EU.- The European Union, the powerful regional alliance of fifteen nations, aims to bring about a common market that allows free mobility of people, capital, and goods among member countries. To promote the cross-country economic integration, the EU has made significant progress in the harmonization of laws and regulations. Its Commission (European Commission) establishes standardization and harmonization of corporate and accounting rules through the issuance of Directives. Directives incorporate uniform rules (to be implemented exactly in all member states), minimum rules (which may be strengthened by individual governments), and alternative rules (which members can choose from). Directives are mandatory in that each member country has the obligation to
incorporate them into its respective national law. However, each country is free to choose the form and method of implementation and also to add or delete options. NAFTA-. The North American Free Trade Agreement was formed in 1993 among Canada, Mexico, and the United States to create a common market. It will phase out duties on most goods and services and promote free movement of professionals, including accountants, among the three countries. There are projects under way to analyze the similarities and differences between financial reporting and accounting standards of the member countries of NAFTA. Other organizations.- Some regional organizationsuch as the Association of Southeast Asian Nations (ASEAN), Community of Sovereign States, Economic Cooperation Organization (ECO), Baltic Council, Asia Pacific Economic Cooperation (APEC), Confederation of Asian and Pacific Accountants (CAPA), and Nordic Federation of Accountants (NFA)ave made efforts toward harmonizing accounting and disclosure standards. G4 group of standard-setting bodies in Australia, Canada, the United Kingdom, and the United States, has also started playing an important role in the harmonization of international accounting standards. The process of harmonizing international accounting standards has come a long way on a path that has been far from smooth. While some critics still doubt the need and feasibility of such standards, it is becoming increasingly clear that the question is not whether but when the Inter national Accounting Standards will be required and followed by business and other entities worldwide. The likely endorsement by the IOSCO and SEC will make that time sooner rather than later.
Accounting Difference across the Countries
Although accounting standards and practices are the same across the board in their origin, the accounting and taxation structures of different countries around the world makes them vary between countries. Different countries apply different accounting practices. This accounting diversity is the reason that one company may seem profitable while another seems to be operating at a loss, in extreme cases. The disparity between global accounting practices can lead to poor business decision-making, difficulties in raising capital in different or foreign markets, and difficulty in monitoring competitive factors across firms, industries, and nations. Their accounting practices are linked to the objectives of the parties who will use the financial information, including people like investors, lenders, and governments. While the IASC, the International Accounting Standards Committee, is trying to make a single set of high-quality, understandable, enforceable accounting standards worldwide, the USA is resisting, insisting that no standards are as good as ours. We use the GAAP, or the Generally Accepted Accounting Principles. However, through the whole Enron thing, the US standards dropped and support of the international standards was given an unexpected boost. Through the international standards and practices, Enron's accounting mistakes would have been caught long before the destruction of the whole company. A difference in accounting principles between countries, for example, would include one such as that capitalization of R&D costs are allowed in Japan, the United Kingdom, France, the Netherlands, Switzerland, Canada, and Brazil, but not in Germany or the United States.
Similarly, book and tax timing differences being recorded on the balance sheet as deferred taxes is required in the United States and the Netherlands, but merely allowed in some cases in the other countries. These accounting differences could really cause conflict between countries because of international transactions and stuff. There are substantial questions of competitive advantages and informational deficiencies that may result from these continuing differences across countries, and the differences from the accounting practices from across different countries are very real and persistent. Some of the differences between countries include fixed asset revaluations stated at an amount in excess of the cost, inventory valuation using LIFO, finance leases capitalized, pension expense accrued during period of service, current rate method of currency translation, pooling method used for mergers, and an equity method used for 2050% ownership. The way of accounting between many countries are very different, especially in what is and is not allowed. The differences in accounting principles between countries could really cause inconsistencies between international operations. Maybe if an international standard were set for all countries, there would be less quarreling and more agreement in accounting between countries. That way there would be less discrepancy in the accounting principles and the balance sheets for each country.
Question-18. What are significant Cross Culture challenges in International Business and what are the solutions to cross culture challenges? Or Question- How the cross cultures challenges and their solutions can be integrated in business organizations dealing with global texture? Answer : Cross Culture Challenges in International Business
Cross National Differences In recent years, with the increase in globalization and diversity in the workplace, cross cultural management has become an important element of organizational. Culture can be analyzed from a country, language, religion, value, ethical and/or many other areas of study as a frame of reference. The main cross national differences are· Social & cultural Environment Social structure of the society Values and belief of people · Political environment · Legal system · Education system and standard · Quality of quantity knowledge work force
· Level of available technology Global HR issues Global human resource strategy is the framework built around managing a global workforce; including recruiting, hiring, setting compensation levels and benefits, and retaining workers in a global organization. Global companies must make decisions about hiring locally, recruiting expatriates, or utilizing emerging new worker groups to fill the needs of a particular region. Additionally, global HR strategy must consider the complexities of regional government interaction with the business, as well as social programs that may compensate for benefits offered by the employer in other regions. Other global HR issues that impact the development of a cohesive strategy include cost of living, local pay scales, retention issues, pension issues, organized labor, and regional leave policies. A)-Standardization and adaptation of HR practices 1 .Host country culture and work place environment 2. Firm’s size, maturity and level of international experience 3. Mode of operation B).Retaining, developing and retaining local Staff C). HR implication of Language Standardization D). Monitoring HR practices of host Country Managing Multiculturalism Cultural diversity Cultural diversity is the variety of human societies or cultures in a specific region, or in the world as a whole. Human have spread throughout the world, successfully adapting to widely differing conditions and to periodic cataclysmic changes in local and global climate. The many separate societies that emerged around the globe differed markedly from each other. Cultural differences that exist between people, such as language, dress and traditions, there are also significant variations in the way societies organize themselves, in their shared conception of morality, and in the ways they interact with their environment. Most people would agree that cultural diversity in the workplace utilizes country’s skills to its fullest, and contributes to overall growth and prosperity. Diversity at its core is about people and the behavioral characteristics that guide how we interact, i.e. “culture.” To better understand this notion, let’s examine the impact of culture within our workplace organizations. Several aspects of culture shape today’s workplace. For example, employees’ communication style, time consciousness, and work practices all stem from their cultural programming. The dominant cultural norm here in the United States dictates that business communication be specific and explicit. Meaning is found in the actual content of words with very little left to interpretation. However, in many ethnic
and international cultures, communication is more implicit and indirect: meaning is found in and around the words themselves. By better understanding the cultural norms and values within their organization, leaders and their units benefit. When this enhanced comprehension becomes a way to guide efforts, hiring practices, and employee relations strategies, diversity initiatives move away from lip service and become actualized. An honest cultural audit of an organization not only helps drive diverse policies and procedures, but goes far in the creation of welcoming workplace communities in which genuine cross-cultural interaction and respect for diversity are naturally occurring. And as an organization’s culture is identified and shared, diverse employees are more likely to express their cultural uniqueness within the context of stated organizational norms and values. When organizational culture and individual human values work together, there can be synergy: the interaction or cooperation of two or more entities to produce a combined effect greater than the sum of their separate effects. That is a definition of diversity in which we can all find meaning. Reasons for Expatriate Failure • Inability of spouse to adjust • Manager's inability to adjust • Other family reasons • Inability to cope with larger international responsibility • Difficulties with new environment • Personal or emotional problems • Lack of technical competence Factors of Expatriate Selection (a)Technical ability (b)Cross- cultural Suitability (c)Family Requirements (d)language (e)Cross- cultural Requirements Training for Expatriates: An expatriate needs following trainings to cope with cross cultural challenges: (1) cultural training, (2) language training, and (3) practical training. Cultural Adjustment of expatriate An expatriate's cultural adjustment typically comprises three stages . 1st Stage : Tourist Stage the expatriate enjoys a great deal of excitement as he or she discovers the new culture. This stage is called the tourist stage.
