Module 3_ FGB

Internationalisation process and managerial implications

The number of multinational companies (MNCs) has increased significantly in recent times.
The key theoretical models explaining a firm’s internationalization process were developed:
the innovation-related models (Bilkey and Tesar, 1977; Cavusgil, 1980; Czinkota, 1982;
Reid, 1981), the incremental internationalization model (Johanson and Wiedersheim-Paul,
1975; Johanson and Vahlne, 1977) and the product cycle model (Vernon, 1966). Although
these models have been refined and updated over time, they have been challenged by new
phenomena, such as the rapid internationalization of small high-tech firms (Knight and
Cavusgil, 2004; Oviatt and McDougal, 1994). Additionally, further advancements in the
world economy, such as global supply chains and offshoring and the internationalization of
developing-country firms, are providing additional challenges to existing arguments that need
a theoretical explanation.

The United Nations Conference on Trade and Development (UNCTAD) World Investment
Report indicates that in 1992 there were 35 000 MNCs, or firms with assets abroad, while in
2008 there were 78817 (UNCTAD, 1992, 2008). This increase in the number of MNCs has
been facilitated by technological advances in transportation and information and
communication technologies, as well as by the liberalization of investment and trade that
accompanied the structural reforms of the last third of the 20th century. Companies have
moved out of their national borders in search of new markets, new and better inputs and new
sources of knowledge.

Innovation-related Models

The firm is initially uninterested in exporting because managers know little about foreign
markets and their attention is focused on the home country. However, sporadic orders from
foreign markets place demands on managerial attention. The firm starts exporting to serve
these requests for products from foreign countries, but this is done in a passive way.
However, increasing requests from foreign markets create a conflict with the attitudes of
domestically-oriented managers.

This conflict and the experience gained serving foreign markets induces managers to revise
their expectations regarding foreign markets and refocus their firms to become active
exporters.
Limitations

Although useful for understanding how and why a domestic firm becomes an international
company with sales abroad, these models provide a limited explanation of the
internationalization process beyond exports. They are not designed to explain how the firm
becomes an MNC with value-added operations abroad.

The model builds on behavioral economics and assumes that managers are risk averse and
have bounded rationality, and that lack of knowledge is an important obstacle for expanding
abroad. It proposes that managers’ lack of knowledge and their risk aversion result in the firm
following an incremental internationalization, gradually increasing its commitment and
investments in a foreign country.

Incremental internationalization enables managers to learn about the foreign country through
direct experience and reduce risks as they increase commitment toward it. The firm
internationalizes incrementally by increasing its commitment in the country in stages: no
export activities, exports via independent representatives, a sales or marketing subsidiary and
finally a production subsidiary.

The incremental internationalization model also explains the selection of countries in which
to internationalize. This is based on the concept of psychic distance, which is defined as ‘the
sum of factors preventing the flow of information from and to the market. Examples are
differences in language, education, business practices, culture, and industrial development.’
(Johanson and Valhne, 1977: 24).

Psychic distance limits the transfer of information across national borders and reduces
managers’ ability to understand information from the foreign country and apply their
knowledge there. Because of managers’ lack of knowledge about foreign markets and their
risk aversion, the firm internationalizes sequentially based on the psychic distance between
the home and destination country.

The firm first expands into countries that are close to the country of origin in terms of psychic
distance.
This enables managers to reduce risks by using knowledge developed in the home market in a
similar environment. The firm then enters more distant countries as managers gain experience
operating in the initial foreign country.

Later studies provided additional depth by discussing how managers’ lack of three types of
knowledge induce them to follow the sequential approach because of perceived costs of
operating abroad (Eriksson, Johanson, Majkgard and Sharma, 1997; Eriksson, Majkgard and
Sharma 2000):

(1) internationalization knowledge, or knowledge about how to manage the increase in

complexity and diversity associated with the overall foreign expansion;

(2) foreign business knowledge, or knowledge of clients, markets and competitors abroad;
and

(3) foreign institutional knowledge, or knowledge of government, institutional frameworks,

rules, norms and values prevalent in foreign countries.

Ownership-location-internalization (OLI) framework

A firm will select among countries in which to set up production facilities depending on the
location advantage that the country provides, on the ownership advantage that the firm has
and on the internalization advantage that the firm may gain from controlling such production
facility. However, it does not provide a prediction on the sequence of countries a firm may
enter because the selection depends on the specific advantages the firm can realize at the time
of the decision.

Transaction-cost model

A firm internalizes cross-border relationships rather than use market mechanisms in its
foreign operations. A firm selects among license, exports, sales subsidiary or production
subsidiary to serve the country based on which method is better for it to achieve its objective
while reducing internalization and transaction costs the most

The product cycle model (Vernon, 1966) builds on the concept of the product life cycle, or
the stages that a product innovation goes through – introduction, growth, maturity and decline
– and uses these to describe the location of sales and production across countries over time.

The model views innovations being generated in developed countries and gradually spreading
to developing countries.
The model proposes that in the introduction stage, a firm located in a developed country
innovates and introduces the innovative product in the home country to serve the needs of
customers there. It undertakes some exports in order to gain economies of scale. These
exports are directed to other developed countries that are similar to the home country in terms
of demand.

In the growth stage, the firm increases exports and later establishes some foreign production
facilities as demand builds in other developed countries. Pressures for cost efficiency increase
as imitators enter into the industry and the production method becomes standardized. As
foreign demand continues to increase, demand becomes more price elastic while labor costs
become a concern due to the standardization of technology.

Thus, in the maturity stage, developed-country markets saturate, the product becomes
standardized and production moves to countries with low-cost labor. Finally, in the decline
stage, production in the home country stops as demand declines and the now standardized
product is imported from less-developed economies.

Vernon (1979) revised the model to accommodate developments in international business

that limited the scope of its applicability, such as the shortening of life cycles or the existence
of firms that introduced innovations in developed and developing countries simultaneously.

However, although the model is useful to explain the movement of innovations across
countries at the industry level (Wells, 1972), it has limited predictability for explaining the
internationalization process at the level of the firm (Melin, 1992).

In the process of globalization, a firm operates their activities globally and

the internationalization process is one of the primary sites of attention.

The changes in the technology in the fields of telecommunications and computer lessen the
costs of cross border operations and encourage firms to engage in transnational production
activities.

Internationalization is a sequential process where firms internalize their economic activities

characterized in terms of aggressiveness and motivated by either internal or external triggers
or a combination of both. It is one of the key strategic decisions for firms to maximize or at
least sustain profits to survive in the world of uncertainty and complexity. The global
economic expansion has been largely facilitated by the growth of TNCs. They dominate
world trade and capital movement with turnover exceeding the GNP of some countries. These
corporations continue to grow and influence the landscape of the world economy.

Export Based Methods for Internationalization

It is the most common way in which a firm becomes international, by producing its products
in the domestic markets but exports a proportion of its products to foreign markets.

Exporting is an oldest and straight forward way of carrying international business.

Its growth can be reduced to the liberalization of trade that has taken place globally and
within regional trading blocs due to concept of free trade like European Union (EU), NAFTA
(North American Free Trade Association), ASEAN (Association of South East Asian
Nations), and APEC (Asia Pacific Economic Corporation). The export based methods of
internationalizing are divided into ‘indirect exporting’ and ‘direct exporting’.

1.Indirect exporting: When a firm does not have any international activity by itself then it
operates through intermediaries for physical distribution of goods and services in the foreign
market. Initially an export house buys products from domestic firm and sells them abroad on
its own account. A confirming house acts for foreign buyers where it brings sellers and
buyers into direct contact and guarantee payments on a commission basis. Finally, a buying
house performs functions in seeking out sellers to match buyer’s particular needs.

2.Direct exporting: In this form a firm is directly involved in distributing and selling its own
products to the foreign markets. It is long term commitment to a particular foreign market
with the firm choosing local agents and distributors specific to that market. It allows the
exporter to monitor developments and competitions in the host market. It promotes
interaction between producer and end user with long term commitments such as providing
after sales services to encourage repeat purchases.

Non-Equity Based Methods for Internationalization

In this form of internationalization, the firm either sells technology or do business in the form
of contract, involving patents, trademarks and copyrights. It is often referred to as intellectual
property rights and form major part of international transactions. This non-equity method of
internationalization takes into forms of licensing, franchising or other types of contractual
agreement.
1.Licensing: It is a permission granted by the licensor (proprietary owner) to a licensee
(foreign party) in the form of a contract to engage in an activity which is otherwise legally
forbidden.

The licensee buys the right to exploit technology and products from the licensor, which is
protected by the intellectual property rights like patent, trademark or copyright.

The licensor benefits from the licensee’s local knowledge and distribution channels; also it is
a low cost strategy for internationalization since the foreign entrant makes little or no
resource commitment. This type of agreement is mostly found in industries like R&D and
other industries where fixed costs are high.

