BDNG3103 PDF

BDNG3103
Introductory International Business
Copyright © Open University Malaysia (OUM)

BDNG3103
INTRODUCTORY
INTERNATIONAL
BUSINESS
Ayub Nasir

Project Directors: Prof Dr Widad Othman
Prof Loo Sin Chun
Open University Malaysia
Module Writer: Ayub Nasir

Universiti Industri Selangor
Moderator: Ruhana Busu

Universiti Putra Malaysia
Developed by: Centre for Instructional Design and Technology

Open University Malaysia
First Edition, January 2005

Second Edition, December 2016 (rs)
Third Edition, April 2019 (MREP)
Copyright © Open University Malaysia (OUM), April 2019, BDNG3103

All rights reserved. No part of this work may be reproduced in any form or by any means without
the written permission of the President, Open University Malaysia (OUM).

Table of Contents
Course Guide ix–xiv
Topic 1 What is International Business? 1

1.1 The Importance of International Business 2
1.1.1 The Growth of International Business 4
1.1.2 Globalisation 6
1.1.3 The Globalisation Debate 9
1.2 International Business Activities 12
1.2.1 Exports and Imports 13
1.2.2 International Investments 14
1.2.3 Other Forms of International Activities and 15
Companies
1.3 Concepts and Challenges in International Business 18
1.3.1 The External Influences on International Business 18
1.3.2 The Competitive Environment 20
1.3.3 Global Standardisation 21
1.3.4 Local Responsiveness 21
1.3.5 National Sovereignty 23
1.4 Motivations and Restrictions in International Business 25
1.4.1 Why do Companies Engage in International Business? 25
1.4.2 Trade Protectionism 27
Summary 31
Key Terms 32
Topic 2 Cultural, Political, Legal and Economic Systems 33

2.1 Culture 34
2.1.1 What is Culture? 34
2.1.2 Social Structure 36
2.1.3 Religion and Ethics 37
2.1.4 Values and Attitudes 38
2.1.5 Language 39
2.1.6 Education 40
2.2 Politics and Legal Environment 42
2.2.1 Basic Political Ideologies 42
2.2.2 Political Risks 46
2.2.3 Types of Legal Systems 47
2.2.4 The Legal Profession 48

iv  TABLE OF CONTENTS
2.3 Economic Environment 50

2.3.1 Economic Systems 51
2.3.2 Differences in Economic Development 52
2.3.3 The Emerging Market Economies 56
Summary 59
Key Terms 60
Topic 3 International Trade Theories and Institutions 61

3.1 Theories of International Trade 62
3.1.1 Age of Mercantilism 62
3.1.2 The Theory of Absolute Advantage 63
3.1.3 The Theory of Comparative Advantage 64
3.1.4 The International Product Life Cycle Theory 66
3.1.5 Theory of Economies of Scale and Imperfect 69
Competition
3.1.6 The Diamond of National Competitive Advantage 70
3.2 International Trade Strategies and Organisations 74
3.2.1 International Strategy 75
3.2.2 Multidomestic Strategy 75
3.2.3 Global Strategy 75
3.2.4 Transnational Strategy 76
3.3 Regional Economic Integration 77
3.3.1 Levels of Economic Integration 78
3.3.2 Arguments on Economic Integration 80
3.3.3 Economic Integration in Europe 81
3.3.4 Economic Integration in the Americas 85
3.3.5 Economic Integration in Asia 86
Summary 88
Key Terms 89
Topic 4 The Financial Environment of International Business 90

4.1 The International Monetary System 91
4.1.1 The Gold Standard 91
4.1.2 The Bretton Woods System 93
4.1.3 The Floating Exchange Rate System 98
4.2 The Foreign Exchange Market 100
4.2.1 The Nature of the Foreign Exchange Market 101
4.2.2 Functions of the Foreign Exchange Market 101
4.2.3 Spot and Forward Exchange Rates 104
4.2.4 Foreign Exchange Risks 106
4.3 Currency Convertibility 109
4.3.1 Government Policies 110
4.3.2 Countertrading 110

TABLE OF CONTENTS  v
Summary 112
Key Terms 113
Topic 5 Market Research, Mode of Entry and Ethical Issues in 115

International Business
5.1 Market Research 115
5.1.1 The Need for Market Research 118
5.1.2 Problems with Research 119
5.2 Foreign Market Entry Strategies 122
5.2.1 Exporting 123
5.2.2 Turnkey Projects 124
5.2.3 Licensing 126
5.2.4 Franchising 127
5.2.5 Joint Ventures 129
5.2.6 Wholly-owned Subsidiaries 130
5.2.7 Strategic Alliances 131
5.3 International Business Ethics and Social Responsibility 134
5.3.1 Human Rights 135
5.3.2 Product Safety 137
5.3.3 Environmental Protection 138
5.3.4 Corrupt Practices 138
Summary 141
Key Terms 142
Topic 6 Operational and Functional Considerations in International 144

Business
6.1 Organisational Design and Control 144
6.1.1 Types of Organisational Structures 145
6.1.2 Centralisation versus Decentralisation 151
6.1.3 Control Systems 152
6.1.4 Managing Change 154
6.2 International Marketing Management 157
6.2.1 Product Attributes 157
6.2.2 Pricing Strategy 158
6.2.3 Communication Strategy 160
6.2.4 Distribution Strategy 161
6.3 International Financial Management 164
6.3.1 Methods of International Payment 165
6.3.2 Managing Working Capital and Cash Flow 168
6.3.3 Source of Investment Capital 170
6.4 Human Resource Management 172
6.4.1 Types of Staffing Policy 172
6.4.2 Managing Expatriates 174

vi  TABLE OF CONTENTS
6.4.3 Performance Appraisal and Compensation 177

6.4.4 International Labour Relations 179
Summary 181
Key Terms 183
Topic 7 International Services 184

7.1 The Importance and Growth of Services in World Economy 185
7.2 Characteristics of Services 187
7.3 Selection of Target Markets 188
7.4 Managing Services Operations 190
7.4.1 Issues Relating to International Services 190
Management
Summary 192
Key Terms 193
Topic 8 International Logistics and Supply Chain Management 194

8.1 International Logistics 195
8.2 Issues in International Logistics 198
8.2.1 „Make-or-Buy‰ Decisions 198
8.2.2 Location Decisions 201
8.2.3 Inventory Management 205
8.3 International Transportation 208
8.4 Supply Chain Management 213
8.4.1 International Sourcing 213
8.4.2 Information Systems 215
8.4.3 Quality Management 223
Summary 229
Key Terms 230
Topic 9 Future of International Business 231

9.1 Changes in International Business Environment 232
9.1.1 The Political and Economic Environment 232
9.1.2 The International Financial Environment 234
9.1.3 Technology 235
9.2 Government Policies 237
9.3 International Trade Relations 239
9.3.1 General Agreement on Tariffs and Trade (GATT) 239
9.3.2 World Trade Organization (WTO) 240
Summary 243
Key Terms 244
Answers 245

COURSE GUIDE

COURSE GUIDE  ix
COURSE GUIDE DESCRIPTION

You must read this Course Guide carefully from the beginning to the end. It tells
you briefly what the course is about and how you can work your way through the
course material. It also suggests the amount of time you are likely to spend in order
to complete the course successfully. Please refer to the Course Guide as you go
through the course material as it will help you to clarify important study
components or points that you might miss or overlook.
INTRODUCTION
BDNG3103 Introductory International Business is one of the courses offered at
Open University Malaysia (OUM). This course is worth 3 credit hours and should
be covered over 15 weeks.
COURSE AUDIENCE
This course is offered to all students taking the Diploma in Management
programme. This module aims to introduce students to the activities and basic
concepts in the international business environment. It also cover the international
aspects of organisational structures, marketing, finance and human resource
management.
As an open and distance learner, you should be acquainted with learning

independently and being able to optimise the learning modes and environment
available to you. Before you begin this course, please ensure that you have the right
course material, and understand the course requirements as well as how the course
is conducted.

x  COURSE GUIDE
STUDY SCHEDULE
It is a standard OUM practice that learners accumulate 40 study hours for every
credit hour. As such, for a three-credit hour course, you are expected to spend 120
study hours. Table 1 gives an estimation of how the 120 study hours could be
accumulated.
Table 1: Estimation of Time Accumulation of Study Hours
Study
Study Activities
Hours
Briefly go through the course content and participate in initial discussions 3
Study the module 60
Attend 3 to 5 tutorial sessions 10
Online participation 12
Revision 15
Assignment(s), Test(s) and Examination(s) 20
TOTAL STUDY HOURS ACCUMULATED 120
COURSE LEARNING OUTCOMES

By the end of this course, you should be able to:
1. Explain the activities and regulations in international business in general;
2. Discuss the basic concepts and challenges in the management of business at

the international level;
3. Describe the environmental factors that influence international business

activities; and
4. Propose the strategies employed by firms in international markets.

COURSE GUIDE  xi
COURSE SYNOPSIS
This course is divided into nine topics. The synopsis for each topic is presented as
follows:
Topic 1 provides an overview of international business. This includes the current

concepts as well as the roles and importance of international business. It also
stresses on globalisation and international competition.
Topic 2 discusses the various elements in the international business environment;

such as culture, political and legal systems, and economic systems; all of which
may pose risks to the profit-seeking firm.
Topic 3 studies the theories in international trade that attempts to explain the
pattern of international trade flows. The general business strategies of firms are
then discussed before ending the topic with a study on regional economic
integration.
Topic 4 describes the history and development of the international monetary

system together with the inherent financial risks that the international firm has to
manage.
Topic 5 discusses foreign market research which is critical in identifying viable

markets and choosing what mode of market entry the firm should use. Ethical
issues of human rights violations, product safety, environmental pollution and
corrupt practices are also discussed.
Topic 6 examines the international operations aspects of the firm, namely the
design of organisational structures, marketing, finance and human resource
management.
Topic 7 deals with the international services sector which has grown tremendously
as an important source of revenue for both the developed and developing
countries.
Topic 8 discusses the international logistics and supply chain management. Issues
related to location, inventory decisions, transportation, sourcing decisions, the use
of information systems and quality management are explained.

xii  COURSE GUIDE
Topic 9 looks at the various possible future scenarios of the international business
environment that is being shaped by the political, economic, financial and
technological relationships among countries around the world. Government
policies and international trade relations are also discussed.
TEXT ARRANGEMENT GUIDE

Before you go through this module, it is important that you note the text
arrangement. Understanding the text arrangement will help you to organise your
study of this course in a more objective and effective way. Generally, the text
arrangement for each topic is as follows:
Learning Outcomes: This section refers to what you should achieve after you have
completely covered a topic. As you go through each topic, you should frequently
refer to these learning outcomes. By doing this, you can continuously gauge your
understanding of the topic.
Self-Check: This component of the module is inserted at strategic locations

throughout the module. It may be inserted after one sub-section or a few sub-
sections. It usually comes in the form of a question. When you come across this
component, try to reflect on what you have already learnt thus far. By attempting
to answer the question, you should be able to gauge how well you have
understood the sub-section(s). Most of the time, the answers to the questions can
be found directly from the module itself.
Activity: Like Self-Check, the Activity component is also placed at various

locations or junctures throughout the module. This component may require you to
solve questions, explore short case studies, or conduct an observation or research.
It may even require you to evaluate a given scenario. When you come across an
Activity, you should try to reflect on what you have gathered from the module
and apply it to real situations. You should, at the same time, engage yourself in
higher order thinking where you might be required to analyse, synthesise and
evaluate instead of only having to recall and define.
Summary: You will find this component at the end of each topic. This component
helps you to recap the whole topic. By going through the summary, you should be
able to gauge your knowledge retention level. Should you find points in the
summary that you do not fully understand, it would be a good idea for you to
revisit the details in the module.

COURSE GUIDE  xiii
Key Terms: This component can be found at the end of each topic. You should go
through this component to remind yourself of important terms or jargon used
throughout the module. Should you find terms here that you are not able to
explain, you should look for the terms in the module.
References: The References section is where a list of relevant and useful textbooks,
journals, articles, electronic contents or sources can be found. The list can appear
in a few locations such as in the Course Guide (at the References section), at the
end of every topic or at the back of the module. You are encouraged to read or refer
to the suggested sources to obtain the additional information needed and to
enhance your overall understanding of the course.
PRIOR KNOWLEDGE
Learners of this course are required to pass BDPP1103 Introductory Principles
Management.
ASSESSMENT METHOD
Please refer to myINSPIRE.
REFERENCES
Czinkota, M. R., Ronkainen I. A., Moffet, M. H., & Moynihan, E. O. (2001).
Global business, (3rd ed.). Fort Worth: Harcourt College Publishers.
Daniels, J. D., Radebaugh, L. H., & Daniel, P. S. (2004). International business:

Environments and operations (10th ed.). New Jersey: Pearson Prentice Hall.
Griffin, R. W., & Pustay, M. W. (2003). International business: A managerial

perspective (3rd ed.). New Jersey: Pearson Prentice Hall.
Hill, C. W. L. (2004). Global business today. International Edition. New York:

McGraw-Hill/Irwin.
Hill, C. W. L. (2003). International business: Competing in the global marketplace

(4th ed.). New York: McGraw-Hill/Irwin.

xiv  COURSE GUIDE
TAN SRI DR ABDULLAH SANUSI (TSDAS) DIGITAL

LIBRARY
The TSDAS Digital Library has a wide range of print and online resources for the
use of its learners. This comprehensive digital library, which is accessible through
the OUM portal, provides access to more than 30 online databases comprising
e-journals, e-theses, e-books and more. Examples of databases available are
EBSCOhost, ProQuest, SpringerLink, Books24ൈ7, InfoSci Books, Emerald
Management Plus and Ebrary Electronic Books. As an OUM learner, you are
encouraged to make full use of the resources available through this library.

Topic  What is
International
1 Business?
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Define the term „globalisation‰;
2. Describe the scope of activities in international business;
3. Explain the role played by international business especially in the
economic development of a country, a particular region as well as
the world in general;
4. Explain important concepts which underline the activities of the
international firm; and
5. Discuss the reasons firms engage in international business and the
challenges the firms have to face.
 INTRODUCTION
In this topic, we will discuss the term „globalisation‰ and the scope of activities in
international business. We will also discuss the roles played by international
business especially in the economic development of a country, a particular region
as well as the world in general.
International business consists of business transactions between parties from more

than one country. For example, firms buy materials from one country, ship them
to another country for processing or assembly and then ship the finished products
to another country to be sold. Firms also build manufacturing plants in a foreign
country to take advantage of lower labour costs or borrow money from

2  TOPIC 1 WHAT IS INTERNATIONAL BUSINESS?
banks in other countries. Those involved in these transactions may include private
individuals, firms and government agencies. Figure 1.1 illustrates international
business transactions as opposed to domestic business transactions.
Figure 1.1: International business transactions
International business differs from domestic business due to several reasons. As

international business involves other countries, its activities are carried out using
different currencies, different legal systems and practices and in different cultures.
Countries also differ in the availability of their natural or labour resources,
resulting in varying production capabilities.
Finally, this topic shall include discussions on the types of international business
activities and its importance to countriesÊ economies, the reasons for its
tremendous growth, the concept of globalisation and its effects. This topic shall
also explain the major factors that motivate firms to engage in international
business and the challenges they face in todayÊs highly competitive environment.
1.1 THE IMPORTANCE OF INTERNATIONAL

BUSINESS
The field of international business has become increasingly important not only as
a subject of academic study but also how it affects our daily lives as individuals,
employees and citizens of a particular country.

TOPIC 1 WHAT IS INTERNATIONAL BUSINESS?  3
Most large corporations today engage in international activities or may be affected

by events taking place around the world (see Figure 1.2). As employees of these
firms, a basic understanding of international business would help us understand
why some of our colleagues from foreign countries are recruited and how we
might interact more effectively with them. The business firm we work for may be
foreign-owned or the Malaysian-owned firm we work for may need to buy foreign
made materials and equipment or even expand their operations outside the
country.
Besides keeping abreast of the latest business techniques and tools which are
developed in other countries in North America, Europe and Japan, the knowledge
and skills of managing in foreign markets would also assist in our career
development. Managers who remain unaware of the innovations of their
international competitors may be doomed to failure in the global market place.
Figure 1.2: World map

Source: https://upload.wikimedia.org
We will often meet colleagues, customers, suppliers and competitors from

different countries with different cultural backgrounds. Being culture literate
would help us understand their countriesÊ and their companiesÊ position in the
context of the global economy. Our ability to recognise and appreciate these
differences may earn their respect, confidence as well as provide us with a
competitive edge. Thus, whether we are managers, consumers or just observers of
global events, international business is very much a relevant subject.

ACTIVITY 1.1
Let us say you work for a large corporation which engages in

international business. As an employee, what can you do in order to
enhance your companyÊs future? Discuss with your coursemates.
1.1.1 The Growth of International Business
SELF-CHECK 1.1
Nowadays, business firms are very eager to conduct business

internationally. What do you think drives them to do so?
Although it is difficult to determine how much international business has occurred

at the different times in history, world trade has grown at a much faster pace than
world production.
According to data from the World Trade Organisation, the volume of world
trade has increased by 20 times from 1950 until 2000 while world production
grew by 6.5 times. The rate of growth, however, slowed down significantly in
2001 due partly to the global economic slowdown and the aftermath of the
September 11 terrorist attacks on the United States.
Figure 1.3: Four factors that increase the growth of international business

Figure 1.3 illustrates the four factors that bring about the increased growth in
international business. These factors are sometimes interrelated and they are as
follows:
(a) Expansion of Technology

Developments in communications and transportation technology have
enabled people in one part of the world to know and demand for products
and services developed in another part of the world. Increasing demand for
these new products and services has increased the number of international
business transactions.
The Internet phenomenon has not only facilitated business-to-customer

transactions but also more business-to-business transactions. About 48% of
the worldÊs population uses the Internet. In 2015, the International
Telecommunication Union estimated about 3.2 billion people, or almost half
of the worldÊs population, would be online by the end of the year, of which,
about 2 billion would be from developing countries, including 89 billion from
least developed countries (Source: http://en.wikipedia.org/
wiki/Global_Internet_usage).
Several major innovations have also occurred in transportation technology

since World War II. The development of commercial jet aircraft and super
freighters and containerisation have made trans-shipment of goods simpler
and more efficient.
Although the costs of improved communications and transportation have

increased, it has risen more slowly than the operating costs of international
businesses.
(b) Government Deregulation

Every country restricts the movement of goods and services, as well as
resources such as labour and capital across its borders. Many of these barriers
are in the form of tariffs on the import of manufactured goods, which are
imposed to protect domestic industries from foreign competition. Such
restrictions make international business more expensive to undertake. As
regulations may be changed at any time, international business is also risky.
Generally, governments today have gradually reduced these trade barriers

and allow greater movement of trade and investments into their countries
for several reasons. Their citizensÊ desire for access to greater variety of goods
and services at lower prices, the increased efficiency of domestic producers

as a result of foreign competition and the need to encourage other countries

to reduce their trade barriers have led to the deregulation of restrictions. This
has enabled firms to gain access to more markets.
(c) Supporting Services

The development of banking, insurance and postal services by governments
and companies also helped to ease international business. Through banks,
payments to exporters for the goods and services sold abroad and
arrangements to convert currencies can easily be made. Insurance companies
cover for damage en route or non-payment by the buyer. Postal agreements
among countries enable us to mail a letter to any place in the world using
stamps from the country where we mail it.
(d) Increase in Global Competition

Foreign competition can also persuade companies to expand its business into
international markets to maintain competitiveness. Companies today can
respond quickly to take advantage of foreign sales opportunities.
International firms can shift production among countries quickly because of
their experience in foreign markets and their ability to transport goods to
many places efficiently. When a few companies respond to foreign market
and production opportunities, other companies also follow suit.
1.1.2 Globalisation
Countries are moving away from being self-contained and isolated entities
separated by:
(a) Trade and investment barriers;
(b) Distance, time zones and language; and
(c) Differences in government regulation, culture and business practices.
Trade and investment barriers are falling, transportation and telecommunications

technology make vast distances accessible and material culture looks similar all over
the world. No nation can afford to exist without interacting with other nations. A
countryÊs successful participation in international business and international
markets should lead to a better life for its citizens.
This process of merging into one interdependent global economic system is

commonly called „globalisation‰.

Two important facets of globalisation are highlighted in Figure 1.4:

(a) Globalisation of markets; and
(b) Globalisation of production.
Figure 1.4: Two facets of globalisation
(a) Globalisation of Markets
The globalisation of markets refers to the convergence of separate

national markets into one huge global market place.
The reduction in trade restrictions has made it easier to sell goods and
services internationally. Tastes and preferences of consumers in different
countries are beginning to converge, helping to create a global market.
Figure 1.5 shows two popular brands which have a global market.
Figure 1.5: Global market brands

Products like McDonaldÊs burgers, Coca-Cola soft drinks, LeviÊs jeans and
Citigroup credit cards are some examples of this trend. These companies
offer standardised products worldwide, thus creating a global market.
However, we shall learn in later topics that there are significant differences
in consumer tastes and preferences, distribution channels, cultural values,
business practices and the law requiring companies to customise their
marketing strategies, product features and operations in order to match the
conditions in different countries.
Most global markets currently are not markets for consumer products but
markets for industrial goods and materials that serve a universal need, such
as microprocessors, computer software and for commodities like oil,
aluminium and rice.
As companies expand their operations and compete with each other, they
bring along their products, operating and marketing strategies and brand
names into other markets, thus also creating some uniformity across different
markets. Therefore, Coca-ColaÊs rivalry with Pepsi, Ford with Toyota, Boeing
with Airbus and Carrefour with Tesco are examples of such markets.
(b) Globalisation of Production

International firms source for goods and services from all around the world to
take advantage of differences in the cost and the quality of factors of
production, such as labour, capital, energy and land. In doing so, they are able
to lower their overall cost and improve the quality of the products they offer.
For example, BoeingÊs 777 jet airliner has parts supplied by a global network
of suppliers. Fuselage, doors and wings are obtained from Japan, landing gears
from Singapore and wing flaps are from Italian manufacturers.
Outsourcing is a practice used by different companies to reduce costs

by transferring portions of work to outside suppliers rather than
completing it internally.
We shall also learn from subsequent topics that substantial obstacles still
exist which make it difficult for firms to optimise their production activities
around the world. These obstacles include barriers to trade and foreign direct
investments, transportation costs as well as the issue of economic and
political risks.

SELF-CHECK 1.2
Explain the differences between globalisation of markets and

globalisation of production.
1.1.3 The Globalisation Debate
SELF-CHECK 1.3
So far, we have looked at the positive aspects of globalisation. What do

you think are the negative aspects?
As globalisation is dependent on the concept of free trade without restrictions or

barriers being imposed by national governments, several arguments have
emerged in support as well as in opposition. While many economists, politicians
and business leaders view globalisation positively, there were also street
demonstrations held protesting it. These arguments mainly arose from the
following issues:
(a) Loss of Jobs and Income

Jobs in the manufacturing sector of the wealthy and advanced economies
would be destroyed when declining trade and investment barriers allow
firms to shift their manufacturing activities to countries where labour costs
are much lower.
However, supporters of globalisation argue that the benefits are greater than
its costs. Free trade will encourage countries to specialise in the production
of goods that they can produce most efficiently while importing the goods
that they cannot produce as efficiently. This will result in the whole economy
being better off. For example, the US imports textiles from China where it
can be produced at a lower cost and this will lead to lower prices for clothes
in the US. This would enable consumers to spend more of their money on
other items. At the same time, the increased income in China from textile
exports would increase the income levels in the country which would allow
the Chinese to purchase more products produced in the US.

(b) Labour Policies and the Environment

Firms may move their manufacturing operations to less developed countries
which do not have adequate laws and regulations to protect labour and the
environment from abuse, thus relieving them from the burden of the cost of
complying with such regulations. This might lead to an increase in
environmental pollution and exploitation of labour. Firms from the
advanced countries might also ignore workplace safety and health issues in
an attempt to reap higher profits.
However, supporters of globalisation believe that free trade enables

developing countries to increase their economic growth rates to become
richer countries, thus, enabling them to make and enforce tougher
environmental and labour laws. Wealth creation and incentives would
encourage enterprises to produce technological innovations that would
reduce or make it easier to cope with the problems of pollution and
population growth.
Supporters also argue that business firms are generally committed to behave
ethically and not move production to countries where they can easily pollute
the atmosphere or exploit labour.
(c) Loss of National Sovereignty

Critics of globalisation are also concerned that the increasing
interdependence between economies would shift economic power from
national governments to supranational governments like the World Trade
Organisation (WTO) and the United Nations (UN). They may impose
policies that undermine the sovereignty of elected governments and limit
government authority to make their own decisions.
Many economists and politicians however, maintain that the power of bodies
such as the WTO and the UN depends on their ability to persuade member
countries to follow certain actions in the interest of members. If they fail,
these countries will withdraw their support which eventually will lead to the
collapse of the supranational organisations.
(d) Widening Gap between the Rich and Poor Nations

Critics point out that despite the supposed benefits of free trade and
investment, the gap between the rich and the poor nations of the world has
become wider. Although some nations like South Korea, Thailand and
Malaysia are capable of economic transformation, the average per capita
income of the worldÊs 17 richest nations in 1990 was 4.5 times that of all other
countries. The income gap was only 2.4 times in 1870. If globalisation is such
a positive development, this divergence should not have occurred.

Several factors other than free trade or globalisation could have been the
cause. Totalitarian governments and destructive economic policies which
provide little protection for property rights and war such as in the countries
of Africa have failed to improve the economic level of their citizens. The
rapid rate of population growth further complicates the issue.
Another factor is the large debt burdens held by the poor countries. The
servicing of these debts result in very little left for these countries to spend
on building important infrastructures, such as roads, power generation
plants, education and health care. Large scale debt-relief programmes could
provide these poor countries with the opportunity to restructure their
economies and invest wisely in public projects that facilitate economic
growth and free trade and investment.
ACTIVITY 1.2
Based on your opinion, how can Malaysia obtain the benefits of
globalisation?
Assess your understanding by answering the following questions.
EXERCISE 1.1
1. The two areas of technology which have helped contribute to the
tremendous growth of international business are in ____________.
A. research and manufacturing
B. communications and transportation
C. agriculture and manufacturing
D. production and processes
2. When a firm designs a product in one country, produces it in

another country and exports the product to other countries, this is
known as the globalisation of:
A. Management
B. Marketing
C. Production
D. Finance

3. Firms that do not participate in international business will more likely

be:
A. Forced to go out of business.
B. Too small to export their goods successfully.
C. Better positioned for unlimited domestic expansion.
D. Affected by the economic but not political developments that is
occurring in the global markets.
4. Although there are many benefits to globalisation, there is a general

agreement that increased international trade and investment will
result in higher prices for goods and services.
A. True
B. False
5. Government deregulation means the increase in barriers imposed by

foreign country governments to encourage trade and investment.
A. True
B. False
6. Is the isolation of specific countries from the international markets

possible? Why or why not?
7. In what way has the increase in competition contributed to the

growth of international business?
1.2 INTERNATIONAL BUSINESS ACTIVITIES

Although international business activity was first carried out in the form of
exporting and importing, business today can be divided into the following three
broader categories.

1.2.1 Exports and Imports

Exporting and importing of goods and services are the most common methods
used compared to any other international mode. The export of goods or
merchandise consist of tangible products such as televisions, automobiles,
machineries, chemicals and other items sent out of a country; imports are goods
brought into a country, as illustrated in Figure 1.6.
Figure 1.6: International exports and imports

Services include all types of non-product sales (export) and purchases (import)
such as travel and tourism, transportation, communications, banking, insurance,
education and distribution rights for motion pictures.
1.2.2 International Investments

International investments are the second major form of international business
activity and can be divided into:
(a) Foreign direct investments (FDI); and
(b) Portfolio investments.
FDI is an investment that gives the investor a controlling interest in a foreign

company. Companies may choose FDI as a way to gain access to certain
resources or to reach a market in a foreign country. Many small firms also
engage themselves in FDIs.
A portfolio investment is a non-controlling interest in a company. Firms may

purchase foreign financial assets such as shares, bonds and certificates of
deposits which are not for the purpose of gaining control. Firms use them for
short-term gain and move funds among countries to earn higher returns.
(Refer Figure 1.7).

Figure 1.7: Examples of portfolio investment
1.2.3 Other Forms of International Activities and

Companies
International firms may also use their assets such as trademarks, patents,
copyrights or expertise under contracts known as licensing agreements. Under
these contracts, the licensor allows the foreign licensee the use of their assets and
receive royalty payments in return. Franchising is a specialised form of licensing
in which the firm (franchisor) allows another firm (franchisee) in a foreign country
to utilise its complete operating systems as well as brand names, trademarks and
logos in return for royalties. In a management contract, the firm agrees to operate
facilities or provide management services to a firm in another country for an
agreed fee.
A firm that is involved in any of these types of transactions can be called an

international business firm. An international firm can therefore be formally
defined as „any organisation that engages in cross-border commercial transactions
with individuals, private firms and/or public sector organisations‰.

The term „multinational corporation (MNC)‰ is often used to identify a firm „that
engages in foreign direct investment and owns or controls value-adding activities
in more than one country‰. They also typically buy resources in several countries,
make goods and services in several countries and sell those goods and services in
several countries.
The term „transnational company (TNC)‰ is often used today in its strategic
context which refers to a company whose „capabilities and contributions may
differ by country but is developed and integrated into its worldwide operations‰.
For example, Caterpillar Inc. learns from all its different operating environments
and uses the knowledge throughout its global operations. This means that the
company combines global coordination to attain efficiency with flexibility to meet
the specific needs in various countries. Its main location of power within the
organisation may be geographically dispersed.
A global company also integrates its operations that are located in different
countries. For example, it may design a product or service to market it to a global
segment or it may rely on its other country operations to produce the components
used in its products and services. In contrast to the TNC, the development of
capabilities and decisions to utilise them globally are mainly made at the
companyÊs home country.
A multidomestic company or sometimes called a locally responsive company

allows each of its foreign country operations called subsidiaries to act more
independently. For example, products and services are designed in India for the
Indian market and in Japan for the Japanese market. This encourages marketing,
advertising and product decisions to be modified and adapted to the specific needs
of each country.
ACTIVITY 1.3
Based on your understanding, name a few companies in Malaysia which

engage in international business. Then, determine the forms of
international business activities that they are involved in.

EXERCISE 1.2
1. International tourism and transportation are important sources of

revenue for the following companies, EXCEPT:
A. Airlines
B. Travel agencies
C. Hotels
D. Shopping centres
2. A ____________ company allows each of its foreign subsidiary to

operate independently, such as in designing and producing a
product or service for the local market.
A. transnational
B. global
C. multidomestic
D. multinational
3. The Disney Company which allows other firms to use their brand
names, logos and characters in return for royalty payment, is
involved in:
A. Exporting of goods
B. Importing of goods
C. Licensing
D. Franchising
4. International business does not include the purchase of financial

assets such as shares and bonds.
A. True
B. False

5. Companies use portfolio investments usually for short-term financial

profits.
A. True
B. False
6. What are the types of international business activities that a firm can
engage in?
7. How is a global company different from a transnational company?
1.3 CONCEPTS AND CHALLENGES IN

INTERNATIONAL BUSINESS
The international firm of the 21st century faces many more challenges compared
to previous periods in history. The global economy is rapidly changing, becoming
more integrated and interdependent as barriers to the free flow of goods, services
and capital are reduced. More nations are joining the ranks of the developed world
and more firms from the developing countries are now major players in many
global industries. On the other hand, greater globalisation also brings various risks
of its own. The manager, therefore, needs to examine closely the external
environment in which the firm operates before forming and implementing any
strategy to exploit the available opportunities.
1.3.1 The External Influences on International

Business
Within a firmÊs external environment, there are several factors, some of which are
beyond the managersÊ control. In addition to knowledge of business operations,
managers should have a working knowledge of political science, societal,
economics and geography.

Figure 1.8 highlights the four external factors which influence international
business.
Figure 1.8: Four external factors which influence international business
Now let us discuss each of the four external factors which influence international
business:
(a) Politics shape business when political leaders control when and how
international business should take place. Political disputes or conflicts can
disrupt trading and investment activities. Domestic laws govern how firms
operate within the country while international laws determine the
relationship between governments and may affect the respective firms from
the countries concerned, such as tax laws and trade sanctions.
(b) Societal factor concerns a societyÊs values, attitudes and beliefs about
themselves and others. The international managerÊs knowledge of foreign
culture would lead to a better understanding and help them function more
effectively in other countries.
(c) Economics is about why countries exchange goods and services with one
another why capital and people travel among different countries and why
different countriesÊ currencies have different values. By studying economics,
the international manager can better understand which country can produce
goods or services at a lesser cost than others and why. The manager can also
learn how to analyse and determine the effect of a countryÊs economic
policies and conditions on the firm and how the firm impacts the host and
home country.

(d) Geography helps ascertain the locations, quantity and quality and
availability of resources in different parts of the world and how to exploit
them best. Mountains, jungles, deserts and climate pose as geographical
barriers that affect communications and distribution channels.
The external environment affects how firms operate and firms need to make
adjustments as to how it produces and market its products and services, recruit
employees and maintain its accounts in a particular country.
1.3.2 The Competitive Environment

The competitive environment in which a firm operates varies by industry,
company and country. Thus, firms in industries where products are homogeneous
in nature may compete more on price. Strategies would therefore be influenced by
cost savings, such as producing on a larger scale to achieve lower average unit
costs and locating sources of cheaper labour and materials. Firms in other
industries may compete more on differentiated and innovative products, thus,
placing more emphasis on research and product development to gain competitive
edge.
Another competitive factor is the size of the company and the resources it
possesses compared to competitors. Large firms like Coca-Cola has much more
resources and international options to choose from, compared to smaller firms,
allowing it to vary its strategies according to different markets.
The size of the firmÊs domestic markets, like the US compared to Switzerland, also
creates different competitive environments. Swiss producers are more highly
dependent on sales to foreign markets than the US producers in order to achieve
economies of scale in product development and production.
Yet another factor which shapes this environment is whether there is international
or local competition in the home country and in foreign markets. Firms that
compete with each other everywhere they try to sell their products, such as Boeing
and Airbus, learn more about each other and use the knowledge to anticipate each
otherÊs actions and strategies in other countries.
Other firms such as Carrefour may face different retailers as competitors in each
of the foreign countries where they operate.
The mentioned factors help to generally describe the competitive environment

within which international firms operate.

ACTIVITY 1.4
In your opinion, how do hypermarkets such as Carrefour remain

competitive when faced with different retailers as competitors?
1.3.3 Global Standardisation

A global strategy is one that implements highly standardised practices among the
countries they operate. For example, a firm may design and produce a product or
service suitable to be marketed to many countries. In doing so, the firm is able to
avoid duplicating product development costs and reduce manufacturing costs by
serving many markets from a single production location. The firm gains from
economies of scale. A Boston Consulting Group (BCG) study showed that when
output is doubled, production costs can be reduced by up to 30%.
Thus, when firms are faced with competitive pressures for cost reduction, they
respond by mass producing and offering a standardised product to the global
marketplace. Production is carried out at the most optimal location in the world
where they can realise location as well as experience curve economies. Some
examples of such industries are commodity-type products like petroleum, sugar,
steel and industrial chemicals where price is the main competitive weapon.
The increasing liberalisation of international trade and investment which

facilitates greater international competition has also generally increased pressures
for cost reduction.
1.3.4 Local Responsiveness

Pressures to be locally responsive require the firm to differentiate its product,
practices and marketing strategies in response to the different country preferences.
The sources of this pressure are indicated in Figure 1.9.

Figure 1.9: Factors that pressure a firm to be locally responsive
(a) Differences in Consumer Tastes and Preferences

Consumers in different countries may significantly differ in their tastes and
preferences due to historical or cultural reasons. Products and/or marketing
programmes have to be customised in order to appeal to each countryÊs
consumers.
Although modern communication and transportation have created some

convergence in consumer tastes and preferences for products like Coca- Cola,
LeviÊs and McDonaldÊs, consumers of certain electronic products, television
programmes and four-wheel drive vehicles have shown a preference for
products that are differentiated to suit local conditions.
(b) Differences in Infrastructure and Traditional Practices

Differences in electrical systems (110-volt/240-volt) infrastructure and
traditional driving practices (left-hand/right-hand drive practices) which are
rooted in history, would require products to be customised to suit the local
differences. More recently, arising differences are the technical standards in
the wireless telecommunications industry between Global System for Mobile
Communication (GSM) and Code Division Multiple Access (CDMA).
(c) Differences in Distribution Channels

An international firmÊs marketing strategies may have to be varied according
to different distribution channels among countries. There may be a few but
powerful food retailers in Germany dominating the market but they are
smaller and larger in number in Italy. Distribution systems in Japan may not
favour American-style high pressure sales.

(d) Host Government Demands

Host country governments may impose stringent regulations such as food or
drug testing procedures, pricing restrictions or rules requiring a higher
percentage of local content in products. These demands would require
foreign products to be locally responsive.
The firm therefore has to customise their product and service offerings and
marketing programmes to meet local requirements and it may not be possible for
the firm to realise the full benefits of location and experience curve economies.
1.3.5 National Sovereignty

Sovereignty refers to a countryÊs ability to decide and implement policies free from
any external influences and control. It provides a government with the right and
responsibility to shape the countryÊs environment and citizens. Governments seek
to improve or maintain the standard of living and the quality of life of its citizens
and stimulate development through its domestic policies.
However, these policies may indirectly influence international trade and

investment while other policies are imposed with a more direct and specific
intention. Accumulation of large quantities of debt which may threaten the
economy and the citizensÊ future standard of living is an example of the former.
Import restrictions to protect infant domestic industries are more direct policies.
Governments also institute foreign policies and the major goal is national security.
They may develop alliances and agreements to protect their borders and improve
trade and investment opportunities.
As each country develops its own policies with varying intentions from country to
country, conflicts and disputes may arise. A countryÊs policies to achieve full
employment may directly affect the employment policies of another country and
development policies of one country may reduce the development capabilities of
another country. Firms operating or seeking to operate in foreign countries would
therefore need to be wary of these uncertainties and risk possibilities.

EXERCISE 1.3
1. The external environment of international business includes all of

the following factors, EXCEPT:
A. CountryÊs geography.
B. Economic factors.
C. Societal factors.
D. Company management.
2. When firms produce and market homogeneous (similar in nature)

products, they tend to compete more on the basis of:
A. Uniqueness of products.
B. Price.
C. Quality.
D. After sales service.
3. All the following factors are reasons for firms to employ globally
standardised procedures, EXCEPT:
A. To gain from economies of scale.
B. To reduce the cost of manufacturing.
C. To improve the infrastructures and traditions.
D. To save on product development costs.
4. Adapting to the environment is important in domestic business but

it is not that important in international business.
A. True
B. False

5. National sovereignty also means the right of a country to impose

their laws on other countries.
A. True
B. False
6. What are the reasons that may require a firm to be locally responsive
in their operations?
7. What are the features that can describe the competitive environment
of international business?
1.4 MOTIVATIONS AND RESTRICTIONS IN

Firms engage in international business for a variety of reasons. While to expand
their markets and to acquire resources can be quite obvious, another major motive
is to minimise the risk of competition. Against these aspirations, foreign country
governments may impose restrictions on imports and exports as measures to
protect the interest of their countries. Thus, the international firm needs to develop
and vary their business strategies country by country to achieve their aspirations.
Both these topics are discussed in detail next.
1.4.1 Why do Companies Engage in International

Business?
Figure 1.10 illustrates the three objectives which influence firms to engage in
international business.

Figure 1.10: Objectives which influence firms to engage in international business
The three major objectives are to:
(a) Expand Sales

Firms search international markets to increase sales. However, sales depend
on consumersÊ interest in the firmÊs products or services and their
willingness to buy them. Firms therefore pursue international markets
because of their size and purchasing power which as a whole are greater
compared to a single country.
Coca-Cola, for example, derives 80% of its income from international

operations while McDonaldÊs foreign activities generate about 65% of its
revenue. AirAsia and Proton are examples of Malaysian firms venturing into
international markets to increase sales.
(b) Acquire Resources

Firms venture abroad seeking materials, components, capital, new
technologies and information that they can also use in their home countries,
to reduce costs or to acquire resources that are not available at home. These
resources would enable the firm to improve the quality of its products and

differentiate it from competitors. Foreign resources and experience can also

be used to improve their domestic operations. Proton, for example, acquired
LotusÊ technologies to develop better cars.
(c) Minimise Risk

Different country markets often face different stages in the business cycle,
such as recessions and growth. Decreasing sales in countries facing
recessions may be offset by increasing sales in another country which is
expanding economically. Firms are also able to avoid price increases or
shortages of supplies of raw materials, components and products in any one
country by obtaining them from different countries.
Firms also engage in international business to counter and prevent the

advantages that competitors gain in foreign markets and use in the home
market. For example, a competitor firm may make higher profits from a
foreign market. These additional funds are then used to increase its
advertising or develop better products in its domestic market, giving them
an advantage over domestic firms. In order to gain similar or higher
capabilities, the domestic firm will also need to venture abroad.
1.4.2 Trade Protectionism

Protectionism is government measures that affect competition, prohibit exports or
imports thus limiting a firmÊs ability to buy or sell abroad. The more common
instruments used to control trade flows are explained next.
(a) Tariffs or duty, are taxes levied on exports (export tariff) and imports (import
tariff).
(b) Non-tariff barriers are as follows:
(i) Subsidies are assistance provided to offset high domestic production

costs to assist exporters to make selling prices cheaper or more
profitable when selling abroad. They may be in the form of research
and development aid or loans or direct payments to compensate
domestic firms for the losses incurred from exporting.
(ii) Quotas are limits imposed on the quantity of products that can be
imported or exported during a certain period of time.

(iii) Administrative barriers are regulations, rulings, standards and testing

procedures which may make exports to a foreign country difficult,
costly or even impossible.
(iv) Local content regulations require that a specified portion of a product

be produced locally using locally sourced materials or components.
There are various reasons for government intervention in trade flows, primarily
for the purpose of protecting the country and its citizensÊ interest. Among the
major ones are to:
(a) Maintain Essential Industries

This is to promote the countryÊs self-sufficiency and avoid dependence on
other countries for supplies of critical raw materials, machinery or
technology. A country may ban the import of certain commodities to
promote home production or restrict exports of commodities which are in
short supply for home consumption.
(b) Protect Infant Industries

Governments may implement import restrictions or export subsidies to
protect young domestic industries from fierce competition until they are able
to thrive independently in international markets. The Malaysian government
imposed similar measures to protect our infant automobile industry.
(c) Prevent Unemployment

Domestic firms and their workers may lose jobs if their employer firms are
not able to compete with more efficiently produced imports. Governments
would impose tariffs, quotas and other barriers to restrict imports.
(d) Promote Local Industrialisation

A government may intervene to help develop their countryÊs industrial base
by regulating imports from foreign producers. The unregulated importation
of lower priced products may prevent the development of the domestic
industry.
Import restrictions also increase foreign direct investment when foreign

firms shift their manufacturing facilities into the country to overcome import
restrictions and avoid the loss of a potential market.

