International Business

PESTEL factors affecting IB

Prof. C.K.Sreedharan.

Unit No: 02

PESTLE Analysis is an analytical tool for

strategic business planning.

It is a strategic framework for understanding

external influences on a business.

International Bussiness Environment:

A detailed analysis of the bussiness

environment of the foreign countries is an

essential pre-requisite for formulating

international bussiness strategies.

The key to successful international

bussiness is the adaptation to the

differences in the environment.

The root cause of most IB problems is the

“Self Reference Criteria” (SRC) in making

decisions.

This is an unconscious reference to one’s

own cultural values, experiences and

knowledge as the basis for decisions.

There are a number of examples of mighty

multinationals tasting bitter failure because

of their failure to adopt to the foreign

markets.

In many cases it was SRC which was

responsible for the failure.

Ex- Procter & Gamble stormed into the

Japanese markets with American products ,

American Managers , American sales

methods and promotion strategies.

The result was disastrous until the company

learnt how to adopt products and

marketing style to Japanese culture.

Ex- American company Texas Instruments which

started making semiconductors in Japan in 1960’s

adopted American approach to hiring, pay and

benefits- dismissing Japanese system of offering

bonuses two times a year as impractical.

The workers disagreed. Morale crumbled and the

company had trouble recruiting employees and

ensuring smooth production flow.

Later when the company adopted the

Japanese methods of recruiting employees

and reward including bonuses and a

promotion system based on seniority, the

situation vastly changed and in 1985 won

the Deming prize for Quality in Japan.

As the environmental factors are beyond

the control of a firm, its success will depend

upon to a large extent on its adoptability to

the environment.

Marketing mix will have to be so designed

to suit the environmental characteristics of

the market.

Environmental scanning is the process by

which companies analyze the micro and

macro environmental factors to determine

opportunities and threats to their

bussinesses.

IB environment can be classified as:

Micro environment and

Macro environment.

Micro environment:

It consists of factors in the immediate

environment of the company that affect the

performance of the company.

These factors are more intimately linked with the

company than the macro factors.

Micro factors need not necessarily affect all the

firms in a particular industry in the same way.

The micro environment factors are:

Suppliers.

Customers

Competitors

Marketing intermediaries and

Publics

Macro Environment:

More uncontrollable than the micro forces.

Some of the macro environmental factors are:

Political and legal environment

Economic environment

Socio-cultural environment
Technological and physical environment and

Demographic factors.

Political Factors:

The political system of a country shapes its

economic and legal systems.

Political systems can be classified as:

Democracy

Socialism and

Totalitarianism

Democracy: Refers to the political system in

which the government is elected by the

people of the country.

Socialism: State owns all industries and

national resources.

Totalitarianism: It is a form of government in

which one person or political party exercises

absolute control over all spheres of human

life.

The various players in international business

have diverse and sometimes conflicting

business interests.

Foreign multinationals use diplomatic

channels to get a favourable climate for

foreign investments, whereas domestic firms

often build up political pressure to oppose

foreign investment to put off competition

from foreign firms.

Importers use political pressure to increase

market access with less tariffs, whereas

domestic manufacturers lobby to obstruct

imports and to operate in a protected

domestic environment.

Exporters are concerned about the removal of

all restrictions on exports and demand higher

levels of export incentives so that exports

remain attractive.

The political environment of the country of

operation becomes increasingly important for

an internationalizing firm as it moves from

exports to FDI as the mode of international

market entry.

As a firm expands internationally and begins

to operate in multiple countries, the political

and legal issues become increasingly complex.

The political system of a country comprise of

various players like political parties with

different ideologies, labour unions, religious

organizations, environmental activists and

various NGOs.

Each of these players in a political system has

its own unique set of beliefs and aspirations

and exerts its influence upon political

decisions.

Political risk:

Political risk is the possibility that political

decisions, events or conditions in an overseas

market or country that adversely affect the

international business is termed as political

risk.

Consequences of political risk

Confiscation:

Government takes over the assets of the

company without any compensation.

Ayub Khan, in Pakisthan confiscated four

hotels of M.S. Oberoi without paying any

compensation.

Expropriation :
It refers to a foreign governments taking over

of a company’s assets by offering some kind of

compensation.

Such compensation paid is generally much

lower than the market value of the assets

taken over.

Communist governments in Eastern Europe

( Poland, Hungary etc) and China expropriated

private firms after the World War II.

Fidel Castro did the same in Cuba during

1958-59.

Governments in Ethiopia, Peru, Zambia have

expropriated private firms.

Nationalization:

It refers to the government’s taking over the

assets and operating the business taken over

under its ownership.

Nationalization of Banks in India in 1969.

International war or civil strike:

Possibility of destruction of company’s local

asset.
Unilateral breach of contract:

Government refuses to honour a contract

negotiated with a foreign company.

Destructive government actions:

Government may impose unilateral trade

barriers- may be in the form of revised

local-content requirements.

Harmful action against employees:

Kidnapping, extortion or terrorist activities.

Restrictions on repatriation of profits:

Government may limit the amount of gross

profit that a foreign company can remit from

its local operations.

Discriminatory taxation policies:

Foreign company may be charged higher tax

than a local competitor.

Political boycott:

Since 1955, a number of Arab countries have

boycotted firms with branches in Israel or

companies that have allowed the use of their

trade names there.

Agitations: Sometimes agitators may target

only the most visible foreign companies.

Example: Attack on KFC, MacDonald etc

When it comes to doing business in China, the

number one rule is : To throw away the rule

book.

If a firm wants to challenge a local partner in a

Chinese court-the firm will be ruining local

business relationship- because suing an

advisory violates Chinese tradition.

Change in political systems may affect

positively / adversely for foreign firms.

In 1990’s- a newly elected government in

Argentina initiated a radical programe to

deregulate and privatize the state centered

economy.

Investors who accepted the risk and stayed

back, prospered as Argentina became more

democratic.

Political risk assessment:

There are some risk analysis agencies, who

provide specialized services for country risk

ratings.

The widely used country risk ratings are:

Business Environment Risk Intelligence(BERI)

index and

Economic Intelligence Unit (EIU) Indices.

Managing political risks:

Avoiding investment: It is the simplest way to

manage political risk. Where investments have

already been made, plants may be shifted to

some other country which is considered to be

safe.

- This may be a poor choice since the

opportunity to do business in a country is lost.

2. Joint Ventures: Enter into joint ventures with

the local firms, the local partner ensures that

any adverse political developments do not

harm the business.

3. Development assistance: Offering

development assistance allows an

international business to assist the host

country in improving quality of life. Since the

firm and the nation become partners both

stand to gain.

4. Threat:

- Firm may manage political risk by controlling

critical inputs and threatening the host

country that it can’t do without the firm.

- This may be done by controlling raw

materials, technology etc.

5. Lobbying:

- Influencing local politics by hiring people to

represent a firm’s business interests.

Lobbyists meet the local public officials and

try to influence them on issues concerning the

firm.

Ultimate goal of a lobbyist is to get a

favourable legislation passed.

6. Insurance:

Companies may insure against the potential

effects of political risk.

Multilateral Investment Guarantee Agency

(MIGA), a subsidiary of the World Bank,

provides insurance against political risks.

Private insurance firms, such as Lloyd’s of

London, also underwrites political risk

insurance.

United Nations Commission on International

Trade Law (UNCITRAL)

UNCITRAL was established in 1966 by the UN

General Assembly with the aim to reduce

obstacles in international trade.

Its objective is to harmonize and unify the

laws of international trade.

‘Harmonization and Unification” of the law of

international trade refer to the process

through which the law facilitating

international trade is created and adopted.

Legal System

There are three main types of legal systems in

use around the world and they are:

Common law system

Civil law system and

Theocratic law system

Common law system:

It evolved in England over hundred of years. It

is now being followed in most of Great

Britain's former colonies, including US and

India.

It is based on tradition, precedent and

custom.

Common law system is more flexible than

other two systems.

Judges in the common law system have the

power to interpret the law so that it appeals

to the unique circumstances of an individual

case.

In turn each new interpretation sets a

precedent that may be followed in future

cases.

As new precedents arise, laws may be altered,

or amended to deal with new situations.

Civil Law System:

It is based on a very detailed set of laws

organized into codes.

When law courts interpret civil laws, they do

so with regard to these codes.

More than 80 countries, including Germany,

France, Japan and Russia operate with a civil

law system.

Judges under a civil law system have less

flexibility than those under a common law

system.

Judges in a common law system have the

power to interpret the law, while judges in a

civil law system have the power only to apply

the law.

Theocratic law system:

In this system, law is based on religious

teachings.

Islamic law is most widely practiced theocratic

law system in the world.

Legal systems differ from country to

country due to differences in tradition,

precedent and religious practices.

In many countries there are a number of

laws that control and regulate the conduct

of business.
International legal environment has three

aspects:

Home country laws

Host country laws and

International laws.

Home country laws:

Most of the international firms are familiar

with home country laws.

Companies generally do not face any problem

with home country laws.

Host country laws:

The deal with:

Labour legislations

Environment legislation

Government taxes

Repatriation of profits.

Local content requirements

Protection of local industries

Import / export restrictions etc.

International laws:

These include:

Treaties

Conventions

Agreement between the nations

IPR issues like patents, trademarks, copyright

etc

Provisions of UN resolutions

Multilateral trade agreements such as WTO.

In many countries with a view to protect

consumer interests regulations have

become stronger.

Regulations to protect the environment

and preserve the ecological balance have

assumed great importance in many

countries.
Some legal issues

International companies often customize their

products to comply with local legal standards.

Sometimes these standards could be very

stringent.

Product liability laws are very stringent in the

USA, the EU and in many other advanced

countries.

In developing countries product liability laws

could be less stringent.

Product liability and product safety cases

brought to US court- may involve payment of

huge damages- sometimes even resulting in

the closure of the firm.

Controls on marketing:

In many countries promotional activities are

subject to various types of controls.

In France, a manufacturer can’t offer a

product that it does not manufacture as an

inducement to buy one that it does.

In France, every word used in the advertising

must be in French, even if the French people

themselves use English.

Media advertising is not permitted in Libya.

Several European countries, restrain the

use of children in commercial

advertisements.

In a number of countries, including India,

the advertisements of alcoholic liquor is

prohibited.

Many countries prohibit cigarette

advertising.

Advertisements, including packaging of

cigarettes must carry the statutory warning

that “ cigarette smoking is injurious to

health”.

With effect from 1 June 2009- the packages

must carry the skull mark also in India.

In countries like Germany, product comparison

advertisements and the use of superlatives like

“best” or “excellent” in advertisements is not

allowed.

In USA, for drugs, food additives, some cosmetic

preparations- a full disclosure regarding the

ingredients used, long range side effects of the

materials used are to be disclosed.

Certain changes in government policies, such as

the industrial policy, fiscal policy, tariff policy etc.

may have profound impact on business.

Some policy developments create opportunities

as well as threats. (Ex- Reduction in tax structure

to some products and increase for other

products)

Local content requirement:

Some countries impose local content law to

pressurize foreign producers into using

greater share of a local content in their

products.

Intellectual Property Rights (IPR)

It is a general term for creative ideas,

innovation or intangible knowledge that give

owner’s a competitive advantage.

IPR’s refer to the right to control and derive

the benefits from writing (copyrights),

inventions (patents), processes (trade secrets)

and identifiers(trade marks).

The registered owner of a copyright would

have the legal right to decide who may copy it

and similarly the registered owner of a patent

would have the legal right to decide who may

use it for another purpose, such as

manufacture of a product.

An IPR specifies a period during which other

parties may not copy an idea, the innovator

can commercialize it to recoup initial

investments and get potential profits.

Unfortunately, the extent of product piracy

indicates just how it is hard to enforce,

protections such as IPR.

American companies loose up to $ 250 billion

annually to counterfeiting- mostly done in

China alone.

TRIPS- Trade Related Aspects of Intellectual

Property Rights- Code of WTO also provide for

stricter protection.

Most governments claim to abide by these

agreements but they seldom implement.

An international company is taking risk in

introducing products based on IPR.

The biggest problem remains the jurisdiction.

An IPR protected by, say a US Patent, trade

mark registration, copy right or design

registration extends only to the US.

It confers no protection in a foreign country.

The industrial liberalization policy in India have

opened up new opportunities and threats.

They have provided a lot of opportunities to a

large number of enterprises to diversify.

But they have also give rise to serious threats to

many existing products.

By way of increased competition, many sellers

markets have given way to buyers markets.

Child labour:

Child labour is a wide spread problem in

developing countries.

International Labour Office (ILO), a UN body

has issued standards and guidelines which the

member countries are expected to follow.

Most of the developed nations insist on strict

enforcement of ILO standards on child labour

with their trading partners.

Environmental Laws:
Environmental protection is becoming a

serious world wide concern.

There is growing concern over thinning of

ozone layer and global warming.

All nations are enacting legislations towards

environmental protection.

Environmental Issues:

In the first place, it is the rich countries that

talk about environment and enact laws to

protect the ecology.

Poor nations tend to oppose extensive

environmental regulation because it prevents

their ability to profit from less-sophisticated

technology(Ex- Carbon Emission).

Poor countries are more concerned about

growth than about environmental protection.

Second, wealthy nations enact environmental

laws to protect themselves from foreign

competition.

Third, rich countries ( developed countries)

have a vested interest in enacting

environmental laws and imposing them on

other nations.

It is the rich nations which manufacture high

technology pollution control equipments.

Developed countries are aware that

environmental industry is a big business and

the developing countries are forced to buy

these equipments from the developed

countries.

Economic environment:

Economic environment consists of:

Economic conditions.

Economic policies and

Economic systems

Economic conditions:

The economic conditions of a country for example

the nature of economy (inflation or recession),

the level of income etc are among the very

important determinants of business strategy.

In a developing country, the low income, and

unemployment may be the reason for the very

low demand for the product.

A firm can’t increase the purchasing power of the

people to generate a higher demand for its

products.

Hence it may have to reduce the price of the

product to increase sales.

It may even be necessary to develop a new

low-cost product to suit the low income market.

Ex- Colgate toothpaste economy pack for Rs.10/-

Shampoo packets for Rs.1/- etc.

Government Debt:

It is the sum total of a government’s financial

obligations, states borrowings from its public,

borrowing from foreign institutions, foreign

governments and from international

institutions.

The larger the total debt, a more uncertain is

the country’s economy. Interest expenses

divert money from more productive uses.

Economic policies:

The economic policy of the govt. has a very

great impact on bussiness.

Some types of bussiness are favourably

affected, some adversely affected, some

not affected at all by changing govt.

policies.

For example – a restrictive import policy or a

policy of protecting the home industries, may

greatly help the import competing / import

substitution industries.

Similarly, an industry that falls under the primary

sector / priority sector in terms of the govt. policy

may get a number of incentives and other

positive support from the govt. whereas those

industries which are regarded as inessential may

have the odds against them.

Economic system:

The scope of IB depends to a large extent

on the economic system.

The economic system can be classified as:

Free market economies- Ex- USA.

Centrally planned economies or

communist countries- Ex-China

Mixed economies – Ex- India.

The freedom of private enterprise is the

greatest in the free market economy.

The free market economy is not planned,

controlled or regulated by the Govt.

The govt. does not compete with private

firms, nor does it tell the industry what to

produce.

The completely free market economy is

however is an abstract system rather than a

real one.

Even the so called market economies are

subject to a number of govt. regulations.

The communist countries- have centrally

planned economic system.

Under the rule of a communist- the state

owns all the means of production,

determines the goals of production and

controls the economy according to central

plan.

In between the capitalist system and the

centrally planed system falls the system of

mixed economy- under which both the

public and private sectors co-exist.

Ex- India.

In many mixed economies, the strategic

and other nationally important industries

are fully owned or dominated by the state.

Socio-Cultural environment:

The buying and consumption habits of the

people, their language, beliefs and values,

religion, customs and traditions tastes and

preferences, education are all socio cultural

factors that affect business.

The marketing mix (4 P’s) will have to be

designed to suit the socio-cultural

environment characteristics of the market.

Religion:

Religion has a considerable impact in IB.

People go to any extent and practice

abnormal activities in the name of religion.

There are more than one million religions

across the globe and each has its own distinct

characteristics and followers.

Hinduism:
It is the only religion where wealth is

worshipped in the form of Goddess Lakshmi,

unlike in the west where richness is merely

respected.

From the time of Rig Veda, worldly wealth was

considered as morally desirable and essential

to lead a full and civilized life.

Christianity:

Protestantism- a branch of Christianity

advocates Capitalism- which is the dominant

economic philosophy.

It advocates hard work and encourages wealth

acquisition.

Islam:

Islam prohibits receipt or payment of interest.

Islamic banks have been experimenting with a

profit-sharing system.

Under this system, when a bank lends money,

the lending bank takes a share in the profit

earned by the business person instead of

demanding interest.
Similarly, a depositor of money will not get

interest from the accepting bank, but takes a

share of the profit earned by it.

Buddhism:

It has followers in China, Korea, Srilanka and

Japan.

Stresses spiritual achievement and wealth

creation is not encouraged.

There is not much stress on entrepreneurial

ventures.

Confusians:

It has followers in China, Korea, Taiwan and

Japan.

It teaches the followers to lower the costs of

doing business and this has largely

contributed to the economic success of Japan,

South Korea and Taiwan(Lean Manufacturing).

It teaches three principles- loyalty, reciprocal

obligations and honesty.

These principles helps organizations maintain

cordial employer-employee relations.

The employees of a Japanese company are

loyal to the organization and in reciprocal

obligation the organization gives them lifetime

employment.

The religion teaches that dishonest behaviour

fetches only short-term benefits.

Belief and preference:

In Thailand, Helen Curtis, switched to black

shampoo because Thai women felt that it

made their hair look glossier.

Nestle, a Swiss multi national company, brews

more than forty varieties of instant coffee to

satisfy different national tastes.

Even when people of different cultures use

the same basic product, the mode of

consumption, purpose of use or perceptions

of the product attributes vary.

Hence the method of presentation or method

of promoting the product may have to be

varied to suit the characteristics of different

markets.

Example- The mode of consumption of

Tuna fish, a seafood exported from India,

differs between the US and European

countries.

In America Tuna fish is used in sandwiches,

which accounts for about 80 % of American

consumption.

In Europe, which also accounts for high

tuna consumption, people eat it right from

the can.

Example 2- A very interesting example is that

of the Vicks Vaporub, the popular cold balm, is

used as a mosquito repellent in some of the

tropical countries.

Language:

The differences in language sometimes pose a

serious problem, even necessitating a change

in the brand name.

Mandarin (Chinese) is the most widely used

language in the world followed by English and

Hindi.

Worldwide there are 6912 living languages.

Papua New Guinea, a small country has the

highest number of 820 languages, followed by

Indonesia- 742 languages, Nigeria- 516

languages, India-427 languages and the USA

-311 languages.

Operating in linguistically diverse countries

make business communication much more

complex.

The lack of understanding of language has

resulted in several marketing blunders like:

Coca Cola was named “Ke-Kou-Ke-La”, when it

was first introduced in China.

Later the company found that the phrase

translated into Chinese meant “ Female horse

stuffed with wax”.

Subsequently the name was changed to

“Ko-Kou-Ko-Le”, which roughly translated as

“Happiness in the mouth”.

2 . Chevrolet’s very popular US car “NOVA”

failed miserably in Latin America.

Later the company found out that “NOVA”

meant “Do Not Move” in Spanish.

The company had to rename the model as

“CARIBE” for Spanish markets.

3. Pepsi’s slogan “Come alive with the Pepsi”

backfired in Taiwan and China, as it

inadvertently translated to “Pepsi will bring

your ancestors back from the grave”.

4. “Preett” was, good brand name in India but

it did not suit in the overseas market,

hence the name was changed to “Prestige”

for the overseas market.

Beliefs: The values and beliefs associated with

colour vary significantly between different

counties:

1. Blue- is considered as feminine and warm in

Holland, but as regarded as masculine and

cold in Sweden.

2. Green- is favourite colour in the Muslim

countries, but in Malaysia, which is a

Muslim Country, it is associated with

illness.

3. White- indicates death and mourning in

China and Korea, but in UK and in some

other European countries, it expresses

happiness and is the colour of the wedding

dress of the bride.

4. Red- is a popular colour in the communist

countries, but many African countries, have a

national distaste for the colour.

Social stigmas: Social stigma associated with

the use of bio gas for cooking purpose.

In the above circumstance, the success of

marketing depends to a large extent, on the

success in changing social attitudes or value

system.

The company’s are also expected to be

socially responsible and is expected to

follow "Corporate Social Responsibility”.

To day in addition to its traditional

accountability for economic performance

and results, the business is being asked to

take responsibility for the quality of life in

our society.

As more and more the society becomes

educated, the more and more marketing

becomes involved in social issues.