2.Franchising: In this form, the franchisee purchases the right to undertake business activity
using the franchiser’s name or trademark rather than any patented technology. Many firms
choose franchising as a means of internationalizing as it establishes firm’s business in short
time with relatively little direct investment and creates global image through standard
marketing approach.

It allows franchiser a high degree of control and enables to understand the local taste and
preferences in the foreign country. For example, Coca-Cola’s franchising arrangements with
various partners in different countries has given an advantage over its arch rival PepsiCo.
Franchising also helps in building up global brand which can be cultivated and standardized
overtime.

Other contractual modes of internationalization: Besides licensing and franchising,

Management contracting is another form of internationalization where a supplier in one
country provides certain ongoing management functions to a client in another country.

Examples include technical service agreements are provided across borders, as when a
company outsources its operations to a foreign firm. Contract-based partnerships are also
formed between different nationalities in order to share the cost of an investment. For
example, pharmaceutical companies, automobile companies make agreements between
themselves to include cooperation, co-research and co-development activities.

Equity Based Methods for Internationalization

When a firm physically invests in any another country, it is referred as Foreign Direct
Investment (FDI).The major advantage of this method is that the firm has greatest level of
control over its proprietary information and technology.

A firm can use different ways to FDI by acquiring an existing firm, creating equity joint
ventures, merging or establishing a foreign operation by its own (green-field investment).

Acquisition and Establishment of a firm by its own (green-field investment): 

Acquisition of an existing foreign company has a number of advantages compared to green-

field investment. For example, it allows an immediate presence in the market which results in
a fast returns on capital and ready access to knowledge of the local market. Also, problems
associated with green-field investments such as cultural, legal and management issues are
avoided.

Joint Ventures: It involves creating a new identity in which both the initiating partners take
active roles in formulating strategy and making decisions. It helps to share technologies and
lower the costs of high risks in various development projects. Joint Ventures make firm to
gain economics of scale and scope in value adding activities on a global basis.
It creates a firm to secure access to partner’s technology and accumulate learning process
which is used for more effective future competition in the industry.
Joint Ventures are common in high technology industries; it usually takes one of the two
forms: Specialized Joint Ventures and Shared value added Joint Ventures. In Specialized
Joint Ventures, each partner brings a specific competency like one firm might indulge in a
function of production and other does with marketing.

For example organizations like JVC (Japan) and Thomson (France) have been into
specialized Joint Venture where JVC contributed the specialized skills involved the
manufacturing technologies needed to produce optical and compact discs, semiconductors
while Thomson contributed the specific marketing skills needed to compete in European
markets.

In Shared value added Joint Ventures, both partners contributed to same function or value
added activity.

For example in the case of Fuji-Xerox, it is a shared value added Joint Venture with the
design, production and marketing function all shared between two firms.
Merging with a firm: In this equity based method for internationalization, a firm uses FDI
by merging with a firm in the foreign country by buying its stake and holding appropriate
ownership in the form of equities.

It helps to extend its business rapidly and can use its infrastructure and knowledge about local
market to improve its market share compared to its competitors. In equity-based methods for
internationalization, creation of consortium is one of the oldest forms of foreign direct
investment. East Asian business models like Japanese Keiretsu and South Korean chaebols
are more successful in building cross industry consortia when compared to western countries.

Consortium of these types are sophisticated forms of strategic alliances designed to maximize

the benefits like risk sharing, cost reductions, economies of scale etc. They tend to have long
term and stable inter firm relationships based on mutual obligations in order to be forerunner
of technology-based industries.

The Japanese Keiretsu is a combination of 20-25 different industrial companies centered on a

large traditional company where transactions conducted through alliances of affiliated
companies. It is divided into two forms, horizontal keiretsu which consists of highly
diversified groups which are organized around core bank and general trading company (For
example, Mitsubishi, Mitsui and Sanwa).

Vertical Keiretsu is organized around a large parent company in a specific industry like
Toshiba, Toyota and Sony etc. There are strong linkages between these two forms and the
organization is extremely complex and wide reaching.

The South Korean chaebols, usually dominated by the founding families are similar
consortia which are centred on a holding company. While a Keiretsu is financed by group
banks and run by professional managers, chaebols get their funding from governments and
are managed by family members.

Examples include Samsung, Daewoo etc are industrialist families and the company keeps the
stock in family hands. When a firm becomes transnational, it has specific impacts on both
host economies and home economies.

The impacts like transfer of resources, capital, technology, an increase of employment,

concerns about sovereignty and trade and balance of payments occur on the host economy.
The specific impacts on home economies will be like loss of technology, sovereignty, loss of
employment and tax avoidance.
Turn Key Projects

Turnkey contractors specialize in international construction, engineering, design, and

architectural projects, typically for airports, hospitals, factories, power plants, oil refineries,
campuses, and upgrades to public transportation such as bridges, roadways, and rail systems.

In a typical turnkey contract, the contractor plans, finances, organizes, manages, and
implements all phases of a construction project, providing hardware and know-how to
produce what the project sponsor requires.

Hardware includes buildings, equipment, and inventory that comprise the tangible aspects of
the system. Know-how is the knowledge about technologies, operational expertise, and
managerial skills that the contractor transfers to the customer during and after completing the
project.

Turnkey projects are typically awarded on the basis of open bidding, in which many potential
contractors participate. Some are highly publicized megaprojects, such as the European
Channel Tunnel, the Hong Kong Airport, and the Three Gorges Dam in China.

Typical examples of turnkey projects include upgrades to public transportation networks such
as bridges, roadways, and rail systems. Most metro projects are financed largely by public
funding.

They are typically in Asia and Western Europe, where demand is driven by intensifying
urbanization and worsening congestion. One of the world’s largest publicly funded heavy-rail
projects is underway in Delhi, India.

Delhi Metro Rail Ltd. (www.delhimetrorail.com) commissioned the estimated $2.3 billion
turnkey project to build roads and tunnels that run through the city’s central business district.
The turnkey consortium includes numerous local firms as well as Sweden’s Skanska AB, one
of the world’s largest construction companies.
An increasingly popular type of turnkey contract in the developing economies is the build-
own-transfer venture. In this arrangement, the contractors acquire an ownership stake in the
facility for a period of time until it is turned over to the client.

The contractors also provide ongoing advice, training, and assistance in navigating regulatory
requirements and obtaining needed approvals from government authorities.

At some point after a successful period of operation, the contractors divest their interest in the
project.

International Collaborative Ventures

An international collaborative venture is a cross-border business alliance in which partnering

firms pool their resources to create a new venture, sharing the associated costs and risks.
Collaborative ventures represent a middle ground between exporting and FDI.

Collaborative arrangements help the focal firm increase international business, compete more
effectively with rivals, take advantage of complementary technologies and expertise,
overcome trade barriers, connect with customers abroad, configure value chains more
effectively, and generate economies of scale in production and marketing. Joint ventures (JV)
and project-based, nonequity ventures are both examples of international collaborative
ventures.

A joint venture partner is a focal firm that creates and jointly owns a new legal entity through
equity investment or pooling of assets. Partners form JVs to share costs and risks, gain access
to needed resources, gain economies of scale, and pursue long-term strategic goals. For
example, Hitachi formed a joint venture with MasterCard to promote a smart card system for
banking and other applications. The Japanese electronics giant invested $2.4 million to take
an 18 percent stake in the JV, established in San Francisco.

Partners in a project-based, nonequity venture are focal firms that collaborate to undertake a
given project with a relatively narrow scope and well-defined timetable, but without creating
a new legal entity. In contrast to JVs, which involve equity investment by the parent
companies, project-based partnerships are less formal, short-term, nonequity ventures.

The partners pool their resources and expertise for a limited time to perform some mutually
beneficial task, such as joint R&D or marketing, but do not form a new enterprise. One
example is Cisco Systems (www.cisco.com), the worldwide leader in Internet networking
technology, which expanded its operations by partnering with key foreign players.

Cisco formed an alliance with Japan’s Fujitsu to jointly develop routers and switches that
enable clients to build Internet protocol networks for advanced telecommunications. In Italy,
Cisco teamed with Italtel to jointly develop network solutions for the convergence of voice,
data, and video to meet growing global demands. Cisco also formed an alliance with the
Chinese telecom ZTE to tap Asian markets. The two companies are collaborating to provide
equipment and services to telecommunications operators in the Asia-Pacific region

Managerial Implications of Internationalization

Regarding the process of managing production and logistics

First, the importance and difficulty of maintaining control over quality, especially when a
significant proportion of production or if the production of sensitive components is carried
out a long way from the traditional operating base of the internationalized companies.

The difficulty of conducting full and relevant operating audits, the need to translate all
technical documents and quality manuals carefully and accurately into the language of users
on the ground, and the need to train and closely supervise the partners being worked with in
particular happen to be some of the key and important performance factors to be emphasized.

