Dmba402 All International Business - P

DMBA402: International Business Management Manipal University Jaipur (MUJ)
MASTER OF BUSINESS ADMINISTRATION

SEMESTER 4
DMBA402
INTERNATIONAL BUSINESS
MANAGEMENT
Unit 1 : International Business Management 1

Unit 1
International Business Management
Table of Contents
SL Fig No / Table SAQ /

Topic Page No
No / Graph Activity
1 Introduction - -
3
1.1 Learning Objectives - -
2 Introduction to International Business 1 1
2.1 Meaning - -
4-7
2.2 Definition - -
2.3 Evolution - -
3 Elements of International Business - I
3.1 Domestic vs. international business - -

3.2 Advantages - - 8 - 17
3.3 Drivers - -
3.4 Entry modes - -
4 Globalization - 2 II
4.1 Globalization Vs International - -
18 - 20
Company
4.2 Merits and demerits - -
5 Summary - -
21
6 Glossary - -
7 Terminal Questions - - 22
8 Answers - - 22
9 Case-let - - 23 - 25

1. INTRODUCTION
Most economies across the world are globalizing rapidly as countries have expanded their
business and are eager to explore foreign markets. Previously, many developing countries
were not open to doing business with other foreign countries and have now liberalized their
trade policies and removed trade restrictions. Technology advancement and the advent of
the internet have reduced the Geographic distance between nations, thereby making it easier
to access global markets. Therefore, international business has flourished in the past few
years.
In this unit, you will study the dynamics of global business in today’s business environment
and the need for multinational companies to tap international markets for their business. In
this unit, you will also examine the difference between international business and global
business.
1.1 Learning Objectives:
After studying this unit, you should be able to:
❖ Explain the concept of international business.

❖ Describe the evolution of international business.
❖ Identify and explain the elements of international business.
❖ List the merits and demerits of globalization

2. INTRODUCTION TO INTERNATIONAL BUSINESS

The term international business not just involves the movement of goods and services but
also consists of various concepts, methods, and techniques of doing business. It also involves
the study of various related theories, rules, and regulations to be followed while doing
business with foreign companies or other countries. This section covers in detail the
definition and evolution of international business.
2.1 Meaning:
International business includes those business transactions that involve two or more
countries or nations. These transactions include:
• Product presence in different markets of the world

• Production bases across the world
• Highly diverse Human resources.
• Investment in international services like banking, international finance and marketing,
advertising, retailing and construction.
• Transactions involving intellectual properties such as patents, copyrights, trademarks
and process technology.
2.2 Definition
International Business is the process of focusing on resources of the globe and objectives of
the organization on global business opportunities and threats, in order to produce, buy sell,
or exchange goods and services worldwide.
International business is defined as the trading of goods, services, capital, know-how and
technology between two countries and at a global or transnational level. This involves
transactions of economic resources such as capital, labor, skills meant for production of
goods and services at an international level.

2.3 Evolution
International trade is a very old concept that can be traced thousands of years back to the
Babylonians, who transported goods to distant lands. Organized international trade can be
traced to the ancient Roman Empire when coinage was introduced to encourage trade across
the vast empire. There is evidence of ancient trade routes that are found in the regions of
Egypt, Arabia, Greece, Asia, and Mesopotamia.
The Silk and Spice Routes were significant discoveries of international business. The Silk
Road was an overland trade route from the Mediterranean Sea to China, developed during
the Han Dynasty between 200 BC and 8 AD. These 6,000 km-long routes extended from the
Mediterranean to the early Chinese capital of Hangman (refer figure 1.3). Goods like
perfumes, fine fabrics, silk, and spices were traded from various European ports to China and
other places in between.
Figure 1.3: Ancient Silk Road and Spice Route
Christopher Columbus Discovered America by sea route while the Indian coast by Vasco da
Gama opened up the international markets like never before. British East India Company,
which was set up in the year 1600 AD, is credited to be the world’s first multinational
company.

Industrial revolution in the eighteenth century lead to the innovation and technology, which
led to mass production facilities, and took the British Empire to global markets. With an
abundant supply of raw materials, minerals, precious metals, low-cost labor, and manpower
supply from their colonies, the British Empire became a world power in terms of
international trade.
Post-World War I, the balance shifted to America and Europe. During this period, the world
saw rapid innovations in science and technology and developments in the field of agriculture.
Immediately after World War II, the governments of western countries realized the need to
break the trade barriers across international borders to revive the economies post war in
their respective countries.
The United Nations Monetary and Financial Conference (Bretton Woods’s conference) held
in July 1944 at New Hampshire, USA, was attended by representatives from 44 nations
across the world. This is where the framework for international business was laid down. The
outcome of the Bretton Woods conference is stated below:
• Establishment of International Monetary Fund (IMF) and International Bank for

Reconstruction and Development (IBRD).
• Regulated foreign exchange market system.
• Currency convertibility.
Subsequent to the Bretton Woods conference, after several rounds of negotiations and
agreements, several trade barriers and tariffs were reduced or removed within the
guidelines of the General Agreement on Trade and Tariffs (GATT).
Creation of the WTO on 1 January, 1995, marked the biggest reform of international trade
since World War II. Under the Marrakech agreement, WTO was formed to replace GATT. The
WTO is the only international body that deals with the rules of trade between nations. Its
main objective is to facilitate smooth international trade.

Self-Assessment Questions - 1
1. ________ can be defined as any business that crosses the national borders of the
country of its establishment.
2. Exports and imports do not constitute an international business. (True/False)
3. __________ is considered as the first MNC in the world.
4. Bretton Woods conference led to the formation of ____________.
a) World Trade Organization
b) International monetary fund
c) United Nations Organization
d) General Agreement on Trade and Tariffs
Essay Questions:
A. List out the differences between domestic and international trade?

B. What are the factors that influence international trade?

3. ELEMENTS OF INTERNATIONAL BUSINESS

In the previous section, we discussed the meaning and evolution of international business.
Let us now consider the various factors that differentiate international business from
domestic business, before learning more about international business.
3.1 Domestic Vs. International Business
The main objective of any business is to make good profits from its operations. While this
holds true in both domestic and international business, we can observe several differences
in case of factors such as geographic boundary, currency, interest rates, taxation,
government regulations, language, culture, and economic factors.
Domestic business transactions and operations are within a country whereas international
business involves transactions with different countries.
In Domestic business, only one currency is used as it is within the country whereas in
international business a buyer of foreign goods must pay in a different foreign currency as
preferred by the seller. In International business there are currency fluctuations that impact
the business but in case of domestic business, currency fluctuations do not impact the
business.
Goods traded in Domestic business are subject to regulations of the domestic country
whereas in international business goods that have crossed a country’s border are subject to
the rules, regulations, quotas, and licensing norms of the foreign country.
Businesses selling abroad have to adhere to the customs, culture, and language of different
countries whereas the domestic businesses have to meet the customs, culture, and language
requirements of only the domestic country.
In international business the interest rates, economic barriers and taxation depend on the
country with which the business trades with whereas in case of domestic business these
factors are uniform as it is related to only one country that is the domestic country.

3.2 Advantages Of International Business
International business involves several benefits due to which companies expand into the
foreign markets. Some of the advantages are as follows:
• Low production Costs – Companies normally identify nations that have abundant
cheaper resources in terms of labor, material, logistics and technology to lower their cost
of production and make profits at a larger scale. For example, countries like China,
Philippines, and Mexico offer such low-cost production opportunities.
• Strategic resources – A company makes use of valuable resources in a foreign country
either by importing resources or by setting up a subsidiary or production plant in that
country. These resources can be human or natural resources like minerals. For example,
India is abundant with skilled engineers and graduates, and many global companies have
made best use of this resource by either setting up a subsidiary in India or through other
partners. Similarly, Australia has rich mineral deposits with the world’s largest mining
companies.
• Large customer base – When companies expand into emerging markets of foreign
countries, they get to tap a larger customer base, with greater revenues, high profits, and
increased growth. This scenario is well suited for a company that has already established
products in its domestic market. For example, Sweden based company IKEA is the
world’s largest furniture retailer, and operates in 37 different countries after being well
established in Sweden.
• Competitive advantage – A company which is good at producing products with unique
competencies and capabilities gain bigger benefits in the international market. For
example, US based Intel’s competencies in making semiconductors and chips have
propelled it to global market leadership in microprocessors.
• Risk Diversification – Any company can divert the business risks by spreading its
operations to a number of different countries rather than depending on only one market
or region. For instance, the Asian financial crisis of 1997, all those companies with
exposure in European and American countries were able to sustain far better than other
countries in Asia.

Activity 1
Name one company that is into overseas operation and state the three benefits of
operating in the overseas market.
3.3 Drivers Of International Business
In this section, we get to learn about some important factors that influence international
business to a large extent.
Emerging markets: Most companies target developing countries that have scope for huge
development or emerging markets. Countries that have been operating below their
capacities normally have the potential for immense business opportunities, sales, and
profits.
Low Cost: Companies prefer locating subsidiaries in countries where cheap labor is
available. Countries with low wages, relaxed labor laws and ease of engaging human
resource are some of the major drivers in engaging in international business.
Changing Demographics: Demographics are the nature of the population of a country. This
includes the age, sex, education, skill, preference and overall quality of the population.
Demographics influence companies to set up operations not just to utilize population as a
source of cheap labor as well as an emerging market for sales and other opportunities. For
instance, India has a huge population of young graduates and engineers. IT majors have made
best of the young educated population in India as a cheap labor resource and at the same
time other MNC’s that deal with Apparel and the mobile phone business have seen huge sales
and growth over the years.
Trading Blocks: The Formation of different regional and international trading blocs such as
European Union, World Trade Organization, South Asian Free Trade Agreement, and North
American Free Trade Agreement has resulted in an increase in trading-related regional
cooperation. Regional blocks contribute to efficient resource allocation, technology
development, promotion of certain businesses, new product creation, and cross-border

mergers. Trading blocs facilitate free trade zones that eliminate any trade or investment-
related barriers. Regional trading blocs can facilitate easy movement of goods, services, and
human resources within the region ensuring equal opportunities for all countries within the
region to allocate resources efficiently.
For instance, the creation of NAFTA led to greater job creation in the US due to increased
exports to Mexico.
Diminishing trade and investment barriers: Around the year 2000, the Free trade regime
ensured business growth globally. Reducing barriers to trade and investments in various
countries around the world thereby providing opportunities to companies looking to expand
their business. Expanding into a foreign country provides access to cheap, highly skilled
labor and a bigger market base. Free trade facilitated the movement of goods, services,
capital, and technology across nations. This led to an increase in FDI, outsourcing, and off-
shoring activities. India benefitted from outsourcing while China benefitted from off-shoring
activities. Free trade also ensured the movement of labor across the globe with other benefits
of better job opportunities and increased salaries.
Technological innovation: Technology is the most powerful driver in triggering

international business to a great extent. The advent of information technology, advanced
communication technology, online businesses, and improvements in logistics has totally
changed the dynamics of business operations. Technology advancement has reduced the
time needed for decision making at an international level. Developments in information
technology Services, Payment gateways, Cloud storage and computing, IT enabled supply
chain management and better internet access have simplified international business
operations by bringing the markets of different countries closer.
Scope for huge profits: The scope for making profits in international business is huge and
multifold in comparison to domestic operations. The revenues earned from overseas
markets by foreign companies are huge. This is due to various factors such as foreign
exchange, cost advantage and expanded market size.
Mitigate Risks: International business involves expanding business across various markets
situated in different geographical regions across the globe. Companies may see high product

sales in one region or market whereas the same product may not see high sales in one region
or market. In this case companies mitigate their risk by re-launching their product in
different countries.
Increased global competition: Companies are forced to take their operations overseas to
meet the increasing demand of consumers due to easy accessibility to product related
information. As the regional markets are fully developed, they reach a point of stagnation
where the sales do not increase or decrease and this has led to companies exploring markets
across the globe for better prospects.
3.4 Entry Modes Of International Business
A business can expand internationally through three major entry modes. They are listed as
given below:
Trade-related Entry Modes:
• Exporting
• International sub-contracting
• Counter trade
• Management Contracts
Transfer-related Entry Modes:
• International Leasing
• International Licensing
• International Franchising
• Build operate transfer
FDI-related Entry Modes:
• Branch office
• Co-operative Joint-Venture
• Equity Joint Venture
• Wholly owned subsidiary

• Other modes
Trade-related Entry Modes:
• Exporting: This involves selling products in an overseas market. A firm can export
goods directly to foreign customers or export intermediaries who are third parties who
facilitate exporting and importing. This method is suitable for small and medium
enterprises that wish to enter international markets. It also minimizes the risk
component as well as the capital requirement. The host company’s involvement in the
international market is limited to identifying customers for marketing its products.
• International sub-contracting: This method of entry is meant for firms in a host
country that have surplus production capacity. MNC’s use this surplus capacity to
manufacture their products. MNC’s supply materials, semi-finished products,
customized components to the host company for producing the final product that will
be bought back by the MNC. The local manufacturer or the host company is responsible
for only processing and assembling in exchange for a processing fee and does not enjoy
any rights to the raw material or components supplied by the MNC. Manufacturing sub-
contracting has benefits like low-cost expertise and nil investment whereas at the same
time the drawbacks are low quality standards and the host company becoming the
competitor.
• Counter trade: This is a form of trade in which the seller and the buyer are from
different countries. They exchange goods for other goods, and there is little or no
exchange of cash for goods being purchased or sold.
• Management Contract: these are agreements where MNC’s manage foreign-based
facilities for a fee during a prescribed or limited period of time by training Local
employees. Such contracts include setting up foreign subsidiaries, providing technical
support to set up and run the plant facility and start operations.
Transfer-related Entry Modes: These entry modes result in transfer of ownership from
one party to another for royalty payment. In this form of entry mode, transfer happens with
a purchase of ownership of property by one party from another. For instance, in the case of
transfer of Technology or intellectual property rights.