Marketing personnel are at interface

between company and society.

In this position they have the responsibility

not only for designing a competitive

marketing strategy , but also for sensitizing

business to the social, as well as the

product demand of society.

Demographic environment:

The various demographic factors are:

Growth rate.

Age composition

Sex composition

Size of population

Family size

Educational levels etc.

The above factors affect the demand for

goods and services.

Markets with growing population and income

are growth markets.

The decline in birth rates- in some of the

developing countries like US- have affected

the demand for baby products.

Johnson & Johnson have overcome this

problem by repositioning their products

like baby shampoo, baby soap- promoting

them to adult segment, particularly to the

females.

A rapidly increasing population indicates a

growing demand for many products.

Growing markets in developing and Less

Developed Countries have encouraged

many multinational corporations to invest

in developing countries.

Physical and technological factors:

Physical factors:

Physical factors such as geographical

factors, weather and climatic conditions

may call for a modification in the product

to suit the environment because thee

environmental factors are uncontrollable.

For example- Esso adapted its gasoline

formulations to suit the weather conditions

prevailing in different markets.

Business prospects also depend upon on the

availability of certain physical facilities.

The demand for refrigerators and other

electrical appliances is affected by the extent

of electrification and the reliability of power

supply.

The demand for LPG gas stoves is affected by

the rate of growth of gas connection.

Technological factors:

A firm which is unable to cope up with the

technological changes may not survive.

Example- Pagers, Kodak films

Technology forces change on people whether

they are prepared for it or not.

Sometimes the change comes so fast, that

organizations can’t cope up with the change.

A feature of technology is it is self-reinforcing-

meaning it feeds on itself, technology makes

more technology possible.

It has a multiplier effect-invention in one place

leads to a sequence of inventions in other

places.
Impact of technology:

High expectations of consumers:

Because of technological advancements,

consumers demand superior products which

calls for substantial investments in R&D.

High expectations of consumers pose a

challenge as well as an opportunity for

business.

Jobs tend to become more knowledge based:

With the advent of technology, jobs tend to

become more sophisticated. A job earlier

done by a semiskilled worker now requires a

skilled and competent worker.

A creative destructor:

A new technology may promote a major

industry but it may also destroy an existing

one.

Example: Photocopiers hurt carbon-paper

business, mobile phones hurt pagers etc.

Technology also has a life cycle similar to a

product like- introduction, growth, maturity

and decline.
Technology has reduced the product life cycle.

Natural environment:

Factors such as topography, port facilities etc

are all relevant to bussiness.

Topographical factors may affect the demand

pattern.

Hilly areas with a difficult terrain, jeeps may

be in greater demand than cars.

A company has to carefully carry out an

environmental scanning considering all the

PEST factors and formulate appropriate

strategies in order to survive in a foreign

market.

Business:

Any revenue generating activity can be

termed as business.

In other words any commercial transactions

can be termed as business.

Hence business can be defined as any activity

involving any or combination of the following:

Marketing
Production

Sourcing / buying

Logistics and supply chain management

Consultancy

When these activities are carried out within

the political boundaries of a country it is called

as domestic business.

When these activities are carried out across

the political boundaries of a country it is

termed as International Business.

International Business is not mere exports. It is

much wider in scope .

IB is all those business transactions that involve

the crossing of national boundaries that include:

Marketing of products in different parts of the

world.

Production bases across the world

Joint ventures with companies across the globe.

Mergers / acquisition / take over of firms in other

countries

Technology acquisition

Transactions involving intellectual properties

such as copyrights, patents, trade marks etc.

Evaluation of International Business

Trade is so old that one can’t really say when

it began.

World trade existed in Babylon, Mesopotamia,

Euphrates and Tigris in 3000 BCE, thousands

of years before Christ.

World trade also existed in Egypt, Indus River

Valley and in China.

International business flourished within

Roman empire and soon outside nations

that were not part of the empire decided to

join as allies.

These nations agreed to pay taxes to the

Roman empire to do business with the

Romans.

The immense growth of the empire

occurred mainly through the linkages of

business.
International trade was also very much

prevalent in ancient India.

Trade across the seas was popular by the time

of the Buddha.

By the time of Buddha sailors had navigated

the subcontinent, and made contacts with

Burma, Malaya (present Malaysia) and

Indonesia.

Spain and Portugal discovered sea routes to

Asian countries in 14 and 15 centuries.

Vasco da Gama reached India by sea in 1498.

Soon England, France and Portugal

monopolized the sea routes and many

countries became the political colonies of the

above countries.

By the middle of 18 th century, Briton

became the undisputed world economic

power due to Industrial Revolution.

This is due to the discovery of steam

engine, technical progress in textiles, iron

and steel.

Industrial base and the wealth plundered

from the colonies made Briton the world’s

first industrial country.

By mid 19 th century, England accounted

for about 40% of the world trade.

The earliest Multi National Enterprises were

mainly European firms ( England, France,

Portugal and Spain), setting up manufacturing

facilities in the colonies to extract primary

resources for conversion to finished goods

back home.

The Dutch and British East India

Companies-perhaps among the earliest Multi

National Enterprises in the world.

They were also closely connected with the

globalization of South Asia.

By the beginning of 20 th century United

States of America, became the world’s

greatest economic power due to its market

oriented policies

Currently about 25% of world production is

sold outside the country of origin, as

opposed to about 7% in 1950.

Nearly all business enterprises, large and

small are inspired to carry on business

across the globe.

Why study IB?

Today global events and competition affect all

most all companies- large or small- because

most of them sell their outputs to and source

supplies from foreign countries.

Many companies also compete with products

and services that come from abroad.

Most managers, regardless of industry or

company size, need to approach their

operating strategies from an international

perceptive.

A manager in any industry needs to

consider where to obtain the inputs (global

sourcing), desired quality and at what best

possible price and where to sell the

products more profitably.

In this present globalization era, a manager

needs to know about:

Best management practices across the globe.

Best human resource practices

Best supply chain, logistic management,

inventory management practices.

Orientation in IB

Classification of firms based on orientation:

The EPRG frame work identifies four types of

attitudes or orientations in IB:

Ethnocentrism( Home country orientation).

Polycentrism(Host country orientation).

Regiocentrism(Regional orientation) and

Geocentrism(World orientation).

- The above stages reflect the philosophies of the

companies leading to different management

strategies.

Ethnocentric orientation:

Overseas operations are viewed as secondary

to domestic operations and primarily as a

means of disposing of surplus domestic

production.

The management feels that home country

personnel and domestic techniques are

superior to foreign personnel and techniques.

Overseas operations are conducted from a

home county base.

This type of approach is suitable for a small

company, just entering IB or for companies

with minimal international commitments.

This involves minimum risk.

However this approach may not be suitable

for a company which wants to expand its IB .

Polycentric orientation:

The philosophy in this approach is that local

personnel(host country) and techniques are

best suited to deal with local market

conditions.

This approach emerges, as company begins to

recognize the importance of inherent

differences in overseas markets, polycentric

attitude emerge

Host country’s employees are hired and the

environment of each market is considered

while formulating the marketing strategy.

The important merit of polycentrism is the

adoption of the marketing strategies to the

local conditions.
Regiocentric orientation:

The company views each region with certain

important common marketing characteristics.

Strategy planning, organizational approach

and product policy tend to be implemented at

regional level.

A regiocentric company views different

regions as different markets, ignoring national

boundaries.

Ex- South East Asia, Gulf region etc.

Geocentric orientation:

A geocentric company views the entire world

as a single market and develops standardized

product mix for the global market.

However, in both regiocentric and geocentric

orientations, national environment

constraints, may restrict multinational

operations and make the approach unfeasible.

For example national differences in laws and

currencies may severely hinder any practical

implementation of this “World Market”

perspective.
Modes of foreign entry

When companies decide to globalize, they

typically follow one of the three approaches:

Produce at home and export abroad.

Enter into a contractual agreement, such as-

licensing, franchising or management

contract- without actually owning significant

value of assets abroad.

3. Own and control assets abroad by having a

Joint Venture or through majority ownership.

This is done through:

Building from scratch, also known as “ Green

Field Investment” or

Acquiring a foreign asset called as “Foreign

Direct Investment”.

Modes of foreign entry

Produce at home

And export

Produce Abroad
Licensing

Franchising

Management contracts

Maintain control over

Assets abroad

Joint Venture

Majority or wholly

Owned Affiliate

Build from

scratch

Acquire or Merge

Modes of entry- Explanation

Export

International licensing

Franchising

Contract manufacturing
Contract marketing

Management contracts.

Strategic Alliances

9. Foreign Direct Investment.

10 . Mergers and acquisitions

11. Take over and

12. Turnkey projects.

International Licensing:

It is an agreement between the licenser and

the licensee over a period of time for the use

of brand name, know-how, copyright, work

method and trade mark by paying a license

fee.

Example- British American Tobacco

Company(BATC) has given licenses in many

countries for the manufacture of their brand

of cigarettes “555”. In India, ITC is the licensed

producer of “555”.

Example- Samsung and Apple have cross

licensed several models of their iPhones.

The licenser has minimum involvement in

day-to-day functions. Therefore the return are

also comparatively low.

Licensing specifies the territory as well as

period.

The licenser gives such permission after

establishing such a commendable position

globally.

It involves brand command.

Franchising:

It is a form of licensing wherein the

franchiser exercises more control over

franchisee.

The franchiser supplies the main part of the

product and provides the following services

to the franchisee:

Trademark.

Operating systems

Product and

Brand name.
Company support systems like, advertising,

training of employees, quality assurance

knowhow are also involved in franchising.

Example- McDonald, Domino Pizza and KFC

are known franchise brands.

In practice, the franchiser is determined to

maintain a standard throughout the world in

terms of quality, brand, logo and symbol.

But the product is adoptable depending on

the socio-cultural background of the country.

McDonalds sells beef burgers in Russia and

vegetable burgers in India.

Contract Manufacturing:

Many companies outsource their products

and concentrate mainly on marketing.

Contract manufacturing is the strategy of

identifying a manufacturing unit to produce

items at a competitive price in any part of the

world.

Nike- is procuring its footwear in a number of

countries in South East Asia.

Japanese electronics giant Sony is planning to

“Make in India” through contract

manufacturing. It is likely to tie up with

Foxconn, a Taiwanese manufacturer, who is

setting up facilities in the country.

Contract manufacturing in service sector offer

ample opportunities for Indian companies in

the form of Business Process Outsourcing

(BPO).

Contract Marketing:

Companies which are strong in production,

may not have equal marketing strength.

They select good marketing firms around the

world to market their products.

Example- Thermax, Ion-Exchange and

Supreme Industries have selected marketing

firms in other countries, which have a good

background with technology support.

Management contracts:

Companies with a low level of technology and

management expertise may seek the assistance of

foreign firms.

Management contract is an agreement between

two companies, whereby one company provides

managerial and technical assistance for a

monitory compensation.

Exxon is a major operator in gulf region in the

field of oil exploration.

Delta Airlines, Air France offer their services to

developing countries.

Port of Singapore Authority (PSA) has entered

into a management contract with JNPT, Navi

Mumbai for the management of the fourth

terminal, which is under construction with

35.7% revenue sharing agreement.

Strategic alliances

A strategic alliance is an agreement between

two or more organizations to pursue a set of

objectives which are mutually agreed upon.

Through strategic alliances, companies can

improve their competitive positioning, gain

entry into new markets, supplement critical

skills, and share the risk and cost of major

development projects.

Strategic alliances can be of different kinds,

depending on the objectives.

1. Collaboration

It is an arrangement between two or more

companies who agree to work together to achieve

a common goal.

The organizations remain independent and retain

their control over their organizations.

The strategic alliance partners do not create a

new entity.

Different kinds of collaborative agreements can

be entered by companies depending on their

requirements.

Examples of two types of collaborations that can

be entered by the companies are explained

below:

a) Technical collaboration

It is an agreement in which one company agrees

to provide technical knowledge or sophisticated

machines and other kind of technical assistance to

another company, for a specific fee or on certain

payment terms.

Example:

L & T Ship Building Ltd., the ship building arm of L

& T Conglomerate has signed a technical

collaboration agreement with Mitsubishi Heavy

Industries Ltd (MHIL)., Japan.

As per the agreement, MHIL will provide licensing

and technology support to L&T for ship building.

b) Marketing collaboration

It is an agreement between companies, in

which one company agrees to market the

products of another company in domestic or

international markets on certain payment

terms.

Marketing collaboration can promote exports.

2. Joint venture

It is another type of collaborative

agreement. It is formed between two or

more companies with a long term

perspective.

Companies pool their resources to create a

separate business entity. A joint venture is a

binding contract between two or more

venture partners to set up a project in a

home country or in a host country or in a

third country.
A joint venture is a binding contract between

two venture partners to set up a project in a

home country or host country or a third

country. In this case both parties are

committed to share risks and profits.

Examples:

Tata SIA Airlines – a full service airline called

Vistara- is a joint venture between Tata Sons

Limited and Singapore Airlines Limited in

which Tata Sons Limited owns 51% equity and

the remaining by the Singapore Airlines

Limited.

Foreign Direct Investment:

FDI is an activity by which an investor, who is

resident of another country, obtains a lasting

interest in, and has a significant influence on the

management of an entity in another country.

Practically, FDI represents foreign assets in

domestic structures, equipment and organization.

It does not include foreign investment in the stock

market.

Examples:

Ford Motor Company, USA has invested US $

2 billion through FDI in India through its

wholly owned subsidiary Ford India Private

Limited in Chennai, Tamil Nadu and in Sanand,

Gujarat.

Vodafone Group, UK has invested through FDI

in India through its 100% subsidiary Vodafone

India Limited, head quartered in Mumbai.

Mergers

It is the process of bringing two companies

together or merging two companies together

into one company, where one company loses

its identity. In this the assets of the two

companies become vested under the control

of one company.

In case of amalgamation, two or more

companies come together to form a new

company. The amalgamated companies lose

their individual identity.

India’s two leading pharmaceutical

companies, Sun Pharmaceuticals and Ranbaxy

Laboratories, merged in April 2014. The

merger deal was for a consideration of USD

3.2 billion, which is considered to be one of

the biggest mergers of the country.

The merger will make Sun Pharmaceuticals

world’s fifth-largest generic pharmaceutical

company with almost Rs. 30,000 crore in

combined revenue, with operations in over 55

world markets with 40 manufacturing facilities

worldwide.

Takeover:

This a strategy whereby a company identifies

a healthy unit with a strong brand name and

network and brings it under the management

of another unit in order to become a leader in

the field and guarantee success.

Since there may be many parties wanting to

take over a well known company, competition

becomes inevitable.

It is obvious that only one entity will win and

the winner has to withstand hostilities.

Therefore the process is called a “ hostile take

over" and the winner is called the “takeover

tycoon”.

Well known examples are :

The take over of thumps up by coca cola.

Take over of Brook Band and Lipton by

Unilever.
Unilever’s take over of Brook Band and Lipton

enhanced its position as a leader in the tea

industry in India.

Takeover / acquisition

This is adapted as a growth strategy in which a

financially strong company acquires all the

assets and liabilities of another company.

Takeover is also a form of acquisition. There

are two types of acquisition or takeovers:

Friendly takeover / acquisition: In this the

target company is formally informed about

the acquisition and there is an agreement on

corporate management and control of

financial issues.

Example:

Tata Motors of India acquired Jaguar Land

Rover, UK, owned by Ford Motor Company for

a net consideration of USD 2.3 billion in 2008.

Hostile takeover / acquisition: The owner loses

the ownership and control of the company against

his / her wishes. Usually a company can become a

target for hostile takeover when the promoters’

holding is less than 25%.

Take over of ‘Mind Tree’ by L & T Infotech- a

hostile take over.

Turnkey Projects:

It is a contract under which a company is fully

involved from concept to completion.

It covers right from supply of manpower,

capital and errection of plant, installation and

commissioning up to the trial operation of a

project.

A turnkey operation is an agreement by the

seller to supply a buyer with a facility fully

equipped and ready to be operated by the

buyer’s personnel, who will be trained by the

seller.

A turnkey contractor may subcontract

different parts of the project.

Example- Oil refineries, cement and fertilizer

plants etc.

Examples:

L & T of India has taken up turnkey airport

projects in Abu Dhabi and at Salalah in Oman.

ExxonMobil of USA has taken up several oil

refinery turnkey projects in the Middle East.

Mitsubishi Corporation of Japan has bagged

the turnkey contract to construct a steel plant

for Steel Authority of India at Rourkela,

Odisha.

Factors considered while deciding the mode of entry

A firm is likely to choose JV, Majority ,Wholly

Owned , build from scratch methods under

the following circumstances:

When there is asset specificity- the asset

involved in the transaction can’t be

redeployed to alternative uses without loss in

value.

2. There is likelihood of greater frequency of

interaction between the parties to the

transaction.

3. There is uncertainty surrounding the outcome of

an arms length transaction (less involvement).

- This approach is preferred in knowledge based

assets such as technology and Managerial Skill

etc.

A firm may adopt arms length approach- like

licensing, franchising or export under the

following situations:

When its activities can be affected by the

authority of sovereign state.

When the company is in the initial stages of

internationalization.

Internationalization process

Most companies pass through different

stages of internationalization.

The important stages in the evolutionary

process are as follows:

Domestic company.

Primarily domestic with some direct or

indirect export / licensing / franchising etc.

3. International company.

4. Multinational company

5. Global company and

6. Transnational company.

International company:
Mainly indulge in exports and imports, they

have no investment outside of their home

country.

The orientation of the company is basically

ethnocentric.

Marketing strategy is extension.

Marketing mix developed for the home

market is extended into foreign markets.

The company concentrates on those foreign

markets where it can sell the same products

as sold in the home market.

Multinational company:

When the orientation shifts from ethnocentric

to polycentric, the international company

becomes multinational.

MNCs have investment in other countries.

When the company decides to respond to

market differences, it evolves into a MNC.

The MNC pursues a multidomestic strategy

and formulates a unique strategy for each

country.
The marketing strategy of the MNC is

Adaptation.

Global company:

The global company will have either a global

marketing strategy or a global sourcing strategy

but not both.

Generally one corporate office is responsible for

global strategy.

It will either focus on global markets and source

from the home or a single country to supply these

markets, or it will focus on the domestic market

and source from the world to supply its domestic

channel

Example: Dr. Reddy’s Laboratory.

Transnational company:

Much more complex. Have a central corporate

office, but give decision making, R & D and

marketing power to each individual foreign

subsidiary.

It links global sourcing strategy with global

marketing.
Each subsidiary carries out its business on a local

for local basis.

They completely adopt to the local countries and

hence the word “National”.

Example: Sony

Entry into foreign markets need not take place

sequentially and in stages- with the firm

testing the international market by exporting

and finally evolving into a mature Multi

National Enterprise-deciding to undertake FDI

abroad.

But it need not always happen in the above

sequence.

How firms go abroad, or their mode of entry is

also determined by location or host country

specific factors- like political factors-

government attitude, taxation, incentives etc.

Hence a firm may be exporting to country ‘X”,

licensing in country “Y” and producing in

country “Z”- since the situation and advantage

may be different in different countries.

In other words, entry can be non-sequential,

depending on the characteristics of the

location.
Location Economies

Each country is different in many ways (like

PEST factors) and these differences can either

raise or lower the costs of doing business in a

foreign country.

In a competitive global market trade barriers

and transportation costs also play a vital role

in enterprise value creation.

The firm will benefit by locating each value

creation activity it performs at that location

where economic, political and cultural

conditions are most conducive and

economical.

Hence if best designers for a product are

available in France, a firm should base its

design activities in France.

If the most productive labour force for

assembly operations is in Mexico, assembly

operations should be based in Mexico.

If the best marketers are in USA, the

marketing strategy should be formulated in

the USA and so on.

Firms that pursue such a strategy can realize

“Location Economies”, which are economies

that arise from performing a value creation

activity in the optimal location for that

activity.

Creating a Global Web

It is the process of creation of Global Web of

value creation activities, with different stages

of the value chain being dispersed to those

locations around the globe, where perceived

value creation are maximized.

Example: Consider IBM’s ThinkPad X 31 laptop

computer.

This product was designed in the USA by IBM

engineers because IBM believed that the USA

was the best location in the world to do the

basic design work.

The case, keyboard and hard drive were made

in Thailand.

The display screen and memory were made in

South Korea.

The built in wireless card was made in

Malaysia.

The microprocessor was manufactured in USA.

These components were shipped to an IBM

operation in Mexico, where the product was

assembled.

Finally it was shipped to USA for final sale.

Reasons to enter IB:

All organization’s irrespective of their size,

are keen to enter into IB.

The governments of many countries are

also want to make their economy grow

through IB and hence IB has become an

inevitable part of their economic policy.

The objectives behind IB can be classified

under two categories:

From an individual company’s angle and

From the government’s angle.