2nd Stage Disillusionment: In this stage, the curve hits the bottom and is characterised by what is called culture shock. 3rd Stage : adapting or adjustment phase. If culture shock is handled successfully, the expatriate enters the third stage, which may be called the adapting or adjustment phase.
Solutions to the Cross Culture Challenges in International Business
Globalisation, the expansion of intercontinental trade, technological advances and the increase in the number of companies dealing on the international stage have brought about a dramatic change in the frequency, context and means by which people from different cultural backgrounds interact. Cross cultural solutions to international business demands are increasingly being viewed as a valid and necessary method in enhancing communication and interaction in and between companies, between companies and customers and between colleagues. Cross cultural consultancies are involved in aiding companies to find solutions to the challenges cross cultural differences carry. International and national businesses are ultimately the result of people. As with incompatible software, if people are running on different cultural coding, problems can occur. Cross cultural consultancies therefore concentrate their efforts on interpersonal communication. Different cultures and cultural backgrounds between a highly diverse staff base brings with it obstacles, challenges and difficulties. Cross cultural differences manifest in general areas such as in behaviour, etiquette, norms, values, expressions, group mechanics and non-verbal communication. These cross cultural differences then follow on through to high level areas such as management styles, corporate culture, marketing, HR and PR. In order to overcome potential pitfalls, specialist attention is required in the form of a cross cultural consultant. As one would approach a doctor for a medical diagnosis or an accountant to examine finances, cross cultural consultants offer the expertise, experience and know-how to diagnose problems and provide solutions to interpersonal cultural differences. Within Business organizations there are many facets in which cultural differences manifest. Some key areas which cross cultural consultants deal with include, but are not exclusive to, the following: Cross Cultural HR: HR covers a wide range of business critical areas that need cross cultural analysis. Consultants may offer advice on a number of areas including recruitment, relocation, international assignments, staff retention and training programmes. Cross Cultural Team-Building: in order to have a well functioning business unit within a company, communication is critical. Cross cultural consultants will provide tools and methods to promote staff integration, reduce cross cultural conflicts and build team spirit.
This is essentially done through highlighting differences and building on strengths to ensure they are used positively. Cross Cultural Synergy: international mergers, acquisitions and joint-ventures require people from different cultural backgrounds to harmonise in order to succeed. Cross cultural consultants counsel on group mechanics, communication styles, norms, values and integration processes. Cross Cultural Awareness Training: working with colleagues, customers or clients from different cultural backgrounds, with different religions, values and etiquettes can occasionally lead to problems. Cross cultural awareness training is usually a generic introduction into a culture, country, region or religion. The aim is to equip the trainee with the adequate knowledge to deal comfortably with people from different cultures, avoiding misunderstandings and mistakes. Cross Cultural Training for Expatriate Relocation: staff that travel overseas need to understand the cultural basics of the host country or region. Knowledge of the country's history, culture, laws, traditions, business practices and social etiquettes all help to minimise the impact of culture shock and hence smooth their transition overseas. Cross Cultural Negotiations: equipped with their knowledge of the two or more cultures that can be meeting around the negotiation table, a cross cultural consultant advises on areas such as negotiation strategies, styles, planning, closure and etiquette in order to increase the chance of a successful outcome, free from misunderstandings, suspicions and general cross cultural communication breakdown. Cross Cultural PR Consultancy: brand image, public relations and advertising are all areas companies must be careful of when moving out of the national context. Tastes and values change dramatically from continent to continent. It is crucial to understand whether the brand name, image or advertising campaign is culturally applicable in the target country. Cross cultural consultants examine words, images, pictures, colours and symbols to ensure they fit well with the target culture. Cross Cultural Language Training: Language training is an area where little investment is made by companies, but where the business advantages are great. Linguistic knowledge goes a long way in bridging cultural gaps and smoothing lines of communication. Cross cultural consultancies provide language training to business staff, moulding their learning to the business environment in which they work. In conclusion, clearly the role and expertise of cross cultural communication consultants is important for today's international business. The potential pitfalls cross cultural differences present to companies are extensive. In essence a cross cultural consultant's primary objective is integration. This integration, between colleagues, clients and customers is crucial for business success. Equipped with experience, knowledge and above all objectivity, a cross cultural consultant creates bridges of understanding and opens lines of communication
Question-19. What do you understand by International Staffing decisions? Explain in detail. or Question- How an International Business Organization go for the procurement of its human resources in a systematic and perfect manner? Write in detail. Answer:
In International Business Organizations it is very crucial to procure suitable human resources of to take international staffing decisions. In fact it is a perfectly sequential process in which first we will go for human resource planning at international level then we will move recruitment and selection process according to international scenario.