Then, there is the importance of having a coordinated policy for managing the certifications
obtained by the companies, both at home and abroad. A home certification does not
necessarily have the same value in another country, and vice versa.

At the same time and although this observation is contrary to the very notion of certification,
the terms for being granted certification are not all identical everywhere and hence require
careful and coordinated understanding, especially for companies operating in sectors (such as
manufacturing in general or sectors associated with food-processing) where these
certifications constitute essential strategic assets for the survival of a business.

Having control over distribution circuits is also an issue that requires the full attention of the
person leading the internationalized companies. Statutory and particularly regulatory
contexts, local cultural and business practices (especially in terms of commissioning), and the
infrastructures available are elements in particular that have a major effect on the
performance or non-performance of local distribution circuits.
The presence on the ground, even very temporarily, of the companies’ leading manager or an
effective member of the companies’ management team, is a factor that strongly determines
performance in the use of local distribution circuits. Finally, having control over supply
circuits, particularly for companies generating part of their production abroad, is also an
essential performance factor that is impacted by the context of the internationalization of the
companies in question.

This means that the assurance of receiving deliveries on time, anticipating difficulties
associated with any customs operations, the certainty of having the required storage space
and appropriate vehicles are all key performance elements that require an investment in
preparation and supervision time that is often lengthy – all the more so if the companies is
operating far from its usual working base.

Regarding the process of commercial management

The process of managing the commercial and sales/marketing side of the internationalized
companies’ products and services is particularly important for companies focusing on the
stage one of the internationalization process: exporting.

The performance factors associated with the “international” dimension of the commercial
management process identified more particularly in the literature are linked to the following 4
concerns:

1)Developing and running an effective commercial network locally, suited to local cultural
and physical contingencies, capable of expressing itself and negotiating in the language of the
country, without distorting the more technical aspects of the products and services being
offered.

2)A proper understanding of the needs and actual expectations of local customers that
encompasses the financial capabilities of the local customer base (particularly in relations
with an end-consumer), the specific cultural features of their expectations and purchasing
habits: practices in the home country of the exporting companies will not necessarily
correspond with those of the target country, for example in terms of the extent of the range on
offer, the distribution channel used, terms of payment and methods of delivery.

3) Complying scrupulously with the statutory and regulatory constraints applied in the target
country in commercial matters.
For cultural or historical reasons, commercial practices may differ fundamentally from one
country to another, even between two countries in close geographical proximity.

These customs and habits logically have an impact on the statutory and regulatory framework
in place in the country and not complying with them can quickly lead to a situation of
conflict, with the risk of potentially lengthy and costly legal proceedings.

This risk is all the greater when the exported product or service is going to a target market in
which the exporting companies is placing the position of a local competitor in danger.

4) Finally, managing the brand and brand image is also a key performance factor in the
internationalized companies, especially for one positioned in luxury or high-end segments,
technologically or commercially.

However, the proactive and ambitious management of brand and image often runs quickly
out of the reach of a small or medium-sized enterprise, particularly if it bases its sales on
advertising campaigns that are targeted and really appropriate for the expectations of local
consumers and if the company is seeking to protect the key elements of its image across all of
the markets it targets.

By contrast, these days it appears more realistic and even an essential factor for the
companies’ success if it makes judicious use of the commercial possibilities and image
enhancement provided by new Web technologies

Regarding the process of managing human resources

Recruitment: The virtually inevitable corollary of internationalization for companies is the

incorporation of the recruitment criteria used, of precise requirements in terms of the use of
languages, openness to the diversity of cultures and the acceptance of international mobility.

These are all requirements that will make it possible to attract the skills and expertise needed
to fit in closely with the demands of internationalization (mobility, openness to other cultures
and established language capabilities).

Training: When a company internationalizes, this has an impact not only on the staff in close
and direct contact with foreign markets and partners, but also (and this is often forgotten in
the context of the companies) on all of the company’s employees, who are inevitably obliged
to include openness to cultural diversity in the way they reason and in their process of
creativity (new products, new processes, etc.).
If they do not, they run the risk of placing an offering in the marketplace that does not
correspond with the expectations of international markets and with the cultural or regulatory
constraints that they impose.

Failure to take sufficient account of this relatively immaterial organizational aspect

frequently explains why a company that has succeeded in building up an effective sales
process in certain target markets, is unable to sustain it over time.

If the company’s sales people have totally incorporated the international dimension of the
business into the way they operate, but their more technology-based counterparts responsible
for designing new products or applications have not, then the companies’ range of new
products and services will not, in the end, correspond with the expectations of its
international markets.

At the same time, depending in the organizational choices that it makes, the internationalized
companies must be aware of the fact that the interference of the international dimension in
the companies’ remuneration practices may end up, if not anticipated and prepared with care,
with disastrous effects in terms of the working atmosphere and motivation of staff.

In fact, two basically identical sliding pay scales will frequently lead to very different net
remuneration, depending on the local tax systems.

This feeling of frustration can be made better or worse depending on the purchasing power
that this pay goes towards generating on a local level.

Regarding the process of financial management

Accounting: while a company operating solely in exports or imports is impacted only by the
fact it may have to work with number of foreign currencies, a company that has subsidiaries
or has opted to take the path of multi-nationalization is soon faced with the complexity
caused by the coexistence of various different statutory and regulatory accounting
frameworks and with checks conducted by several auditing bodies (this is inevitably the case
for a company with a legal entity in the United States, the United Kingdom or in Asia).

This complexity also has repercussions on the obligations that must be complied with in
terms of the consolidation of accounts and financial statements, which makes a process that is
already complex at the start even more complex (and hence costly)
Tax matters: the question that is posed inevitably to an internationalized company with legal
entities in several countries is the one of optimizing the company’s profits and tax situation,
taking account of the diversity of statutory and regulatory contexts with which it is faced.

This issue is so complex that most Companies admit basing themselves closely on the advice
of specialized consultancies in order to avoid overstepping the subtle line that separates tax
fraud from tax avoidance (which is subject to serious financial penalties at the end of legal
proceedings that are often very lengthy and expensive and at the cost of seeing the
companies’ image badly damaged) while at the same time optimizing the company’s tax
situation as well as possible, given the opportunities presented by the various tax
environments in which the companies are operating.

Finally, in terms of cashflow management, the question raised is a dual one.

First, it relates to calculating the companies’ actual net accounting cashflow situation, taking
account of the fact that receipts and expenditure are potentially entered in a large number of
accounts in several banking establishments, themselves located in several different countries.

Consolidating all of this information, ideally on an ongoing basis and not at irregular
intervals, is potentially complex and needs to be thought through with care. Otherwise, the
individuals responsible for the company may not have an accurate picture of their cashflow
situation and the extent of the financial resources that they have available on a day-to-day
basis. Finally, there is the issue of transferring (and hence repatriating) the funds available in
the company’s various accounts.

While, technologically speaking, this question generally receives a rapid and inexpensive
response when the transactions take place in the eurozone, with the United States, Canada or
Japan, it can sometimes be a great deal more difficult to resolve in other countries for purely
technological reasons (such as incompatible protocols or transfer systems) or for political or
regulatory reasons.

As for the basic principles of healthy financial management, these are essentially impacted by
the nature of the resources and tools that the internationalized companies will put in place to
handle the financial risks brought about by its internationalization.

Types of Financial risks:

Exchange rate risk: born of the fact that not all financial transactions are conducted in the
same currency and hence there are currency conversions to be carried out while the exchange
parity of currencies fluctuates constantly – and sometimes quickly and significantly.

Converted at the wrong time, a currency can generate an exchange loss in relation to the time
a contract is signed. This can more than absorb the operating profit generated by the basic
commercial transaction.

This means there is a need to work with a bank to implement a non-speculative hedging
strategy to cover the company’s real exchange rate risks and to include the cost in advance
when conducting any commercial negotiation in foreign currency

Interest rate risk: this is an issue that exists essentially for companies that have to deal with
long financing cycles (several months or years) that require high levels of funding (in direct
investments in materials or to fund working capital requirements) – and especially for
Companies involved in major export projects. The longer the financing cycle and the more
funding is obtained in countries with different macroeconomic environments and the more
rate conditions chop and change, it is vital for an internationalized companies that wants to
operate effectively, again with the support of its bank, to implement a non-speculative
hedging strategy to cover the company’s real interest rate risks and to include that cost in
advance when conducting any commercial negotiations involving an interest rate risk.

The risk of non-payment: this risk comes into existence once a contractual relationship,
itself inherently uncertain, is established with a customer. But this risk is magnified as soon
as this customer is located beyond the companies’ national borders.

In fact, it is not always the first thing a company thinks about and it can sometimes be very
costly, despite the quality of the databases available today, to gain an accurate idea of the
reputation and financial credibility of a customer located in another country. This increases
the risk of entering into an unfortunate contract with an insolvent customer.