From the individual company's angle:

Managing the product life cycle:

All companies have products, which pass

through different stages of their life cycles.

When the product reaches the last stage of life

cycle called the declining stage in one country, it

is important for the company to identify other

countries where the product could be in other

stages.

For example, Enfield India reached maturity

and declining stage in India for the 350 cc

motorcycle. The company entered Kenya,

West Indies, Mauritius and other places

where the heavy engine two-wheeler

became popular.

The Suzuki 100 cc vehicles reached the last

stage of its cycle in Japan and entered India

in the early 1980’s, where it is still doing a

good bussiness even today.

2. Spreading the risk:

Only depending on the domestic market

could be risky due to reduced demand over

a period of time.

New competition entering the field may

also impact the demand for the products.

3. Survival:

Most of the countries are not as fortunate

as US, in terms of market size, resources

and opportunities and they must trade with

others to survive.
Hong Kong- without food and water from

China , could not have survived.

Middle east countries even for their basic

needs, heavily depend on other countries.

Most of the European nations are very

small in size, hence limited domestic

market, without foreign market they can’t

survive.

Nestle does only 8 % of its bussiness in its

home country Switzerland and rest of the

bussiness comes from other countries.

4. Geographic expansion as a growth strategy:

Even if companies expand their business at home,

they may still look overseas for new markets and

better prospects.

Ex- Arvind Mill expanded by setting up

warehouses abroad.

Ranbaxy’s growth is mainly attributed to

geographic expansion every year to new

territories.

Other examples- Arabindo Pharma, Cipla, Dr.

Reddy’s Laboratory.
Toyota, Samsung, Nokia, LG etc.

5. Corporate growth :

Every corporate in the world has strategic

plans to multiply its sales turnover.

Incase some of the ventures fail, others will

offset the losses because of multi-locational

operations.

For example- Coca cola is still today not

earning any profit in a number of countries.

But this will not affect the company

because more than a hundred countries are

contributing to offset its losses.

Kellog’s can’t think of profits in India for

another couple of years.

6. Technology advantage:

Some companies have outstanding technological

advantage through which they enjoy core

competency.

There is a need for such technology in other

countries.

Biocon- core competency- Bio-technology.

Gharda Chemicals- core competency- Pesticides.

Other examples- Thermax, ion exchange, L&T etc.

Samsung, Nokia, Apple etc.

7. Incentives offered by governments:

Host country governments offer fiscal,

infrastructure and other incentives to

attract IB.

The Aditya Birla group enjoyed such

benefits in Thailand and Indonesia.

8. Labour advantage:

Many countries have highly skilled, cost effective

and highly productive labour force. Their unique

skills may not be available throughout the world.

Ex- Diamond industry- 11 out of 12 diamonds are

polished in India.

Knitwear(Tiruppur) carpet weaving, cashew

processing and sea food India has the relative

advantage.

9. Emergence of SEZ’s, EOU’s etc:

After seeing China’s success many

countries including India have set up SEZ’s,

EOU’s and Technology Parks.

The companies which set up their

operations in these zones enjoy many

benefits and competitiveness.

From the government point of view:

Earning valuable foreign exchange (Forex):

Forex earning is necessary for any country. If the

exports are high and imports are low (trade

surplus), it indicates a surplus balance of payment.

On the other hand, if imports are high and exports

are low (trade deficit) it indicates an adverse

balance of payment, which all economies would

want to avoid.

2. Interdependency of nations:

India depends on Gulf regions for crude oil, and in

turn, the Gulf countries depend on India for tea,

rice etc.

Developed countries depend on developing

countries for primary goods, where as developing

countries depend on developed countries for

value added finished products.

No single country is endowed with all the

resources to survive on its own.

3. Diplomatic relations:

Diplomacy and trade always go hand in

hand.

Many sovereign nations send their

diplomatic representatives to other

countries for promoting trade.

4. Core competency of nations:

Some countries are endowed with some

resources. Such countries can compete well

anywhere in the world.

Rubber products from Malaysia, knitwear

from India, rice from Thailand and wool

from Australia are some examples.

India has core competency in IT also.

5. Foreign trade policy and targets:

All developing and less developing countries

want to improve their economic condition

through foreign trade.

They announce favourable trade policies to

boost foreign trade. High targets are set for IB.

India’s FTP for 2015-20 places highest

importance for promoting foreign trade in the

five year period.

6. WTO and international agencies:

The apex body world trade, WTO is striving

for freer and transparent world trade.

WTO is also working for the elimination of

tariff and non-tariff barriers to promote

harmonious world trade.

Similarities between domestic trade and IB:

Both aim for customer satisfaction.

Both carry out their operations, respecting

and adhering to local regulations.

Both generate employment opportunities.

Both are subject to a set of code of conduct

and ethics that include corporate

governance.

Differences between domestic (DB) and IB:

Environment:

PEST environments are known in case of

DB.

The environment is not fully known. Many

hidden factors may emerge from time to

time and may pose problems in case of IB.

Plan and Strategy:

Can be worked out for short terms and

carried forward to long term in case of DB.

Only long term strategy will work in case of

IB.

Ex- Pepsi operations in India.

Honda ( earlier JV with Hero).

Currencies and their movements:

Little impact in case of DB.

The currency unit varies from nation to

nation. This may sometimes cause

problems in currency convertibility.Also

there could be problem in exchange range

fluctuations. Foreign exchange control may

vary from country to country in case of IB.

Legal aspects:

Only local regulations are applicable in case

of DB.

IB is subjected to:

1. International regulations

2. Host country regulations and

3. Sometimes home country regulations

are applicable.

Pricing strategy:

A majority of companies use cost plus

margin pricing or competitive pricing in

case of DB.

In case of IB companies use :

1. Marginal cost pricing

2. Transfer pricing

3. Competitive pricing

Bussiness risks:
Can be predicted, more or less accurately in

case of DB.

Very difficult to predict, risks may crop up

due to political, the society itself and

several other unknown factors.

Promotion:

Advertising or other promotional methods

are not restricted, if they are not socially

objectionable in case of DB.

Different countries have different

restrictions in case of IB.

Special difficulties in IB:

Differences in languages – Even when the

same language is used in different countries,

the same words or terms may have different

meanings.

Trade restrictions.

High costs of distance.

Differences in Political, legal, Economical,

Social, Cultural and Technology Environments.

Reasons for foreign trade

The natural resources of the world are

unevenly distributed.

One country possess product “X” in surplus

and lacks in respect of product “Y”. In another

country the reverse may be true.

Example:

Concentration of resources such as oil in the

middle east.

Abundant availability of diamond in South

Africa.

Hence uneven distribution of resources make

foreign trade inevitable and desirable.

Trade Theories

Hence it is a fact that foreign trade between countries

existed for thousands of years.

But it was not until the 15 th. Century that people

tried to explain why trade occurs and how trade

benefits the countries.

Trade theories try to explain why trade between

countries take place.

These theories are getting modified and new theories

are being developed.

Trade Theories

Classical Trade Theories

Modern Trade Theories

* Theory of Mercantilism

* Modern / New Trade Theory

* Theory of Absolute Advantage

* Factor Endowment / Theory

* Theory of Comparative Advantage

of National Competitive Adv.

* Factor Endowment Theory

* Product Life Cycle Theory

Michael Porter’s diamond theory.

This theory says that firm’s home country

environment is responsible for developing

competencies and innovations.

Michael Porter, Professor of Harvard, studied

100 companies in 10 developed countries to

learn how a firm can become competitive.

This is also called as “Theory of Competitive

Advantage” or “Theory of National

Competitive Advantage.”

According to Porter, a company which enjoys

competitive advantage is in a stronger position

to trade with other countries.

Porter says firm’s competitive advantage stems

from the following factors:

Factor conditions and endowments

Firm’s strategy and rivalry

Demand conditions

Related and supporting industries and

Government’s role.

Chance factors

Porter’s Diamond Model

Government’s Role

Factor conditions &

Endowments
Firm’s strategy ,

Structure &

Rivalry.

Demand conditions

Related & Supporting

Industries.

Chance

Factor conditions and endowments:

Factor conditions include land, labour, natural

resources, capital and infrastructure.

These factors will give initial competitive

advantage to a nation.

Porter says sustained competitive advantage

comes from advanced factors like skilled labour,

capital and infrastructure. These are created but

not inherited.

Specialized factors are difficult to duplicate and a

firm that possesses these factors enjoys

competitive advantage because others can not

easily replicate them.

Porter also argues that lack of resources often actually

help countries to become competitive.

Abundance generates waste and scarcity generates an

innovative mind set. Such countries are forced to

innovate.

Example: Drip irrigation system by Israel.

Demand conditions:

A sophisticated and demanding domestic market is

an important requirement to achieve international

competitiveness.

The firms that have demanding domestic

consumers are likely to sell superior products

because the market demands high quality.

Example: The French consume excellent quality

wine. These consumers force their wine industries

to produce excellent quality wine.

Related and supporting industries:

Related and supporting industries enhance the

competitive advantage of a firm through close

working relationships, joint research, sharing of

knowledge and experience. This includes presence of

suppliers also.

Example: Automobile hub around Chennai and Pune.

Firm’s strategy , structure and rivalry:

Intense competition spur innovation resulting

in improved efficiency.

Domestic competition makes the companies to

seek opportunities to reduce cost, improve

quality and come out with innovative ideas and

products.

Rivalry induces firms to look for ways to

improve efficiency.

Structure refers to the management styles

and hierarchy in decision making process.

An appropriate structure depending on the

market conditions can provide necessary

advantage to the firm.

Government role:

Government can influence all four of Porter’s

determinants through subsidies and favourable

tax rates.

India’s case is typical. Till 1991, Indian firms

were protected from competition and remained

almost morbid. The scenario changed after

1991.

Porter says instead of protecting domestic

industries through trade barriers,

governments should focus on improving the

other four components of the diamond.

This helps the firm to acquire competitive

advantage.

In addition to these basic five factors Porter

also says that “ Chance” factor also plays a

vital role in providing a competitive advantage

to firm.

Chance refers to random events such as major

technological breakthroughs ( Example-

Android platform used by Samsung gave a

tehnological advantage over its main

competitor- Nokia), war and destruction and

sudden discovery of some disease etc.

These chance happenings either enhance or

impede competitiveness of firms.

Utility of Porter’s theory:

Porter’s theory can be used to predict the

pattern of international trade that we observe

in the real world.

Countries should be exporting products from

those industries where all five components of

the diamond are favorable, while importing in

those areas where the components are not

favorable.

Limitations of Porter’s theory:

Porter developed his research based on case

studies and these tend to apply only to

developed countries.

Porter’s model does not adequately address

the role of MNC’s.

Usefulness of trade theories

All the trade theories try to explain the importance of

international trade.

They also try to identify the factors which are

responsible for promoting trade.

Trade theories also influence the governments to

understand the importance of free trade and may

make them to remove trade restrictions and promote

free trade.

For an international manager , whose company

is willing to set up a subsidiary in a foreign

location, knowledge about the trade theories is

useful.

In order to prepare a project report and defend

the proposals when doubts are raised by the

overseas officials, international managers need

to understand the trade theories.

Application of Porter’s model

India has acquired national competitive

advantage in IT industry. India is one of the

leading exporters of IT related products and

services.

Porter’s model can be used to explain the

reasons for the competitiveness of the

industry.

Factor endowments

Land: Adequately available. Land is available at prime

locations also.

Skilled workforce: India has substantial number of

people qualified and trained in IT. This skilled

workforce is available in plenty. Since the supply of

skilled people far exceeds the demand, the skilled

workforce is available at a reasonable cost.

Capital: Establishment of IT industry is knowledge

based and not much capital is required. Funding is

also available through banks, financial institutions

and venture capitalists.

Demand conditions

There are many well established and

performing IT industries like TCS, Infosys,

Wipro, Tech Mahindra, L&T InfoTech etc.

These industries demand and recruit people of

caliber and expertise.

The people seeking employment in these

companies are motivated to acquire and

enhance their domain expertise.

Related and supporting industries

India has one of the largest number of professional

colleges, spread all over the country. These colleges

are producing a large number of qualified IT

engineers every year.

In addition to these professional colleges there are

many professional training institutes like Aptech,

NIIT, CMC etc providing advanced IT related training.

They are many Indian and MNC companies

producing the entire range of IT related products and

accessories.

Firm’s strategy, structure and rivalry

There is immense and healthy competition between

the IT industries in India.

Each company is providing advanced training to its

employees to derive competitive advantage over the

rivals.

Companies suitably compensate the employees to

retain them.

Companies are also forced to innovate and focus on

research and development to remain relevant and

competitive.

Government support

Government of India is extending a plethora

of incentives, benefits and tax concessions to

promote exports from IT sector.

Software Technology Parks and Special

Economic Zones are established to encourage

exports from IT sector.

From the above it can be observed that all the

four components of Porter’s diamond are

favourable for IT industry in India.

In addition to the major components of the

diamond, the fifth component-government is

also extending its support to the IT industry.

Hence India has acquired national competitive

advantage in IT products and services and is in

an advantageous position to export IT related

products and services.

Countries offer different opportunities for

firms to create value for themselves.

Countries also differ in the risk, that

company’s face.

Selecting the right location is important for

the companies to maintain a competitive

advantage.

Before entering into a new market, a firm has

to make the following decisions:

In which country to locate sales, production,

administrative and auxiliary services.

The mode of entry and

The resources to be allocated to each

country where it operates.

In selecting locations for international

operations, a company should analyze three

factors:

Its objectives

Its competencies and

Its comparative environmental fit (internal

environment of the firm) with the

environment of the country under

consideration.

Scanning Technique

Scanning technique is used to compare

countries on broad parameters of

opportunities and risks / threats.

Without scanning, a company may:

Overlook opportunities and risks and

Examine too many or too few possibilities.

Starting a business venture in an overseas

location is a risky decision.

The decision making process basically involves

two factors:
Examination of external environment of

proposed locations (PEST) and

Comparing each of them with the company’s

objectives and capabilities.

Steps in Scanning

Step I:

Scan all the countries broadly and then

narrow them to the most promising ones.

In this stage, the already available information

regarding the country is made use of.

People who have knowledge and experience

of the country are consulted.

Countries are short listed based on the best fit

with the companies resources and objectives.

Step II:

It is the detailed analysis.

After initial scanning, a few promising

countries are selected.

On site visits are paid to short listed countries

to collect more specific information.

Detailed examination of country conditions-

which reveals both opportunities and risks- are

thoroughly examined.

Opportunities:

Opportunities can be discussed under the

following factors:

Sales expansion and

Resource acquisition

Sales expansion:

Expansion of sales is the important factor,

which motivate companies to enter in IB.

Sales potential can be estimated based on

economic (per capita income) and

demographic data.

However, companies must also consider

variables other than income and population

when estimating potential demand for their

products in different countries.

Countries with similar per capita income may

have different preferences for products and

services because of cultural differences.

Example:

Large Hindu population in India has least per

capita consumption of beef.

Resource acquisition:

Companies enter into IB to secure resource

that are either not adequately available or too

expensive in their home countries.

If scarce resources are to be acquired, they

are limited to certain areas / countries.

Example: Oil and petroleum products.

Even when resources are limited to few

countries, there are better opportunities in

some countries than in others.

There are cost differences in extraction,

transportation and taxes.

Cost effectiveness ( cost optimization) is also

important to obtain competitive advantage.

Cost considerations:

Total cost is made up of several sub costs-

such as labour, transportation, govt.

incentives etc.

Labour cost: It is an important factor in firm’s

production location decisions.

Labour cost is not homogeneous. Skills vary

from country to country and location to

location within a country.

Example:

If a firm wants to set up a low cost call center,

it is necessary to have people with specific

language skills. Similarly if a firm wants to

establish a R&D facility, sufficient number of

science and engineering graduates must be

available.

If a country’s labour force lacks the specific

skill levels required, a company may have to

train, further adding to the cost.

Infrastructure:

Infrastructure problems add to operating

costs.

Poor infrastructure and social services-

education, medical facility etc- may offset

labour cost advantage.

In many developing countries infrastructure is

both poor and unreliable, which adds to

company’s cost of operation.

Ease of transportation and communication is

another aspect which is considered by the

firms while locating their operations.

There are also advantages in locating the

operations in countries where there is a lower

tariff and trade restrictions since tariff costs

are lesser.

Govt. incentives and disincentives:

Many countries offer several incentives to

attract FDI. These incentives reduce operating

cost of a company.

Firms also consider the ease of doing business

in a country.

Countries differ in terms of ease or difficulty

of starting a business, hiring and firing of

workmen, getting credit and closing a

business.

Risks

Any decision by company involves weighing

opportunity against risk.

Risks can be classified as:

Political risk

Monetary risk and

Competitive risk

Political Risk:

Already discussed under PEST.

2. Monetary risk: Companies may be affected

by:

Changes in exchange rates and

Ability to move funds (repatriation) out of a

country.

Exchange rate changes:

The change in the value of a foreign currency

is a two edged sword.

Exchange rate fluctuation affects both exports

and imports.

Example: If rupee appreciates against dollar

( from $1 = Rs. 45 to $1 = 43), exports earn

less rupee against dollar- making it less

lucrative.

Imports will be cheaper, in terms of dollar-

since one had to pay lesser rupee.

The effects will be vice-versa if the rupee

depreciates ( $ 1= 43 to $ 1= 45) against

dollar.

Exchange rate changes can be forecasted

using past data on trends in exchange rates,

inflation and foreign trade deficits.

Also exchange risk can be minimized by

entering into forward contract.

Mobility of funds:

When investing abroad, a company considers

the ease with which funds can be taken out of

the country.

Liquidity is required to cover unexpected

contingencies.

Liquidity differs from country to country due

to the nature of capital markets and govt.

exchange control regulations.

Sometimes companies may want to sell all or

part of their equity in a foreign unit so that the

funds may be used elsewhere.

The existence of an active stock market is an

important factor.

Govt. can restrict the conversion of funds

( 100% convertibility on current account and

govt. regulation on convertibility of capital

account) through exchange control.

Hence the investor may not get the entire

sales proceeds.

Competitive risk:

Success in a particular country may also

depend on presence of competition and their

actions.

A company may try to reduce competitive risk

by either getting a strong foothold in foreign

markets before competition ( first mover

advantage) or by avoiding strong competition

altogether.

Sources of information for assessing country risk

Following are some of the sources:

Individualized reports
Govt. agencies and

International organizations and agencies and

Trade associations.

Individualized reports:

Market research and business consulting

companies conduct studies for a fee in most

countries.

2. Govt. agencies:

Govt. and their agencies are another source

of information.

Example: Ministry of commerce & trade, Central

Bank etc.

3. International organizations & agencies:

Some of the agencies are listed below:

United Nations (UN)

World Trade Organization (WTO)

International Monitory Fund (IMF)

European Union (EU).

- These agencies compile basic statistics and

prepare reports concerning common trends

and problems.

4. Trade associations:

- Trade associations concerned with various

product lines collect, evaluate and publish a

wide variety of data.

Country comparison tools

Once companies collect information on

possible locations through scanning, they

need to analyze the information.

Companies generally use a cross functional

team from different functions from

production, marketing, finance, HR and legal

departments for a thorough evaluation and

analysis.

Two tools are generally used for comparison:

Grids and

Matrices

Grids:
- A company may use a grid to compare

countries on whatever factors it considers

important.

- The company assigns weights to each variable

as per its perceived importance.

Variable

Weight Country

I II III

1 Return

( Higher number = Preferred rating)

Size of investment needed 0 – 5

Direct costs

0–3

12

Tax rate

0-2

1
2

Market size- Present

0-4

24

Market size- 3 to 10 years

0-3

Immediate market potential

0–2

12

Market share – 3 to 10 years 0 - 2

Total

18

10 18

Risk (Lower number = Preferred rating)

Variable

Weight Country
I II III

Market loss

0 -4

Exchange risk

0–3

Political risk

0–3

Business risk

0–4

Business laws

0–2

1
2

Total

14

From the table, it is evident that country I is

High Return-Low Risk, country II is Low

Return- Low Risk and country III is high

Return- High Risk countries.

Grids can be used as a tool for ranking various

countries based on Return – Risk parameters.

However, it becomes cumbersome, as the

number of variables increase.

Matrices

Opportunity and Risk relationship can be

plotted on a matrix.

With an Opportunity – Risk matrix, a company

can:

Decide on suitable parameters and fix

appropriate weightage to them depending on

the importance as perceived by the firm and

Evaluate each country on the weighted

indicators.