• International Leasing: When the owner of a property (Lessor) leases out the property
to another party (Lessee). In international leasing the MNC (Lessor) leases out its new
or used equipment to another company (Lessee). Now the lessee is usually from
developing countries who cannot afford to own such properties or equipment. The
Lessor or MNC retains the ownership for a leasing fee and the Lessee or the foreign
company obtains possession of the property or equipment. During the possession of
the property the lessee has to pay a leasing fee every year. The MNC’s usually lease out
property, equipment, plant, idle machinery, Automobiles like cars, trucks and land
movers. The lessor or MNC gets easy access to target markets, fixed earnings for idle
machinery and gains experience in the foreign market from where the lessee comes
from. The lessee gains access to equipment with low investment, familiarity with hi-
tech foreign equipment, minimized operational and investment risk.
• International Licensing: A domestic company permits another foreign firm to use the
domestic company’s technology or products and distribute the company’s product for
compensation called royalty. By licensing, the domestic company need not bear any
costs and risks of entering foreign markets on its own and can get an income from
royalties. There is a risk of providing valuable technological knowledge to foreign
companies, and thereby losing some degree of control over its use. Monitoring licenses
and safeguarding company’s Intellectual Property Rights can prove to be challenging in
an international scenario. The advantages of licensing are that it requires no capital
investment or detailed involvement with foreign customers. Apart from the benefit of
Royalty income, licensing creates an opportunity to utilize research and development
that is already created. The licensee is a local company that provides leverage against
government action to mitigate risks. The disadvantage is that the returns generated
from licensing are less than FDI or franchising. Risk of Pirating technology, Technology
entering the home market of the licensor thereby creating competition and loss of
quality control over business operations and final product.
• International Franchising: In franchising a company (franchisor) who owns an
existing business with a particular brand name, grants the right to another company
(franchisee) to conduct the same business with the same brand name and business
operations in a specific manner within the same country or a different country.

Franchising involves either selling franchisor’s product, using its brand name,
production, marketing techniques and business models. Production equipment,
managerial systems, operating procedures, advertising and promotional material, loan
financing is all a part of the franchise. The franchisee operates the business under the
franchisor’s proprietary rights and is obligated to adhere to the procedures prescribed
in the agreement.
The franchisee bears the costs and risks in establishing the overseas operations. The
franchisors generally maintain greater control over the quality of products, services
and on the overseas operations to ensure the company’s image is not affected
negatively. As per the franchise agreement the franchisor receives royalty that is
calculated over the sales percentage and in certain franchise contracts the franchisor
has to buy the equipment and inputs from the franchisor. McDonalds and Burger King
use the franchising model.
• Build operate transfer: refers to turnkey operations. A foreign investor takes
responsibility for the design and construction of an entire operation. On the completion
of the project, the project is turned over to the purchaser and hands over the
management to the local personnel who are trained for this purpose. In return for the
project completion the investor receives periodic payments. This is applicable in the
case of projects related to Air ports, power projects, dams, roadways flyovers, chemical
plants and manufacturing-based mills. Tata, L&T, GMR are some of the instances.
FDI-related Entry Modes:
Foreign Direct Investment – The investment made by a company in a foreign country to

start its business operations is known as FDI. The options available under FDI are as given
below:
• Branch office: MNC’s open a branch office in a host country. Production and operation
activities are carried out in the branch office which is fully under the control of the
parent company. This entry mode is best suited for service-based businesses such as
Banking, Law firms, Accounting, Software and Customer Service etc. For instance, State

Bank of India has its branch offices in United Kingdom and UAE to run its overseas
operations.
• Co-operative Joint-Venture: this is popularly known as Strategic Alliance which is a
co-operative agreement between firms which goes beyond normal company dealings.
Strategic alliances are projects where two companies join together to work on either
joint R&D, technology sharing, knowledge sharing, joint marketing which usually
happens through product exchange, sharing production facilities. Co-operative
ventures are of two types: equity or non-equity based.
o Equity based Co-operative ventures: In such strategic alliance’s firms get into
contracts in exchange for equity holdings in each other’s firms.
o Non- Equity based Co-operative ventures: These are contracts that may be
through trade or transfer related entry modes. Here the firms agree to co-operate
and work with each other or form an independent organization to manage their
co-operative venture and its operations but do not hold equity or stakes in each
other’s firm.
• Equity Joint Venture: This is a shared ownership in a foreign joint venture. Generally,
the venture is 50-50 ownership and the operations are managed by the alliance
partners. The host country normally sets investment limits on the alliance partners. In
India for instance Tata Motors has a tie up with Fiat Auto. Here India is the Host County
and foreign brands tie up with an Indian partner in order to operate and sell their
products in India. Therefore, the benefits of the joint venture are easy access to host
markets, local partners, distribution networks, brand image and managerial expertise
in the host country.
Wholly owned subsidiary: here the MNC has 100% ownership in the venture located in the
host country. For this purpose, the MNC either sets up a brand-new project called a green
field project or green field investment or the MNC acquires an existing company. Green field
projects create employment opportunities, add to the number of existing manufacturing
capacities and bring in new technology. On the other hand, acquiring a company in a host
country benefits through acquisition of the technology, brand name, logistics, distribution,
business contacts and elimination of competition. The disadvantages of venturing into the

host country are downsizing of employees to cut cost can create a negative impact on the
brand image and government interference in matters related to pricing, financing, and
employee hiring.
• Other Modes:
• Merger or acquisition – A company can merge into or acquire an existing company
with established operations in a foreign country. It saves time for initial setup and
regulatory approvals. The acquiring company can use all the established brand names
and distribution networks of the acquired company.
• Strategic investment – Any firm can purchase a stake in a foreign company, whereby
they are entitled to a share of the profits. Generally, the investing company does not
participate in the management of the target company.

4. GLOBALIZATION
In the previous section, we learnt the various aspects of international business. Globalization
is the shift towards a more integrated and interdependent world economy. The
characteristics of globalization include liberalization of world trade, cross border flow of
finance, technology and human resource, increased FDI, cross border manufacturing and
marketing.
According to business terminologies, globalization is defined as ‘the worldwide trend of

businesses expanding beyond their domestic boundaries’.
According to IMF: “the growing economic interdependence of countries worldwide through

increasing volume and variety of cross border transactions in goods and services and of
international capital flows and also through the more rapid and widespread diffusion of
technology.”
Globalization encompasses the following:
• Expanding the business globally

• Developing a global outlook of the business by not differentiating between domestic
and foreign markets.
• Locating production and other business facilities based on the global business need.
• Developing products and production volumes based on global market requirement
• Global sourcing of factors of production such as raw materials, labor, capital,
machinery, technology, managerial expertise, financing from the best possible source
across the globe
• Global orientation of organizational structure and management culture.
In this section, we will understand globalization, Organization Models, its benefits and
challenges.

4.1 Global Vs International Company :
Most of us assume that international and global business are the same and that any company
that deals with another country for its business is an international or global company. In fact,
there is a considerable difference between the two terms.
Global company International company
A global company has factories, A company that sells its products
offices and distribution outlets in all over the world but has its
many countries catering to factories and distribution centers
multiple markets. only in its home country.
A global company operates across In International business a

the globe with subsidiaries in company only imports or exports
different countries but the products in two or more countries
decisions are taken at the but keeps its main operations and
headquarters. decision making in its home
country.
A global company will have its Here the business investment and
business investments in countries head office remain in the home
in which it wishes to operate. country or country of origin.
4. 2 Benefits Of Globalization
Let us consider the merits and demerits of globalization. Here are some of the merits of
globalization are as follows:
• Globalization helps in the free flow of capital from capital rich countries to developing
countries resulting in an increase in global investment.
• Globalization facilitates free flow of technology to developing nations and ensures
further Innovations and advancement in technology.
• Increase in capital flow into developing nations results in an increase in
industrialization and spread of production facilities across the globe.
• Consumers get better products at competitive prices.
• An increase in employment opportunities also results in a better standard of living and
balanced development.
• It provides several platforms for international business dispute resolutions which
facilitate international trade.

4.3 Demerits Of Globalization
The Demerits of globalization are as follows:
• Globalization kills the domestic business as the domestic players fail to compete with
MNC’s in terms of technology and scale of operations.
• Due to the lack of adequate law, the human resources of developing nations are subject
to undue exploitation.
• There is a decline in demand for domestic products thereby leading to a decline in
income of domestic players in business.
• Globalization also causes ecological damage as companies set up polluting production
plants in countries with limited or no regulations on environmental safety.
Activity 2
Aditya Birla group is a global corporation. Justify this statement based on their
business stratrgies.
Refer this link for guidance –

http://www.adityabirla.com/media/press_reports/20070114_dare_to_dream.htm
5. ‘The worldwide trend of businesses expanding beyond their domestic

boundaries’____________.
6. The MNC has 100% ownership in the venture located in the host country_________.
7. McDonalds and Burger King use the __________ model
8. Counter trade is a _________ related entry mode.
9. A _______ has factories, offices and distribution outlets in many countries
catering to multiple markets.

5. SUMMARY
Now, let us summarize what we have discussed in this unit about introduction to
international business:
• International business is mainly concerned with issues related to companies and

governments involved in cross-border transactions.
• Domestic and International business is differentiated on the basis of geographic
boundary, currency, interest rates, taxation, government regulations, language, culture,
and economic factors.
• Low cost of production, large customer base, risk diversification, and competitive
advantage are some of the advantages of international business.
• A business can expand internationally through three major entry modes that are trade
related, transfer related and FDI related entry modes.
• Globalization is the shift towards a more integrated and interdependent world
economy.
6. GLOSSARY
IPR: Intellectual Property Rights are the legal rights over an intangible asset. For example,
designs, ideas, music composition and so on.
BPO: is business process outsourcing which refers to when companies outsource business
processes to a third-party (external) company.
ITES: is Information Technology enabled services. Information Technology enables the

business by improving the quality of service.
Subsidiary: A company whose controlling interest is held by a bigger (parent) company.
Trading bloc: An agreement between some countries or regions to promote trade and
eliminate trade barriers within the member states.

7. TERMINAL QUESTIONS
1. Explain the evolution of international business.

2. State the factors distinguishing domestic trade from international trade.
3. Analyze various drivers of international business.
4. Explain the merits and demerits of globalization.
8. ANSWERS
Self- Assessment Questions 1
1. International business
2. False
3. British East India Company
4. b) International monetary fund
Self-Assessment Question 2 Answers
5. Globalization
6. Wholly owned subsidiary
7. Franchising
8. Trade
9. global company
Terminal Questions
1. The Origins of international trade can be traced thousands of years back to the
Babylonians, who used to transport their wares to distant lands. For more details, refer
to sub-section 2.5
2. Domestic business transactions and operations are within a country whereas
international business involves transactions with different countries. Refer 3.1.
3. In this section, we get to learn about some important factors that influence
international business to a large extent. For more details, refer to section 3.3.
4. Let us consider the merits and demerits of globalization. Here are some of the merits
of globalization are as follows Refer 4.2

9. CASE-LET
BATA – An International Company
Bata Shoe Company, founded in 1894 in the former Czechoslovakia (presently

headquartered in Lausanne, Switzerland), is one of the world's leading footwear retailers
and manufacturers, with operations across five continents managed by three regional
meaningful business units (MBUs). The MBU approach provides quality resources and
support in key areas to the companies operating in similar markets such as product
development, sourcing, or marketing support. Each MBU is entrepreneurial in nature, and
can quickly adapt to changes in the market place and seize potential growth opportunities.
Bata’s three MBUs are Bata Europe, Lausanne, Switzerland; Bata Emerging Markets,
Singapore; and Bata Branded Business, Best, Holland.
Bata's strength lies in its worldwide presence. While local companies are self-governing,
each one benefits from its link to the international organization for back-office systems,
product innovations, and sourcing.
Research and development – Bata operates six Shoe Innovation Centres (SICs). Research
is conducted in applying new technologies, materials, and designs for shoe comfort features.
Each SIC has a product focus – to supply complete packages of services for the manufacturing
and marketing of innovative shoes.
Shoe making expertise – Apart from being one of the world's leading footwear retailers,
Bata is also an expert in making shoes, with over 110 years of experience in manufacturing.
Currently, they operate 33 production facilities across 22 countries.
While most modern day manufacturers outsource to Asia, Bata manufactures predominantly
in their own manufacturing facilities across the world, guaranteeing quality and expertise.
Approximately half their factory outputs are destined for sale through Bata-owned retail
stores, and the balance is manufactured to the specifications of wholesale customers or
under contract to other footwear brands.