(e) Maintain National Security

The export of strategic defence goods, such as sophisticated computer
hardware and software and materials with a nuclear potential which can be
used to threaten national security if placed in the wrong hands, are also
restricted. The United States government, for example, prevents these
exports unless prior approval has been granted.
For non-defence goods, trade controls may be imposed as a matter of foreign

policy to prevent another country from meeting its political objectives. For
example, the United States may impose trade sanctions on the sale of
technology or chemicals to North Korea who would use them in their
defence development programmes.
(f) Maintain Spheres of Influence

A country may put in place trade restrictions to force other countries to
follow certain political actions or punish those who do not. The United States
may threaten to restrict Chinese products because of ChinaÊs controversial
human rights records.
(g) Preserve National Identity

This concerns those industries which a country believes must be protected to
preserve their cultural identity. Thus, France protects its cinema industry to
prevent the invasion of the English language films, while Japan and South
Korea bans the import of rice to preserve rice farming as a historical identity.
ACTIVITY 1.5
What do you think are the advantages and disadvantages of government

intervention in international trade?

EXERCISE 1.4
1. Both the Coca-Cola Company and McDonaldÊs derive more than

____________ % of their total revenue from international markets.
A. 30
B. 40
C. 50
D. 60
2. Subsidies will help ____________ to become better international

competitors.
A. domestic producers
B. foreign competitors
C. importers
D. both importers and international businesses
3. Subsidies, quotas and local content requirements are all forms of

tariff barriers.
A. True
B. False
4. Malaysian export restrictions to China may increase foreign direct

investments by ChinaÊs companies into Malaysia.
A. True
B. False

5. The Malaysian government used the „Infant Industry‰ argument to

support the national car manufacturer, Proton.
A. True
B. False
6. Why do firms need to venture abroad to acquire resources?
7. How does the maintaining of national security justify government

intervention in trade flows?
 This opening topic introduced and explained the basic and current concepts
underlying the activity of international business.
 First, we learned about the increasing role and importance of international

business in line with its tremendous growth in recent years and the reasons for
its growth.
 Next, we learned that globalisation can be viewed as comprising two aspects

of production and of marketing.
 The activities conducted in international markets are categorised as the export

and import of goods and services and investments. The other activities which
we briefly learned are licensing, franchising and management contracts, all of
which will be dealt with in greater detail in later topics.
 In order to have a better understanding of international competition, we

learned about external factors that interact within which the international firm
operates.
 We also learned about the reasons that drive firms to engage in businesses
abroad which are mainly to expand their sales, to acquire needed resources
and/or to minimise the risk of competition.
 Finally, we learned about the practice of trade protectionism by country

governments to restrict the free flow of trade into or out of their countries
based on seven major reasons.

Administrative barriers National security

Competition National sovereignty
Global standardisation Non-tariff barriers
Globalisation Quotas
Infant industries Restrictions
International business Subsidies
Local content regulations Tariffs
Local responsiveness Trade protectionism
National identity

Topic  Cultural,
Political, Legal
2 and Economic
Systems
LEARNING OUTCOMES
1. Explain the diversity of culture and how the various elements of
culture impact the international firmÊs decisions;
2. Describe the basic political ideologies that exist;
3. Examine the types of political risks faced by international
firms operating in countries with differing systems;
4. Assess the basic legal systems of the world and how they influence
the international firm; and
5. Appraise several types of economic systems and their impact on

firms.
 INTRODUCTION
In this topic, we will shift our attention to study in greater depth on the differences
among countries in the aspects of their culture, political and legal, and economic
systems of which we have briefly mentioned in the first topic.
For the international business manager, an awareness of each of these external

environmental factors would help towards a useful understanding and
appreciation of foreign markets and how their firmÊs business can be conducted
more effectively and successfully in foreign country environments. The type of

34  TOPIC 2 CULTURAL, POLITICAL, LEGAL AND ECONOMIC SYSTEMS
products to be sold, how they are promoted and distributed, and pricing strategies
will all be strongly influenced by these factors.
Finally, in this topic, the concept of culture is analysed to help us understand how
diverse cultural values and attitudes shape the demands of consumers, their tastes
and preferences. The different political and legal systems regulate how businesses
can operate in foreign countries while economic systems indicate their differing
emphasis on economic development.
2.1 CULTURE
The following subtopics explain the elements that constitute culture and how the
activities of international business can be affected when cultures differ among
foreign countries.
2.1.1 What is Culture?

Culture is the characteristics and knowledge of a particular group of people, defined by
everything from language, religion, cuisine, social habits, music and arts.
The Center for Advance Research on Language Acquisition goes a step further, defining
culture as shared patterns of behaviours and interactions, cognitive constructs, and
understanding that are learned by socialisation. Thus, it can be seen as the growth of a
group identity fostered by social patterns unique to the group.
Let us look at the following terms:
Culture can be defined as a system of values and norms that are shared among
a group of people (such as in a society) and when taken together, they
constitute a design for living.
Values are shared assumptions about how things ought to be, for example,
about what a group believes to be good, right and desirable.

TOPIC 2 CULTURAL, POLITICAL, LEGAL AND ECONOMIC SYSTEMS  35
Norms mean the social rules and guidelines that prescribe the appropriate
behaviour in particular situations within the society. A society may be
equivalent to a country.
SELF-CHECK 2.1
What should a business firm do to adjust itself to a specific culture in a
particular country?
The process of adjusting and adapting to a specific culture other than our own
is known as acculturation, a key success factor in international operations.
Definition of Acculturation
(a) Cultural modification of an individual, group, or people by adapting to
or borrowing traits from another culture.
(b) A merging of culture as a result of prolonged contact.
(c) The process by which a human being acquires the culture of a particular
society from infancy.
Source: www.Merriam-Webster.com/dictionary/acculturation
A societyÊs culture determines the rules that govern how firms operate in the
society. Firms must build awareness of the cultural diversity of international
markets to operate effectively. Problems may arise when a person from one culture
has to adjust to another culture.
The basic elements that determine culture are social structure, religion, values and
attitudes, language and education, as seen in Figure 2.1. The explanation for each
are in the subsequent subtopics.

Figure 2.1: Elements of culture
2.1.2 Social Structure

Every society has a social structure that determines the roles of individual
members, the stratification of the society (division of population into classes) and
the individualÊs mobility within the society.
Although all societies involve individuals living in family units and work groups,
they define family and groups differently and place different importance on the
role of the individual. Americans define the basic family unit as comprising
parents and their children. The Arabs consider uncles, cousins and in-laws as part
of the family unit, while the Somalian society is organised into clans comprising
individuals of the same tribe. American societies therefore promote individualism
and encourage the development of individual talents. Japanese societies are
group-focused and the individualÊs role is to serve the group. As employees, their
work attitudes will also be similarly focused.
Social stratification systems exist because each culture values some people more
highly than others and distinguish a person by their social class or status. The caste
system in India and the British class structure are examples of this system. Firms
operating in such societies need to take class differences, for example between
supervisors and workers, into account when hiring and promoting employees.
This is to avoid assigning jobs traditionally performed by members of one group
to another group as it may lower the morale and productivity of the groups
concerned.
Social mobility refers to the ability of individuals to move from one class to another
within society. In a rigid system like in India, a lower caste member may face
difficulty interacting and gaining the cooperation of colleagues when they are
promoted to higher supervisory roles.

Apart from workplace relations, the international firm may also need to tailor
promotional messages more carefully so as not to offend groups not targeted.
2.1.3 Religion and Ethics

Religion can be defined as a system of shared beliefs and rituals that are concerned
with the realm of the sacred. Ethical systems are sets of moral principles or values
that are used to guide and shape behaviour. Most ethical systems are based on
religious principles.
There are numerous religions in the world today, some of which are very
influential in certain parts of the world. The major ones, in terms of number of
followers are Christianity with 1.7 billion followers, Islam with 1 billion, Hinduism
with 750 million and Buddhism with 350 million followers. Although
Confucianism is more a set of guiding principles than a religion, it also has an
important ethical influence on culture and behaviour in certain parts of Asia.
Christianity has three main branches which are Roman Catholic, Orthodox and
Protestant. According to the German sociologist Max Weber, Protestant ethics
emphasises on the importance of individual hard work, achievement and frugality
for the glory of God. They strive constantly for efficiency, savings and
reinvestment of profits for future productivity, all of which are necessary in a
capitalist economy and entrepreneurial activity.
Hinduism and Buddhism stress the afterlife and spiritual achievement rather than
involvement in this world. Hinduism believes that the way to achieve spiritual
perfection is by leading a severe ascetic lifestyle of material and physical self-
denial. However, Buddhism does not support the Hindu caste system and may be
more encouraging towards entrepreneurial activity than Hinduism.
While Islam supports entrepreneurship, it strongly prohibits exploitation and

discrimination. The role of women managers in business may also be limited
compared to Western countries and products have to abide by the halal ruling.
Islam also regards interest payment as usury. However, these restrictions have
also revealed opportunities as evidenced by the successful marketing of non-
alcoholic beverages and interest-free banking products.
Confucianism has 150 million followers throughout Asia. It has been characterised
more as a code of conduct rather than a religion with the emphasis on loyalty and
relationships. The economic success of Japan, South Korea, Singapore and China
could be a result of loyalty to central authority and placing the good of the group
before that of the individual.

The impact of religion on international business varies from country to country,

depending on the similarity of religious beliefs and tolerance of other religious
view points.
2.1.4 Values and Attitudes
Values are the principles and standards that have been internalised and
accepted by members of a society.
Attitudes are the thoughts, feelings and actions resulting from those values.
Thus, cultural attitudes towards time, age and status may reflect these values and
influence the opportunities available to international business in a given society.
(a) Time
Attitude towards time differ greatly among cultures. In western cultures,
time means an opportunity to produce more and increase oneÊs income and
is not to be wasted. In Latin America, it is not unusual if meetings begin 45
minutes late and meetings may be interrupted by the host entertaining
unscheduled visitors like family and friends. Westerners may wrongly
interpret the hospitality of the host as a sign of rudeness and disrespect.
In other cultures like the Japanese and the Arabs, meetings may start on time
but initial meetings would focus on establishing relationships and
determining whether the parties can trust and work with each other
comfortably. In contrast, Westerners expect to get down to business
immediately after exchanging a few pleasantries and follow a set agenda.
(b) Age
While youthfulness is considered a virtue in a society like the United States
and may send young „high achievers‰ to negotiate with international
partners, the Asian and Arab cultures respect age and correlates a managerÊs
stature with age. Similarly, the Chinese would prefer to deal with older and
more senior members of a firm and may feel offended when dealing with
young counterparts.

In the Japanese culture where group-based decisions are important, senior

managers will not approve projects unless they have obtained a consensus
among junior managers. Foreign firms often commit the mistake of focusing
their attention in negotiations to the senior managers, when they should be
persuading the junior managers.
(c) Status
Values and attitudes towards the means by which a person achieves his
status also vary across the different cultures. In some societies, status may be
inherited through the wealth or rank of a personÊs ancestors, such as the
noble class in some European countries. In the United States, however, hard
working entrepreneurs are held in high regard and their children would not
be similarly respected if they fail to match their parentÊs achievements.
In Japan, a personÊs status is linked to the status of the group to which he

belongs. Thus, attending elite universities such as the Tokyo University or
employment in elite organisations such as Toyota Motor Corporation or the
Ministry of Finance would grant a high status.
2.1.5 Language
Language shapes the way people perceive the world and helps define culture. In
countries with more than one language, we may also find more than one culture,
such as the „English-speaking‰ and the „French-speaking‰ cultures in Canada.
Language may be verbal and messages are conveyed by the words used and how
they are spoken, for example, the tone of the voice. Messages may also be
communicated through non-verbal means by way of gestures, body position and
eye contact.
In international business, language serves four important purposes which are:
(a) Information Gathering and Evaluation

Language is important in information gathering and evaluation. Market
intelligence is best obtained by becoming part of the market rather than
observing it from the outside. The capable manager is therefore personally
able to see and hear what is going on, rather than relying on the opinions of
others.
(b) Easier Access to Society

Language is also able to provide the manager with easier access to society.
The ability to speak the local language means better acceptance and higher
willingness of the locals to openly communicate with the manager, at the
same time fostering cordial relationships.

(c) Ability to Communicate

The capability to speak a common language within the firm or with diverse
distributors has also become increasingly important. A foreign manager
needs to communicate with employees of a subsidiary in another country
and would otherwise require an interpreter.
(d) Ability to Interpret Different Contexts of Culture

Besides the ability to communicate, language also provides the manager with
the ability to interpret different contexts of culture. For example, the use of
English in different countries carries different meanings. When the British
say „Negotiations Bombed‰, it means it was a huge success, which conveys
exactly the opposite to the Americans.
Firms also need to exercise more care in the use of language in conveying
advertising messages. There often is a need for advertisements originally in the
language of the home country to be accurately translated into the local language
and words used have to be carefully selected to avoid difficulty in pronouncing
them.
2.1.6 Education
A countryÊs education system, both public and private, plays an important role in
the transmitting and sharing of culture. CountriesÊ education systems have
varying emphasis on the quality of their education, whether based on particular
skills or the overall level of the education. Japan and South Korea emphasise on
the sciences more than the Western countries and Germany on apprenticeship
programmes for craftsmen and machinists. The United StatesÊ system stresses on
the development of self-reliance, creativity and self-esteem, and provides
widespread access to higher education.
In employment, the international firm has to provide employees with training

programmes taking into account their educational background, skills and literacy
levels.
ACTIVITY 2.1
Which basic culture element do you think has the biggest influence on the
growth of international business?

EXERCISE 2.1
1. The Japanese culture places very high importance on:

A. Group membership
B. Individualism
C. Personal achievement
D. Individual preferences
2. Which of the following religious beliefs are most likely to support

economic development and growth?
A. Christianity and Buddhism
B. Hinduism and Buddhism
C. Confucianism and Islam
D. Islam and Christianity
3. Culture includes all the following elements, EXCEPT:

A. Language
B. Religion
C. Geography
D. Social institutions
4. Culture is a system of values and norms that are shared among a

group of people and shapes their way of life.
A. True
B. False
5. Hinduism is the most widely practised religion in the world.

A. True
B. False

6. How does education impact culture?
7. Why is knowing the local language important to the international

business manager?
2.2 POLITICS AND LEGAL ENVIRONMENT

The two subjects of law and politics are considered as a pair because they are both
intertwined in the sense that political decisions may change laws and laws may
regulate the power of politicians. The system of government in a country is known
as the political system. It brings together people of different backgrounds and
allows them to work together to govern themselves. A countryÊs political system
influences how business is conducted domestically and internationally.
We shall now learn about the political ideologies upon which countries base their
political systems and the risks associated with doing business in different
countries.
2.2.1 Basic Political Ideologies

Political systems can be assessed according to two related dimensions. Firstly, the
degree to which collectivism is emphasised against individualism. Secondly, the
degree to which they are democratic or totalitarian. These two dimensions are
interrelated because systems that emphasise on collectivism tend to be totalitarian
while systems that value individualism tend to be democratic. Figure 2.2 illustrates
the types of political ideologies.
Figure 2.2: Types of political ideologies

(a) Collectivism
This refers to a political system that places primary importance on collective
goals rather than individual goals. The needs of society as a whole are
generally held as more important than individual freedom. Collectivism was
firstly advocated by Plato (427-347 BC), who believed that individual rights
should be sacrificed for the good of the majority, property should be
commonly owned and society should be divided into classes with
philosophers and soldiers who would rule for the benefit of all.
Modern socialism was based on the teachings of Karl Marx (1818-1883), who
believed that in a capitalist society where individual freedom is not
restricted, the few will benefit at the expense of the many. Therefore, to
correct this situation he advocated that the state should own all enterprises
and means of production, and ensure that workers are fully compensated for
their labour.
In the 20th century, the socialist ideology can be divided into the
communists, who believed that socialism can be achieved only through
violent revolutions and totalitarian dictatorship, and the social democrats,
who strived to achieve socialism by democratic means. Communism has
weakened with the collapse of the Soviet Union and in the countries of
Eastern Europe in 1989, as well as other nations such as Cambodia, Laos,
Vietnam, Angola and Mozambique. Many believe that it is now only a matter
of time before communism in China will also collapse. In Great Britain,
France, Germany, India and Brazil, social democratic parties have held
power from time to time, where private companies in certain industries have
been nationalised into state-owned enterprises to be run for the good of the
public. However, it has been shown that state-run companies performed
poorly and has become inefficient, counter to public interest. As a
consequence, many social democratic parties were voted out of office and the
state-owned enterprises were sold to private investors. BritainÊs
Conservative Party and GermanyÊs Christian Democratic Party are more
committed to private ownership and free market economics.
(b) Individualism
Individualism refers to a philosophy that the individual should have the
freedom to pursue his own economic and political beliefs. It stresses that the
interest of the individual should take precedence over the interest of the
state. This ideology can be traced to another Greek philosopher, Aristotle
(384-322 BC). He argued that private property receive the greatest care and
is therefore more highly productive.

The central message of individualism is that individual economic and

political freedoms should be the ground rules upon which society should be
based. It emphasises the importance of individual freedom and self-
expression, and believes that the welfare of society is best served by letting
people pursue their own self interest. These ideas can also be found in the
writings of economists Adam Smith and John Stuart Mill.
Individualism can be viewed as advocating democratic political systems and

free market economies championed by the United States, and collectivism as
championed by the now defunct communist Soviet Union.
(c) Democracy
Democracy refers to a political system by which a country is governed by the
people, exercised directly or through elected representatives. It goes hand-
in-hand with individualism.
In ancient Greece, the pure form of democracy was practised with the
citizensÊ direct involvement in government decision making. However, the
large populations of modern societies have made this impractical. TodayÊs
democratic countries practise what is known as representative democracy,
where the citizens elect individuals to represent them in government. If the
elected representatives fail to perform his job adequately, they will be voted
out at the next election. An ideal representative democracy is indicated by
the following basic characteristics:
(i) An individualÊs right to freedom of expression, opinion and freedom to
organise;
(ii) Free of the press;
(iii) A regular election in which all eligible citizens are allowed to vote;
(iv) Universal adult suffrage;
(v) Limited terms for elected representatives;
(vi) A fair court system that is independent of the political system;
(vii) A non-political state bureaucracy;
(viii) A non-political police force and armed service; and
(ix) Relatively free access to government information.

(d) Totalitarianism
Totalitarianism is a form of government in which one person or one political
party exercises absolute control over all areas of human life and prohibits
opposing political parties. The individualÊs right to freedom of expression
and organisation, free media and regular elections are denied to the citizens.
There are four major forms of totalitarianism in the world today. Up to the
demise of the Soviet Union, the most widespread form was communist
totalitarianism, which is a version of collectivism advocating that socialism
can only be achieved through totalitarian dictatorship.
The second form is called theocratic totalitarianism, where political power is

controlled by a party or individual who governs according to religious
principles. This is practised in Iran and Saudi Arabia based on Islamic
principles and freedom of political and religious expression is limited.
Thirdly, tribal totalitarianism, which arose in the African countries such as

Zimbabwe, Tanzania, Uganda and Kenya. A typical country consists of
several different tribes and one political party, which is not always the
majority tribe, that represents the interest of a particular tribe monopolising
power.
The fourth major form is known as right-wing totalitarianism, which

generally allows some individual economic freedom but restricts individual
political freedom in order to prevent the rise of communism. They are hostile
to socialist or communist ideologies and many are backed by the military.
Some examples of right-wing totalitarianism were the fascist regimes of
Germany and Italy during 1930-1940 and the right-wing dictatorships in
Latin America. Most of these countries, however, are now multi-party
democracies.
Although collectivism and individualism are at the opposite ends of political

systems, as is democracy and totalitarianism, there are also gray areas that
exist in between. Democratic nations may practice collective values, while
totalitarian nations may allow some degree of individualism. China, for
example, is a totalitarian state but is economically moving towards greater
individual freedom.

ACTIVITY 2.2
Visit ChinaÊs web site at www.chinatoday.com and TaiwanÊs website at

www.sinica.edu.tw/taiwan/. Study and compare these two nations who
share a common history and tradition yet have opposing political
ideologies. Discuss the similarities and the differences in their approach
to business.
2.2.2 Political Risks

The political climate in a foreign country may change and affect the viability of a
firmÊs operations. Tax and minimum wage laws affect the firmÊs profitability and
the cost of labour respectively, and environmental protection laws affect the
production technology and the cost of waste disposal. Civil wars, kidnappings of
foreign personnel and government take-over of foreign assets may threaten
foreign operations.
Most political risks can be divided into three categories:
(a) Ownership risks, whereby the property of the firm is threatened through
expropriation or confiscation.
Expropriation is the taking-over of foreign-owned properties by the

government with compensation being provided. However, these
compensations are often unsatisfactory to the owners. Confiscation also
means the taking over of foreign-owned assets, but it does not involve
compensation for the firm.
(b) Operating risks, in which changes in laws, environmental standards, tax

regulations, terrorism and armed uprisings threaten the ongoings of the firm
and the safety of its employees.
(c) Transfer risks, when the government interferes with a firmÊs ability to shift
funds into and out of the country.
Political risks may be the result of government actions through passing of laws. It
may also arise from non-governmental actions, such as kidnappings, extortion and
terrorism. Although political risks may occur in democratic as well as in
totalitarian political regimes, they are more likely to happen in totalitarian
countries.

2.2.3 Types of Legal Systems

An international firm faces a complex task of not only having to obey the laws of
its own home country but also the laws of all the host countries in which it
operates. Laws determine which markets firms can enter, the prices of their
products or services, and the cost of labour, raw materials or technology.
Managers, therefore, need to be aware of the different countriesÊ legal systems,
which may differ in terms of the nature of the system and the degree the judiciaryÊs
independence from the political system.
Legal systems differ based on their historical, cultural, political and religious
backgrounds. There are three basic systems of law:
(a) Common Law

It is a system of law that relies on the rulings of previous cases (called
precedents), custom and traditions, and common usage as the basis for court
decisions. Its origins can be traced to England hundreds of years ago. It is
now found in the United States and most of the United KingdomÊs former
colonies, such as Hong Kong.
(b) Civil Law

The civil law system, sometimes known as code law, is a compilation of laws
organised into codes. It has its origins in the Roman code of law dating back
to 450 BC. More than 70 countries, including Germany, France, Japan and
Russia operate with a civil law system.
Common law and civil law differ because the former is based on the courtsÊ
interpretation of events, whereas civil law is based on how the law is applied
to the facts of the case. For example, contracts in a common law country tend
to be detailed, with all the terms and conditions spelled out. In a civil law
country, they tend to be shorter and less specific because many of the issues
detailed in a common law contract are already included in the civil code. The
courts will interpret civil law with reference to these codes.
(c) Theocratic Law

A theocratic law system is based on the established rules governing the faith
and practice of a particular religion. Although both Hindu and Jewish laws
are still being practised, Islamic law is the most widely implemented legal
system in the modern world. Islamic law, or the Syariah, is based on the Holy
Quran, and the Sunnah, or decisions and teachings of the Prophet
Muhammad.

Islamic law not only concerns moral behaviour but it also extends to cover
commercial activities. It is intended to govern all aspects of life. Several
Islamic countries such as Iran, Sudan, Pakistan and Saudi Arabia, for
example, have adopted Islamic banking systems and banned traditional
commercial banking. They have pronounced interest to be non-Islamic and
illegal. Banks therefore cannot charge interest or benefit from interest and
instead structure fees into their loans to allow them to make a profit.
The underlying principle is that money can earn a return by being employed
productively, but not by being earned in financial markets.
ACTIVITY 2.3
Different countries have different kinds of legal systems in relation to

business operations. List down and discuss the importance of law in
international businesses.
2.2.4 The Legal Profession

As international trade expands, legal services are increasingly required by firms,
such as in the area of contract negotiations and intellectual property protection. As
such, the legal profession itself is also experiencing internationalisation.
However, the international practice of law is not without barriers. Cultural and
political differences between countries which influence the law still remain. Apart
from the law itself, rules and procedures pertaining to the practice of law also
varies from country to country. There are different professional codes governing
lawyersÊ standards of conduct regarding issues such as confidentiality, fees,
conflicts of interest and publicity.
Law firms also face barriers in extending their services due to government
restrictions on foreign firms from hiring local lawyers, forming partnerships with
local law firms or entering the country to practise law. Other countries may allow
foreigners to open offices within their borders to offer their services. For example,
until 1986 the Japanese market for legal services was closed to foreign lawyers who
wanted to practise in Japan. Germany blocks the practice of foreign lawyers and
the establishment of foreign firms within their country until very recently. Hong
Kong and Singapore, however, welcome foreign law firms, while the European
Community (EC) countries are beginning to relax their rules for lawyers from
other EC member countries.

For the international business firm, its need for legal services can be obtained
through several ways. The larger firms may set up its in-house legal department
by recruiting trained lawyers. When it is necessary to have local representation,
they may choose a law firm that has overseas connections who can represent them
through their foreign branch offices, affiliates or correspondent relationships.
However, smaller international business firms still rely on outside legal counsel
for their needs.
EXERCISE 2.2
1. More than 70 countries, including France, Germany and Japan,
operate on this legal system.
A. Common law system
B. Theocratic law system
C. Civil law system
D. Socialist law system
2. A countryÊs ____________ influences how business is conducted

domestically as well as internationally.
A. political system
B. economic system
C. legal system
D. financial system
3. China is an example of a ____________ totalitarian government.

A. fascist
B. theocratic
C. communist
D. tribal

4. In theocratic totalitarianism, the government imposes law and order

through the use of military power.
A. True
B. False
5. Common law is based on customs and traditions, usage and

precedents.
A. True
B. False
6. What are the three types of political risks? How may they affect the
international business firm?
7. Describe the various sources on which Islamic theocratic law is

based.
2.3 ECONOMIC ENVIRONMENT

In connection with the political system, we are more likely to find free market
economic systems where individualism is given prominence. In collectivist
political systems, the government may have control over enterprises and markets
may be more restricted.
The international managerÊs ability to anticipate economic trends and events in

foreign countries may affect the firmÊs future performance. Important dynamic
issues such as the size, growth potential, market stability, how governments view
foreign competition and their economic objectives may assist firms to assess their
viability of doing business.

2.3.1 Economic Systems

Let us now learn about the three broad types of economic systems. They are:
(a) Market Economy/Capitalism

In a pure market economy, resources and all productive activities are owned
and controlled by the private sector. Production is determined by the
interaction between supply and demand through the price system. If
demand for a product exceeds supply, prices will rise encouraging producers
to produce more. If supply exceeds demand, prices will fall and producers
will produce less. In this system, consumers are sovereign, which means that
consumers decide what to buy, and companies face no restrictions in how
they operate.
The role of the government in a market economy is to encourage competition

and efficiency between producers. Private ownership ensures that
entrepreneurs have the right to earn profits for their efforts, which provides
the incentive for them to find better ways to serve consumer needs. This
constant striving for improvement in products and processes can be
considered as a major positive impact on economic growth and
development.
In most market economies, monopolies are against the law, such as the anti-
trust laws in the United States. Monopolies emerge when they are allowed
to restrict supply. Rather than increasing output when demand increases, the
monopolist restricts output and let prices increase. Since they have no
competitors, they have no incentive to look for better ways to lower their
production costs. Although this situation is good for the monopoly firm, it is
bad for consumers and society as a whole.
(b) Command Economy/Socialism

Command economies can be found in the communist countries, such as
Myanmar and North Korea. It is also known as centrally planned economies,
whereby all economic activities such as goods and services that the country
produces, the quantity produced and the prices at which they are sold, are
all planned by the government. In pure command economies, all enterprises
are owned by the state, the rationale being that the government can direct
investments in the best interest of the nation.
Other socialist-inclined governments like France and India also practice

some elements of a command economy, although it has declined.

(c) Mixed Economy

In reality, there is no purely market or completely command economy being
practised. Most market economies have some degree of government
ownership and control. At the other end of the spectrum, command
economies are shifting to a more market oriented economy.
Between free market economies on one hand, and command economies on

the other, are mixed economies. In mixed economies, governments may tend
to take ownership of troubled firms which are considered vital to national
interests. Renault, the automobile company, was at one time taken over by
the French government to prevent its collapse and the resulting
unemployment. Some governments may own significant resources, but it
allows supply and demand to set prices, while other countries without much
resources levy high taxes for funds. Governments may also control economic
activity through their fiscal policies.
ACTIVITY 2.4
What type of economic system does Malaysia practise? Explain your
answer.
2.3.2 Differences in Economic Development

Different countries have different levels of economic development, which
international business firms should be aware of in making their expansion and
investment decisions or strategies.
(a) Economic Classification by Income

In measuring economic development, a countryÊs Gross Domestic Product
(GDP) is commonly used as a yardstick. GDP is the final value of goods and
services produced by a certain country within a certain period of time. This
value includes goods and services produced by the citizens and people of
other nationalities living in the country. Per capita income is the total income
of an individual in a country. As examples, Table 2.1 summarises the GDP
(Purchasing Power Parity, PPP) per capita growth rate of some of the worldÊs
nations in the year 1990–2014.

Table 2.1: List of Countries by GDP (PPP) Per Capita Growth Rate from 1990–2014
GDP Growth Rate

GDP Per Capita GDP Per Capita
Country (%)
(USD) in 1990 (USD) in 2014
1990–2014
Brazil 6,622 15,893 140.0
China 980 13,206 1247.62
Germany 19,033 46,401 143.79
India 1,146 5,701 397.43
Japan 19,230 36,619 90.43
Nigeria 1,959 5,911 201.8
Poland 5,996 25,262 321.33
Russia 8,013 22,990 186.91
Switzerland 26,734 59,540 122.71
United Kingdom 17,446 40,233 130.61
Source: World Bank, World Development Indicators (1990–2014)
From Table 2.1, among the richest countries are Japan, Switzerland, Germany
and the United Kingdom 5,701% respectively. Switzerland, one of the
worldÊs richest nations had a GDP per capita (per head of population) of
USD59,540 (2014), whereas Mozambique (not shown in table), with a GNP
per capita of only USD1,129 (2014), is one of the worldÊs poorest. Large
countries such as India and China are among the poorest and very dynamic
countries. Large nations such as China and India achieved USD13,206 and
USD5,701 with 1247.62% and 397.43% GDP growth rates respectively from
1990–2014.
GDP per capita figures, however, can be misleading because it does not
consider the differences in the cost of living between countries. For example,
although the GDP of Switzerland showed USD59,540 (2014) exceeding that
of the United States at USD54,629 (2014) (not shown in table), the higher cost
of living in Switzerland meant that American citizens could actually afford
more goods and services than the Swiss.
The Purchasing Power Parity (PPP) method adjusts the GDP of countries
with the cost of living and allows a more direct comparison of living
standards between countries. Let us use the cost of living in the United States
as a base for comparison with India. While the GDP per capita for India was
USD5,701, the PPP per capita was USD5,610 (2014) (not shown in table). This

may indicate that the cost of living in India was lower than in the United
States, and that USD5,701 in India could buy as much as USD5,610 worth of
goods and services in the United States, as much as USD55,837 (2014) and
PPP as USD55,140 (2014).
The above figures further suggest that the standard of living among
countries also differ drastically. The average Indian citizen can afford to
consume only about (5,610  55,140  100%) 10.17% of the goods and services
that the average US citizen can. Therefore, despite having a population of 1
billion, India does not appear to be an attractive market for consumer goods.
This conclusion, however, may not be accurate because India has a wealthy
middle class, although the majority may be poor.
The GDP and PPP figures are also a static picture of a countryÊs economic
development. We will need to further rely on the rate of growth in Gross
Domestic Product (GDP). For example, India may be shown as poorer than
the United States, but it does not tell us whether the income gap is closing.
They may currently be poor but it is growing at a much quicker rate than the
advanced countries. With their potential, they may in future become more
advanced and be huge markets for the international firmÊs products.
Currently, they may contribute little to revenues, but their future
contributions could be much higher and firms may want to gain a foothold
in the market now.
Another wider approach to measuring development is called the Human

Development Index (HDI) which was developed by the United Nations and
used to measure the quality of human life in different countries. The three
criteria used are:
(i) Life expectancy at birth, which depends on the quality level of health
care accorded;
(ii) Educational attainment, which is measured through combining the
adult literacy rate and enrolment in primary, secondary and tertiary
education; and
(iii) Average incomes, which are based on PPP estimates, to measure
whether incomes are sufficient to meet the basic life necessities in a
country such as food, shelter and health care.

(b) Economic Classification by Regions

World Bank reports on developing countries are usually provided according
to geographical regions. International corporations find this classification
important because their activities tend to be organised along geographical
lines as well.
The major regions are as follows:

(i) East Asia and the Pacific countries such as Korea, China and Japan;
(ii) Latin America and the Caribbean, such as Brazil, Argentina and Chile;
(iii) The Middle East and North African countries such as Saudi Arabia,
Egypt, Algeria and Libya;
(iv) South Asia includes countries on the Indian continent;
(v) Sub-Saharan Africa such as Ethiopia, Sudan, Nigeria, Mozambique,
Namibia and South Africa; and
(vi) Eastern Europe and Central Asia, such as the Czech Republic, Ukraine,
Poland and the countries of Russia.
The regions of North America, Western Europe and Australia, and Japan are
categorised as high income countries, or members of the Organisation for
Economic Cooperation and Development (OECD) countries.
It is also important to note that although these countries are located within
similar regions, they may be very different from each other in terms of ethnic
origin, history, politics and economics.
Figure 2.3 provides a clearer picture of these regions.

Figure 2.3: Regions of the world
ACTIVITY 2.5
What is the difference between „Economic Classification by Income‰ and

„Economic Classification by Regions‰?
2.3.3 The Emerging Market Economies

Since the late 1980s, two trends have radically changed the worldÊs government.
Firstly, a wave of democratic revolutions took place when totalitarian
governments in Eastern Europe and the Soviet Union collapsed and were replaced
by democratically elected ones. Secondly, there has been a strong shift from
centrally planned or mixed economies to a more free market system. Many
countries in Asia, Latin America and Western Europe begun selling state-owned
enterprises to private investors and deregulated their economies to promote
greater competition. These are the so called emerging economies of the world
today.
The major underlying reason for economic transition was that command and
mixed economies have revealed weaknesses that generally failed to deliver the
kind of economic achievement that was achieved by free market-based systems,
such as the United States, Switzerland and Taiwan.

The process of shifting towards a free market-based system requires several steps
as explained in the following.
(a) Deregulation
In the command economies, deregulation of the markets means the removing
of legally imposed restrictions to allow the free play of market forces, the
formation of private enterprises and how they operate, uplifting controls
over prices and outputs and international trade.
In the mixed economies where the role of the government is more limited,
deregulation is much easier to implement because a private sector already
exists. India, for example, has reformed their industrial licensing system that
made it difficult for new private enterprises to be established and opened up
sectors such as electricity generation, steel making, air transport and some
areas of the telecommunications industry to the private sector. India has also
removed limitations placed on foreign ownership of Indian assets and
lowered the barriers to international trade.
(b) Privatisation
Privatisation is the transfer of ownership of state-owned properties to private
individuals. It was first implemented by the British government in 1979
when 20 state firms were converted into privately owned companies.
This is an economic strategy usually used by the government as a way to

reduce their burden of the cost of operating these enterprises. Funds raised
from the effort can then be utilised to finance other government projects. At
the same time, the companies can become more productive, efficient and
innovative, and can expand the choices for the private sector. Privatisation is
also intended to attract new foreign capital into their countries.
For international firms, a countryÊs privatisation exercise may offer

opportunities to acquire the properties for sale at a low cost and allow the
expansion of their operations from an established base provided by these
properties.
(c) Legal Systems

Many countries that are the emerging from the communist bloc, where all
properties were government-owned, lacked the legal structure needed to
protect private property rights and enforcement of contracts that are
required for the smooth functioning of a market economy.

Foreign capital may be hesitant due to the weak system of law which cannot
offer adequate protection for their investments. In the event of contract
disputes, procedures for resolving them are either insufficient or poorly
developed.
In the long-term, major changes in the flow of trade and investments will take
place as these emerging economies continue their effort to become major players
in global trade.
EXERCISE 2.3
1. Which of the following is NOT a developing country?

A. China
B. France
C. India
D. Malaysia
2. Among the countries of the emerging market economies are the

countries of:
A. Argentina and Brazil
B. Russia and Eastern Europe
C. Malaysia and Thailand
D. Germany and Italy
3. Which method adjusts the national income of countries with the cost
of living and allows a more direct comparison of living standards
between countries?
A. Gross National Product (GNP)
B. Gross Domestic Product (GDP)
C. Purchasing Power Parity (PPP)
D. GDP Growth Rate

4. A centrally planned economy is one in which the countryÊs resources

are primarily owned and controlled by the private sector, not the
public sector.
A. True
B. False
5. Privatisation means the selling of privately owned companies to the

government to settle their debts.
A. True
B. False
6. What are the major features that differentiates between the three
economic systems of the world today?
7. What are the three steps that need to be taken by the emerging market
economies in their efforts to transform to a free market-based system?
 In this topic, we have focused on the existing issues of culture, politics, legal
and economic systems in the external environment of the international
business firm.
 We have learned that although international markets are increasingly facing

globalisation, the world remained strongly multi-cultural.
 Culture has a greater impact on consumer goods tastes and preferences

compared to industrial goods, which are more universal in nature.
 We also learned that political and legal systems tend to differ from country to
country, even among those sharing similar political ideologies.
 Based on these different systems, governments determine how businesses are

carried out in relation to their respective countries.
 The area of business contracts and settlement of disputes is another important

area that gives direct impact to the international firm.

 Finally, we learned about the three major economic systems practised by

countries today, which are broadly categorised as the free market system,
command economy and mixed economic system. These different systems are
also related to political systems.
 The economic success of democratic countries indicates a strong positive

relationship with the free market economic system.
 Thus, the desire to be as economically-developed drove many communist

countries to convert to democracies such as in Russia and Eastern Europe.
 The topic ends with a discussion on these former communist countries which
are now termed as the emerging market economies.
Acculturation Market economy

Attitudes Mixed economy
Culture Norms
Collectivism Organisation for Economic
Cooperation and Development
Command economy (OECD)
Democracy Privatisation
Deregulation Politics
Ethics Purchasing Power Parity (PPP)
Gross Domestic Product (GDP) Religion
Human Development Index (HDI) Social structure
Individualism Totalitarianism
Legal system Value

Topic  International
Trade
3 Theories and
Institutions
LEARNING OUTCOMES
1. Explain why countries trade with each other;
2. Distinguish between the different theories and the pattern of
trade flows between countries;
3. Examine the four basic strategies of international firms
according to different marketing environments abroad; and
4. Discuss the meaning of regional economic integration, the
arguments supporting or opposing economic integration and its
impact on the international business firm.
 INTRODUCTION
In this topic, we will discuss the international trade as the exchange of goods,
services, assets or money between persons or organisations of two countries.
It occurs when parties involved in the transaction believe that they will benefit
from the exchange. In this topic, we will look into the significance of international
trade to businesses, consumers and workers, which have led to the development
of several theories to explain and predict the factors that motivate international
trade. We shall trace several theories from the period of the 1500s up to the modern
theories of the 20th century.

62  TOPIC 3 INTERNATIONAL TRADE THEORIES AND INSTITUTIONS
Topic 3 also explains in detail and compares the four basic strategies employed by
international firms when they compete in the international environment, namely
an international strategy, a multi-domestic strategy, a global strategy and a
transnational strategy. Each has its own advantages and disadvantages in which
its appropriateness varies with the environment.
The final section of the topic studies the institution of regional economic trading
blocs, called economic integration, among countries to promote trade among
country members and develop their economies. The different levels of economic
integration shall be explained, each with its own distinctive features and issues.
We shall also study in greater depth selected trading blocs existing today to assess
its development.
3.1 THEORIES OF INTERNATIONAL TRADE

In the following subtopics, we shall review six theories that explain why a country
benefits by engaging in international trade as well as explain the pattern of exports
and imports of products between different countries.
3.1.1 Age of Mercantilism

Mercantilism emerged in England and was propagated during the period
1500- 1800, when gold and silver were the medium of exchange and considered as
a measure of a nationÊs wealth. Gold and silver could be earned by exporting
goods.
It advocates that countries should therefore encourage and maintain more exports
than imports which would then result in a trade surplus position. A country could
then accumulate wealth and prestige.
As a result, governments would practise intervention to achieve a surplus balance

of trade. Exports were subsidised while tariffs and quotas were imposed on
imports.
Towards the late 1700s, weaknesses began to emerge with this practice, as pointed
out by the classical economist, David Hume (1711–1776). According to Hume, the
resulting inflow of gold and silver would increase domestic money supply and
cause inflation in England. In France, to which England exports, money supply
would decrease, thus demand and prices of goods would also fall. This change in
relative prices would cause France to buy fewer English goods (because they have
become more expensive), while England would buy more French goods (because

TOPIC 3 INTERNATIONAL TRADE THEORIES AND INSTITUTIONS  63
they have become cheaper). EnglandÊs balance of trade would deteriorate and
FranceÊs balance of trade would improve. Hume further argues that no country
could sustain a surplus trade balance in the long run by accumulating gold and
silver, as advocated by the mercantilists.
3.1.2 The Theory of Absolute Advantage

In 1776, another classical economist, Adam Smith, argued that the real wealth of a
country should not be measured in the amount of gold or silver that it accumulates,
but consists of the goods and services available to its citizens. This means that the
more goods and services that a country could produce the wealthier it would
become.
He developed the Theory of Absolute Advantage which holds that different

countries produce some goods more efficiently than other countries. Countries
should therefore specialise in producing those products that they were most
efficient at. Specialisation could increase a countryÊs efficiency due to three
reasons:
(a) Workers become more skilled by repeatedly doing the same tasks;
(b) Workers would not lose time switching from the production of one type of
product to another; and
(c) More effective working methods could be developed from the experience
and incentives provided by long production runs.
Excess from the specialised production could then be used to pay for more imports
than the country could themselves produce.
The sources for a country to obtain efficiency advantage can be natural or acquired.
Natural advantage can be due firstly to climatic conditions which allow a country
to produce certain agricultural products efficiently. For example, MalaysiaÊs
climate is suitable for the production of palm oil and Sri LankaÊs for the production
of tea. Secondly, a country can obtain natural advantage from natural resources
that it has access to. Oil, ores and metals are natural resources which no single
country possesses sufficiently to be independent of the rest of the world except for
short periods of time. Lastly, it can be due to the availability of labour or skills in
particular industries. Sri Lanka could instead process tea into instant tea to reduce
bulk and transport costs on tea exports.