Example:

Following weightage are given by a firm for

various risk parameters:

Parameters

Percentage

Weightage

Expropriation risk

20%

0.2

Forex controls

25%

0.25

Civil disturbances & terrorism

20%

0.2

Natural disasters

20%

0.2

Exchange rate fluctuation

15%

0.15
Total

100 % 1.0

Following weightage are given by the firm for various

opportunity parameters:

Parameters

Percentage

Weightage

Govt. incentives

25%

0.25

Market size

20%

0.2

Competition

20%

0.2

Cost advantage

20%

0.2

Profitability

15%

0.15

Total
100 % 1.0

Each country is rated on a scale of 1 to 10 for

each variable (10 indicating the best score and

1 the least) and these ratings are multiplied by

weightage given to the each parameters.

Construction of risk matrix: (For country A)

Parameters

Score

Weighted score

Expropriation

8 x 0.2 = 1.6

Forex controls

6 x 0.25 = 1.5

Civil unrest & terrorism 5

5 x 0.2 = 1.0

Natural disasters

4 x 0.2 = 0.8

Exchange rate fluctuation 3

3 x 0.15 = 0.45
Total 5.35

Similarly each opportunity parameters can

also be rated on a scale of 1 to 10 and

multiplied by the weightage given to that

parameter.

From the scores of risk and opportunity given

to each country a matrix can be plotted as

shown :

Risk- Opportunity matrix:

From the matrix plotted, the following

conclusions can be made:

Countries E & F are the most desirable

because they have a combination of a high

level of opportunity and a low level of risk.

The level of opportunity in country A may not

be as high as company would like, but the

low level of risk may be attractive.

Country B promises a high level of

opportunities but also has a high level of risk.

MNC’s and Investment

Uninational company:
An uninational company or a domestic company has

all its operating assets and organizational sub-units

in its home country.

It may on occasion engage in exporting or importing

by transacting with foreign firms, but its own

capacity to function is limited to the domestic

market.

The multinational is a business unit which

operates simultaneously in different parts of the

world either by manufacturing or marketing or

both.

In some cases, the manufacturing unit may be in

one country, while the marketing and R & D may

be in other countries.

In other cases, all the business operations are

carried out in different countries, with a strategic

head quarters in any part of the world.

For a MNC, the strategic nerve center is the

company’s headquarters (HQ), where

major decisions are taken and policies

formulated.

At its HQ the main roles of a typical MNC

are:

Strategy formulation for worldwide

operations.
Execution of policies and decisions and

Maintaining control over global strategies

and operations.

Every MNC has to operate through its

satellite units, called “subsidiaries”.

Hence, MNC’s have HQs and a number of

subsidiaries scattered throughout the

world.

A typical MNC operates as per the following

model:

Headquarters

S1

S2

S3

S4

(S- Subsidiaries)

Example: The Manhattan based company,

Colgate Palmolive Inc. which manufacturers

and markets dental care, health care, hair care

and skin care products, in more than 120

countries.

Example: Procter & Gamble, based in

Cincinnati also has similar product lines and

operates in more than 150 countries.

Samsung, the South Korean conglomerate, has

its head quarter in Seoul. It carries out its

global operations through more than 150

subsidiaries.

Tata Group, the Indian multinational

corporation has its head quarter in Mumbai

and operates in more than 100 countries

across the globe.

At one time American based multinationals

ruled the world.

To day many Japanese, Korean, European and

Indian multi-nationals have spread their wings

in many parts of the world.

There are about 35,000 MNC’s around the

world to day, controlling over 170,000 foreign

affiliations.

The main feature of MNC is the power center.

The power center is at the Head Quarters and

all major policy / strategic decisions are taken

at the HQ.

Some Indian MNC’s

Tata Motors:

Largest automobile in the country.

Has tie up with Rover of UK and sell small cars

in Europe.

Has acquired Daewoo commercial vehicle

company.

Bharat Forge:

Auto components manufacturing company.

In 03-04 it acquired a German forging

company, making it second largest forging

company in the world.

Sundaram Fasteners:

Manufacturer of fasteners. It has a

manufacturing facility at China.

It has also acquired a fastener company- Dana

Spicer- a UK based company.

It has a manufacturing facility at Kualampur

also.

ONGC:

It has crude oil exploration activities in Iraq,

Iran, Sudan, Vietnam, Myammar, Russia etc.

Sterilite Industries Ltd.

Metals and mining bussiness. It also deals with

aluminium.

Owns copper mines in Tasmania.

Essel Propack:

Largest manufacturer of lami tubes in the

world.

It has 17 plants located across 11 countries.

It commands 30 % of market share.

It has manufacturing facilities at Egypt, China,

Germany, US etc.

It has acquired Switzerland’s Propack A.G.

Asian Paints:
“Glocal”- is the right word to describe the

global strategy of Asian Paints for it explains

the setting up of manufacturing facilities

overseas that produces paints according to

local requirements.

Asian Paint acquired Berger International Ltd.

Which gave access to 12 markets across China,

South East Asia, West Asia.

It has also acquired SCIB Chemicals an

Egyptian company.

It has a JV in Bangladesh and has acquired a

largest paint company in Srilanka.

Moser Baer:

Manufacturers DVD for media storage.

It was a JV between Moser Bayer India and

Swiss firm Moser Bayer to make time keeping

machines.

The JV failed but the name was retained by

the Indian company and diversified in to

floppy disc production.

Subsequently the firm started producing CD’s

and now Moser Bayer is the worlds third

largest manufacturer of CD’s.

The company is present in 82 countries and

almost 85 % of output is exported to Europe

and US.

Infosys Technologies Ltd.

It has 26 global software development centers

in US, Canada, Australia, UK and Japan.

Wipro Ltd. : Software exporter.

I- Flex Solutions Ltd.: Banking software.

Hindalco Ltd:

Aditya Birla Group. Main bussiness is

aluminium.

Took over Novelis a UK based company.

Dr. Reddy’s Laboratories, Aurobindo

Pharmaceuticals etc.

Classification based on equity

MNC’s can be classified in to two types

depending on the extent of control:

Equity based and

Non equity based.

Equity based MNCs

Many older MNC’s obtained their

multinational status through direct foreign

investments.

They either built from ground up or bought

the equity of the desired capital assets.

Equity ownership provides the basis for

managerial control over the foreign

company which is integrated with the HQ.

Examples of equity based MNC:

Joint ventures

Mergers / Acquisitions / Take over

Greenfield venture

Non-Equity based MNCs

Management contracts

Production sharing arrangements

Industrial lease agreements and

Technology transfer agreements.

Management of contracts:

A new generation of MNC’s has started to emerge

in which the source of managerial control is

technology and management expertise, instead of

ownership of the operating assets.

Long term contracts with the owners of the

operating facilities are entered in to often

formally, informally sanctioned by the host

government.

Under such a contract the owners will let the

MNC to take over possession and

management of the bussiness and the MNC

will obligate itself to share profits with the

owners by some agreed formula.

Example: Hotel, mining, etc.

Production sharing :

In mining, crude oil production and other “Resource

Based” bussinesses, profit sharing may be replaced

by output sharing.

The arrangements provide that the MNC not only

produce in an extractive sector (iron ore, coal, crude

oil etc.) but also must meet specific obligations for

the development of indigenous supplier industries,

training engineers and managers for keeping pace

with developments.

This formula involves sharing of output of the

ventures.

For instance the contract may provide 40:60

output sharing of a mining output, the MNC

retaining 40 % of output, and market on

behalf of the owner the remaining 60 %.

Industrial lease agreements:

These are contracts under which an owner,

leases a complete industrial facility to an

MNC.

The rent consists of normally of a fixed annual

sum plus a payment based on the output of

the plant.

Technology transfer agreements:

In the high technology industries – electronics,

aircraft, computers, biochemical etc. - the

host governments places the highest priority

on indigenous production capability.

In technology transfer agreements, MNC enters in to

JV with the host country company, often with the

assistance of the govt.

The responsibility of the MNC is to transfer

technology, assistance in efficient adoption of the

product to suit the host country, effective long term

cooperation after the plant starts production and

marketing of output outside the host country.

Reasons for growth of MNC’s..

Cutting edge technology:

Continuous up gradation of the technology

and ensuring the latest technology is adopted.

Protecting reputation:

Products develop a good or bad name, which

transcends international barriers.

It would be very difficult for an MNC to protect its

reputation if a foreign licensee does an inferior job.

MNC’s prefer to invest in a country rather than

licensing, to ensure maintenance of their good name.

Building reputation:

MNC’s invest to build their reputation.

If the goodwill is established, the firm can

expand and build a strong customer base.

Example: Excellent growth of foreign banks,

such as Citibank, Grindlays, Standard

Chartered and HSBC in India.

Exploiting product life cycle theory:

Even in an developed country opportunities

for further growth eventually dry up.

MNC’s are always on the look out for markets

which are not penetrated and where they can

fully exploit all the stages of life cycle of the

product.

Example: Laptops, LCD TV’s etc.

Financial Power:

MNC’s have huge financial capability.

Transfer pricing:

To quote low prices for inter-company

transactions where taxes are high and

enhance the price where tax rates are lower.

Criticism against MNC’s…

Interference with economic objectives:

A MNC may wish to locate a plant in an area

of prosperity where as the host country would

prefer its location in an undeveloped region.

MNC’s demands of local infrastructure and

other supports may add to the host country’s

expenditure.

Technology dependency:

Since the MNC’s typically do their research

and development activities at home, host

countries become technologically dependent

on the MNC’s for innovation.

Inappropriate technology:

MNC’s technology is designed for world wide profit

maximization, not to the development needs of poor

countries.

The technology brought by MNC’s is hardly suitable

to LDC’s.

The technology could be capital intensive but

developing countries need a labour intensive one.

In addition the technology brought in by MNC

may be highly expensive.

Also the MNC’s charge exorbitantly in the

form of fee and loyalty, which put a severe

financial strain on the foreign exchange

resources of a developing country.

There are also instances of “Technology being

Dumped”, which implies that MNC’s use

obsolete technology with the help of turnkey

projects shipped down from other countries,

where the technology has become obsolete.

Destruction of competition:

MNC’s may destroy competition and acquire a

monopoly status.

Destruction of natural resources:

MNC’s may cause fast depletion of some of

the non-renewable natural resources in the

host country.

No concern for society:

MNC’s do not give enough importance to the

society in which they operate.

An example is Union Carbide, which did not

show much concern for the people of Bhopal.

In South Africa, HIV medicines are sold at an

expensive price irrespective of the cost.

When people die out with these dreaded

diseases in some region, MNC’s consider that

place as a huge potential for bussiness

prosperity.

No role in infrastructure development:

In the developing countries active

participation is needed in the development of

infrastructure like roads, ports, power plants

etc.

MNC’s enjoy all the benefits offered by the

countries but do not actively contribute

towards infrastructure development.

Most MNC’s in India deal in non-essential products

such as soaps, toothpastes, shampoos and other

consumer products.

For example Unilever, Johnson & Johnson, Colgate

Palmolive, Procter & Gamble etc- there is no

contribution for infrastructure development.

No MNC is actively involved in developing activities

such as infrastructure.

No real employment:
There is a misconception that MNC’s generate

employment but on the contrary they retard

growth.

The top positions are occupied by home

country professionals and lower operating

level employment is given to locals.

Environmental degradation:

MNC’s do not have any value for the

environment and pollution control.

The main motto is to earn money.

No concern for valuable human lives.

Example- Union Carbide tragedy at Bhopal.

Manipulation of tax rules:

MNC’s indulge in transfer pricing which

enables them to avoid taxes by manipulating

prices on intra- company transactions.

Merits of MNC’s …….

Increase in domestic investment:

MNC’s help to increase domestic investment

level thereby increasing the income level and

employment in host country.

Facilitates transfer of technology:

MNC’s have become vehicles for the transfer

of technology, especially to the developing

countries.

Professional Management:

MNc’s brings in a managerial resolution in the

host countries through professional

management and by employing a highly

sophisticated management techniques.

Increase in foreign trade:

MNC’s enable the host countries to increase

their exports and decrease import

requirements.

Break monopoly:

MNC’s help increase competition and break

domestic monopoly.

Availability of quality products:

MNC’s make available international quality

products to the consumers.

Country risk

Country risk is one of the special issues faced

by MNC’s when investing abroad.

It involves the possibility of loses due to

country specific economic, political and social

events.

Various types of country risks faced by the

MNCs are:

Expropriation

Confiscation

International war or civil strike:

Unilateral breach of contract:

Harmful action against employees:

Restrictions on repatriation of profits:

Discriminatory taxation policies

Political boycott

* Already discussed under PEST factors.

Managing political risk:

Avoiding investment

Joint Ventures

Threat – by controlling critical inputs

Lobbying

Insurance (MIGA- Multilateral Investment

Guarantee Agency )

** Discussed under PEST

Organization structures of MNCs:

A MNC which operates in different parts of the world

needs an appropriate and effective organizational

structure to execute its strategies.

There is a close relationship between the firm’s

strategic objectives and the organization structure.

By creating a proper organizational structure, a firm

can establish consistency and congruence not only in

its operations but also in the coordination between

the subsidiaries and the headquarters.

The structure shall facilitate quick response to

local market dynamics and at the same time

shall be capable of meeting the worldwide

strategy of the headquarters.

MNCs adopt a variety of organizational

structures to carry out its global operations

and it is very difficult to classify them.

The organizational structures adopted by the

MNCs can be broadly classified under five

fundamental types as given below:

1. Domestic plus foreign subsidiary structure;

2. International division structure;

3. Global product division structure;

4. Global geographic structure; and

5. Multinational matrix structure

Domestic plus foreign subsidiary structure:

This type of structure is suitable for those

MNCs which have a steady domestic market

and a few subsidiaries in other countries. (see

figure -1).

Fig. 1- Domestic plus foreign subsidiary structure

International division structure:

In this type of structure, there are two distinct

responsibility centers – the domestic division

and the international division, both

independently looking after the respective

functions.

All the overseas subsidiaries are under the

operational control of the international

division.

In this type of structure, the MNC is able to

formulate appropriate strategies depending on the

market dynamics and also to allocate necessary

resources as per the need (see figure-2 ).

Example:

For a long time the US based coca-cola MNC used

this structure to carry out its global soft drink

bottling operations.

Tata Group’s Titan also operates through

international division structure.

Fig. 2- International division structure

Global product division structure:

The MNC locates its product specific

subsidiaries in different countries.

The subsidiary produces a specific product and

each subsidiary operates as a profit centre

with considerable autonomy.

This type of structure is suitable when the

MNC manufacturers different variety of

products and sold in diverse markets.(see

figure- 3)

Example:

Unilever of USA (Hindustan Unilever –HUL is a

subsidiary) operates through global product

division structure.

Motorola, the American MNC is another

example of a global firm which has adopted

the global product division structure.

Fig. 3- Global product division structure

Global geographic structure:

This type of structure is suitable for those

MNCs who have operations in the different

regions of the globe and the products are

adopted as per the preferences of the regional

markets.

The worldwide operations are divided into

different regions in such a way that the

markets have some common characteristics.

(see figure -4)

Example:

Nestle, a Swiss multi national company, brews more

than forty varieties of instant coffee to satisfy

different national tastes. Nestle conducts its global

business through global geographic structure.

Similarly the British multinational company, Cadbury

Schweppes PLC, produces different variety of

chocolates ranging from bitter to increasing levels of

sweetness as per the tastes of the different regions.

Cadbury also operates through global geographic

structure.

Fig. 4- Global geographic structure

Multinational matrix structure:

It is the combination of the several structures.

It is one of the most complex structures.

It is a flexible structure and facilitates forming

of different product groups depending on the

expertise required.

After accomplishing a specific project, the

group is dissolved. The members may be given

a new task and assignment.(see figure -5)

Example:

These types of structures are used by turnkey

project firms and construction firms.

Technology giant Siemens uses this structure.

In India L & T and WIPRO use this structure.

Subsidiaries are a common feature and

most multinational corporations organize

their operations in this way.

A subsidiary, or a subsidiary company is

a company that is owned by or controlled by

another company, which is called the parent

company, parent, or holding company.

Subsidiaries are created to serve several

business needs like:

1. Corporate structuring;

2. To expand business activities;

2. Development of new products and

services;

3. For regulatory compliance;

4. To ensure tax efficiency; and

5. To expand into new geographical markets

As companies expand and grow in size and

diversify their operations in the local /

domestic market or expand to foreign

markets, the number of subsidiaries tends to

increase and the organizational structures of

the companies also become more complex.

Types of subsidiaries:

MNC’s generally prefer to have two types of

subsidiaries in foreign countries:

1. Fully owned subsidiary and

2. Joint venture subsidiary.

Examples of fully owned subsidiary:

Examples:

Sony Consumer Electronics India Pvt. Ltd.

Nokia Telecommunication India Pvt. Ltd.

Samsung Electronics India Pvt. Ltd.

All the above firms are fully owned Indian

subsidiaries formed under Companies Act

2013.

Example of JV:

Tata SIA Airlines – a full service airline called

Vistara- is a joint venture between Tata Sons

Limited and Singapore Airlines Limited in

which Tata Sons Limited owns 51% equity and

the remaining by the Singapore Airlines

Limited.

Even though there is a defined comprehensive

framework for corporate governance, when it

comes to the governance of subsidiaries, the

companies often face a variety of challenges.

Governance of subsidiaries involves two

critical issues:

1. The mechanism for extending corporate

governance practices and policies to the

downstream subsidiaries; and

2. The appropriate governance structures

of the subsidiaries so that they protect

the image of the parent company and

deliver the desired results.

MNCs face corporate governance challenges.

The typical challenges that are often faced

are:

1. The balance between the degree of control

that needs to be exercised by the parent

(HQ) over its subsidiaries and the degree of

independence that needs to be provided to

them and

2. The extent of standardization of the systems

and processes across the organization and

local adaptation at the subsidiary levels.

- This involves establishment of systems and

processes in the subsidiaries that would

assure the HQ that subsidiaries also reflect the

same values, ethics, controls and processes

that are at the parent company.

- Any mismatch or deviation in this can result in

subsidiary governance failures, which may

damage the reputation and result in economic

risks to the parent company.

The subsidiary must be familiar with the

business philosophy, culture and strategic

direction of the parent company.

The parent company also shall ensure good

governance practices are cascaded effectively

down to the level of subsidiaries and the

governance mechanism is seamless and

harmonious throughout the organization.

MNCs also face considerable challenge in

balancing the extent of autonomy extended to

subsidiaries which operate in far-flung

overseas markets in the strategic decision

making and the compulsions of the

subsidiaries to adapt to the specific local

market conditions like social / cultural

diversity, institutional framework and

regulation and economic characteristics.

Managing subsidiaries effectively is also a big

challenge.

MNCs use a wide range of strategies to keep

control over the subsidiaries like:

1. Share of capital in case of international joint

ventures;

2. Active participation in the board of directors;

3. Staffing key management positions;

4. Controlling the extent of technology transfer;

5. By controlling critical key inputs.

The increasing globalization trends have

compelled the subsidiaries to transform from

independent stand alone operations to more

integrated and interdependent networks.

MNCs pursue a strategy combining both global

integration and local adaptation.

Bartlett and Ghoshal have developed the famous

2 X 2 strategy matrix with the dimensions local

responsiveness and global integration and have

identified four types of strategies:

1. International company / strategy;

2. Multinational company / strategy;

3. Global company / strategy; and

4. Transnational company / strategy.

1. International company / strategy:

Involved in only imports or exports.

Don’t have their own establishments in foreign

countries.

No FDI investment in foreign countries where they

operate.

Decisions are taken and strategies are formulated by

the domestic company.

It is low on both global integration and local

responsiveness.

Since these companies don’t give importance to

consumer preferences in foreign markets, companies

may fail.

Multinational company / strategy:

These firms have operations in two or more

countries; generally number of countries the firm

operates may be between 2 to 10 or more.

Firms focus on local responsiveness; they adapt to

the local market conditions and forego potential

economies of scale.

May have FDI investment in a few foreign markets

where they operate.

Example: McDonald .
Global company:

Any firm having operations in many countries; the

number of countries may be more than 15 countries.

Mostly have FDI in many of the countries.

Major decisions are taken at the headquarters and

have a centralized approach.

Key activities like design, research & development take

place at the HQ.

Firms focus on global integration at the expense of

local responsiveness, thus integrating organizational

processes to a high degree and benefit from economy

of scale and scope as well as from integrated learning

across global organization.

Examples: Microsoft, Coca Cola, Shell etc.

Transnational company:

The firm is a combination of international,

multinational and global companies.

Firm thinks globally as well as locally.

Has a very complex structure.

Flexible and adapt to the local cultures and consumer

behaviours.

Combines the benefits of global scale and learning

with the benefits of locally adapted products and

processes.

Associated with high levels of intra-company trade in

goods and services, as well as extensive lateral

knowledge flows.

Decision making process is decentralized. Each

subsidiary is responsible to take its own decision.

R & D activities are decentralised to the subsidiary

level as per local taste and preferences.

This strategy allows selected subsidiaries to

become strategic centres for a particular product

or technology.