Bata innovations in footwear production techniques are being used by other competitors in
the industry even today.
In 2010, Bata served 1 million customers a day; employed more than 50,000 people;
operated more than 5,000 retail stores; and managed retail presence in more than 70
countries.
Discussion Questions
1. Bata is a global company. Justify. (Hint: operates in 70 countries)

2. Identify the strategy that Bata uses for entry into new markets. (Hint: Own showrooms)
3. What are the factors that help Bata retain its global leadership position? (Hint:
Innovation)
Source: www.bata.com, Retrieved on 28 June 2012
References:
• Francis, Cherunilam, (2014), International Business: text and cases, (5th ed), PHI
Learning Private Ltd.
• K. Aswathappa, (2013). International Business, (5th ed), Tata McGraw-Hill Publications
Co. Ltd.
• Batra, G. S. (2006). Liberalisation, Globalisation and International Business. Deep and
Deep Publications.
• Bhalla, V. K. & Shiva, Ramu S. (2008). International Business –Environment and
Management. Anmol Publications.
• Chauhan, P.L., Kakkad, Ratish, Patel, Rupal H. (2006). International Business. Shanthi
Prakashan.
• Cherunilam, Francis (2010). International Business Environment. Himalaya Publishing
House.
• K. Aswathappa (2010). International Business. Tata McGraw-Hill Publications Co. Ltd.
• McDonald, Frank and Burton, Fred (2002). International Business. International
Thomson Computer Press.

• Nelson, Carl A. (1999). International Business - A Manager’s Guide to Strategy in the

Age of Globalism. PWS South Western Duxbury Cole Onwo.
• Porter, Michael (1990). The Competitive Advantage of Nations. The Free Press.
• Thomson Jr., Arthur; Strickland III, A. J.; Gamble, John E. & Jain, Arun K. (2006). Crafting
and Executing Strategy: The Quest for Competitive Advantage. Tata McGraw Hill
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E-References:
• http://www.wto.org, retrieved on 17th September, 2010

• http://cas.bellarmine.edu/tietjen/Ecol&Evol/connections.htm, retrieved on 18th
September, 2010
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2012
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• https://en.wikipedia.org/wiki/International_business


SEMESTER 4
DMBA402
MANAGEMENT
Unit 2 : International Trade Theories & their application 1

Unit 2
International Trade Theories & their
application
Table of Contents
SL Topic Fig No / Table / SAQ / Page No

No Graph Activity
1 Introduction - -
3
2 Why do nations trade - I 4-5
3 Theories of international trade 1, 2, 3, 4, 5 1, 2 II III
3.1 Mercantilism - -
3.2 Absolute advantage theory - -
3.3 Comparative advantage theory - - 6 - 22
3.4 Heckscher-Ohlin trade theory - -
3.5 Product lifecycle theory - -
3.6 Porter’s diamond model - -
4 Summary - -
23
5 Glossary - -
7 Answers - - 25
8 Case-let - - 26 - 29

1. INTRODUCTION
World history and civilizations in the past indicate that economic benefit was a key motive
behind most of the major wars and trade discoveries. In India, the British ruled our country
for a long period, as they set up their colonies, and exploited the abundant natural resources
and labor. India was their source for raw materials as well as a market to sell their products
for profits. Similarly, Africa was colonized for trading and business. Invasion of Iraq and
Libya by the US were wars that were fought not for social or political causes in reality but for
economic benefits, profits, and future growth. Theories of international trade and their
application provide an understanding of the reasons behind such invasions and the benefits
that are generated in trade. Trade theories guide investors, businesses, consumers, and
governments on the method of making gains within various trading systems across the globe
In the previous unit, you learnt the concept of international business along with various
modes of entering foreign markets. In this unit, you will study international trade theories
that explain various trade patterns, trade motives, and trends in international trade.
❖ Explain the reasons for international trade.

❖ Analyze why Mercantilist theory failed?
❖ Describe ‘Absolute Cost Advantage Theory’ and its features.
❖ Illustrate and explain the Comparative Advantage Theory.
❖ Explain how factor endowments theory affects foreign trade.
❖ Describe stages of International Product lifecycle theory
❖ Outline and explain features of Porter’s diamond model
❖ Summarize the implications of these theories on international trade.

2. WHY DO NATIONS TRADE?

International Trade Theories help us understand the reasons why countries trade with each
other.
For instance, the US is a rich economy yet it does not produce all goods and services in its
own country and imports goods from countries such as China and India. Why do
economically strong nations have to trade with other countries when they can produce such
products in their own country?
The answer to the above question would be that different countries are gifted with different
natural, human, and capital resources. In a global scenario, every nation differs in terms of
its efficiency levels in production of goods and services due to varying natural resources,
population and availability of capital. Most developed nations compare the opportunity
costs, Cost benefit and productivity involved in producing goods in their own country much
before they decide to import goods and services. Therefore, developed nations such as US
and Japan rather prefer importing other products and services from India and China due to
the low-cost benefit and the opportunity costs involved in it. Here are the reasons why
nations trade with each other in detail.
Here is the reason why nations trade?
• Natural resources: Nation's trade because every country is endowed with different
resources and technology. By trading with each other countries make use of their
abundant resources and procure scarce resources from other countries. For Instance,
US is endowed with technology and India with Cheap skilled labor. US can make use of
Cheap labor and India can make use of the technology from US.
• Labor: Developed nations seek abundant labor in less developed or developing nations
like India, Manila or China to make use of Labor to reduce costs and improve efficiency
in production.
• Capital Resources: Developed nations that are capital rich such as US, Singapore and
Germany trade globally with other countries and invest their capital with the
expectation to make huge profits and get ownership stakes in companies of other
countries.

• Opportunity cost: Nation's trade with other countries in those products where their
opportunity cost is low to make profits. At times it is more beneficial and cheaper to
outsource production operations or trade products from other countries rather than
produce the product themselves within their own country.
• Absolute advantage: Some Nations are good at producing certain products and it is
profitable for such countries to produce in bulk and sell these products to different
nations. For instance, China is good at making Electronic Products.
• Economies of scale: Some Countries can produce certain products in large quantities
thereby reducing the cost of production and reaping the benefit of economies to scale
and can trade such products for a higher cost with other nations and make huge profits.
• Mutual Benefits: There are mutual benefits for countries as they can trade
commodities that they do not manufacture in their respective countries as well as
build better trade relations by mutually supporting each other to promote trading.
Activity 1
Why is India-EU FTA considered as a win-win situation for both India and EU. Discuss if the
trade of India and EU are complementary?
Hint: Refer the website http://commerce.nic.in/trade/international_ta.asp and read the draft
of India-EU FTA

3. THEORIES OF INTERNATIONAL TRADE

International trade theories help us analyze the pattern of international trade and help the
government and policy makers to understand the ways to maximize the gains from trade.
The following are the trade theories related to international trade:
3.1 Mercantilism
Mercantilism theory of international trade originated in England in the mid 16th century.
Between the mid-16th century and 18th century, governments all over the world believed that
Mercantilism was the only way to achieve prosperity in a country.
Mercantilism theory: according to this theory it is important government controls the

foreign trade to ensure the prosperity and military security of the country. The main focus
of this theory is that gold and silver are the key elements of national wealth and the
government should work towards those measures that increase the inflow of gold and silver.
This can be achieved by exporting more and importing less, thus having a surplus balance of
trade. This theory aims at framing an economic policy that increases exports and limits
imports. This will increase the inflow of gold and silver which were the main currency of
trade at that point in time. The greater the inflow of gold and silver through exports the
greater the national wealth and prosperity. On the other hand, it was important to bring
policy interventions such as tariffs and quotas on imports and subsidies for exports.
Thus, mercantilism is a ‘zero sum game’ whereby economic growth/prosperity of a country

is dependent on the cost of other economies going into a loss.
Mercantilist doctrine advocates the following:
• State intervention to achieve surplus of balance of trade.

• To achieve a surplus, the government has to discourage imports by imposing tariffs and
quotas and subsidizing exports.
• Another source of Mercantilism was to build trade surplus by itself, this included
Colonizing resource rich, less developed countries. Colonies were the source for

various natural and man-made resources such as tea, sugar, tobacco, rubber, cotton,
spices like pepper, cloves, cinnamon, cardamom and dry fruits.
• These resources were shipped to the mercantilist nation, where the resources were
converted into finished products such as clothing, cigars, rubber-based products,
packaged whole spices and spice powders.
• The finished goods were shipped to colonies for sale. The Mercantilist nation made
huge profits by buying raw materials at a cheap price and selling it to colonies at a
higher price. In this manner the Mercantilist nation-built trade surplus by itself. For
Instance, India was the colony from where the resources such as tea, rubber, spices,
cotton were bought cheap by the mercantilist nation, United Kingdom. UK then sold the
finished goods to India.
Telmex telecom: Mercantilist way of operations
In an era of global economic liberalization under WTO, an excellent example of mercantilist

theory is Telmex – a Mexican telecommunication company. It is head quartered in Mexico
City and operates in neighboring countries such as Argentina, Brazil, Colombia and other
Central American countries along with Mexico. Telmex offers a variety of services in
telecommunication such as telephone services, data services, wireless services, broadband
services, internet-based services and IPTV services. Telmex owns around 92% of the
telephone lines in Mexico City and has virtual monopoly in telecommunications operations
in Mexico, Central American countries and parts of South America. Telmex was earlier a
state-owned enterprise which was privatized in 1990 and was essentially a state grant of a
telephone monopoly to a private individual.
Telmex, a large telecommunication conglomerate, granted by the crown at very low prices,
today enjoys a monopoly in telecommunication services in the region. A market without
competition has no motivation to improve its services. It has no intent to invest its large
profits in improving the quality of services, increasing productivity, or generating economies
of scale. Rather, each year it spends millions of dollars in lobbying with politicians and
controlling regulatory bodies for proposing

3.2 Absolute Advantage Theory
According to Adam Smith, in his renowned book ‘Wealth of Nations’ in 1776, criticized
mercantilism with his arguments. In the past, England was well known for their superiority
in manufacturing processes and as the world’s most efficient textile manufacturers. England
had a combination of various factors such as favorable climate, fertile soil, efficient and
skilled manpower with years of experience and expertise in textile production. Similarly, the
French had the world’s most efficient wine industries. Therefore, England had an absolute
advantage in the textile manufacturing and France in the production of wine. Adam Smith
pointed out that a country has an absolute advantage only if it has highly efficient and cost-
effective products in comparison to any other country producing the same product.
Absolute advantage theory: According to Smith countries should specialize in production

and manufacturing of only those goods and services in which they have an absolute
advantage or what they are good at manufacturing. Therefore, goods that are cost effective
and efficient in terms of production can be traded with goods from other countries in which
that country has an absolute advantage.
According to Smith, England should specialize in the production of textiles and France should
specialize in the production of wine. Both countries should exchange such products of
absolute advantage with each other, i.e., England should sell textiles to France and France
should sell wine to England.
The crux of Smith’s absolute advantage theory is that a country should not produce goods at
home in which it does not have cost advantage; instead, it should import the same from other
countries. In Absolute advantage theory countries benefit from trade as it was based on
the ‘positive sum game’ whereas mercantilism theory was based on the ‘zero game’. Where
one country makes a profit and the other country makes a loss.
Illustration 1: The efficiency of each country in the production of the two products is
measured in terms of the labor hours required to produce one unit of each product.

Table 1 shows an illustration of Absolute advantage.