Here again there is a case for advising an internationalized companies to work with its bank
to implement a preventative hedging strategy to cover against the risk of non-payment (by
using factoring, documentary credit, etc.) and again to include this cost in advance during any
commercial negotiations involving a level of risk considered as high in relation to the amount
of the contract and/or a poor level of knowledge about the customer’s reputation.

Effects on the information system

As business gradually becomes internationalized, the information system also becomes more
complex. If a carefully considered allowance is not made for this change and hence the
system is subjected to more and more uncoordinated additions of information, this can soon
lead to a significant loss of efficiency in the operating management of the business.

This increase in complexity relates to 3 different aspects that are virtually always
complementary to one another: More complex data and information contained in the
companies’ databases or exchanged within the company.

As it is multilingual by necessity and hence is translated into the various languages of the
countries with which the companies works or exports to, this information (mainly technical
and commercial in nature) needs to be converted into the various currencies or measurement
systems used in those countries. \

At the same time, the validity, relevance and completeness of the information provided or
managed by the companies also need to have final approval in relation to the statutory and
regulatory context of these countries – otherwise it may lead to commercial disputes or court
cases should there be unanticipated technical difficulties associated with the local constraints
imposed in one of the companies’ partner countries.

More complex technical infrastructure needed to manage information properly. Even though
use of the Web and especially Web 2.0 technologies are becoming more widespread across
the world, there are still many technical incompatibilities in terms of the transfer, repatriation
or storage of data.

Also, the level of security for transactions and transfers is far from being uniform throughout
the world, especially when the companies is involved in major export projects or is
committing to partnerships with distant countries. Internationalization is therefore also
synonymous with regular audits of the internationalizing companies’ information system and
technical infrastructure, particularly in terms of the overall security of the system.

Finally, there is increased complexity in the software infrastructure and an adaptation (mainly
language-related) of the customized applications developed by and for the companies that is
internationalizing.

If staff located abroad need to be able to use or interact with this software infrastructure, there
may be a need to envisage either translating it into the language of its users, or to envisage
development in a common language (usually English) that can potentially be used
internationally (but with a lower level of accuracy than if it were in the mother tongue of each
user).

As with matters relating to technical infrastructure, the financial consequences of these

adaptations may quickly become significant and the cost of these investments may sometimes
be hard to offset in view of the margins generated in international business.

Effects on the power and decision-making system

The effects of internationalization on the internationalized companies’ power and decision-

making system are felt mainly at the stage of opening subsidiaries for certain areas of the
business and, further still, when the company begins multinational operations.

In fact, while an extremely centralized power and decision-making system in the hands of the
companies’ main director or his nearest staff may be envisaged if the companies is restricting
itself to exports, this becomes hard to sustain as soon as the company creates one or more
subsidiaries, and even more so when the company becomes multinational and fully
incorporates the specific requirements of the various accounting, tax, employment and
environmental legislations of the countries in which it is operating into its decision-taking
rules.

When this is the case, the full involvement of decisionmakers who are totally informed and
capable of understanding local legal and cultural subtleties quickly becomes a necessity.
Otherwise poorly prepared decisions leading to poorly controlled consequences may be
taken.

Opening the system of power to players other than the companies’ main director, his family
members or trusted colleagues is also synonymous with a total revamp of the companies’
philosophy and its structure of the power and decision-making system.

This revamp generally and very traditionally comes up against a series of strong barriers and
reluctance that are often difficult to control because they tend to be informal and are tainted
with irrationality.
These take the form of resistance to change, conservatism, refusal to share power and the
rejection of the multi-cultural mindset needed to accommodate the internationalization of the
business.

Effects on the audit system

Finally, the gradual internationalization of the companies’ business also have major
repercussions on the companies’ system of audit – in particular in the areas of controlling
costs, management accountancy and management audits.

Indeed, right from the impending export stage, the accounting and financial auditing of the
companies obliges the company to introduce an accurate system for calculating its costs,
especially its cost prices, so that a price can be established that will enable the companies to
generate a sufficient profit margin to be able to cope with the uncertainty and risk that are a
particular factor of the costs associated with doing business internationally. Very quickly, the
need to incorporate such a cost-calculating component as part of a broader accounting system
becomes apparent.

This broader accounting system then becomes the core of management accounting and the
system of management auditing for Companies opening subsidiaries abroad and/or that are
becoming a genuine multinational.

It opens itself up to the strategic guidance of the companies by incorporating dashboards

dedicated to monitoring international operations, in particular by providing accounting and
financial information and projections that are nuanced in accordance with a series of data
relating to the accounting, financial, employment, fiscal and cultural context of the various
countries in which the companies are operating.

At an advanced stage of internationalization, this management audit system finally includes

accounting, financial and employment-related data that will enable the companies to offer its
staff, especially when they are working abroad, a remuneration and system of financial and
non-financial incentives that will protect them from any uncertainty associated with the
context of the country in which they are working.

Organizational Participants in the International Business that make business happen

Focal Firms
They include well-known multinational enterprises and small and medium-sized exporting
firms, as well as contemporary organizations such as the born global featured in the opening
vignette.

Multinational Enterprise

An MNE is a large company with substantial resources that performs various business
activities through a network of subsidiaries and affiliates located in multiple countries.
Examples include well-known companies like Nestlé, Sony, Unilever, Nokia, Ford, Barclays,
ABB, and Shell Oil.

An MNE is a large company with substantial resources that performs various business
activities through a network of subsidiaries and affiliates located in multiple countries.

Leading MNEs are listed on the Fortune Global 500 (www.fortune.com).

Examples include well-known companies like Nestlé, Sony, Unilever, Nokia, Ford, Barclays,
ABB, and Shell Oil.

Although such firms employ a range of foreign market entry strategies, MNEs are best
known for their foreign direct investment (FDI) activities. They operate in multiple countries,
especially in Asia, Europe, and North America, by setting up production plants, marketing
subsidiaries, and regional headquarters. MNEs such as Exxon, Honda, and Coca-Cola derive
much of their total sales and profits, often more than half, from cross-border operations.

While there were fewer than 7,500 MNEs worldwide in 1970, today the total count stands at
nearly 80,000.1 . Exhibit 3.4 displays a sample of MNEs and the diverse industry sectors
these focal firms represent. Note that, due to the global financial crisis and worldwide
recession, the market value of sectors in the exhibit declined substantially in recent years.

The largest drops occurred in the financial and consumer discretionary sectors, each of which
declined in value by almost 50 percent between 2005 and 2009. Some focal firms operate in
the services sector, including airlines, retailers, and construction companies. Examples
include HSBC in banking, CIGNA in insurance, Bouygues in construction, Accor in
hospitality, Disney in entertainment, Nextel in telecommunications, and Best Buy in retailing.

Although retailers are usually classified as intermediaries, some large ones such as IKEA,
Walmart, and Gap are considered focal firms themselves. In addition, nontraditional Internet-
mediated businesses that deliver knowledge-based offerings such as music, movies, and
software online have joined the ranks of global focal firms. Amazon and Netflix are
examples.

Not all focal firms are private businesses. In developing countries and centrally planned
economies, some focal firms are partly or wholly owned by the government. Lenovo Group is
China’s leading computer maker. It owns the former PC business of IBM and is about 25
percent government-owned.

CNOOC is a huge oil company that tried to buy Unocal in the United States in 2005. It is 70
percent owned by the Chinese government. Numerous other leading Chinese MNEs—China
Mobile and China Netcom in telephony, Dongfeng Motor Corporation and Shanghai
Automotive in cars, and China Life in insurance—are wholly or partly owned by the Chinese
government.

MNEs have played a major role in the current phase of globalization. In the years following
World War II, most multinationals, typically from the United States and the United Kingdom,
went abroad seeking raw materials, production efficiencies, and foreign-based customers.
Today, these firms undertake sourcing, manufacturing, servicing, and marketing activities
that span all areas of the world

A typical MNE, and one whose products you may have sampled, is Sodexo (www.
sodexo.com), the world’s second-largest contract foodservice provider. Sodexo is the second-
largest employer in France, number six in Europe, and twenty-second globally.

Its 355,000 employees provide cafeteria-style food to universities, hospitals, corporations,

and public institutions at 33,900 sites in more than 80 countries. Sodexo serves more than 40
million consumers per day and earns revenues topping $20 billion annually. Typical
customers include the British-Dutch firm Unilever, Germany's Ministry of Foreign Affairs,
and the U.S. Marine Corps. Sodexo is the food source for numerous college cafeterias in
Australia, Canada, and the United States. Chances are, if you eat in a university cafeteria, it’s
a Sodexo operation.

Small and Medium-sized Enterprises

Another type of focal firm that initiates cross-border business transactions is the SME. As
defined in Canada and the United States, small and medium-sized enterprises (SMEs) are
manufacturers or service providers with fewer than 500 employees (in the European
Union and numerous other countries, they are defined as having fewer than 250 employees).