Next, advantage can be acquired such as in product or process technology. Product

technology enables a country to produce a unique product that can be
distinguished from the products of competitors. For example, Denmark exports
silver tableware because Danish companies have developed distinctive products,
not because they have rich silver mines. Process technology would enable a
country to produce a homogeneous product efficiently. Japan, for example,
employs new labour-saving and material-saving processes to process and export
steel, although they import the iron and coal needed for steel production.
Therefore, these new product and process technology is able to create an
advantage for the countries where they are developed.
3.1.3 The Theory of Comparative Advantage

Although the Theory of Absolute Advantage can be easily understood, it has a
weakness.
Adam SmithÊs theory seems to suggest that no trade would then take place.
However, David Ricardo expanded on the Theory of Absolute Advantage.
RicardoÊs Theory of Comparative Advantage states that a country should produce

and export those goods and services which it is relatively more efficient at
producing than other countries, and import those goods and services which other
countries are relatively more efficient in producing. All the countries concerned
would then still be economically better off by engaging in trade.
We shall assume an example between Germany and Italy.
Table 3.1: Production of Machine Tools and Trucks between Germany and Italy
Production
Machine Tools Trucks Trade Off Ratio
Possibilities
Germany 60 60 1:1
Italy 15 30 1:2
Germany is equally efficient in the production of both machine tools and trucks
and has absolute advantage in the production of both products. With the available
resources, it can out produce Italy in both products. Italy on the other hand, is
relatively more efficient in the production of trucks than Germany. It can produce
2 trucks for each machine tool while Germany can only produce 1 truck. Thus,
Italy has a comparative advantage in the production of trucks (see Table 3.1).

Table 3.2: Assumed Production and Consumption Before

Trade of Machine Tools and Trucks between Germany and Italy
Assumed Production/
Machine Tools Trucks
Consumption Before Trade
Germany 44 16
Italy 12 6
Total 56 22
Table 3.2 shows the assumed production and consumption position of each
country before any trading and specialisation. Each country exists self-sufficiently.
Table 3.3: Production Before Trade, with Specialisation

of Machine Tools and Trucks between Germany and Italy
Production Before
Trade, with Machine Tools Trucks Trading Rate
Specialisation
Germany 60 Nil 1:1.5
Italy Nil 30 1:1.5
Total 60 30
As per Table 3.3 assumes, Germany would concentrate on machine tools. Italy
should concentrate in producing trucks where it is more efficient. The surplus
production is not needed for its own consumption and would be traded for the
product needed. It is assumed that both countries have agreed to exchange their
products at a trading rate of 1:1.5, i.e. 1 machine tool is exchanged for 1.5 trucks.
Table 3.4: Assumed Consumption After Trade of

Machine Tools and Trucks between Germany and Italy
Assumed Consumption
After Trade
Germany 44 24
Italy 16 6
Total 60 30

In Table 3.4, Germany required 44 machine tools for its own internal consumption,
and Italy required 6 trucks for its own consumption. The surplus unit of each
country is traded. Table 3.5 shows the number of units of both machine tools
gained after trading the surplus production with each other. Thus, total
consumption of machine tools and trucks can increase in both countries as a result
of specialisation and trade.
Table 3.5: Number of Units (Machine Tools and Trucks)

Gained After Trade between Germany and Italy
No. of Units Gained After

Trade (1d – 1b = 1e)
Germany - 8
Italy 4 -
The basic message of the theory of comparative advantage is that potential world
production is greater with unrestricted trade than it is when trade is restricted.
Consumers in all nations can consume more if there are no trade restrictions, even
in countries that lack an absolute advantage in the production of any good.
ACTIVITY 3.1
What is the weakness of the theory of absolute advantage? How does the
theory of comparative advantage help to improve on the theory of
absolute advantage?
3.1.4 The International Product Life Cycle Theory

The International Product Life Cycle (PLC) theory was introduced by Raymond
Vernon in the 1960s. It was based on an observation that in the 20th century a very
large proportion of the worldÊs new products had been developed by American
firms and sold first in the United States, such as televisions, instant cameras,
photocopiers and personal computers.
The international PLC theory states that the location of production of certain kinds
of products shifts as they go through three different stages called the new product,
maturing product and standardised product stages as shown in Figure 3.1.

Figure 3.1: The international product life cycle

Source: Charles W.L.Hill (2004)

(a) Stage 1: New Product

From Figure 3.1, the United States is shown as the innovating country.
Innovation requires highly skilled labour and large quantities of capital for
research and development, which are normally available in highly
industrialised countries. The products would be non-standardised and
require close communication among the different components of skills.
Product design and manufacturing would therefore be most effective when
it is located near the parent company. Due to the high cost of production and
the uncertainty of the market size, the firm will initially sell most of the
product in the domestic market. Export sales will be limited.
(b) Stage 2: Maturing Product

As demand for the product increases, production expands and the
innovating country increases its sales to other countries. As competitors
increase and production processes become more standardised (i.e. requiring
less use of skilled labour), the firm faces strong pressures to reduce cost.
Product variations also begin to develop.
The innovating firm has to decide whether to lose their market share to other
countriesÊ lower cost manufacturers, or relocate production abroad where
costs are lower and maintain their market share.
(c) Stage 3: Standardised Product

The product manufacturing process becomes completely standardised.
Competition is fierce and profit margins are small. Production would be
located in a country that can offer the cheapest unskilled labour. As
production in the low-cost countries increases, they eventually export the
product.
At this stage the innovating country continues to reduce its domestic

production. The mass-produced products may even be exported back to the
innovating country. Production in the other advanced countries will also
reduce.
It should be noted that throughout the PLC, the countries of production,

consumption, export and import depends on the availability of their labour
and capital. Vernon pointed out that it could very well be the same innovator
firms that are moving production from the United States, firstly to other
advanced countries and then to the less developed countries. Thus, although
the pattern of trade changes, the same firms continue their operations to
secure market share, profits and competitiveness.

The international PLC theory is also the first theory explaining how
international trade and investment are interrelated. However, it is limited
and more appropriate for technology-based products only.
ACTIVITY 3.2
Think of other types of products that follow the pattern of the
international PLC. List them down.
3.1.5 Theory of Economies of Scale and Imperfect

Competition
This is the first of two major new trade theories developed in the 1980s in attempts
to analyse international trade more in line with the real issues of the time, such as
economies of scale and imperfect competition. Paul Krugman focused on two
types of economies of scale: internal economies of scale and external economies of
scale.
(a) Internal Economies of Scale

According to Krugman, the larger the firm the greater will be the benefits of
economies of scale, and the lower the cost of production per unit. A firm that
possesses this internal economies of scale could monopolise an industry
domestically and internationally, thus creating an imperfect market. With the
lower cost advantage, the firm can set lower prices and sell more products.
In order for the firm to achieve its economies of scale, it must take resources
away from other domestic industries to expand production. As the firm
expands, the country will narrow its range of products in the industry it
specialises, thus providing an opportunity for other countries to specialise in
the products that it has abandoned. Internal economies of scale therefore
leads a firm to specialised in a narrow product range to produce the larger
volume necessary to enjoy the benefits of economies of scale.
Other firms in other countries may also produce similarly narrow product
ranges but with product differentiation. This further explains why countriesÊ
firms in similar industries buy and sell similar but differentiated products.
For example, Europe and the United States both produce cars, yet they also
import cars from each other. This is known as intra-industry trade.

(b) External Economies of Scale

The achievement of external economies of scale depends not on the size of
the firm but on the size of the industry. A country may not have one massive
firm producing large quantities of a particular product, but it has many small
firms that interact to create one large and competitive industry. Such a
country can also dominate world markets in the particular product. Firms in
other countries may find they are not being competitive enough to enter that
industry.
External economies of scale may result in industry maintaining its

dominance in world markets. It also explains why certain industries do not
shift to countries with lower cost resources or labour. How these small firms
interact will be partially explained by the next theory that we shall study.
ACTIVITY 3.3
Are there industries in Malaysia which are either internal or external?
Discuss on myINSPIRE.
3.1.6 The Diamond of National Competitive

Advantage
The „Diamond‰ is the second new trade theory, which was developed by Michael
E. Porter in his book called The Competitive Advantage of Nations. It was based
on a survey of 100 companies in 10 nations that attempted to explain why a nation
can achieve success in a particular industry and other nations fail.
Figure 3.2 shows the four attributes or components that shape a nationÊs
environment in which firms compete. The existence of each component may
promote the creation of competitive advantage.

Figure 3.2: Determinants of national competitive advantage

Source: The Competitive Advantage of Nations by Michael E. Porter
The four attributes are:
(a) Factor Conditions

Factor conditions refer to the nationÊs position in terms of the presence of the
factors of production. Factors may be naturally endowed (called basic
factors) such as natural resources, climate, location and demographics, or
advanced factors such as communication infrastructure, skilled labour,
research facilities and technology. Advanced factors, which are a product of
investment by individuals, companies or governments, are the most
significant for competitive advantage.
While basic factors can provide an initial advantage, it has to be strengthened

and extended by investment in advanced factors. A country lacking in basic
factors, such as Japan and Singapore, need to invest more in the advanced
factors to build competitive advantage.
(b) Demand Conditions

This refers to the role of domestic demand in building competitive
advantage. The sophisticated and demanding domestic consumers would
pressure local firms to produce innovative and high standards of product
quality, thus shaping the attributes of domestically made products. For
example, JapanÊs sophisticated and knowledgeable camera buyers helped to
stimulate the Japanese camera industry to continuously improve product
quality and introduce innovative models.

(c) Related and Supporting Industries

The third attribute of a countryÊs competitive advantage is the presence of
internationally competitive suppliers or related industries. Suppliers will
compete to produce lower priced higher quality products and technology
innovations to meet the needs of the particular industry. Thus, an industry
or firm located close to suppliers will enjoy better exchange of ideas and
inventions to save cost.
When Steve Jobs introduced the Apple personal computer and demand for
personal computers exploded, suppliers of software, disk drives and
computer chips located in the Silicon Valley to be closer to Apple and other
personal computer manufacturers. This local availability of suppliers
strengthened the United StatesÊ competitive advantage in world markets.
(d) Firm Strategy, Structure and Rivalry

The domestic environments in which firms compete shape their ability to
compete in international markets. Firstly, different nations are characterised
by different management ideologies, which either help them or do not help
them to build competitive advantage. For example, the United States firmsÊ
focus on finance and lack of attention to improving manufacturing processes
and product design in the 1970s and 1980s led to an over emphasis on short-
term financial returns. As a consequence, the United States lost their
competitiveness in engineering-based industries where manufacturing and
product design is very important (e.g. automobile industry) to Japan and
Germany.
Secondly, strong domestic competition pushes firms to look for ways to

improve efficiency, which makes them better international competitors. They
are pressured to innovate, improve quality, reduce costs and invest in
upgrading advanced factors.
PorterÊs theory combines the findings of previous theories and argues that
the presence and interactions of all four components is usually required to
boost competitive performance. Governments also influence each of the four
components, such as providing subsidies for factors, setting product
standards for consumer goods, regulate suppliers and competition.

EXERCISE 3.1
1. According to the theory of ____________, a countryÊs wealth is
measured by its holding of gold and silver.
A. mercantilism
B. absolute advantage
C. comparative advantage
D. merchandise
2. The theory of comparative advantage was developed by:

A. Adam Smith
B. David Ricardo
C. Raymond Vernon
D. Michael Porter
3. The theory of ____________ says that countries should specialise in

goods that they can produce more efficiently than others and
import the goods that they cannot.
A. mercantilism
B. absolute advantage
C. comparative advantage
D. national competitive advantage
4. Michael Porter believed that countries who wish to improve their

capabilities to compete on a global basis should restrict the exports
of goods and services.
A. True
B. False

5. The lesser the volume of production, the easier it is for firms to

achieve economies of scale in production.
A. True
B. False
6. What is the basic message of the theories of absolute advantage and

comparative advantage with regards to international trade?
7. Briefly describe the stages of the international product life cycle

theory.
3.2 INTERNATIONAL TRADE STRATEGIES AND

ORGANISATIONS
Firms may use four basic strategies to enter and compete in international markets,
namely an international strategy, a multidomestic strategy, a global strategy and a
transnational strategy. Each of these strategies has its own advantages and
disadvantages and the use of each varies with the degree of pressure for cost
reduction or local responsiveness. Figure 3.3 illustrates these strategies.
Figure 3.3: Four basic business strategies in international business

Source: C. W. L. Hill (2004)

We shall now study the four basic strategies in detail.
3.2.1 International Strategy

Firms following an international strategy centralise the development of products
in their home country and offer differentiated products to new overseas markets,
where competitors do not possess those skills and products. They face little
pressure for local responsiveness, such that they do not need to customise their
products to meet local requirements, as well as pressures for cost reduction.
Although these firms may establish manufacturing and marketing facilities in
foreign markets, it is rather limited. Some examples of these firms are IBM,
Microsoft and Toys „R‰ Us.
3.2.2 Multidomestic Strategy

A multidomestic firm (i.e. those pursuing multidomestic strategies) strives to
achieve maximum local responsiveness. The products they offer and marketing
strategies are customised to match the different country conditions. Thus, they
establish subsidiaries in produce, market and conduct R & D activities
independently in each major market that they do business.
These firms usually face high pressure for local responsiveness and little pressure
to reduce costs. This strategy may not be appropriate if cost is major competitive
factor. Multidomestic firms also face weak global coordination capabilities being
highly autonomous. Unilever previously pursued this strategy.
3.2.3 Global Strategy

The global strategy is a low cost strategy, where firms concentrate production,
marketing and R & D activities in a few favourable locations. They are able to enjoy
the benefits of economies of scale. Global firms tend to look for similarities
between different markets and offer a standardised product to avoid customising
their products because customisation increases costs.
Firms employing this strategy, such as Intel, Texas Instruments and Motorola in
the semiconductor industry, faces strong pressures for cost reduction but
pressures for local responsiveness are minimal.

3.2.4 Transnational Strategy

Transnational firms encounter strong pressures for cost reduction and pressures
for local responsiveness simultaneously which is typical of some industries in
todayÊs competitive environment. Such firms need to utilise and transfer skills and
competencies developed in any of their worldwide operations in order to
simultaneously achieve cost and differentiation advantages.
Caterpillar, for example, had to compete with low-cost producers Komatsu and
Hitachi. Caterpillar needed to obtain economies of scale to reduce their cost. At the
same time, construction practices and government regulations which differ
between countries meant that Caterpillar had to remain locally responsive.
Caterpillar reacted by redesigning its products to use many identical components
and built a few large-scale component manufacturing facilities and assembly
plants at favourable locations. The firm also added local product features, tailoring
the finished product to suit different local needs. By pursuing this strategy,
Caterpillar was able to reduce costs through large scale manufacturing while
simultaneously responding to pressures for local responsiveness.
EXERCISE 3.2
1. The ____________ strategy places more emphasis on lowering cost

than the other basic international business strategies.
A. international
B. multidomestic
C. global
D. transnational
2. Which of the following is NOT a factor making it necessary for local

responsiveness?
A. Similar distribution channels
B. Demands of host country governments
C. Differences in infrastructure and traditions
D. Different consumer tastes and preferences

3. IBM, Toys „R‰ Us and Microsoft are examples of companies pursuing a/an:
A. International strategy.
B. Multidomestic strategy.
C. Global strategy.
D. Transnational strategy.
4. All multinational corporations must pursue a multidomestic strategy

to succeed in international markets.
A. True
B. False
5. A multidomestic firm typically try to establish R & D, marketing and

production facilities in each major market they do business.
A. True
B. False
6. When a firm encounters strong pressures for cost reduction, while

simultaneously facing pressures for local responsiveness, which would
be the most appropriate strategy to employ?
7. Draw a diagram to show the different positions of the four basic

strategies (international, multidomestic, global, transnational) in
response to pressures for cost reduction and pressures for local
responsiveness.
3.3 REGIONAL ECONOMIC INTEGRATION

Regional economic integration means an agreement among countries within a
particular geographic region to reduce or remove tariff and non-tariff barriers to
the free flow of goods, services and factors of production between each other.
Since the last few years there have been an increasing number of such regional
trade agreements. We shall focus our discussion on the more notable economic
integrations that has occurred in North America, Europe and Asia. However, we
shall first learn the four different forms of integration and what are the opinions
held in support or against its formation.
3.3.1 Levels of Economic Integration

From the least integrated to the most integrated, (refer to Figure 3.4) the five levels
of economic integration are Preferential Trade Agreement (PTA), Free Trade Areas
(FTA), customs union, common markets and economic union.
(a) Preferential Trade Agreement (PTA)

In the PTA, member nations impose less trade barriers on its members
compared to non-members. It is the loosest pact of integration.
A good example for PTA is British Commonwealth Preference Scheme (1932)

which comprised UK and its former colonies.
(b) Free Trade Areas

The Free Trade Areas (FTAs) is the loosest and most popular form of regional
economic integration. In an FTA, all barriers (whether tariff or non-tariff) to
the trading of goods and services among member countries are either
removed or minimal. One notable feature of an FTA is that each member
country is free to set any tariffs, quotas or other restrictions on trade with
non-member countries.
Sometimes, an FTA is formed for only certain classes of goods and services.
For example, an agricultural free trade area means there are no restrictions
on the trade of agricultural products only.
Figure 3.4: Five levels of economic integration

(c) Customs Union

Similar to the FTA, members of a customs union remove or minimises
barriers to trade in goods and services. However, the customs union
establishes a common trade policy with respect to non-member countries.
Imports from non-member countries are subject to tariffs when sold to any
member country.
An example of a customs union is the Andean Pact which consists of Bolivia,

Colombia, Ecuador and Peru as members.
(d) Common Markets

In addition to eliminating barriers to trade and sharing a common external
trade policy like customs union, the common market also allows the free
movement of the factors of production between member countries. Labour,
capital and technology are free to move across member countriesÊ borders.
Due to this freedom of movement, factors may move to countries where they
will be most productively employed. While aggregate productivity may be
enhanced, there may be countries that may not benefit. Member countries,
therefore, must be prepared to cooperate closely in monetary, fiscal and
employment policies.
The integration between Argentina, Brazil, Paraguay and Uruguay is moving

towards the establishment of a common market.
(e) Economic Union

An economic union requires that economic policies of member countries also
be integrated, other than the removal of trade barriers, a common external
trade policy and free movement of factors of production. Member countries
would harmonise monetary policies, taxation policies and fiscal policies.
Governments need to sacrifice some degree of their national sovereignty to
achieve higher coordination. A common currency would also be used.
The closest example would be the European Union that has established a
common currency complete with a common central bank. However, there
are still some member countries that have yet to adopt the Euro currency and
differences in tax rates still exist.
SELF-CHECK 3.1
Is regional economic integration similar to the concept of free trade?

3.3.2 Arguments on Economic Integration

There have been several arguments surrounding the issue of economic integration.
They focus on the following:
(a) Trade Creation and Trade Diversion

Trade creation occurs when high-cost domestic producers are replaced by
low-cost producers in other countries within the economic integration. Thus,
consumers can gain access to more goods at a lower price than would have
been possible without integration. The elimination of tariff has also created
more trade within the economic integration.
However, the effect of trade diversion, which occurs when lower-cost

external producers (from non-member countries) are replaced by higher-cost
producers from countries within the economic integration, is negative. On
the whole, a regional economic integration would benefit the world only if
the amount of trade it creates is greater than the amount it diverts.
For example, let us suppose that the United States and Mexico, both impose
tariffs on imports from all countries. They then set up a free trade area,
eliminating all trade barriers between them but maintaining tariffs on
imports from all other countries. If the United States, which previously
produced all its own textiles, starts to import textiles from Mexico which can
produce it at a lower cost, then trade is said to have been created. Trade with
all other countries would also not decrease. However, if the United States
had previously imported textiles from Costa Rica, which can produce them
cheaper than both Mexico and the United States (but has now become more
expensive than MexicoÊs due to the import duties maintained with non-
member countries), then trade has been diverted from a lower-cost producer
to a higher-cost producer.
(b) Reduced Import Prices

The lower demand for imported goods, due to the higher prices to cover the
cost of tariff imposed by the bloc of countries in the integration, may be
substantial. The exporting country may then be forced to reduce the prices
of their goods. The trade position of member countries may improve, but this
would be offset by the deteriorating trade position of the non-member
exporting country.

(c) Increased Competition and Economies of Scale

There may be a lower degree of monopoly in the production of certain goods
and services due to the increased market size resulting from integration. The
larger market increases the number of firms competing, improves efficiency
and lower prices for consumers. Many industries may also gain the
advantage from economies of scale as a result of the larger volume of
production.
(d) Higher Factor Productivity

The free mobility of factors of production would likely increase the aggregate
wealth of the common market countries. Labour and capital, for example,
would move from low productivity countries to countries with higher
productivity. It will also lead to higher degree of cross-cultural
understanding among member countries.
However, a poorer country may lose their most talented workers as well as
badly needed capital to richer countries where opportunities appear to be
more profitable.
(e) Regionalism versus Nationalism

The biggest obstacle to achieving economic integration is the reluctance of
member countries to sacrifice a certain degree of their national sovereignty.
In the spirit of nationalism, they may not be willing to surrender, for
example, their independence to decide in the better interest of the countryÊs
citizens at the expense of regional interest.
3.3.3 Economic Integration in Europe

Europe consists of two trade blocs, i.e. the European Union (EU) and the European
Free Trade Association (EFTA). The EU, on which our discussion will focus, has
15 members, and EFTA has four. The EU is also far more influential economically
and politically, as illustrated in Figure 3.5.

Figure 3.5: The European Union

Source: Encarta Encyclopedia
(a) The Development of the European Union

The two World Wars which devastated Western Europe, left the European
countries with the desire for lasting peace and greater cooperation to rebuild
their nations and potential economies.
The EU originated from the European Coal and Steel Community formed in
1951 to remove barriers to the shipments of coal, iron, steel and scrap metal
within the industry. In 1957, a common market called the European
Economic Community (EEC) was established under the Treaty of Rome.
With the signing of the Maastricht Treaty in 1992, the European Union was
established. The total number of member countries is 15, with 10 more
scheduled to join in May, 2004. With a total population of 350 million and a
GDP greater than the United States, the EU is a potential global super power.

(b) The Organisational Structure of the European Union

International firms need to understand the governance of the EU just as they
need to understand the governing process of the individual European
countries so as to understand how they make decisions that may affect the
firmÊs strategy. The EU is made up of several agencies which are the
European Commission, European Council and the European Court of
Justice.
The European Commission provides the political leadership and direction

for the EU. Its major functions are to formulate proposals for legislation;
safeguards the treaties signed by member countries, and manage and execute
EU policies and budgets as well as international trade relations.
The European Council, or Council of Ministers, comprises different ministers

of member countries representing their countries in the more than 25
different councils such as Foreign Affairs, Economy and Finance, and
Agriculture. The Council has the final say in legislative matters, whether to
adopt, amend or ignore laws proposed by the Commission.
The European Parliament is made up of 626 members who are elected every
five years. Membership is based on the population of each country. The
Parliament is responsible for legislation, budget control and supervision of
executive decisions. Laws proposed by the Commission must be approved
by Parliament before submitting it to the Council for adoption.
The European Court of Justice is an appeals court where individuals, firms

and organisations are fined by the Commission for violating EU laws. It deals
mostly with economic matters and is relevant to international firms.
(c) The Single European Act, 1987

It was adopted by member countries in 1987 and commits them to work
towards a single market. Among other things, the act was to remove the
remaining barriers to free trade and investment among member countries
and to harmonise the technical and legal standards for doing business, such
as customs checkpoints, certification procedures, tax rates and excise duties.

(d) The Treaty of Maastricht, 1992

This treaty, among others, committed member countries to:
(i) Adopt a common currency by January 1, 1999;
(ii) Establish a common foreign and defence policy;
(iii) A common citizenship; and
(iv) A stronger EU parliament „with teeth‰.
The euro currency (see Figure 3.6) is now being used by 19 member countries
(Denmark and Sweden not included), often referred to as the European Monetary
Union (EMU), or the Euro Zone. Its implementation required member country
governments to give up their own currencies and their control over monetary
policies. The Euro is administered by the European Central Bank (ECB) which was
established in 1998.
There is one concern among Asian countries and the United States as to whether
the EU will implement protectionist policies towards external trade, although the
Single European Act laid down a free market philosophy. The economic union of
the EU is also seen as moving towards the formation of a political union among
member countries.
Figure 3.6: The euro currency

Source: Encarta Encyclopedia

3.3.4 Economic Integration in the Americas

Among the notable regional economic integration in the American continent are
the Andean Pact, MERCOSUR and the North American Free Trade Area (NAFTA).
We shall focus our discussion on the North America Free Trade Agreement,
comprising the countries of Mexico, Canada and the United States with a
combined population of about 400 million.
The NAFTA took effect in January 1, 1994 and is the first time that industrialised
countries formed an economic cooperation with a developing country (Mexico).
The United States and Canadian firms would be able to take advantage of MexicoÊs
cheap labour and benefit from the large and growing Mexican market. Consumers
would benefit from its lower-cost agricultural products.
However, there was concern about the potential loss of jobs in Canada and the
United States as firms might close down factories and set them up in Mexico as a
result of MexicoÊs cheaper wages, poor working conditions and weak enforcement
of environmental regulations. The United States labour unions lobbied for new
labour standards and environmentalists pushed for environmental standards to be
upgraded and complied.
Canada-US trade in goods and services in 2015 reached close to CA$881 billion.
Canada is the second largest market for US services exports with Canada-US
services trade nearly reaching over CA$122.8 billion in 2015, a 205.1 per cent
increase since 1993. The United States was the number one destination for
Canadian merchandise exports in 2015, and was CanadaÊs largest supplier of
merchandise imports. Canada is the main foreign supplier of energy to United
States (Mexico is 4th), and was the largest cumulative source of foreign direct
investment (FDI) into the United States.
Between 1993 and 2015, Mexico-Canada merchandise trade grew eight-fold to

almost CA$37.8 billion in 2015, showing an average annual growth rate of 10.1 per
cent. Services trade between Canada and Mexico has increased six-fold during the
NAFTA period, to nearly $3.9 billion in 2015. In 2015, Mexico was CanadaÊs third
largest trade partner and was CanadaÊs third largest supplier and fifth largest
export market for merchandise trade.
As the Mexican economy and the Mexican peso strengthened, firms left Mexico
and relocated to cheaper countries such as China, Vietnam and Guatemala.
In short, NAFTA is an effort to move the economy of North America towards a

bigger market. Firms which are operating in the member countries can execute
their business across borders without high trade obstacles. However, some of the

contending issues in NAFTA are the potential loss of jobs and industries in both
the US and Mexico, economic and political stability in Mexico and protecting and
stimulating US investment.
3.3.5 Economic Integration in Asia

Due to political differences and low level of economic development among many
countries, economic integration efforts in Asia were less successful. The more
significant forms are the Association of South East Asian Nations (ASEAN) and
the Asia Pacific Economic Cooperation (APEC).
(a) Association of South East Asian Nations (ASEAN)

ASEAN was formed in 1967 which includes the 10 countries of Brunei,
Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand and
Vietnam. It has a total population of about 500 million and holds potential
market and investment opportunities.
In January, 1993, the ASEAN Free Trade Area (AFTA) was officially formed
with the intention of reducing tariffs to a maximum of 5% on all trade within
the area by January, 2008. However, progress has been limited due to several
reasons. Some countries such as Malaysia, Singapore and Thailand continue
to implement protectionist measures and the economic development gap
with Laos, Myanmar and Vietnam complicates matters. Several ASEAN
countries were also hard hit by the financial crisis in 1997.
As the countriesÊ economies recover, we may be able to see better progress

being made.
(b) Asia Pacific Economic Cooperation (APEC)

APEC was founded in 1989 to promote multilateral economic cooperation in
trade and investment among the 21 member countries Asia and the Americas
that border the Pacific Rim. The industrialised countries are scheduled to
achieve free and open trade by 2010, while the other members by 2020.
While APEC has the potential to become a significant economic bloc because
of its large volume of output and trade, its size poses a problem. Unlike the
EU and NAFTA, which are located closely with a unity of purpose, APEC
has too many countries with diverse interests.
Although progress towards forming a free trade area is slow, the member
countriesÊ heads of government continue to meet regularly to chart and
propose developments. If it succeeds in establishing an FTA, it may be the
worldÊs largest.

EXERCISE 3.3
1. The Pacific Rim countries:

A. Are a group of poor Asian countries and is not relevant to
international business.
B. Account for a small volume of world output.
C. Include countries like Japan, China, Hong Kong and South
Korea.
D. Are members of MERCOSUR.
2. All of the following countries are members of the European Union,

EXCEPT:
A. Germany
B. Sweden
C. France
D. Norway
3. Which of the following would indicate a favourable balance of

trade position?
A. When a country exports more than it imports.
B. When a country imports more than it exports.
C. When the countryÊs government is democratic.
D. When a country is in economic recession.
4. Economic integration among groups of countries in Asia has been

more successful than in other parts of the world due to the high
degree of cooperation between governments.
A. True
B. False

5. There is total agreement that regional economic integration benefits

all countries and firms that are involved in international business.
A. True
B. False
6. What is the difference between a free trade area and a customs union?
7. What is meant by the terms „trade creation‰ and „trade diversion‰?
 There are several theories in international business.
 The classical trade theories of Adam Smith and David Ricardo strongly argue
that firms should specialise in the production of goods that they are absolutely
or relatively efficient in producing and buy the goods that they cannot produce
as efficiently as other countries.
 The IPLC theory suggests that the production location of goods shifts from the
innovating country, firstly to other advanced countries and finally to
developing countries in search of lower costs as the product becomes more
standardised and the requirement for skilled labour reduces.
 The IPLC is also the first theory that explains a link between international trade
and international investment.
 The latest group of theories are the new trade theories of Paul Krugman and
Michael Porter which focus on economies of scale and national competitive
advantage respectively. These theories to a large extent explain why countries
trade with each other and the benefits that can be obtained from free trade.
 We also learned about the four basic strategies that international firms can
implement and the degree of each strategyÊs appropriateness in different
marketing environments abroad.

 Each strategy is distinguished by the different degrees of pressures for either,

or both, cost reduction and/or local responsiveness. These strategies are
known as the international, multi-domestic, global and transnational
strategies.
 The end of the topic explained the meaning of regional economic integration,
which is an agreement among a group of countries to allow a freer flow of trade
within the group by removing or minimising tariff or non-tariff barriers.
 Economic integration exists on four levels of differing strengths of cooperation

beginning from the FTA, the custom union, the common market and finally
the economic union.
 We have also seen the various arguments put forth that support and oppose
the concept of economic integration and learned how it impacts on the
international business firm.
 The more prominent regional trading blocs, namely the EU, NAFTA, AFTA
and APEC were also highlighted, tracing their development and success until
recent times.
Asia Pacific Economic Corporation Economics of scale

(APEC)
Imperfect competition
Association of South East Asian
Nations (ASEAN) Mercantilism
Business strategies Product life cycle theory
Competitive advantages Theory of absolute advantage
Diamond model Theory of comparative advantage
Economic integration Trade theories

Topic  The Financial
Environment
4 of
International
Business
LEARNING OUTCOMES
1. Discuss the historical development of the international monetary
system;
2. Identify the role of the international monetary system in
international trade and investment;
3. Differentiate between fixed and floating exchange rates;
4. Explain how currencies are traded and quoted on world financial
markets; and
5. Examine the risks and implications of the international monetary
system for managing currency transactions and business
strategy.
 INTRODUCTION
In this topic, we shall learn about the history of the modern international monetary
system, from the period when gold and silver were the medium of exchange, the
systems that were practised before and after the two World Wars, until the current
floating exchange rate system. These systems exist because most countries have

TOPIC 4 THE FINANCIAL ENVIRONMENT OF INTERNATIONAL BUSINESS  91
their own currencies. Since international business is conducted between different

countries, there is a need for a mechanism to exchange these different currencies.
Examples of foreign currency transactions, such as the „spot and forward

transactions‰ are provided to assist us in understanding the foreign exchange risks
faced by international business firms in their daily operations and its implications
on the firmsÊ decisions and strategies.
4.1 THE INTERNATIONAL MONETARY SYSTEM

The present international monetary system has its origin in the ancient trading
system of exchanging goods and services for gold or silver which were the
mediums of exchange then. However, this system has evolved through what is
known as the Gold Standard, followed by the Bretton Woods, a fixed exchange
rate system and the present floating exchange rate system.
4.1.1 The Gold Standard
Figure 4.1: Gold ingots
In the early times when international trade was limited in volume, goods
purchased from another country were typically paid for in gold and silver.
However, as the volume of trade expanded with the Industrial Revolution in the
1800s, a more convenient method of payment was required. It was not practical to
ship large quantities of gold or silver around the world. Thus, resulting in the
emergence of arrangement for payments to be made in paper currency that can be
converted into gold on demand at a fixed rate.
92  TOPIC 4 THE FINANCIAL ENVIRONMENT OF INTERNATIONAL BUSINESS
This system of pegging currencies to gold and guaranteeing its convertibility

into gold is known as the Gold Standard.
Great Britain was the first country to use the gold standard in 1821, followed by
the other major trading nations such as Germany, the United States and Russia.
(a) Rates of Exchange under the Gold Standard

Under a common gold standard, the value of any currency was determined
by their value in terms of gold. For example, if one US dollar (USD) was
equivalent 23.22 grains of pure gold, and there are 480 grains to an ounce,
therefore, an ounce of gold would cost USD20.67 (480/23.22). This is known
as the „gold par value‰, i.e. the amount of currency needed to purchase one
ounce of gold.
The gold par value of other currencies can be similarly worked out. Based on
these gold par values, the exchange rates can thus be determined. As an
example, if one United Kingdom Pound (GBP) as a currency code from
www.xe.com/1804217.php is equivalent to 113 grains of gold, one ounce of
gold would cost GBP4.25 (480/113). Thus, the implied exchange rate for
converting pounds into dollars would be GBP1 = USD4.87 (USD20.67/
GBP4.25). This system was preferred by many firms and individuals as long
as they had faith that they can exchange their currency for gold at the
promised rates at any time upon request.
(b) The Collapse of the Gold Standard

From 1821–1918, the most important currency in international trade was the
British sterling pound as most firms worldwide accepted gold or the pound
in the settlement of transactions. The international monetary system also
became known as the sterling-based gold standard. The expansion of the
British empire throughout the world also reinforced its influence, and
London became a dominant international financial centre until today.
When World War I broke out, normal commercial transactions ceased.

Several governments printed money to finance their military expenditures,
resulting in inflation. The economic pressures of war also caused countries
to suspend buying and selling gold at their currenciesÊ par value. Although
several countries attempted to readopt the gold standard up to 1933, they
were not successful. Great Britain was pushed into depression. Those who
held pounds lost confidence in its value and began converting their holdings
into gold. The British government could not satisfy these demands without

seriously depleting their gold reserves, so it suspended its convertibility in

1931. This was followed by the United States which abandoned the gold
standard in 1933.
The United States devalued (i.e. reducing the value) its dollar price of gold
from USD20.67 per ounce to USD35.00 per ounce, effectively making its
exports cheaper and increasing the price of imports. This step was taken to
boost output and create employment. However, other countries also adopted
a similar tactic and devalued their currencies at will and the gold par value
of currencies was no longer certain. As more people lost confidence in
currencies and preferred to change them into gold, other countries
suspended their currency convertibility into gold. By 1939, when World War
II broke out, the gold standard was no longer in practice.
4.1.2 The Bretton Woods System

In 1944, representatives from 44 countries met at a resort in Bretton Woods, New
Hampshire, to design a new international monetary system. In order to overcome
the weaknesses under the gold standard such as the competitive devaluations of
currencies, the Bretton Woods agreement established two new institutions the
International Monetary Fund (IMF) to oversee the international monetary system,
and the International Bank for Reconstruction and Development (IBRD or
popularly known as the World Bank) to finance long-term economic development.
Under the Bretton Woods agreement, all countries were to fix the value of their
own currencies in terms of gold but were not required to exchange their currencies
for gold. Only the US dollar (USD) remained convertible to gold at a price of
USD35.00 per ounce, but only at the request of foreign governments. Currency par
values could then be translated into US dollars. Thus, the US dollar (USD) became
the key currency of postwar commerce. The Bretton Woods system was effectively
a fixed exchange rate system.
SELF-CHECK 4.1
According to the Bretton Woods agreement, what is the task of the IMF
and the task of the World Bank?

(a) The International Monetary Fund (IMF)
Figure 4.2: The International Monetary Fund (IMF) logo
The IMF was officially established on 27 December 1945 and commenced

operations on 1 March 1947. Initially consisting of 29 member countries, it
has grown to include 189 countries by the end of May 10, 2016. The IMF was
created to oversee the functioning of the international monetary system with
the following major purposes:
(i) Promote international monetary cooperation;
(ii) Facilitate the expansion and balanced growth of international trade;
(iii) Promote exchange stability, to maintain orderly exchange
arrangements among members, and to avoid competitive exchange
depreciation;
(iv) Assist in the establishment of a multilateral system of payments; and
(v) Make its resources temporarily available to members experiencing
balance of payment difficulties.
All participating countries agreed to maintain the value of their currencies

within 1% of the par value by buying or selling currencies (or gold) as
necessary. If, for example, foreign exchange dealers were selling more of a
countryÊs currency than is demanded, the countryÊs government would have
to buy its currency from the foreign exchange markets to increase demand
and maintain its gold par value.

If the government concerned was unable to maintain its value within the 1%
of par value, they are allowed to devalue their currency up to 10%.
Devaluations of larger than 10% would require the IMFÊs approval.
The IMF also extends foreign currency loans to participating countries to

help them maintain stability. Large borrowers, however, would have to
comply with the IMFÊs monetary and fiscal policies.
The overall aim was to try to avoid the chaos experienced between the two
world wars, maintain stability in the world trade environment and impose a
monetary discipline on countries to curb inflation.
ACTIVITY 4.1
Visit www.imf.org for information on the monetary issues of the world.
(b) The World Bank
Figure 4.3: The World Bank logo

The official name for the World Bank is the International Bank for
Reconstruction and Development (IBRD). The World Bank was created to
help in the reconstruction of the economies of Europe by providing low-
interest loans. However, this role was overshadowed by the United StatesÊ
Marshall Plan, under which the United States lent money directly to
European nations. So the bank turned its attention to the development of
Third World countries, such as in building power stations, roads and
transportation, agriculture, education, population control and urban
development.
The World Bank has two loan schemes. The first, called the IBRD Scheme,
raised money through the sale of bonds in the international money markets.
These low interest loans are usually offered to risky customers whose credit
rating is poor. The second scheme is supervised by the International
Development Agency (IDA), an arm of the bank established in 1960. Funds
for these loans are obtained from the subscriptions of the rich member
countries such as United States, Germany and Japan. Borrowing countries
have 50 years to pay at an interest rate of 1% a year.
ACTIVITY 4.2
Visit www.worldbank.org to get the full details on the organisation.
(c) The Collapse of the Fixed Exchange Rate System

The Bretton Woods fixed exchange rate system was dependent on the US
dollar (USD) and the stability of the United StatesÊ economy. As long as the
United StatesÊ inflation rate remained low and the country is not in a deficit
trade balance (i.e. imports exceeds exports), the system would work well.
However, several events in the United States in 1965-1968 led to the ultimate
collapse of the fixed exchange rate system. The United States government
had increased their money supply to finance the Vietnam war and welfare
programmes without increasing their taxes, causing price inflation and
stimulated higher imports, resulting in a deficit trade balance. It gave rise to
speculation that the US dollar (USD) would be devalued setting off massive
purchases of the German deutsche marks, which was expected to be revalued
(i.e. to increase in value). Despite the German central bank, the Bundesbank,
buying up to 2 billion US dollars from the foreign exchange market, they
failed to increase demand for the US dollar. The United States also did not
have sufficient gold reserves in the event the foreign governments demanded

gold in exchange for their US dollar (USD) holdings (in 1970 the United States
government had gold reserves valued at USD11 billion against the USD47
billion held by foreign governments and individuals).
On August 15, 1971, President Richard Nixon (see Figure 4.4) announced that
the US dollar was no longer convertible into gold. Most of the worldÊs major
currencies were allowed to float (i.e. no longer fixed in value), thus effectively
ending the fixed exchange rate system established at Bretton Woods.
Figure 4.4: President Richard Nixon
ACTIVITY 4.3
Visit http://www.econ.iastate.edu/classes/econ355/choi/bre.htm and

read about the collapse of the Bretton Woods system in 1971, and how it
was reluctantly replaced with a regime of floating exchange rates.

4.1.3 The Floating Exchange Rate System

Following the collapse of the fixed exchange rate system, member countries of the
IMF met in Jamaica in 1976 to formalise new rules for the international monetary
system.
(a) The Jamaica Agreement

The main elements of the Jamaica agreement include the following:
(i) Acceptance of floating rates and allowing IMF member countries to
intervene in the foreign exchange markets to stabilise their currencies.
(ii) Gold was abandoned as a reserve asset. Gold deposited with the IMF
as reserves were returned to member countries at market price.
(iii) Amount of contribution to the IMF by member countries was increased
to USD41 billion (since increased to USD300 billion and membership
has now increased to 189 countries). More countries were also given
greater access to IMF funds.
Thus, the IMF continued in its role of assisting countries to cope with their
economic and exchange rate problems, although within the context of a
different exchange rate system.
The floating (or flexible, or managed) exchange rate system poses many new
and different problems for the participating countries. The value of
currencies is determined primarily by the interaction between the forces of
supply and demand for the currency in the world market place. Each country
was free to adopt whatever exchange rate system which met its requirements
best. Thus, the United States adopted a floating exchange rate system, while
other countries adopted a fixed exchange rate by pegging their currencies to
the US dollar (USD), the French franc (FF), or some other currencies.
ACTIVITY 4.4
Which foreign exchange rate system has the Malaysian government

adopted? Give some reasons for the choice.