Country Olive oil Shoes
Spain 2 4
Italy 4 2
Source: International business by K Ashwathapa
As per this table Spain has an absolute advantage in production of olive oil as it takes only 2
hours to produce one unit of olive oil whereas Italy has an absolute advantage to produce
shoes as it takes only 2 hours to produce per unit of shoes. Therefore, as per this theory Spain
should export olive oil and import shoes. Similarly, Italy should export Shoes to Spain and
import Oil from Spain.
There is a sub-concept within this theory called Acquired Advantage
Acquired Advantage is about how companies acquire an absolute advantage over the rest of
the world. It is about what makes them special in terms of production in comparison to other
countries. The acquired advantage could be developing a particular manufacturing
technique, business process, method, technology or resource that gives an absolute
advantage over the rest of the world. For Instance: China is the largest producer of Steel with
around 57% of the world steel production in 2020. Similarly, Italy is the top wine producer
in the world.
Activity 2
Choose one product manufactured in India and state three reasons why India has an
acquired advantage in this product. How has the product contributed in increasing
our Exports.
3.3 Comparative Advantage Theory
Comparative advantage theory or the comparative cost advantage theory, was first
developed by 19th-century by the British economist David Ricardo. The comparative
advantage theory can be applied in a scenario where two countries are good at making two

or more products and need to decide which product has to be manufactured within their
country and which product has to be bought from other countries.
Comparative Advantage theory: A country has a comparative advantage in producing

goods if the opportunity cost is lower at home than in the other country. According to the
comparative advantage theory, a country should produce and export those products for
which it is relatively more productive than that of other countries and import those goods
for which other countries are relatively more productive than it is. Similarly, a country is said
to have a Comparative advantage in a particular product when its opportunity cost is lower
than the opportunity cost of other countries.
Illustration 3: Example showing the concept of Comparative advantage.
Let us consider two products cell phones and printers made in China and Philippines.
Table 3 shows the number of units of both the products manufactured in a day.
Cell Phones Printer
units per day units per day
China 30 10
Philippines 10 30
• Based on this illustration let’s analyze who has a comparative advantage in producing
printers. Is it China or Philippines?
1. China can make 30 units of cell phones in a day if it dedicates all its time and resources
in producing only cell phones.
Similarly, China can make 10 units of printers in a day if it dedicates all its time and
resources in producing only printers.
2. If China only produces 30 cell phones, then the opportunity cost is 10 printers
(As China has to give up on making 10 printers due to limited resources such as labor)
and If China only produces 10 printers, then the opportunity cost is 30 cell phones.
(As China has to give up on making 30 cell phones due to limited resources such as
labor)

3. As per Table 3, Philippines can make 10 units of cell phones in a day if it dedicates all
its time and resources in producing only cell phones.
Similarly, Philippines can make 30 units of printers in a day, if it dedicates all its time
and resources to producing only printers.
4. If Philippines only produces 10 cell phones, then the opportunity cost is 30 printers
(As Philippines has to give up on making 30 printers)
and If Philippines only produces 30 printers, then the opportunity cost is 10 cell phones
(As Philippines has to give up on making 10 cell phones).
5. The opportunity cost for China to produce 1 printer is 3 cell phones. How?
China can make 30 Cell phones or either 10 Printers
Therefore, Opportunity cost to produce one printer is 30 / 10 = 3
The opportunity cost for China to produce 1 printer is 3 cell phones.
The opportunity cost for Philippines to produce 1 printer is 1/3 cell phone. How?
Philippines can make 10 Cell phones or either 30 Printers
Therefore, Opportunity cost to produce one printer is 10/30 = 1/3
The opportunity cost for Philippines to produce 1 printer is 1/3 cell phones.
Therefore, China’s Opportunity cost to produce one printer = 3 cell phones
Philippines Opportunity cost to produce one printer = 1/3 cell phones
Therefore, for Philippines it is cheaper to produce a printer as the opportunity cost is

the lowest i.e.,1/3 cell phones than China where the opportunity cost is higher i.e., 3 cell
phones.
Finally, we can represent this analysis in a table as shown in Table 3A.

Table 3A - Opportunity cost to make one printer

Cell Printer Calculation Opportunity
phones cost
of
1 printer
China 30 10 30/10 = 3 3 cell phones
Philippines 10 30 10/30 = 1/3 1/3 cell
phones
Result It is cheaper for Philippines to produce a printer as the
opportunity cost is the lowest
6. The answer to the main question in this section
“Who has a comparative advantage in producing printers? Is it China or Philippines?”
Philippines has a lower opportunity cost in producing printers therefore we can say
that Philippines has a comparative advantage in printers.
7. Philippines has a comparative advantage in printers not because it produces a greater

number of printers but because it has a lower opportunity cost in comparison to China.
That is why this concept is called a comparative advantage as it compares the advantage
of production with other trading partners or countries in terms of the opportunity cost.
• Based on this illustration and table 3, let’s now analyze who has a comparative
advantage in producing cell phones. Is it China or Philippines?
8. China can make 30 Cell phones or either 10 Printers
For China, the opportunity cost of producing 3 cell phones = 1 printer (refer table 3A)
Then the opportunity cost of 1 cell phone = 1/3 printer (1 printer / 3 cell phones) or
(10 printer / 30 cell phones)
Similarly, Philippines can make 10 cell phones or either 30 Printers
For Philippines, the opportunity cost of producing for 10 cell phones = 30 printers
Then the opportunity cost of 1 cell phone = 3 printers (30printers /10cell phones)
China’s Opportunity cost to produce one cell phone = 1/3 printer

Philippines Opportunity cost to produce one cell phone = 3 printers
Table 3B - Opportunity cost to make one cell phone

Cell Printer Calculation Opportunity
phones For 1 cell cost
phone of
1 Cell phone
China 30 10 10/30 = 1/3 1/3 printers
Philippines 10 30 30 / 10 = 3 3 printers
Result It is cheaper for China to produce a cell phone as the
opportunity cost is the lowest
China has a lower opportunity cost in producing cell phones therefore we can say that China
has a comparative advantage in cell phones.
9. To summarize this concept, China has a comparative advantage in producing cell

phones and the Philippines has a comparative advantage in producing printers.
10. To conclude, if countries have to benefit, they have to specialize in the production of
those products with a comparative advantage or low opportunity cost and then trade
these products with countries that specialize and have a comparative advantage in their
own products.

Cost comparison
Labour cost of production (in hours)
1 unit of wine 1 unit of cloth
Portugal 70 80
England 110 90
Opportunity costs and efficiency
Wine cloth
Portugal 70/80 = 7/8= 0.87 80/70 = 8/7= 1.14
England 110/90 = 11 /9= 1.22 90/110 = 9/11= 0.81
A country has a comparative advantage in producing goods if the

opportunity cost is lower at home than in the other country. The table shows
that Portugal has the lower opportunity cost in wine-making while England
has the lower opportunity cost in making cloth. Thus, Portugal has the
comparative advantage in the production of wine whereas
England in the production of cloth.

Difference between Comparative advantage and absolute advantage.

SL Basis Absolute Advantage Comparative Advantage
No
1 Meaning A country is said to A country is said to have

have absolute Comparative advantage
advantage when it is when it is highly efficient in
highly efficient in comparison to other
production countries in production with
a low opportunity cost.
2 Creators Adam Smith came up David Ricardo first

with this theory developed this theory
3 Assumptio No Trade Barriers, Two countries producing one

ns continuous returns to product, labor and capital
scale inputs are the same for both
countries
4 Trade Trade is not mutually Trade is mutually beneficial

beneficial and benefits both countries
5 Cost Cost is the primary Opportunity cost is the

factor primary factor
3.4 The Heckscher-Ohlin Trade Theory
The Heckscher-Ohlin (H-O) theory is also known as the Factor Endowment Theory. This
theory is an extension of the comparative advantage theory. Swedish economists Eli
Heckscher (in 1919) and Bertil Ohlin (in 1933) came up with a different explanation of
comparative advantage theory. They argued that comparative advantage emerges due to the
difference in natural factor endowments. Natural factor endowments are the extent to which
a country is gifted with resources such as land, labor, capital and natural resources. The
difference in resources in various countries leads to a difference in the factor costs. If a
country is abundant with a particular factor, then the cost of such a factor will be less. For
instance, China, India, Indonesia, Vietnam are rich in labor resource as the population in
these countries are high, therefore the cost of labor is cheap. Countries like US, Japan, France,
Germany and Singapore are capital abundant countries and therefore make capital goods

that cost less in these countries. Similarly, if a country is scarce in terms of certain resources
the factor cost of such resources will be very high. For instance, Petrol and Fuel are scarce in
India therefore the cost of fuel is very high. When a factor is scarce it has to be imported from
other countries. In this case, fuel is scarce in India therefore fuel will be imported from oil
rich countries; therefore, the cost of fuel is high in India.
The more abundant a factor, the lower its cost. The more scare a factor, the higher the cost.
The Heckscher-Ohlin (H-O) theory postulates that countries will export those goods that
highly use factors that are locally abundant and countries will import those goods that highly
use factors that are locally scarce.
The theory is based on the hypotheses that countries trade with each other as they differ
with respect to the availability of the factors of production i.e., land, labor and capital. For
example, US is a capital rich country hence its exports basket will be dominated by capital
intensive products like, aero planes, submarines, tanks, space system, nuclear plants, super
computer, high-end servers etc. Whereas India has labor abundance, so its export basket is
dominated by product with labor contents like gems and jewelry, textiles, handicrafts, sports
toys, handlooms, apparel, electronics and information technology services.
3.5 International Product Lifecycle Theory
International Product lifecycle theory is a marketing strategy proposed by
Raymond Vernon in the mid-1960s. In the 20th century, American firms produced and sold
a large percentage of the world’s latest products. American firms were backed by huge

market sizes and the immense wealth that led to innovations in new consumer products. The
high cost of labor was also a reason to build cost-saving innovations. The emphasis was on
information, risk, and economies of scale, rather than cost.
The theory is about how a company will begin exporting products and then undertake
foreign direct investment. When the product moves through its life cycle over time a
country’s exports transform into its imports. The three distinct stages of the product life
cycle help us relate to the essence of this theory. Raymond Vernon focused on the lifecycle of
the product and came up with his theory which identified three distinct stages:
New product stage – The need for a new product in the domestic market is identified and it
is developed, manufactured and marketed in limited numbers as we are not sure as to how
the product will perform in the market in terms of profits. Exports are non-existent or take
place in a limited manner.
Maturing product stage – This is the stage where the product has become popular in the
domestic market as well as foreign markets. As Foreign demand increases and
manufacturing facilities are set up overseas to meet the demand. The product succeeds in
the foreign markets and at the end of the maturity stage, the production begins in the
developing countries.
Standardized product stage – In the last stage, the makers look for countries where it can
be made at the lowest cost as the markets become price sensitive. The product is popular
and the price is optimized. Eventually, the product is imported into the firm’s home country.
Although Dell is a US-based company, it manufactures the hardware in Asia and later this
gets it transported to the US, its country of origin, in the form of US imports. Hence a product
that started as an export commodity of a country may end up becoming an imported product.
Activity 3
Make a list of three companies whose exports have transformed into its imports.

Match the proponent with the theory:
Product lifecycle theory / H-O theory / Theory of Comparative Advantage
David Ricardo
3.6 Porter’s Diamond Model
In 1990, Michael Porter, Professor at Harvard, analyzed that classical trade theories on
comparative advantage fail to explain appropriately why trade takes place across countries.
Michael Porter conducted a study on 100 companies in developed countries to understand
how a firm can become competitive. A company with a competitive advantage is a lot
stronger in trading with companies in different countries. Here, competitive advantage being
the reason behind some nations’ success and others’ failure in international competition. His

thesis outlined four broad attributes that shape the environment in which local firms
compete and these attributes promote the creation of competitive advantage.
The Porter’s diamond model is a diamond shape diagram with four corners representing
four elements
1. Factor Conditions
2. Demand conditions
3. Relating and supporting industries
4. Strategy and rivalry
• Factor Conditions – Factor conditions include land, labor, natural resources and
infrastructure. There are basic factors like natural resources, climate, and location.
These factors will give a competitive advantage initially to a country. However, in the
long run sustained competitive advantages emerge from what Porter has termed as
advanced or specialized factors. Such specialized factors include communications
infrastructure, research facilities, skilled labor and capital. Specialized factors are
created and do not come naturally. Specialized factors are difficult to duplicate and a
company that possesses specialized factors enjoys a greater competitive advantage as
other companies cannot replicate such specialized factors.
• Demand conditions – The role of home demand in improving competitive advantage
is emphasized since firms are most sensitive about the needs of their closest customers.
Sophisticated local consumers increase the competitiveness of a country as they
provide vital information to companies about emerging products and consumer
requirements. Therefore, companies strive to maintain very high product standards.
For example, Italian leather products are of a very high quality due to the demand of
the local consumers where producers are forced to maintain very high product
standards in terms of design and quality.
• Relating and supporting industries – The presence of suppliers or related industries
is advantageous since the benefits of investment in advanced factors of production spill
over to these supporting industries. Related and supporting industries are beneficial to
firms in terms of collaborating working environment, joint research, knowledge
sharing and process outsourcing. Industries that are profitable within a country tend

to be grouped into clusters of related industries. For example, IT firms in the Silicon
Valley India; Shenzhen is China’s special economic zone and a manufacturing hub for
electronics.
• Firm strategy, structure and rivalry –
• Strategy: is all about global competitiveness and the ability of a firm to meet market
demands. According to Porter, Government policies, incentives, and inter-country-
based competition tend to affect a firm’s competitiveness and international strategies.
Favorable government policies and conditions lead to success whereas unfavorable
conditions and stringent government policies can lead to failure in the international
business strategy.
• Rivalry: Rivalry among firms pushes them to become more innovative and proactive
to improve quality, churn new ideas and constantly improve products.
• Structure: refers to management styles practiced by firms. Certain countries in general
have a uniform management style. Such countries tend to be more competitive in
industries due to which they adapt a uniform style. For instance, Germany has a
Hierarchical management structure whereas Japan has a more unity based
authoritative management culture. Here in Japan firms work closely in organized
networks and work in a highly integrated environment.
Porter states that these four attributes constituted the diamond and he argued that firms are
most likely to succeed in industries where the diamond is most favorable. He also stated that
the diamond is a mutually reinforcing system and the effect of one attribute depends on the
state of others. For example, favorable demand conditions will not result in a competitive
advantage unless the state of rivalry is enough to elicit a response from the firms.
Figure 2.2 gives you an illustration of Porter’s diamond model.