Firm encourages extensive knowledge flows not

only vertically between headquarters and

subsidiaries, but horizontally between different

subsidiaries.

Example: Unilever, Sony etc.

Foreign Investment

International or Foreign investment

Foreign Direct

Investment (FDI)

Portfolio

Investment

International Investment refers to the transfer

of assets to another country, or acquisition of

assets in another country.

These assets include :

Capital

Technology

Managerial talent and

Manufacturing infrastructure.

Portfolio Investment:

This refers to the passive ownership of foreign

securities such as stocks and bonds for the purpose

of generating financial returns.

It does not entail active management or control over

these assets.
The foreign investor has a relatively short term

interest in the ownership of these assets.

It is also called as “Hot Money or Flight Money”-

since it can be taken away at the slightest possibility

of uncertainty or trouble.

Foreign Direct investment:

The firm establishes a physical presence

abroad through acquisition of physical assets

such as capital, technology, land, plant and

equipment.

This is a foreign market entry strategy that

gives investors, partial or full ownership of a

productive enterprise dedicated to

manufacturing, marketing or R&D activities.

The investor has a long term interest.

Foreign Direct Investment

Hence FDI can be defined as an activity by

which an investor, who is resident in one

country, obtains a lasting interest in, and has a

significant influence on the management of an

entity in another country.

In simple terms, FDI refers to the purchase

of significant number of shares of a foreign

company in order to gain a certain degree

of management control.

At the core of FDI is the international flow

of capital.

Countries set different thresholds at which

they classify an international capital flow as

FDI.

Most governments set the threshold at

anywhere from 10 to 25% equity ownership in

a company abroad. (In USA it is 10%).

In contrast, an investment that does not

involve obtaining a degree of control in a

foreign company is called “Portfolio

investment”.

According to UN’s World Investment Report,

FDI includes three components:

Equity capital

Reinvested earnings and

Intra-company loans.

FDI routes in India

Under the FDI policy of India, a foreign investor

can enter the country through two routes:

1. Automatic route; and

2. Government approval

The features of automatic route are:

FDI under this route does not require prior

approval either by the government of India or

by the Reserve Bank of India;

The investors are only required to notify the

concerned regional office of RBI within 30

days of receipt of inward remittance and file

required documents with that office within 30

days of issue of shares to the foreign investor;

and

Investment is permitted up to prescribed

sectoral limit.

Government approval route

All activities / sectors that are not covered

under automatic route or where the proposed

FDI exceeds the specific sectoral caps require

prior government approval and are

considered by respective ministries.

Areas / sectors / activities hitherto not open

to FDI / NRI investment will continue to be so

unless otherwise notified by the government.

FDI is important to developing and Less

developed countries, because it helps in

international resource flows and also

complement domestic investment.

FDI can immensely help in the economic

development of a country.

FDI to various countries, depend on the

host countries economic policies and

liberalization policies.

As a general principle, host countries that

offer what MNC’s are seeking and / or host

countries whose policies are most

conducive to MNC activities, stand a good

chance of attracting MNC.

Core FDI policies consist of rules and regulations

governing the entry and operations of foreign

investor and the standards of treatment accorded

to them.

These policies can range from outright prohibition

of FDI entry to non-discrimination in the

treatment of foreign and domestic firm and even

preferential treatment to foreign firms.

The policies are formulated to satisfy

various objectives of reducing or increasing

FDI, influencing FDI in thrust areas and

encouraging specific contributions to the

economy.

Among the supplementary policies used to

influence locational decisions is the trade

policy.

FDI in India does not have a uniform limit.

Some industries / sectors allow 100% FDI,

meaning the entire business can be funded

from FDI.

The percentage investment in some critical or

sensitive industries / sectors can vary from

26% to 49% to 51%.

There are some industries where FDI is strictly

prohibited under any route.

The World Investment Report 2020 by the

UNCTAD reported that India was the 9 th

largest recipient of FDI in 2019 with 51 billion

dollars of inflows during the year, an increase

from the 42 billion dollars of FDI received in

2018, when India ranked 12 among the top 20

host economies in the world.

According to Department for Promotion of

Industry and Internal Trade (DPIIT),

cumulative FDI equity inflow to India stood at

US$ 469.99 billion from April 2000 to Match

2020, indicating that government’s effort to

improve ‘Ease of Doing Business’ and relaxing

FDI norms has yielded results.

As per Global Investment Trends Monitoring

Report, the following are the top 7 countries

that attracted the most FDI in 2019:

1. USA - 251 Bilion dollars

2. People’s Republic of China - 140 B dollars

3. Singapore - 110 B dollars

4. Brazil - 75 B dollars

5. UK - 61 B dollars

6. Hong Kong - 55 B dollars

7. France - 52 B dollars

As per UNCTAD, Global foreign direct

investment inflow was $ 1.23 trillion in 2014

and UNCTAD forecasts an upturn in FDI figures

to $ 1.4 trillion in 2015 and beyond $ 1.5

trillion in 2016-17.
FDI flows to developing economies reached a

historic high in 2014, touching $ 681 billion

inflow.

Why FDI?

FDI is required to fill the gap between

domestically available investment and the

desired levels of the resources necessary to

achieve growth and development targets.

If domestic savings are inadequate to

generate enough investments, foreign capital

is required to fill the gap between desired

investment and domestic investment.

2. FDI can improve foreign exchange earnings

and can help to reduce trade deficits.

3. FDI is expected to result in technology, new

management approach and skill transfer.

Such transfers are expected to be desirable

and productive for recipient nations.

4. Firms set up by MNC’s act as nuclii of

growth.

- An enterprise set up by a foreign company

gives birth to several other enterprises

which supply inputs to parent company.

It is estimated that every dollar of FDI

increases domestic investment by 80% (0.8

times ) of the amount of FDI.

Hence FDI results in spread effect.

5. FDI can generate healthy competition in

the recipient countries.

When FDI comes in the form of greenfield

projects, it results in the creation of new

enterprises, adding to the number of

players in the market.

This can increase the level of competition in

the host country.

Intense competition enhances consumer

choice and brings down price.

Increased competition tends to stimulate

capital investments by firms in plant,

equipment and R&D in order to gain

competitive advantage over their rivals.

All these tend to result, in the long run,

increased productivity, innovations and

greater economic growth.

But when MNC’s buy out popular local

brand / companies, benefits from the

expected competition will not result.

For example, Coca Cola bought the

dominant domestic brand Thumps-Up,

Hindustan Lever( now Hindustan Unilever)

acquired Tomco, the largest domestic rival

and Lakme, the largest cosmetics company.

However, such acquisitions do not add to

any additional benefits to the economy.

6. Very often locational advantages attract

FDI. A firm undertakes FDI to exploit such

advantages.

Firms locate their firms in Mexico, since it

has the highly skilled labour force that can

be hired at fairly low wages.

Also productivity and quality of work are

high in Mexico.

Hyundai, the automobile giant from South

Korea, has chosen Chennai in India for its

car manufacturing plant.

Skilled labour at low wages, location of

auto parts manufacturers such as Wheels

India, Brakes India, Sundaram fasteners,

Bimetal Bearings, India Pistons etc round

Chennai, guaranteed power supply, cheap

land and proximity to sea port have

attracted the company to Chennai.

7. Infrastructure: In order to facilitate and

enable the investors perform well, the host

countries study other competitive

destinations and enhance the level of

infrastructure to match the requirements of

the investors

Incentives to attract FDI

Incentives are any measurable economic

advantage afforded to a specific enterprise or

categories of enterprises by a government, in

order to encourage them to behave in a

certain manner.

They include measures either to increase the

rate of return of a particular FDI undertaking

or to reduce its costs or risks.

The main types of incentives used are:

Fiscal incentives.

Financial incentives.

Market preferences and

Preferential treatment.

Fiscal incentives

Reduction in the standard corporate tax rate.

Investment and reinvestment allowances.

Tax holidays.

Accelerated depreciation provision and

Exemptions from import duties.

Financial incentives -Continued

Government grants

Subsidized credits.

Government equity participation and

Government insurance at preferential rates.

Market preferences

Granting of monopoly rights.

Protection from import competition.

Closing the market for further entry and

Preferential government contracts.

Subsidized dedicated infrastructure and

services.

However it is not in the public interest if

the cost of incentives granted exceed the

value of the benefits to the public.

Effect of incentives on investment

decisions

Incentives play a minor part in the locational

decisions of MNC’s.

The MNC’s consider market size and growth,

production costs, skill levels required,

adequate infrastructure, economic stability

and the quality of the general regulatory

framework.

However, when the location is broadly

determined, then incentives can play a

decisive role in choosing between

Maharashtra or Gujarat.

Disadvantages of FDI

The investing firms may not serve the

interest of the host countries.

There will be an outflow of earnings as they

are repatriated to the home country of the

investor.

There is possibility of importing substantial

inputs from the country of the investor.

4. The investing country has controlling

technology, for which it charges a huge

technology fee.

5. Small and medium level industries could be

eliminated and infant and other home

industries may suffer if they can’t compete.

Methods for foreign investors to

invest in India.

Foreign company:

A foreign company is one which has been

incorporated outside India and conducts

business in India.

Foreign Company as per Companies Act, 2013

– Section 2(42).

Company or Body Corporate incorporated

outside India having a place of business in

India whether by itself or through an agent,

physically or through electronic mode and

conducts any business activity in India in any

other manner.

Incorporation is the legal process used to

form a corporate entity or company.

A corporation is the resulting legal entity that

separates the firm's assets and income from

its owners and investors. ...

It is the process of legally declaring a

corporate entity as separate from its owners.

Investment options

Branch / Liaison As an Indian company SEZ

Office

Fully owned

Indian

subsidiary

JV with an

Indian

company

Strategies for investment in India:

A foreign investor may directly set up its

operations in India through a branch

office or a liaison office.

It may do so through a subsidiary

company set up in India under Indian

laws.

3. It may invest in bussiness units in SEZ’s and

EOU’s.

Generally the second option of setting up

operations through an Indian arm is

advisable.

When a new enterprise is created it is

called as “Greenfield investment”.

1. Liaison office / Representative office:

A liaison office is not allowed to undertake any

business activity in India and therefore can’t earn

any income in India.

The role of such office is thus limited to collecting

information about possible market opportunities

and providing information about the company

and its products to prospective Indian customers.

The Foreign Investment Promotion Board of RBI is

the regulatory body governing such operations.

Branch office:

The govt. has allowed foreign companies

engaged in manufacturing and trading activities

abroad to set up branch offices in India for the

following purposes:

1. To represent the parent company / other foreign

companies in various matters in India.

- Example- Acting as buying / selling agents in

India.

2. To undertake export and import trading

activities.

3. A branch office is not allowed to carry out

the manufacturing activities on its own but

it is permitted to sub contract them to an

Indian manufacturer.

Permission for setting up branch office is

granted by RBI on a case to case basis.

RBI considers the operating history of the

applicant world-wide and its proposed

activities in India for granting approval.

Through an Indian arm:

There are two entry strategies through

which a foreign investor can enter

through an Indian arm:

As an Indian company or a subsidiary of a

foreign company in India and

As a joint venture.

As an Indian company or subsidiary:

A foreign company can commence operations in

India, through the incorporation of the company,

under the provisions of the Indian Companies Act

2013.

Foreign equity in such companies can be 100 %,

depending on the bussiness plan of the investor,

subject to prevailing investment policies of the

govt. and receipt of required approval.

Once a company has been duly registered

and incorporated as an Indian company, it

will be subject to the same Indian laws and

regulations that are applicable to other

domestic Indian companies.

Examples:

Sony Consumer Electronics India Pvt Ltd.

Nokia Telecommunication India Pvt. Ltd.

Samsung Electronics India Pvt. Ltd.

Joint ventures with an Indian partner:

Foreign companies can set up their operations in

India by forging strategic alliances with Indian

partners.

Example:

Petronet LNG Limited –

It is a JV between :

Gail (India) Limited

Bharat Petroleum Corporation Limited

Oil and Natural Gas Limited and

Gaz de France

Product: LNG

Setting up operations through a JV has

several advantages:

Established distribution / marketing set

up of the Indian partner.

Available financial resources of the Indian

partner.

Established contracts of the partner,

familiarity with rules / regulations.

How to invest in foreign countries?

The various methodologies available for Indian

investors to invest in foreign countries are:

Through Global Depository Receipts(GDR).

Through American Depository Receipts ADR) and

Through Foreign Currency Convertible

Bonds(FCCB).

Indian companies are allowed to raise

equity capital in the international markets

through the issue of GDRs / ADRs / FCCBs.

These are not subject to any ceilings on

investment.

Foreign investment through GDRs / ADRs /

FCCBs is treated as Foreign Direct

Investment.

Foreign direct investment is freely allowed in

all sectors including the services sector, except

where the existing and notified sectoral policy

does not permit FDI beyond a ceiling.

PRESENT FDI CAP SCENARIO

SR.NO

SECTOR

ROUTE

CAP

BANKING

AUTOMATIC upto 49%

74%-Govt. route

>49%

ALL MANUFACTURING SECTORS EXCEPT

DEFENCE EQUIPMENTS

AUTOMATIC

100%
3

DEFENCE EQUIPMENTS

Up to 49nnnautomatic,

Beyond 49% with

the approval of

Cabinet Committee

INFRASTRUCTURE- HIGH WAYS, PORTS,

POWER GENERATION

AUTOMATIC

100%

OIL EXPLORATION

AUTOMATIC

100%

AIRLINES
AUTOMATIC

49%

EOU/SEZ/INDUSTRIAL PARKS

AUTOMATIC

100%

Single brand retail

Multi brand

Auto upto 49%.

Govt-routebeyond 49%

51%

Insurance

Automatic upto 26%

Govt. route > 26 to 49%

49%

10

Courier service

Courier service

100%

Auto upto

49%

For the remaining items/activities FDI can be

brought through Government Approval.

Government approvals are accorded on the

recommendation of the concerned ministry.

For the following categories, Government

approval for FDI through the FIPB shall be

necessary:-

All proposals that require an Industrial Licence

which includes (i) the item requiring an

Industrial Licence under the Industries

(Development and Regulation) Act, 1951;

(ii) Foreign investment being more than 24%

in the equity capital of units manufacturing

items reserved for small scale industries.

All proposals falling outside notified sectoral

policy/caps or under sectors in which FDI is

not permitted.

Some areas where FDI is prohibited:

ATOMIC ENERGY

LOTTERY BUSINESS

GAMBLING AND BETTING

BUSINES OF CHIT FUNDS

Advantages of India

The advantages of India as an investment

destination rest on number of factors:

A large and growing market.

Availability of world-class scientific, technical and

managerial manpower.

Cheap Labour

Abundant natural resources

A large English speaking population and

Independent judiciary.

Criteria for investment

Political stability

Safety and security for life, money and

output.

Good governance.

Proactive govt. policies and implementing

authorities.

Adequate infrastructure.

6. Good banking system with updated

technology.

7. Productivity of labour force.

8. Simple and clear tax procedures.

9. Availability of raw materials, components

and consumables.

10. Demand for products.

Tax Haven
A tax haven is a country that extends foreign

individuals and foreign businesses insignificant

or no tax liability in an economically and

politically stable environment.

Tax haven countries also maintain strict

secrecy and provide less or no financial

information regarding the financial dealings of

the foreign individuals or the foreign business

entities to concerned overseas tax authorities.

UNCTAD, World Investment Report 2015,

states that the developing countries lost about

US$ 100 billion in tax revenues owing to

investors routing FDI through tax havens such

as Mauritius, and has made a strong case for

multilateral action to address this issue.

Panama is known as a tax haven and like any

other tax havens there is less regulation and

more privacy for non-residents and foreign

business entities.

Panama does not ask offshore companies to

pay income tax on international transactions,

sales tax, and other fees-only an annual

franchise tax of US$ 300 to the government.

In the notorious ‘Panama Paper Leak’ widely

reported in April / May 2016, there were

nearly 2000 individuals and entities with links

to India were allegedly having offshore

holding of companies in tax havens.

In September 2015, the Swiss Bankers’

Association reported that banks in Switzerland

held the equivalent of $6.5 trillion in assets

under management, of which it said 51

percent originated from abroad.

This made Switzerland the world leader in

global cross-border asset management, with a

28 percent share of the market.

Swiss is also considered to be the largest tax

haven in the world.

Switzerland has committed to the

Organization for Economic Co-operation and

Development’s (OECD) global level Common

Reporting Standard (CRS) of automatic

information exchange, but it will only start

implementing it in 2018.

Offshore Banking

It is the provision of financial services by banks

to non-residents.

In its simplest form, this involves the

borrowing of money from non-residents and

lending to non-residents.
An offshore bank is a bank located outside the

country of resident of the depositor, typically

in a low tax or tax haven country.

Any international business unit is always

looking for funds for their operations.

Sometimes the company can’t take funds

from their home country due to strict

regulations, interest rates or taxes.

An IB unit is in search of locations where their

investments are safe, and from which the

funds can be taken out without any

restrictions and invested abroad for any

ventures in any part of the world.

The bank does not deal in the currency of the

country, where it is operating, so that it

dealings do not affect the country’s economy

where it is operating.

Offshore banks provide an alternative-

usually- cheaper source of funding for MNC’s

so they do not have to rely totally on their

own national markets.

The term offshore originates from the fact

that most of these banks operate in islands,

however these banks also operate in

landlocked nations such as Switzerland,

Luxembourg and Andorra.

Offshore banks have the following features:

A very lenient, flexible with least regulations

Operates in a economically / politically stable

countries.

Operates in a low taxation country- hence

called as tax havens.

Maintains utmost secrecy about the account

holders.

Operates in those tax haven countries where

there is absence of exchange control.

Advantage to host country:

The offshore banks can raise foreign currency

loans for the host country at reasonable

interest rates. Hence host country gains better

access to international capital markets.

Onshore banks are forced improve their

services.

Advantages:

It provides a politically and economically stable

place for those residents who are residing in

countries which are politically unstable, possibility

of confiscation and a persistent civil war .

These banks may provide a higher rate of interest

than the home country banks since they operate

with a low cost base.

Interest is paid by these banks without tax being

deducted.

4. Offshore finance is one of the few industries,

along with tourism, in which geographically

remote island nations can competitively

engage. It can help developing countries

source investment and create growth in their

economies, and can help redistribute world

finance from the developed to the developing

countries.

5. They provide anonymous bank accounts and

complete secrecy regarding identify of the

account holders.

Criticisms:

Offshore banks are are associated with tax

evasion, money laundering and underworld

crime.

They serve the interest of those in higher

income.

They are less financially secure because of

less transparency in their dealings and least

regulatory control .

Offshore financial centers: (Few examples)

Singapore

Mauritius

Barbados

Bahrain

Switzerland

Luxembourg

It is perfectly legal to open an offshore bank

account and it is not a crime to have one.

But the legal requirement is that the fact of

having the offshore bank account shall be

disclosed to the tax authorities and the

applicable taxes on the interest income shall

be paid to the government

It is also necessary to disclose the source of

income.
This is the most critical problem area of the

offshore banks since they maintain total secrecy

regarding the account holders and seldom

disclose any financial information to tax

authorities.

Offshore banks thus help in tax evasion thereby

promoting accumulation of illicit wealth.

History of WTO

International Trade Organization (ITO) was

formed along with World Bank (WB) and

International Monitory Fund (IMF)for

economic recovery of nations after the World

war II.

Somehow ITO could not become a full fledged

international organizations like WB and IMF.

ITO treaty was not approved by the U.S. and a

few other signatories and hence could not be

established.

In 1948, 23 countries formed the General

Agreement on Tariffs and Trade (GATT), under

the guidance of United Nations to ensure

smooth and free international trade for the

benefit of member countries.

India is one of the founder members.

Over a period of time world trade became

very complex and GATT became ineffective,

since agreements remained only agreements

and no country really implemented them.

Several complex world trade issues like Trade

in services etc were not covered by GATT.

Also GATT’s institutional structure and dispute

settlement mechanism were not effective

with the result that it could not enforce

compliance with agreements.

Due to the limitations and ineffectiveness of

GATT lead to the birth of World Trade

Organization(WTO) in 1 January 1995 in the

Uruguay Round of talks ( 1986-1994).

WTO has its headquarters in Geneva,

Switzerland, has a membership of more than

150 countries.

More than 97% of global trade is transacted

among these members.

It is the only regulatory body of the world

trade, whose objective is to ensure freer,

transparent and predictable trading regime in

the world.
WTO is based on sound legal system and

decisions are made by consensus.

Also there is a provision for majority vote in

the event of a no decision by member

countries.

No one country controls WTO.

Agreements must be ratified by the member

countries in their respective parliaments and

hence agreements become binding.

WTO agreements cover:

Goods

Services- banking, insurance, consultancy and

Intellectual property- patents, copyrights,

designs and trade marks.