EXERCISE 4.1
1. Which of the following organisations was formed as a result of the

Bretton Woods Agreement?
A. United Nations
B. World Trade Organisation
C. World Bank
D. Organisation for Economic Cooperation and Development
2. Under the floating exchange rate system, exchange rates of each

countryÊs currency is determined mainly by:
A. The forces of supply and demand.
B. The respective country governments.
C. The World Bank.
D. The worldÊs most powerful economic nations.
3. The World Bank was created to oversee the management of the

Bretton Woods fixed exchange rate system.
A. True
B. False
4. Under the gold exchange standard, all currencies are convertible

into gold.
A. True
B. False

5. The Bretton Woods exchange rate system collapsed due to the

expected weakening of the Japanese yen.
A. True
B. False
6. What are the purposes for which the International Monetary Fund
(IMF) was established?
7. What are the two loan schemes available under the International
Bank for Reconstruction and Development?
4.2 THE FOREIGN EXCHANGE MARKET

This subtopic explains the nature and functions of the foreign exchange market.
We shall also focus on some of the risks encountered by international business
firms in international financial transactions. Figure 4.5 displays a sample of a
foreign currency.
Figure 4.5: Sample of a foreign currency

4.2.1 The Nature of the Foreign Exchange Market

The worldwide volume of foreign exchange being traded is estimated at USD1.5
trillion per day, compared to about USD200 billion per day in 1986. The largest
trading centres are in London (31% of activity), followed by New York (16%),
Tokyo (9%) and Singapore (6%). Zurich, Frankfurt, Paris, Hong Kong, San
Francisco and Sydney are the major secondary trading centres. LondonÊs
dominance in the foreign exchange market was due firstly to its position as the
capital of the worldÊs first major trading nation since the 19th century. Secondly,
its central position between Tokyo and New York made it a critical link between
the Asian and the American markets.
The foreign exchange „market‰ has no formal structure. It is not located in any one
place, or floor like the stock exchange where trading takes place. It is a global
network of banks, brokers and foreign exchange dealers linked by electronic
communications systems. It is also described as „a market that never sleeps‰
because trading continues for 24 hours a day. Due to time zone differences,
London opens soon after Tokyo closes and is still open for the first few hours of
trading in New York. These three centres closes for only 3 hours per day, during
which time the minor centres such as San Francisco and Sydney continues trading.
Buyers and sellers convert the currencies of countries into that of other countries
through the foreign exchange market. As examples, Malaysian tourists utilise the
foreign exchange market when they exchange the Malaysian ringgit (MYR) for
United Kingdom pound (GBP), and the Toyota Company exchanges Canadian
dollars for Japanese yen when it exports automobiles to Canada. The British
government also uses the foreign exchange market to arrange a multi-million
pound loan to monsoon-ravaged Bangladesh for the rebuilding of their economy.
Brokers, central banks and commercial banks participate in the foreign exchange
market by buying and selling currencies on behalf of governments, businesses and
individuals. Approximately 90% of the transactions involve the US dollar, a
dominant role carried down from the Bretton Woods system.
4.2.2 Functions of the Foreign Exchange Market

The foreign exchange market serves two major functions. The first function is to
convert the currency of one country into the currency of another country, and
secondly it is to protect or insure against the negative consequences of
unpredictable changes in exchange rates (foreign exchange risks).

Figure 4.6: Functions of the foreign exchange market
ACTIVITY 4.5
Take a few minutes to read and learn the currencies of the countries
around the globe. Do you know the name of several global currencies?
Name the currencies for Algeria, Bolivia, Chile, Denmark, Egypt, Finland,
Germany, Holland, India, Jordan, Kenya, Libya, Madagascar, Nepal,
Oman, Panama, Qatar, Singapore, Taiwan, Uganda, Vatican City, and
Zaire.
(a) Currency Conversion

The price of goods and services are quoted in each countryÊs currency, such
as – dollar in the United States, pound in Great Britain, francs in France,
marks in Germany, yen in Japan and the euro in the member countries of the
euro zone. While the countriesÊ currency must be used within the respective
countriesÊ borders, they are not recognised as "legal tender" outside their
own countries. Japanese must exchange their yen to US dollars (USD) when
they travel and spend in New York, using a specific exchange rate quoted by
a commercial bank or a broker. International business firms, as the major
participants, use the foreign exchange market for four main reasons as
follows:
(i) Convert the payments that they receive for their exports or income
from foreign investments into the currency of their home country;
(ii) Convert the amount of their countryÊs currency into the currency of the
country from where they buy goods and services as payment;
(iii) Invest their spare cash for short-terms by placing deposits in the
currency of another country so as to earn interest; and
(iv) Speculate in the currency of another country for short-terms by
investing in the currency of a country that they anticipate will rise in
value against the home country currency and profit from the difference
or change in exchange rates.
An exchange rate is the rate at which one currency is converted into another
currency. We can look at exchange rate as being the price of foreign
exchange, just like the price of other commodities. As examples, Table 4.1
shows some foreign exchange rates quoted against the US dollar (USD).
Table 4.1: Currency Exchange Rates (October 17, 2016)
Country USD Equivalent Currency Per USD

Argentina (Peso) 0.06594 15.1650
Australia (Dollar) 0.75986 1.3160
Brazil (Real) 0.31208 3.2043
Britain (Pound) 1.2162 0.8222
Canada (Dollar) 0.7599 1.3160
China (Yuan) 0.1485 6.7336
France (Euro) 1.0981 0.9107
Hong Kong (Dollar) 0.1289 7.7592
India (Rupee) 0.01497 66.8042
Japan (Yen) 0.0096 104.220
Korea (Won) 0.00088 1,141.80
Mexico (Peso) 0.00527 18.9890
Russia (Rouble) 0.01587 62.9959
Sweden (Krona) 0.11315 8.8380
Switzerland (Franc) 1.01089 0.9892
Source: www.xe.com
ACTIVITY 4.6
Using the rates provided in Table 4.1, calculate how much of each foreign
currency is required to purchase USD100,000.00.

(b) Insuring against Foreign Exchange Risks

Firms that conduct international trade are exposed to and may be adversely
affected by foreign exchange risks that occur as a result of the fluctuation in
exchange rates from the period a contract is signed until it is fulfilled. In
order to explain how the foreign exchange market performs this function, we
must first understand the difference between spot rates and forward rates.
ACTIVITY 4.7
Visit this website to know all about the foreign market exchange:
https://www.fxstreet.com/
4.2.3 Spot and Forward Exchange Rates

Let us now turn our attention to spot and forward exchange rates.
(a) Spot Exchange Rates
The spot exchange rate is the rate at which two parties agree to exchange
currency and execute the deal immediately.
It is the rate at which a foreign exchange dealer converts one currency into
another currency on a particular day. For example, when a French tourist
goes to bank in Kuala Lumpur to convert her francs into ringgit, the exchange
rate is the spot rate for that particular day. Such a transaction is referred to
as a spot exchange.
Spot exchange rates can be quoted in two ways. Let us use the exchange rates
between the US dollar (USD) and the Japanese yen (JPY) as our examples.
(i) As the price of Japanese yen in terms of the US dollar: USD0.008095 per
yen (USD0.008095/JPY1).
(ii) As the price of US dollar in terms of the Japanese yen: Yen123.54 per
dollar (JPY123.54/USD1).

Spot rates change continually, determined by the interaction between the

demand and supply of a currency relative to the demand and supply of other
currencies. Assuming the spot exchange rate when the market opens on a
particular day is GBP1 = USD1.50. As the day progresses, many people want
US dollars and dollars are in short supply, and few people want the British
pound and supply is plentiful. By the end of the day, the spot rate may
change to GBP1 = USD1.48. The US dollar (USD) is said to have appreciated
in value and the British pound has depreciated.
Such continual change in the spot rates can pose problems for an
international firm. For example, a United States company that imports
notebook computers from Japan has entered into a purchase agreement and
must pay its Japanese supplier JPY200,000 for each computer when it arrives
in 30 days time. The current dollar/yen spot exchange rate is
USD1 = JPY120, and the computerÊs selling price is USD2,000 each. At this
rate, each computer would cost USD1,667 (i.e. JPY200,000/JPY120), yielding
a gross profit of USD333 (USD2,000 – USD1,667). However, the importer has
no funds presently and has 30 days to sell all the computers. Over the next
30 days, the dollar unexpectedly depreciates against the yen say to
USD1 = JPY95, but the importer still has to pay the Japanese supplier
JPY200,000 which is now equivalent to USD2,105 (JPY200,000/JPY95). The
change in the spot rates has transformed into a loss of USD105 per computer
(USD2,000 – USD2,105) for the importer.
In order to avoid this risk, the US company can engage in a forward exchange
as explained in the following section.
ACTIVITY 4.8
Let us suppose a French visitor is trying to convert his 500 Swiss francs
(CHF) into Malaysian ringgit (MYR). Can you help him to find the spot
exchange rate? You may visit this website:
http://www.canadianforex.ca/exchange-rate
and use the currency tools to help you.

(b) Forward Exchange Rates
A forward exchange occurs when two parties agree to exchange

currency and execute the deal at some specific time in the future.
The rates used in such future transactions are known as forward exchange
rates. They are usually quoted for 30 days, 90 days and 180 days into the
future.
Using the same computer importer example, let us assume that the 30-day
USD/JPY forward exchange rate is USD1 = JPY110. The importer can enter
into a forward exchange contract (FEC) with a banker/foreign exchange
dealer at the said forward rate guaranteed and pay USD1,818.18
(JPY200,000/JPY110) for each computer. It can now make a profit of
USD181.82 (USD2,000 – USD1,818.18). The firm has thus insured itself
against the possibility of a profitable deal turning into an unprofitable one.
4.2.4 Foreign Exchange Risks

There are three types of foreign exchange risks or exposures that international
firms have to confront. Each has to be managed quite differently from the other
and they are as follows:
(a) Transaction Exposure

Any contract, agreement, purchase or sale that is denominated in a foreign
currency to be settled some time in the future poses a transaction exposure.
Thus, this refers to the extent to which the proceeds from a transaction is
affected by fluctuations in foreign exchange values.
Firms can manage this type of exposure either by contractual hedging, which
is by entering into a FEC as illustrated in earlier example, or by natural
hedging. Natural hedging refers to a firmÊs arrangement to have foreign
currency cash inflows (receipts) and outflows (payments) roughly at the
same times and in the same amounts. Foreign currency cash flows can then
be matched by offsetting outflows against inflows.

(b) Translation Exposure

International firms must integrate the financial accounts of all its foreign
subsidiaries into a set of consolidated financial statements. Problems arise
when financial statements of foreign subsidiaries denominated in the foreign
countriesÊ currency are consolidated into the parent companyÊs currency.
Fluctuations in exchange rates may change the value of the foreign
subsidiaries when measured in the parent companyÊs currency. It is also
known as accounting exposure. It does not result in any cash flow impact
unless liquidation or sale of the foreign subsidiary is anticipated.
(c) Economic Exposure
Economic exposure is the impact of unexpected changes in exchange

rates that change the value of an international firmÊs operations, such as
an economic or a financial crisis.
While transaction exposure is concerned with the effect of short-term

changes in exchange rates on individual transactions, economic exposure is
concerned with the long-term effect of exchange rate changes on future
prices, sales and costs. Firms may manage this situation by diversifying their
operations over several countries to remain prepared for such an occurrence.
For example, Hewlett-Packard produces the same products in their
manufacturing facilities in Singapore, United States, Puerto Rico and Europe.
SELF-CHECK 4.2
Which type of foreign exchange risk would most international companies

be commonly exposed to? How can the company protect itself from such
risks?

EXERCISE 4.2
1. The ____________ is the most widely traded currency in the world.

A. US dollar (USD)
B. German marks
C. Japanese yen
D. British pound
2. If Importer A has to pay USD3,000 for each unit of digital camera

and Importer AÊs selling price is RM11,000, what would be the
USD/RM exchange rate that would be just sufficient to cover costs
(rounded to 2 decimal places)?
A. USD1/RM3.67
B. USD3.67/RM1
C. USD1/RM0.27
D. USD3.80/RM1
3. When a firmÊs operations exposure encounter unexpected changes

in exchange rates, such as during a financial crisis that reduces its
value, it is known as:
A. Transaction
B. Translation
C. Economic
D. Accounting
4. The three largest financial centres are in Zurich, Washington and

Singapore.
A. True
B. False

5. Transaction exposure is also known as accounting exposure.

A. True
B. False
6. Explain the differences between a spot and a forward exchange rate.
7. For what reasons do international firms convert currencies?
4.3 CURRENCY CONVERTIBILITY

Many countries restrict the conversion of their domestic currency into a foreign
currency making international trade and investment difficult. Restrictions range
from a minor one such as restricting the amount of foreign currency the countryÊs
resident may take with them on trips out of the country, to major restrictions such
as restricting business firmsÊ ability to take foreign currency out of the country.
These restrictions can be classified by three different levels of currency
convertibility.
(a) Freely Convertible

When a government allows both residents and non-residents of its country
to purchase unlimited amounts of a foreign currency with the domestic
currency, the currency is said to be freely convertible.
(b) Externally Convertible

When only non-residents may convert domestic currency into a foreign
currency without any limitation, a currency is said to be externally
convertible.
(c) Non-convertible
When both residents and non-residents are not allowed to convert domestic
currency into a foreign currency, it is known as non-convertible.
Foreign firms face serious problems if the currency of the country where they
operate is non-convertible. The firm may generate profits but it may not be able to
convert those profits into a foreign currency and take it out of the country.

4.3.1 Government Policies

Governments may impose policies restricting the convertibility of the local
currency into a foreign currency to preserve their foreign exchange reserves. These
reserves are needed to service its foreign denominated borrowings and to pay for
imports.
When a countryÊs economy is facing a downturn and the value of the domestic
currency is depreciating rapidly, residents and non-residents may believe that the
value of their money is better preserved if invested abroad and held in a foreign
currency. They may rush to convert their domestic currency into a foreign
currency a phenomenon known as capital flight. If the government allows free
convertibility, not only will its foreign exchange reserves be depleted, but it will
also lead to depreciation in the exchange rate (due to the increase in the supply of
the countryÊs currency as it is sold off in the foreign exchange market). The price
of imports would also increase leading to a rise in inflation, thus further
weakening the economy.
ACTIVITY 4.9
What restrictions on convertibility did Malaysia impose during the last

financial crisis in 1997? Was the governmentÊs policy successful in
meeting its objective? Discuss.
4.3.2 Countertrading
Countertrade refers to the exchange of goods and services with other goods
and services (like barter trading), with or without some amount of money
involved.
This can be used as an alternative method of exchange when a countryÊs currency

is non-convertible.
For example, in 1984 General Electric was awarded a contract for a generator
project in Romania for USD150 million. As the Romanian government had
imposed a policy of non-convertibility of its currency, General Electric agreed to
take payment in the form of Romanian goods that could be sold for USD150
million on international markets.

Countries are increasingly becoming aware of the benefits of countertrading. Up

to 20% of world trade has been conducted involving some form of countertrade
arrangements.
ACTIVITY 4.10
What are the potential problems in countertrading? Discuss your answer.
EXERCISE 4.3
1. When residents are not allowed to convert domestic currency into

a foreign currency, but non-residents are allowed to the domestic
currency is said to be:
A. Freely convertible
B. Internally convertible
C. Externally convertible
D. Non-convertible
2. One important purpose for governments to impose restrictions on

the convertibility of local currency into a foreign currency is to:
A. Pay for the countryÊs imports
B. Pay for the countryÊs exports
C. Pay higher returns to investors
D. Pay higher salaries to government personnel
3. Countertrading is the exchange of goods or services with gold.

A. True
B. False

 We have discussed the financial environment of international business. Firstly,

we read about the development of the worldÊs international monetary system
during the period of the Gold Standard, by which the currency values of all
countriesÊ participating in international trade was linked to gold (known as
gold par values).
 Any party who prefers to hold gold may freely exchange their paper money
into gold.
 The gold standard, however, came to end after the World Wars and was
replaced by the Bretton Woods system of fixed exchange rates in 1944. Under
this system, only the US dollar (USD) was convertible into gold, while all other
currencies are linked to the US dollar (USD).
 The dependence of the US dollar (USD) meant that the United StatesÊ economy
must always remain stable with low inflation rates and not suffer any deficit
in its trade balance.
 However, as the United StatesÊ economy weakened during 1960-1970 and was
not able to maintain its position, the Bretton Woods system also failed. It was
abandoned in 1973 and a system of floating exchange rates was formally
implemented and in force until today.
 We have also learned about the nature and functions of the foreign exchange
market together with its risks (foreign exchange risks) brought about by the
uncertainty in the fluctuation of exchange rates under the floating exchange
rate system.
 We have also worked through some examples of the spot and forward
exchanges and how forward exchange can be used to protect a firm from losses
in a foreign exchange transaction.
 Finally, we have learned that not all countries allow free convertibility of their
domestic currency as a result of government imposed policies.
 An international firm may face problems in a country whose domestic

currency is non-convertible.

 However, firms may resort to a method called countertrade to overcome this

problem.
 Countertrading is a barter like arrangement, whereby goods and services can

be exchanged with other goods and services, with or without some amount of
money involved. This method is increasingly gaining acceptance as more
countries become aware of its benefits.
Bretton Woods system Foreign exchange market

Countertrading Foreign exchange risks
Currency exchange risks Gold standard
Financial environment International Moretary Fund (IMF)
Fixed exchange rate system World Bank
Floating exchange rate system

Topic  Market
Research,
5 Mode of Entry
and Ethical
Issues in
International
Business
LEARNING OUTCOMES
1. Explain the importance of conducting a global market research;
2. Examine several methods used by international firms in
entering foreign markets;
3. Discuss the appropriateness of choosing a particular foreign
market mode of entry;
4. Describe the current issues in international business ethics; and
5. Assess the impact of international ethics on business firms and
social responsibility.

TOPIC 5 MARKET RESEARCH, MODE OF ENTRY AND ETHICAL ISSUES IN  115
 INTRODUCTION
This topic focuses on the importance of doing market research before making a
decision as to which market(s) to enter or to set up its operations. Firms that
venture abroad without prior research may be unprepared and are exposed to
risks due to the various differences in the foreign environment. It has been
reported that failure to conduct such a research on foreign markets has been the
major cause of many firmÊs international business losses. Although exporting
remains as the most widely used strategy in foreign market expansion, there are
other methods such as licensing, franchising, turnkey operations, joint ventures,
wholly owned subsidiaries and forms of strategic alliances that we shall also study.
The final subtopic discusses the issue of business ethics in international markets,
such as human rights, product safety and environmental protection. These issues
may have a serious long-term impact on the international firm if not properly
managed. In this context, we shall also study the benefits that can be gained by the
international firm from a strategy of social responsibility.
5.1 MARKET RESEARCH

Given the opportunities and challenges in the international market place a firm
would seldom have sufficient resources to take advantage of all the opportunities.
Thus, international managers must formulate and implement a strategic plan to
match their products and resources (whether human, physical or financial) to
markets. In order to pick the best location in the best interest of their business,
managers need to engage in global market research to gather information for the
purpose of making these decisions.
For example, firms must determine where to sell, where to produce and who are
their competitors are (refer to Figure 5.1). These will depend on a wide range of
information, such as the size of the market, its growth potential, competition,
government regulations and economic as well as political stability, before firms
are able to select a target country or market segment. As firms have limited
resources, these foreign market requirements must be appropriately matched with
their human resources capabilities, available physical and financial resources and
the level of management commitment to venture into international markets. The
information obtained would then be utilised towards developing an international
marketing programme.

116  TOPIC 5 MARKET RESEARCH, MODE OF ENTRY AND ETHICAL ISSUES IN
Figure 5.1: Factors to consider in market research
ACTIVITY 5.1
Similar to a well-built house, marketing organisations also need a strong

foundation (product and services) to sustain in the business world.
Therefore, a good market research is critical in helping management to
support this effort. Explain some of the importance of market research
from an international business perspective.
(a) Sources of Data Collections

There are two types of data collections.
Primary data is the collection of original facts and figures. Being original
and not having been done before, primary data collection can be costly
and time-consuming.
Secondary data is the data that has been collected by others and is
usually less expensive and easier to collect.
For this market research reason, international business researchers usually

attempt to gather secondary data first, before spending their time and money
collecting primary data. The raw data, which are raw facts and figures,
collected are then analysed and compiled into useful information.

Secondary data can be obtained from external sources such as the following:
(i) Individualised reports and studies prepared by market research and
business consulting companies for a fee;
(ii) Reports provided by service companies such as banks, accounting
firms, transportation agencies for their international clients;
(iii) Government agenciesÊ statistical reports, news and regulations on
individual foreign countries such as those from the Ministry for
International Trade (MITI) and Malaysia External Trade Development
Corporation (MATRADE);
(iv) Reports and recommendations on common trends and problems
provided by international organisations and agencies such as the
United Nations (UN), the World Trade Organisation (WTO), the
International Monetary Fund (IMF), the Organisation for Economic Co-
operation and Development (OECD) and the European Union (EU);
(v) Journals of trade associations which contain a wide variety of data
dealing with technical and competitive factors in their industries;
(vi) Information service companies that maintain databases from different
sources provide information for a fee, or public libraries for free; and
(vii) Material available on the Internet and World Wide Web (WWW).
However, these information need to be checked for reliability.
Primary data are collected when more specific information is required, and
can be collected through several methods such as:
(i) Experimentation, which is carried out under a controlled environment
to establish precise cause-and-effect relationships;
(ii) Observation, which requires the researcher to observe the activities and
behaviours of users;
(iii) Surveys can be carried out through personal interviews, the mail or the
telephone; and

(iv) Focus groups involve gathering a group of knowledgeable people for a

limited period of time and given a specific topic to discuss. It is helpful
in providing information about perceptions, emotions and attitudes. The
ideal size for a focus group is between 7–10 participants. Figure 5.2
highlights some examples of primary and secondary data.
Figure 5.2: Primary and secondary data
SELF-CHECK 5.1
What is primary and secondary data? Explain in your own words.
5.1.1 The Need for Market Research

As illustrated in the preceding subtopic, a wide range of information is required
towards formulating and implementing an effective strategic plan. Doing business
abroad without conducting a proper research places the firm, their assets and their
future international business at risk.
Research allows management to identify markets and develop appropriate

international business strategies. It provides feedback about business activities
and information to anticipate events, take appropriate action and adequately
prepare for changes in the international market place.

Despite this, many firms conduct very little research before they enter a foreign
market. They tend to view it as relatively unimportant for four major reasons:
(a) Managers lack sensitivity to the differences in culture, consumer tastes and
market demands.
(b) Managers have a limited appreciation for the different marketing

environments in foreign countries. There may be different labour
regulations, distribution systems and media regulations and availability,
compared to their home country markets.
(c) Managers are not familiar with the sources of data and may also lack the
ability to use the data that they are able to obtain. Thus, they perceive that
the cost of conducting global research as not a worthwhile investment
compared to the benefits to be gained.
(d) Firms may rely on what little actual experience they have had in dealing with
a foreign country as a substitute for organised research.
5.1.2 Problems with Research

While firms undertake business research to assist them in their decision process,
they are seldom able to gather all the information that they like due to time and
cost constraints. The lack, obsolescence and inaccuracy of data on many countries
make research difficult and expensive to undertake. Comparability problem adds
to the problems in market research.
(a) Reasons for Inaccuracies
(i) Published data may be incomplete or inaccurate as a result of the

governmentsÊ inability to collect the information required. Poor
countries may have limited resources and such data may receive a
lower priority in their national budget.
(ii) Government officials may lack competence to maintain and analyse

accurate records because they are not well educated. Manual
calculations may be used instead of electronic data processing systems.
(iii) Publication of false or misleading information to purposely mislead

government officials or companies and institutions abroad. They may
use data selectively and create false impressions.

(iv) Academicians may conduct studies based on too few observations,

non-representative samples or poorly designed questionnaires.
(v) Culture may also cause mistrust of how the data gathered will be used,
leading survey respondents to answer inaccurately.
(vi) People may cover up their personal data, such as unreported income,
to avoid taxes. Published figures may thus be substantially distorted.
(b) Comparability Problems
(i) Countries may publish data based on different time periods, so

companies need to extrapolate or make inferences from those different
periods.
(ii) There may also be differences in definitions. For example, accounting

rules for depreciation may differ, or the „family income‰ category may
include only parents and children, while other countries may also
include grandparents, uncles and cousins.
(iii) Countries differ in how they measure investment flows. They may be
recorded as the value of the total project, merely the value of foreign
capital, or percentage of the project owned by foreigners.
(iv) National income and per capita income may also not reflect the actual
activities taking place outside the market economy. For example, the
extent of people in one country who may grow their own vegetables,
sew clothes or bake bread for their own consumption may distort
comparisons with other countries where people generally buy these
products and services.
(v) Fluctuations in exchange rates also make comparison difficult.

Appreciation or depreciation in currency values may reflect an increase
or decrease in wealth in relation to other currencies, but it does not
affect domestic purchasing power or living standards.
ACTIVITY 5.2
What are several reasons for inaccuracies and compatibility problems in

conducting market research?

Therefore, firms need to be aware of these problems when relying on available

published (secondary) information. In some countries, such as the former Soviet
Union and countries of Eastern Europe, market information may not be available
and firms may be required to conduct a more expensive primary research.
ACTIVITY 5.3
Your company is considering expanding its operations abroad. Which

type of data would you recommend to be obtained first and why?
EXERCISE 5.1
1. All the following issues may give rise to comparability problems in

global market research, EXCEPT:
A. Fluctuation in exchange rates.
B. Different methods of measuring investment flows.
C. Differences in time periods of data compiled.
D. Different countries using similar definitions.
2. Primary research refers to:

A. All researches conducted by a firm to fill specific information
needs.
B. All types of research conducted by international firms.
C. The preliminary research conducted before commencing the
actual research
D. Research that does not address issues that firms are
particularly concerned about.

3. The ideal size of a focus group comprises:

A. 4 to 5 members
B. 5 to 7 members
C. 7 to 10 members
D. 9 to 12 members
4. Secondary data may be used for many purposes other than the
original one it was intended for.
A. True
B. False
5. Cultural factors may affect government officialsÊ ability to maintain

and analyse records.
A. True
B. False
6. What are the factors that may cause inaccurate data or information to
be gathered in global market research?
7. Explain the four major reasons international managersÊ belief that

global market research is relatively unimportant and fail to conduct
one.
5.2 FOREIGN MARKET ENTRY STRATEGIES

When a firm has decided to enter a foreign market, the firm has to further decide
on the best mode of entry. Firms can choose between six main modes of entry,
namely exporting, turnkey projects, licensing, franchising, establishing joint
ventures or setting up a new wholly owned subsidiary. These strategies are
explained in the subtopics that follow.

ACTIVITY 5.4
What are the decisions that a firm should make before considering the
best mode of entering a foreign market?
5.2.1 Exporting
Exporting refers to the activity of selling products (or services) made in the firmÊs
own country for use or resale in other countries as illustrated in Figure 5.3. This is
the most widely used method of market expansion and it is not just for large firms,
but many small firms can also significantly benefit by exporting. Export activity
has been made easier with the gradual decline in trade barriers, while modern
communications and transportation technologies have helped to alleviate
logistical problems.
Figure 5.3: Exporting
(a) Advantages of Exporting

Firstly, substantial costs of establishing a manufacturing operation in the
foreign country can be avoided. Secondly, by manufacturing the product from
a centralised location and exporting it to other countries, the firm may be able
to achieve economies of scale from the large volume of production and sales.
Using this strategy, firms such as Sony and Matsushita was able to dominate
world markets with their televisions and video cassette recorders.

(b) Disadvantages of Exporting

Exporting from the home country may not be suitable if there is other lower-
cost locations abroad for manufacturing the firmÊs products. Firms may not
be able to take advantage of cheaper resources or labour elsewhere.
However, firms can identify and manufacture its products at the best
location abroad and export to the rest of the world from that location.
Secondly, high transportation costs can make exporting uneconomical,

especially for bulk products. One way to overcome this is by manufacturing
at a regional location, thus enabling the firm to realise some degree of
economies of scale and simultaneously limit its transportation costs.
The third disadvantage is that tariff barriers can also make exporting
uneconomical and risky. For example, when Japanese car manufacturers/
exporters were threatened with the imposition of import duties by the United
States government, they set up manufacturing plants in the United States to
avoid the high duties.
Lastly, exporter firms need to rely on local agents (in the foreign country) for
marketing. As the foreign agents often carry the products of competitor
firms, they may not be totally loyal and do as good a job as expected. Firms
can overcome this by setting up a wholly owned subsidiary in the foreign
country to handle marketing, while continuing to manufacture from a single
location.
5.2.2 Turnkey Projects

Turnkey projects are most common in the chemical, pharmaceutical, petroleum
refining and construction industries. Contractor firms that specialise in the design,
construction and start up of turnkey plants, handle every aspect of the project,
including the training of operating personnel. Upon completion of the project, it is
handed over to the foreign client (usually governments) ready for full operation.
An example of such a project in Malaysia was the Bakun Dam, which was awarded
to a joint venture company between the ABB Group of Switzerland and
Companhia Brasileira de Projectos e Obras of Brazil.
(a) Advantages of Turnkey Projects

Firms with the technological know-how, which is a valuable asset, can earn
high returns from turnkey projects. These firms can employ this strategy in
countries where Foreign Direct Investments (FDIs) are restricted by the
countryÊs government regulations. It may also be less risky in a country with
unstable political and economic environment.

There are also benefits to the client. Clients need not identify individual
contractors or sub-contractors and deal with conflicting schedules in
assigning responsibilities. Under the turnkey package, there is only one
entity (i.e., the contractor) to negotiate, supervise and hold accountable. This
arrangement also allows the client to acquire a complete system, together
with skills training provided to the clientÊs personnel to maintain and operate
the system upon its hand-over.
(b) Disadvantages of Turnkey Projects

There are three main disadvantages in turnkey projects. Firstly, the
contractor firm will not have any long term interest in the foreign country.
Their business relationship would end once the project is completed and this
may be disadvantageous in countries which are potential major markets for
the output from the technological process exported. Firms can take up a
minority interest in the operation to ensure their presence over a longer term.
The second disadvantage is that the foreign client firm may eventually
become a competitor to the foreign contractor firm, such as the oil firms in
Saudi Arabia, Kuwait and other Arab countries competing with western
firms who originally provided them with oil refining technology.
Thirdly, the contractor firm may lose their competitive advantage to

potential or actual competitors if the technological know-how is their source
of competitive advantage.
ACTIVITY 5.5
A firm that enters into a turnkey project usually may no longer have any
long-term interest in the foreign country. This can be a disadvantage if
that country subsequently proves to be a major market for the output of
the process that has been exported. How might a firm get around this
problem?

5.2.3 Licensing
Licensing is an arrangement whereby a firm (the licensor) permits another

firm (the licensee) the use of its intellectual property for a specified period and
receives royalty payments in return.
The property licensed includes patents, trademarks, copyrights, technology and

technical know-how and formulas. For example, the Walt Disney Company (refer
to Figure 5.4) allows other firms to use its trademarks (brand names, logos, cartoon
characters) to be used in a variety of merchandise.
Figure 5.4: Walt Disney Trademark

Source: Walt Disney Company©
(a) Advantages of Licensing

The licensor does not have to bear the costs of market development or risks
associated with opening a new foreign market. The licensee puts up most of
the capital necessary. This strategy is also attractive when a firm lacks the
capital to develop its operations abroad or is unwilling to commit resources
to an unfamiliar or politically unstable market. Licensing can also be used
when a firm is prohibited from entering a foreign market by barriers
imposed. Lastly, a firm can use this strategy when it possesses an intellectual
property but it does not want to develop it. For example, AT&T had invented
the transistor circuit in the 1950s but did not want to produce the transistors,
so it licensed the technology to several other companies such as Texas
Instruments.

(b) Disadvantages of Licensing

Firstly, licensing does not allow the firm to realise economies of scale because
each licensee would set up its own manufacturing operations, thus not
allowing the licensor tight control over manufacturing, marketing and
strategy. Secondly, the licensor may not be able to coordinate strategies
across countries by using the profits earned in one country to support a
different licensee operating in another country (apart from the royalty
payments).
Thirdly, the licensor may lose its competitive advantage, in the form of the
property licensed out, to the licensee. To reduce this risk, firms can enter into
a cross-licensing agreement whereby a firm licensing its property may
request that the foreign partner license some of its know-how to the firm, in
addition to a royalty payment.
ACTIVITY 5.6
Let us suppose a firm is entering into a licensing agreement. Identify how

it can reduce the risks of losing control over its technology.
5.2.4 Franchising
Franchising is similar to licensing. However, it is a longer term commitment in
which the franchisor firm not only sells intellectual property to the franchisee, but
also insists that the franchisee abide by prescribed rules as to how it does business.
McDonaldÊs (refer to Figure 5.5) is one of the companies that have many
franchisees around the world. Thus, McDonaldÊs imposes strict rules as to how
franchisees should operate a restaurant, extending ongoing control over the menu,
cooking methods, staffing policies as well the design and location of its outlets.
McDonaldÊs also organises its franchiseesÊ supplies and provide management
training and financial assistance. The franchisor and the franchisee are
interdependent and each party contributes its part of the product or service that is
ultimately offered to the customer.
The franchisor may also penetrate a foreign market by setting up a master

franchisee which holds the rights to open outlets on its own or develop sub-
franchisees in the country or region. The sub-franchisees would pay royalties to
the master franchisee, which would remit a predetermined percentage of it to the
franchisor. This approach is favoured when it is costly to directly oversee and
control the franchiseesÊ operations or they are not confident in the evaluation of
franchisees.

Figure 5.5: McDonaldÊs logo

Source: 1999 McDonaldÊs Corporation©
(a) Advantages of Franchising

Similar to licensing, the franchisee assumes the cost and risks of opening a
foreign market. Using this strategy, firms can quickly expand their business
internationally at relatively low cost and risk. Franchising has a strong
market potential and offer high financial gains, especially when the
franchisor has established a strong reputation for quality that can attract
customers. From the franchiseeÊs perspective, the franchise offers a lower risk
as they are undertaking a proven successful concept. There are also major
benefits from a governmental perspective. The franchisorÊs country does not
suffer a loss or replacement of jobs, as opposed to a situation when
manufacturing firms relocate to other countries to obtain lower costs of
labour and resources. The franchiseeÊs countries do not face a large outflow
of foreign exchange because the bulk of the profits generated from franchise
outlets would remain within the country.
(b) Disadvantages of Franchising

Franchises often face the problem of quality control. While brand names such
McDonaldÊs or Hilton Hotel conveys a message of quality, foreign
franchisees may not safeguard quality as they are supposed to. As a result,
the poor quality service may damage the firmÊs reputation worldwide. In the
case of McDonaldÊs, the large number of outlets worldwide also makes
quality control difficult. Master franchisees, which is wholly owned or
partially owned by the parent company, may help overcome this problem.
The firm can then place its own managers in the subsidiary to help monitor
the franchises.
SELF-CHECK 5.2
State the differences between licensing and franchising.

5.2.5 Joint Ventures
Figure 5.6: In joint ventures, partners may or may not hold equal shares
A joint venture (see Figure 5.6) can be defined as the participation of two or more
independent firms in a jointly owned enterprise with each party contributing
assets and shares risks and a common business objective.
(a) Advantages of Joint Ventures

Firstly, a firm contributing technological know-how may benefit from the
local partnerÊs knowledge of the host countryÊs culture, language,
competitive conditions, business practices and political systems.
Secondly, partner firms may share the high costs and risks of opening a
foreign market.
Thirdly, many governments regulate foreign equity participation in local

operations or the political situation may be unstable. Joint ventures may be
the only feasible mode of entry besides reducing the risk of take overs and
government interference, as local partners may have some influence over the
host governmentÊs policies.

(b) Disadvantages of Joint Ventures

Joint ventures have several disadvantages. First, a firm may risk losing
control of its technology to its joint venture partner. However, agreements
can be drawn up to minimise this risk or firms can opt to hold majority
ownership in the joint venture company.
Secondly, a firm may not be able to exercise tight control needed in order to
achieve economies of scale, nor does it allow a firm to achieve the high levels
of coordination in its operations that is required in global competition.
The third disadvantage is that the shared ownership can lead to conflicts and
struggle for control between the partners in the event goals and objectives
change or their strategic views differ. Conflicts may also occur when the
foreign partnerÊs knowledge about local markets increases and they become
less dependent on the local partner. This increases the foreign partnerÊs
bargaining power leading to conflicts over control of goals and strategies.
5.2.6 Wholly-owned Subsidiaries

A wholly-owned subsidiary is 100% owned by the international firm. It can be
established either by setting up a new operation in the foreign country, often called
a „greenfield‰ operation, or it can acquire an established firm in the foreign
country to promote its products or services. For example, Petroliam Nasional
Berhad (PETRONAS) is MalaysiaÊs national petroleum corporation, which is
wholly-owned by the Government of Malaysia and has more than 82 wholly-
owned subsidiaries in more than 30 countries.
Figure 5.7: Petroliam Nasional Berhad (PETRONAS)

(a) Advantages of Wholly-owned Subsidiaries

A firm whose competitive advantage lies in its technological expertise may
not want to risk losing their advantage. Thus, for many high-tech firms, a
wholly-owned subsidiary is preferred.
Secondly, this mode of entry allows the firm to maintain tight control over
its operations in different countries enabling it to coordinate its global
strategies, such as using profits from one country to meet competition in
another country.
The third advantage is it enables the firm to realise economies of scale by

specialising a subsidiary in the manufacturing of certain products or
components and exchanging the products or components with other
subsidiaries.
(b) Disadvantages of Wholly-owned Subsidiaries

Generally, establishing a wholly-owned subsidiary is the most expensive
method of entering foreign markets. Firms have to bear the full costs and
risks of setting it up, and acquisitions may give rise to problems of merging
different corporate cultures.
ACTIVITY 5.7
Let us suppose a firmÊs core competency is dependent on its

technological expertise. The firm is pursuing a global strategy although
its transportation costs and trade barriers are very high. What is the
optimal mode of entry for this firm to enter a foreign market?
5.2.7 Strategic Alliances
Strategic alliances are cooperative business arrangements in which two or

more firms cooperate for their mutual benefit. These firms may be potential or
actual competitors.

(a) Advantages of Strategic Alliances

Firstly, strategic alliances may facilitate entry into a foreign market. For
example, Motorola struck a deal with Toshiba to secure government
approval to enter the Japanese market by building microprocessors for
Toshiba, who provided Motorola with marketing expertise.
Secondly, strategic alliances allow firms to share the costs and risks of
developing new products or processes.
Thirdly, complementary skills and assets that neither company can develop
on their own can be combined, such as the case between JVC and Thompson
to manufacture videocassette recorders.
Fourthly, it can be used to help firms establish industry technological

standards, such as the case between Phillips and Matsushita in establishing
the digital compact cassette system (DCC) as the new technical standard
against SonyÊs mini compact disc technology then.
(b) Disadvantages of Strategic Alliances

The major concern is that alliances may allow competitors to gain a low-cost
route to new technology and markets. For example, many strategic alliances
between US and Japanese firms were seen as a Japanese strategy to obtain
the project engineering and production process skills from successful US
companies. New inventions were channelled to Japan, while the resulting
products were distributed and sold in the US markets.
ACTIVITY 5.8
Which mode of entry have Proton, Tenaga Nasional Berhad (TNB) and
Petronas chosen as their foreign market entry strategy?

EXERCISE 5.2
1. ____________ is a type of ownership sharing among international

firms, in which two or more firms own the company.
A. Turnkey operation
B. Joint venture
C. Franchise
D. Licensing
2. ____________ is a complete system whereby a every aspect of the

project, including the training of operating personnel is handed
over to the client upon completion of the project ready for full
operation.
A. Licensing
B. Franchising
C. Joint venture
D. Turnkey operation
3. Exporting from the home-country would be more advantageous to

the firm because:
A. Transportation costs are high.
B. Foreign governments impose tariff barriers.
C. It can achieve economies of scale.
D. Cheaper resources can be found in other countries.
4. The more the firms in a joint venture, the more likely the venture
will be successful.
A. True
B. False

5. Cross-licensing is an agreement providing for the exchange of

technology between the firms involved.
A. True
B. False
6. Discuss the advantages and disadvantages of a strategic alliance.
7. Explain what is meant by licensing agreements.
5.3 INTERNATIONAL BUSINESS ETHICS AND

SOCIAL RESPONSIBILITY
The term ethics commonly refers to the rules and principles that determine what
is right and wrong conduct. Business ethics is the application of general ethical
principles to business behaviour. Although many ethical principles such as „do
not kill‰, „do not steal‰ or „not to break business agreements without reason‰ are
universally accepted, some are bound by culture. Under such circumstances,
international business firms are confronted with difficult ethical dilemmas.
Since culture and customs vary from country to country, some argue that business
firms should adopt the customs of the country in which they are currently
operating, regardless of their own ethical principles. This view is known as the
„cultural relativism‰ approach to business ethics, or the „when in Rome, do as the
Romans do‰ approach. The cultural relativist approach can be shown to be
inappropriate. For example, does this mean that if slavery is practised in a country,
then it is acceptable to practise slavery when doing business in that country?
Thus, the differences that exist between countries may cause some important
ethical issues to arise, such as violation of human rights, product safety, pollution
of the environment and corruption or bribery. This subtopic focuses on the issues
that have been the subject of much debate with respect to the activities of
international business firms.

The notion of social responsibility holds that a firmÊs responsibility is not only to
make profits (an economic view), but further include protecting and improving
the welfare of society wherever they operate (a socio-economic view). It is
therefore the business firmÊs obligation to pursue long-term goals that are good for
society, beyond what is required by law and economics. More international firms
have begun to implement various training programs to develop ethical awareness
among members of their organisations and to build an ethical corporate culture.
In so doing, firms strive to strike a balance between the achievement of their
economic goals (profits) and the goals of the society within which they operate
(welfare of society) to realise the long-term benefits of being socially responsible.
The United Nations Development ProgrammeÊs Human Development Report

2000 points out that „Global corporations can have enormous impact on human
rights in their employment practices, in their environmental impact, in their
support for corrupt regimes or in their advocacy for policy changes‰.
ACTIVITY 5.9
Since culture and customs vary from country to country, some argue that
business firms should adopt the customs of the country in which they are
currently operating, regardless of their own ethical principles. Do you
agree with this statement? If not, why? Discuss with your coursemates on
myINSPIRE.
5.3.1 Human Rights

Firstly, we look at the ethical issue of international firms doing business in
countries that abuse or violate human rights.
The United Nations Universal Declaration of Human Rights, 1948 has laid down
the basic principles that should always be adhered to irrespective of the culture in
which one is doing business. It has been accepted by almost every country. Figure
5.8 highlights Article 23 of the said Declaration.