Figure 2.2: Porter’s Diamond Model

Name the trade theory that matches the statement:
1. Mercantilism is a ‘zero sum game’ where one country makes profit at the cost of
another country __________.
2. Factor Conditions, Demand conditions, Relating and supporting industries
3. And Strategy and rivalry are the four dimensions of ___________.
4. The product moves through its life cycle; over time a country’s exports transform
into its imports _________.
5. Countries will export those goods that use factors that are locally abundant and
import those goods that use factors that are locally scarce _________.
6. When a country is highly efficient in comparison to other countries in production
with a low opportunity cost.it has a ______________.

4. SUMMARY
Let us now summarize the salient features discussed in this unit about international business
environment:
• International Trade Theories help us understand why countries trade.

• The mercantilists believed that it is not important to increase the volume of foreign
trade but only focus on policies to maximize exports and minimize imports.
• According to Smith, countries should produce those goods and services in which they
have an absolute advantage.
• As per Ricardo, a country has a Comparative advantage when it is highly efficient in
comparison to other countries in production with a low opportunity cost.
• International Product lifecycle theory is a marketing strategy proposed by Raymond
Vernon in the mid-1960s.
• As per the Heckscher-Ohlin theory a country will specialize in the production of those
goods and services where it is abundant with resources, factor inputs and those that
are suited for production.
• Porter states that the four attributes constituted the diamond and he argued that firms
are most likely to succeed in industries where the diamond is most favorable.
5. GLOSSARY
Zero Game: Mercantilism advocated that export should be maximized and import be
minimized thus enhancing prosperity in country at the cost of other country.
Positive Sum Game: PSG enunciates that trading countries benefit from trade due to
specialization, opportunity cost and better efficiency.
Comparative Cost Advantage: A country has a comparative advantage in producing goods

if the opportunity cost is lower at home than in the other country.

1. Why do nations trade with each other?

2. Why did Mercantilist theory fail?
3. Explain the theory of Comparative advantage with an illustration.
4. Refer to the table and explain which country has an Absolute Cost Advantage in
producing olive oil with relevant reasons.
Table 1 shows an illustration of Absolute advantage.

Country Olive oil Shoes
Spain 2 4
Italy 4 2
5. How are factor endowments and factor costs related to the Heckscher-Ohlin Trade
Theory?
6. Discuss in brief ‘Porter’s Diamond Model’ and its features?
7. Explain product lifecycle theory and its various stages?

7. ANSWERS
Self-Assessment Questions – 1 Answers
1. David Ricardo - Comparative advantage theory

2. Eli Heckscher & Bertil Ohlin – H-O theory
3. Raymond Vernon - International Product lifecycle theory
Self-Assessment Questions – 2 Answers
1. Mercantilism
2. Dimensions of Porter’s diamond model.
3. International Product life cycle theory.
4. The Heckscher-Ohlin (H-O) theory
5. Comparative advantage
Terminal Questions
1. International Trade Theories help us understand the reasons why countries trade with
each other. Refer to section 2.
2. Mercantilism theory of international trade originated in England in the mid 16th
century. Refer to section 3.1.
3. Comparative advantage theory or the comparative cost advantage theory, was first
developed Refer 3.3
4. According to Adam Smith, in his renowned book ‘Wealth of Nations’ in 1776, Refer to
section 3.2.
5. The Heckscher-Ohlin (H-O) theory is also known as the Factor Refer 3.4.
6. In 1990, Michael Porter, Professor at Harvard, analyzed classical trade theories Refer
3.6
7. International Product lifecycle theory is a marketing strategy proposed by Refer 3.5

8. CASE-LET
India is a global leader in diamond cutting and polishing. It is estimated that 67–75% of total
diamonds cut and polished worldwide are done in India. Gems and jewellery sector is one
among the largest employer and number one contributor in terms of exports of India. In the
year 2011-12, gems and jewellery exports has gone up by about 5% at Rs 2,000 billion (US$
36.10 billion) against Rs 1,950 billion (US$ 35.20 billion) in 2010-
11. Gems and jewellery sector accounts for India’s 14% of the total merchandise exports.
Import figure of gems and jewellery by India is Rs
721.60 billion (US$ 13.10 billion). India has become the global hub for diamond cutting and
polishing. This can be seen by an analysis of trade theories. India has cheap cost of labour,
and being endowed with a lot of manpower resources, skilled craftsmanship is easily
available in India. Increasing participation of women in gems and jewellery sector,
favourable government policies, adoption of Kimberly process etc. are some of the key
factors behind India’s success in gems and jewellery sector. These factors are explained
below:
• Low cost of labour: Being endowed with labour factor advantage, the cost of cutting
and polishing in India is a fraction of what other countries have. India has dedicated
low cost diamond cutting clusters like Surat, Ahmadabad, Jaipur, Kolkata, Bombay etc.
Efficiency level of these workers is much higher than that of similar countries in global
markets. Diamond jewellery that is produced at a cost of US$ 60 to US$ 90 in India can
fetch just double the price like 120$ to 180$ in international markets. This enables
India to earn huge profits and generate interest of retailers and workers.
• Availability of skilled craftsmen: Diamond cutting and polishing is an ancient
industry in India. India, being endowed with a lot of manpower resources has special
pool of skilled, dedicated workers/artisans/craftsmen in this sector. The true strength
of the India’s gems and jewellery sector has been its beautiful handcrafted articles that
are intricate and comparable to world-class designs. Indian artisans/craftsmen have
achieved high level of excellence in this art as it has been passed from generation to

generation. Indians have got special expertise in processing of very small diamonds
that require immense skill and knowledge.
• Rising disposable income: As disposable income rises both in developed as well as
developing countries, the use of gems and jewellery will increase. The rising disposable
income of emerging Indian middle class has been a major demand driver for the sector
in recent years. Similarly, there has been an increase in the demand of gems and
jewellery from emerging markets internationally. Diamond jewellery is considered as
a lifestyle product and as income levels in major markets have risen, the gems and
jewellery sector has recorded tremendous growth in the past few years. Even in
recession times, the demand for gems and jewellery has been significant and prices of
both products are rising internationally.
• Rise in number of working women: In India, women workers are increasingly joining
the workforce in gems and jewellery sector. There has been a spurt in the number of
working women in the diamond cluster of India, i.e. Surat, Mumbai, Ahmedabad, Jaipur,
Kolkata etc. This trend has worked as a double edged sword—firstly it has empowered
women financially, and secondly it has changed the general attitude of women towards
purchase of gems and jewellery products.
• Favourable government policies: Indian government has been very supportive of
this industry. It abolished the Gold Control Act, 1992 thus opening up the gold and
diamond mining to private foreign investors. The duties on gold and diamonds have
been slashed significantly; as a result there has been huge domestic demand for gems
and jewellery pushing this industry to high trajectory growth path.
• Nurturing new talent: The government of India has set up Indian Diamond Institute
and many regional training centres for nurturing the talent in gems and jewellery
sector. Talented personnel have been rendering valuable services to both domestic as
well as international requirements in the sector. This has helped design improvement
and constant innovation in the sector thereby reducing costs and penetrating global
markets. India has the best talent pool in the world as far as diamond cutting and
polishing is concerned. The talent is competent at global standards in jewellery design,
refining, model making, jewellery manufacturing, CAD/CAM, gemmology and diamond
grading.

• Adoption of Kimberly Process Certification System: India is a member of the

Kimberley Process Certification Scheme (KPCS) adopted by General assembly of UN.
KPCS promotes conflict-free diamonds and helps in preventing the smuggling of non-
standard trade diamonds from conflict zones of Africa. India allows both export and
import only if the consignment is accompanied with the Kimberly Process certificate
KPCS increases the credibility of diamonds processed in India in the global market, thus
fulfilling social and humanitarian commitments at international level. This has helped
India to boost its export to developed countries.
• Increased awareness and changing preferences: In recent years, there has been
significant rise in branded retailing in gems and jewellery sector. Ad campaigns were
launched to promote the purchase of diamonds through economically viable options. .
An increased promotion by retailers has made consumers aware of diamond jewellery.
This has brought about a change in the trend of purchasing diamond by creating a
demand from various segments, which include people from all age groups.
• Development of Special Economic Zones (SEZ): SEZ Act 2005 and
subsequent rules has changed the diamond industry in India. Various SEZs are
set up to provide special incentives/ benefits/ infrastructural advantages, etc.
to this highly export-oriented sector in order to reap the desired expansion
and diversification in global markets. Now, SEZ units in various SEZ areas are
catering to designing, cutting and polishing of jewellery. The development of
SEZs for gems and jewellery has facilitated the growth and has enhanced the
trade potential for the sector.
Discussion Questions:
a. Which of the above discussed theory(ies) is relevant to justify India’s leadership as

global gems and jewellery hub?
b. What are the various reasons that made India global hub for diamond cutting and
polishing?
c. How far SEZs has contributed to India gems and jewellery success?
Source: Adapted from www.ibef.org and www.dnb.co.in

References:
• Bhalla V. K. and Shiva Ramu S. (2008). International Business –Environment and

Management, Anmol Publications.
• Batra G. S. (2006). Liberalisation, Globalisation and International Business, Deep and
Deep Publications.
• Cherunilam Francis. (2010). International Business Environment,
Himalaya Publishing House.
• McDonald Frank and Burton Fred. (2002) International Business, International
• Bennet Roger (2006). International Business, Pearson Education Ltd.
• Paul Justin (2009). International Business, Prentice Hall of India Pvt. Ltd.
• Czinkota Michael R, Ronkainen Llkka A, Moffett Michael H. (2002). International
Business, PWS South Western Duxbury Cole Onwo.
• Nelson Carl A. (1999). International Business - A Manager’s guide to Strategy in the Age
of Globalism, PWS South Western Duxbury Cole Onwo.
• Chauhan PL, Kakkad Ratish, Patel Rupal H. (2006). International Business, Shanthi
Prakashan.
• Aswathappa K. (2010). International Business, Tata McGrawhill Publications Co Ltd.
E-References:
• http://www.economywatch.com, retrieved on 20 April 2012

• www.ibef.org, retrieved on 25 April 2012
• www.khansacademy.com


SEMESTER 4
DMBA402
MANAGEMENT
Unit 3 : International Business Environment 1

Unit 3
International Business Environment
Table of Contents

No Graph Activity
1 Introduction - -
3–4
2 Economic Environment - -
2.1 National economic policies - -
2.2 Types of economic policies - - 5–9
2.3 Economic structure - -
2.4 Balance of payments - -
3 Political Environment - -
3.1 Nature of politics - -

3.2 Political risks - - 10 – 13
3.3 Political Risk Assessment - -

3.4 Managing Political Risk - -
4 Demographic Environment - -
4.1 Importance of Demographic - -
14 - 15
environment
4.2 Socio-cultural Environment - -
5 Legal Environment - -
5.1 Legal systems - -
16 – 21
5.2 Dispute resolution systems - -
5.3 Legal Issues for MNC’s - -
6 Summary - - 22
7 Glossary - - 22
9 Answers - - 23
10 Case-let - - 24 - 25

1. INTRODUCTION
In the previous unit, you studied international trade theories. This unit covers the economic,
political, demographic, technological and legal environments in which an IB operates. The IB
environment gives an insight into different theories that companies adopt while going
international.
Scanning the global business environment is important for any firm whether the company
operates domestically or internationally. There is increased global competition in the
domestic markets as they are now open to foreign players. This analysis is part of a
company’s analysis-system, involving both internal as well as external factors. The analysis
system may comprise the following areas in order to explore the business opportunities and
challenges in key markets for any firm.
Understanding the IB environment helps the management to allocate resources and operate
efficiently in any country.