Principles of WTO trading system:

Non-discrimination: it has two major

components:

Most Favoured Nation (MFN): If some

country is granted a special favour, the

country has to give the same favour to all

other WTO members.

National Treatment Policy: Imported and

locally-produced goods should be treated

equally( after the foreign goods have entered

into the country). This is introduced to tackle

non-tariff barriers.

2. Reciprocity: Member countries shall

reciprocate concessions towards each other.

3. Binding and enforceable commitments

4. Transparency: The WTO members are

required to publish their trade regulations, to

maintain institutions allowing for the review

of administrative decisions affecting trade, to

respond to requests for information by other

members, and to notify changes in trade

policies to the WTO.

Introduction to World Trade Organization (WTO)

The WTO was formed in I sty. of January 1995 at

Geneva, Switzerland, with the General Agreement

on Tariffs and Trade (GATT) as its basis.

It is the only global organization which deals with

the rules of trade between nations at a near

global level.
It is responsible for negotiating and implementing

new trade agreements and is also responsible for

ensuring that member countries adhere to all

WTO agreements.

WTO agreements are negotiated and signed

by the bulk of the trading nations and ratified

by the Parliaments.

Hence WTO agreements are binding on the

member nations.

Mission / Goal of WTO

The goal of WTO is to improve the welfare of

the people of its member countries.

This goal is to be achieved through lowering

trade barriers and providing a platform for

negotiation of trade.

Its main mission is to ensure that trade flows

as smoothly, predictably and freely as

possible.

Objectives of WTO

The objectives are as follows:

Promote trade flows by encouraging member

nations to adopt nondiscriminatory and

predictable trade policies

Raising standard of living, income, promoting

full employment, expanding trade and

optimum utilization of the world’s resources.

3. Introduce sustainable development- a concept

which envisages that development and

environment can go together

4. Taking positive steps to ensure that

developing countries, especially the least

developed ones, secure a better share of

growth in world trade.

5. Establish procedures for resolving trade

disputes among members.

Functions of WTO:

The main functions of WTO are:

Implementation, administration and

operation of WTO agreements signed by the

member countries.

To provide a forum for negotiations

To handle and settle trade disputes

Monitoring national trade policies of the

member countries

5. Assistance to developing, least- developed

and low-income countries in transition to

adjust to WTO rules through technical

assistance and training

6. Carries out economic research and analysis of

global trade and

7. It cooperates closely with the other

international organizations like International

Monitory Fund (IMF) and World Bank.

Structure of WTO:

Ministerial Conference

General council

Dispute Settlement

Trade Policy Review

Body

Body

Council for Trade

Council for Services Council for

in Goods

TRIPS
Committees

Committees Committees

The Ministerial Conference: (First Level)

It is the supreme decision making forum.

Comprises of designated ministers of the

member nations.

The ministers meet at least once in two years.

It can take decision on all matters under any

of the multilateral agreements.

General Council: (Second Level)

The day to day work is handled by the General

Council.

It has representatives, usually, ambassadors,

from all member countries.

It acts on behalf of the Ministerial Conference.

It also has another two more functions,

namely, Dispute Settlement and Trade Policy

Review functions.

Councils: (Third Level):

There are three councils handling different

areas like:

Council for Trade in Goods (GATT- General

Agreement on Tariff and Trade)

Council for Trade in Services (GATS- General

Agreement on Trade in Services) and

Council for Trade Related Intellectual

Property Rights (TRIPS)

Committees: (Fourth Level)

Each Councils have several working groups

called as committees, which assist the

councils.

Agreements:

There are more than 60 different WTO agreements,

which are ratified by the member countries. Some of

the key agreements are:

Agreement on agriculture (AoA)

General Agreement on Trade in Services(GATS)

Sanitary and Phyto-Sanitary Agreement(SPS)

Agreement on Trade Related Investments(TRIMS)

Agreement on Technical Barriers to Trade(TBT)

Trade Related Aspects of Intellectual Property

Rights(TRIPS)

7. Import Licensing

8. Agreement on Anti-dumping

9. Agreement on Rules of Origin

10. Valuation of Goods at Customs

11. Agreement on Pre-shipment Inspection.

Agreement on Agriculture:

This has three central concepts:

Domestic support: Subsidies given by various

member countries have to be gradually reduced,

since the subsidies help in flooding the global

market at a very low prices, which may affect the

producers in poor countries.

Market Access: All members shall gradually

reduce tariffs to encourage free trade.

Export subsidies: All members shall gradually

reduce export subsidies.

General Agreement on Trade in Services

(GATS):

The member country to declare those services

for which it guarantee access to foreign

suppliers.

GATS gives complete freedom to members to

choose which service to commit for opening

up.

The members also can limit the extent or

degree to which foreign service providers can

operate in the country.

Sanitary and Phyto-Sanitary Agreement: (SPS)

Deals with policies relating to food safety as

well as animal plant health.

Member countries can refuse imports from

certain regions / countries due to the fear of

the spread of pests / bacterial contaminations

/ diseases.

Exports that can be affected are- fruits,

vegetables, meat, poultry products, dairy

products etc.

Agreement on Trade Related Investments

(TRIMS)

Currently prohibits countries from imposing

five types of investment conditions on

investors.

Agreement on Technical Barriers to Trade: (TBT)

To ensure that stringent technical requirements,

standards as well as testing and certification

procedures do not create unnecessary obstacles to

trade.

Purpose is to check misuse of mandatory product

standards by member countries.

Recommends countries to base their standards

around international standards.

Trade Related Aspects of Intellectual Property

Rights (TRIPS):

The main objective is to provide protection to

the holder of the intellectual property right,

which can be claimed by an individual,

company or even people of a geographical

region.

TRIPS covers the following:

Patents: These are inventions that are new. A

patent is valid for 20 years from the date of

sanction of patent.

Copyright: A copy right prohibits a person

from reproducing or copying any literary,

dramatic or musical work without the

consent of the owner who has the copy right

over that work. Minimum protection granted

is 50 years and 25 years for photographic

works.

3. Geographical indications: These are places,

names used to identify origin and quality,

reputation or other characteristics of the

products.

- Examples are- “Champagne” ( French white

wine), “Kancheepuram Saree”.

- The agreement says that geographical

indications have to be protected in order to

avoid misleading the public and to prevent

unfair competition.

4. Layout Designs:

To provide protection to integrated circuit

layout designs.

5. Trade marks: Names, marks, symbols etc.

Protection granted is for 7 years. It can be

renewed indefinitely.

Import Licensing:

Import licensing procedure has to be gradually

reduced to facilitate trade of the developing

countries.

Import licensing procedure shall be made as

fast as possible.

Agreement on Anti-Dumping:

This WTO agreement permits antidumping

duty to be levied when goods are exported

from a member country at a price lower than

normal value.

Antidumping duty can be levied only when

the dumped imports cause injury to domestic

industries.

Antidumping duty that can be charged is the

difference between normal value of the

product and the exported value.

Agreement on Rules of origin:

Member countries, especially, developing and

least developed countries can enter into

regional trade agreements by eliminating

tariff and non-tariff barriers for their mutual

economic development.

Rules of origin are the criteria needed to

determine the national source of a product.

Their importance is derived from the fact that

duties and restrictions in several cases depend

upon the source of imports.

There is wide variation in the practice of

governments with regard to the rules of

origin.

Valuation of goods at Customs:

Customs can reject transaction values when it has

reasons to doubt the value declared by the

importers.

In order to protect the interests of the importers

in such situations, Customs is required to provide

them an opportunity to justify their price.

Where Customs is not satisfied with the

justifications given, it has to give importers in

writing, its reasons for not accepting the

transaction value the importer has declared.

Agreement on Pre-Shipment Inspection (PSI):

Member countries shall ensure that PSI

activities are carried out in a

non-discriminatory manner, and that the

procedures and criteria employed in the

conduct of these activities are objective and

are applied on an equal basis to all exporters.

They shall ensure uniform performance of

inspection by all the inspectors of the

Pre-Shipment Inspection agencies engaged by

them.

Contribution of WTO:

It is a rule based system, which is expected to

lead to smooth and orderly international

trade.

Developed and developing countries can be

benefitted by the lowering of tariffs and other

restrictions.

The concepts of liberalization, privatization

and globalization have been strengthened

through WTO.

WTO has brought services trade into

multilateral system

Dispute settlement mechanism facilitates

amicable resolution of disputes between the

countries.

Trade policy review mechanism which

continuously monitors the trade policy of

various countries has resulted in the greater

transparency in international trade.

TRIPS is another important contribution in the

promotion of international trade.

Problem areas of WTO:

Major trade reforms have mostly benefitted

the developed countries.

WTO is not very successful in removing the

non-tariff barriers practiced by some of the

developed countries, which go against the

developing and underdeveloped countries.

Industries in developing and underdeveloped

countries are facing increased threat from

technologically superior MNCs.

Criticisms against WTO:

Domestic markets will be increasingly

threatened because of the lowering of tariffs

leading to free entry of foreign goods, as well

as due to the establishment of local

manufacturing bases by the foreign

companies.

Export markets will become more difficult

because of the competition among the

developing countries with similar comparative

advantages.

Many believe that it is only the developed

countries which have benefitted most and

developing and least developed countries

have not benefitted from WTO agreements.

The decision making process of WTO is

complicated and the vast majority of

developing countries believe that they have

little say in the WTO decision making process.

Impact of WTO on India:

1. Positive impacts:

- Enhanced exports : There is a possibility of

increase of exports from India, in which India has

the competitiveness, due to reduced tariffs and

other barriers.

- Security and predictability: The dispute

settlement mechanism, agreements of safeguard,

subsidies and anti-dumping measures may

provide security and predictability in the

international trade.

- Enhanced trade links- India has the advantage of

having trade links with all the WTO members.

Negative impact:

Price increase: WTO agreements are likely to

cause a steep hike in the prices of drugs and

agricultural inputs.

Danger to service sector: Service sector in India is

less developed than in the developed countries.

Inclusion of trade in services could be detrimental

to India’s interests.

Not really free trade: Developed countries are

imposing more restrictions on the trade than the

underdeveloped countries. Developed countries

seem to manipulate WTO agreements.

Forex Dealing

Different countries have different currencies. The

currencies are neither equivalent in value nor

stable.

The foreign exchange market is a market where

currencies are bought and sold.

The exchange rate is the rate at which one

currency is exchanged for another currency.

US dollar is the currency through which most of

the international transactions are carried out.

Forex dealings are carried out through banks

or authorized dealers who are authorized to

deal in foreign currency by RBI, in India.

Participants in forex market:

Customers: Customers are the people

involved in the foreign trade. Exporters

require conversion of the dollars into rupees

and importers require conversion of rupee

into dollars.

Commercial banks: Commercial banks offer

the services for converting one currency into

another

3. Foreign exchange brokers: Generally banks

buy and sell foreign exchange through

brokers. Operating through the brokers is

advantageous because brokers collect buy and

sell quotations for most currencies from many

banks, so that the most favourable quotation

is obtained quickly and at very low cost.

4. Central Banks: Central banks frequently

intervene to buy and sell their currencies in a

bid to influence the rate at which their

currency is traded.

5. Overseas forex market and

6. Speculators:

Banks- Banks speculate to make profit on

favouable movement in exchange rate.

Big companies may speculate.

Individuals- May buy and sell for short term

profits.

Two way quotations:

Typically, the quotation in the interbank

market is a two way quotation.

It means that the rate quoted by the bank will

indicate two prices- one at which it is willing

to buy the foreign currency, and the other at

which it is willing to sell the foreign currency.

For example, a Mumbai bank may quote its

rate for US dollar as under:

1 USD = Rs. 75.1525 / 1650

If one dollar is bought and sold, the bank

makes a gross profit of Rs. 0.0125.

The difference between the rates is also

known as the “Spread”.

The buying rate is known as the “bid rate” and

the selling rate is known as the “offer rate”.

Exchange quotations are given in two ways:

Direct quotation and

Indirect quotation

Direct quotation: The exchange quotation

which gives the rate for the foreign currency

in terms of the domestic currency is known

as direct quotation.

- Example: 1 USD = Rs. 75.1525 / 75.1650

Direct quotations are used in India.

In a direct quotation, the quoting bank will

apply the rule, “ Buy low, Sell high”.

2. Indirect quotation: In this type of quotation,

the quantity of foreign currency is given per

unit of domestic currency.

Example: Rs. 100 = USD 1.5385 / 1.5391

-In a indirect quotation, the quoting bank will

apply the rule, “ Buy high, Sell low”.

Types of exchange rates:

The transactions in a Forex market can take

place under the following ways:

On the same day (Value today)

Two days later or (Spot)

Some days later (Forward)

1. On the same day (Value today) :

- Where the agreement to buy and sell is

agreed upon and executed on the same date,

is known as cash or ready transaction.

- It is also known as value today.

2. Two days later or (Spot)

The transaction where the exchange of

currencies takes place two days after the date

of the contract is known as the spot

transaction.

For instance, if the contract is made on

Monday, the delivery should take place on

Wednesday.

If Wednesday is a holiday, the delivery will

take place on the next day, i.e., on Thursday.

3. Some days later (Forward)

The transaction in which the exchange of

currencies takes place at a specified future

date, subsequent to the spot date, is known as

a forward transaction.

The forward transaction can be for delivery

one month or two months or three months

etc.

The forward contract for delivery of one

month means the exchange of currencies will

take place after one month from the date of

contract.

Major forex instruments:

Spot market

Forward market

Future market

Option market and

Swaps

Spot market: In this segment of forex market

the sale and purchase transactions are settled

within two days of the deal. The spot rate

means the prevailing exchange rate.

Forward market: In this segment of forex

market the sale and purchase are settled at

some future date, normally after 90 days of

the deal.

Future market: It is a special type of forward

contract in which two parties to buy or sell an

asset at a certain time in future.

Futures are often settled in cash .

Future contracts are traded on organized

exchanges in a variety of commodities like

grains, livestock, bonds, currencies etc.

A forward contract is a private and

customizable agreement that is settled at the

end of the agreement and is traded over the

counter.

A futures contract has standardized terms and

is traded on an exchange, where prices are

settled on a daily basis until the end of the

contract.

Option market: An option is a type of contract

between two parties where one person grants

the other person the right, but not the

obligation, to buy a specific asset at a specific

price within a specific time period.

Alternatively, the contract may grant the

other party the right, but not the obligation,

to sell a specific asset at a specific price within

a specific time period

Options are of two types- Call options and Put

options.

Swaps: It is an agreement to a future

exchange of one asset for another, one

liability for another.

Exchange Rate Theories

There are two theories for determining

foreign exchange rates:

Purchasing Power Parity (PPP) and

Interest Rate Parity (IRP)

Purchasing Power Parity

Different countries have different levels of

economic development. One common

measure of economic development of a

country is Gross National Income (GNI)

divided by per head of population- known as

per capita income.

GNI is regarded as a yardstick for the

economic activity of a country.

Countries such as Sweden, Japan, Switzerland

and USA are said to be among the richest

countries.

USA achieved a GNI per capita of USD 54,960,

where as China achieved USD 7820 and India

achieved USD 1590 in 2015.

One of the world’s poorest countries, Burundi

had a GNI per capita of only USD 260 in 2015,

while one of the World’s richest, Switzerland

achieved USD 84,180.

However, GNI per capita per person figures

can be misleading because they do not

consider differences in the cost of living.

For example, although GNI per capita of

Switzerland is USD 84,180, which exceeds the

USA, which is at USD 54,960, the higher cost

of living in Switzerland means that the USA

citizens could actually afford more goods and

services than Switzerland.

To account for differences in the cost of living

among the countries, one can adjust GNI per

capita by purchasing power –referred as

Purchasing Power Parity Adjustment.

Purchasing Power Parity Adjustment allows a

more direct comparison of living standards in

different countries.

The base for the adjustment is the cost of

living in the USA.

PPP relationship with official exchange rates:

The estimates of per capita income in various

countries are not strictly comparable because

they are based on the conversion of the per

capita income of a country as measured in its

local currency (Rupee in India) to a common

currency( USD), the conversion being based

on the official exchange rates.

The official exchange rates do not reflect the

purchasing power of different countries in

their respective countries.

Thus, for example, if India has a lower per

capita income say USD 1590, but when

converted into rupees, it may buy much more

in India than what USD 1590 can buy in the

USA, due to relatively lower prices in India.

PPP of India is about USD 6610 as on 2020.

Hence comparison of national and per capita

incomes do not reflect the true purchasing

power in different countries.

A change in exchange rate will also change the

per capita income of a country as expressed in

a foreign currency- which need not necessarily

improve the purchasing power in a country.

An example is when India devalued its currency

against the US dollar, even when there was no change

in the economy.

In India, in 1990 - INR 21 = 1USD

After devaluation, in Mar. 1992 - INR 29 = 1USD

After 10 years, in 2007

- INR 46 = 1 USD

After 5 years, in 2007

- INR 40 = 1 USD

In Sep. 2011

- INR 49 = 1 USD
In October, 2016 - INR 67 = 1 USD

** The practice of devaluation and depreciation of local

currency against the USD is a very common in

developing and Least Developed Countries

PPP Theory

The law of one price is the basis of this theory.

As per this law- after making allowances for

tariff and transport costs- the price of goods in

one country should not significantly differ

from that in another country.

Mathematically this can be expressed as:

Price (Domestic) = e X P(Price of the same product in foreign

mkt.) where e is the official exchange rate between two countries.

Thus if an item costs USD 1 In the USA,

exchange rate is Rs 74.92 = 1 USD, its price in

India will be:

Price in India = 74.92 X 1 = Rs. 74.92

The equation can be written as;

e = P (Domestic) / P ( Foreign)
P(D) / P(F) is Inflation Ratio between two

countries

Exchange Rate = e = Ratio between inflation rates

in two countries.

Real Exchange rate = Nominal exchange rate X Foreign price index

Domestic price index

Implications of PPP Theory

Country must export to a country whose

inflation rate is higher than the domestic

rate.

In case of imports, the strategy is reverse.

It provides a tool for determining the real

exchange rates.

Limitations

There are so many factors- interest rates,

balance of payment position, intervention by

Central Banks like RBI, in case of India are

many factors which affect the exchange rate.

Thus relative price level difference advocated

by the theory alone can not determine the

exchange rate between two countries.

2. The law of one price, has been challenged by

Absolute Advantage Theory and Factor

Endowment Theory. One price can’t prevail in

two countries, since the factor endowments

conditions could be significantly different.

3. There is inconsistency in the basket of

products considered for inflation calculations.

Interest Rate Parity

This theory states that the forward rate differs

from the spot rate by an amount which equals

the interest rate differential.

In this process, the currency of a country with

a lower interest rate should be at a forward

premium in relation to the currency of a

country with a higher interest rate.

Implications of IRP:

If domestic interest rates are less than

foreign interest rates, foreign currency must

trade at a forward discount to offset any

benefit of higher interest rates in foreign

country to prevent arbitrage.

If domestic interest rates are more than

foreign interest rates, foreign currency must

trade at a forward premium to offset any

benefit of higher interest rates in domestic

country to prevent arbitrage.

Forward Margin / Swap points

Forward rate may be the same as the spot

rate for the currency. Then it is said to “ at

par” with the spot rate.

But this rarely happens. More often the

forward rate for a currency may be costlier or

cheaper than its spot rate.

The difference between the forward rate and

the spot rate is known as the “forward

margin” or “swap points”.

The forward margin may be either at “premium” or

at “discount”.

If the forward margin is at premium, the foreign

exchange contract will be costlier under forward rate

than under the spot rate.

If the forward margin is at a discount, the foreign

currency will be cheaper for forward delivery than

for spot delivery.

Under direct quotation, premium is added to spot

rate to arrive at the forward rate.

Discount is deducted from the spot rate to arrive at

the forward rate.

Interpretation of interbank quotation:

The market rte for a currency consists of the

spot rate and the forward margin.

For example, US dollar is quoted as under in

the interbank market on 25 January, as under:

Spot USD 1 = Rs. 65.4000 / 4200

Spot / February 2000 / 2100

Spot / March 3500 / 3600

The forward rates for dollar can be derived

from the above quotation as below:

Buying rate Selling rate

Feb Mar. Feb Mar.

Spot rate 65.4000 65.4000 65.4200 65.4200

Add; premium 0.2000 0.3500 0.2100 0.3600

Forward rate 65.6000 65.7500 65.6300 65.7800

Note: Where the forward margin for a month is given in an

ascending order as in the example, it indicates that the

forward currency is at premium.

If the forward currency is at discount, it would

be indicated by quoting the forward margin in

the descending order.