1. International Human Resource Planning
International Human Resource Planning can be defined as the process by which an International business organization ensures that it has the right number of people of right competencies at the right positions and places, at the right time and capable of effectively & efficiently accomplishing all the tasks to achieve its overall goals & objectives. In fact the process of International Human Resource Planning basically translates the organizational plans & objectives to the number of exactly capable employees required at different foreign locations to achieve those objectives according to decided plans. a. Objectives & Policies of International Business Organization: Organizational objectives and policies at international levels are thoroughly studied in context with the future vision. International Human Resource Planning must be based on organizational objectives and it must cope with the organizational policies. The objectives of Human Resource Plans are designed after the conceptualization and as according to the overall Organizational objectives & policies. b. International Human Resource Needs Forecast: Human Resource need forecast at international level is very essential for the process of International Human Resource Planning. It is the process of estimating the future requirement of the quantity & quality of Workforce in the International Business Organization. International Human Resource need forecast is not a rough guess work only rather it considers both internal as well as external factors. The internal factors include production plans & their levels, new products and services, organizational structure, international organizational budget and organizational plans for employee separation. The external factors cover competition, economic environment, law making bodies, fastly changing global scenario in field of technology or social understanding. As we have already discussed International Human Resource need forecast is based on various factors but the techniques being used for this forecasting also matters a lot as another factor. There are so many Human Resource needs forecasting techniques such as Expert
Judgment, Trend analysis, Job analysis, Work Study Techniques, Delphi Technique and Budget & Planning analysis. c. International Human Resource Supply Forecast: International Human Resource need analysis provide the HR practitioners an estimate of the number and kind of employees that will be required to the global organization at different locations for coming future but this is not enough. The next step for Human Resource Practioners is to be aware of the futuristic situations whether the organization will in a position to procure the required number of employees of required skills & capabilities at different locations along with the source of such procurement. For this information International Human Resource supply forecast is required to be conducted for so many valid reasons. These reasons are (a) International Human Resource Supply forecast helps the business organization to ensure the availability of the quantity of employees along with their expected skills and positions. (b) International Human Resource Supply forecast helps the organizations to have an analytical screening & assessment of its existing workforce. (c) International Human Resource Supply forecast save the organization from the sudden shortage of workforce where and when it is highly needed. The analysis of International Human Resource Supply covers three major factors 1. Existing Human Resource at different levels and locations with different skills & qualification. 2. The internal sources of Human Resource Supply at International level. 3. The external sources Human Resource Supply at International level. The International Human Resource Supply forecast is so important that it measures the number of specific employees likely to be available from within or outside an organization. International Human Resource Supply forecast is just like creating a skill inventory for global organizations with consolidated information. d. International Human Resource Programming: International Human Resource Programming is the forth step in the process of International Human Resource Planning. After forecasting the demand and supply of Human Resource an International business organization has to formulate a program for its Human Resource Requirements at International level as according to its corporate objectives. International Human Resource need forecast and International Human Resource supply forecast both these must be reconciled or balanced in such a way that organization can ensure the vacancies be filled by right kind of employees with right skills at right time. This is called International Human Resource Programming. e. Implementation of International Human Resource Plan: Formulation of any plan is useless if implementation is not carried out in a proper manner at predetermined & appropriate time. Implementation of International Human Resource Plan requires converting conception of the plan into action in real terms. A series of action programs such as Recruitment, Selection, Placement, Training & Development, Retaining, Succession Planning & Redeployment are initiated as a part of Human Resource plan implementation.
2. International Recruitment
International Recruitment attracts a large number of qualified applicants who desire to work in a global or international organization. The recruitment information given by the global companies helps the qualified candidates who are willing to work to send their resume, along with a letter expressing their desire to work. It also helps the unqualified candidates to self select themselves out of the job candidacy. Thus, the accurate information provided by the global or international business organizations attracts the qualified and repels the unqualified candidates. Thus, recruitment helps the global or international business organizations in finding out potential candidates for actual or anticipated vacancies in the company.
Traditional Sources of Recruitment by International Business organizations
International or Global business organizations use the traditional sources of recruitment, which are appropriate for finding the right candidates. These Traditional sources of recruitment are classified as Internal Sources and External Sources a. Internal Sources - Internal sources are traditional sources from within the organization. International business Organization prefers to depend upon internal sources in order to build good public relations, build employee morale, and to retain the competent employees. In addition, internal recruitment is less expensive and enhances good selection, as the employee’s performance is in accordance with the organizational requirements and the employees are adjusted to the company’s culture. Internal sources include existing employees and past employees.
Existing Employees - Global business organizations consider the present employees for the
present and future vacancies at both the parent organization and subsidiaries in various countries. The techniques of recruiting the candidates from the source of present employees include promotion and transfers. The global business organizations fill the vacancies by promoting the qualified candidates and by promotion culturally fit candidates from the lower levels or by transferring the candidates. Previous Employees - Global business organizations started depending upon this source due to job-hopping and high rate of business fluctuations in high technology based industries. The advantage of this source of previous employees is that the candidate’s performance and behavior fit to the business organization and its culture and also the compensation suit the candidate expectations. b. External Sources - External Sources are those sources, which are the organizational pursuits. Global business organizations search for the required candidates from these sources. The reasons for searching for the candidates from these sources include availability of candidates with required skills, knowledge, talent and cultural background, possibility of selecting the candidates without any preconceived notion or reservation. The sources of external recruitment generally include: 1. Multi National Companies visit the premier institutes and select the candidates. 2. Private employment agencies or Consultants like Global placements. 3. Public employment agencies like Ministry of Foreign Affairs.