Figure 5.8: Article 23 of the United Nations Universal Declaration of Human Rights, 1948
Source: http://www.un.org/Overview/rights.html
Totalitarian countries like China have been reported to routinely violate the
human rights of their citizens by restricting their political freedom through
repression of political dissidents. China has also been known to allow the
employment of child labour, forced labour or very poorly paid „sweat shop‰
labour.
The above example would imply that the „rights‰ under Article 23 as mentioned
above „just and favourable working conditions‰, „equal pay for equal work‰, and
remuneration that ensures „existence worthy of human dignity‰ have been
abused.
It would be unethical to employ child labour in sweat shop conditions and pay
wages below subsistence, even if it is an accepted practice in countries such as
China and Bangladesh.
Several international firms which have manufacturing facilities or their suppliers

in China, such as Gap, Disney, Wal-Mart and Nike, have been criticised for using
sweat shop labour. The ethical dilemma facing these firms is to terminate the
employment of children and let them live on the streets begging for food or
continue their employment and pay subsistence wages. By abandoning them, it
may do more harm than good if the interests of the children were to be protected.
Finding a way to improve their lives would be the ethical thing to do.

For example, when Levi Strauss discovered that its supplier employed child
labour, it further investigated the situation and found that many women workers
in the factory brought their children to work with them because there were no
school facilities and the little amount that the children earned helped keep the
family income above subsistence level. Levi Strauss built a school for the children
under 14 years of age, and additionally paid the parents the money which the
children would have otherwise earned. It may be a small price for Levi Strauss to
pay, but it meant a big difference for the childrenÊs lives.
5.3.2 Product Safety

Another ethical issue is whether an international firm should comply with the
same standards of product safety as that required in its home country when
operating in foreign countries. The United States and several European countries
are guided by their respective product safety laws, while in other countries they
are less extensive. Under these laws, firms can be held responsible (concept of
product liability) when a product causes injury, death or damage. Complying with
safety standards and product liability insurance increases costs and firms may
tend to follow the more relaxed local standards in the foreign country.
From the moral point of view, William H. Shaw, an ethics lecturer and author,
states that the responsibilities of businesses in the area of product safety include:
(a) Giving safety the priority as warranted by the product;
(b) Not having the misconception that accidents occur exclusively as a result of
product misuse and they are thereby absolved from all responsibility;
(c) Monitoring the manufacturing process from design, testing to production to
ensure specifications are complied;
(d) Reviewing marketing strategies and advertising for any potential safety
problems;
(e) Providing written information about the productÊs performance to
consumers; and
(f) Investigating customer complaints about products and taking the necessary
response.

5.3.3 Environmental Protection

As countries pursue economic development and industrialisation proceeds at a
rapid pace, the earthÊs air, land and waters are being increasingly polluted.
Depletion of the ozone layer and global warming caused mainly by deforestation
(cutting down of trees) and chlorofluorocarbons (CFCs) are major concerns. These
are said to be the result of industrial activities which are posing a threat to the
future of the planet. Thus, the business activities of large multinational
corporations have also been contributory. Environmental protection, such as
installing anti-pollution devices and using manufacturing processes that reduce
pollution or waste may increase the costs of business.
In 1992, more than 100 countries met in Rio De Janeiro, Brazil for the first
international United Nations Earth Summit to address the problems of
environmental protection. In 1997, another convention was held in Kyoto, Japan
to commit participating countries to reduce greenhouse gas emissions. 55
countries who are responsible for 55% of the of worldÊs gas emissions must ratify
the treaty in order for it to take effect. The United States rejected the treaty because
of the high costs it would bring to its industry. The United States is responsible for
25% of the worldÊs carbon dioxide emissions.
While environmental protection laws may be lacking in less developed countries,

other countries face the problem of enforcement. Some international firms locate
their production facilities in countries which have weak environmental laws to
save costs. However, other firms have shown to be environmentally responsible
companies by redesigning their manufacturing processes and use inputs more
efficiently. In 2002, more than 700 companies attended the UN Summit on
Sustainable Development in Johannesburg, South Africa to cooperate in
environmental agreements. These agreements would put all companies on the
same level, so that companies that practice environmental protection would not be
at a cost disadvantage.
5.3.4 Corrupt Practices

The last issue is concerning the payment of bribes to corrupt government officials
in order to gain access to a foreign country or the giving of gifts to support business
relationships. Member countries of the Organisation for Economic Cooperation
and Development (OECD), comprising about 20 of the worldÊs most powerful
economies, have worked towards making the bribery of foreign government
officials a criminal offence. The United StatesÊ Foreign Corrupt Practices Act
prohibits American companies from paying bribes to foreign officials to obtain or

retain business, although many developed countries do not have such laws. In
many other countries, payoffs to government officials are deemed a common
acceptable practice.
There are opposing economic views regarding investments which involve bribery.
Some economists argue that such investments bring substantial benefits to the
local population in terms of jobs created and income, and should not be ignored.
It may help improve economic efficiency and growth in these developing
countries. However, other economists are of the view that corruption reduces the
returns on business investments, thus reducing the incentive to invest and may
affect the economic growth in such countries.
Gray areas also exist in cultures where the giving of gifts is practised and expected
in developing relationships with foreign government officials. Although it may
appear to be reasonable in countries like China, this practice conflicts with western
principles of fair play. For example, two western firms are competing to secure a
supply contract from a Chinese firm. The winning firm is not the lowest bidder,
but the firm that had employed the son of the Chinese firmÊs CEO as a negotiation
consultant. The winning firm has simply been able to recognise the importance of
relationships, although principles of fair play seem to have been violated.
According to an ethicist, Thomas Donaldson, firms in international business

should be guided by three ethical principles:
(a) Respect for core human values (rights), which determine the absolute moral
threshold for all business activities;
(b) Respect for local tradition; and
(c) The belief that context matters when deciding on what is right and wrong.
Thus, ethical decisions must respect core human values while simultaneously
observing local cultural differences.

EXERCISE 5.3
1. The United StatesÊ Foreign Corrupt Practices Act:
A. Prohibits American firms from paying bribes in their home-

country, but allows it in foreign countries.
B. Prohibits American firms from paying bribes wherever they

operate.
C. Prohibits American firms from paying bribes in European

countries, but allows it in Third-World countries.
D. Prohibits foreign firms from paying bribes to American firms

in the United States.
2. The Universal Declaration of Human Rights was proclaimed in

1948 by participating countries of the:
A. Asia Pacific Economic Cooperation
B. Organisation for Economic Cooperation and Development
C. United Nations
D. Organisation of Petroleum Exporting Countries (OPEC)
3. A socially responsible company will balance the benefits to be

gained against the costs of achieving those benefits.
A. True
B. False
4. All economic views agree that corruption reduces the returns on

business investments, thus reducing the incentive to invest and
may affect the economic growth in such countries.
A. True
B. False

5. Global warming is caused mainly by deforestation (cutting down of

trees) and chlorofluorocarbons (CFC) released into the atmosphere
from industrial activities.
A. True
B. False
6. What are the steps that firms should take in order to follow ethical
product safety practices?
 The need for firms to carry out a global market research to gather information
about foreign markets is to help them make appropriate decisions as to which
foreign market is feasible to enter, what competitive strategy as well as the
mode of entry to use.
 Many firms fail in their ventures abroad because they neglect to conduct such
a research.
 There are several reasons given for this neglect, ranging from the managersÊ
lack of sensitivity to differences in foreign culture and tastes, limited
appreciation to different marketing environments, lack of familiarity with
sources of data and how to use them, and relying on the few experiences they
had in foreign country dealings as a substitute.
 The general business strategies of cost leadership, differentiation, focus and six
different modes of entry into foreign markets (exporting, turnkey projects,
licensing, franchising, joint ventures and wholly-owned subsidiaries) were
discussed at length together with each modeÊs advantages and disadvantages.
 The issues that often arise in international business ethics are the issues of
human rights, product safety, environmental protection and corruption
involving countries, where international firms operate or involving the firmsÊ
own practices.
 The concept of social responsibility and how firms tend to benefit in the long-
term if they indulge in socially responsible activities were also briefly
discussed.

Exporting Primary data

Ethics Secondary data
Franchising Social responsibilities
Human rights Sources of data
Joint ventures Strategic alliances
Licensing Turnkey projects
Market research Wholly-owned subsidiaries
Product safety

Topic  Operational
and Functional
6 Considerations
in
International
Business
LEARNING OUTCOMES
1. Discuss several types of organisational structures;
2. Assess the different requirements in a foreign marketing
environment with regard to the firmÊs products, pricing
decisions, promotional approaches and distribution channels;
3. Explain the mode of financial settlement in international
transactions and the sources of investment capital available;
4. Examine the staffing policies in international human resource
management; and
5. Describe the approach to managing expatriate managers and
foreign country employee relations.

144  TOPIC 6 OPERATIONAL AND FUNCTIONAL CONSIDERATIONS IN
 INTRODUCTION
This topic focuses on the operational and functional aspects of international
business firms. We shall look at alternative organisational structures for use in
international operations and control systems to ensure that the firmsÊ strategies
and goals can be monitored and achieved. Then, we shall learn about the 4Ps of
marketing from an international perspective, namely the issues of product
attributes, pricing, communication (promotion) and distribution (place) strategies.
Next, we shall discuss the financial management aspects of international business,
such as payments and receipts, working capital and sources of investment capital.
Finally, we shall discuss the issues of equipping international managers for foreign
postings and managing the local employees of foreign subsidiaries where the
different approaches to staffing polices together with performance appraisal and
compensation systems shall be explained.
6.1 ORGANISATIONAL DESIGN AND CONTROL

Organisational design (or organisational structure) is the pattern of structural
components and configurations used to manage the total organisation. It is the
vehicle through which strategies are implemented and work is accomplished. The
structure provides the firm with a route or channel for communicating decisions
and reports, and coordinating the overall activities of the organisation. More
specifically, the organisational structure is used by the firm to:
(a) Allocate resources;
(b) Assign tasks to its employees;
(c) Inform employees about the firmÊs rules, procedures and expectations about
the employeesÊ job performance; and
(d) Collect and transmit information necessary for problem solving and decision
making.

TOPIC 6 OPERATIONAL AND FUNCTIONAL CONSIDERATIONS IN  145
As a domestic firm expands internationally, their products and services, markets

and people in the organisation become more diverse. The firmÊs organisational
structure and control system must change to accommodate their international
activities. The design of an international firmÊs structure will depend on three
factors:
(a) Stage or degree of internationalisation (involvement in international
activities);
(b) Most desirable way to group people (human resources) and physical
resources to achieve organisational goals; and
(c) Type and degree of control to be exercised by headquarters.
There is no organisational structure which we can term as the best or perfect. A

structure that works for one company may not be appropriate for another. A new
structure implemented may turn out to be not working out as planned and needs
to be fine tuned. In more extreme cases, the structure may be found to be totally
ineffective and an entirely new organisational structure must be devised.
SELF-CHECK 6.1
What are the benefits that a firm will gain from its organisational design?
6.1.1 Types of Organisational Structures

We shall now learn about the various basic structures usually implemented
according to the different stages of internationalisation.
(a) Little or No Formal Organisation Stage

In the very early stages of international involvement, international activities
are handled by the domestic operations. Sales and profit are so small that
there is no change in the organisational structure. As transactions increase
and the firmÊs interest expands, an export sub-department within the
marketing division may be established with a few experienced employees to
take responsibility for the international activities as shown in Figure 6.1.

Figure 6.1: Little or no formal international structure
As international involvement grows, the firm may alternatively set up a

separate export division with equal ranking as the other functional divisions
of finance, R&D or human resources.
(b) International Division Stage

Under this stage, the firm has become much more involved in foreign
markets and the export department structure becomes obsolete. For example,
apart from exporting, the firm may undertake joint ventures which require
employees involved to have functional experience. The firm would usually
establish an international division, centralising all responsibility for
international activities, as shown in Figure 6.2.

Figure 6.2: International division structure
(c) The Global Organisation Stage

As the firm becomes totally committed to international operations,
communication and coordination among parts of the organisation which
may be located in many and distant locations becomes most important. Firms
must also be able to react to competitors simultaneously in many parts of the
world, if competition is on a global basis.
The major consideration at this stage is how employees and related physical
resources of the company should be grouped, or arranged, in order to
accomplish the tasks assigned to them efficiently. Four basic approaches are
available: the functional, product, geographic (or area) and the matrix
structure. Sometimes, firms may apply several approaches in various parts
of the organisational structure.
The four basic approaches are discussed in the following paragraphs.
(i) The Functional Division Structure

Using the functional structure, the firm organises personnel according
to the type of work to be done, such as marketing, engineering, finance
or production as illustrated in Figure 6.3.

Figure 6.3: Functional division structure
For example, the production division would be responsible for the

firmÊs worldwide production operations. From the administrative
point of view, the functional structure is the simplest form because it
emphasises on the basic tasks of the firm. It works best when both the
products and customers are relatively few and similar in nature. An
example of a company which uses functional division structure is
ExxonMobil whose products and production methods are basically
similar worldwide.
(ii) The Product Division Structure

In this structure, workers are organised according to the different types
of product, as illustrated in Figure 6.4.
Figure 6.4: Product division structure

Each product division is responsible for all the manufacturing and

marketing of the firmÊs products worldwide. Thus, cost efficiency can
be improved through the centralisation of manufacturing facilities.
This structure is one of the most often used by consumer product

multinational corporations, mainly because of the diversity of their
products, such as Unilever (refer to Figure 6.5).
Figure 6.5: Unilever logo
(iii) The Geographic (Area) Division Structure

This approach follows closely the marketing concept because attention
is concentrated on individual areas or markets. Resources are organised
on the basis of where work is to be done. Each geographic division, as
illustrated in Figure 6.6 is responsible for the manufacturing and
marketing in their respective geographic area or region such as
implemented by the Ford Motor Company.
Figure 6.6: Geographic (area) division structure

(iv) The Matrix Division Structure

In this organisational structure, a subsidiary reports to more than one
group. Figure 6.7 shows an example of this structure. Here you can see
that the United Kingdom subsidiary reports to the product division
(textiles and agricultural products division) as well as the Europe-
Africa group (geographic division). As each division shares
responsibility over foreign operations, the divisions will become more
interdependent, exchange information and resources with each other.
Eastman Kodak for example, implements a matrix system.
Figure 6.7: Matrix division structure
Due to the dynamic nature of business and growth, a firmÊs structure

often evolves along with its business. Most firms have a mixed
structure. For example, PepsiCo is organised by product lines (soft
drinks and snacks). However, each product line has its own
international division, which separates it from the firmÊs domestic
operations. Generally, as firms grow in size, their product lines increase
and they grow more dependent on foreign operations, new structures
will evolve in order to maintain control over the increasing complexity
of their operations.
ACTIVITY 6.1
What are the advantages and disadvantages of the functional, product,
geographic (or area) and the matrix structures? Discuss with your
coursemates on myINSPIRE.

6.1.2 Centralisation versus Decentralisation

In the design of its organisation, the third major factor for the firm to consider is
the type and degree of control to be exercised by headquarters (HQ). The firm must
determine the level of autonomy, power and control that it wants to grant to its
subsidiaries.
If the firm wants to maintain tight control and strategic decision making is
concentrated at headquarters, the system is described as centralisation. On the
other hand, if subsidiaries are allowed a high degree of autonomy and most
decisions are made at the local (subsidiary) level, it is known as
decentralisation.
Both approaches possess advantages and disadvantages. For example, a firm may
choose to decentralise decision making by allowing individual subsidiaries a wide
discretion over strategy, finance, production and marketing decisions. Subsidiary
managers may then focus only on the subsidiaryÊs needs rather than on the firmÊs
overall needs. In order to avoid this situation, the firm decentralises its decision-
making authority at corporate HQ so that decisions can then take into account the
firmÊs overall needs. However, such a step would restrict the managers from
responding quickly and effectively to changes in market conditions, they being
closest to the markets.
To realise the benefits of both approaches, firms are typically neither totally
centralised nor decentralised. The overall corporate strategy is provided by the HQ,
while subsidiaries are allowed the freedom to implement the strategies within the
limits approved by HQ – an approach known as „coordinated decentralisation‰. For
example, some functions of the firm, such as finance and R&D, may be decided
centrally, while others, such as promotional decisions, are left to the subsidiaries.
Using this approach, firms are able to address the need to coordinate all their
international activities without overlooking the role and contribution by
subsidiaries.
ACTIVITY 6.2
Decentralisation may result in better decision making. Do you agree with

this statement? Why? Discuss with your coursemates on myINSPIRE.

6.1.3 Control Systems

While the organisational structure provides a framework within which the firmÊs
objectives can be met, a control system is a process to verify and correct those
actions that differ from the firmÊs established plans. Control serves as an
integrating mechanism to ensure that the actions of the sub-units (i.e. divisions or
subsidiaries) of the firm are consistent and in support of the overall strategic and
financial objectives of the firm, despite the global differences.
In multinational corporations, four main types of control systems are used as

shown in Figure 6.8. They are:
Figure 6.8: Four main types of control systems
Most firms use all four systems, although emphasis may vary with the firmÊs
strategy.
(a) Personal Control

Personal control is exercised by personal contact with subordinates, by
which subordinatesÊ actions are directly supervised. In large international
firms, it is used between managers at different levels of its organisational
structure. For example, the CEO may use personal control to influence the
behaviour of his immediate subordinates, such as the head of divisions.
Heads of divisions in turn may use personal control to influence their
subordinates, and so on down through the corporation.
(b) Bureaucratic Control

This is a system of rules and procedures that directs the actions of business
sub-units. The most important form of bureaucratic control within
international firms are budgets and capital spending procedures.

Budgets are a set of rules for allocating a firmÊs financial resources, and
specify precisely how much the sub-unit may spend. For example, the R&D
budget specifies how much cash the unit can spend on product development.
If they spend too much on one project, they may have less to spend on other
projects. They will take action to stay within the budget. Most budgets are
set through negotiations between HQ and the sub-units. Capital spending
rules sets limits on a sub-unitÊs amount of capital expenditure (say,
USD50,000), exceeding which HQ approval must be obtained. It gives HQ
additional control over how money is spent.
(c) Cultural Control

Cultural control requires an extensive socialisation process whereby
employees absorb the norms and value systems of the firm, and share a
corporate culture. When this occurs, employees tend to control their own
behaviour, which reduces the need for direct supervision. At Matsushita, for
example, new managers spend their early months attending cultural and
spiritual training to build a common vision and values. They study the
company credo, the Seven Spirits of Matsushita, and the philosophy of its
founder, Konosuke Matsushita. They will learn to translate these lessons into
their daily behaviour and decision making.
Firms seldom purely use one type of control mechanism, but opt for a
combination. However, they may place different levels of emphasis on
different types of performance measures.
(d) Output Control

Output control involves setting performance goals for sub-units to achieve,
such as profitability, productivity, growth, market share and quality. Goals
depend on the subsidiariesÊ role in the firm. Product divisions or subsidiaries
are usually given goals for profitability, sales growth and market share.
Functional divisions are given goals related to their particular activity, and
R&D will be given product development goals. Performance goals are also
established through negotiations between HQ and sub-units. Control is
achieved by comparing actual performance against the targets and
intervening to take corrective action.
If goals are met or exceeded, sub-unit managers will be rewarded. If they are
not met, HQ or top management will intervene to find out why and take the
appropriate corrective action to look for ways to improve. Managers may
also be replaced.

6.1.4 Managing Change

Change management is another important aspect in international firms. An
organisation change refers to any significant alteration in a firmÊs strategy,
organisational structure, technology, culture or employees. The international
environment is never static, thus managing change in ways that enhance a firmÊs
productivity and profitability is a continual challenge faced by firms.
(a) Reasons for Change

Firms need to change for several reasons. The most significant is when there
are changes in the environment in which the firm operates. New markets
may open, while other markets shrink in size. For example, upon completion
of the European UnionÊs (EU) internal market, firms must develop
appropriate strategies. Some firms rearranged production among their
existing factories to benefit from economies of scale, others restructured their
product lines, and yet others buy over their competitors to widen their
presence within the EU. Firms also have to improve their productivity and
quality in meeting increased competition.
Technology requires firms to make changes in work roles and reporting

systems. For example, personal computers in the workplace reduced the
need for mainframe computers and altered the role of corporate management
information systems staff. Advances in telecommunications technology have
also allowed computer firms to establish joint ventures with foreign software
suppliers, which software is then transmitted electronically via satellite.
Cultural values and norms can also drive firms to undertake organisation
change. Decrease in the consumption of tobacco products in the United
States, for example, caused firms like Phillip Morris to diversify into other
products. Changing strategies, Phillip Morris purchased General Foods and
Kraft, and aggressively entered the European market.
(b) Instituting Change

How firms initiate or introduce change is important so that any resistance to
change can be overcome and ensure success in the international arena.
Several issues and approaches are mentioned as follows.
(i) When change disrupts basic values, such as those that are against
religion, the people affected may resist it. It is much easier to adapt to
things that do not challenge our value systems than to things that do.

(ii) Any adjustments made abroad must take into account the costs or
benefits of the change. Some adjustments can improve performance,
such as productivity or sales. Other changes may only improve
performance marginally. Some adjustments are costly, while others are
inexpensive.
(iii) Resistance to change may be lower if the number of changes is not too
many. Firms should not demand too much adjustment at one time and
introduce new policies more slowly.
(iv) Discuss changes with those affected and allow them to participate in
the decision to change. For example, employees may be more satisfied
if management listened to their views, even though management make
decisions contrary to the employeesÊ suggestions.
(v) Individuals or groups who must support change should receive some
benefits from the change. For example, firms may develop a bonus
system to reward productivity and quality based on the new approach.
(vi) Firms should locate opinion leaders, who can play a strong role in
influencing others, to help speed up the acceptance of change. As
examples, workers in Mexico may be more willing to listen to their
peers rather than supervisors, and in India and Korea, opinion leaders
are generally older people.
(vii) Firms should implement change when resistance is likely to be low. For
example, labour-saving production methods may make employees fear
that they will lose their jobs. Such measures should therefore be
introduced in times of labour shortage.
(viii) Firms should not only bring their home-grown expertise abroad, but
also learn from whichever country they operate. These experiences
should then be capitalised not only in their own country but among all
the countries in which it operates the transnational practice.
ACTIVITY 6.3
Which type of organisational structure does Sime Darby Berhad use?

EXERCISE 6.1
1. Which of the following organisational structure division is ideal

when the firmÊs products and production methods are basically
similar worldwide?
A. International
B. Functional
C. Product
D. Matrix
2. Interdependence among division and the exchange of information

and resources are features of a ____________ structure organisation.
A. geographic
B. functional
C. matrix
D. product
3. When successfully implemented, which type of control system

would require the least amount of direct supervision?
A. Personal
B. Bureaucratic
C. Output
D. Cultural
4. In a matrix structure, a subsidiary has to report to more than one

group.
A. True
B. False

5. As product lines become more diverse, a firm is likely to shift from a

product to a functional structure.
A. True
B. False
6. In determining the level of autonomy, power and control that firms

wish to grant to its foreign subsidiaries, what are the three different
approaches available?
7. Explain what are the major factors that may require a firm to change
its strategies, organisational structure, technology or employees in
todayÊs dynamic environment.
6.2 INTERNATIONAL MARKETING

MANAGEMENT
In determining the product, pricing, promotion and distribution strategies to
satisfy individual and organisational objectives across different countries, a firm
needs to first determine whether a mass produced or standardised product is
appropriate. When it is not appropriate, firms have to adapt and adjust their
marketing strategy accordingly. While the firm needs to consider the additional
cost of adapting, neglecting the differences in consumer taste and preferences
among countries can lead to failure.
In the following subtopics, we shall discuss several major problems as well as ways
they can be overcome in respect of the marketing mix of international firms.
6.2.1 Product Attributes

Products can sell well when their attributes match consumer needs. For example,
the attributes of a car includes its power, design, quality, performance, fuel
consumption and comfort. Consumer needs, however, vary from country to
country depending on their culture and level of economic development. Product
sales are also constrained by a countryÊs different product standards.

(a) Cultural Differences

As we have learned, consumer tastes and preferences are influenced by
cultural elements, the most important of which is customs and tradition. It
particularly impacts consumersÊ consumption habits. Thus, different types
of food and drinks are consumed and favoured across different countries.
Scent preferences also differ from one country to another. Thus, a range of
other cultural differences exist between countries, although some cultural
convergence has occurred.
(b) Economic Development

The level of economic development of a country can influence consumer
behaviour. Consumers in highly developed countries prefer a lot of extra
performance attributes in their products, while consumers in less developed
countries prefer more basic products and product reliability may be more
important. These differences can be attributed to their different levels of
income and purchasing power.
(c) Product and Technical Standards

Mass production and marketing of a standardised product is also not
possible due to different product standards imposed by the government of
various countries. Firms also have to incur additional cost when products
have to be modified to meet the different standards and specifications.
Technical standards such as for video equipments and television frequency
signals also limit the firmÊs ability to standardise their products.
6.2.2 Pricing Strategy

We shall study three aspects of international pricing strategies, i.e. price
discrimination, strategic pricing methods and government regulations that limit a
firmÊs ability to set prices that it would prefer.
(a) Price Discrimination

Price discrimination, by charging different prices for the same product in
different countries, can help a firm maximise its profits. If a firm has a
monopoly, it can charge as high a price as the market will bear, while prices
have to be lower in a competitive market.
However, two conditions must exist before price discrimination can work.
First, the firm must be able to keep its country markets separate. For example,
a Ford Escort may cost USD2,000 more in Germany than in Belgium. If Ford
cannot keep the two markets separate, car dealers can buy Escorts in Belgium
and sell them in Germany slightly lower than Ford was selling and make a
profit. The second condition is that there must be different price elasticities

of demand in different countries. In countries where demand is inelastic, i.e.

when a large change in price produces only a small change in demand, firms
may charge a higher price. Demand is said to be elastic when a small change
in price results in a large change in demand. The two most important factors
that determine elasticity are income levels and competitive conditions. When
consumersÊ incomes are limited, they tend to be very price conscious and
when there many competitors, consumers may buy from the firm that
charges the lowest price.
(b) Strategic Pricing

Strategic pricing consists of three types as follows:
(i) Predatory pricing – Refers to using price as a competitive weapon to

drive weaker competitors out of the market. Once competitors have left
the market, the firm can raise prices and enjoy high profits.
(ii) Multipoint pricing – Refers to a firmÊs pricing strategy in one market

which impacts its competitorsÊ pricing strategies in another market. For
example, when Fuji cut the prices of film rolls in the US, Kodak
responded by aggressively cutting their prices in Japan. Fuji eventually
withdrew its aggressive stance in the US.
(iii) Experience curve pricing – Refers to fixing low prices in an attempt to

build global sales as quickly as possible. The larger sales volume would
allow the firm to move down the experience curve and enjoy economies
of scale.
(c) Government Regulations

Regulations, such as anti-dumping regulations and competitive policies,
may limit a firmÊs ability to implement price discrimination or strategic
pricing strategies.
(i) Anti-dumping regulations – Dumping means selling a product for a

price that is less than the cost of producing it. Governments may
impose anti-dumping regulations by charge higher duties on imports
of products found to have violated anti-dumping regulations.
(ii) Competitive policy – Most industrialised countries have laws to promote

fair competition and restrict monopoly practices, which can be used to
limit the prices a firm can charge in a particular country. For example,
Hoffman-La Roche (a Swiss pharmaceutical manufacturer) was found
overcharging their tranquilisers and was ordered to reduce its prices by
35 to 40 per cent by the British government.

ACTIVITY 6.4
Let us suppose that your firm sells electric appliances in two different
countries, which is Country „A‰ and Country „B‰. It is strategised that the
appliances sold in one country cannot be used in the other country because
each of these countries uses a different voltage system. The average income
level in Country „B‰ is well above that found in Country „A‰. Besides that,
many other firms are selling the same electric appliances in Country „A‰.
There are very few competitors in Country „B.‰ What strategy should your
firm pursue to increase its profits?
6.2.3 Communication Strategy

In communicating product attributes to prospective customers in another country,
several communication channels are available including direct selling, sales
promotion, direct marketing and advertising. Some firms use several channels
simultaneously to communicate their message. However, the effectiveness of a
firmÊs international communication can be jeopardised by cultural barriers, source
effects and noise levels. We shall discuss these three factors in the following:
(a) Cultural Barriers

Due to cultural barriers, a message that means one thing in one country may
mean something different in another country. For example, Benetton had
won an award in France for their advertisement which featured a black man
and a white man handcuffed together. The advertisement was attacked by
US civil rights groups for promoting racial discrimination, and Benetton had
to withdraw it. Cultural differences restrict a firm from using the same
marketing message and selling approach all over the world.
Apart from developing cultural literacy, the firm should use a local
advertising agency to develop its marketing message, and employ a local
sales force if the firm uses direct selling.
(b) Source and Country of Origin Effects

Source effects occur when the receiver of the message, for example the
potential consumer, evaluates the message based on the status or image of
the sender. It can be damaging for an international firm if the potential
consumers have a bias against foreign firms. One way to overcome source
effects is to de-emphasise the productsÊ foreign origin.

Country of origin effects refers to the extent to which potential consumers

evaluate products based on the place of manufacture, especially when the
consumer lacks adequate knowledge of the product. When there is a negative
country of origin effect, the firm may have to use promotional messages that
strongly stress the positive attributes of the product.
However, source and country of origin effects can also be positive. For
example, Italian clothes and German cars enjoy positive source effects
universally. In such cases, the firm should emphasise its foreign origins.
(c) Noise Levels

Noise refers to the amount of other messages competing for potential
consumersÊ attention. It tends to reduce the effectiveness of communication.
Noise levels also vary among countries, tending to be high in developed
countries and lower in developing countries.
6.2.4 Distribution Strategy

Distribution is the process of getting products and services from the firm into the
hands of customers. In this subtopic, we shall discuss selecting the means by which
to offer its goods for sale in the markets it wants to serve.
Channels of Distribution
A typical distribution system consists of a channel that includes a wholesale
distributor and a retailer. Distribution systems between countries may vary
according to its retail concentration, channel length or channel exclusivity, each of
which we will study in the following.
(a) Retail Concentration

A retail system may be concentrated, which means that there are a few
retailers which supply most of the market. While in a fragmented retail
system, there are many retailers but no one has a major share of the market.
In densely populated countries like Japan, which also has a large number of
urban centres, the retail system is more fragmented with many small stores
that serve local neighbourhoods and to which people frequently walk to. The
small retailers also enjoy government legal protection. These small retailers
can obstruct the setting up of a large retail outlet by petitioning to their local
government.

The retail systems in many developing countries are also very fragmented,
but for different reasons. In India, for example, Unilever has to sell to 600,000
rural villages by means of bullock carts or bicycles since they do not have
proper roads.
In other countries, like the United States and France, the retail system is more
concentrated. The increase in the number of car ownership, number of
households with refrigerators and freezers, and the number of two-income
households have contributed to the growth of large retail firms such as Wal-
Mart and Carrefour.
(b) Channel Length

Channel length means the number of intermediaries between the
manufacturer and the consumer. When a manufacturer sells directly to the
consumer, the channel is very short. If the manufacturer has to sell through
an import agent, a wholesaler and a retailer, a long channel exists. Channel
length is determined most importantly by the degree to which the channel
system is fragmented because it encourages more wholesalers to emerge to
serve retailers.
For the producer, the more fragmented the retail system, the more expensive
it is to sell directly to so many small retailers, each yielding only a small
order. The producer firm would also need a large sales force. Thus, it is more
economical for the producer to sell to wholesalers and the wholesalers to deal
with the retailers. When the retail system is concentrated, the firm would
deal directly with retailers, cutting out the need for wholesalers.
(c) Channel Exclusivity

An exclusive distribution channel is one that is difficult for firms to gain
access, such as shelf space in supermarkets. Reputable and long-established
producers enjoy exclusivity because retailers prefer to carry their products
rather than the products of new or unknown firms. In Japan, for example,
manufacturers, wholesalers and retailers have long established relationships.
Based on this relationship plus an attractive mark-up offered by the
manufacturer, distributors will not carry the products of competitors. Thus,
many US and European manufacturers find it difficult to gain access to the
Japanese market.
In choosing the optimal distribution strategy, firms have to consider the

relative costs and benefits of each alternative. The relative costs and benefits
may vary from country to country depending on the three factors – retail
concentration, channel length and channel exclusivity.

ACTIVITY 6.5
Can you suggest any product or product line that requires little or no
modifications in marketing strategies wherever in the world they are
being sold?
EXERCISE 6.2
1. The most important factors a firm must consider in their product

attributes to match them with the needs of consumers are as
follows, EXCEPT:
A. Cultural elements, especially customs and traditions.
B. The level of economic development of countries.
C. The degree of retail concentration of countries.
D. Product and technical standards of countries.
2. Which of the following is generally not true about „channel length‰

in a more fragmented retail system?
A. It is more expensive to sell directly to the many small retailers.
B. A larger sales force is required to service the retailers.
C. It is more economical to deal with wholesalers.
D. Firms need not use the services of wholesalers.
3. Negative „source effects‰ in product communications/messages

can develop when consumers:
A. Evaluate products based on the status or image of the sender.
B. Lack adequate knowledge of the product concerned.
C. Evaluate products based on the productÊs place of manufacture.
D. Have a bias against foreign firms.

4. Price discrimination is the charging of different prices for similar

products in different countries to maximise profits.
A. True
B. False
5. The greatest potential cost savings are through the standardisation of

products.
A. True
B. False
6. Explain the three types of strategic pricing methods firms can use in
their international marketing programmes.
7. What is meant by the term „channel exclusivity‰?
6.3 INTERNATIONAL FINANCIAL

MANAGEMENT
Firms engaged in international business is confronted with the problem of having
to trust parties they may have never seen or met, who abides by a different legal
system and who could be very difficult to track down if they default on an
obligation.
For example, a United States firm exporting to an importer in France might fear
that if he ships the products to France before he receives payment, she might take
delivery of the products and not pay him. On the other hand, the French importer
might worry that if she pays for the products before they are shipped, the US firm
might keep the money and never ship the products, or might ship defective
products. Each has his or her own preferences to protect his or her interests. While
the United States exporter would prefer the French importer to pay for the
products before they are shipped, the French firm would prefer not to make
payment for the goods until they arrive.
To overcome this problem, a third party, normally a reputable bank (which both
parties can trust) is used to act as an intermediary. The following subtopic explains
the payment and collection procedures in detail.

6.3.1 Methods of International Payment

There are two methods of payment involving the bank. The first is known as the
documentary collection method whereby the bank acts merely as an agent to
facilitate the collection of funds. In the second method, called the letter of credit
(L/C) collection method, the bank is directly involved in the transaction by
guaranteeing payment to the exporter on behalf of the importer. We shall study
these methods in detail.
(a) Documentary Collection Method
Figure 6.9: Documentary collection method
Figure 6.9 illustrates the documentary collection method. This method

involves a four-step process, as follows:
Step 1:
Buyer and seller agree on the terms of the contract, including the buyerÊs
obligation to make payment upon delivery of the following normally
required documents:
(i) An invoice (or packing list) which details the price and description of
the merchandise.
(ii) A draft (also called a bill of exchange). The draft is an order written by
an exporter (drawer) instructing the importer (drawee) to pay a
specified amount of money at a specified time. There are two major
types of draft. A sight draft requires payment to be made upon the
transfer of title (i.e. ownership) to the goods from the exporter to the
importer. When the bank in the importerÊs country receives the sight
draft from the exporterÊs bank, it shall notify the importer who then
pays the draft. Upon payment, the bank shall give the bill of lading to
the importer who can then take delivery of the goods.
A time draft allows for payment to be delayed, normally or 30, 60, 90

or 120 days. Once accepted by the importer by stamping a notice of
acceptance on the draft, it becomes a promise to pay by the importer.
(iii) A bill of lading is issued by the carrier company to the exporter. It

serves three purposes. First, as an acknowledgement of receipt to
indicate that the carrier has received the merchandise described in the
document; secondly, as contract obligating the carrier to deliver the
goods to the designated destination; and thirdly, as a document of title
to the merchandise which shall be transferred to the importer upon
final payment.
Step 2:
The seller ships the merchandise as consigned in the bill of lading to the
collecting bank in the foreign country (Hong Kong). The seller draws the
draft, payable on sight of the documents, and delivers it to the remitting bank
(in the United States) together with all other documents.
Step 3:
The United States bank sends the documents with instructions to the
collecting bank.
Step 4:
When the merchandise arrives in Hong Kong, the shipping company notifies
the collecting bank. The collecting bank advises the buyer that the cargo has
arrived and that payment is due. The buyer accepts the draft and makes
payment. The collecting bank then endorses the bill of lading to the buyer,
which allows the buyer to take delivery of the merchandise from the port.
The funds collected are then forwarded to the seller through the remitting
bank.
Using the method mentioned, the seller is able to control the merchandise
until payment is made. However, there is some degree of risk for the seller.
The buyer may not accept the draft and make payment (a non-acceptance)
leaving the buyer with only a few options arrange to ship the merchandise
back to the US, try to find another buyer, abandon the merchandise at the
port, or renegotiate the contract with the original buyer. Due to these risks,
the documentary collection method is usually used only between
subsidiaries of the same company or with a customer whom the seller has
had a long and excellent relationship with.

Figure 6.10: Letter of credit collection method
(b) Letter of Credit Collection Method

Figure 6.10 illustrates the letter of credit collection method. In this method,
all the documents are as in the documentary collection method with the
exception of an additional document, called the letter of credit. The letter of
credit is an undertaking by a bank to guarantee payment to the exporter
(seller) upon fulfillment of the terms set forth in the letter, usually the
presentation of the required shipping and export documents. While the
banks merely act as intermediaries in the documentary collection, they are
parties directly involved under the letter of credit method.
The procedure can be simplified to seven different steps as follows:
Step 1:
The buyer and seller agree on the terms of the contract, which includes the
buyerÊs obligation to furnish the seller with a confirmed, irrevocable (cannot
be changed or altered) letter of credit.
Step 2:
The buyer applies to the bank in his area for a letter of credit. (The bank
evaluates the application in the same way as in a loan application.)
Step 3:
Assuming the bank approves the letter of credit application, it will issue the
letter of credit, guaranteeing payment to the seller if the terms of the letter
are met. The letter of credit is then forwarded to a bank in the sellerÊs area.

Step 4:
The appointed bank in the sellerÊs area (advising bank) advises the seller that
he is the beneficiary of the issuing bankÊs letter of credit. The confirming bank
(may also be the advising bank) further adds its guarantee of payment to that
of the issuing bankÊs.
Step 5:
The seller ships the merchandise and presents the documents specified in the
letter of credit (usually the invoice, draft, bill of lading) to the confirming
bank. When the confirming bank accepts the documents, the seller will be
paid.
Step 6:
The confirming bank forwards the documents to the issuing bank.
Step 7:
The issuing bank endorses the bill of lading over to the buyer allowing the
buyer to collect the merchandise.
In the event the buyer refuses to make payment under this procedure, this is a
problem of the issuing bank. The arrangement between the applicant (buyer) and
the issuing bank is of no concern to the seller. As long as the seller has provided
the documents as specified in the letter of credit, the transaction is completed and
the seller is entitled to payment. Thus, the interest of both the buyer and the seller
can be protected.
6.3.2 Managing Working Capital and Cash Flow

The task of managing working capital and cash balances is more complicated for
international firms than for domestic firms. International firmsÊ dealings involve
foreign subsidiaries and foreign markets each using a different currency. The
processes involve three corporate financial goals, and they are to:
 Minimise working capital balances;
 Minimise currency conversion costs; and
 Minimise foreign exchange risks.

(a) Minimising Working Capital Balances

Working capital is required to facilitate the firmÊs day-to-day transactions
and to cover against unexpected demands for cash. As the rate of return on
working capital is low, financial managers prefer to invest surplus cash in
some other form so as to earn higher rates of return. At the same time, a firm
needs to maintain sufficient cash balance to pay workers or suppliers.
Running out of cash may result in expensive emergency borrowings or a loss
of reputation that may cause suppliers and lenders to cut off their lines of
credit. Thus, the firm has to balance their need for cash against the cost of
holding assets which yield low returns.
A centralised cash management system can be used, whereby a central cash

manager in the Treasury Division at HQ coordinates the firmÊs worldwide
cash flows. Each subsidiary provides the central cash manager with a daily
cash report and an analysis of its expected cash balances and needs over the
short-term which will be used to decide how much cash each subsidiary
should hold. Cash in excess of their needs will be sent to a central corporate
bank account. The pooled funds can be channelled to subsidiaries with an
unexpected or emergency need for cash, and also investing in short-term
opportunities available. Thus, the firm is able to reduce the precautionary
cash balances held as a whole and reduce their assets from being tied up in
low returns accounts.
(b) Minimising Currency Conversion Costs

International firmsÊ subsidiaries continually buy and sell parts and finished
goods among themselves. Thus, there is a constant need to transfer funds
among the subsidiariesÊ bank accounts. The bank charges for transferring
these funds and charges for converting currencies involved can be
substantial.
These costs can be reduced by the subsidiaries engaging in a process of

bilateral netting i.e. between two subsidiaries. For example, a firmÊs Mexican
subsidiary has to convert US$1 million worth of pesos into sterling pounds
and the British subsidiary has to convert US$3 million worth of pounds into
pesos. Instead of incurring so much transfer charges and cost of conversion,
the British subsidiary can simply pay the Mexican subsidiary the difference
of US$2 million in pesos. These costs can be reduced further by multilateral
netting, a similar process but involving three or more subsidiaries.

(c) Minimising Foreign Exchange

Currency values may appreciate or depreciate in value. Firms therefore try
to increase their net holdings of currencies that are expected to rise and
decrease net holdings of currencies that are expected to fall in value. For
example, if the Thai baht is expected to decline in value, the firmÊs financial
officers would try to minimise the firmÊs holding of baht-denominated assets
by demanding that transactions in baht be paid quicker (a process known as
leading) or by reducing their baht bank balances. Firms may also try to delay
payments in baht (known as lagging) or by increasing their short-term baht
denominated borrowings. If the currency is expected to rise in value, the
same techniques can be employed in reverse.
6.3.3 Source of Investment Capital

Capital funds are required to finance a firmÊs expansion in foreign markets. If
capital is provided by the owners of the firm, it is called equity capital. If it is
obtained through borrowings such as from banks, it is called debt capital. These
funds can be obtained from the following major sources:
(a) Euro Note Market

Large international firms are sometimes larger and more creditworthy than
the banks they are borrowing from. Therefore, instead of borrowing from the
banks, these firms sell their own debt notes directly to the market to obtain
funds and bypass the costs of bank borrowings. These notes are known as
commercial paper. In international money markets, they are known as Euro-
commercial paper.
(b) International Bond Market

A bond is a debt instrument carrying a promise by the firm to repay the
principal along with interest on a specified date. For example, Petronas sells
global bonds denominated in US dollar and Euros to raise USD1 billion and
€500 million respectively. The US dollar bond will carry a maturity period of
10 years, while the €500 million bonds will have a seven-year maturity.
(c) International Equity Market

Foreign firms may issue new shares in foreign stock markets by listing their
shares on major stock exchanges, such as New York, Tokyo or London.
(d) Private Placements

A private placement is the sale of debt or equity to a large investor. The sale
is normally a one-time transaction in which the investor holds the bond until
maturity (if debt) or until hold the shares until it is repurchased by the firm
(if equity).