SMEs now make up the majority of companies active in international business. Nearly all
firms, including large MNEs, started out small. Compared to the large multinationals, SMEs
can be more flexible and quicker to respond to global business opportunities.

They are usually less bureaucratic, more adaptable, and more entrepreneurial and are often
the basis for entrepreneurship and innovation in national economies. Being smaller
organizations, SMEs are constrained by limited financial and human resources.

This explains why they usually choose exporting as their main strategy for entering foreign
markets: Their limited resources prevent them from undertaking FD expensive entry mode.
To compensate, SMEs leverage the services of intermediaries and facilitators to succeed
abroad.

As their operations grow, some gradually establish company-owned sales offices or

subsidiaries in key target markets. Because of their size and relative inexperience, SMEs
often target specialized products to market niches too small to interest large MNEs.

SMEs owe much of their international success to support provided by distributors in foreign
markets and globe-spanning logistics specialists such as FedEx and DHL. Smaller firms also
rely on information and communications technologies that allow them to identify global
market niches and efficiently serve specialized buyer needs. As a result, SMEs are gaining
equal footing with large multinationals in marketing sophisticated products around the world.

In Eastern Europe, the development of emerging market countries is driven increasingly by

the rise of fast-growing SMEs. Examples include the Latvian coffee shop chain Double
Coffee and the Hungarian employment recruiter CVO Group.

Many of Eastern Europe’s small firms operate not in manufacturing but in intellectual,
knowledge-intensive industries such as software and consulting. The rise of Eastern European
SMEs has resulted mainly from two trends: the access these firms have gained in recent years
to the massive European Union and direct investment by foreign investors in emerging
markets.

Distribution Channel Intermediaries in International Business

Intermediaries are physical distribution and marketing service providers in the value chain for
focal firms. They move products and services in the home country and abroad and perform
key downstream functions in the target market on behalf of focal firms, including advertising,
sales, and customer service.

Intermediaries are of many different types, ranging from large international companies to
small, highly specialized operations. Techdata (www.techdata.com) is a large distributor of
laptops, peripherals, and other information technology products. Like typical wholesalers, the
firm buys such goods from manufacturers and then resells them to retail stores. There are
three major categories of intermediaries: those based in the foreign target market, those based
in the home country, and those that operate via the Internet

Intermediaries Based in the Foreign Market

Most intermediaries are based in the exporter’s target market. They provide a multitude of
services, including conducting market research, appointing local agents or commission
representatives, exhibiting products at trade shows, arranging local transportation for cargo,
and clearing products through customs. Intermediaries also orchestrate local marketing
activities, including product adaptation, advertising, selling, and after-sales service. Many
finance sales and extend credit, facilitating prompt payment to the exporter.

In short, intermediaries based in the foreign market can function like the exporter’s local
partner, handling all needed local business functions. A foreign distributor is a foreign
market-based intermediary that works under contract for an exporter and takes title to and
distributes the exporter’s products in a national market or territory, often performing
marketing functions such as sales, promotion, and after-sales service.

Foreign distributors are essentially independent wholesalers that purchase merchandise from
exporters (at a discount) and resell it after adding a profit margin. Because they take title to
the goods, foreign distributors are often called merchant distributors. They promote, sell, and
maintain an inventory of the exporter’s products in the foreign market. They also typically
maintain substantial physical resources and provide financing, technical support, and after-
sales service for the product, relieving the exporter of these functions abroad.

Distributors may carry a variety of noncompeting complementary products, such as home

appliances and consumer electronics. For consumer goods, the distributor usually sells to
retailers. For industrial goods, the distributor sells to other businesses and/or directly to end
users. Distributors are a good choice for firms that seek a stable, committed presence in the
target market. They typically have substantial knowledge of the exporter’s products and of
the local market.

An agent is an intermediary (often an individual or a small firm) that handles orders to buy
and sell commodities, products, and services in international business transactions for a
commission. Also known as a broker, an agent may act for either the buyer or seller but does
not assume title or ownership of the goods. The typical agent is compensated by commission,
expressed as a percentage of the price of the product sold.

In economic terms, the agent brings buyers and sellers together. Agents operate under
contract for a definite period of time (often as little as one year), renewable by mutual
agreement. The contract defines territory, terms of sale, compensation, and grounds and
procedures for terminating the agreement. The function of the agent is especially important in
markets made up of many small, widely dispersed buyers and sellers.

For example, brokers on the London Metal Exchange (LME; www.lme.co.uk) deal in copper,
silver, nickel, and other metals sourced from mining operations worldwide. The volume of
metal buying and selling is huge—around $5 billion per year—and the suppliers are widely
dispersed worldwide. The LME greatly increases the efficiency with which manufacturing
firms access the metal ingredients they need to conduct manufacturing operations.

Agents are common in the international trade of commodities, especially agricultural goods
and base minerals. In the services sector, agents often transact sales of insurance and
securities. A manufacturer’s representative is an intermediary contracted by the exporter to
represent and sell its merchandise or services in a designated country or territory.
Manufacturer’s representatives go by various names, depending on the industry in which they
work—agents, sales representatives, or service representatives.

In essence, they act as contracted sales personnel in a designated target market on behalf of
the exporter, but usually with broad powers and autonomy. Manufacturer’s representatives
may handle various noncompetitive, complementary lines of products or services. They do
not take title to the goods they represent and are most often compensated by commission.

With this type of representation, the exporter usually ships merchandise directly to the
foreign customer or end user. Manufacturer’s representatives do not maintain physical
facilities, marketing, or customer support capabilities, so these functions must be handled
primarily by the exporter. In consumer markets, the foreign firm must get its products to end
users through retailers located in the foreign market.

A retailer represents the last link between distributors and end users. Some national retail
chains have expanded abroad and are now providing retail services in multiple countries. For
example, Tesco, Seibu, Carrefour, and Royal Ahold are major retail store chains based in
Britain, Japan, France, and the Netherlands, respectively. Rolex and Ralph Lauren sell their
products directly to these retailers.

This type of transaction has emerged from the international growth of major retail chains.
Often, a traveling sales representative facilitates such transactions. Large international
retailers such as Carrefour and Walmart maintain purchasing offices abroad. Walmart and
Toys “R” Us have opened hundreds of stores worldwide, especially in Mexico, Canada,
Japan, China, and Europe. IKEA, a Swedish company, is the world’s largest furniture retailer.
Dealing directly with foreign-based retailers is efficient because it results in a much shorter
distribution channel and reduced channel costs.

Intermediaries Based in the Home Country

Some intermediaries are domestically based. Wholesaler importers bring in products or

commodities from foreign countries for sale in the home market, re-export, or use in the
manufacture of finished products. Manufacturers also import a range of raw materials, parts,
and components used in the production of higher value-added products. They may also
import a complementary collection of products and services to supplement or augment their
own product range. Retailers such as department stores, specialized stores, mail-order
houses, and catalogue firms import many of the products they sell. A trip to retailers such as
Best Buy, Canadian Tire, or Marks & Spencer reveals that most of their offerings are sourced
from abroad, especially from low labor cost countries.

Wholesalers import input goods that they in turn sell to manufacturers and retailers. A typical
importer in this category is Capacitor Industries Inc. (www.capacitorindustries.com), an SME
that imports low-cost electronic components from China and sells them to motor makers and
other manufacturers in the United States and other countries. Capacitors are tiny devices that
store electrical charges, keep motors running, and protect computers from surges. Capacitor
Industries’ strategy is simple—buy from a low-cost country and sell in an advanced economy
at a profit. Importing from China and other low-cost suppliers means it can undercut the
prices of domestic suppliers by up to 30 percent.

For exporting firms that prefer to minimize the complexity of selling internationally, a trading
company serves as an intermediary that engages in import and export of a variety of
commodities, products, and services. A trading company assumes the international marketing
function on behalf of producers, especially those with limited international business
experience. Large trading companies operate much like agents, coordinating sales of
countless products in markets worldwide. Typically, they are high-volume, low-margin
resellers compensated by adding profit margins to what they sell.

Trading companies are very common in commodities and agricultural goods such as grain.
Companies such as Cargill (www.cargill.com) provide a useful service as international
resellers of agricultural goods. With 160,000 employees in more than sixty countries and
annual sales of more than $100 billion, Cargill is often listed as the largest private firm in the
United States. It buys, sorts, ships, and sells a wide range of commodities, including coffee,
sugar, cotton, oil, hemp, rubber, and livestock, controlling about 25 percent of U.S. grain
exports and one-fifth of the U.S. meat market. Most of its profits come from turning
commodities into value-added products, including oils, syrups, and flour. The company also
processes the ingredients many food companies use to produce cereal, frozen dinners, and
cake mixes.