Professional organizations. Databanks maintained by the global organizations. Causal Applicants through Internet services and various websites. Similar organizations at International level The International or Multinational business organizations mostly use the modern recruitment sources, in addition to the sources listed above. Modern Techniques of International Recruitment The international business organizations in addition to traditional sources and techniques are using a number of modern recruitment techniques and sources. These Techniques include walk in and consult in, headhunting, body shopping, business alliances, and telerecruitment. Walk-In - The busy global business organizations and the rapid changing companies do not find time to perform various functions of recruitment. Therefore, they advise the potential candidates to attend for an interview directly and without a prior application on a specified date, time and at a specified place.. Consult–In - The busy and dynamic international business organizations encourage the potential job seekers to approach them personally and consult them regarding the jobs. Head-hunting - The International business organizations request the professional organizations to search for the best candidates particularly for the senior executive positions. The professional organizations search for the most suitable candidates and advise the International business organizations regarding the filling up of the positions. Head–hunters are also called search consultants. Body Shopping - Professional organizations and the hi-tech training institutes develop the pool of human resources for the possible employment. The prospective employers contact these organizations to recruit the candidates. Otherwise, the organizations themselves approach the prospective employers to place their human resources. These professional and training institutions are called body shoppers and these activities are known as body shopping. Business Alliance - Business Alliances like acquisitions, mergers, and take over helps in getting human resources. In addition, the International business organizations do also have alliances in sharing their human resources on ad-hoc basis. Tele-Recruitment - The technological revolution in telecommunication field helped the International business organizations to use Internet as sources of recruitment. Organizations advertise the job vacancies through the World Wide Web www Internet. The job seekers send their applications through e-mail or Internet websites. Modern Sources of International Recruitment Modern Sources of global recruitment include: Parent country nationals, Host country nationals and third country nationals. Parent Country Nationals - Parent Country Nationals are employees of a business organization or its subsidiaries located in various countries who are the citizens of the country where the headquarters of International business organizations is located. Parent country nationals in international business normally are managers, heads of subsidiary companies, technicians, troubleshooters and experts. They visit subsidiary companies and operations to help them in carrying out their operations, to ensure their smooth
4. 5. 6. 7.
functioning and control them. However, sending parent country nationals involves cost and causes ego and cultural problems. Host Country Nationals - Host Country Nationals are the employees of the subsidiary of International business organizations who are the citizens of the country where the subsidiary is located. Employing host country nationals is advantageous as they are familiar with native culture, local business norms and practices, local bureaucrats, market intermediaries and suppliers of inputs so they can manage local workers efficiently. They also know the tastes and preference of the local customers. But sometimes they may not be familiar with the objectives, goals and strategies of the parent business organizations and the needs of the headquarters. Third Country Nationals - Third Country Nationals is an employee of a subsidiary of International business organizations located in a country, which is not its home country. The software professional of India work in American Subsidiaries located in various countries of Europe are called third country nationals. The advantage of employing Third Country National includes less cost with required expertise, skill knowledge and foreign language skills and cultural fit due to work experience in multicultural environment. However, the local government may impose conditions and regulate in employing third country nationals.
3. International Selection Decisions
International business organizations need people with higher order skills, balanced emotions, and ability to adjust to multi-cultural environment. Hence the selection process of International business organizations varies from that of a domestic business organization. Selection process of an International business organization includes selection procedure, selection approach and selection methods.
The International business organizations conduct the selection procedure after receiving the applications from qualified candidates. The selection procedure includes: Appraisal of Application or Resume - The candidate’s qualifications, family background, experiences, age, skill are provided in the resume’ are analyzed and compared with the job analysis in order to find the match between the job and candidates. Some of the candidates are selected at this level for further stages. Written Test - Candidates found suitable at the first level are called for written test. The written test examines the candidate’s knowledge in the job related areas and aptitude. Some candidates are selected at this stage based on their scores. Preliminary Interview - The selected candidates at the previous stage are called for preliminary interview. The purpose of preliminary interview is to solicit necessary in formation from the prospective candidates and to assess the applicant’s suitability to the job. Psychological Tests - Psychological Tests are conducted to the selected candidates. The International business organizations conduct various tests to screen the candidates. The important among are Aptitude Tests, Intelligence Test, Skill Test, Mechanical Aptitude
Test, Psychomotor Test, Job Knowledge Test, In-Basket Games, Interest Test and Personality Tests. Secondary Interview - International business organizations thoroughly examine the candidate regarding his or her suitability to the job through interview process. The International business organizations use video conferencing or telephonic interview rather than conducting physical interview, as the former is less costly. The candidates selected at the previous stage are called for final interview. Medical Test - In fact, due to the variations in climate conditions in various International business organizations give more weight age to the health and medical fitness of the candidate. Hence, International business organizations insist complete medical check-up of the candidate to check his or her suitability. Reference Checks - Despite the conduct of various selection tests, it would be very difficult to the International business organizations to get reliable information regarding the candidate’s preference, skill, values, ethics etc., through application, tests and interview. Hence, International business organizations rely mostly on reference letters for this purpose. Reference checks play vital role in the selection process of International business organizations. Final Decision - The International business organizations take the final decision regarding the candidate’s selection based on the scores of the tests and interview. A global firm takes the final decision very carefully. Employment- Thus, after taking the final decision, the International business organizations intimated its decisions to the selected candidates and they communicate their acceptance. International Selection Approach Selection policy is vital in global business as it deals with the various types of people, jobs and placement. In fact, selection policy contributes for the achievement of the strategic goal of International business organizations. There are three types of approaches followed in selection policies in International business organizations viz., the ethnocentric approach, the polycentric approach and the geocentric approach. The Ethnocentric Approach - Under this approach, parent country nationals are selected for all the key management jobs. The Polycentric Approach - Under this approach, the host country nationals fill the positions including the senior management positions of the subsidiaries. The Geocentric Approach - Under this approach, the most appropriate candidates are selected for jobs from any part of the globe. International business organizations generally follow this approach International Selection Techniques International business organizations require the human resources adaptable not only to the job and organizational requirements, but also to the emotions of the people of difference countries of the world. As such, the selection techniques for global jobs vary from that of domestic jobs. The selection techniques for global jobs are: a. Screening the background of the applicant. b. Conducting tests to determine the candidate’s suitability to the job norms. c. Conducting tests to evaluate the candidate’s suitability and adaptability to the new culture and environment.
d. Conducting tests to evaluate the suitability and adaptability of candidate’s spouse and family members to the new culture and environment. e. Predicting the adjustment of the candidate, his or her spouse and family members to the new job, culture of the company, country and the new environment. The candidate must be asked specifically structured questions relating to His or her adjustment, Interaction with the host nationals, Technical competence, Cultural novelty, Family situation and Communication skills.