EXERCISE 6.3
1. A firm mainly uses „netting‰ for cash flow management for the
purpose of:
A. Eliminating foreign currency risk.
B. Reducing the volume of foreign currencies to be managed.
C. Diversifying its financing across several currencies.
D. Borrowing in foreign currencies.
2. All of the following are the main financial objectives of working

capital and cash flow management, EXCEPT:
A. To minimise working capital balances.
B. To minimise currency conversion costs.
C. To minimise purchases of raw materials.
D. To minimise foreign exchange risks.
3. Which of the following can be a source for both debt as well as

equity capital?
A. Equity market
B. Bond market
C. Private placement
D. Euro note market
4. An applicant for a letter of credit deals directly with the advising

bank.
A. True
B. False

5. A commercial bill of exchange that requires payment to be made

immediately is known as a sight draft.
A. True
B. False
6. What are the three major purposes of the bill of lading?
7. Explain in proper sequence the various steps in a documentary

collection method.
6.4 HUMAN RESOURCE MANAGEMENT

Differences in culture, levels of economic development and legal systems among
the countries where a firm operates require firms to customise its recruiting,
terminating, training and compensation policies between countries.
6.4.1 Types of Staffing Policy

Staffing policy refers to the selection of employees for particular jobs. It does not
only concern selecting individuals who possess the necessary skills, but it also
whose behaviours, beliefs and value systems are consistent with the firmÊs
corporate culture.
In international business, there are three types of staffing policies: the ethnocentric
approach, the polycentric approach and the geocentric approach.
(a) The Ethnocentric Approach

In an ethnocentric staffing policy, key management positions are held by the
parent countryÊs personnel. For example, all the important positions in the
foreign subsidiaries of Dutch firm Phillips would be held by Dutch nationals.
Firms pursue this type of policy because they believe that:
(i) The host country lacks qualified individuals to fill these senior
positions, especially in less developed countries;
(ii) This policy is the best way to maintain a unified corporate culture.
Parent country managers would have been fully socialised into the
firmÊs culture while employed in the home country; and

(iii) This is the best way to transfer core competencies to a foreign operation,
i.e. by transferring parent country personnel who have the skills and
knowledge of that competency to the foreign subsidiary.
However, this practice is declining because it limits career advancement

opportunities for the host country personnel, which may lead to dissatisfaction,
lower productivity and higher turnover. An ethnocentric staffing policy can also
cause firms to fail to understand the cultural differences in host country
marketing and management termed as „cultural myopia‰.
(b) The Polycentric Approach

A polycentric policy requires that host country nationals be recruited to
manage the subsidiaries. Parent country nationals would occupy the key
positions at corporate headquarters. This policy has two advantages:
(i) It reduces the likelihood of cultural myopia. Host country nationals are
unlikely to commit mistakes arising from cultural misunderstanding;
and
(ii) It is less expensive to maintain host country nationals compared to
parent country nationals.
The polycentric approach also has disadvantages, as follows:

(i) A gap may develop between host country managers and parent
country managers due to the cultural differences. This may lead to a
lack of integration and isolation between corporate headquarters and
foreign subsidiaries, making coordination and implementation of
strategies difficult; and
(ii) Host country nationalsÊ progress may be limited to the senior positions
within their own subsidiary with limited opportunities to gain
experience outside their own country.
(c) The Geocentric Approach

The geocentric staffing policy recruits the best people for key management
positions throughout the organisation, regardless of nationality. As
advantages, this policy enables the firm to:
(i) Make the best use of its human resources;
(ii) Build a team of international executives who are comfortable working
in a number of cultures and suffers no cultural myopia; and
(iii) Better capitalise on the multidirectional transfer of core competencies
compared to the other approaches.

However, the firmÊs ability to pursue this policy may be limited by host
country laws that require foreign subsidiaries to employ their citizens. A
geocentric policy can also be very expensive because of the higher
compensation structure enjoyed by geocentric managers and may cause
resentment within the firm.
Firms may also vary their staffing policies from subsidiary to subsidiary,
managing some on an ethnocentric basis and others on a polycentric or
geocentric basis.
ACTIVITY 6.6
What would generally be the most appropriate staffing policy approach

for a firm pursuing an international, multidomestic and transnational
business strategy? Why?
6.4.2 Managing Expatriates

Expatriates are citizens of one country who are working in another country. For
example, a Malaysian citizen working in Japan is an expatriate manager. One
important issue concerning these managers is expatriate failure, i.e. the premature
return of an expatriate manager to his home country, which incurs a high cost to
the parent firm. The reasons for this failure are as follows:
(a) Inability to cope with larger overseas responsibilities;
(b) ManagerÊs inability to adjust;
(c) SpouseÊs inability to adjust;
(d) Personal or emotional problems;
(e) Lack of technical competence; and
(f) Other family problems.

The order of importance, however, may vary among parent companies. For
example, for Japanese firms the most common reason is the managersÊ inability to
cope with larger overseas responsibilities, but for US firms the top reason is the
inability of the managersÊ spouses to adjust in the new foreign environment.
(a) Expatriate Selection and Training

Research conducted by Mendenhall and Oddou stated that expatriatesÊ
tendency to equate domestic performance with overseas performance
potential as a major cause of expatriate failure in many firms. A manager
who performs well in the domestic environment may not be able to adapt to
managing in a different cultural environment. They further identified that
success in a foreign posting may depend on the following characteristics of
the manager:
(i) Self-orientation – An expatriate with high self-esteem, self confidence

and mental strength is more likely to be able to adapt.
(ii) Others-orientation – Willingness to communicate using the host

countryÊs language and to develop relationships with host country
nationals.
(iii) Perceptual ability – Ability to understand and appreciate why people

of other countries behave the way they do and not treat them as if they
were home country nationals.
(iv) Cultural-toughness – Refers to how well an expatriate adjusts to

postings to „tougher‰ countries whose culture is more unfamiliar and
uncomfortable. For example, some countries may have poor health care
and housing standards, inhospitable climates, lack of western
entertainment (for western country nationals) and difficulties in
language.
The next step after selecting the manager with the four above mentioned
attributes, the manager has to be trained to undertake a specific job and equip
themselves with the skills required for success in a foreign posting. The types
of training are:
(i) Cultural Training

It involves training not only the manager, but also the managerÊs whole
family, in the host countryÊs culture, history, politics, economy,
religion, and social and business practices to foster appreciation.

(ii) Language Training

Although it is possible to conduct business all over the world using
only English, a willingness to communicate using the local language
can help build rapport and with local employees and increase the
managerÊs effectiveness. A foreign language training enables managers
to relate more easily to a foreign culture and foster a better image of the
firm.
(iii) Practical Training

This may take the form of arranging a familiarisation trip to the host
country before the formal posting so as to ease culture shock. Where
there exists an expatriate community, firms ensure that the new
expatriate family is quickly integrated into the group which serves as a
support network of friends and information.
Another important issue is that firms tend to overlook to prepare expatriate

managers for re-entry into their home-country organisation upon completion
of their foreign assignment. A research study revealed that many expatriates
did not know what their new position would be when they returned home
and were uncertain about their new roles and future career development,
while some were given lower level jobs. Thus, firms lose the knowledge,
skills and capabilities of these expatriates when they leave to take up new
jobs at other firms. Firms should carefully plan to re-integrate them back into
the home-country organisation.
ACTIVITY 6.7
In general, most countries differ in its compensation practices and this

raises a difficult question for an international business. Should the firm
pay executives in different countries according to the standards in each
country or standardise pay on a global basis? Why?

6.4.3 Performance Appraisal and Compensation

The issue of performance appraisal and compensation concerns how best to
evaluate the expatriate managersÊ performance and how to adjust compensation
according to different countryÊs economic and compensation practices.
(a) Problems in Performance Appraisal

The expatriatesÊ performance appraisal by headquarters management are
seen as unfair and does not fully appreciate their skills and experience, due
to reasons of unintentional bias. Expatriate managers may be evaluated by
two groups i.e. host-country management and home-country management
who are both subject to bias.
For example, an expatriate manager introduced participative decision

making while working in a subsidiary in India. Due to the social stratification
in India, the host-country management viewed this negatively, since
expatriate managers are looked upon as experts who should not ask
subordinates for help in making decisions.
Home-country managers may rely solely on hard data, such as the

subsidiaryÊs productivity, profitability or market share when evaluating an
expatriate managerÊs performance. Due to the distance and lack of working
experience abroad, home-country managers fail to take into account factors
that are beyond the expatriate managerÊs control, such as adverse changes in
exchange rates and economic downturns. The expatriate managerÊs other
less visible abilities (or Âsoft variablesÊ), such as ability to develop cross-
cultural awareness and to work productively with local managers were
neglected.
Several steps can be taken to reduce these biases. First, more weight should
be given to an on-site managerÊs appraisal than to an off-site managerÊs
appraisal. The on-site manager is more likely to evaluate the soft variables.
The on-site manager should also be of the same nationality as the expatriate
manager to avoid cultural bias and should preferably be one who has served
in the same location. Lastly, the on-site manager should consult home-
country managers in termination evaluations to balance any cultural
misunderstanding.

(b) Compensation Issues

International firms face the question of whether to pay executives in different
countries according to each countryÊs standards or to equalise pay on a global
basis. In a polycentric policy, pay can follow each countryÊs standards
because of the managerÊs lack of mobility among different countries, while
an ethnocentric firm can formulate a common pay scheme for all expatriates.
However, problems arise with geocentric policies because expatriate
managers include many different nationalities.
A firmÊs compensation package must be effective in:

(i) Providing an incentive to leave the home country on a foreign
assignment;
(ii) Maintaining a given standard of living;
(iii) Taking into consideration career and family needs; and
(iv) Facilitating re-entry into the home country.
The components of a typical expatriate compensation package consist of the

following:
(i) Base salary – Is normally similar in amount as for a similar position in
the home-country.
(ii) Foreign service premium – Is extra pay for working outside their
country of origin, as an incentive to accept foreign assignments.
(iii) Allowances – May include hardship allowances (for ÂtoughÊ locations),
housing allowances, cost of living allowances and education
allowances for expatriate children.
(iv) Taxation – May be higher than home country rates or expatriates may
have to pay taxes both in the host-country and home-country. Firms
may pay whatever difference in the higher amount of tax so that the
expatriatesÊ take-home pay would not be reduced.
(v) Benefits – Refer to medical and pension benefits.

6.4.4 International Labour Relations

The human resource management function of an international business firm is also
to foster harmony and minimise conflict between the firm and organised labour
(i.e. trade unions).
Labour unions generally work to better the interests of the workers they represent,
such as better pay, greater job security and better working conditions through
negotiations with management. Their bargaining power is derived from threats to
disrupt production, such as through protests and strikes. Unions are most
concerned about multinational firms because their bargaining power can be
reduced by the firmÊs power to shift their operations to another country. The other
concern is that international firms employ only low-skilled tasks in foreign
operations, while keeping highly-skilled jobs in their home-country. This also
makes it easy for a firm to switch production from one location to another. Unions
also fear that when firms import employment practices from the firmÊs home-
country, their influence and power will be reduced.
Although labour unions have tried to increase their bargaining power by

establishing international labour organisations, by lobbying for governments to
impose restrictions on multinationals and by trying to achieve international
regulations on multinationals through the United Nations, these efforts have not
been very successful.
International firms approach labour relations differently from each other. In a

decentralised approach, labour relations activities are left to their foreign
subsidiaries to manage because of varying labour laws, union power and the
nature of collective bargaining. Other firms use a centralised approach to labour
relations in order to control labour costs, which accounts for a large percentage of
total costs. Centralised decisions are required if firms were to move production to
other countries which involve major new investments and plant closures.

EXERCISE 6.4
1. „Cultural toughness‰ as a criterion of a successful expatriate

manager means:
A. The superior physical strength of the manager.
B. The ability to speak many foreign languages.
C. The ability to adjust to an unfamiliar and uncomfortable
foreign culture.
D. The ability to uphold oneÊs own culture in a foreign
environment.
2. Expatriates are ____________.

A. people who are naturalised citizens of a country.
B. people who are citizens of a third-country.
C. people working outside their home-country.
D. locals from the country of the foreign subsidiary.
3. All of the following were efforts made by labour unions to increase

their bargaining power, EXCEPT:
A. Establishing international labour organisations.
B. Increasing the number of union membership.
C. Lobbying governments to impose restrictions on
multinationals.
D. Trying to achieve international regulations on multinationals
through the United Nations.

4. To reduce biases in the performance appraisals of expatriate

managers, an off-site managerÊs evaluation should be given more
weight than an on-site managerÊs.
A. True
B. False
5. In a geocentric staffing policy, expatriates can be paid following

countryÊs standards because of the managerÊs lack of mobility among
different countries.
A. True
B. False
6. Distinguish between the ethnocentric, the polycentric and geocentric

staffing policies.
7. Discuss the types of training that can be provided to managers to

equip them with the skills required for a successful foreign
assignment.
 At the most advanced stage, the globalisation stage, firms may be structured
according to four basic structure types, i.e. a product, functional, geographic/
area and matrix division structure.
 Since organisational structures are designed for the purpose of allocating

resources and tasks across its worldwide operations, firms more often use a
combination of designs in their overall organisational structure according to
what fits their strategies and objectives best.
 Business activities further require an effective control system to ensure that

objectives can be met, and to take corrective measures if otherwise.
 Relevant aspects of international marketing according to the four components

of product, price, communication and distribution were also explained.

 Important issues arise mainly due to the different marketing environments

abroad, especially whether marketing strategies and programmes should be
standardised worldwide or customised to suit each marketÊs unique needs.
 While customisation incurs high costs, neglecting to take into account the
different market needs may lead to failure.
 We further discussed the issue of trust and the risk exporters and importers
have to bear when they are engaged in international transactions.
 We learned how a third party, the bank, can act as intermediary to overcome
this mistrust.
 Firms also strongly need a competent cash flow and working capital
management system to ensure they are able to maintain sufficient cash to meet
daily expenditures while ensuring a decent return on their short-term assets
and to avoid the risk of a fall in the value of the currencies that the firm holds.
 These tasks can be performed by centralised monitoring and control by

headquarters.
 In the final section of the topic, we focused on the important issues in

managing human resources across many countries.
 In staffing, there are three different approaches the ethnocentric, polycentric

and geocentric policies.
 Next, we discussed the issue of adequately preparing expatriate managers to

ensure a successful foreign posting, how their performance can be
appropriately appraised and their re-entry into the home-country
organisation.
 The nature of expatriate compensation systems, which should be adequate for

their needs as well as being able to provide an incentive were also discussed.
 Lastly, we studied the role of trade unions and how firms can manage their
international labour relations better, whether through centralising or
decentralising labour relations decisions.

Centralisation Organisational control

Communication strategy Organisational design
Decentralisation Organisational structures
Distribution strategy Product attributes
Expatriate Pricing strategy

Services
7
LEARNING OUTCOMES
1. Identify the reasons for the tremendous growth and importance of
the services industry;
2. Explain the meaning and unique characteristics of services, as
opposed to products;
3. Discuss the approaches firms can use to identify suitable
international markets to offer their services; and
4. Discuss the issues in management of services in order to become
more successful in international markets.
 INTRODUCTION
In this topic, we will discuss how the services industry has seen tremendous
growth and has become increasingly important to many developed as well as non-
developing countries as a source of economic development. In the United States,
the services sector accounts for more than seventy percent of the countryÊs gross
national product and provides the source for most of the new jobs. We shall learn
what factors have contributed to this growth.
The international service business firm can be defined as „a firm that transforms
resources into an intangible output that creates utility for its customers‰. The
unique characteristics of services require the service firm to employ different
approaches to identify markets and to succeed in offering their services in
international markets.

TOPIC 7 INTERNATIONAL SERVICES  185
In the later part of this topic, we will discuss the approaches firms can use to
identify suitable international market to offer their services and finally, to discuss
the various issues in management of services in order to become more successful
in international markets.
7.1 THE IMPORTANCE AND GROWTH OF

SERVICES IN WORLD ECONOMY
In recent years, the services sector has grown to become an important part of many
countriesÊ economies, especially in the industrialised countries like United States,
Japan and Europe. In the United States, the services sector produces 75 per cent of
the countryÊs GNP and employs 79 per cent of the workforce.
However, developing countries, which had first established their economies based
either on a strong agricultural sector and/or then a manufacturing sector, are also
venturing into the services sector. Examples of some of these countries are Mexico,
Bermuda, Bahamas, Singapore and Hong Kong. The reasons vary from a lack of
natural resources to the recognition of the strong demand for services which they
are able to provide through a skilled and inexpensive labour force. Figure 7.1
provides some of the examples of services sectors.
Figure 7.1: Examples of services sectors

186  TOPIC 7 INTERNATIONAL SERVICES
The strong overall growth in the services trade can be attributed to two major
factors, as follows:
(a) Deregulation in the Services Sector

Deregulation is the reduced regulation of services by governments and the
industry itself, especially in transportation, banking and telecommunications
intended to enhance competition. As a result, international services firms
have been able to offer their services worldwide. Figure 7.2 shows the two
telecommunication firms, American Telephone and Telegraph Company
(AT&T) and Nippon Telegraph and Telephone (NTT), have benefited from
deregulation. In the airline industry, these changes have resulted in lower
prices, higher demand and a rise in volume of business. Within the services
industry itself, business practices have also become increasingly competitive
and aggressive such as in health care, law and accounting. International
markets have become an important target for expansion and competition for
market share.
Figure 7.2: American Telephone and Telegraph Company (AT&T)

and Nippon Telegraph and Telephone (NTT)
(b) Technology
Advancement in technology, especially computerisation, is the other major
contributing factor to the growth of the services sector. Through
computerisation, previously expensive offerings of services have now
become more feasible through cheaper and more rapid data transmission
capabilities. For example, financial institutions have been able to expand the
delivery of their services through a worldwide network. Technology has also
resulted in the expansion of other technology-intensive industries which are
not labour-dependent.

ACTIVITY 7.1
Besides financial institutions, give a few examples of other institutions

which have been able to expand their businesses through the use of
technology.
7.2 CHARACTERISTICS OF SERVICES

Services have certain unique characteristics which are different from products.
They are often not tangible and not storable. Services may also require customer
participation and may be linked to tangible products. We shall discuss each of
these in the following:
(a) Services are Intangible

Services have no physical existence and cannot be touched or felt. Unlike a
digital camera, services cannot be held, manipulated, used, stored or
returned when damaged. A consumer who goes to a lawyer for legal advice
would obtain knowledge that cannot be held or seen. Due to this intangible
characteristic, the value or quality of a service is more difficult to assess
compared to a product.
(b) Services are Generally Not Storable

Services cannot be created in advance and stored or saved for future use,
such as an empty airline seat or an unsold newspaper. The empty seat on an
airplane can no longer be sold once the plane has taken off. TodayÊs
newspaper, similarly, cannot likely be kept for sale tomorrow when the next
dayÊs newspaper is circulated. The unused capacity cannot be stored for
future usage. Their economic value is lost as soon as their window of
opportunity closes. Due to the high level of perishability, service firms have
to therefore plan their capacity to serve how many customers at any given
time. Insufficient capacity would mean lost sales, while too much capacity
increases costs and lowers the firmÊs profits.
(c) Services Often Require Customer Participation

Some services must be delivered in the customerÊs presence or with their
involvement because it is usually simultaneous with the time it is used or
consumed. For example, beauty and hairdressing salons provide services
that must involve the customers. This close interaction with customers may
have positive as well as negative impacts. Firstly, the firm may not be able to
standardise their offerings because services has to be customised to the needs
of different customers. However, it provides the firm with the opportunity
to differentiate their services. Secondly, services offered must maintain

certain level of consistency in order to fulfil customersÊ expectations. This
may be difficult to achieve over the long-term. Lastly, quality control efforts
could result in service uniformity, which customers may negatively perceive
as an attempt to limit their options. The human element, therefore, plays a
greater role in services compared to product offerings.
(d) Services may be Tied to the Purchase of a Product

Services may complement products in the form of support services, such as
providing customers with assistance to operate a product, for maintenance
or repairs. For example, when an aircraft is purchased, the seller often
provides for the training of pilots and technical personnel, maintenance
services and technological updates. In the sale of computer hardware, the
product is dependent on the availability of software, servicing and upgrades.
The offering of the product alone may be insufficient. The firmÊs ability to
sell their products may be dependent on these related services. Services and
products can therefore be combined and adjusted for market positioning
purposes and meet the needs of different customer groups.
ACTIVITY 7.2
Identify the Malaysian firms which offer services in the international
market.
SELF-CHECK 7.1
State the differences between services and goods.
7.3 SELECTION OF TARGET MARKETS

In offering their services internationally, firms may identify opportunities abroad
by using the following approaches or strategies:
(a) Follow the Path of the Product

For services that support or are delivered in conjunction with products, such
as in banking and accounting, firms can determine where their major
international clients have set up new operations abroad and follow them.
Firms may then simultaneously look for new clients. If there exist clusters of
manufacturer clients, the service firm would be able to also obtain economies
of scale.

(b) Search for Market Situations Similar to Home Market

When services are provided independent of products, local firms can explore
and analyse the foreign market situation regarding IT development or
market trends. The local firms can collaborate with foreign firms to utilise e-
commerce and e-business to obtain „win-win situation‰ in business. This,
most importantly, would enable the firm to understand similar problems
that occur in similar situations. For example, a management consultant can
explore the possibility of supervising a smooth transition from manual to
computerised systems upon learning of such plans of a foreign country.
(c) Identify Points of Transition

Points of transition refer to the changes taking place in foreign countriesÊ
domestic environment. For example, when new public transportation
systems are being introduced in a foreign country, the firm may offer its
services to improve the efficiency of the new system.
(d) Keeping Informed of Sponsored International Projects

Firms may also obtain leads for opportunities by keeping abreast of
international projects that are being sponsored by either domestic or
international organisations, such as the UN or the World Bank. Such projects
are often in need of support services.
ACTIVITY 7.3
Air Asia is MalaysiaÊs second national airline which offers budget flights
to local destinations and the ASEAN region which includes Singapore,
Bangkok, Hatyai, and Phuket. Visit www.airasia.com and identify the
strategies the company uses in selecting its target market.
SELF-CHECK 7.2
Point out the strategies that can be chosen in offering services

internationally.

7.4 MANAGING SERVICES OPERATIONS

In order to be successful, international service operations involves the
management of several issues such as capacity planning, location planning, design
and layout of facilities, and scheduling of operations, which we shall discuss in the
following subtopic.
7.4.1 Issues Relating to International Services

Management
The basic issues in the successful management of international services involve:
(a) Capacity Planning

Capacity planning is about deciding how many customers the firm would be
able to serve at any one time. It affects the quality of the services provided to
customers because of its close customer involvement. Having the capacity to
satisfy demand can often cause a company to take advantage of this
tremendous benefit. When Apple introduced the iPhone 4 to the China
market in 2010, its supply was insufficient to meet the usersÊ demand. In the
US, high demand for the iPhone 4 led to telecommunication operators having
to stop taking orders on the first day of preorders, citing processing
problems. Apple apologised to customers who were turned away due to
insufficient supply.
(b) Location Planning

It is important that service firms locate themselves close to the customers
they plan to serve as it often requires their involvement. However, firms that
are information providers may be an exception because they may use
electronic communication. Most international service operations require the
setting up of branch offices in each foreign market and employing local staff.
(c) Design and Layout of Facilities

Service facilities must be carefully designed to establish a proper look and
layout. They may wish to highlight their foreign identity or may blend their
country heritage with the local culture, such as putting up signs in English
and Bahasa Malaysia. Other firms may choose to downplay their foreign
identity, such as British-owned DunkinÊ Donuts which many Americans
believe is an American firm.

(d) Operations Schedule

International service firms must schedule their operations to best meet the
customersÊ needs. Airlines transporting passengers from the United States to
Europe, for example, can schedule their departures late in the evening.
Passengers would thus be able to work during part of the day before they
depart and arrive early the next morning. This optimal arrangement takes
into account customer preferences, time zones, jet lag as well as aircraft
utilisation and maintenance requirements.
ACTIVITY 7.4
In your opinion, why is location planning crucial in the management of

international services? What will be the outcome for a company if this
factor is not properly taken into consideration?
EXERCISE 7.1
1. Which firmÊs activity does not demonstrate a service?

A. A camera manufacturer
B. A camera retailer
C. A photo print shop
D. A camera repair firm
2. Capacity planning in managing services means that firms:

A. Must schedule their service offerings to meet customersÊ as
well as the firmÊs utilisation of time optimally.
B. Design a proper look and layout of their service facilities.
C. Decide how many customers it would be able to serve at any
one time at an acceptable level of quality.
D. Suitably locate themselves to serve the needs of customers
effectively.

3. Singapore is an example of a country that has strongly relied on the

international services industry as a source of economic development
because it lacks natural resources.
A. True
B. False
4. Location planning is an equally important management issue to an

information service firm because they may use electronic
communication channels.
A. True
B. False
5. Explain the strategies that an international firm can use in identifying

new foreign target markets to which they can offer their services.
 We have learned that services possess certain unique characteristics that

products do not share.
 Services can be offered as stand-alone services or linked to products.
 As services are intangible, perishable, require customer involvement and may

be tied to products, different approaches to their management are required.
 In offering services abroad, firms may either follow the path of their major
clients, look for markets which share similar home-market needs, identify
developments (transition points) in the foreign country that may require their
services, or keeping aware of internationally sponsored projects to identify
foreign market opportunities.
 Finally, we learned about the major issues in the management of international

services.
 We have discussed capacity and location planning, designing facilities and

operations scheduling as the major issues in successfully meeting the needs of
customers.

Deregulation Not storable

Intangible Service sector
International services Target markets

Logistics and
8 Supply Chain
Management
LEARNING OUTCOMES
1. Explain international logistics and the issues in „make or buy‰
decisions;
2. Identify the issues of location decisions and inventory
management in international business;
3. Discuss the various modes of international transportation and the
factors to consider in the selection of an appropriate mode; and
4. Describe the concept of the supply chain, use of information
systems and quality management.
 INTRODUCTION
In this topic, we will discuss international firmsÊ activities that involve the
production and distribution of products or services. As the distribution of
products or services is frequently managed as part of the marketing function in a
firm, we shall be focusing more on the production aspects and on physical
products rather than services.

TOPIC 8 INTERNATIONAL LOGISTICS AND SUPPLY CHAIN MANAGEMENT  195
With activities dispersed around the globe, international firms are faced with the
issue of deciding where to locate their manufacturing facilities, whether they
should be concentrated in a single country or dispersed as well. They are further
confronted with sourcing decisions, such as whether they should make component
parts for their final products themselves, or buy them from external suppliers. In
this respect, firms attempt to optimise their performance by striving for lower costs
while creating value in their activities to better serve customer needs. Then, we
shall further discuss the related topics pertaining to international modes of
transport and inventory management, all of which are part of the process of
international logistics and can provide an important source of competitive
advantage to international firms. Finally, we shall study the concept of the supply
chain and discuss the issues of information systems and quality management of a
global supply chain.
8.1 INTERNATIONAL LOGISTICS
Business logistics can be defined as the process of planning, implementing and

controlling the efficient, cost-effective flow and storage of raw materials, in
process inventory, finished goods, and related information from point-of-
origin to point-of-consumption for the purpose of conforming to customer
requirements.
Source: Council of Supply Chain Management Professionals
International logistics refer to the management of the flow of materials, parts,

supplies and other resources into, through and out of the international firm. This
process consists of two major stages:
(a) Materials Management

This stage of the process refers to the management of the flow of materials,
parts, supplies and other resources from suppliers to the firm and between
subsidiaries within the firm itself. Materials management, therefore, also
includes sourcing, materials or parts inventory management, transportation
between suppliers and manufacturers.
ACTIVITY 8.1
How can the role of information and technology influence the materials
management functions?

196  TOPIC 8 INTERNATIONAL LOGISTICS AND SUPPLY CHAIN MANAGEMENT
(b) Physical Distribution

The physical distribution stage involves the flow of finished products from
the firm to the customers. As in materials management, this stage also
involves the selection of appropriate modes of transportation, the carrying
costs of inventory costs and speed of delivery to customers. Physical
distribution is often managed as part of a firmÊs marketing function.
International logistics can be differed from domestic logistics based on

two classifications of differences which are basic differences and country
differences.
Basic differences emerge because the firm deals with more than one country.
(i) Firstly, firms often have to ship goods over longer distances to reach
their customers;
(ii) Secondly, it involves the use of different currencies;
(iii) Thirdly, countries differ in their border-crossing procedures such as
documentations and customs inspections. This may require the
participation of additional intermediaries such as freight forwarders,
customs agents and banks; and
(iv) Lastly, the modes of transportation may also be different, such as
trucks, railway and by sea or air.
Country differences refer to the more specific attributes within each foreign
country. Transportation systems and intermediaries available may vary from
country to country and freight rates may be computed differently. The
packaging and labelling requirements may also differ among countries.
Logistics play an important role for firms in integrating their geographically

dispersed manufacturing and distribution networks where materials or
components may be sourced from one country, processed or assembled in a
second country and sold in yet another country.

SELF-CHECK 8.1
Based on your reading, state two major stages involved in international

logistics.
ACTIVITY 8.2
In your own words, what is the role of logistics in the management of

international services? Discuss with your coursemates in myINSPIRE.
EXERCISE 8.1
1. Materials management involves all the following activities,

EXCEPT:
A. Sourcing of raw materials and/or component parts.
B. Inventory management.
C. Transportation between suppliers and manufacturers.
D. Distribution of goods to wholesalers and retailers.
2. Physical distribution involves the flow of finished products from

the firm to the customers.
A. True
B. False
3. Explain differences in international logistics that differentiate it

from domestic logistics.

8.2 ISSUES IN INTERNATIONAL LOGISTICS

We shall study the issues or aspects in the materials management which require
the international firm to make important strategic considerations.
8.2.1 “Make-or-Buy” Decisions

These are sourcing decisions whether the firm should manufacture themselves the
component parts for their final products or to outsource them i.e. buying from
independent outside suppliers.
The extent to which the firm makes or buys the component parts that they
require in their production is known as vertical integration.
For example, a car contains more than 10,000 components. Ford in Europe makes
only about 45 per cent of the carÊs value in its own plants. The remaining 55 per
cent comes from independent suppliers. However, firms like Nike and Reebok
practice very little vertical integration by outsourcing most of its production to
outside suppliers in low-wage countries like China and Thailand.
(a) Advantages of „Make‰ Decision

Apart from lower costs, manufacturing component parts itself would allow
the firm to invest in highly specialised assets, protect proprietary product
technology and facilitate the scheduling of related processes.
(i) Efficient in Productions

The firm may be more efficient in the production of the component
parts than any other firm. Boeing, for example, outsources some
component parts to their aircraft, but produces the aircraft wings in-
house because it is more efficient compared to any other firm in the
world. It therefore makes little sense for Boeing to outsource this
particular activity.
(ii) Facilitate Specialised Investments

Investment in specialised assets refers to investments in equipments
that can be used for a specific purpose in the manufacturing of a
uniquely designed component. As an example, Ford has developed a
high-performance, high-quality and uniquely designed fuel-injection
system, which increased fuel efficiency, and can help sell more Ford
cars. To manufacture the fuel-injection system requires investments in

specialised equipment that can only be used for this particular purpose
(i.e., specialised assets).
If Ford decides to outsource its manufacturing, the appointed

independent supplier may become dependent on Ford for business,
since Ford is the only possible customer. Ford is perceived to be in a
stronger bargaining position, and might use its position to force the
supplier to lower its prices. On the other hand, Ford also might become
too dependent on the supplier for a vital component of the car. Ford
cannot obtain it from alternative suppliers who do not have the
necessary specialised equipment. The supplier may be perceived by
Ford to have a stronger bargaining power and use it to demand higher
prices. This mutual dependency may result in Ford manufacturing its
own fuel-injection systems.
(iii) Protect Proprietary Product Technology

This refers to technology that is unique to a firm and gives the firm a
competitive advantage. The firm would not want the technology to fall
into the hands of competitors. Thus, the firm may prefer to make such
component parts in-house to maintain control over its technology.
(iv) Improved Scheduling

Through vertical integration, the firm may be able to save costs because
it makes planning, coordination and scheduling of related processes
easier. For example, FordÊs vertical integration into steel foundries, iron
ore shipping and mining made it possible for the firm to achieve tight
coordination and scheduling enabling it to produce engine blocks
within 24 hours. Ford substantially reduced its iron ore inventory
holding costs.
(b) Advantages of „Buy‰ Decision

Buying component parts from independent suppliers allows the firm greater
flexibility and lowers the firmÊs costs and may help the firm to secure orders
from international customers.
(i) Flexibility
The firm can maintain flexibility by being able to switch to other
suppliers as circumstances require. The attractiveness of sources of
supply may change with changes in exchange rates, trade barriers and
political instability. The firm can avoid these risks by switching their
orders to other suppliers from other countries.

(ii) Lower Costs

Vertical integration into the manufacture of component parts may
increase the firmÊs cost structure, thus making it more advantageous to
outsource their supplies. Firstly, the additional manufacturing sub- units
and their activities may bring greater problems of coordination and
control. More information has to be processed and the increased
activities may be difficult to control effectively. The resulting
inefficiencies may more than offset any advantages that can be derived
from vertical integration. Secondly, the manufacturing sub-units may
lack an incentive to reduce costs because it has a secure customer within
the firm and need not compete with other suppliers. Thirdly, the pricing
for goods transferred to sub-units within the firm can become a complex
process because of different tax systems in the countries where they are
located, fluctuation in exchange rates and headquarterÊs lack of
knowledge about local conditions. These problems can be avoided by
buying the component parts from outside suppliers.
(iii) Securing Orders from International Customers

By outsourcing some manufacturing to independent suppliers based in
other countries, it may help the firm to secure more orders from that
country. For example, the Indian government may ask Boeing to award
some sub-contracting work to Indian manufacturers before Air India
places a large order for commercial aircraft.
When faced with these make-or-buy decisions, the firm has to consider
which brings them the most benefits. Manufacturing in-house may be
most beneficial when highly specialised assets are involved,
or proprietary technology need to be protected, or when the firm is
simply more efficient than any other external supplier. When no such
benefits exist, it may be better to outsource production to take
advantage of greater flexibility and control, or gain from the larger
orders that it may be able to secure. Table 8.1 highlights the advantages
of „make-or-buy‰ decisions.
Table 8.1: The Advantages of „Make-or-Buy‰ Decisions
Make Buy
 Efficient Production  Flexibility
 Facilitate Specialised Investments  Lower Costs
 Protect Proprietary Product  Securing Orders from International
Technology Customers
 Improved Scheduling

ACTIVITY 8.3
Let us suppose a firm must decide whether to produce a component part
in-house or to outsource to an independent supplier. To manufacture the
component part, a high amount of investment is required, while the most
efficient suppliers are located in countries with fluctuating exchange
rates. What are the pros and cons of:
(a) Manufacturing the component part in-house; and
(b) Outsourcing to an independent supplier.
Which option would you recommend? Why?
8.2.2 Location Decisions

An international firm that chooses to make their own component parts rather than
buy them faces the decisions of where to locate its production. The firmÊs decision
must take into consideration several factors that are country-related or product-
related issues, government policies and organisational issues. Table 8.2 shows the
factors that influence the firmÊs location decisions.
Table 8.2: Factors that Influence the FirmÊs Location Decisions
Country-related Issues  Cost and availability of resources

 Infrastructure support
 Country of origin effects
Product-related Issues • Value-to-weight ratio

• Production technology
 Quick customer feedback
Government Policies • Political stability

• Trade policies
• Economic development incentives
 Foreign trade zones (FTZ)
Organisational Issues • Business strategies

• Organisational structure
 Inventory management

(a) Country-related Issues

The most important features of countries that can influence the location
decisions are:
(i) Cost and Availability of Resources

Countries that have abundant supply of a factor of production at low
cost will attract firms that require the factor. Thus, China was able to
attract toys, footwear and textile manufacturers because of a large and
low-cost labour force.
(ii) Infrastructure
Manufacturing facilities require infrastructural support, such as
construction contractors, materials and equipment. For the facility to be
utilised effectively, it requires electrical, water, transportation and
telephone services. It also requires adequate medical, education,
housing and other related services for its managers and employees and
their families.
(iii) Country of Origin Effects

Certain countries have such a high reputation for manufacturing high-
quality products, such as Italy for stylish design and Germany for
engineering as opposed to a country like Pakistan, that it can affect
consumer preference towards a firmÊs product. For example, it would
be easier to sell watches made in Germany than the ones made in
Pakistan, especially in industrialised countries. Therefore, firms
wishing to market its product as high quality may choose to be located
in Germany or Japan, while firms competing on the basis of low costs
and prices may choose to be based in Pakistan or Indonesia.
(b) Product-related Issues

These are issues related to the productÊs value-to-weight ratio, the
production technology required and customer feedback.
(i) Value-to-weight Ratio

Goods with low value-to-weight ratios, such as iron ore, cement and
coal tend to be produced in many locations in order to minimise
transport costs. Other goods such as microprocessors or diamonds,
which have high value-to-weight ratios, can be produced in a single or
a few locations without losing cost-competitiveness.

(ii) Production Technology

The type of manufacturing technology in terms of its fixed costs,
achievement of economies of scale and flexibility may also influence
location decisions. The fixed costs of setting up a manufacturing plant
can be so high that a firm has to manufacture from a single or a few
locations and serve their worldwide market. Conversely a relatively
low fixed cost can make it more economical to manufacture in many
locations. This allows the firm better local responsiveness and avoid the
risks associated with becoming too dependent on one location, such as
an adverse change in exchange rates.
(iii) Quick Customer Feedback

Products for which firms require quick customer feedback are often
produced in locations closer to the customers. In the United StatesÊ
apparel industry, for example, the more fashionable items such as
sportswear are produced near or in the United States to enable the
manufacturer to respond quickly to changing market trends. Low-
fashion items like socks and briefs are more likely to be produced
outside the United States, such as in Taiwan or Indonesia to take
advantage of lower costs.
(c) Government Policies

The more important aspects are political stability, trade policies, economic
development incentives and foreign trade zones.
(i) Political Stability

A government that alters their fiscal, monetary and other regulations
without consulting the business community would raise the risk and
uncertainty of operating in that country. A country that allows firms to
make knowledgeable investment, production and staffing decisions
will be a more desirable location.
(ii) Trade Policies

Trade barriers, such as high tariffs or export restrictions, may force a
firm to locate a facility within the country. For example, Toyota, Nissan
and Mazda built factories in the United States to avoid the export
restriction imposed by the Japanese government to limit the export of
Japanese-made cars to the United States.

(iii) Economic Development Incentives

Governments may offer international firms cheap land, highway
improvements, job-training programmes and discounted water and
electricity rates to attract them so that jobs can be created by new
factories.
(iv) Foreign Trade Zones (FTZ)

FTZ is a specially designated and controlled geographic area in which
foreign goods may be kept, processed and then re-exported without
incurring any duty. The existence of FTZs allows the international firm
greater flexibility in importing or exporting and creates an opportunity
to lower their costs.
(d) Organisational Issues

This refers to the firmÊs business strategies, organisational structure and
inventory management that are also important considerations in location
decisions.
(i) Business Strategies

A firm that adopts a cost-leadership strategy must look for low-cost
locations, where as a firm that focuses on product quality must locate
facilities with adequate skilled labour and managerial talent.
(ii) Organisational Structure

A firmÊs organisational structure also influences the location of its
factories. A firm using geographic area decentralises authority to the
respective area managers. These managers, seeking to maintain control
over their respective area are likely to locate factories within their own
areas. For example, Ford was once structured as three area
groups – North America, Europe and Asia Pacific. Rather than
exporting automobiles from these regions, each area focused on
producing automobiles to meet the needs of customers in its respective
areas. On the other hand, a firm with a global product structure will
locate factories anywhere in the world to meet the firmÊs cost and
quality performance goals.
(iii) Inventory Management

The firmÊs location decisions may affect inventory management
policies. While firms attempt to keep lower levels of inventory to
reduce their holding costs, they must ensure that they do not run out
of materials and/or finished goods despite the distances and longer
times involved in shipping goods.

For firms implementing a „Just-In-Time‰ (JIT) inventory system, where the

factory is located is even more critical. It requires close coordination between
the firm and its suppliers because materials or component parts are delivered
usually in frequent small shipments directly to the firmÊs factory, just as they
are needed for production. As such, car parts makers such as Toyota Machine
Works and TRW Steering Systems for example, are located in Wales or
England to better serve their major customers like Jaguar and Range Rover.
ACTIVITY 8.4
In your opinion, what are the problems that a firm may encounter when
making wrong decisions regarding location?
8.2.3 Inventory Management

In deciding the level of inventory to be maintained, the firm needs to take into
consideration three major factors, which are the order cycle time, the desired level
of customer service and the use of inventories as a strategic tool. These are
discussed in the following paragraphs.
(a) Order Cycle Time

The order cycle time refers to the time that passes between the placement of
an order and the receipt of the goods. In international business, the order
cycle is often longer than in domestic business. It involves the time taken to
transmit orders, process the orders, prepare and pack the goods for shipment
and transporting them. Consistency in the order cycle time is also difficult to
maintain, as delivery times would depend on the choice of transportation
mode. Thus, larger inventories will have to be maintained to meet both the
firmÊs domestic and international orders.
The order cycle time can be reduced and consistency increased without
increasing costs by altering the methods of transportation, changing the
location where inventories are kept or improving the way orders are
transmitted and processed.