First, the imports tend to be high-volume, low-margin resellers dealing largely in

commodities such as grains, minerals, and metals. Second, note that five of the ten are based
in Japan, where trading companies long have played a critical role in external trade. Being an
island country with few natural resources, over time Japan became very good at importing
parts and materials needed in manufacturing. Trading companies are also common in South
Korea, India, and Europe

In Japan, large trading companies are known as sogo shosha. The sogo shosha usually
engage in both exporting and importing and are specialists in low-margin, high volume
trading. They may also supply a range of manufacturing, financial, and logistical services. To
stay close to foreign markets, managers of the sogo shosha travel widely, employ extensive
networks of local offices, participate in trade shows, and establish business relationships with
agents and distributors worldwide.
The sogo shosha include giant firms that are little known in the West, such as Mitsui,
Sumitomo, Itochu, and Marubeni, all firms on the Fortune Global 500. In the 1990s, total
trade of the nine top sogo shosha averaged about 25 percent of Japan’s total GDP. They
typically have extensive global operations. For example, Marubeni (www.marubeni.com) has
hundreds of subsidiaries in seventy countries. It is consistently ranked in the upper end of the
Global 500 and had recent annual sales of more than $25 billion.

In the United States, trading companies have had a relatively negligible impact on the volume
of export activity. Although the U.S. Congress passed the Export Trading Company (ETC)
Act in 1982, providing firms with incentives to engage in joint exporting through the
formation of export trading companies, few were formed. One deterrent is the preference of
U.S. firms to pursue international expansion independently of other firms.

A domestically based intermediary is the export management company (EMC), which acts as
an export agent on behalf of a (usually inexperienced) client company. For example, Sharco
is an EMC based in Chicago that assists manufacturers in the heating, ventilation, and
refrigeration industries with exporting their products to Asia and the Middle East. In return
for a commission, an EMC finds export customers on behalf of the client firm, negotiates
terms of sale, and arranges for international shipping. While typically much smaller than a
trading company, some EMCs have well-established networks of foreign distributors in place
that allow exported products immediate access to foreign markets. EMCs are often supply-
driven, visiting the manufacturer’s facilities regularly to learn about new products and even to
develop foreign-market strategies. But because of the indirect nature of the export sale, the
manufacturer runs the risk of losing control over how its products are marketed abroad, with
possible negative consequences for its international image.

Online Intermediaries

Some focal firms use the Internet to sell products directly to customers rather than going
through traditional wholesale and retail channels. By eliminating traditional intermediaries,
companies can sell their products more cheaply and faster. This benefits SMEs in particular
because they usually lack the often-substantial resources needed to undertake conventional
international operations. Countless online intermediaries broker transactions between buyers
and sellers worldwide. Emergent technologies offer—and sometimes require—new roles that
intermediaries have not taken previously. Many traditional retailers establish Web sites or
link with online service providers to create an electronic presence. The electronic sites of
retailers like Tesco (www.tesco.com) and Walmart (www.walmart.com) complement existing
physical distribution infrastructure and bring more customers into physical outlets.

FACILITATORS IN INTERNATIONAL BUSINESS

The third category of participant in international business is facilitators, independent

individuals or firms that assist the internationalization and foreign operations of focal
firms and make it possible for transactions to occur efficiently, smoothly, and in a
timely manner.

Facilitators include banks, international trade lawyers, freight forwarders, customs

brokers, and consultants. Their number and role have grown due to the complexity of
international business operations, intense competition, and technological advances.
Facilitators provide many useful services, from conducting market research to identifying
potential business partners and providing legal advice. They rely heavily on information
technology and the Internet to carry out their facilitating activities. Some facilitators are
supply-chain management specialists, responsible for physical distribution and logistics
activities of their client companies.

An important facilitator of international trade is the logistics service provider, a transportation

specialist that arranges for physical distribution and storage of products on behalf of focal
firms, as well as controlling information between the point of origin and the point of
consumption. Companies such as DHL, FedEx, UPS, and TNT provide cost-effective means
for delivering cargo anywhere in the world. They also offer traditional distributor functions
such as warehousing, inventory management, and order tracking. FedEx, a leading express
shipping company, delivers approximately 3.4 million packages and 11 million pounds of
freight per day and offers supply-chain management services. It delivers to some 220
countries and territories, covering virtually the entire planet with its fleet of more than 670
aircraft and 43,000 cars, trucks, and trailers. FedEx’s business in Brazil, China, and India has
grown rapidly.

Red Wing, a U.S. shoe manufacturer, has taken advantage of UPS’s supply chain services to
bypass its own Salt Lake City distribution center, which is normally used to consolidate and
repackage goods for shipment to retail stores. Red Wing produces some of its shoes in China
and sorts and repackages them at a UPS facility in southern China. Shoes are then delivered
directly to Red Wing retail stores around the United States. By using outside express delivery
firms, Red Wing gets its product to market faster and at lower cost. To serve the international
distribution needs of companies like Red Wing, UPS has built more than fifty warehouses in
China.

Red Wing and countless other international manufacturers use common carriers, companies
that own the ships, trucks, airplanes, and other transportation equipment they use to transport
goods around the world. Common carriers play a vital role in international business and
global trade. Maersk (www.maerskline.com) is a leading carrier, based in Denmark and
operating some 500 ships that move containerized cargo around the world. You may have
seen Maersk containers traveling down the highway, on the backs of trucks and lorries, on
their way to being loaded on ocean-going ships. A consolidator is a type of shipping company
that combines the cargo of more than one exporter into international shipping containers for
shipment abroad.

Most exporters use the services of freight forwarders because they are a critical facilitator in
international business. Usually based in major port cities, freight forwarders arrange
international shipments for the focal firm to a foreign entry port, and even to the buyer’s
location in the target foreign market.

They are experts on transportation methods and documentation for international trade, as well
as the export rules and regulations of the home and foreign countries. They arrange for
clearance of shipments through customs on the importing side of the transaction. Freight
forwarders are an excellent source of advice on shipping requirements such as packing,
containerization, and labeling.

Governments typically charge tariffs and taxes and devise complex rules for the import of
products into the countries they govern. Customs brokers (or customs house brokers) are
specialist enterprises that arrange clearance of products through customs on behalf of
importing firms. They are to importing what freight forwarders are to exporting. They
prepare and process required documentation and get goods cleared through customs in the
destination country. They understand the regulations of the national customs service and
other government agencies that affect the import of products. Usually the freight forwarder,
based in the home country, works with a customs house broker based in the destination
country in handling importing operations.
Various players facilitate the financial operations of international business. Commercial
banks make possible the exchange of foreign currencies and provide financing to buyers and
sellers who usually require credit to finance transactions. The process of getting paid often
takes longer in international than in domestic transactions, so a focal firm may need a loan
from a commercial bank. Commercial banks can also transfer funds to individuals or banks
abroad; provide introduction letters and letters of credit to travelers; supply credit information
on potential representatives or foreign buyers; and collect foreign invoices, drafts, and other
foreign receivables. Within each country, large banks in major cities maintain correspondent
relationships with smaller banks spread around the nation or the world or operate their own
foreign branches, thus providing a direct channel to foreign customers.

Banking is one of the most multinational business sectors. Barclays, Citicorp, and Fuji Bank
have as many international branches as any of the largest manufacturing MNEs. These banks
frequently provide consultation and guidance free of charge to their clients, since they derive
income from loans to the exporter and from fees for special services.

However, banks are often reluctant to extend credit to SMEs, as these smaller firms usually
lack substantial collateral and they experience a higher failure rate than large MNEs. In the
United States, smaller firms can turn to the Export Import Bank (Ex-IM Bank; www.exim .
gov), a federal agency that assists exporters in financing sales of their products and services
in foreign markets. The Ex-Im Bank provides direct loans, working capital loans, loan
guarantees, and other financial products aimed at supporting the exporting activities of
smaller firms.

In other countries, particularly in the developing world, governments provide financing at

favorable rates even to foreign firms, often through public development banks and agencies,
to finance the construction of infrastructure projects such as dams and power plants.
Incoming investment usually results in new jobs, technology transfer, or substantial foreign
exchange.

Governments in Australia, Britain, Canada, Ireland, France, and numerous other countries
similarly provide financing to MNEs for the construction of factories and other large-scale
operations in their countries. In the United States, several state development agencies have
provided loans to automakers like BMW, Honda, Mercedes, and Toyota to establish plants in
individual states.
Focal firms and other participants also use the services of international trade lawyers to help
navigate international legal environments. The best lawyers are knowledgeable about their
client’s industry, the laws and regulations of target nations, and the most appropriate means
for international activity in the legal/regulatory context. Foreign lawyers are familiar with the
obstacles to doing business in individual countries, including import licenses, trade barriers,
intellectual property concerns, and government restrictions in specific industries.