Suppose that on 20 April, the quotation for

pound sterling in the interbank market is as

follows:

Spot GBR 1 = Rs. 73.4000 /4300

Spot / May 3800 / 3600

Spot / June 5700 /5400

Since the forward margin is in descending

order (3800/3600) forward sterling is at

discount:

Buying rate Selling rate

May Jun May Jun

Spot rate 73.4000 73.4000 73.4300 73.4300

less; discount 0.3800 0.5700 0.3600 0.5400

Forward rate 73.0200 72.8300 73.0700 72.8900

Cross rate:

If the quotation for a particular currency is not

available, this can be arrived through other

rates.

Example:

If dollar to Indian rupee is - $ 1 = Rs. 65.2400/ 65.2600

If dollar to Euro is - $ 1 = Euro. 4.9660 / 4.9710

Rupee/ Euro = Dollar / Rupee (Divide) Dollar / Euro

Euro to rupee is = 65.2400 / 4.9660

= 13.1373

Factors determining spot exchange rates

Balance of payments

Rate of inflation

Interest rate

National income

Political factors

Type of exchange rates:

Exchange rate systems can be classified

according to the degree by which exchange

rates are controlled by the government.

Exchange rate systems can be classified into

three categories as given below:

Fixed / pegged exchange rate and

Floating / crawling / flexible exchange rate

and

Managed exchange rate system

Fixed exchange rate regime:

In this the exchange rate is allowed to fluctuate

only within very narrow band.

The currency may be devalued or revalued against

the other currencies depending on the market

situation.

The rate of the domestic currency with respect to

a foreign currency is fixed by the central bank.

Fixed rate provides stability in international prices

for the conduct of trade.

Usage of this system is not common.

Floating exchange rate:

The rate of domestic currency against a

foreign currency depends on the market

forces- supply and demand of foreign

exchange in the foreign exchange market.

Most major currencies are floating when

compared to the US dollar, British pound, Euro

and Japanese Yen.

Managed exchange rate system:

Exchange rate is allowed to rise and fall

depending on the supply and demand, but

government intervenes and controls if it

moves too high or too low.

The government steps into the forex market

and purchases or sells whatever currency is

necessary to keep the exchange rate within

desired limits.

Most countries in the world adopt this

exchange rate policy.

Earlier mobilizing funds from the international

markets used to be the exclusive domain of

multinational corporations due to their wide

spread and reach.

However, after the advent of globalization

which has increased cross-border capital

flows, even smaller companies can now access

international capital easily and at reasonable

cost.

Many large companies in India need foreign

exchange for importing critical capital

equipments and modern technology for

expansion and growth.

Indian companies can raise foreign currency

resources abroad through the issue of

American Depository Receipts and Global

Depository Receipts in accordance with

‘Depository Receipt Scheme, 2014’.

ADR / GDR issues based on shares of a

company are considered as a part of FDI in

India.

Therefore, such issues shall conform to the

existing FDI policy and can be issued by the

companies only in the areas where FDI is

permissible.

A depository receipt has the following

features:

1. A type of negotiable financial instrument

(transferable financial security);

2. Traded on a local stock exchange; and

3. Physical certificate allowing investors to hold

shares in equity of other countries.

** Both the issuing company and the investors

are benefitted by the depository receipts.

The benefits to the company are:

1. Enables the company to raise capital from foreign

markets;

2. Listing of DRs on an international stock exchange

would increase the liquidity of the shares of the

company;

3. There is no exchange risk involved for the issuing

company as shares underlying DRs are denominated in

domestic currency of the company (rupees in case of

India) , although the company receives the funds in

foreign currency; and

4. DRs enhance the profile and status of the company

and the company gains international recognition.

The investors are benefitted in the following

ways:
1. Investors gain the benefits of diversification;

2. Investors are provided with an opportunity to

reap the benefit of investing in a foreign or an

emerging foreign market; and

3. Investors get arbitrage advantage due to the

price differentials that may exist in different

stock exchanges.

There are two common types of depository

receipts and they are:

American Depository Receipt (ADR): These

are shares of non- USA companies, listed and

traded on US stock exchanges.

- ADRs are denominated and pay dividends in

US dollars and may be traded like regular

shares of a stock.

2. Global Depository Receipt (GDR):These are

shares of foreign companies listed and traded

on non-US markets.

GDRs are often listed in Frankfort stock

exchange, Luxemburg Stock Exchange, London

Stock Exchange and Singapore Stock

Exchange.

Procedure for issue of ADR / GDR

ADR / GDR is issued in the same way like any

other financial instruments. It is administered by a

depository bank on behalf of the issuing company.

The depository bank is selected by the issuing

company in such a way that it is generally located

in the countries where the ADR / GDR are to be

traded.

ADR / GDR is considered as a ‘Deposit Agreement’

between the bank issuing it and the holder of

GDR.

The agreement specifies the duties and rights of

each party

The issuing company issues FCCBs or ordinary

shares as per the scheme.

The depository bank buys the FCCBs or shares

of the issuing company and deposits the

shares in the custodian bank.

The custodian bank which is situated in the

country of the issuing company holds the

FCCBs or shares of the company that underlie

the ADR / GDR.

The depository bank issues ADR / GDR

certificates to the foreign investors against the

shares held by the custodian bank.

The physical possession of the shares rests

with the custodian bank although the

ownership of the shares vests with the foreign

investors.

The depository bank is the registered owner

of the shares and its name appears in the

Register of Members of the issuing company.

It is generally the depository bank which

selects the custodian bank.

The custodian bank is responsible for the safe

keeping of the shares of the ADR / GDR.

It also collects dividend and forwards any

notice of the issuer to the depository bank,

which then sends them to the ADR / GDR

holder.

There are two more important players in the

issue of ADR / GDR and they are the lead

manager and the clearing house.

The lead manager is responsible for all the

marketing related activities concerning the

issue.

Also provides professional advice to the

issuing company on the matters concerning

the type of security to be issued-equity, bonds

or FCCB, the rate of interest, pricing of the

security etc.

The clearing house is an agency responsible

for settling trading accounts, clearing trades,

collecting and maintaining margin monies,

regulating delivery and reporting trading data

List of few ADRs that are being traded as on

June 20, 2016:

Tata Motors

Wipro Limited

Dr. Reddy’s Laboratories

Vedanta

Infosys

Mahanagar Gas Limited

HDFC Bank

ICICI Bank

List of few GDRS that are being traded as on

June 20, 2016:

Mahindra and Mahindra

GAIL

Reliance Industries Limited

Axis Bank

State Bank of India

L&T

Reasons for Indian companies preferring GDRs:

Compared to total numbers of ADRs issued by Indian

companies, numbers of GDRs issued are substantially

more.

There are two main reasons for the increased

preference:

1. GDR can be listed in several global markets compared

to ADR (can be listed only in American stock

exchanges) and can attract more investors. Also

companies can collect larger volume of funds through

GDRs; and

2. Another reason is the easier listing, accounting and

reporting requirements set by London and Luxemburg

stock exchanges.
European Union Bonds

Eurobonds are issued by multinational

corporations.

For example, a British company may issue a euro

bond in Germany, denominating it in U.S. dollars.

It is important to note that the term ’Euro’

has nothing to do with the euro region.

The prefix "euro" is used more generally to refer

to deposits outside the jurisdiction of the domestic

central bank.

A type of foreign bond issued and traded in

countries other than the one in which the bond

is denominated.

A dollar denominated bond sold in Europe by a

US firm is a Eurobond.

A GDR / ADR, on the other hand, is a

long-term bond issued by firms and

governments outside of the issuer’s home

country, usually denominated in the currency

of the country in which it is issued.

An example of this would be an Indian

company issuing a dollar-denominated public

bond in the United States.

Globalization has opened up the borders of the

countries, and has increased the cross-border business

flows resulting in global economic integration.

This has enhanced the market size for the firms but

also increased the global business competition.

Global operations have compelled the firms to design

their products for international markets, rationalize

their purchasing, production and distribution functions

optimally.

Firms are giving increasing levels of importance to

international logistics and supply chain management

to derive competitive advantage.

The firms operate in a global economy where

raw materials, components and products are

sourced from low cost production locations to

meet the global consumer demands at

competitive and affordable prices.

The pursuit of cost and other advantages by

the firms are making the supply chains longer

and longer.

Continuous changes in the world economy are

forcing the firms to keep changing their

sourcing decisions, which further places added

stress on the supply chain management.

One of the most complex and important

business decisions facing the business today is

whether to produce a component , assemble,

process or service internally (in sourcing), or

to purchase the same component, assembly,

process or service from an outside supplier

(outsourcing).

As the world markets become increasingly

competitive and open to trade, purchasers must

identify suppliers who are capable of providing

quality products at the lowest possible total cost.

The concept of global outsourcing was initiated by

Japanese automobile manufacturers.

The successful adaption of outsourcing by

Japanese companies, especially Toyota, and

Honda has inspired many other companies to

follow the strategy.

‘Production sharing,’ a term coined by Peter

Drucker, is the natural outcome of the

growing international sourcing.

Production sharing is the practice of carrying

out different stages of manufacturing of a

product in several countries across the globe.

This phenomenon has become very common

in many industries.

The design and development could be done in

one country, the various components may be

produced in different countries, the final

assembly and testing could be carried out in

yet another country and the product may be

marketed and sold globally.

Peter Drucker says that the only thing that is

really made in Japan in respect of an

electronic calculator with the label ‘Made in

Japan’ is the label.

Global sourcing is the process of procuring goods

and services across geo-political boundaries with

the intention of producing a less costly product.

It is a process of buying goods and services from

other countries.

Many firms adapt this strategy since different

parts of the world are at different stages of

industrial development and hence have different

cost structures.

Global sourcing aims to exploit relative global

efficiencies in the areas like low cost skilled

labour, low cost raw materials, low tax structures

or low trade tariffs.

Multinational firms often adapt global

sourcing as a centralized procurement

strategy.

The multinational will implement

corporate-wide standardization across all its

subsidiaries and then go for global sourcing in

a big way to derive economy of scale benefits.

International outsourcing

Outsourcing is the process of procuring some

inputs, part of a process or certain services by

a firm from ‘sources outside the firm.’

It is basically an act of shifting some of the

company’s non-core activities or certain

responsibilities to an external agency / service

provider.

Through this business practice the firm can

focus on its core activities / processes, and

strategic issues.

The firm can enhance its competitive

advantage through reduced cost, accessing

better technology and expertise.

By outsourcing the company can also demand

certain measurable and improved service

levels.

Outsourcing emerges as a strategic decision

after thorough evaluation of the relative

advantages of make-or-buy option.

Outsourcing is not just purchasing, but the

scope extends much beyond just the purchase

of raw materials or intermediate parts /

components.

It is a long term relationship of a company

with an external provider of activities (product

or services) that would otherwise have been

performed in-house.

There are two types of outsourcing, on-shore

outsourcing and off-shore outsourcing.

While on-shore outsourcing is the process of

outsourcing within the same country,

off-shore outsourcing involves outsourcing

from a foreign country, also called as

international outsourcing.

International outsourcing has two variants-

manufacturing outsourcing and service

outsourcing.

The service outsourcing can be of two types-

information technology outsourcing (ITO) and

business processes outsourcing (BPO).

IHRM

An international business must procure,

motivate, retain and effectively utilize services

of people both at the corporate office and at

its foreign plants.

The process of procuring, allocating and

effectively utilizing human resources in an

international business is called International

Human Resource Management(IHRM).

The broad activities of IHRM, namely,

procurement, allocating and utilizing, cover all

the six activities:

Human resource planning

Employee hiring

Training and development

Remuneration

Performance management and

Industrial relations.

A major issue in IHRM is the staffing of

overseas facilities. Various options available

are:

Home country national – Place where the

company is headquartered

Host country national- Place where a

subsidiary is located, local employees

Other country or third country national – any

other employee other than 1 & 2.

Apart from the three categories described

above, there is one more category called as

“ Expatriates”.

These are the people working outside their

home country with a planned return to their

home country or a third country.

Ethnocentric and regiocentric staffing policies

tend to rely on extensive use of expatriates.

Staffing policy:

International business approach tend to adopt

four types of approaches for staffing:

Ethnocentric approach

Polycentric approach
Regiocentric approach and

Geocentric approach

( Already discussed)

Expat selection:

As expatriates play a major role in IB, MNC’s

take great care in their selection process. Four

major criteria are:

Technical competence

Relational skills

Ability to cope with environmental variables

and

Family situation

Technical competence:

An expat who is located away from

headquarters should have a high level of

technical competence since advice and help in

case of any problem is not easily available.

Relational skills:
This refers to the ability of the individual to

deal effectively with the superiors,

subordinates, support staff and clients.

This skill becomes very important since an

expat has to function in an alien environment.

Relational skills include multicultural

sensitivity, interpersonal skills, language and

communication skills.

Ability to cope with environmental variables:

In an international context cultural

environment of the host country is more

significant.

The expat should have knowledge about host

country nationals tastes, attitudes, beliefs,

customs, practices and manners.

The expat should be open to diverse views in

an organization, including those based on

cultural differences.

Family situation:

This refers to the ability of the expat’s family

to adjust to the living conditions in the foreign

environment.
Things to be done before sending on a foreign

assignment:

Once the right candidate is selected for the foreign

assignment, the candidate and often the entire

family needs to be provided with all necessary

information about the country of posting.

Provide cultural and language orientation.

If possible arrange pre-assignment visits for the

entire family to explore the environment, and also to

collect information regarding schooling and other

facilities.

Provide local contact information, including a

combination of company expatriates and local

colleagues for assistance and help.

Assign home-country mentors who are familiar with

the challenges of expatriation to guide the

employee.

Provide explicit job description so that the employee

knows precisely what is expected.

Inform the family, prior to their acceptance of the

posting the expected hardship so that they can

prepare themselves beforehand.

Some common hardship factors:

Climate and physical conditions- extreme climatic

conditions and natural disasters.

Medical facilities

Educational facilities

Infrastructure

Political and social environment- freedom

expression, corruption etc

Crime levels

Language

Recreational facilities

Availability of goods and services

Expatriate and cultural shock:

An expat’s adjustment to the local culture

comprises of three stages:

Tourist stage

Disillusionment or culture shock and

Adapting or adjustment phase

Tourist stage: (Stage I)

In the initial stages of the posting, the expat

enjoys a great deal of excitement as he / she

discovers a new culture.

Business travellers generally remain at this

stage.

Disillusionment or culture shock -(Stage II)

This stage follows after the first stage of

excitement.

In this stage expat faces depression as the

difficulties with the new culture start troubling.

Difficulties could be language, problems in

getting products of personal preferences, home

sickness etc.

This stage is also called as cultural shock stage.

The expat feels strongly displaced, and te

behaviour changes.

The routine is disrupted, frustration, anxiety

and anger takes over the expat.

Cultural shock is a critical stage, and how the

individual copes with the psychological

adjustment in this phase has significant

impact on his or her success or failure.

Generally cultural shock is said to be the main

reason for expat’s failure.

Adapting or adjustment phase: (Stage III)

If the cultural shock is handled successfully,

the expat enters the third stage which is called

as adapting or adjustment phase.

The expat feels more confident, works more

effectively and has learned to cope with the

cultural diversity.

Cultural shock cycle

Time in a new culture

Mood

Stage I

Stage II

Stage III

Consequences of expat’s failure:

Expat failure results in high cost. The direct costs are

– travel cost, relocation of personal belongings, high

salary, training for the assignment, support provided

to spouse and family members and re-staffing cost.

The intangible costs are- Impact on host unit’s

operations, impact on the morale of employees and

loss of company reputation.

In addition, there is expat’s own sense of failure,

declining status with the peers and impact on the

emotional behaviour of the family of the expat.

Training and development:

After the selection of a person, the next job is

training the person for the overseas

assignment.

Training aims at improving the current skills

and behaviour, where as development seeks

to increase overall performance levels through

a series of management development

programmes and job rotation.

Expatriate training:

An expatriate needs pre-departure training

before leaving for a foreign assignment.

The spouse as well as the whole family should

be included in the training programmes.

Training is given in the following areas:

Cultural training

Language training and

Practical training.

Cultural training:

Popularly called as “Cross Cultural Training

(CCT)”.

Training involves- host country’s culture,

history, politics, religion, social and business

practices.

Language training:

Ability to speak in the host country language

will help build rapport with local employees

and improve expatriate’s effectiveness.

In addition to English, an expatriate needs to

know the language of the host country.

Practical training:

It is aimed at helping the expatriate and family

members to quickly settle into the day to day

life of the host country.

A support network of friends and colleagues is

established

The firm sees to that the expatriate is placed

where expatriate community exists and the

family is quickly integrated into this group.

Expatriate performance management:

Generally, both host nation and home nation

managers assess the performance of an

expatriate.

Both are subject to biases. Home country

appraisal may be biased due to lack of

experience of working abroad.

The host country managers may be biased by

their own cultural frame of reference and

expectations.

The expatriate may have to work under

challenging environment. Political situation,

considerable time spent in adjusting to the

new environment may result in the

underperformance, even though the manager

is doing an excellent job.

It is difficult to evaluate the performance of

the expatriate.

There are several variables which influence,

the performance, and they are:

The compensation package

The task

Headquarter’s support

The environment in which the expatriate has

to perform and

Cultural adjustments to be made by the

individual and his family members.

Components of remuneration package:

Base salary:

It is the primary component of package and

other allowances are directly related to the

base salary( Other allowances are generally

given as the percentage of base salary).

Benefits:

It forms a major portion of expat remuneration.

Benefits are designed in such a way, it is tax

efficient, and it is ensured that net income is

maximum, taking the taxation into consideration.

Many firms offer spouse assistance, to help guard

against income lost by an expatriate’s spouse as a

result of relocation.

This may be in the form of allowance or providing

spouse with employment.

Foreign service incentive:

It is the extra pay the expatriate receives for

working outside his country of origin as an

inducement to accept foreign postings, to

compensate for living in an unfamiliar country

isolated from friends and relatives.

Allowances:

Four types of allowances are generally included in

the compensation package. They are hardship

allowance, housing allowance, cost of living

allowances and education allowance.

A hardship allowance is normally paid when the

expatriate is sent toa difficult location where basic

amenities such as health care, schools and retail

store facilities are inadequate.

Other allowances are self explanatory.

Tailoring the package:

Working with the various components of

remuneration explained earlier, MNC’s seek to

tailor-make remuneration packages to fit the

specific situation.

The most common approach to expatriate pay is

the balance sheet approach.

This approach attempts to provide expatriates the

same standard of living in the host country as they

enjoy at home plus a financial inducement for

accepting an overseas assignment.

Repatriation process:

On completion of the overseas assignment,

the MNC may bring the expatriate back to the

home-country.

Not all foreign assignments end with a

transfer home, the expatriate may be given

another international assignment.

The re-entry or bringing back the expatriate to

the home-country should be carefully

planned.
The returning person undergoes what is

termed as re-entry shock or reverse culture

shock.

While people expect life in a country to be

different, they may be less prepared for

homecoming which may cause problems of

adjustment.

Culture and Leader Effectiveness

The GLOBE Study Background

The "Global Leadership and Organizational Behavior Effectiveness" (GLOBE)

Research Program was conceived in 1991 by Robert J. House of the Wharton

School of Business, University of Pennsylvania. In 2004, its first comprehensive

volume on "Culture, Leadership, and Organizations: The GLOBE Study of 62

Societies" was published, based on results from about 17,300 middle managers

from 951 organizations in the food processing, financial services, and

telecommunications services industries.

A second major volume, "Culture and Leadership across the World: The GLOBE

Book of In-Depth Studies of 25 Societies" became available in early 2007. It

complements the findings from the first volume with in-country leadership

literature analyses, interview data, focus group discussions, and formal analyses of

printed media to provide in-depth descriptions of leadership theory and leader

behavior in those 25 cultures.

Cultural Dimensions and Culture Clusters: GLOBE's major premise (and finding)

is that leader effectiveness is contextual, that is, it is embedded in the societal and

organizational norms, values, and beliefs of the people being led. In other words, to

be seen as effective, the time-tested adage continues to apply: "When in Rome do

as the Romans do."

As a first step to gauge leader effectiveness across cultures, GLOBE empirically

established nine cultural dimensions that make it possible to capture the similarities
and/or differences in norms, values, beliefs –and practices—among societies. They

build on findings by Hofstede (1980), Schwartz (1994), Smith (1995), Inglehart

(1997), and others.

They are:

Power Distance: The degree to which members of a collective expect power to be

distributed equally.

Uncertainty Avoidance: The extent to which a society, organization, or group relies

on social norms, rules, and procedures to alleviate unpredictability of future events.

Humane Orientation: The degree to which a collective encourages and rewards

individuals for being fair, altruistic, generous, caring, and kind to others.

Collectivism I (Institutional): The degree to which organizational and societal

institutional practices encourage and reward collective distribution of resources

and collective action.

Collectivism II(In-Group): The degree to which individuals express pride, loyalty,

and cohesiveness in their organizations or families.

Assertiveness: The degree to which individuals are assertive, confrontational, and

aggressive in their relationships with others.