International or Global Business Organizations, after selecting the candidates place them on the jobs in various countries, including the home country of the employee. However, the employees of the International Business Organizations are also placed in foreign countries. Even those employees who are placed initially in their home countries are sometimes transferred to various foreign countries. Thus, the employees of International Business Organizations working and living in foreign countries and their family members living or working in foreign countries are called Expatriates in the foreign country. Expatriates are those living or working in a foreign country. The parent country nationals working in foreign subsidiary and third country nationals are expatriates. Large numbers of expatriates normally have adjustment problems with the working culture of the International Business Organization, culture of the foreign country or laws of that country. Some expatriates adjust themselves easily, while some others face severe problems of adjustments. Such employees may leave their assignments in between and return to home country by terminating their work contracts. Many Indian expatriate in some gulf countries could not adjust to the culture and returned India before their assignments are completed. Thus, the major problem with expatriates is adjustment in the new international environment.
International Adjustment - International Adjustment is the degree to which the
expatriates feel comfortable living and working in the host country culture. This significantly influences job performance. The expatriate is completely new to the host country environments, social rules, norms etc. The expatriates have a strong desire to reduce psychological uncertainty in the new environment. Psychological uncertainty is also called cultural shock. Cultural Shock – It may be defined as frustration and confusion that result from being bombarded by uninterruptible cues. For example, students in USA drink beverages in the classroom; students in African countries leave the class immediately after the close of the lecture but before the teacher leaves the class, people in USA wish you immediately when there is eye-to-eye contact with you. These cultural differences cause cultural shock to Indians. Researchers found that to a large degree cultural shock follows the general pattern of a Ushaped curve. This figure presents the relationship between culture shock and the length of
time the expatriate has been working in the host country’s culture. The ‘U’ is divided into four stages, viz., honeymoon, culture shock, adjustment and mastery. Honeymoon stage - The expatriate and his or her family members are fascinated by the culture of the host country, the different accommodation, the transportation facilities and educational facilities to the children during the early stage of arrival. This stage last up to a period of three to four months. Culture shock stage - The International Business Organizations take care of the new arrivals and completely neglects the previously arrived employee and his or her family after three four months. During this stage, the employees have to take care of themselves and their family members. Expatriates may get frustrated, confused and unhappy with living and working abroad. Their social relations are disillusioned during this stage. The shock of the existing culture may trouble them. Adjustment stage - Gradually the expatriates start learning the values, norms, behaviour and culture of the people in host country and adjust themselves to the culture of the host country. Mastery stage - The expatriates concentrate on working efficiently after adjusting themselves with the culture of the host country. They learn and adapt the new environment thoroughly and become like citizens. Now in this stage the Expatriates behave and function like the citizens of the host country.
Dimensions of International Adjustment - It is very significant to understand the
major dimensions of International Adjustment, which are three in numbers as adjustment to the foreign workplace, adjustment to interacting with the host nationals and adjustment to the general environment of foreign host country. The research studies discovered certain skills, which would help both the individual expatriate and international organizations in dealing with the adjustments. There are four dimensions of adjustment skills as Individual, Job, Organization culture, and Non-Work dimensions. Individual Dimension - Individual Dimension includes the skills and the capabilities that an individual expatriate possess. There are three sets of individual skills such as selfefficacy, Interpersonal and Perceptual skills are: Self-Efficacy Skills - The expatriate must have self-confidence, self-esteem and mental hygiene. He or she must be able to keep mental and social health with a feeling of being able to control or deal with surprises from cultural environment of the host country. Areas of self-efficacy are stress reduction, technical competence and reinforcement substitution. Interpersonal Skills -Interpersonal Skills include expatriate’s ability, desire and tendency to interact, mix or involve and develop relationships with host nationals. Perceptual Skills - These skills include expatriate’s ability to understand the behavior of the host nationals, their practices, belief, liking disliking and culture. These skills reduce the degree of psychological uncertainties associated with cross-cultural experiences. Job Dimensions – It is understood that the expatriate must have required skills, knowledge and abilities to carry out the job successfully in the host country. However, certain factors like Role clarity, Role Discretion, Role Novelty and Role conflict help or hamper the expatriate’s adjustment in the host country.
Role Clarity - Role clarity deals with the degree of clarity that the employee understands the
job duties, responsibilities, tasks, demands and roles.. Role Discretion - Role discretion is the degree of flexibility of work place rules, regulations, expectations, procedures and policies. Role Novelty - Role Novelty refers to the degree of distinctiveness of the duties, responsibilities and the tasks of the new job compared to those of the old job in the home country. Role Conflict - Role conflict occurs when the expatriates start receiving conflicting signals regarding their roles, duties, and behavior and performance levels from the people at work place. Organizational Culture Dimension - Organizational Culture is very significant in International human resource management. It is pattern of basic assumptions innovated, discovered or developed by the organizational group as it learns to cope with its problems of external adaptation and internal integration that had worked well enough to be considered valuable, and, therefore, to be taught to new members as the most accurate way to perceive, think and feel regarding those problems. Every business organization has its own culture with different rules, regulations customs, traditions, norms, expectations and the expatriates are informed of this culture. Similarly, the expatriate must also learn culture of the new organization in the foreign country. The expatriates may find it difficult during the early days of their assignments due to the cultural novelty but gradually they learn and adapt it. Non-work Dimension - The non-work dimension includes culture novelty and adjustment of spouse or family. Culture Novelty - Culture Novelty includes differences in values, beliefs, norms, religious faith, sex roles or myths. The degree of culture novelty is more, if these factors of the host country differ much from those of the home country of the expatriate. Spouse or Family Adjustment - The adjustment with the host country and its environment may be a factor of decision to leave the host country before the contract expires, if the spouse and family members of the expatriate fail to adjust to the host country’s culture. Some of the Indian expatriates decided to leave as their wives fail to adjust to foreign culture regarding sexual relations and marriage system particularly when their female children enter the teenage and force the husbands to leave the foreign job and country.