Firms need international trade lawyers to negotiate contracts for the sales and distribution of
goods and services to customers, intermediaries, or facilitators. Lawyers play a critical role
when negotiating joint venture and strategic alliance agreements or for reaching agreement on
international franchising and licensing. International trade lawyers also come into play when
disputes arise with foreign business partners. A good lawyer can explain labor law and
employment rights and responsibilities. Internationalizing firms often apply for patents for
their products and register their trademarks in the countries where they do business, which
requires the services of a patent attorney. In addition, lawyers can help to identify and
optimize tax benefits that may be available from certain entry modes or within individual
countries.

Insurance companies provide coverage against commercial and political risks. Losses tend to
occur more often in international business because of the wide range of natural and human-
made circumstances to which the firm’s products are exposed as they make their way through
the value chain. For example, goods shipped across the ocean are occasionally damaged in
transit. Insurance helps to defray the losses that would otherwise result from such damage.

International business consultants advise internationalizing firms on various aspects of doing

business abroad and alert them to foreign market opportunities. Consultants help companies
improve their performance by analyzing existing business problems and helping management
develop future plans. Particularly helpful are tax accountants, who can advise companies on
minimizing tax obligations resulting from multi-country operations. Market research firms
are a potential key resource for identifying and targeting foreign buyers. They possess or can
gain access to information on markets, competitors, and the methods of international
business.

GOVERNMENTS IN INTERNATIONAL BUSINESS

Governments exist at the local, provincial, national, and supranational levels to make and
enforce laws and regulations and provide essential economic security by devising fiscal and
monetary policies. Recently, many governments have developed new legislation aimed at
protecting the natural environment. For example, the U.S. and European governments are
cooperating to develop policies to cut carbon dioxide emissions. Multilateral environmental
regulations are deemed necessary to address climate change, which can lead to harmful cross-
national events such as crop failures and business calamities.

Increasingly, governments also regulate markets. During the recent global financial crisis,
governments moved to stimulate national economies, through such programs as the
Economic Stimulus Act in the United States, the European Union stimulus plan, and the
Economic Stimulus Plan in China. In some cases, important companies were nationalized.
For example, the governments of Belgium, Luxembourg, and the Netherlands took control of
Fortis, a large bank services company that faced financial ruin. In the United States, the U.S.
Treasury took partial ownership of General Motors.

National finance ministers and central bank directors coordinated efforts aimed at restoring
order following the global financial crisis. Central banks are the monetary authorities in each
country that issue currency and regulate national money supplies. Australia, Canada, China,
Indonesia, the United States, and numerous European countries cut bank interest rates and
injected billions into national money supplies. The European Central Bank (www.ecb.int)
devised new banking regulations with the goal of averting future crises. At the G-20 Summit
in London in 2009, heads of state announced a range of synchronized policy initiatives
intended to revive the global economy, stimulate employment, reform national financial
systems, and improve global institutions like the International Monetary Fund.

Officials from various countries coordinated efforts to restore international growth by

providing more credit and liquidity in world banking systems. Several governments
advocated creating a new, global currency to replace the U.S. dollar as the favored currency
in international business.

Governments participate in international business by investing in other economies. The trend

is best exemplified by the sovereign wealth funds (SWFs), state-owned investment funds that
undertake systematic, global investment activities to generate income or to achieve policy
objectives, such as reviving a collapsed economy. In 2007 China invested billions in
Blackstone, a New York-based private-equity firm. In 2008, the governments of Singapore,
Kuwait, and South Korea provided much of a $21 billion lifeline to Citigroup and Merrill
Lynch, two banks that lost fortunes in the global financial crisis.
While SWFs have been around for decades, their numbers increased dramatically in the
2000s. Many are based in oil-producing countries and originate from massive commodity
sales. For example, Kuwait’s SWF derives from oil revenues and amounts to several hundred
billion dollars. Some funds represent other types of assets, such as the SWF in Quebec,
Canada, based on provincial pension funds. Holdings of some SWFs exceed the GDPs of the
national economies of countries into which they invest. For example, the Abu Dhabi
Investment Authority, the Government Pension Fund of Norway, and the China Investment
Corporation each have several hundred billion dollars under management. Collectively,
SWFs now amount to several trillion dollars.

Given their size, critics charge that SWFs substantially affect their investment targets, even to
the point of endangering national interests. To address the potential harm of SWFs, some
governments passed legislation to restrict inward SWF investments. In 2008, for example,
Germany passed a law that requires parliamentary approval for foreign investments that
acquire more than 25 percent of a German company. The United States has a similar law.
Some experts believe governments’ role in the world economy should be curtailed and
advocate capitalism and free trade as the best means for global economic success.

Instruments of Trade Policy

Historically, as part of their protectionist measures, governments of different countries have

applied many different types of policy instruments, not necessarily based on their economic
merit, for restricting free flow of goods and services across national boundaries. While some
such measures of government intervention are simple, widespread, and relatively transparent,
others are complex, less apparent and frequently involve many types of distortions. In this
unit, we shall describe some of the most frequently used forms of interference with trade.
Understanding the uses and implications of the common trade policy instruments will enable
formulation of appropriate policy responses and more balanced dialogues on trade policy
issues and international trade agreements.
Trade policy encompasses all instruments that governments may use to promote or restrict
imports and exports. Trade policy also includes the approach taken by countries in trade
negotiations. While participating in the multilateral trading system and/or while negotiating
bilateral trade agreements, countries assume obligations that shape their national trade
policies. The instruments of trade policy that countries typically use to restrict imports and/ or
to encourage exports can be broadly classified into price- related measures such as tariffs and
non-price measures or non-tariff measures (NTMs).

Tariffs

Tariffs, also known as customs duties, are basically taxes or duties imposed on goods and
services which are imported or exported. It is defined as a financial charge in the form of a
tax, imposed at the border on goods going from one customs territory to another. They are the
most visible and universally used trade measures that determine market access for goods.

Import duties being pervasive than export duties, tariffs are often identified with import
duties and in this unit, the term ‘tariff’ would refer to import duties. Tariffs are aimed at
altering the relative prices of goods and services imported, so as to contract the domestic
demand and thus regulate the volume of their imports.

Tariffs leave the world market price of the goods unaffected; while raising their prices in the
domestic market. The main goals of tariffs are to raise revenue for the government, and more
importantly to protect the domestic import-competing industries.

Specific Tariff : A specific tariff is an import duty that assigns a fixed monetary tax per
physical unit of the good imported. It is calculated on the basis of a unit of measure, such as
weight, volume, etc., of the imported good. Thus, a specific tariff of `1000/ may be charged
on each imported bicycle.

The disadvantage of specific tariff as an instrument for protection of domestic producers is

that its protective value varies inversely with the price of the import. For example: if the price
of the imported cycle is ` 5,000/, then the rate of tariff is 20%; if due to inflation, the price of
bicycle rises to ` 10,000 , the specific tariff is only 10% of the value of the import. Since the
calculation of these duties does not involve the value of merchandise, customs valuation is
not applicable in this case.
Ad valorem tariff: An ad valorem tariff is levied as a constant percentage of the monetary
value of one unit of the imported good. A 20% ad valorem tariff on any bicycle generates a
`1000/ payment on each imported bicycle priced at `5,000/ in the world market; and if the
price rises to ` 10,000, it generates a payment of `2,000/. While ad valorem tariff preserves
the protective value of tariff on home producer, it gives incentives to deliberately undervalue
the good’s price on invoices and bills of lading to reduce the tax burden. Nevertheless, ad
valorem tariffs are widely used the world over.

Mixed Tariffs : Mixed tariffs are expressed either on the basis of the value of the imported
goods (an ad valorem rate) or on the basis of a unit of measure of the imported goods (a
specific duty) depending on which generates the most income( or least income at times) for
the nation. For example, duty on cotton: 5 per cent ad valorem 0r ` 3000/per tonne,
whichever is higher

Compound Tariff or a Compound Duty is a combination of an ad valorem and a specific

tariff. That is, the tariff is calculated on the basis of both the value of the imported goods (an
ad valorem duty) and a unit of measure of the imported goods (a specific duty). It is generally
calculated by adding up a specific duty to an ad valorem duty. For example: duty on cheese at
5 per cent advalorem plus 100 per kilogram.

Technical/Other Tariff: These are calculated on the basis of the specific contents of the
imported goods i.e the duties are payable by its components or related items. For example:
`3000/ on each solar panel plus ` 50/ per kg on the battery.

Tariff Rate Quotas: Tariff rate quotas (TRQs) combine two policy instruments: quotas and
tariffs. Imports entering under the specified quota portion are usually subject to a lower
(sometimes zero), tariff rate. Imports above the quantitative threshold of the quota face a
much higher tariff.

Most-Favored Nation Tariffs: MFN tariffs are what countries promise to impose on imports
from other members of the WTO, unless the country is part of a preferential trade agreement
(such as a free trade area or customs union). This means that, in practice, MFN rates are the
highest (most restrictive) that WTO members charge one another. Some countries impose
higher tariffs on countries that are not part of the WTO.
Variable Tariff: A duty typically fixed to bring the price of an imported commodity up to
the domestic support price for the commodity.