Gender Egalitarianism: The degree to which a collective minimizes gender

inequality.

Future Orientation: The extent to which individuals engage in future-oriented

behaviors such as delaying gratification, planning, and investing in the future.

Performance Orientation: The degree to which a collective encourages and rewards

group members for performance improvement and excellence.

This first step allowed GLOBE to place 60 of the 62 countries into country

clusters. Cultural similarity is greatest among societies that constitute a cluster;

cultural difference increases the farther clusters are apart. For example, the Nordic

cluster is most dissimilar from the Eastern European.

Country Clusters and Leader Styles: GLOBE next analyzed the responses of the ca.

17,300 middle managers from 61 of the 62 countries to 112 leader characteristics,

such as modest, decisive, autonomous, and trustworthy, based on the following

definition of leadership: an outstanding leader is a person in an organization or

industry who is "exceptionally skilled at motivating, influencing, or enabling you,

others, or groups to contribute to the success of the organization or task."

The analysis generated 21 leadership scales. Based on a 7-point scale and the

"world mean" of each scale (i.e., the average of 61 country means), the 21

leadership scales ranked from the "most universally desirable" to "the least

universally desirable" as follows:

Integrity (6.07), Inspirational (6.07) ,Visionary (6.02), Performance-oriented (6.02)

Team-integrator (5.88) , Decisive (5.80), Administratively competent (5.76)

Diplomatic (5.49), Collaborative team orientation (5.46) , Self-sacrificial (5.0)

Modesty (4.98), Humane (4.78), Status conscious (4.34), Conflict inducer (3.97)

Procedural (3.87), Autonomous (3.85), Face saver (2.92) ,Non-participative (2.66)

Autocratic (2.65), Self-centered (2.17), and Malevolent (1.80).

These 21 leadership scales were statistically and conceptually reduced to six

scales, resulting in six leader styles: The performance-oriented style (called

"charismatic/value-based" by GLOBE) stresses high standards, decisiveness, and

innovation; seeks to inspire people around a vision; creates a passion among them

to perform; and does so by firmly holding on to core values.

The team-oriented style instills pride, loyalty, and collaboration among

organizational members; and highly values team cohesiveness and a common

purpose or goals.

The participative style encourages input from others in decision-making and

implementation; and emphasizes delegation and equality.

The humane style stresses compassion and generosity; and it is patient, supportive,

and concerned with the well-being of others.

The autonomous style is characterized by an independent, individualistic, and self-

centric approach to leadership.

The self-protective (and group-protective) style emphasizes procedural, status-

conscious, and 'face-saving' behaviors; and focuses on the safety and security of

the individual and the group.

Hofstede's Cultural Dimensions

Understanding Different Countries

This theory is a framework for cross-cultural communication, developed by Geert

Hofstede.

It describes the effects of a society's culture on the values of its members, and how

these values relate to behavior, using a structure derived from factor analysis.

Imagine this scenario: Mr. A’s boss has asked him to manage a large, global team.

In this new role, he'll be working closely with people in several different countries.

He's excited about the opportunities that his connectedness will present, but he's

also nervous about making cross-cultural faux pas.

He knows that cultural differences can act as a barrier to communication, and that

they could affect his ability to build connections and motivate people. So, how can

he begin to understand these differences and work effectively with people from

different cultures?

In this context, Mr. A can use Hofstede’s Six Dimensions of Culture to work

effectively with people from a range of cultural and geographic backgrounds.

Hofstede's Six Dimensions of Culture

Psychologist Dr Geert Hofstede published his cultural dimensions model at the end

of the 1970s, based on a decade of research. Since then, it's become an

internationally recognized standard for understanding cultural differences.

Hofstede studied people who worked for IBM in more than 50 countries. Initially,

he identified four dimensions that could distinguish one culture from another.

Later, he added fifth and sixth dimensions, in cooperation with Drs Michael H.

Bond and Michael Minkov.

These are:

1. Power Distance Index (high versus low).

2. Individualism Versus Collectivism.

3. Masculinity Versus Femininity.

4. Uncertainty Avoidance Index (high versus low).

5. Pragmatic Versus Normative.

6. Indulgence Versus Restraint.

1. Power Distance Index (PDI)

This refers to the degree of inequality that exists – and is accepted – between

people with and without power.

A high PDI score indicates that a society accepts an unequal, hierarchical

distribution of power, and that people understand "their place" in the system. A

low PDI score means that power is shared and is widely dispersed, and that society

members do not accept situations where power is distributed unequally.

Application: According to the model, in a high PDI country, such

as Malaysia  (100), team members will not initiate any action, and they like to be

guided and directed to complete a task. If a manager doesn't take charge, they may

think that the task isn't important.

DI Characteristics Tips

High PDI  Centralized

organizations.

 More complex

hierarchies.

 Large gaps in

compensation, authority

 Acknowledge a leader's

status. As an outsider,

you may try to

circumvent his or her

power, but don't push

back explicitly.
 Be aware that you may

and respect. need to go to the top for

answers.

Low PDI

Flatter organizations.

Supervisors and

employees are

considered almost as

equals.

 Delegate as much as

possible.

 Ideally, involve all those

in decision making who

will be directly affected

by the decision.

2. Individualism Versus Collectivism (IDV)

This refers to the strength of the ties that people have to others within their

community.

A high IDV score indicates weak interpersonal connection among those who are

not part of a core "family." Here, people take less responsibility for others' actions

and outcomes.

In a collectivist society, however, people are supposed to be loyal to the group to

which they belong, and, in exchange, the group will defend their interests. The

group itself is normally larger, and people take responsibility for one another's
wellbeing.

Application: 

Central American countries Panama and Guatemala have very low IDV scores

(11 and six, respectively). In these countries, as an example, a marketing campaign

that emphasizes benefits to the community would likely be understood and well

received, as long as the people addressed feel part of the same group.

IDV Characteristics Tips

High IDV  High value placed on

people's time and their

 Acknowledge individual

accomplishments.

need for privacy and

freedom.

 An enjoyment of

challenges, and an

expectation of individual

rewards for hard work.

 Respect for privacy.

 Don't mix work life with

social life too much.

 Encourage debate and

expression of people's

own ideas.

Low

IDV


Emphasis on building

skills and becoming

master of something. 

People work for intrinsic

rewards. 

Maintaining harmony

among group members

overrides other moral

issues.

 Wisdom is important.

 Suppress feelings and emotions

that may endanger harmony.

 Avoid giving negative feedback in

public.

 Saying "No" can cause loss of

face, unless it's intended to be

polite. For example, declining an

invitation several times is

expected.

3. Masculinity Versus Femininity (MAS)

This refers to the distribution of roles between men and women. In masculine

societies, the roles of men and women overlap less, and men are expected to

behave assertively. Demonstrating your success, and being strong and fast, are

seen as positive characteristics.

In feminine societies, however, there is a great deal of overlap between male and

female roles, and modesty is perceived as a virtue. Greater importance is placed on

good relationships with your direct supervisors, or working with people who

cooperate well with one another.

The gap between men's and women's values is largest in Japan and Austria, with

MAS scores of 95 and 79 respectively. In both countries, men score highly for

exhibiting "tough," masculine values and behaviors, but, in fact, women also score

relatively highly for having masculine values, though on average lower than men.

Application: 

As we've highlighted, Japan has the highest MAS score of 95, whereas Sweden has

the lowest measured value of five. Therefore, if you open an office in Japan, you

should recognize you are operating in a hierarchical, deferential and traditionally

patriarchal society. Long hours are the norm, and this, in turn, can make it harder

for female team members to gain advancement, due to family commitments.

At the same time, Japan is a culture where all children (male and female) learn the

value of competition and winning as part of a team from a young age. Therefore,

female team members are just as likely to display these notionally masculine traits

as their male colleagues.

By comparison, Sweden is a very feminine society, according to Hofstede's model.

Here, people focus on managing through discussion, consensus, compromise, and

negotiation.

MAS Characteristics Tips

High MAS  Strong egos – feelings of

pride and importance are

attributed to status.

 Money and achievement

are important.

 Be aware of the

possibility of

differentiated gender

roles.

 A long-hours culture may

be the norm, so

recognize its

opportunities and risks.

 People are motivated by

precise targets, and by

being able to show that

they achieved them

either as a group or as

individuals.

Low

MAS

Relationship

oriented/consensual.

More focus on

quality of life.

 Success is more likely to be achieved

through negotiation, collaboration and

input from all levels.

 Avoid an "old boys' club" mentality,

although this may still exist.

 Workplace flexibility and work-life

balance may be important, both in

terms of job design, organizational

environment and culture, and the way

that performance management can be

best realized.

4. Uncertainty Avoidance Index (UAI)

This dimension describes how well people can cope with anxiety.

In societies that score highly for Uncertainty Avoidance, people attempt to make

life as predictable and controllable as possible. If they find that they can't control

their own lives, they may be tempted to stop trying. These people may refer to

"mañana," or put their fate "in the hands of God."

People in low UAI-scoring countries are more relaxed, open or inclusive.

Bear in mind that avoiding uncertainty is not necessarily the same as avoiding risk.

Hofstede argues that you may find people in high-scoring countries who are

prepared to engage in risky behavior, precisely because it reduces ambiguities, or

in order to avoid failure.

Application: 

In Hofstede's model, Greece tops the UAI scale with 100, while Singapore scores

the lowest with eight.

Therefore, during a meeting in Greece, you might be keen to generate discussion,

because you recognize that there's a cultural tendency for team members to make

the safest, most conservative decisions, despite any emotional outbursts. Your aim

is to encourage them to become more open to different ideas and approaches, but it

may be helpful to provide a relatively limited, structured set of options or

solutions.

UAI Characteristics Tips

High UAI

 Conservative, rigid and

structured, unless the

danger of failure requires

a more flexible attitude.

 Many societal

conventions.

 People are expressive,

and are allowed to show

anger or emotions, if

necessary.

 A high energy society, if

people feel that they are

in control of their life

instead of feeling

overwhelmed by life's

vagaries.

Be clear and concise

about expectations and

goals, and set clearly

defined parameters. But

encourage creative

thinking and dialogue

where you can. 

Recognize that there

may be unspoken "rules"

or cultural expectations

you need to learn. 

Recognize that emotion,

anger and vigorous hand

gestures may simply be

part of the conversation.

Low

UAI

 Openness to

change or

innovation, and

generally

inclusive.

 More inclined to

open-ended

learning or

decision making.

 Less sense of

 Ensure that people remain focused,

but don't create too much structure.

 Titles are less important, so avoid

"showing off" your knowledge or

experience. Respect is given to those

who can cope under all

circumstances.

urgency.

5. Pragmatic Versus Normative (PRA)

This dimension is also known as Long-Term Orientation. It refers to the degree to

which people need to explain the inexplicable, and is strongly related to religiosity

and nationalism.

This dimension was only added recently, so it lacks the depth of data of the first

four dimensions. However, in general terms, countries that score highly for PRA

tend to be pragmatic, modest, long-term oriented, and more thrifty. In low-scoring

countries, people tend to be religious and nationalistic. Self-enhancement is also

important here, along with a person's desire to please their parents.

Application: 

The U.S. has a normative score. This is reflected in the importance of short-term

gains and quick results (profit and loss statements are quarterly, for example). It is

also reflected in strong normative positions politically and socially.

PRA Characteristics Tips

Pragmatic

 People often wonder

how to know what is

true. For example,

questions like "What?"

and "How?" are asked

more than "Why?"

 Thrift and education are

seen as positive values.

 Modesty.

 Virtues and obligations

are emphasized.

Behave in a modest way. 

Avoid talking too much

about yourself. 

People are more willing

to compromise, yet this

may not always be clear

to outsiders; this is

certainly so in a culture

that also scores high on

PDI.

Normativ

 People often want to know

"Why?"

 Strong convictions.

 As people tend to oversell

themselves, others will

assess their assertions

critically.

 Values and rights are

emphasized.

Sell yourself to be taken

seriously.

People are less willing to

compromise as this

would be seen as

weakness.

Flattery empowers.
6. Indulgence Versus Restraint (IVR)

Hofstede's sixth dimension, discovered and described together with Michael

Minkov, is also relatively new, and is therefore accompanied by less data.

Countries with a high IVR score allow or encourage relatively free gratification of

people's own drives and emotions, such as enjoying life and having fun. In a

society with a low IVR score, there is more emphasis on suppressing gratification

and more regulation of people's conduct and behavior, and there are stricter social

norms.

Application:

 According to the model, Eastern European countries, including Russia, have a low

IVR score. Hofstede argues that these countries are characterized by a restrained

culture, where there is a tendency towards pessimism. People put little emphasis on

leisure time and, as the title suggests, people try to restrain themselves to a high

degree.

PDI Characteristics Tips

High

Indulgence

Optimistic.

Importance of freedom of

speech.

Focus on personal

happiness.
 Don't take life too

seriously.

 Encourage debate and

dialogue in meetings or

decision making.

 Prioritize feedback,

coaching and mentoring.

 Emphasize flexible

working and work-life

balance.

High

Restraint

Pessimistic.

More controlled

and rigid behavior.

 Avoid making jokes when

engaged in formal sessions.

Instead, be professional.

 Only express negativity about

the world during informal

meetings.

The CAGE Distance Framework 

This identifies Cultural, Administrative, Geographic and Economic differences or

distances between countries that companies should address when crafting

international strategies. It may also be used to understand patterns of trade, capital,

information, and people flows. [2]  The framework was developed by Pankaj

Ghemawat, a professor at the University of Navarra - IESE Business School in

Barcelona, Spain.

The impacts of CAGE distances and differences have been demonstrated

quantitatively via gravity models. Such models "resemble Newton's law of

gravitation in linking interactions between countries to the product of their sizes

(usually their gross domestic products) divided by some composite measure of

distance

Practical Use

Ghemawat offers some advice on how the CAGE Framework can help managers

considering international strategies:

 It makes distance visible for managers.

 It helps to pinpoint the differences across countries that might handicap

multinational companies relative to local competitors.

 It can shed light on the relative position of multinationals from different

countries. For example, it can help explain the strength of Spanish firms in

many industries across Latin America.

 It can be used to compare markets from the perspective of a particular

company. One method to conduct quantitative analysis of this type is to

discount (specifically, divide) raw measures of market size or potential with

measures of distance, broadly defined.

Ghemawat emphasizes that different types of distance matter to different extents

depending on the industry. Because geographic distance, for instance, affects the

costs of transportation, it is of particular importance to companies dealing in heavy

or bulky products. Cultural distance, on the other hand, affects consumers’ product

preferences. It should be a crucial consideration for a consumer goods or media

company, but it is much less important for a cement or steel business.

To facilitate quantitative analysis based on the CAGE framework, Prof. Ghemawat

has developed an online tool called the CAGE Comparator. The CAGE

Comparator covers 163 home countries and 65 industries, and allows users to

customize the impacts of 16 types of CAGE distance.

Professor Ghemawat recommends using the CAGE framework together with

the ADDING Value Scorecard and the AAA Strategies.

The Atlas of Economic Complexity

It is book on economics written by Ricardo Hausmann and others. The book attempts to

measure the amount of productive knowledge that each country holds, by visualizing the

differences between national economies. 

Why do some countries grow and others do not? The authors of The Atlas of Economic

Complexity offer readers an explanation based on "Economic Complexity," a measure of

a

society’s productive knowledge. Prosperous societies are those that have the knowledge to

make a larger variety of more complex products. The Atlas of Economic Complexity attempts

to measure the amount of productive knowledge countries hold and how they can move to

accumulate more of it by making more complex product.

Through the graphical representation of the "Product Space," the authors are able to
identify

each country's "adjacent possible," or potential new products, making it easier to

find paths to

economic diversification and growth. In addition, they argue that a country’s economic

complexity and its position in the product space are better predictors of economic growth

than many other well-known development indicators, including measures of competitiveness,

governance, finance, and schooling.

The book locates each country in the product space, provides complexity and growth

potential rankings for 128 countries, and offers individual country pages with detailed

information about a country’s current capabilities and its diversification options. The maps

and visualizations included in the Atlas can be used to find more viable paths to greater

productive knowledge and prosperity.

Extract of the book

Over the past two centuries, mankind has accomplished what used to be unthinkable. When

we look back at our long list of achievements, it is easy to focus on the most audacious of

them, such as our conquest of the skies and the moon. Our lives, however, have been made

easier and more prosperous by a large number of more modest, yet crucially important feats.

Think of electric bulbs, telephones, cars, personal computers, antibiotics, TVs, refrigerators,

watches and water heaters. Think of the many innovations that benefit us despite our minimal

awareness of them, such as advances in port management, electric power distribution,

agrochemicals and water purification.

This progress was possible because we got smarter. During the past two centuries, the amount

of productive knowledge we hold expanded dramatically. This was not, however, an

individual phenomenon. It was a collective phenomenon. As individuals we are not much

more capable than our ancestors, but as societies we have developed the ability to make all

that we have mentioned – and much, much more.

Modern societies can amass large amounts of productive knowledge because they distribute

bits and pieces of it among its many members. But to make use of it, this knowledge has to be

put back together through organizations and markets. Thus, individual specialization begets

diversity at the national and global level. Our most prosperous modern societies are wiser, not

because their citizens are individually brilliant, but because these societies hold a diversity of

knowhow and because they are able to recombine it to create a larger variety of smarter and

better products.

The social accumulation of productive knowledge has not been a universal phenomenon. It

has taken place in some parts of the world, but not in others. Where it has happened, it has

underpinned an incredible increase in living standards. Where it has not, living standards

resemble those of centuries past. The enormous income gaps between rich and poor nations

are an expression of the vast differences in productive knowledge amassed by different

nations. These differences are expressed in the diversity and sophistication of the things that

each of them makes, which we explore in detail in this Atlas. Just as nations differ in the

amount of productive knowledge they hold, so do products. The amount of knowledge that is

required to make a product can vary enormously from one good to the next. Most modern

products require more knowledge than what a single person can hold. Nobody in this world,
not even the saviest geek nor the most knowledgeable entrepreneur knows how to make a

computer. He has to rely on others who know about battery technology, liquid crystals,

microprocessor design, software development, metallurgy, milling, lean manufacturing and

human resource management, among many other skills. That is why the average worker in a

rich country works in a firm that is much larger and more connected than firms in poor

countries. For a society to operate at a high level of total productive knowledge, individuals

must know different things. Diversity of productive knowledge, however, is not enough. In

order to put knowledge into productive use, societies need to reassemble these distributed bits

through teams, organizations and markets.

Accumulating productive knowledge is difficult. For the most part, it is not available in books

or on the Internet. It is embedded in brains and human networks. It is tacit and hard to

transmit and acquire. It comes from years of experience more than from years of schooling.

Productive knowledge, therefore, cannot be learned easily like a song or a poem. It requires

structural changes. Just like learning a language requires changes in the structure of the brain,

developing a new industry requires changes in the patterns of interaction inside an

organization or society. Expanding the amount of productive knowledge available in a

country involves enlarging the set of activities that the country is able to do. This process,

however, is tricky. Industries cannot exist if the requisite productive knowledge is absent, yet

accumulating bits of productive knowledge will make little sense in places where the

industries that require it are not present. This “chicken and egg” problem slows down the

accumulation of productive knowledge. It also creates important path dependencies. It is

easier for countries to move into industries that mostly reuse what they already know, since

these industries require adding modest amounts of productive knowledge.

By gradually adding new knowledge to what they already know, countries economize on the

chicken and egg problem. That is why we find empirically that countries move from the

products that they already create to others that are “close by” in terms of the productive

knowledge that they require. The Atlas of Economic Complexity attempts to measure the

amount of productive knowledge that each country holds. Our measure of productive

knowledge can account for the enormous income differences between the nations of the

world and has the capacity to predict the rate at which countries will grow. In fact, it is much
more predictive than other well-known development indicators, such as those that attempt to

measure competitiveness, governance and education. A central contribution of this Atlas is

the creation of a map that captures the similarity of products in terms of their knowledge

requirements. This map provides paths through which productive knowledge is more easily

accumulated. We call this map, or network, the product space, and use it to locate each

country, illustrating their current productive capabilities and the products that lie nearby.

Ultimately, this Atlas views economic development as a social learning process, but one that

is rife with pitfalls and dangers. Countries accumulate productive knowledge by developing

the capacity to make a larger variety of products of increasing complexity.

This process involves trial and error. It is a risky journey in search of the possible.

Entrepreneurs, investors and policymakers play a fundamental role in this economic

exploration. By providing rankings, we wish to clarify the scope of the achievable, as

revealed by the experience of others. By tracking progress, we offer feedback regarding

current trends. By providing maps, we do not pretend to tell potential explorers where to go,

but to pinpoint what is out there and what routes may be shorter or more secure. We hope this

will empower these explorers with valuable information that will encourage them to take on

the challenge and thus speed up the process of economic development