Question-20. What is Compensation? How an International Business organizations work out their Compensation decisions? or Question- What are the fundamentals and Components of International Compensation? Answer:
Compensation of Human Resources
Compensation of Human resource is a form of insurance providing wage replacement and medical benefits to employees injured in the course of employment in exchange for mandatory relinquishment of the employee's right to sue his or her employer for the tort of negligence. The trade off between assured, limited coverage and lack of recourse outside the worker compensation system is known as "the compensation bargain." While plans differ between jurisdictions, provision can be made for weekly payments in place of wages (functioning in this case as a form of disability insurance), compensation for economic loss (past and future), reimbursement or payment of medical and like expenses (functioning in this case as a form of health insurance), and benefits payable to the dependents of workers killed during employment (functioning in this case as a form of life insurance). General damages for pain and suffering, and punitive damages for employer negligence, are generally not available in workers' compensation plans, and negligence is generally not an issue in the case. These laws were first enacted in Europe and Oceania, with the United States following shortly thereafter.
International Compensation and Benefits
Business Organizations with worldwide operations need to develop compensation plans for employees that are in line with their global business strategy. Companies that articulate a clear global pay philosophy and develop the corresponding compensation programs are best positioned to effectively execute their strategy, since executives and key contributors around the globe are unified on a common set of goals. The idea of integrating a company's global rewards strategy for executives with business objectives is not new. What gets less attention is the process and elements that companies should analyze when developing a truly global compensation program. Before a company can design a program, it must assess where it falls currently on the "global" spectrum. For instance, an "international" company might have an R&D center in the U.S, manufacture in a low-cost region, and send expatriates to help execute the business strategy in a particular region or country. A company that is truly global operates seamlessly across borders, developing products and services at various locations around the world. Typically, truly global companies have executives that hail from a variety of countries. Top 5 consultants have assisted established multi-nationals and emerging growth companies by helping them assess where they are on the global spectrum and in determining what types of compensation programs are needed to help globalize the company. This entails reviewing current programs and assessing their effectiveness as a company continues to expand internationally. We then begin designing, as appropriate, the following:
Global and local salary structures (who should participate in the global pay plan?) Annual incentive programs (what target levels are appropriate for various regions, and what performance measures are needed?)
Long-term incentive programs specific to each country (what equity vehicles are appropriate for specific countries when considering local laws and employee expectations?) Overall global employee stock ownership (to what extent can broad based equity programs such as ESPPs be rolled out internationally?) Expatriate policy development (what policies need to be in place?) Communications plans (how do you communicate your plans to ensure that managers and employees understand them and make best use of them?)
Apart from the career opportunities, International Compensation and benefits are the most important and major factor of attraction for the expatriate employees to accept the international assignment. It is the amount of remuneration paid by the International Business Organizations to the expatriate employees in return to their services and contribution to the organization. International Compensation includes the amount of salary, foreign allowances, the different kinds of fringe benefits and employee’s welfare, bonus, profit sharing, stock options and the like. International Business Organizations give a number of benefits to their expatriate employees in addition to the salary. These benefits include Air fare, Paid leave, Medical allowance and Conveyance allowance, Educational allowance for employee’s children, Gratuity, Resettlement allowance and Profit sharing employee’s stock option in some cases. Significance Of International Compensation – In International Human resource Management, Compensation plays the most vital role as expatriate employees leave their home country, relatives and friends mostly to earn money and better prospects. Some employees even sacrifice the family life in order to make good money at the shortest span of time therefore the International Business Organizations must give due importance to the international compensation plans failing which they will not be able to procure human resource with higher skills and potential. The International Business Organizations have to formulate and administer the international compensation and benefits very carefully as mostly employee’s satisfaction and work performance are based on alluring compensation and expatriate employees compare the pay of different employees with their skill, knowledge performance. Objectives of International Compensation - International Business Organization formulate the compensation policy with the specific and well-defined objectives as follows: 1. International Compensation is designed to acquire qualified and competent candidates. 2. It helps to retain the present competent employees with high performance. 3. It is formulated to secure equity between employee performance and salary levels. 4. Attractive International Compensation ensures desired employee behavior. 5. International Compensation is designed to pay according to the content, difficulty of the job and in tune with the effort and merit of the employees. 6. International Compensation helps to simplify collective bargaining procedure and negations.
7. International Compensation is used promote organization feasibility. Factors affecting International Compensation - International Compensation is directly as well as indirectly affected by a number of factors in International Business Organizations, which are as follows: 1. Compensation levels in comparable International Business Organization 2. Ability of International Business Organization to pay 3. Cost of living in various countries of international assignments. 4. Potential and Productivity of expatriate employee. Compensation Plans in International Business Organizations In International Compensation Management two major issues involved are national economic differences and payment practices. The second issue is the mode to payment to expatriate employees. There are significant differences in the compensation levels and structures among different countries. This is because; the International Business Organizations have to compensate the expatriates employees based on the local compensation levels. Expatriate pay – In most of the International Business Organizations Expatriate pay is based on the balance sheet approach. Under the balance sheet approach, the compensation package enables the Expatriate employee in various countries to maintain the same standard of living. Gratuity - Gratuity is the inducement to the expatriates to work for quite longer period in the foreign country. Expatriate employees are paid gratuity at a fixed rate for every year of completion of service in the foreign country. Allowances in International Compensation - Expatriate employees are paid various allowances like car allowance, resettlement allowance, housing allowance, hardship allowance, cost of living allowance, education allowance, medical allowance etc. Taxation - Some countries pay tax-free salary or tax-free gratuity. Most of the countries pay taxable salary and gratuity. Compensation for expatriate employees includes: Profit Sharing and ESOP - The International Business Organizations or multinational corporations have introduced a scheme of profit sharing in order to motivate the expatriate employees for improved and higher performance. Under this scheme, if the profit of International Business Organization cross a certain limit, the employees with foreign assignment get a right have a share in the net profit of the organization to motivate them. The expert and efficient employees go on shifting to the other organizations, which pay higher salary and offers better facilities. Another plan introduced to motivate the employees and to retain them is the Employee Stock Ownership or ESOP. It allows the employee to purchase the share or stock of the company at a fixed and reduced price. Employees are motivated when the company allows them to buy the shares at concessional price. The stock ownership is viewed as performance based incentives. In corporate world this plan is described as Golden Hand- cuffs.