(b) Customer Service Levels

Customer service level is the measure of the firmÊs ability to fill all orders
within the set time. A customer service level of 100 per cent denotes that the
firm is able to fill all orders according to the time specified by the customer.
If this is also the firmÊs inventory policy, which is to achieve a 100 per cent
customer service level, then the firm has to keep more inventory on hand,
thus raising inventory holding costs.
Due to this higher cost, the firm should not set a goal to achieve the highest
possible customer service level, but rather an acceptable level. The firm
should realise that different country customers have differing needs,
requirements and expectations. For example, if a foreign customer expects to
receive the goods she ordered within 30 days, the firm should not promise
delivery within 10-15 days. Customers may not demand or expect such quick
delivery.
(c) Inventories as a Strategic Tool

The international firm can use inventories as a strategic tool by increasing or
maintaining inventories according to different circumstances. When there is
a strong likelihood of currency devaluation, the firm may increase its
inventories instead of holding cash to reduce its exposure to devaluation
losses. In the case of high inflation, keeping larger inventories can provide
the firm with an inflation hedge. However, in countries where a property tax
is levied on inventories, the firms have to balance between the cost of
maintaining high levels of inventories with the benefits accruing from
hedging against inflation or devaluation.
The management of inventory therefore has to recognise the trade-offs

between the benefits and costs under the different circumstances to achieve
optimum results in line with the firmÊs overall corporate strategy.

EXERCISE 8.2
1. Among the country-related issues to be considered in location

decisions is:
A. Production technology
B. Cost and availability of resources.
C. Organisational structure.
D. Inventory management.
2. The order cycle times in inventory management can be reduced and

consistency increased without increasing costs by the following
methods, EXCEPT:
A. Altering the methods of transportation.
B. Changing the location where inventories are kept.
C. Improving the way orders are transmitted and processed.
D. Changing customer service levels.
3. Which of the following products can be considered to have the

highest value-to-weight ratio?
A. Iron ore
B. Trucks
C. Microprocessors
D. Cotton

4. Governments may offer incentives to international firms to set up

factories so that jobs can be created by the new factories.
A. True
B. False
5. Foreign Trade Zones (FTZ) is a specially designated and controlled

geographical area where a firm may keep goods, process and re-
export the goods without incurring any duty.
A. True
B. False
6. Describe how firms can use inventory as a strategic tool.
7. In the „make-or-buy‰ sourcing decisions, explain the advantages of

„make‰ to the firm.
8.3 INTERNATIONAL TRANSPORTATION

Transportation determines how and when goods will be received and represents
a significant element of cost. Thus, a reduction in transportation costs can provide
an opportunity for the firm to increase their profits. International transportation
can be divided into three parts, as follows:
(a) Transportation Infrastructure

An established transportation network consists of superhighways, bridges,
tunnels, ports, and air and rail facilities. Transportation infrastructures vary
from country to country. Some countries, for example, may have excellent
port facilities but lack internal highways and roads. There are also
infrastructure related difficulties, such as costs and efficiency of loading and
unloading, theft and piracy, which hamper the efficient flow of goods. The
frequency of transportation services also vary. For example, a particular port
may not be visited by a ship for several weeks or even months. Sometimes,
only small-sized vessels serve a given location.
The firm has to therefore consider these issues when planning its location
and transportation framework.

(b) Availability of Transportation Modes

International transportation frequently requires ocean and airfreight modes,
although some goods are shipped abroad by rail or truck. In addition, land
or sea bridges allow for the transfer of freight among various modes of
transportation, resulting in intermodal movements. Figure 8.1 shows some
of the modes of transportation available.
Figure 8.1: Some modes of transportation
In ocean shipping, the most common types of vessels are the conventional
cargo vessel, the container ships and the combination container and roll- on,
roll-off vessels. Conventional cargo vessels are used for oversized and
unusual cargo which may be less efficient than container ships. Container
ships carry standardised steel containers which facilitate loading and
unloading onto truck trailers, railroad cars or barges. As a result, the time the
ship has to spend in port is reduced. Expanding the capabilities of the
container ship is the combination vessel, which additionally features a roll-
on, roll-off capability. This combination vessel has a portion of the ship below
deck for trucks, cars, buses, construction equipments, which provides
flexibility in ocean shipping. However, the use of ocean shipping is
constrained by the lack of ports and port services, especially in developing
countries that lack the funds to develop ports. Firms may use the
neighbouring countriesÊ ports and facilities and then transport the goods
over land to their final destination.

Air freight is available in most countries. However, the total volume of air
freight compared to the total volume of international shipments is small (less
than 1 per cent). High value items are more likely to be shipped by air.
Various efforts have also been made to develop better and more efficient
airport services as well as the aircrafts. Jumbo cargo planes and passenger-
cargo combination aircrafts are now in use.
(c) Choice of Transportation Modes

The appropriate choice of the available modes of transportation will be
strongly influenced by the needs of the firm and its customers. The
performance of each mode must be considered on four dimensions.
(i) Transit Time

Transit time is the period between the departure and arrival of the
carrier. This varies significantly between ocean freight and airfreight,
which can have a major impact on the firmÊs overall logistical
operations. For example, a 45-day ocean shipment can be reduced to 24
hours if the firm chooses air freight which may reduce the need for
inventories if they replenished frequently. In emergency situations
such as production delays, a shipment normally made by ocean freight
can be made by air so as not to miss its delivery date. Perishable
products, which has a short life span, would require short transit times
and be transported by airfreight.
(ii) Predictability
Both ocean freight and air freight are subject to delays in arrival time,
often due to weather hazards. However, delays via air relative to ocean
freight tend to be shorter and are more predictable. Due to the higher
predictability of air freight, firms can keep lower inventory safety stock
and can make more precise delivery promises to their customers.
Goods shipped by air are also likely to suffer less loss or damage from
exposure to movement.
(iii) Cost
Cost is a major factor in considering the choice of international
transportation modes. While air freight is more predictable and faster,
it is also more costly than ocean freight. Firms have to consider both the
costs and the benefits or value of their choice of mode. Firstly, the
physical density and the value of the cargo – bulky products may be
too expensive to be shipped by air, whereas very compact products
may be more appropriate for air transport. Thus, high-priced items
such as diamonds or microprocessors can be easily justified to be sent
by air than coal or iron ore. Secondly, the firm must determine how
important it is for the goods to arrive on time. The need to reduce or
increase inventory must be measured. Firms using air freight as a tool

for aggressive market expansion must consider the cost of the
transportation as it may also affect the price of the product and the need
for the productÊs availability abroad. The firm, must therefore, consider
the effects of its choice of transport on its overall activities in relation to
cost.
(iv) Government Involvement

Carrier companies may be owned or heavily subsidised by
governments. Firms can thus be pressured to use their national carriers,
even if there are more economical alternatives. Such preferential
policies are often enforced when government cargo is being
transported. The United Nations Conference on Trade and
Development (UNCTAD) has recommended, for balance of payment
reasons that 40 per cent of shipping between two countries be allocated
to vessels of the exporting country, 40 per cent to vessels of the
importing country and 20 per cent to third-country vessels (the
40/40/20 guideline). Firms have to adapt their choice of modes within
the international transportation environment they operate in.
SELF-CHECK 8.2
International transportation can be divided to three parts. Explain each

part.
ACTIVITY 8.5
In your opinion, what is the importance of transportation in a firmÊs

decision to conduct international business?

EXERCISE 8.3
1. What is the greatest constraint in global ocean shipping?

A. Perishability of products
B. Lack of port facilities
C. Transit time
D. Weather conditions
2. In determining the cost of transportation, the firm must consider

the following EXCEPT:
A. Justify the need against the cost of airfreight.
B. Analyse the importance of time in relation to cost.
C. Consider the total cost of each alternative mode of transport.
D. Look for carrier that can offer the lowest price.
3. Transit time is the time that passes between the placement of an

order and the receipt of the goods.
A. True
B. False
4. Intermodal movements in international transportation refers to the

transfer of freight from one mode of transportation to another.
A. True
B. False

5. Most international shipments in international business use air freight.

A. True
B. False
6. Explain what is meant by the 40/40/20 guideline recommended by

UNCTAD in international shipping.
8.4 SUPPLY CHAIN MANAGEMENT

A firmÊs supply chain includes the coordination of materials, information and
funds from the initial raw materials supplier to the ultimate customer. While
logistics focuses much more on transportation and storage of materials, parts and
final goods, supply chain management goes further to include the management of
the firmÊs relations with suppliers and customers. We shall study the supply chain
network that coordinates suppliers, intermediaries, manufacturers and customers.
8.4.1 International Sourcing

Sourcing is the process of obtaining inputs, whether raw materials or component
parts, and supply it to the firmÊs production process. It is the first step in the
process of materials management that we studied in the beginning of the topic.
For example, Ford assembles its cars in Mexico for sale in Mexico and the United
States. The cars are designed by Mazda in Japan. Ford purchases parts
manufactured in Japan, ships them to Mexico or the United States for final
assembly and sells them in either or both the countries. In Europe, Ford decided
to manufacture the Escort model by sourcing parts globally from plants in 15
different countries for final assembly in the United Kingdom and Germany.

Although firms can obtain parts and materials in the home country and avoid
problems connected with language differences, long distances, exchange rate
fluctuations, politics and complex transportation channels, domestic sources may
be unavailable for many firms or they may be more expensive than foreign sources.
The firm may also decide to purchase most materials or parts from independent
suppliers while producing the most expensive parts itself. The reasons for firms to
pursue global sourcing strategies can be summarised as follows:
(a) Reduce costs through cheaper labour, land and facilities and/or less
restrictive work rules;
(b) Improve quality;
(c) Increase exposure to technology available worldwide;
(d) Improve the process of supplies delivery;
(e) Supplement domestic supplies with foreign sources;
(f) Gain access to materials that are only available abroad, due to its technical or
product capabilities;
(g) Establish a presence in a foreign market;
(h) Secure more orders from the supplier country; and
(i) React to competitorsÊ foreign sourcing practices.
Let us look at supplier relations and procurement strategy in international

sourcing:
(a) Supplier Relations

When a firm decides that it must outsource its supplies of raw materials or
component parts, it must then determine how to work and manage its
relationship with suppliers. Apart from the outsourcing approach that we
have learned (also known as armÊs length relationship), Japanese firms such
as Toyota employs what is known as the keiretsu relationship with their
independent suppliers. Under this system, Toyota will first send a team of
their manufacturing experts to each of their key suppliers to observe how the
supplier makes its parts. The team may advise on how to cut costs and
enhance quality. Toyota commonly identifies two suppliers for each part and
have the suppliers aggressively compete with each other. Both suppliers,
however, will have an ongoing relationship, with the supplier that performs
best getting the most business. While Japanese companies develop close
relationships with their suppliers, American firms tend to maintain an armÊs
length relationship.

(b) Procurement (Purchasing) Strategy

When firms outsource from independent suppliers on a global basis, the
purchasing function becomes an important link. There are five major
purchasing strategies that firms can implement, namely:
(i) Assign a domestic buyer or buyers for international purchases;
(ii) Use foreign subsidiaries or business agents;
(iii) Establish international purchasing offices;
(iv) Assign the responsibility to a specific business unit or units; and
(v) Integrate and coordinate worldwide sourcing.
These strategies would illustrate the firmÊs move from the simple to the more
complex process of purchasing as the firmÊs degree of internationalisation
increases. The firmÊs key concern is to select the best supplier, establish a
solid relationship and evaluate the supplierÊs performance continuously to
ensure that they can secure the best price, quality and punctual delivery of
materials or component parts.
8.4.2 Information Systems

Another key part of a global supply chain management is information.
Information technology and systems can be used to link suppliers, manufacturers,
intermediaries and customers, such as Enterprise Resource Planning (ERP),
Electronic Data Interchange (EDI) and E-commerce systems.
(a) Enterprise Resource Planning (ERP)

Business organisations are complex systems in which various functions such
as purchasing, production, distribution, sales, human resources, finance and
accounting must work together to achieve the goals of the organisation.
However, in the functional structure used by many business organisations,
information flows freely within each function, but not so between functions.
Human interaction is essential to maintain global communication and
human skills are a vital factor to manage information flow of the supply
chain. However, it is not possible to practise global supply chain
management without advanced technology. Software solutions also abound
for just about every supply chain function, from planning to warehouse
inventory management and shipping. The next generation of ERP products
are aimed beyond the single enterprise and manufacturing sector to
encompass the entire supply chain and also service companies (Figure 8.2).

Figure 8.2: Enterprise resource planning (ERP)

Source: http://www.qualiantech.com/images/erp_modules.GIF
ERP represents an expanded effort to integrate standardised record keeping

that will permit information sharing among different areas of an organisation
in order to manage the system more effectively. ERP software provides a
system to capture and make data available in real time to decision makers and
other users throughout an organisation. It also provides a set of tools for
planning and monitoring various business processes to achieve the goals of
the organisation. ERP systems are composed of a collection of integrated
modules. There are many modules to choose from, and different software
vendors offer different but similar lists of modules. Some are industry specific,
and others are general in purpose. Among the most widely used are modules
for accounting and finance (e.g. general ledger, account payable, account
receivable, payroll), manufacturing (e.g. master scheduling, MRP, capacity
requirements planning), sales (e.g. order entry), supply chains (e.g.
purchasing, inventory control), human resources and maintenance.

(b) Electronic Data Interchange (EDI)

EDI allows for transmission of vast quantities of data at high speeds in a
secure fashion. With the advent of the Internet and Web, many companies
are utilising the Internet as a transmission tool and for retaining EDI message
sets. This combination of EDI/Internet has been replaced by a new
generation of Web-enabled ERP software systems and applications that
handle all supply chain functions, and provide electronic commerce
capabilities. This switchover promotes what experts call intelligent
networking, which will allow flexible intercommunication between global
networks. In a world of rapidly changing technology and consumer-driven
global markets, the company needs a partner who embraces these realities
while committing to the companyÊs goals of supply chain security and
efficiency (see Figure 8.3).
Figure 8.3: Electronic data interchange (EDI)

Source: http://www.canary.co.nz/img/img/EDI.png
Types of EDI can be classified into:
(i) Proprietary system – It involves an EDI system that is managed and

owned by a single company that buys from multiple suppliers or
directly receives orders from customers without using a third party.

(ii) Value-added network (VAN) – It is known as the third-party network

or many-to-many system that is widely used in the EDI system. During
the process of VAN system, the EDI transmission will go through the
third party company that acts as the intermediary or central clearing
house. When buying firms send purchase order (PO) to various
suppliers through VAN, the third-party company will sort and
transmit according to the supplier. If the trading partners have a
different system, VAN system can still transform or transmit the
information because it is a compatible system that can be used by all
companies.
And many of these solutions are starting to be offered on the web through
application service providers (ASP). The most common message set for
supply chain information has been the electronic data interchange (EDI). The
following are several advantages of EDI:
(i) Reduced paperwork;
(ii) Improved accuracy compared to previous system which is manually
processed;
(iii) Increased transmission speed of order;
(iv) Reduced administrative work such as filing, data entry and etc;
(v) Reduced cost of order placement and related processing and handling;
and
(vi) Improved information availability such as shipment advises.
(c) Material Requirements Planning (MRP)

MRP is a computer-based information system that translated the finished
product requirements of the master schedule into time-phased requirements
for subassemblies, component parts, and raw materials, working backward
from the due date using lead times and other information to determine when
and how much to order. Hence, requirements for end items generate
requirements for lower-level components, which are broken down by
planning periods (e.g. week) so that ordering, fabrication and assembly can
be scheduled for timely completion of end items while inventory levels are
kept reasonably low. MRP is as much a philosophy as it is a technique, and
as much an approach to scheduling as it is to inventory control.
MRP begins with a schedule for finished goods that is converted into a
schedule of requirements for the subassemblies, component parts, and raw
materials needed to produce the finished items in the specified time frame.

Thus, MRP is designed to answer three questions – „What is needed?‰, „How

much is needed?‰ and „When is it needed?‰.
The primary inputs of MRP are a bill of materials, which tells the composition
of a finished product; a master schedule; which tells how much finished
product is desired and when; and an inventory records file, which tells how
much inventory is on hand or on order. The planner processes this
information to determine the net requirements for each period of the
planning horizon.
Outputs from the process include planned-order schedules, order releases,

changes, performance-control reports, planning reports and exception
reports. An MRP system has three major sources of information:
(i) A master schedule – One of three primary inputs in MRP; states which
end items are to be produced, when they are needed, and in what
quantities.
(ii) A bill-of-materials – One of the three primary inputs of MRP; a listing
of all of the raw materials, parts, subassemblies, and assemblies needed
to produce one unit of a product.
(iii) An inventory records file – One of the three primary inputs in MRP;
includes information on the status of each item by time period.
(d) Free-Trade Zones (FTZ)

A free-trade zone (FTZ) is a specific class of special economic zone. They are a
geographical area where goods may be landed, handled, manufactured or
reconfigured, and re-exported without the intervention of the customs
authorities. Only when the goods are moved to consumers within the country
in which the zone is located do they become subject to the prevailing customs
duties. Free trade zones are organised around major seaports, international
airports, and national frontiers – areas with many geographical advantages for
trade. It is a region where a group of countries has agreed to reduce or
eliminate trade barriers.
The areas include airport, seaport, or any other designated areas for duty-
free import of raw materials, components, sub-assemblies, semi-finished or
finished goods. Such items can be stored, displayed, assembled, or processed
for re-export or entry into the general market of the importing country (after
paying the required duties). Read more at http://www.businessdictionary.
com/definition/free-trade-zone-TZ.html.

(e) Just-In-Time (JIT) and Lean Operations

The term Just-in-time (JIT) is used to refer to an operations system in which
materials are moved through the system and services are delivered with
precise timing so that they are delivered at each step of the process just as
they are needed. Initially, the term JIT referred to the movement of materials,
parts and semi-finished goods within a production system. Over time, the
scope of JIT broadened and the term become associated with lean operations.
Now the two terms are often used interchangeably to refer to a highly
coordinated, repetitive manufacturing or service system designed to produce
a high volume of output with fewer resources than more traditional
repetitive systems, but with the ability to accommodate more variety than
traditional systems.
In some respects, the just-in-time concept was operational over 60 years ago
at Henry FordÊs great industrial complex in River Rouge, Michigan. Toyota
learned a great deal from studying FordÊs operations and based its JIT
approach on what it saw. However, Toyota was able to accomplish
something that Ford could not; a system that could handle variety. Many of
the methods that are common to JIT and lean operations were developed as
part of Japanese car maker ToyotaÊs approach to manufacturing. You can get
a sense of terms such as:
(i) Muda – Waste and inefficiency. Perhaps the driving philosophy. Waste
and inefficiency can be minimised by using certain tactics.
(ii) Kanban – A manual system used for controlling the movement of parts
and materials that responds to signals of the need (i.e. demand) for
delivery of parts or materials.
(iii) Pull system – Replacing material or parts based on demand; produce
only what is needed.
(iv) Heijunka – Variations in production volume lead to waste. The
workload must be leveled; volume and variety must be averaged to
achieve a steady flow of work.
(v) Kaizen – Continuous improvement of the system. There is always room
for improvement, so this effort must be ongoing.
(vi) Jidoka – Quality of the source. Each worker is expected to perform
ongoing quality assurance. The objective is to avoid passing defective
products to the following work stations, and to make workers aware of
quality.

(vii) Poka-yoke – Safeguards built into a process to reduce the possibility of

committing any errors.
(viii) Team concept – Use small teams of workers for process improvement.
(f) Five S
Workers cannot be efficient if their workplaces are messy and disorganised.
A great deal of time can be wasted looking for the right tool or moving
around piles of materials that are scattered about. Within the lead production
system, firms can use the „Five S‰ principle to create a more organised work
environment (Table 8.1). The five SÊs are derived from Japanese terms; seiri
(sort), seiton (straighten), seiso (shine), seiketsu (standardise) and shitsuke
(sustain).
Table 8.1: Definition of Five S Terms
Five S Term Definition

1. Sort Separate needed from unneeded items and discard the unneeded.
2. Straighten Neatly arrange what is left, with a place for everything and
everything in its place. Organise the work area so that it is easy to
find what is needed.
3. Shine Clean and wash the work area and make it shine.
4. Standardise Establish schedules and methods for performing the cleaning and
sorting.
5. Sustain Create the discipline to perform the first four S practices, so that
everyone understands, obeys and practises the rules when in the
plants.
Source: William J. Stevenson and Sum Chee Chuong (2012).

Operation Management. 11th Edition. Asia Global Edition. McGraw Hill Education
(g) E-business
The commercial blossoming of the Internet has led to an explosion of
Internet-related activities, many of which have a direct impact on
organisationsÊ supply chains, even if those organisations themselves are not
users of the Internet. E-business refers to the use of electronic technology to
facilitate business transactions. E-business or e-commerce, involves the
interaction of different business organisations as well as the interaction of
individuals with business organisations. Applications include Internet
buying and selling, e-mail, order and shipment tracking, and electronic data
interchange. In addition, companies use e-business to promote their products
or services, and to provide information about them. Delivery firms have seen
the demand for their services increase dramatically due to e-business.

Among them are giants UPS and FedEx. The following lists some of the
numerous advantages of e-business:
(i) Companies and publishers have a global presence and the customer
has global choices and easy access to information;
(ii) Companies can improve competitiveness and quality of service by
allowing access to their services any place, any time. Companies
also have the ability to monitor customersÊ choices and requests
electronically;
(iii) Companies can analyse the interest in various products based on the
number of hits and requests for information;
(iv) Companies can collect detailed information about clientsÊ
preferences, which enables mass customisation and personalised
products;
(v) Supply chain response times are shortened. The biggest impact is on
products that can be delivered directly on the Web, such as forms of
publishing and software distribution;
(vi) The roles of the intermediary and sometimes the traditional retailer
or service provider are reduced or eliminated entirely in a process
called disintermediation. This process reduces costs and adds
alternative purchasing options;
(vii) Substantial cost savings and price reductions related to the
reduction of transaction costs can be realised. Companies that
provide purchasing and support the Web can save significant
personnel costs;
(viii) E-commerce allows the creation of virtual companies that distribute
only through the Web, thus reducing costs. Amazon.com and other
net vendors can afford to sell for a lower price because they do not
need to maintain retail stores or warehouse space; and
(ix) The playing field is leveled for small companies that lack significant
resources to invest in infrastructure and marketing.
Source: Adapted from Devid Simchi-Levi, Philip Kaminsky and
Edith Simchi-Levi (2000). Designing and Managing the Supply
Chain: Concepts, Strategies and Case Studies, New York:
Irwin.McGraw Hill

(h) E-commerce (EC)

The emergence of the Internet has rapidly transformed the management of
globally dispersed supply chains. It is less expensive and easier to install and
manage, allowing even small firms to use. This web-based system not only
helps to automate and speed up the internal processes of a firm (intranet) but
also links the business systems of the firmÊs suppliers and customers
efficiently.
As an example, Dell Computer Corporation has manufacturing facilities in

the United States, Brazil, Ireland, Malaysia and China. More than half of the
firmÊs 200 suppliers are located in Asia. DellÊs business was originally based
on direct selling to customers (mailings and telephone contact), cutting off
wholesalers and retailers, enabling it to offer lower prices to consumers.
Since the mid-1990s, the firmÊs sales have been made over the Internet and
by the year 2000, 80 per cent of all its sales were made through this medium.
Through the Internet, DellÊs customers are able to customise their orders,
mixing and matching computer hardware components, to get the system that
suits their requirements. Components suppliers are constantly provided
with these information so that they have up-to-the-minute information about
demand trends for the components that they supply together with volume
expectations for the next 4 to 12 weeks. These information are used by the
suppliers to schedule their production to produce components just enough
for DellÊs needs. Dell is thus able to manage its global supply chain to
minimise its inventory while assembling the personal computers according
to customer orders and delivering on time. E-commerce has made Dell very
attractive to customers and provided it with a significant cost advantage over
competitors.
ACTIVITY 8.6
In your opinion, how has the Internet enhanced the supply chain
management system?
8.4.3 Quality Management

Quality is another important aspect in all levels of the supply chain. Quality of a
product or service is defined as conforming to specifications, value, fitness for use,
support by the firm and the image it carries. A quality product or service is one
that meets or exceeds the expectations of the customer. Firms that can offer better
quality products or services have an advantage over other firms in attracting
customers.

(a) Quality Management

Total Quality Management (TQM) which was first practised by Japanese
firms, means not tolerating any kind of defects (zero defects approach). The
goal is to eliminate all defects and focus on benchmarking their products or
services against the best companies in the world whether in design, processes
or purchasing. The process of TQM is based on three important principles,
namely:
(i) Customer satisfaction;
(ii) Employee involvement in the process; and
(iii) Continuous improvements in quality.
Although achieving a higher level of customer satisfaction may increase

production costs in TQM, these costs would also decline in the long-run as
defects decline. TQM is a continuous improvement process (also known as
kaizen) at every level of the organisation and involves employees to help
identify and eliminate all problems encountered. Thus, striving for
continuous improvement is a part of every employeeÊs daily work. TQM is
even more challenging in an international setting due to differences in
culture and the environment.
Another new quality management tool known as Six Sigma was introduced
by Motorola and is now being used by many international firms, such as
General Electric, GlaxoSmithKline and Lockheed Martin. This approach
focuses on the firmÊs entire production system by eliminating defects, cut
down product cycle times and costs.
Both the above methods provide firms with the means to improve the quality
of organisations.
(b) Quality Standards and Certifications
(i) The Background

The ISO story began in 1946 when delegates from 25 countries met at the
Institute of Civil Engineers in London and decided to create a new
international organisation „to facilitate the international coordination
and unification of industrial standards‰. On 23 February 1947 the new
organisation, ISO, officially began operations. Since then, this
international organisation has published over 21000 International
Standards covering almost all aspects of technology and manufacturing.
Today the committee has members from 163 countries and 3,368
technical bodies to take care of standards development. More than 135

people work full time for ISOÊs Central Secretariat in Geneva,

Switzerland.
Quality standards can be measured according to three different levels.

At the general-level, firms may be presented with awards for quality
excellence, such as the Deming Award or Malcolm Baldridge National
Quality Award. There may also be quality standards at the industry-
level for suppliers to comply, and company-level standards set by
individual companies for their suppliers to follow.
Certification of quality such as by the International Standards

Organization (ISO) has become even more important. The ISO 9000,
which has now been revised as the ISO9001:2015, is an important part
of business operations in Europe and has been adopted in 161 countries
throughout the world. It is intended to promote the idea of quality at
every level of an organisation. Rather than evaluating the quality of a
particular product, the ISO 9001:2015 evaluates and analyses the
management systems and procedures including the purchasing, design
and training in organisations. A firm that wants to be ISO certified must
document the performance of each function in its organisation that
affects quality and follow through the documented routine. A report
will then be filed and certified by a team of independent auditors.
Although this process can be expensive and time consuming, and does
not provide the solution to all issues pertaining to quality, ISO
certification will help firms to obtain more business, especially in
European countries.
(ii) What is a Standard?
A standard is a document that provides requirements, specifications,
guidelines or characteristics that can be used consistently to ensure that
materials, products, processes and services are fit for their purpose.
Over 21,000 International Standards have been published.
(iii) What are the Benefits of ISO International Standards?
ISO International Standards ensure that products and services are safe,
reliable and of good quality. For business, they are strategic tools that
reduce costs by minimising waste and errors, and increasing
productivity. They help companies to access new markets, level the
playing field for developing countries and facilitate free and fair global
trade.

The most popular standards are:
 ISO 9000 Quality management;
 ISO 14000 Environmental management;
 ISO 3166 Country codes;
 ISO 26000 Social responsibility;
 ISO 50001 Energy management;
 ISO 31000 Risk management;
 ISO 22000 Food safety management;
 ISO 27001 Information security management;
 ISO 45001 Occupational health and safety;
 ISO 37001 Anti bribery management systems; and
 ISO 13485 Medical devices.
(iv) Benefits of International Standards

International Standards are the backbone of our society, ensuring the
safety and quality of products and services, facilitating international
trade and improving the environment in which we live in. Conformity
to International Standards helps reassure consumers that products,
systems and organisations are safe, reliable and good for the
environment.
(v) Economic Benefits of Standards

Numerous studies have shown that standards boost business and
economies. In the UK, for example, standards account for an US$8.2
billion annual growth in GDP, while in Canada, the use of standards
has injected over US$91 billion into the economy since 1981.
For Business
International Standards are strategic tools and guidelines to help
companies tackle some of the most demanding challenges of modern
business. They ensure that business operations are as efficient as
possible, increase productivity and help companies access new
markets.

ISO standards help businesses to:

 Cut costs, through improved systems and processes;
 Increase customer satisfaction, through improved safety, quality
and processes;
 Access new markets, through ensuring the compatibility of
products and services; and
 Reduce their impact on the environment.
For Consumers
ISO has over 21000 standards touching almost all aspects of daily life.
When products and services conform to International Standards
consumers can have confidence that they are safe, reliable and of good
quality. For example, ISO's standards on road safety, toy safety and
secure medical packaging are just a selection of those that help make
the world a safer place. To make sure that the benefits of ISO
International Standards are as broad as possible, ISO supports the
involvement of consumers in standard development work with
its Committee on consumer policy (COPOLCO). International
Standards on air, water and soil quality, on emissions of gases and
radiation and environmental aspects of products contribute to efforts
to preserve the environment and the health of citizens.
For Government
ISO standards draw on international expertise and experience and are
therefore a vital resource for governments when developing public
policy. National governments can use ISO standards to support public
policy, which has a number of benefits, including the following:
 Getting expert opinion – By integrating an ISO standard into

national regulation, governments can benefit from the opinion of
experts without having to call on their services directly.
 Opening up world trade – ISO international standards are adopted

by many governments, so integrating them into national regulation
ensures that requirements for imports and exports are the same the
world over, therefore facilitating the movement of goods, services
and technologies from country to country.

ACTIVITY 8.7
Name some Malaysian firms which have received the ISO 9001:2015
certification.
EXERCISE 8.4
1. ISO 9000 was established by the ____________.

A. United Nations
B. European Union
C. North American Free Trade Agreement
D. International Monetary Fund
2. Determining the best processes used by the best companies in the

world is called ____________.
A. Benchmarking
B. Improvising
C. Just-in-time
D. Enterprise resource planning
3. Walmart uses the ____________ system to connect its 14,000

suppliers throughout the world to its inventory ordering system.
A. Enterprise Resource Planning (ERP)
B. ISO 9001:2015
C. Electronic Data Interchange (EDI)
D. Total Quality Management (TQM)

4. Kaizen is a continuous improvement process at every level of the

organisation and involves employees to help identify and eliminate
all problems encountered.
A. True
B. False
5. The purchasing function serves as a link between the firm and its
suppliers.
A. True
B. False
6. Give five reasons why firms pursue a global sourcing strategy.
 We have learned that international logistics refer to the management of the

flow of materials, parts, supplies and other resources into, through and out of
the international firm.
 In this respect, firms have to decide whether to manufacture component parts

that they need in their final products themselves („make‰) or to outsource
them from independent suppliers („buy‰). We also learned that there are
several advantages to each choice.
 In the event the firm decides to „make‰, it is faced with the issue of where to
locate their manufacturing facilities that would meet their needs best.
 The firm must take into consideration several issues that are either country-
related or product-related, and government policies as well as organisational
issues.
 In the management of inventory, firms have to decide the level of inventory

needed against the cost of holding inventory.
 In international transportation, the firm must first have knowledge on the

available modes of transport that it can use, which may vary from country to
country according to their infrastructures.

 When choosing the most appropriate mode of transport, the firm must
consider four important factors. These are transit time factor which the period
between the departure and arrival of the carrier, predictability of the mode of
transport, cost and whether there are any foreign or home-country government
policies that may restrict their choices.
 In the management of the firmÊs global supply chain, the reasons that drive
firms to source for the materials or component parts from abroad were
discussed.
 We also learned how the firm can manage their relationship with suppliers and
the importance of the purchasing function as the link between the firm and its
suppliers.
 We further studied how information systems, such as EDI, ERP and

E-Commerce can be used in a firmÊs global supply chain.
 Finally, we discussed quality management as another important aspect of the

supply chain through implementing quality management systems and quality
standards.
Certifications Location
E-business Logistics
Electronic Data Interchange (EDI) „Make-or-Buy‰ decisions
Enterprise Resource Plan (ERP) Physical distribution
Five S Quality management
Free Trade Zones (FTZ) Supply chain management
Information system Transit time
International sourcing Transportation
Inventory management Vertical integration
Just-in-time (JIT) and lean operation

Topic  Future of
International
9 Business
LEARNING OUTCOMES
1. Describe some current developments in the political, economic
and financial environment which provide the basis for the
future outlook;
2. Identify the role of technology in the conduct of future
international activities; and
3. Explain the priorities of a countryÊs domestic policies in relation
to their international trade policies.
 INTRODUCTION
In this topic, we will discuss the possible developments in the future of
international business environment. Although international firms face changes
constantly in world market conditions, it is important that they recognise the
importance of the changes taking place in the international environment and adapt
appropriately to new situations. Firms would then be in a better position to seize
new opportunities brought about by the changes in the environment and emerge
in a more competitive position.
We shall first focus on the expected political, economic and financial environment.
On the other hand, we need to discuss the roles of technological environment in
the conduct of future international activities. Finally, we will explain the priorities
and shift our attention to changes in government policies and countriesÊ trade
relations that may affect the activities of international business.

232  TOPIC 9 FUTURE OF INTERNATIONAL BUSINESS
9.1 CHANGES IN INTERNATIONAL BUSINESS

ENVIRONMENT
In this subtopic, we shall analyse the international business environment in the
context of the political and economic changes as well as the financial conditions
and technological development.
9.1.1 The Political and Economic Environment

The worldÊs political environment is undergoing a substantial transformation
brought about by the breaking up of old coalitions, changes in political groupings
and the formation of new ones.
(a) Relationship between the East and the West

The conflict between the East (mainly the grouping of communist countries of
Russia and Eastern Europe) and the West (mainly the United States and the
countries of Western Europe) came to end with the raising of the „Iron
Curtain‰. This event brought two separate political and economic systems
closer together. A confederation of independent states which has replaced the
former Soviet Union and the nations of Eastern Europe, reasserted their
independence and implemented free-market oriented economies. As a result
of this easing of political tensions, international firms are presented with new
opportunities in trade and investments. In the near future, selected Eastern
and Central European countries are likely to continue to be attractive for
international investments due to their low labour cost, cheaper factors of
production and proximity to Western Europe. However, the European Union
may impose trade barriers to prevent an unbalanced economic development
which may undermine the stability of their economic integration.
In Russia, the rapid transformation has caused major internal economic

adjustments resulting in inflation and unemployment. There is also a
domestic fear of outsiders in these countries, which poses a constraint on
their participation in international trade. Economic development may
therefore be slow and gradual. Governments in these states need to find
market-oriented approaches to reduce the outflow of capital, which are badly
needed in their own countries.
On the whole, international firmsÊ activities in these regions may be subjected

to the risk of economic and political instabilities. The institution of free-
market systems may be halted and may even be reversed due to the growing
hardship the majority of the population is being exposed to during the
transformation process.

TOPIC 9 FUTURE OF INTERNATIONAL BUSINESS  233
(b) Relationship between the North and the South

This refers to the relationship between the developed countries of the
northern hemisphere and the less developed countries in the southern
hemisphere. The economic gap between the north and the south is not likely
to diminish and will continue to exist for some time in the future. The
disparity is likely to be based on the continuing burden of debt and the
problem of satisfying the basic needs in the less developed countries, causing
potential political and economic conflicts. For example, the developing
countries of Africa were first seen as a relatively attractive region for
international business. However, continuing political instability and the
inconsistent practices of African firms as trading partners resulted in
pessimistic views towards the region. Although trade liberalisation may
encourage exports to these regions, it may not attract sufficient investment
funds to transform the economic future of the region unless accompanied by
a reform of their internal trading policies and practices.
Environmental protection will be another major issue shaping the

relationship between the developed and the less developed countries. While
desiring for economic growth, their approach to cooperation with the
developed countries is uncertain with three possible scenarios anticipated.
The first scenario is one of continued cooperation through a sharing of
resources and technology. This would increase the flow of trade between the
developed and the less developed countries with new business opportunities
emerging. The second possibility is confrontation, as a result of the
unwillingness to share resources and technology. Under this scenario, the
volume of international business could be greatly reduced. A third scenario
is that of economic isolation, as each group believes that they are facing
unique problems and seek their own solutions.
(c) Emerging Markets

The emerging markets of South America and the Asia Pacific regions is
believed to be the fuel for global economic growth. In South America, the
international business environment would improve due to economic
integration, market liberalisation and privatisation. Foreign direct
investments and trade from the United States, Europe and Japan may
increase due to the presence of substantial natural resources and relatively
low cost of production.
Countries in the Asia Pacific region are likely to collaborate in terms of trade
and investment. China might emerge as the new economic power, given their
pragmatic policies. However, the willingness on the part of international
firms to undertake long-term commitments, to transfer technology and
establish partnerships with the Chinese firms are keys to a successful

venture. Korean firms could emerge as strong international competitors

should they be able to improve further on the quality of their products.
However, the possibility of their reunification with North Korea needs to be
considered. India is expected to offer major opportunities due to its market
size, its significant natural resources, and large educated middle class society
especially in engineering and computer sciences. Although these emerging
economies may grow significantly, their potential may be hampered by
uncertain international and domestic policies, social and political conditions
as well as inadequate infrastructures in transport and legal systems.
SELF-CHECK 9.1
How do conflicts between countries affect business firms in dealing with

their international business activities?
ACTIVITY 9.1
Between the groups of countries labelled as the North, South, East or
West, which group does Malaysia belong to? Discuss with your
9.1.2 The International Financial Environment

The international debt problem of the developing countries will remain a major
global issue in trade and business. This debt burden combined with the low prices
for commodities due to the excess supply of most primary products would
dampen the growth prospects of many developing countries. As a result, they may
be forced to reduce their level of imports and require assistance from the
developed countries. The developed nations have a strong incentive to help debtor
countries through fund provisions and debt relief measures, such as debt
forgiveness. The incentive consists of market opportunities that economically
healthy developing nations can offer.
The US dollar (USD) will continue to be one of the major international currencies,
although the use of the Euro in international trading and financial transactions is
also likely to increase. The floating exchange rate system is expected to continue
with occasional government intervention in the currency markets to stabilise their
currency values and exchange rates. However, due to the large international flows
of financial resources, market forces will be the key determinant of currency values

rather than government actions. As such, domestic monetary and fiscal policies
may have a lesser effect on the value of international currencies than investor
confidence, earnings expectations, economic and political stability.
Another major financial concern is the United StatesÊ international debt. In early
1999, the United States carried an international debt of about US$1.3 trillion,
making it the largest debtor country in the world. It owes more to other nations
than all the developing countries combined. Although most of these debts are
denominated in USD and the amounts required to service these debts are only a
small portion of the United StatesÊ GNP, the accumulated debt may be of concern.
For example, at an assumed interest rate of 10% per year, it would require an
annual payment of US$130 billion. Thus, the future of the United StatesÊ
international trade activity will become a greater priority and be devoted to
generating sufficient funds for such repayment. This may also serve as a source of
major economic growth for firms in the United States.
The United StatesÊ international debt problem may also contribute to an

increasingly tight money supply worldwide. This factor combined with the
financial needs of the emerging economies of central and Eastern Europe, the
former Soviet Union and many other developing nations may result in increasing
competition for capital. The scarcity of funds will lead to higher interest rates
worldwide. Developing countries and smaller international firms may find it
difficult to obtain financing as financial institutions are expected to become more
conservative in their lending policies. Easier access to better financial resources
will become a key competitive factor or even become critical to the survival of
international firms.
ACTIVITY 9.2
Based on your understanding, what type of industry will be most affected

by unstable currency markets and exchange rates? Discuss with your
9.1.3 Technology
Communications technology which has become widely available globally, offers
new opportunities for conducting international business. The expanding use of fax
machines, portable telephones, computers and other personal communication
devices has revolutionised the flow of information. The Internet is experiencing
tremendous growth, with web sites doubling every 50 days and a new home page
coming online every 4 seconds. As communications technology expands, a firm

can centralise its entire communications system in one location. Colleagues and
customers can be reached faster and more directly, while consumers can gain
greater awareness of products resulting in greater demand and competition.
Computer technology would enable firms to send data and pictures across
computer networks enabling faster product development.
Other technologies, such as superconductive materials and composites have made

it possible for the development of new systems in the field of transportation and
electric power. These discoveries are pushing exploration of the outer space and the
deep oceans. The development of biotechnology is leading the progress in
agriculture, medicine, chemistry and also in manufacturing systems in industries.
However, investments in technology require large amount of funds while success

is uncertain. Firms and countries are finding it increasingly difficult to gather
sufficient funds necessary for investments in technology, while not engaging in
these investments may mean falling behind in the race for further advancements.
EXERCISE 9.1
1. What are the expectations regarding the value of international

currencies?
A. The US dollar (USD) will be replaced as the major
international currency.
B. Gold will return to its former status in the near future.
C. Market forces will be the key determinant of a currencyÊs
value.
D. Government actions will be the key determinant of a
currencyÊs value.
2. The East-West relationship can be described as the relationship

between:
A. The developed and the less developed countries of the world.
B. The Muslim and non-Muslim countries of the world.
C. The countries of eastern and western Europe.
D. The communist countries and the democratic countries.

3. Debt constraints and low commodity prices will continue to hamper

the growth prospects of many developing countries.
A. True
B. False
4. How do advances in communications affect international business?
9.2 GOVERNMENT POLICIES

Government domestic policies are increasingly being affected by international
trade activities as economic activities become more intertwined. For example, a
reduction in automobile exports may result in a shift in employment. The effects
will be felt throughout the economy and industries that are linked to the
automobile industry will also experience lesser activity. The pressure of foreign
competition or from local firms that have made gains from international activities
may drive the affected industries to restructure their activities. These industries
are more likely to look to their governments for help in their restructuring efforts,
who may respond by taking more protectionist measures.
Restructuring, however, may result in an increase in productivity as it provides

the opportunity to reallocate resources to new sectors of the economy or to
activities with a greater potential. For example, although employment in farming
activities in the United States has dropped from 40 per cent of the population to
less than 3 per cent , the farming industry was able to produce large surpluses of
farm products.
However, governments cannot be expected to ignore the effects of

deindustrialisation, for example, the removal or reduction of industrial activity in
their countries, for the sake of free trade. As such, they would only allow a more
open market policy subject first to the fulfilment of their domestic needs.
Recognising the importance of international trade activities, governments will
need to coordinate their policies that affect the international business environment.
They may involve greater cooperation with other governments.