1.1 Learning Objectives
After studying this unit you should be able to:
❖ Analyze the economic environment of a country to run the business.

❖ Interpret the factors affecting the political environment of a country.
❖ Explain the demographic environment and its importance in international trade.
❖ Discuss the legal issues involved in international trade.

2. ECONOMIC ENVIRONMENT
The economic environment includes the economic factors and conditions in which a business
functions and considers such factors that impact the business. The factors include prime
interest rates, economic policies, profits, national security, political stability and so on. The
economic environment includes national economic policies, economic structure and balance
of payments.
2.1 National Economic Policies
National economic policies aim at achieving the four major economic objectives:
• Full employment.
• A high economic growth rate.
• A low rate of inflation.
• Absence of a deficit in the country’s balance of payments.
2.2 Types Of Economic Policies:
The economic policies include industrial policy, trade Policy, monetary policy and fiscal
policy.
Industrial policy: refers to the government’s policy towards industries with regard to their
establishment, functioning, growth, and management. The policy lays guidelines for foreign
capital, labor and tariffs. It indicates respective areas of the large, medium, and small-scale
sectors. Thus, industrial development is designed, regulated and controlled by industrial
policy.
Functions of the industrial policy:
• Corrects the imbalances in the development of industries and bring diversification of

industries.
• Industrial policy decides the nature of the relationship between the government and
business as it is important to regulate the way industry functions.

• Directs the flow and prevents waste of scarce resources in the most desirable area of
investment in accordance with national priorities.
• Set boundaries among the public, private, joint sectors as well as small, medium and
large scale industries.
• Lay guidelines for importing foreign capital and conditions to utilize them.
Monetary Policy:
Monetary policy refers to the measures taken by RBI to ensure price stability in the economy.
The measures generally used are money supply, interest rates and inflation.
Functions of the monetary policy:
• The major functions are controlling inflation, managing employment levels,

maintaining long term interest rates, financial stability and price control.
• The policy provides a platform for RBI to announce norms for governing financial
bodies such as banks, financial institutions, non banking financial institutions and
primary dealers in money and foreign exchange markets.
• RBI monetary policy focusses on controlled expansion of financial growth and price
stability.
• RBI controls minting coins, managing exchange rates, supervises banks and the bond
market on the basis of the monetary policy.
Fiscal Policy:
Fiscal policy helps the government decide how much money it should spend to support
economic activities, and how much revenue it must earn from the system, to run the
economy. The Fiscal Policy includes government measures on tax, public expenditure and
debt. The fiscal policy operates through the budget. The government has been preparing
annual budgets, placing them before the parliament, obtaining approval and spending funds
and raising revenues as per the yearly budgets.

Trade Policies:
Trade policies refer to all the procedures and practices that have a bearing on the trade
movement of a country. International trade policies of a country may be of two kinds.
Inward-looking approach: also called as import substitution approach. The policy

doctrine is based on the fact that a country should not trade with other nations. This policy
stresses restrictions on trade, people and communication. This results in developing
indigenous technology and a learn by doing approach.
Outward-looking approach: also called as export promotion strategy, calls for easy
movement of goods and services among nations. Free trade encourages learning by trade,
higher standards of living, trading partners gain productivity.
2.3 Economic Structure
International Business managers need to understand and assess international economic

forces at work. Variables that are examined when assessing national economic environments
include:
Economic structure – The structure of a nation’s economy is determined by the size and
rate of its population growth, income levels and distribution of income, natural resources,
agricultural, manufacturing and services sector. Economic infrastructure is the sum of all the
external facilities and services that support the work of firms including communication,
transportation, electricity supply, banking and financial services.
Industry structure – The structure of an industry is determined by factors such as:
• Entry and exit barriers.

• Number of competing firms.
• Market share among firms in that sector.
• Average size of competing units.
Market growth – It is measured in terms of local currency and adjusted for inflation. Local
currency is used because conversions into other currencies are affected by exchange rate
fluctuations.

Income levels – It is taken as the GDP per capita and GDP is directly proportional to the
productivity of the country. Net income is another important variable and is without tax
payments from individual gross incomes.
Openness of the economy – The ratio of a country’s imports and exports to its Gross
National Product (GNP) indicates its vulnerability to fluctuations in international trade. A
nation with a high foreign trade or GNP depends heavily on the economic well-being of the
nations it exports to. Conversely, closed economies have a high degree of control over the
economy.
International debt – An outstanding loan that one country owes to another country or
institutions within that country. Foreign debt also includes due payments to international
organizations. Foreign exchange reserves should not be less than outstanding short-term
foreign debts. On the other hand, a high foreign debt servicing requirement maybe a positive
indicator, suggesting that a country has borrowed heavily to invest in its future.
Degree of urbanization – This is an important factor because there are major differences in
incomes and lifestyles between urban and rural areas in most countries.
2.4 Balance of payments (BOP)
Balance of payments is a summary of economic transactions that occur between home

country residents and foreigners over a period of time. The balance is shown monthly,
quarterly or annually. It is an indicator of the economic health of the country, forex controls,
import restrictions and policies such as tax increments and interest rate hikes. BOP helps to
understand the economic dealings with other countries and identify trends that are
beneficial or harmful to the economy so that the government takes appropriate measures.
Deficits and surpluses –
BOP Deficit - means the nation imports more commodities, capital and services than it
exports. A country becomes poor as it cannot attract enough foreign investment leading to
reduced foreign exchange reserves. To meet the deficit the country will increase its

borrowing from the IMF and other nations, leading to external debt and foreign ownership
of their assets.
BOP Surplus - A balance of payments surplus means the country exports more than it
imports. It provides enough capital to pay for all domestic production.
Influence of Balance of Payments (BOP) on International Trade:
1. BPO shows the appreciation or depreciation in the currency value of a country based on
which the level of trading increases or decreases through exports and imports.
If the domestic currency value falls it increases exports and reduces imports. Foreign
buyers find the products cheap due to which exports increase and imports decrease as they
become expensive for the domestic buyers who see a fall in purchasing power due to the fall
in currency. The domestic buyers get to buy less foreign products in the existing currency
value as the value of the foreign currency would be higher.
If the value of the domestic currency increases it reduces exports and increases
imports. Exports are reduced as foreign buyers will find it costly to buy the domestic
country’s products and imports will increase as imports are cheaper due to the increase in
the value of the domestic currency as there is increased purchasing power.
For instance, in India, the rupee value is lower than dollars so we have high exports and in
turn the government controls import as the imports are costly.
In the US, Indian products seem cheap for the US based buyers as their dollar value is higher.
In the same scenario If an Indian buyer wishes to import American products it will seem
expensive as the value of the US Dollar is higher than the rupee.

3. POLITICAL ENVIRONMENT
The Political environment (PE) impacts the economic and legal conditions of a country. This
includes political conditions, general stability and peace in the country and the attitude of
the government towards business. Stable political systems promote business-friendly
decisions towards local businesses and attract foreign investors.
3.1 Nature Of Politics
The nature of politics is based on the type of government and the policy of a country. The
Government formulates and implements laws, controls its territory and can enter into or
cancel any agreements with other countries. Therefore, international businesses have to deal
with nations and their authority.
• Sovereignty – Sovereignty refers to the absolute power of the state. The two problems
that immediately arise in concern with sovereignty are:
• The ability to make independent decisions since countries rely on each other for goods,
markets, economic assistance and defense.
• The question of where national sovereignty lies is not clear as it may exist in the head
of state, the parliament, the prime minister, the cabinet or in the ‘people’.
• National interest – National interest, as defined by the government, will depend on
the cultures, background, perceptions and experiences of the decision makers involved,
which might change over time and according to circumstances. A nation’s ability to
define its interests depends on its power, control over raw materials; scientific and
technological knowledge; size, structure health and education of its population;
political stability and society.
• Political Instability
Political instability may arise from revolution and insurgency, involvement in foreign
wars, changes in government, bad international relations, falling national income, high
inflation and rising foreign debt, resulting in the physical destruction of a firm’s assets,
higher taxes, import controls and barriers on money leaving the country.

3.2 Political Risk: It may emerge from social unrest due to unevenly distributed income,
competing political ideologies or ethnic groups within a nation, rise or fall of individual
leaders or from international relations. In the modern world, a country’s economic prospects
depend heavily on foreign investment and goodwill of the business community.
There are two types of political risks, namely macro and micro risks as explained below:
• Macro risk: affects all foreign firms operating in the country equally and may include
these;
Expropriation: is the seizing of private assets with less compensation to the owners.
Nationalization: here an entire industry being run privately is taken over by the
government for the restructuring of an entire economy.
Political boycotts: This is where countries boycott firms with branches in rival
countries or companies or rival nations trying to set up their branches.
• Micro risk: pertains to a particular company industry or project. Government

regulations, taxes, and terrorist threats. For example, import restrictions on specific
products, compulsory breaking up of a firm into smaller parts, cancellation of contracts
and so on.
Firm-Specific Risks: another micro risk that affects an MNC at a project or corporate
level. For instance, foreign exchange risks.
Country-specific risks: This is a micro risk that affects an MNC at a project or

corporate level but originates at the country level. Blocked funds or money, HR issues,
religious controversies, and environment-based concerns.
Global specific risks: This is a micro risk that affects an MNC at a project or corporate
level but originates globally. Pandemic, Terrorist attacks, cyber-crimes, environment
issues are global specific risks.

3.3 Political Risk Assessment:
Companies and MNCs conduct political risk assessments to assess risk. This is done by
managers in host countries who assess the issues and evaluate their impact on the business.
The Top management of head offices then issue directives for each host country managers
to resolve issues.
Risk assessments are conducted in two ways:
1. Use of experts or consultants familiar with the host country: consultants monitor
important indicators and assess political changes.
2. Use of internal staff and in-house capabilities: In-house company staff are assigned to
foreign subsidiaries to monitor political activities or by hiring people with expertise in
political conditions.
3.4 Managing Political Risks:
1. Avoiding Investment: Simply avoiding investment in countries that rank high on risks
is a relatively safe idea. However, this leads to a loss of opportunity to invest in that
country.
2. Adaptation: is including the risk factors into the business strategies by
• Local equity and debt: getting local firms, government and FI’s to fund the
company’s subsidiaries. Localizing the product mix and operations to suit the local
culture.
• Developmental Assistance: Where the company takes up developmental measures
in the host country to improve quality of life. Here the company and the host nation
partner with each other.
• Insurance: Companies take up huge insurance against their business to insure
against losses due to wars, terrorism and against currency convertibility.
3. Threat: Here the firm may threaten the host country that the host country cannot do
without the firm as the supply of material, products, technology will be stopped by the
firm if its operations are disrupted.

4. Lobbying: Here the firm hires a person called the lobbyist who will represent the firm
and contact local public officials and try to influence them to resolve issues or favor the
firm.
5. Terrorism Consultants: MNC’s hire consultants in counter terrorism to train
employees to cope with the threats of terrorism.
6. Other methods:
• Signing treaties for mutual benefits and protection.
• Speeding up profit repatriation
• Phase wise technology transfer policy
• Strategic alliances with local partners
• Scanning political environment
1. The two objectives of National economic policies are and ___________.

2. FDI policy is dictated by the government of the host country. (True/False)
3. Balance of payment is an indicator of a country’s ______________.
4. _______ is the seizing of private assets with less compensation to the owners.

4. DEMOGRAPHIC ENVIRONMENT
A demographic environment is based on demographic factors related to population statistics
and composition. Demographic factors are gender, age, sex, income, education level,
occupation and ethnicity. Understanding the demographic environment helps companies in
strategy planning, to trace through international markets for business opportunities and
identify target markets for specific products or services.
4.1 Importance Of Demographic Environment:
Market Segment: Analyzing demographic factors helps companies to choose the

appropriate market segment to sell their products. Assessment of factors that involve
gender, education level culture, religious norms and income-based grouping helps design an
effective marketing plan to increase sales thereby avoiding unnecessary expenditure on
advertisement and promotion on uninterested customers.
Building Brands and Strategies: Demographic factors provide valuable information on

various types of customer groups and help select the right target audience to generate higher
sales. It helps companies focus on better product positioning and brand building. A strong
well-thought-out marketing strategy goes a long way to creating successful brands that will
stay in the market for a longer period.
Identifying Market trends: Demographic factors help identify market trends across various
time periods. It facilitates product comparison based on which future corrective measures
are taken. Alterations can be made to the product features to make the product more
acceptable and rather successful in a market.
Demographic changes: The demographic factors are never constant as the composition of
a population keeps on changing from time to time. The population is subject to changes
related to birth, death, aging, and migration. Social trends bring changes in the place, time,
and area where people live and the way they live. Marketers in the international arena spend
a great deal of time and money in constantly keeping a tab on such data to project the current
trend in terms of product preferences and lifestyle at a particular point in time pertaining to
a given market.