The advantages of Employee stock ownership plan include: 1. ESOP increases employee involvement and participation. 2. This plan links compensation package closely to performance. 3. The plan enables the International Business Organizations to improve their performance. 4. This scheme establishes significance of team effort among employees. Fundamentals of International Compensation Increasingly, today, globalization is a reality for organizations of almost any size. Only the smallest companies seem unaffected by the disappearance of global boundaries among organizations, markets, and people. Globalization has increased awareness of and concern for creating internationally equitable compensation systems in many companies. The complex nature of international compensation dictates that it receives special attention from organization operating in a multinational environment. It is crucial that organizations understand the kind of employees employed by international firms, the elements that comprise an international compensation system, and the special problems associated with returning citizens on overseas assignments to their home corporation. An expatriate, sometimes referred to as an expat, is a citizen of the country in which the organization's headquarters is domiciled. For example, an American working for U.S. subsidiary or branch located in Thailand is an expatriate. An organization may elect to send a domestic employee or manager to an overseas assignment for any number of reasons: to broaden an employee's or manager's perspectives relative to international operations, to start or staff new ventures, to train local employees, to utilize specific expertise possessed by the employee, to protect the organization's interests, to help develop the employee or manager, to assist in the transfer of technology or skills, or to market products. Evidence suggests that American firms use expatriates to a much lesser extent than do Japanese firms. Components of International Compensation Compensation for employees of U.S. organizations operating in an international environment consists of four components: base salary, indirect monetary compensation (benefits), equalization benefits, and incentives. Base Salary. Two alternatives exist for determining base salary for an expatriate: (1) adhering to the established policies and procedures of the parent company's country, including formal job evaluation; or (2) following the policies and practices of the country in which the expatriate works. Since many international assignments are for short durations, usually 3 to 5 years, it may be wise to keep base salary aligned with salaries in the home country. Doing so makes the transition back to the U.S. less complicated since major salary changes do not have
to be made. Indirect Monetary Compensation (Benefits). The benefits package for expatriates is generally the same as the one provided in the home country. However, an organization must be aware that specific countries require benefits that may not be offered in the home country. For example, in France employers are required by law to provide every employee with 25 days of vacation. Although an American working for an American company in France is not legally entitled to such a vacation, the organization may want to follow this practice to avoid morale problems with expatriates. Other countries have retirement, disability, and termination that are different from the U.S. Equalization Benefits. These benefits are intended to keep expatriates in the same financial condition they were in before accepting an overseas assignment and to reduce any negative aspects of living in a foreign country. A limited selection of the benefits available includes the following: * Housing allowance * Educational allowance for children * Foreign service premium * Assignment completion bonus * Emergency leave * Home leave * Language training * Domestic staff * Club membership * Spousal employment * Cultural training for family This list only scratches the surface of the equalization benefits that can be offered in terms of financial allowances, social adjustment assistance, and transitional support for the expatriate's family. Incentives. Expatriates may receive a variety of incentives ranging from cash bonuses of various kinds, to stock options, and performance-related payments. Crafting an effective international compensation plan requires a careful
consideration of the various types of compensation as well as the specifics of the assignment and employee involved. The Problem of the Repatriation While some may regard an overseas assignment as glamorous, others may also view it as hindering career progression. Organizations must be sensitive to those employees it is considering sending on overseas assignments. The organization must provide as much information as possible about returning from an international assignment. This repatriation policy must be well thought out and incorporated into a repatriation plan. Additionally, organizations must provide information about career path opportunities for employees accepting overseas assignments. The organization must do as much as possible to let employees working abroad know that they will not be forgotten and will be re-assimilated into the organization upon their return to the home country. Failure to have a sound repatriation policy and plan will make it difficult to get sufficient numbers of employees to accept international assignments.
Question –21. What is Risk Management? What type of risks are involved in International Business and how these risks are handled and managed at International Business Scenario? Or Question- Define and explain Risk Management. What are the basic techniques of risk management in international business? Answer:
Risk Management is the name given to a logical and systematic method of identifying, analyzing, treating and monitoring the risks involved in any activity or process Risk management is the identification, assessment, and prioritization of risks (defined in ISO 31000 as the effect of uncertainty on objectives, whether positive or negative) followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities. Risks can come from uncertainty in financial markets, project failures (at any phase in design, development, production, or sustainment life-cycles), legal liabilities, credit risk, accidents, natural causes and disasters as well as deliberate attack from an adversary, or events of uncertain or unpredictable root-cause. Several risk management standards have been developed including the Project Management Institute,
the National Institute of Science and Technology, actuarial societies, and ISO standards. Methods, definitions and goals vary widely according to whether the risk management method is in the context of project management, security, engineering, industrial processes, financial portfolios, actuarial assessments, or public health and safety. The strategies to manage risk typically include transferring the risk to another party, avoiding the risk, reducing the negative effect or probability of the risk, or even accepting some or all of the potential or actual consequences of a particular risk. Certain aspects of many of the risk management standards have come under criticism for having no measurable improvement on risk, whether the confidence in estimates and decisions seem to increase. Principles of risk management The International Organization for Standardization (ISO) identifies the following principles of risk management:] Risk management should:
create value - resources expended to mitigate risk should generally exceed the consequence of inaction, or (as in value engineering), the gain should exceed the pain be an integral part of organizational processes be part of decision making explicitly address uncertainty and assumptions be systematic and structured be based on the best available information be tailorable take into account human factors be transparent and inclusive be dynamic, iterative and responsive to change be capable of continual improvement and enhancement be continually or periodically re-assessed