Preferential Tariff: Nearly all countries are part of at least one preferential trade agreement,
under which they promise to give another country's products lower tariffs than their MFN
rate. These agreements are reciprocal. A lower tariff is charged from goods imported from a
country which is given preferential treatment. Examples are preferential duties in the EU
region under which a good coming into one EU country to another is charged zero tariffs.
Another example is North American Free Trade Agreement (NAFTA) among Canada,
Mexico and the USA where the preferential tariff rate is zero on essentially all products.
Countries, especially the affluent ones also grant ‘unilateral preferential treatment’ to select
list of products from specified developing countries The Generalized System of Preferences
(GSP) is one such system which is currently prevailing.

Bound Tariff : A bound tariff is a tariff which a WTO member binds itself with a legal
commitment not to raise it above a certain level. By binding a tariff, often during
negotiations, the members agree to limit their right to set tariff levels beyond a certain level.
The bound rates are specific to individual products and represent the maximum level of
import duty that can be levied on a product imported by that member. A member is always
free to impose a tariff that is lower than the bound level. Once bound, a tariff rate becomes
permanent and a member can only increase its level after negotiating with its trading partners
and compensating them for possible losses of trade. A bound tariff ensures transparency and
predictability.

Applied Tariffs: An 'applied tariff' is the duty that is actually charged on imports on a most-
favoured nation (MFN) basis.

A WTO member can have an applied tariff for a product that differs from the bound tariff for
that product as long as the applied level is not higher than the bound level.

Escalated Tariff structure refers to the system wherein the nominal tariff rates on imports of
manufactured goods are higher than the nominal tariff rates on intermediate inputs and raw
materials, i.e the tariff on a product increases as that product moves through the value-added
chain.

For example , a four percent tariff on iron ore or iron ingots and twelve percent tariff on steel
pipes.
This type of tariff is discriminatory as it protects manufacturing industries in importing
countries and dampens the attempts of developing manufacturing industries of exporting
countries.

This has special relevance to trade between developed countries and developing countries.
Developing countries are thus forced to continue to be suppliers of raw materials without
much value addition.

Prohibitive tariff: A prohibitive tariff is one that is set so high that no imports will enter.

Anti-dumping Duties: Dumping occurs when manufacturers sell goods in a foreign country
below the sales prices in their domestic market or below their full average cost of the product.

Dumping may be persistent, seasonal, or cyclical. Dumping may also be resorted to as a

predatory pricing practice to drive out established domestic producers from the market and to
establish monopoly position. Dumping is an international price discrimination favoring
buyers of exports, but in fact, the exporters deliberately forego money in order to harm the
domestic producers of the importing country.

This is unfair and constitutes a threat to domestic producers and therefore when dumping is
found, anti-dumping measures which are tariffs to offset the effects of dumping may be
initiated as a safeguard instrument by imposition of additional import duties so as to offset
the foreign firm's unfair price advantage.

This is justified only if the domestic industry is seriously injured by import competition, and
protection is in the national interest (that is, the associated costs to consumers would be less
than the benefits that would accrue to producers).

For example: In January 2017, India imposed anti- dumping duties on color-coated or pre-
painted flat steel products imported into the country from China and European nations for a
period not exceeding six months and for jute and jute products from Bangladesh and Nepal.

Countervailing Duties : Countervailing duties are tariffs that aim to offset the artificially
low prices charged by exporters who enjoy export subsidies and tax concessions offered by
the governments in their home country.

If a foreign country does not have a comparative advantage in a particular good and a
government subsidy allows the foreign firm to be an exporter of the product, then the subsidy
generates a distortion from the free-trade allocation of resources.
In such cases, CVD is charged in an importing country to negate the advantage that exporters
get from subsidies to ensure fair and market oriented pricing of imported products and
thereby protecting domestic industries and firms. For example, in 2016, in order to protect its
domestic industry, India imposed 12.5% countervailing duty on Gold jewelry imports from
ASEAN.

Import subsidies: In some countries, import subsidies also exist. An import subsidy is
simply a payment per unit or as a percent of value for the importation of a good (i.e., a
negative import tariff).

Tariffs as Response to Trade Distortions: Sometimes countries engage in 'unfair' foreign-

trade practices which are trade distorting in nature and adverse to the interests of the domestic
firms. The affected importing countries, upon confirmation of the distortion, respond quickly
by measures in the form of tariff responses to offset the distortion. These policies are often
referred to as "trigger-price" mechanisms.

Tariffs as Response to Trade Distortions: Sometimes countries engage in 'unfair' foreign-

trade practices which are trade distorting in nature and adverse to the interests of the domestic
firms.

Effects of Tariffs

A tariff levied on an imported product affects both the country exporting a product and the
country importing that product.

(i)Tariff barriers create obstacles to trade, decrease the volume of imports and exports and
therefore of international trade.

The prospect of market access of the exporting country is worsened when an importing
country imposes a tariff.

(ii)By making imported goods more expensive, tariffs discourage domestic consumers from
consuming imported foreign goods.

Domestic consumers suffer a loss in consumer surplus because they must now pay a higher
price for the good and also because compared to free trade quantity, they now consume lesser
quantity of the good.

(iii)Tariffs encourage consumption and production of the domestically produced import

substitutes and thus protect domestic industries.
(iv)Producers in the importing country experience an increase in well-being as a result of
imposition of tariff.

The price increase of their product in the domestic market increases producer surplus in the
industry.

They can also charge higher prices than would be possible in the case of free trade because
foreign competition has reduced.

(v)The price increase also induces an increase in the output of the existing firms and possibly
addition of new firms due to entry into the industry to take advantage of the new high profits
and consequently an increase in employment in the industry.

(Vi)Tariffs create trade distortions by disregarding comparative advantage and prevent

countries from enjoying gains from trade arising from comparative advantage.

Thus, tariffs discourage efficient production in the rest of the world and encourage inefficient
production in the home country.

(vii)Tariffs increase government revenues of the importing country by the value of the total
tariff it charges.

Trade liberalization in recent decades, either through government policy measures or through
negotiated reduction through the WTO or regional and bilateral free trade agreements, has
diminished the importance of tariff as a tool of protection. Currently, trade policy is focusing
increasingly on not so easily observable forms of trade barriers usually called nontariff
measures (NTMs). NTMs are thought to have important restrictive and distortionary effects
on international trade.

Import Quota

An import quota is a direct restriction which specifies that only a certain physical amount of
the good will be allowed into the country during a given time period, usually one year. Import
quotas are typically set below the free trade level of imports and are usually enforced by
issuing licenses. This is referred to as a binding quota; a non-binding quota is a quota that is
set at or above the free trade level of imports, thus having little effect on trade. Import quotas
are mainly of two types: absolute quotas and tariff-rate quotas.
Absolute quotas or quotas of a permanent nature limit the quantity of imports to a
specified level during a specified period of time and the imports can take place any time of
the year. No condition is attached to the country of origin of the product. For example: 1000
tonnes of fish import of which can take place any time of the year from any country. When
country allocation is specified, a fixed volume or value of the product must originate in one
or more countries.

Example: A quota of 1000 tonnes of fish that can be imported any time of the year, but where
750 tonnes must originate in country A and 250 tonnes in country B. In addition, there are
seasonal quotas and temporary quotas. With a quota, the government, of course, receives no
revenue. The profits received by the holders of such import licenses are known as ‘quota
rents’.

While tariffs directly interfere with prices that can be charged for an imported good in the
domestic market, import quota interferes with the market prices indirectly. Obviously, an
import quota at all times raises the domestic price of the imported good. The license holders
are able to buy imports and resell them at a higher price in the domestic market and they will
be able to earn a ‘rent’ on their operations over and above the profit they would have made in
a free market.

The welfare effects of quotas are similar to that of tariffs. If a quota is set below free trade
level, the amount of imports will be reduced. A reduction in imports will lower the supply of
the good in the domestic market and raise the domestic price. Consumers of the product in
the importing country will be worse-off because the increase in the domestic price of both
imported goods and the domestic substitutes reduces consumer surplus in the market.
Producers in the importing country are better-off as a result of the quota.

The increase in the price of their product increases producer surplus in the industry. The price
increase also induces an increase in output of existing firms (and perhaps the addition of new
firms), an increase in employment, and an increase in profit. They have become so invasive
that the benefits due to tariff reduction are practically offset by them.

Subsidies

Export subsidies and incentives

Governments or government bodies also usually provide financial contribution to domestic

producers in the form of grants, loans, equity infusions etc. or give some form of income or
price support. If such policies on the part of governments are directed at encouraging
domestic industries to sell specified products or services abroad, they can be considered as
trade policy tools.