4.2 Socio-Cultural Environment
The cultural and social norms of people differ worldwide in all key markets as they have
been shaped over centuries passing from one generation to another. Language, material
culture, customs, aesthetics, religious beliefs, attitudes, values, and social organization have
been important for the survival and development of societies globally. Due to these socio-
cultural factors, the customers/consumers of a particular country/region become
conditioned to accept certain things as per conditioned behavior. The increasingly
competitive international business environment necessitates the exporters/ companies
doing business overseas to customize their organizational policies keeping in mind the local
cultural norms. For example, Coca-Cola has to sweeten its drinks in India as Indians have an
affinity for sweet taste. Indian meat exporters export only “HALAL” meat to Arab countries
with the inscription “FIT FOR ISLAMIC USE” during packing. If a firm fails to adapt its
business approach to the culture and traditions of specific foreign markets, its survival may
be in danger. In the context of the socio-cultural environment, there are a number of factors
that firms have to consider while foraying into international markets. The same has been
explained in detail in unit 4 entitled “Culture & International Business”.

5. LEGAL ENVIRONMENT
The legal environment includes the laws passed by the government as well as the decisions
rendered by the various commissions and agencies at every level of the government.
Businesses have to abide by the domestic laws of each nation and the supranational laws in
every country where the operations are spread. For instance, in the EU some of the national
laws affecting business are:
• Intellectual property protection.

• Consumer protection and product liability.
• Formation and termination of contracts.
• Marketing practices.
• Carriage of goods.
5.1 Legal Systems
Most nations have their legal systems based on one of the following:
Common law – Common law applies to the entire world including most countries of the
Commonwealth. These systems are based on judgments in specific cases, ad hoc legislation
Code law – here laws are bifurcated into Criminal, Civil and Commercial Codes which are
used to determine all legal matters. Most European countries have Code law systems.
Common law is based on statutes and legally binding regulations whereas Code law is based
on judicial interpretations of the meanings of the words embodied in legislative codes.
Islamic law – This is also termed theocratic law. The base of this law is taken from the Koran
and blended with the existing common law or civil code provisions of the country. The
important rules that apply to the manner of conducting business in Islamic countries include
the following:
• Interest payments on financial dealings are not allowed as it is considered

inappropriate to reward those with excess funds while penalizing those who need to
borrow. This affects the banking and banking practices that are dependent on the

interest to make profits. Banks charge upfront fees to compensate for interest and
instead pay profit shares on deposits rather than payment of interest on deposits.
• Businesses depend on leasing arrangements rather than borrowing money to obtain
fixed assets.
• Investments in alcohol, gambling and casinos are prohibited.
Socialistic Law: This law is prevalent and influences regulations in former communist
countries such as the Soviet Union, China, Vietnam, North Korea, and Cuba. Socialist Law is
based on the Civil Law system with major modifications from the Marxist-Leninist ideology.
Production and distribution are state-owned. The land is also state-owned and, in most
cases, collective ownership of land with little tolerance of private property rights.
Government sets centralized planning and business practices have uniform national
standards. The center is controlled by the communist party which nominates officers and
staff.
5.2 Dispute Resolution Systems
Disputes that occur during international transactions are resolved through negotiation,
arbitration or litigation. The issues normally arise due to conflict of laws as each nation has
its own set of laws. Important differences among the business laws of various countries
include:
• Laws concerning the situations, in which an offer may be withdrawn without penalty
• Distinguishing between commercial and non-commercial contracts in some countries.
These disputes are heard in special courts.
• The intervals beyond which cases become ‘statute barred’ differ. In Britain, the period
for most cases is six years whereas in France it can be up to 30 years. In Germany, it
depends on whether the case concerns a commercial contract and if so, whether both
parties are traders or not.
• National differences occurring due to the legality of exemption clauses and penalty
clauses.
• The necessity to ‘protest’ unpaid debts prior to suing for payment in certain countries.
This means getting a notary to ask the customer for payment or reasons for failure to

do so. The latter are put into a formal deed of protest which is then used as evidence of
refusal to pay.
International Dispute Resolution:
Legal disputes arise in three situations:
• Between governments
• Between a firm and a government
• Between two firms
Dispute Resolution
1. Dispute Between governments are resolved through the world court at the Hague and
international court of justice, the principal judicial organ of the UN
2. Disputes between a firm and a government or disputes between two firms are handled
in the courts of the country of one of the parties involved or through arbitration.
In the second situation where there is a Disputes between a firm and a government or
disputes between two firms, the contracts contain jurisdictional clauses that specify
that a law of a particular country will prevail as agreed by the parties to a contract. In
most cases the law of England is mentioned although neither of the parties resides in
UK due to the fact that English law has dealt with questions of international trade for
many countries and has ready answers for questions on cross border transactions. If
the jurisdictional clauses are not specified then the country in which the case is heard
will prevail.
Methods / Steps of Dispute Settlement:

Conciliation: This is a non-bonding agreement between parties to resolve disputes by

asking a third party to mediate and is also known as mediation. The mediator carefully
listens to each party, explores, clarifies and discusses possible solutions with the intent that
the parties will agree to it. Conciliation sessions are private and all the meetings between the
parties and the mediator are confidential. The statements made by parties are neither
disclosed nor used as evidence in any future litigation or arbitration. The success rate of
conciliation process is excellent and effective to resolve disputes with Chinese business
partners who feel less threatened in conciliation.
Activity 1 - State one example each of these three scenarios :
• Legal disputes Between governments

• Legal disputes Between a firm and a government
• Legal disputes Between two firms
Arbitration – This refers to the process of settlement of disputes by having independent

referees, who are agreeable to both sides, adjudicate the matter. Informal Arbitration is
workable; most arbitration is conducted under formal domestic or international arbitration
groups organized specifically to facilitate the resolution of commercial disputes.
Litigation: is Seeking justice in a court. This is generally avoided by parties to an agreement

due to the cost incurred and long delays involved. The drawbacks of Litigation are:
• Fear of creating a poor image and damaging public relations.

• Fear of unfair treatment in a foreign court.
• Difficulty in obtaining judgment
• Judgment is difficult to deal with than mutual agreement which has two-way benefits
• High cost and long delays in settling matters
• Loss of confidentiality as litigation is public.

5.3 Legal Issues For MNC’s
Intellectual property rights: Intellectual property arises out of people’s intellectual talent
and capabilities. This involves books, content, patent, trademarks, copyrights, software and
formulae. Certain countries like Paris are very strict with their Intellectual property laws
whereas in countries where weak enforcement leads to piracy of Intellectual property such
as in China and Thailand.
Product liability and safety: Product liability holds manufacturers and sellers responsible
for defective products that can cause harm to customers. The affected person can sue
manufacturers demanding monetary compensation and punishment through civil and
criminal law suits.US has the toughest product liability and safety laws. For instance, a toy
manufactured in China before it gets shipped to Japan, Brazil, the EU, and the US has to get
four different certificates from four different labs before being shipped to four different
nations. For instance, for the US it is ASTM F-963, For European Union the safety standard is
ENZI and, for Japan it is ST2016.
Advertising and sales and promotion: MNC’s invest a lot of time and money on advertising
their products across the globe. Ads include exaggerated or false claims about the product
sometimes. Most countries have laws to control false claims. Advertisements can be banned
even if the content is perfectly true. Ads on child-based products are strict. Ads related to
tobacco and alcohol is limited or banned and in India Ads on these products or usage of
tobacco has to compulsorily be accompanied by disclaimers.
Labor Laws:
Employee dismissals: employers have a right to terminate employees in US. In UK an

employer has to consult the trade union before making a dismissal. If the dismissal includes
more than 10 employees then the consultation with the trade union happens prior to 60
days. In Germany the employer should consult a work council for the approval of dismissal.
In India Employee unions are active in certain states and MNC’s acquiring manufacturing
units are required to adhere to existing employment arrangements based on what terms the
seller negotiated with the trade union prior to the purchase. MNC’s have to also adhere to

laws related to cleaner, safer working conditions and adhere to norms related to employee
safety. International labor organization has issued standards on policies related to child
labor and discrimination which member countries are expected to follow.
Environmental Laws:
These laws are meant to protect the depletion of the environment. US have banned export of
hazardous materials, Signed environmental treaties such as NAFTA and regional marine
treaties and the ASEAN Agreement on the Conservation of nature.
Most poor nations oppose Environmental regulations as they are concerned about growth
and profit more than the environment. Rich nations use Environmental laws to protect
themselves from foreign competition.EU banned meat supply from the East Bloc as its meat
and dairy product industry was losing to foreign competition. However, a review of
environmental laws and regulations for an MNC is a must to avoid any future disputes and
losses.
5. This refers to the process of settlement of disputes by having independent

referees _______________.
6. ________________ factors are gender, age, sex, income, education level, occupation
and ethnicity.
7. Interest payments on financial dealings are not allowed in ______________
law

6. SUMMARY
Let us now summarize the points discussed in this unit about the international business
environment:
• The economic environment refers to the conditions under which a business operates
and takes into account all economic factors that have affected it.
• The Political environment impacts the economic and legal conditions of a country. This
includes factors such as political conditions, general stability and peace in the country
and the attitude of the government towards business.
• Understanding the demographic environment helps companies in strategy planning, to
trace through international markets for business opportunities and identify target
markets for specific products or services.
• The legal environment includes the laws passed by the government as well as the
decisions rendered by the various commissions and agencies at every level of the
government.
7. GLOSSARY
Expropriation: The action of dispossessing someone of property.
Islamic law: This is derived directly from the Koran and typically is mixed with the pre-
existing common law or civil code provisions of the country concerned.
GNP: Gross National Product is the total value of goods and services that the country’s
citizens produced irrespective of their location in a year.
Litigation: The process of taking a party to court to settle a legal matter.

1. Describe various aspects related to the economic environment?
2. Explain political risk assessment and the methods of managing political risks?
3. What are the legal issues related to MNC’s?
4. Explain the importance of demographic environment in international business?
5. What are the different options available for settling disputes?
6. Explain the social and economic effects of technological advancement?
9. ANSWERS
Self-Assessment Questions 1 Answers
1. Full employment, a high economic growth rate.

2. True.
3. Economic health.
4. Expropriation
Self-Assessment Questions 2 Answers
5. Arbitration
6. Demographic
7. Islamic
Terminal Questions
1. The economic environment includes national economic policies, economic structure

and balance of payments. Refer 2.
2. Companies and MNCs conduct political risk assessments to assess risk. Refer 3.3.3 and
3.4
3. Intellectual property arises out of people’s intellectual talent and capabilities. Refer 5.3
4. Analyzing demographic factors helps companies to choose the appropriate market
segment to sell their products. Refer 4.1
5. Disputes that occur during international transactions are resolved through negotiation,
arbitration or litigation. Refer 5.2

10. CASE LET
cars were exported by the MSIL to Hungary and in 2009-10, sales volume crossed 1 million
cars, out of which around 1,47,000 cars were exported to other countries.
MSIL exports to the more than 100 countries including Poland, Finland, Iceland, Switzerland,
Netherlands, Algeria and Italy.
In this process, MSIL became the only Indian company to manufacture and sell 1 million cars
in a year and is the largest passenger car manufacturer with over 45% market share in India.
MSIL’s revenue has grown constantly over the years:
Table 3.3: Maruti Sales 2006 to 2009-10

Net sales (Rs. in million) Net sales (Rs. in million)
Year Year
2006-07 1,45,922 2009-10 3,01,198

2007-08 1,78,603
2008-09 2,03,583
The government of Japan has honored MSIL with a METI award for promotion of Japanese
brand in India. Maruti Suzuki is one of the six companies, and one of the two companies
outside Japan, to have received this award.