Risk Assessment or Assessment of Risk Once risks have been identified, they must then be assessed as to their potential severity of impact (generally a negative impact, such as damage or loss) and to the probability of occurrence. These quantities can be either simple to measure, in the case of the value of a lost building, or impossible to know for sure in the case of the probability of an unlikely event occurring. Therefore, in the assessment process it is critical to make the best educated decisions in order to properly prioritize the implementation of the risk management plan. Even a short-term positive improvement can have long-term negative impacts. Take the "turnpike" example. A highway is widened to allow more traffic. More traffic capacity leads to greater development in the areas surrounding the improved traffic capacity. Over time, traffic thereby increases to fill available capacity. Turnpikes thereby need to be expanded
in a seemingly endless cycles. There are many other engineering examples where expanded capacity (to do any function) is soon filled by increased demand. Since expansion comes at a cost, the resulting growth could become unsustainable without forecasting and management. The fundamental difficulty in risk assessment is determining the rate of occurrence since statistical information is not available on all kinds of past incidents. Furthermore, evaluating the severity of the consequences (impact) is often quite difficult for intangible assets. Asset valuation is another question that needs to be addressed. Thus, best educated opinions and available statistics are the primary sources of information. Nevertheless, risk assessment should produce such information for the management of the organization that the primary risks are easy to understand and that the risk management decisions may be prioritized. Thus, there have been several theories and attempts to quantify risks. Numerous different risk formulae exist, but perhaps the most widely accepted formula for risk quantification is: Rate (or probability) of occurrence multiplied by the impact of the event equals risk magnitude Corporate risk management emerged as a catch-all phrase for practices that serve to optimize risk taking in a context of book value accounting. Generally, this includes risks of non-financial corporations, but also those of business lines of financial institutions that are not engaged in trading or investment management. Risks vary from one corporation to the next, depending on such factors as size, industry, diversity of business lines, sources of capital, etc. Practices that are appropriate for one corporation are inappropriate for another. Corporate Risk Management can be defined as in a corporate setting, the familiar division of risks into market, credit and operational risks breaks down. Of these, credit risk poses the least challenges. To the extent that corporations take credit risk new and traditional techniques of credit risk management are easily adapted. Operational risk largely doesn't apply to corporations. It includes such factors as model risk or back office errors. Some aspects do affect corporations such as fraud or natural disasters but corporations have been addressing these with internal audit, facilities management and legal departments for decades. Also, corporations face risks that are the operational risk of financial institutions but are unique to their own business lines. An airline is exposed to risks due to weather, equipment failure and terrorism. A power generator faces the risk that a generating plant may go down for unscheduled maintenance. In corporate risk management, these risks those that overlap with the operational risks of financial firms and those that are such operational risks but are unique to non-financial firms are called operations risks. The real challenge of corporate risk management is those risks that are akin to market risk but aren't market risk. An oil company holds oil reserves. Their "value" fluctuates with the market price of oil, The oil reserves don't have a market value. A chain of restaurants is thriving. Its restaurants are "valuable," but it is impossible to assign them market values.
Something that doesn't have a market value doesn't pose market risk. This is almost a tautology. Such risks are business risks as opposed to market risks. In the realm of corporate risk management, we abandon the division of risks into market, credit and operational risks and replace it with a new categorization: Market Risk, Business Risk, Credit Risk, Operations Risk.
Corporations do face some market risks, such as commodity price risk or foreign exchange risk. These are usually dwarfed by business risks. In a nutshell, the challenge of corporate risk management is the management of business risk. Techniques for addressing business risk take two forms" Both approaches are discussed below. Economic Value Techniques of the first form focus on a concept called economic value. This is a vague notion that generalizes the concept of market value. If a market value exists for an asset, then that market value is the asset's economic value. If a market value doesn't exist, then economic value is the "intrinsic value" of the asset what the market value of the asset would be, if it had a market value. Economic values can be assigned in two ways. One is to start with accounting metrics of value and make suitable adjustments, so they are more reflective of some intrinsic value. This is the approach employed with economic value added (EVA) analyses. The other approach is to construct some model to predict what value the asset might command, if a liquid market existed for it. In this respect, a derogatory name for economic value is mark-to-model value. This economic approach to managing business risk is applicable if most of a firm's balance sheet can be marked to market. Economic values then only need to be assigned to a few items in order for techniques of FRM to be applied firm wide. An example would be a commodity wholesaler. Most of its balance sheet comprises physical and forward positions in commodities, which can be mostly marked to market. More controversial has been the use of economic valuations in power and natural gas markets. The actual energies trade and, for the most part, can be marked to market. However, producers also hold significant investments in plants and equipment and these cannot be marked to market. Suppose some energy trades spot and forward out three years. An asset that produces the energy has an expected life of 50 years, which means that an economic value for the asset must reflect a hypothetical 50-year forward curve. The forward curve doesn't exist, so a model must construct one. Consequently, assigned economic values are highly dependent on assumptions. Often, they are arbitrary.
Book Value The second approach to addressing business risk starts by defining risks that are meaningful in the context of book value accounting. Most typical of these are: earnings risk, which is risk due to uncertainty in future reported earnings, and Cash flow risk, which is risk due to uncertainty in future, reported cash flows.
Of the two, earnings risk is more akin to market risk. Yet, it avoids the arbitrary assumptions of economic valuations. A firm's accounting earnings are a well defined notion. A problem with looking at earnings risk is that earnings are, well, non-economic. Earnings may be suggestive of economic value, but they can be misleading and are often easy to manipulate. A firm can report high earnings while its long term franchise is eroded away by lack of investment or competing technologies. Financial transactions can boost short-term earnings at the expense of long-term earnings. After all, traditional techniques focus on earnings, and their shortcomings remain today. Cash flow risk is less to market risk. It relates more to liquidity than the value of a firm, but this is only partly true. As anyone who has ever worked with distressed firms can attest, "cash is king." When a firm gets into difficulty, earnings and market values don't pay the bills. Cash flow is the life blood of a firm. However, as with earnings risk, cash flow risk offers only an imperfect picture of a firm's business risk. Cash flows can also be manipulated, and steady cash flows may hide corporate decline.
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