As the need for greater collaboration among governments grows, it may also at the
same time be more difficult to obtain consensus because of the lack of a common
purpose. For example, the bond that encouraged collaboration among the western
countries from 1945-1990 was their need for a common defence against the
communist countries, which relegated trade relations to second place. Now that
the communist threat has diminished, the priority for their own economic
performance has increased. Collaboration may become increasingly difficult
without a jointness of purpose.
Governments may also face the problem of trade balance issues, which are short-
term in nature, and competitiveness issues, which are more long-term. The
problem of trade deficits is often countered with import restrictions by
governments, such as in the United States, which may affect the long-term
competitiveness of the country. Exerting pressure on Japan to further open their
markets to American exports may only have a minor effect on the United StatesÊ
trade deficit position. Governments are therefore expected to impose appropriate
measures to overcome such problems.
In the years to come, governments will be faced with problems that emerge from
the need for technological development, which individual firms may not be able
to surmount on their own. For example, to overcome the issues of environmental
pollution and global warming, the private sector will need the administrative
guidance and collaboration with governments. The firm may therefore have to
spend more time and effort dealing with government-corporate collaborations.
ACTIVITY 9.4
Name some of the policies that are implemented by the Malaysian

government in managing its international trade activities.

EXERCISE 9.2
1. Managers of international firms will, in the future, have to spend

more time and effort dealing with governments.
A. True
B. False
2. Recognising the importance of international trade to their

countriesÊ economic development, governments would most
definitely place international policies on a higher priority over
domestic policies.
A. True
B. False
3. Now that the threat from the communist countries has reduced, it
would be easier for the western countries to cooperate and form
collaborations.
A. True
B. False
9.3 INTERNATIONAL TRADE RELATIONS

In the following subtopics, we will discuss the General Agreement on Tariffs and
Trade (GATT) and World Trade Organization (WTO).
9.3.1 General Agreement on Tariffs and Trade (GATT)

GATT was a multilateral agreement regulating international trade. GATTÊs
purposes was the substantial reduction of tariffs and other barriers and the
elimination of preferences, on a reciprocal and mutually advantages basis. It was
negotiated during the United Nations Conference on Trade and Employment and
was the outcome of the failure of negotiating governments to create the
International Trade Organisation (ITO). GATT was signed by 23 nations in Geneva
on October 30, 1947 and took effect on January 1, 1948.

Three principles of the agreement under GATT are:

(a) Non-discrimination – This is based on the principles of the most favoured
nation. This principle states that any reduction in tariff given to the most
favoured nation should also be extended to other GATT members.
(b) Elimination of non-tariff trade barriers – Non-tariff barriers such as the quota
for agricultural foods and countries that have difficulties in Balance-of-
Payments (BOP) were the main targets.
(c) Discussion – This involves meetings among countries to solve
misunderstanding in their international trade activities. Through GATT, 35
per cent of world tariff were reduced during 1947 to 1962 after five trade
discussions.
9.3.2 World Trade Organization (WTO)

The formation of the World Trade Organization (WTO) has provided the countries
participating in international trade with a forum for trade negotiations and dispute
settlement. However, countries encountering major trade imbalances may
prescribe their own domestic policies to remedy their situations. This may cause
retaliation by other countries and result in an increasingly adverse trade relation.
Multilateral trade negotiations, for example trade between more than two
countries, can only be strengthened and trade flows enhanced if the countries are
willing to sacrifice some of their national sovereignty in the interest of improving
trade relations. If the major trading countries resort to the imposing of non-trade
barriers, unilateral actions and bilateral negotiations, protectionism will increase
and the volume of international trade may decline.
International trade relations will also be influenced by new participating countries

such as China and Central Europe as they develop more favourable trading
policies and practices. Market and sourcing opportunities offered by these
countries may attract a substantial flow of trade and investments. ChinaÊs
admission to the WTO brought both positive and negative responses among its
own population as well the developed countries. Due to its low cost of labour from
about 800 million peasants living in poverty, the developed countries fear that
their markets will be flooded by inexpensive imported goods from China.
Developing countries like Sri Lanka, Guatemala and Malaysia are concerned that
ChinaÊs supply of low-cost labour will allow Chinese factories to under price their
exports. While many export-oriented Chinese firms believe that ChinaÊs entry into
the WTO will enhance their ability to market their goods in foreign countries,
others fear that the state-owned enterprises in China will not be able to compete
successfully against their foreign and domestic rivals when protective measures
are lifted.

Table 9.1 summarises the benefits and drawbacks of WTO.
Table 9.1: Benefits and Drawbacks of WTO
Benefits Drawbacks
 Encourages stability.  Intervenes and determines the policies

of a country.
 Misunderstandings or disputes are
resolved.  Too obsessed with free trade to the
extent of ignoring other genuine
 Its basic principles produce efficient interests and issues.
trade transactions.
 Commercial interest of under
 The exporting countries are safe from developed countries.
the incitement of lobbying parties (e.g.
EPA was once lobbied by US petrol  Trade is more important than
producers). environmental protection.
 The system encourages the existence of  Commercial interest is more

good government and does not ban significant than health and safety
international trade activities. issues.
 Eliminates jobs and increases poverty

among under developed and
developing countries.
 Small countries have less voice in the

WTO.
 Is not democratic.
At the same time, as governments strive to achieve self-sufficiency in their

economic sectors such as in agriculture and heavy industries, an oversupply of
these commodities and products may occur. As a result, these economic sectors
may face restructuring, especially agricultural produce such as wheat, corn and
dairy products, and industrial products such as steel, chemicals and automobiles.
ACTIVITY 9.5
Visit World Trade Organization (WTO) at www.wto.org and get

acquainted with the purpose, foundation and activities of this
organisation.

EXERCISE 9.3
1. The issue of national sovereignty will be a major obstacle in

international trade relations, because:
A. The countries involved are not willing to sacrifice their
domestic interests.
B. Higher levels of cooperation among countries can be attained.
C. Trade barriers will be eliminated.
D. Countries will place a higher priority on international
relations.
2. ChinaÊs admission to the World Trade Organization (WTO) is seen

as having no negative effects to either the developed or developing
countries.
A. True
B. False
3. The World Trade Organization (WTO) is a forum for negotiations

where disputing member countries can settle their political
differences.
A. True
B. False

 Topic 9 provided the future outlook for international business. We have

analysed the possible changes that can take place in the political and economic
environment of international business in the context of relationships first
between the east (comprising the countries of eastern and central Europe, and
the former Soviet Union) and the west (made up of countries in Western
Europe and North America).
 While the countries of eastern and central Europe would provide promising
opportunities in terms of its market and resources, the independent states of
the former Russia may face a slower and gradual growth due to lack of capital.
 The economic gap between the countries of the north (developed countries)
and the south (developing countries) will remain.
 The debt burden of many developing countries will dampen their potential for
growth unless financial assistance is forthcoming from the developed
countries.
 However, the economically healthy developing countries will be attractive

investment and market destinations for the developed countries.
 The emerging markets will also experience slow growth due to lack of stable
trading policies and infrastructures.
 The advancement in technologies, especially communications technology, will

provide new opportunities in e-commerce business and enhance information
flows.
 Other technologies in composites and biotechnology may also provide

opportunities for expansion.
 However, investments in technology require a vast amount of funds and

capabilities which the private sector would not be able to handle without
government assistance, thereby foreseeing a higher level of government-
corporate collaboration.
 Government policies will continue to place emphasis on domestic interests,

although recognising the importance of international relations.
 There may be greater cooperation among some countries in their effort to

coordinate domestic and international policies.

 Trade deficits will remain an issue, especially for the United States. However,
this will not be solved by imposing restrictions on imports which may affect
the countryÊs competitiveness in the long-term.
 Governments have to find and apply more appropriate measures to resolve the
issue.
 In international trade relations, the WTO may provide a forum for negotiations
to ensure freer flow of international trade.
 The inclusion of China into the WTO brings new possibilities both for China
and other major trading countries.
 ChinaÊs large population ensures an abundant supply of low-cost labour as

well as market opportunities for international business.
 However, other developing countries fear that underpriced exports from

China may threaten their competitiveness in world markets.
 In conclusion, international business firms must be prepared to face greater

challenges and adapt to changes in the international environment to sustain
their competitiveness.
Emerging markets International trade relations

Financial environment Political environment
Government policies Technology

ANSWERS  245
Answers
TOPIC 1: WHAT IS INTERNATIONAL BUSINESS?
Exercise 1.1
1. B
2. C
3. D
4. B
5. B
6. Long-term isolation from international markets may not be possible because

of the increasing interdependence between markets. A firm may choose not
to export their goods or services but it may still face competition from foreign
companies who have entered its domestic market. Furthermore, most
companies source their goods internationally. Even, if the firm buys all its
supplies from a domestic firm, that supplier firm may have sourced its goods
from abroad.
7. TodayÊs companies are quick to respond to foreign sales opportunities.

International firms shift production among countries seeking lower factor
costs and constantly look out for newer markets. Because of their experience
they are able to transport goods to many places efficiently. When a few
companies respond to foreign market and production opportunities, other
companies also follow suit. Foreign competition, therefore can also persuade
companies to expand its business into international markets to maintain their
competitiveness.

246  ANSWERS
Exercise 1.2
1. D
2. C
3. C
4. B
5. A
6. International business activities can be categorised according to the

following categories:
(a) Exporting and importing of goods and services is the most commonly
used mode of activity. The export of goods/merchandise consists of the
sending out of the country tangible products such as televisions,
automobiles, machinery, chemicals and other items while imports are
goods brought into a country. Services are non-product sales (export)
and purchases (import) such as travel and tourism, transportation,
communications, banking, insurance, education and distribution rights
for motion pictures.
(b) International investments is the second major form of international

business activity and can be divided into foreign direct investments
(FDI) and portfolio investments. FDIs is an investment that gives the
investor a controlling interest in a foreign company. Portfolio
investments are purchases of foreign financial assets such as shares,
bonds and certificates of deposits which are for short-term gains and
not for the purpose of gaining control.
(c) Other forms of activity are licensing, franchising and management

contracts that involve the international firms using their assets such as
trademarks, patents, copyrights or expertise under contracts known as
licensing agreements in return for royalty payments or fees.
7. The term „transnational company‰ (TNC) describes the strategy of a firm

whose different competencies possessed by their various country
subsidiaries is developed and integrated into its worldwide operations. The
TNC learns from all its different operating environments and applies the
knowledge gained throughout its global operations. Its location of authority
within the organisation may be geographically dispersed to subsidiaries
where it is found to be optimal.

ANSWERS  247
A global company integrates its operations that are located in different

countries. For example, it may design a product or service to be marketed to
a global segment or it may rely on its other country subsidiaries to produce
its products or services. It differs from the TNC because the centre of
authority and development of capabilities are mainly made at the companyÊs
home country/headquarters.
Exercise 1.3
1. D
2. D
3. C
4. B
5. B
6. The sources of this pressure to be locally responsive may arise from:
(a) Consumer tastes and preferences may differ greatly between countries
due to historical or cultural reasons. Products and/or marketing
programmes have to be customised in order to appeal to each countryÊs
consumers. Products like Coca-Cola, LeviÊs jeans and McDonaldÊs
burgers have to be differentiated to suit local conditions.
(b) Differences in infrastructures such as electrical systems and in

traditional practices such as left-hand/right-hand driving would
require products to be customised to suit the local differences. More
recently arising differences are the technical standards in the wireless
telecommunications industry, between GSM and CDMA.
(c) Differences in distribution systems may require an international firmÊs

marketing strategies to be varied according to different distribution
channels among countries. Some countries may have a few but
powerful food retailers dominating the market while retailers in other
countries are smaller in size but larger in number. Distribution systems
in Japan, for example, may not favour American-style high pressure
sales.

248  ANSWERS
(d) Host country governments may impose stringent regulations such as

food or drug testing procedures, pricing restrictions or rules requiring
a higher percentage of local content in products. These demands would
require foreign products to be locally responsive.
The firm may need to be locally responsive and customise their product and
service offerings and marketing programmes to meet local requirements. It
may therefore not be possible for the firm to realise the full benefits of
location and experience curve economies.
7. The following factors can generally describe the competitive environment

within which international firms operate.
(a) Homogeneous or Differentiated Nature of Products

The competitive environment in which a firm operates varies by
industry, company and country. Thus, firms in industries which
products are homogeneous in nature may compete more on price.
Strategies would therefore be influenced by cost savings, such as
producing on a larger scale to achieve lower average unit costs and
locating sources of cheaper labour and materials. Firms in other
industries may compete more on differentiated and innovative
products, thus placing more emphasis on research and product
development to gain competitive edge.
(b) Size of Company and Their Resources

Another competitive factor is the size of the company and the resources
it possesses compared to competitors. Large firms like Coca-Cola has
much more resources and international options to choose from
compared to smaller firms, allowing it to vary its strategies according
to different markets.
(c) Size of Domestic Markets

The size of the firmÊs domestic markets, like the United States
compared to Switzerland, also creates different competitive
environments. Swiss producers are more highly dependent on sales to
foreign markets than US producers to achieve economies of scale in
product development and production.

ANSWERS  249
(d) Local or International Nature of Competition

Yet another factor which shapes this environment is whether there is
international or local competition in the home country and in foreign
markets. Firms that compete with each other everywhere they try to
sell their products, such as Boeing and Airbus, learn more about each
other and use the knowledge to anticipate each otherÊs actions and
strategies in other countries. Other firms may face different competitors
in each of the foreign countries where they operate.
Exercise 1.4
1. D
2. A
3. B
4. B
5. A
6. In seeking and acquiring materials, components, capital, new technologies

and information from abroad that they can also use in their home countries,
firms are able to reduce costs or obtain resources that are not available in
their own home country. These resources would enable the firm to improve
the quality of its products and differentiate from competitorsÊ products.
Foreign resources and experience can also be used to improve their domestic
operations.
7. Certain sophisticated computers can be used to design weapons and related

systems which may then be used to threaten the exporter country.
Radioactive materials, similarly, can be used to develop nuclear weapons.
Thus, governments impose restrictions on the sale of such materials to
prevent them from falling into the hands of the wrong parties. The United
States government, for example, prevents these exports unless prior
approval has been granted.
For non-defence goods, trade controls may be imposed as a matter of foreign

policy to prevent another country from meeting its political objectives. For
example, the US may impose trade sanctions on the sale of technology or
chemicals to North Korea who would use them in defence development
programmes.

250  ANSWERS
TOPIC 2: CULTURAL, POLITICAL, LEGAL AND

ECONOMIC SYSTEMS
Exercise 2.1
1. A
2. D
3. C
4. A
5. B
6. The emphasis placed on education varies from country to country whether

the quality of their education is based on particular skills or the overall level
of the education. Japan and South Korea emphasises the sciences more than
Western countries and Germany on apprenticeship programmes for
craftsmen and machinists. The US system stresses on the development of
self-reliance, creativity and self-esteem and provides widespread access to
higher education. Therefore, educational background, skills and literacy
levels varies. A countryÊs system of public and private education thus plays
an important role in transmitting and in the sharing of culture.
7. In international business, language serves four important purposes:
(a) It is important in information gathering and evaluation. Market

information is best obtained by becoming part of the market rather than
observing it from the outside. The capable manager who is personally
able to see and hear what is going on need not rely on the opinions of
others.
(b) The manager will be able to have easier access to society. The ability to
speak the local language means better acceptance and higher
willingness of the locals to openly communicate with the manager, at
the same time fostering cordial relationships.
(c) A foreign manager needs to communicate with employees of a

subsidiary in another country or with local distributors. Otherwise,
he/she would require an interpreter.

ANSWERS  251
(d) Besides the ability to communicate, language also provides the

manager with the ability to interpret different contexts of culture. For
example, the use of English in different countries carries different
meanings. When the British say „Negotiations Bombed‰, it means it
was a huge success which conveys exactly the opposite to Americans.
Exercise 2.2
1. C
2. A
3. C
4. B
5. B
6. The three categories of political risks are:
(a) Ownership risks whereby the property of the firm can be threatened
through either expropriation or confiscation. Expropriation is the taking-
over of foreign-owned properties by the government with compensation
being provided. However, these compensations are often unsatisfactory to
the owners. Confiscation also means the taking over of foreign-owned
assets but it does not involve compensation for the firm.
(b) Operating risks in which changes in laws, environmental standards, tax

regulations, terrorism and armed uprisings threaten the on goings of
the firm and the safety of its employees.
(c) Transfer risks when the government interferes with a firmÊs ability to
shift funds into and out of the country.
7. Islamic law or the Syariah is based on the Holy Quran and the Sunnah which
are decisions and sayings of the Prophet Muhammad. Islamic law not only
concerns moral behaviour but it also extends to cover commercial activities.
It is intended to govern all aspects of life.
Several Islamic countries such as Iran, Sudan, Pakistan and Saudi Arabia, for
example, have adopted Islamic banking systems and banned traditional
commercial banking. They have pronounced interest to be non-Islamic and
illegal. Banks therefore cannot charge interest or benefit from interest and
instead structure fees into their loans to allow them to make a profit.

252  ANSWERS
Exercise 2.3
1. B
2. B
3. C
4. B
5. B
6. The three economic systems are the market economy, the command economy
and the mixed economy. Their major differences are in the manner in which
resources are owned and utilised and the role of government, as explained
in the following:
(a) Market Economy

In a pure market economy, resources and all productive activities are
owned and controlled by the private sector. Production is determined
by the interaction between supply and demand through the price
system. If demand for a product exceeds supply, prices will rise
encouraging producers to produce more. If supply exceeds demand,
prices will fall and producers will produce less. In this system,
consumers are sovereign which means that consumers decide what to
buy and companies face no restrictions in how they operate. The role
of the government in a market economy is to encourage competition
and efficiency between producers.
(b) Command Economy

In a command economy, all economic activities such as goods and
services that the country produces, the quantity produced and the
prices at which they are sold are all planned by the government. In pure
command economies, all enterprises are owned by the state, the
rationale being that the government can direct investments in the best
interest of the nation.

ANSWERS  253
(c) Mixed Economy

In mixed economies, governments may tend to take ownership of
troubled firms which are considered vital to national interests. Renault,
the automobile company, was at one time taken over by the French
government to prevent its collapse and the resulting unemployment.
Some governments may own significant resources but it allows supply
and demand to set prices while other countries without much resources
levy high taxes for funds. Governments may also control economic
activity through their fiscal policies.
7. The process of shifting towards a free market-based system requires several

steps as follows:
(a) Deregulation
Deregulation of the markets means the removing of legally imposed
restrictions to allow the free play of market forces, the formation of
private enterprises and how they operate, uplifting controls over prices
and outputs and international trade.
(b) Privatisation
Privatisation is the transfer of ownership of state-owned properties to
private individuals. This is an economic strategy usually used by the
government as a way to reduce their burden of the cost of operating
these enterprises. Funds raised from the effort can then be utilised to
finance other government projects. At the same time, the companies
can become more productive, efficient and innovative and expand the
choices for the private sector. Privatisation is also intended to attract
new foreign capital into their countries.
(c) Legal Systems

Many countries that are the emerging from the communist bloc lacked
the legal structure needed to protect private property rights and
enforcement of contracts that are required for the smooth functioning
of a market economy. Foreign capital may be hesitant due to the weak
system of law which cannot offer adequate protection for their
investments. In the event of contract disputes, procedures for resolving
them are either insufficient or poorly developed.

254  ANSWERS
TOPIC 3: INTERNATIONAL TRADE THEORIES

AND INSTITUTIONS
Exercise 3.1
1. A
2. B
3. B
4. B
5. B
6. The basic message of both the theories of absolute advantage and

comparative advantage is that the wealth of a country and thus the well-
being of its citizens would be better if more goods can be made available to
them. While Adam SmithÊs theory is limited to mean that countries should
specialise in the productions of goods in which they possess an absolute
efficiency advantage, David Ricardo suggests that countries that do not
possess absolute advantage might possess a comparative or relative
efficiency advantage and could also specialise. Specialisation by countries
would mean that countries would have to import those needed goods that
they do not produce, thus encouraging trade.
Potential world production would be greater with unrestricted trade than

when trade is restricted. Consumers in all nations can consume more if there
are no trade restrictions, even in countries that lack an absolute advantage in
the production of any good.
7. The international PLC theory consists of three stages called the New Product
Stage (stage 1), the Maturing Product (stage 2) and the Standardised Product
Stage (stage 3).
In Stage 1, a new innovative product is introduced by a firm in an advanced

country (usually the US) where the necessary resources such as highly skilled
labour, capital for R & D and technology are available. These products tend
to be high cost and produced initially in limited amounts more for home
consumption than for exports.

ANSWERS  255
In Stage 2, as production expands in response to higher demand, the product

begins to be exported to other advanced countries (like Europe) which can
afford to buy the product. At the same time, other advanced countriesÊ
competitors learn the new technology to also produce the product or
different variations of the product. With stiffer competition, manufacturing
process becomes more standardised and there is strong pressure to reduce
cost. The firm has a critical need to look for ways reduce cost or risk losing
its market share to competitors.
In Stage 3, the product manufacturing process has become completely

standardised i.e. not requiring skilled labour. Competition is fierce and profit
margins are small. Production would now shift to countries that can offer the
cheapest unskilled labour, such as in South East Asia or China.
Exercise 3.2
1. C
2. A
3. A
4. B
5. A
6. The most appropriate strategy under such circumstances may be the

transnational strategy which is typical of some industries in todayÊs
competitive environment. Such firms need to utilise and transfer skills and
competencies developed in any of their worldwide operations in order to
simultaneously achieve cost and differentiation advantages.
The example given in the module is of Caterpillar facing competition from

low-cost producers Komatsu and Hitachi. Caterpillar had responded to both
pressures by redesigning its products to use many identical components and
built a few large-scale component manufacturing facilities and assembly
plants at favourable locations. The firm also added local product features,
tailoring the finished product to suit different local needs. By pursuing this
strategy, Caterpillar was able to reduce costs through large scale
manufacturing while simultaneously meeting pressures for local
responsiveness.

256  ANSWERS
7.
Exercise 3.3
1. C
2. D
3. A
4. B
5. B
6. Both the free trade area (FTA) and the customs union allows for more free
trade among member countries by eliminating or minimising tariff or non-
barriers. However, FTA members set its own policies with regards to trade
with non-member countries while the customs union establishes a common
external trade policy when conducting trade with non-members.

ANSWERS  257
7. Trade creation occurs when high-cost domestic producers are replaced by

low-cost producers in other countries within the economic integration.
Consumers thus can gain access to more goods at a lower price than would
have been possible without integration. The elimination of tariff has also
created more trade within the economic integration.
Trade diversion which occurs when lower-cost external producers (from

non-member countries) are replaced by higher-cost producers from
countries within the economic integration has a negative effect on overall
trade.
The world as a whole would only benefit if the economic integration creates
more volume of trade than the amount it diverts.
TOPIC 4: THE FINANCIAL ENVIRONMENT OF

Exercise 4.1
1. C
2. A
3. B
4. A
5. B
6. The IMF was created for the purpose of overseeing the functioning of the
international monetary system. Its major duties are to:
(a) Promote international monetary cooperation among member

countries.
(b) Facilitate the expansion and a balanced growth in international trade.
(c) Promote stability in the exchange of currencies by maintaining orderly

exchange arrangements among members and avoid competitive
devaluation of currency values among member countries.

258  ANSWERS
(d) Assist in the establishment of a multilateral system of payments.
(e) Make its resources available to members experiencing balance of

payment difficulties.
All member countries agreed to maintain the value of their currencies within
1% of the par value by buying or selling currencies (or gold) as necessary. If
the government concerned was unable to maintain its value within the 1% of
par value, they are allowed to devalue their currency up to 10%.
Devaluations of larger than 10% would require the IMFÊs approval.
The IMF also extends foreign currency loans to member countries to help
them maintain stability. Large borrowers, however, would have to comply
with the IMF imposed monetary and fiscal policies.
7. The first scheme is called the IBRD Scheme which raised money through the
sale of bonds in the international money markets. They are low interest loans
and are usually offered to risky customers whose credit rating is poor. The
second scheme is supervised by the International Development Agency
(IDA), an arm of the bank established in 1960. Funds for these loans are
obtained from the subscriptions of the rich member countries such as United
States, Germany and Japan. Borrowing countries have 50 years to pay at an
interest rate of 1% a year.
Exercise 4.2
1. A
2. A
3. C
4. B
5. B
6. A spot rate is the exchange rate quoted for transactions that require
immediate delivery. A forward rate is a contract to deliver a specified
quantity of a currency on a specific future date (generally 30, 60, 90, 120 or
180 days) at a fixed contractual rate.

ANSWERS  259
7. International business firms use the foreign exchange market to convert

currencies for four main reasons:
(a) Convert the payments that they receive for their exports or income
from foreign investments into the currency of their home country.
(b) Convert the amount of their countryÊs currency into the currency of the
country from where they buy goods and services as payment.
(c) Invest their spare cash for short-terms by placing deposits in the
currency of another country so as to earn interest.
(d) Speculate in the currency of another country for short-terms by

investing in the currency of a country that they anticipate will rise in
value against the home country currency and profit from the difference
or change in exchange rates.
Exercise 4.3
1. C
2. A
3. B
TOPIC 5: MARKET RESEARCH, MODE OF ENTRY

AND ETHICAL ISSUES IN
Exercise 5.1
1. D
2. A
3. C
4. A
5. B

260  ANSWERS
6. Data or information gathered in the process or global market research can be

as a result of the following reasons:
(a) GovernmentsÊ inability, especially in poor countries with limited

resources, to collect the information required resulting in incomplete or
inaccurate data collected.
(b) Government officials may lack competence to maintain and analyse

accurate records because they are not well educated.
(c) Data may be used selectively to publish false or misleading information
to purposely create false impressions for government officials or
companies and institutions abroad.
(d) Academicians may conduct studies based on too few observations,

non-representative samples or poorly designed questionnaires.
(e) Culture may also cause mistrust of how the data gathered will be used,
leading survey respondents to answer inaccurately.
(f) People may cover up their personal data, such as unreported income,
to avoid taxes.
7. Managers tend to view it as relatively unimportant and not conduct research

due to four major reasons:
(a) They lack sensitivity to the differences in culture, consumer tastes and
market demands.
(b) They have a limited appreciation for the different marketing

environments in foreign countries, despite the different labour
regulations, distribution systems and media regulations and
availability from their home-country markets.
(c) They are not familiar with the sources of data and may also lack the
ability to use the data that they are able to obtain. As a result, they
perceive that the cost of conducting global research is not a worthwhile
investment compared to the benefits to be gained.
(d) Lastly, they may rely on what little actual experience they have had in
dealing with a foreign country as a substitute for organised research.

ANSWERS  261
Exercise 5.2
1. B
2. D
3. C
4. B
5. A
6. As advantages, strategic alliances may:
(a) Help facilitate a firmÊs entry into a foreign market, such as the alliance
between Motorola and Toshiba. Motorola managed to secure
government approval to enter the Japanese market together with
ToshibaÊs marketing expertise, by building microprocessors for Toshiba;
(b) Allow firms to share the costs and risks of developing new products or
processes;
(c) Allow firms to combine complementary skills and assets that neither
company can develop on their own, such as between JVC and
Thompson to manufacture videocassette recorders; and
(d) Be used to help firms establish industry technological standards, such

as between Phillips and Matsushita, to establish the Digital Compact
Cassette System (DCC) as the new technical standard against SonyÊs
mini compact disc technology.
The major disadvantage is that alliances may allow competitors to gain a

low-cost route to new technology and markets. For example, many strategic
alliances between US and Japanese firms were seen as a Japanese strategy to
obtain the project engineering and production process skills from successful
US companies. New inventions were channelled to Japan while the resulting
products were distributed and sold in the US markets
7. Licensing agreements are permits issued by one firm (licensor) to another

allowing the other firm (licensee) to use its intellectual property. In return
the licensor is compensated in the form of a royalty payment. The property
licensed may include patents, trademarks, copyrights, technology, technical
know-how or specific business skills.

262  ANSWERS
Exercise 5.3
1. B
2. C
3. A
4. B
5. A
6. William H. Shaw, an ethics lecturer and author, recommended that the

morally responsible product safety firm should implement the following 6
steps:
(a) Give safety the priority as warranted by the product.
(b) Should not have the misconception that accidents occur totally due to
misuse of products by consumers and absolve themselves of all
responsibility.
(c) Monitor the manufacturing process from design, testing to production

so as to ensure that specifications are complied.
(d) Review marketing strategies and advertising for potential safety

problems.
(e) Provide written information about the productÊs performance to

consumers.
(f) Investigate customer complaints about products and take the necessary
response.

ANSWERS  263
TOPIC 6: OPERATIONAL AND FUNCTIONAL

CONSIDERATIONS IN INTERNATIONAL
BUSINESS
Exercise 6.1
1. B
2. C
3. D
4. A
5. B
6. A firm has three different options to determine how much authority it wants
to allow at their subsidiaries. In a centralisation approach, major or strategic
decision-making is concentrated at headquarters to enable the firm to
maintain tight control over its global operations. Second, a decentralisation
approach which allows subsidiaries a high degree of autonomy and make
most decisions at the local (subsidiary) level. A third approach is to combine
both approaches into what is called a coordinated centralisation approach by
which overall corporate strategy is provided by HQ while subsidiaries are
allowed the freedom to implement the strategies within the limits approved
by HQ. Using this third approach, firms are able address the need to
coordinate all their international activities without overlooking the role and
contribution by subsidiaries.
7. There are three major reasons. Firstly, when there are changes in the
environment in which the firm operates, such as the opening of new markets,
expansion or reduction in the size of markets. Firms need to develop
appropriate strategies like rearranging production among their existing
factories to benefit from economies of scale, restructuring their product lines
or buying over competitor firms to achieve a wider presence within markets.
Firms also have to improve their productivity and quality in meeting the
likely increased competition in new or expanded markets. Secondly, new
technological developments require firms to make changes in work roles and
reporting systems, such as that brought about by personal computers and
telecommunications technology. These developments have changed the
need for mainframe computers and the role employees play. Lastly, cultural
values and norms can also drive firms to change. For example, decreasing

264  ANSWERS
consumption of tobacco products has driven tobacco product producers like

Phillip Morris to diversify into other products and enter other markets. All
these factors would require the firm to alter its strategies, organisational
structure, technologies and employees.
Exercise 6.2
1. C
2. D
3. A
4. A
5. A
6. International firmsÊ strategic pricing method consists of three types as

follows:
(a) Predatory pricing means using price as a competitive weapon to drive

weaker competitors out of the market. Once competitors have left the
market, the firm can raise prices and enjoy high profits.
(b) Multipoint pricing is when a firmÊs pricing strategy in one market

impacts on its competitorsÊ pricing strategies in another market. For
example, when Fuji cut the prices of film rolls in the US, Kodak
responded by aggressively cutting their prices in Japan. Fuji eventually
withdrew its aggressive stance in the US.
(c) Experience curve pricing means fixing low prices in an attempt to build
global sales as quickly as possible. The larger sales volume would allow
the firm to move down the experience curve and enjoy economies of
scale.
7. Channel exclusivity are privileges, such as supermarket shelf space,

provided by retailers to reputable and long established producers whose
products are preferred compared to new or lesser known firms. Based on this
relationship plus an attractive markup offered by the producers, distributors
will also not carry the products of competitors. This exclusivity makes it
difficult for other firms to gain access to the market; hence it is also known
as exclusive distribution channels.

ANSWERS  265
Exercise 6.3
1. D
2. C
3. C
4. B
5. A
6. A bill of lading is a document issued by the carrier company to the exporter

and serves three important purposes in international transactions:
(a) As an acknowledgement of receipt to indicate that the carrier has

received the merchandise described in the document;
(b) As a contract obligating the carrier to deliver the goods to the

designated destination;
(c) As a document of title to the merchandise which shall be transferred to

the importer upon final payment.
7. This method involves a four-step process, as follows:
Step 1: Buyer and seller agree on the terms of the contract, including the
buyerÊs obligation to make payment upon delivery of the required
documents, normally an invoice, a draft (whether a sight or time) and a bill
of lading.
Step 2: The seller ships the merchandise consigned in the bill of lading to the
collecting bank in the foreign country. The seller draws the draft (say, a sight
draft) and delivers it to the remitting bank in the exporterÊs country together
with all other documents.
Step 3: The remitting bank sends the documents with instructions to the
collecting bank.

266  ANSWERS
Step 4: When the merchandise arrives in the buyerÊs country, the shipping
company notifies the collecting bank. The collecting bank advises the buyer
that the cargo has arrived and that payment is due. The buyer accepts the
draft and makes payment. The collecting bank then endorses the bill of
lading to the buyer, which allows the buyer to take delivery of the
merchandise from the port. The funds collected are then forwarded to the
seller through the remitting bank.
Exercise 6.4
1. D
2. C
3. B
4. B
5. B
6. (a) The Ethnocentric Approach

In an ethnocentric staffing policy, key management positions are held
by the parent countryÊs personnel. For example, all the important
positions in the foreign subsidiaries of Dutch firm Phillips would be
held by Dutch nationals.
(b) The Polycentric Approach

A polycentric policy requires that host-country nationals be recruited
to manage the subsidiaries while parent-country nationals would
occupy the key positions at corporate headquarters.
(c) The Geocentric Approach

The geocentric staffing policy recruits the best people for key
management positions throughout the organisation, regardless of
nationality.
7. (a) Cultural Training involves training not only the manager but also the
managerÊs whole family, in the host countryÊs culture, history, politics,
economy and religion.

ANSWERS  267
(b) Language Training in a foreign language enables managers to relate

more easily to a foreign culture and foster a better image of the firm.
Although it is possible to conduct business all over the world using
only English, a willingness to communicate using the local language
can help build rapport with local employees and increase the
managerÊs effectiveness.
(c) Practical Training takes the form of arranging a familiarisation trip to

the host country before the formal posting so as to ease culture shock.
Whether there exists an expatriate community, firms ensure that the
new expatriate family is quickly integrated into the group which serves
as a support network of friends and information.
TOPIC 7: INTERNATIONAL SERVICES
Exercise 7.1
1. A
2. C
3. A
4. B
5. Firms can use the following approaches or strategies to identify new target
markets to offer their services internationally:
(a) Follow the Path of the Product

Firms can determine where their major international clients have set up
new operations abroad and follow them. While servicing these major
clients, they may at the same time look for new clients. Examples of
these services are banking and accounting which are offered in support
of products.
(b) Search for Markets Similar to Home Market

When services provided are independent of products, firms must look
for market situations abroad that are similar to their domestic market
in their area of expertise. Firms may easily overcome any problems that
occur as they are more likely to be similar to their home-market

268  ANSWERS
problems. For example, a management consultant may offer to oversee

the smooth transition in the implementation of a computerised system
from a manual system in organisations in a foreign country.
(c) Identify Points of Transition

Points of transition refer to the changes taking place in foreign
countriesÊ domestic environment. For example, when new public
transportation systems are being introduced in a foreign country, the
firm may offer its services to improve the efficiency of the new system.
(d) Keeping Informed of Sponsored International Projects

Firms may also obtain information about internationally sponsored
projects, such as those by the United Nations or the World Bank, in
which they can participate and offer their support services.
TOPIC 8: INTERNATIONAL LOGISTICS AND

SUPPLY CHAIN MANAGEMENT
Exercise 8.1
1. D
2. A
3. International logistics can be differentiated from domestic logistics based on

two classifications of differences. Basic differences emerge because the firm
deals with more than one country. Firstly, firms often have to ship goods over
longer distances to reach their customers. Secondly, it involves the use of
different currencies. Next, countries differ in their border-crossing procedures
such as documentations and customs inspections. This may require the
participation of additional intermediaries such as freight forwarders, customs
agents and banks. Lastly, the modes of transportation may also be different,
such as trucks, rail, by sea or air.
Country differences refer to the more specific attributes within each foreign
country. Transportation systems and intermediaries available may vary from
country to country and freight rates may be computed differently. The
packaging and labelling requirements may also differ among countries.

ANSWERS  269
Exercise 8.2
1. B
2. D
3. C
4. A
5. A
6. The international firm can use inventories as a strategic tool by adjusting

their inventory levels different circumstances. When there is a strong
likelihood of a currency devaluation, the firm may increase its inventories
instead of holding cash to reduce its exposure to devaluation losses. In the
case of high inflation, the firm can keep larger inventories as a hedge against
inflation. However, in countries where a property tax is levied on
inventories, the firms has to balance between the cost of maintaining high
levels of inventories with the benefits accruing from hedging against
inflation or devaluation.
7. When a firm decides to manufacture component parts itself, it may enjoy the
following advantages:
(a) Lower Costs

The firm may be more efficient in the production of the component
parts than any other firm. It therefore makes little sense for it to
outsource this particular activity.
(b) Facilitate Specialised Investments

Investments in specialised assets are investments in equipment that can
be used for a specific purpose in the manufacturing of a uniquely
designed component. For example, Ford has developed a high-
performance, high-quality and uniquely designed fuel-injection system
which increased fuel efficiency and can help sell more Ford cars. To
manufacture the fuel-injection system, Ford requires investments in
specialised equipment that can only be used for this particular purpose
(for example specialised assets).

270  ANSWERS
(c) Protect Proprietary Product Technology

This refers to technology that is unique to a firm and gives the firm a
competitive advantage. The firm would not want the technology to fall
into the hands of competitors. Thus, the firm may prefer to make such
component parts in-house to maintain control over its technology.
(d) Improved Scheduling

Through vertical integration, the firm may be able to save costs because
it makes planning, coordination and scheduling of related processes
easier. For example, FordÊs vertical integration into steel foundries, iron
ore shipping and mining made it possible for the firm to achieve tight
coordination and scheduling enabling it to produce engine blocks
within 24 hours. Ford substantially reduced its iron ore inventory
holding costs.
Exercise 8.3
1. B
2. D
3. B
4. A
5. B
6. The 40/40/20 guideline is an international quota system recommended by

the United Nations Conference on Trade and Development (UNCTAD) for
balance of payment purposes.
It recommended that 40 percent of shipping between two countries be

allocated to vessels of the exporting country, 40 percent to vessels of the
importing country and 20 percent to third-country vessels.
Exercise 8.4
1. B
2. A
3. C

ANSWERS  271
4. A
5. A
6. The reasons for firms pursuing global sourcing strategies can be summarised
as follows:
(a) To reduce costs through cheaper labour, land and facilities and/or less
restrictive work rules;
(b) To improve quality;
(c) To increase exposure to technology available worldwide;
(d) To improve the process of supplies delivery;
(e) To supplement domestic supplies with foreign sources;
(f) To gain access to materials that are only available abroad, due to its
technical or product capabilities;
(g) To establish a presence in a foreign market;
(h) To secure more orders from the supplier country; and
(i) To react to competitorsÊ foreign sourcing practices.
TOPIC 9: FUTURE OF INTERNATIONAL

BUSINESS
Exercise 9.1
1. C
2. D
3. A
4. Communications technology offers new opportunities for conducting

international business as it becomes widely available globally. Fax machines,
portable telephones, computers and other personal communication devices
has revolutionised the flow of information. The Internet is experiencing

272  ANSWERS
tremendous growth providing e-commerce opportunities. Communications

technology may enable firms to centralise its entire communications system
in one location. Colleagues and customers can be reached faster and more
directly while consumers can gain greater awareness of products resulting in
greater demand and competition. Computer technology would also allow
firms to send data and pictures across computer networks enabling faster
product development.
Exercise 9.2
1. A
2. B
3. B
Exercise 9.3
1. A
2. B
3. B

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MAKLUM BALAS MODUL
If you have any comment or feedback, you are welcome to:
1. E-mail your comment or feedback to modulefeedback@oum.edu.my
OR
2. Fill in the Print Module online evaluation form available on myINSPIRE.
Thank you.
Centre for Instructional Design and Technology

(Pusat Reka Bentuk Pengajaran dan Teknologi )
Tel No.: 03-27732578
Fax No.: 03-26978702


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BDNG3103

Introductory International Business

Copyright © Open University Malaysia (OUM)

Copyright © Open University Malaysia (OUM)

Module Writer: Ayub Nasir

Moderator: Ruhana Busu

Developed by: Centre for Instructional Design and Technology

First Edition, January 2005

Copyright © Open University Malaysia (OUM), April 2019, BDNG3103

Copyright © Open University Malaysia (OUM)

Topic 1 What is International Business? 1

Topic 2 Cultural, Political, Legal and Economic Systems 33

Copyright © Open University Malaysia (OUM)

2.3 Economic Environment 50

Topic 3 International Trade Theories and Institutions 61

Topic 4 The Financial Environment of International Business 90

Copyright © Open University Malaysia (OUM)

Topic 5 Market Research, Mode of Entry and Ethical Issues in 115

Topic 6 Operational and Functional Considerations in International 144

Copyright © Open University Malaysia (OUM)

6.4.3 Performance Appraisal and Compensation 177

Topic 7 International Services 184

Topic 8 International Logistics and Supply Chain Management 194

Topic 9 Future of International Business 231

Copyright © Open University Malaysia (OUM)

Copyright © Open University Malaysia (OUM)

COURSE GUIDE DESCRIPTION

As an open and distance learner, you should be acquainted with learning

Copyright © Open University Malaysia (OUM)

Table 1: Estimation of Time Accumulation of Study Hours

COURSE LEARNING OUTCOMES

1. Explain the activities and regulations in international business in general;

2. Discuss the basic concepts and challenges in the management of business at

3. Describe the environmental factors that influence international business

4. Propose the strategies employed by firms in international markets.

Copyright © Open University Malaysia (OUM)

Topic 1 provides an overview of international business. This includes the current

Topic 2 discusses the various elements in the international business environment;

Topic 4 describes the history and development of the international monetary

Topic 5 discusses foreign market research which is critical in identifying viable

Copyright © Open University Malaysia (OUM)

TEXT ARRANGEMENT GUIDE

Self-Check: This component of the module is inserted at strategic locations

Activity: Like Self-Check, the Activity component is also placed at various

Copyright © Open University Malaysia (OUM)

Daniels, J. D., Radebaugh, L. H., & Daniel, P. S. (2004). International business:

Griffin, R. W., & Pustay, M. W. (2003). International business: A managerial

Hill, C. W. L. (2004). Global business today. International Edition. New York:

Hill, C. W. L. (2003). International business: Competing in the global marketplace

Copyright © Open University Malaysia (OUM)

TAN SRI DR ABDULLAH SANUSI (TSDAS) DIGITAL

Copyright © Open University Malaysia (OUM)

International business consists of business transactions between parties from more

Copyright © Open University Malaysia (OUM)

Figure 1.1: International business transactions

International business differs from domestic business due to several reasons. As

1.1 THE IMPORTANCE OF INTERNATIONAL

Copyright © Open University Malaysia (OUM)

Most large corporations today engage in international activities or may be affected

Figure 1.2: World map

We will often meet colleagues, customers, suppliers and competitors from

Copyright © Open University Malaysia (OUM)

Let us say you work for a large corporation which engages in