1. Which business theory will you associate with this case? (Hint: Porter’s diamond
model)
2. What kind of approach did SMC adopt to make an entry into Indian market? (Hint: SMC
utilized technology to make low-cost cars in large numbers taking advantage of the low-
cost manufacturing in India).
Source: http://www.marutisuzuki.com retrieved on 20 September 2010
References:
• Francis, Cherunilam, (2014), International Business: text and cases, (5th ed) ,PHI
Learning Private Ltd.
• K. Aswathappa, (2013). International Business, (5th ed), Tata McGraw-Hill Publications
Co. Ltd.
• Bhalla V. K. and Shiva Ramu S. (2008). International Business – Environment and
Management, Anmol Publications.
• Batra G. S. (2006). Liberalisation, Globalisation and International Business, Deep and
Deep Publications.
• Cherunilam Francis. (2010). International Business Environment, Himalaya Publishing
House.
E-References:
• http://www.economywatch.com, retrieved on 15 November 2010

• http://www.marutisuzuki.com, retrieved on 20th September 2010
https://blogs.worldbank.org/opendata/new-world-bank-country-classifications-
income-level-2021-2022


SEMESTER 4
DMBA402
MANAGEMENT
Unit 4 : Culture and International Business 1

Unit 4
Culture and International Business
Table of Contents

Topic Page No
No / Graph Activity
1 Introduction - -
3
1.1 Objectives - -
2 Meaning of Culture - 1I
Need to understand cultural - -
2.1
differences 4-9
2.2 Hofstede’s cultural dimensions - -
2.3 General Cultural Dimensions - -

3 Country Culture 1 2
3.1 Significance of country culture - - 10 - 14

Comparative study on cultures of - -
3.2
Japan, China, Brazil, France, and USA
4 Culture in an International Business 2 3 II
Organisation
4.1 Cross cultural management - -
15 - 22
Comparative study on corporate - -
4.2 cultures of Japan, China, Brazil, France,
and USA.
5 Summary - - 23
6 Glossary - - 24
8 Answers - - 25
9 Case-let - - 26 - 27

1. INTRODUCTION
In the previous unit, you studied various factors like economic, political, demographic, and
legal environments in which an international business operates. We analyzed the effects of
the environment on companies while dealing with international business management.
In the late twentieth century, the world saw a transformation in culture that brought the
people of various countries to come together. Better Relations between people of different
nations lead to many cultural changes that we see today. This led to the globalization of
business.
Culture is an important element to run an international business. Culture has an impact on

different business functions ranging from accounting to finance and from production to
service. This indicates a connect between culture and international business.
1.1 Objectives
❖ Describe culture in an international scenario.

❖ Analyze national cultures of different countries.
❖ Explain the importance of managing cultures internationally.
❖ Evaluate corporate cultures from different countries.

2. MEANING OF CULTURE
In this section, you will learn the meaning of culture and the purpose of understanding
various cultures.
Culture is defined as the sum total of knowledge, arts, beliefs, laws, morals, customs, and
other abilities and habits gained by people as part of society.
Art and human customs, civilization, and the way of life of a specific society or group are all
considered as culture. Culture involves everything from birth to death and everything in
between it. Respecting every culture is a must.
Research shows that national ‘cultures’ generally characterize the dominant groups’ values
and practices in society, and not of the marginalized groups, even though the marginalized
groups represent a majority or a minority of the society.
Culture is very indispensable to understanding international business.
2.1 Need To Understand Cultural Differences
Cultural differences impact the success and failure of MNCs as they deal with people and
their culture. The company will have to make product-based modifications to meet the
requirements of the consumers in a specific country. They use different marketing strategies
for various consumers to advertise their products depending on the culture of that country.
A company needs to understand cultural differences in international business due to the
following reasons:
• Different consumers use different products: Consumers in different countries do

not use the same products as their tastes and preferences differ. The company has to
research or find out about consumer choices before producing or launching any
product in that geographical region.
• Workforce diversity: The organization must manage and motivate people with
different cultural values and attitudes. Hence the management style, practices, and
systems must be modified accordingly.

• Offices across the globe: Businesses set up offices in different countries. Candidates
are identified, hired, and trained to work in other countries. Cultural training is given
because the cultural and corporate environment differ in every country. This training
may include language training, corporate training, and training in technology and so on,
which will help the trainee to work in a foreign environment.
• Product differentiation and marketing – Product differentiation and marketing are
business strategies that are a must due to the variations in consumer tastes and
preferences across nations. The per capita income of consumers determines the kinds
of products and services that consumers can afford. For example, in underdeveloped
countries, the demand for luxury products is limited.
• To Motivate employees – market research shows a low level of job satisfaction among
Japanese employees in comparison to the employees of North America and European
countries; however, the production levels stayed high. A study was conducted to
motivate the employees of Japan and resolve this issue. The study revealed a relation
between job satisfaction and production. For Japanese workers it is difficult to change
jobs. The job turnover among Japanese workers is comparatively lower than the
American workers. Although, the Japanese workers are not satisfied with specific
aspects of their work, they do realize that the leadership style and management
practices remain uniform across various firms in Japan. Thus, dissatisfaction in their
job does not impact their level of production.
Exhibit 1: Understanding foreign cultures: Areas of general
precautions
1. Gift giving and cultural distaste 8. Eye contact, hand gestures
2. Entertainment at home and and etiquette
local customs 9. Protocol and etiquette
3. Table manners and etiquette 10. Business cards
4. Punctuality 11. No smoking
5. Lunch and dinner time 12. Dress code
6. Topics in conversation 13. Prohibited materials
7. Business entertainment, 14. Interpretation or translation
customs and strategies 15. No littering

Adapted from Business Class: Etiquette Essentials for Success at Work by Jacqueline
Whitmore, St. Martin's Press (2005),
The following are the necessary guidelines for international business:
• Avoid the use of self-reference criteria (SRC) for judging and giving feedback to others.
There could be many angles to a single observation. Personal judgement should not be
a hindrance when listening to others' points of view.
• Create a niche segment globally as countries have diverse markets with constant
changes in products, people, capital, and culture.
• Build affordable products and services, and make them easily accessible, thereby
increasing the overall market share.
2.2 Hofstede’s Cultural Dimensions
According to Dr. Geert Hofstede, ‘Culture is more often a source of conflict than of synergy.
Cultural differences are a trouble and always a disaster.’
Professor Hofstede carried out a detailed study of how values in the workplace are
influenced by culture. He worked as a psychologist for IBM from 1967 to 1973. At that time,
he gathered and analyzed data from many people in several countries. Professor Hofstede
established a model using the results of the study which identifies four dimensions to
differentiate cultures. Later, a fifth dimension called ‘long-term outlook’ was added. The
following are the five cultural dimensions:
• Power Distance Index (PDI) – These focus on the level of equality or inequality
between individuals in a nation’s society. A country with high power distance ranking
depicts that inequality of power and wealth has been allowed to grow within the
society. These societies follow a caste system that does not allow upward mobility of
its people. A country with low power distance ranking depicts a society which de-
emphasizes the differences between its people’s power and wealth. In these societies
equality and opportunity is stressed for everyone. Countries with high PDI index are
Arab countries, Russia, India and China. Those with low score are Australia and Japan.

• Individualism – This dimension focuses on the extent to which society reinforces

individual or collective achievement and interpersonal relationships. A high
individualism ranking (western countries, Canada, Hungary) depicts that individuality
and individual rights are dominant within the society. Individuals in these societies
form a larger number of looser relationships. A low individualism ranking (Asian and
African countries like Indonesia and Colombia) characterizes societies of a more
collective nature with close links between individuals. These cultures support extended
families and collectives where everyone takes responsibility for fellow members of
their group.
• Masculinity – These focus on the extent to which the society supports or discourages
the traditional masculine-work role model of male achievement, power, and control. A
country with high masculinity ranking (like Japan, Venezuela, Hungary) shows the
country experiences high level of gender differentiation. In these cultures, men
dominate the society and power structure, with women being controlled and
dominated by men. A country with low masculinity ranking (like Norway and Sweden)
shows a low level of differentiation and discrimination between genders – women are
treated equal to men in all aspects of the society.
• Uncertainty Avoidance Index (UAI) – These focus on the degree of tolerance for
uncertainty and ambiguity within a society. A country with high uncertainty avoidance
ranking shows that the country has low tolerance for uncertainty and ambiguity. A rule-
oriented society that incorporates rules, regulations, laws, and controls is created to
minimize the amount of uncertainty. A country with low uncertainty avoidance ranking
shows that the country has fewer concerns about ambiguity and uncertainty and has
high tolerance for a variety of opinions. A society which is less rule-oriented, readily
agrees to changes, and takes greater risks. Latin American countries, Germany,
Belgium, Japan and Eastern Europe score high on this. Countries with low UAI score are
Sweden, Denmark and China.
• Long-Term Orientation (LTO) – It describes the range at which a society illustrates a
pragmatic future-oriented perspective instead of a conventional historic or short-term
point of view. The Asian countries (China, Japan, Hong-Kong) score high on this
dimension. These countries have a long-term orientation, believe in many truths,

accept changes easily, and have thrift for investment. Cultures recording little on this
dimension, trust in absolute truth, are conventional and traditional. They have a small
term orientation and a concern for stability. Many western cultures score considerably
low on this dimension.
In India, PDI is the highest Hofstede dimension for culture with a rank of 77, LTO dimension
rank is 61, and masculinity dimension rank is 62.
1. _____________is defined as the art and other signs or demonstrations of human

customs, civilization, and the way of life of a specific society or group.
2. Consumer tastes and preferences across countries are similar. (True/False)
3. Match the following:
a) PDI 1) tolerance for uncertainty and ambiguity.
b) Individualism 2) pragmatic future-oriented perspective.
c) Masculinity 3) equality or inequality between individuals.
d) UAI 4) individual or collective achievement.
e) LTO 5) support or does not support male dominance

Activity 1
Visit a nearby bank and observe the cultural diversities. Apply the cultural
dimensions of Hofstede and document your study.
Hint: Hofstede’s five cultural dimensions.
2.3 General Cultural Dimensions:
National Culture: This is the dominant culture within the political boundaries of a country.
Formal education is imparted and business is conducted in the language of dominant culture.
Dominant culture influences the language of business transactions and the laws that govern
business.
Business Culture: This represents the norms, values and beliefs that pertain to all aspects
of doing business and guides everyday business transactions. This includes use of business
cards, dressing, protocols, etiquette related to business.
Organizational culture: Cultures that tend to develop within national and business culture.
Organizational culture refers to philosophies, values, beliefs, expectations, assumptions and
norms that keep an organization together and shared by the employees.

3. COUNTRY CULTURE
In the previous section, we analyzed the importance of cultural dimensions and also went
through Hofstede’s cultural dimensions. In this section, we will discuss the significance of a
country’s culture.
3.1 Significance Of Country Culture
The world has various countries made of different kinds of society with their own unique
culture. A country’s culture should not be imposed on individuals coming from a different
cultural background from a different country. For instance, the Cadbury Kraft acquisition in
2009 was an international deal between the US based company Kraft that had acquired the
British chocolate giant, Cadbury. These companies belonged to the US and the UK that had
different cultures. Let us discuss the major cultural elements that are related to business.
Cultural elements that relate to business
The three cultural components of a country pertaining to business are:
• Language.
• Religion.
• Conflicting attitudes.
Language
Language is an integral part of communication whereas gestures, facial expression, eye

contact and body language are a part of non-verbal communication. An interpreter is
required when two people do not speak a common language. Failure to understand the
cultural context during verbal or non-verbal communication results in sending a wrong
message thereby hampering possible business opportunities or creating negativity in good
business relations.
Religion
Religion has a great influence on how people think and conduct themselves in a business
meeting or business scenario. Religion is a very sensitive aspect that has to be dealt with

great care. Respecting religion is synonymous with respecting one’s culture. Therefore,
considerations must be given to religious days, time, beliefs and practices if it falls within the
realm of business transactions or norms of a country.
Exhibit 2: Culture and international business: Significance of color in different

countries
i. Black is believed to have a negative impact on the customers in markets like Singapore,
Malaysia, Libya, Japan, Middle East, Greece, Argentina and some countries in Latin
America. Hence, that color should be avoided in packing/labelling the product for sales
in these markets.
ii. Yellow is associated with illness in South Korea, and certain shades of yellow are
reserved for the royal families to wear in Malaysia.
iii. In Italy, purple is believed to have negative impact on the minds of customers/people
while Italians prefer colors with soft tones as it channelizes positive energy.
iv. Red is a positive color in Denmark, but represents witchcraft and death in many African
countries.
v. Green is preferred and welcomed among Muslims and countries populated by Muslims
except Malaysia which has over 90% Muslim population but a cultural distaste with
green.
vi. Japanese prefer a combination of red and white and gold and silver.
vii. People in Peru, Surinam, Hong Kong, Korea, Taiwan, Greece and Malaysia have positive
opinions about bright colors.
viii. The color saffron is preferred among Hindus and Sikhs as it is associated with their
religion.
ix. White is not preferred by people in China, Taiwan, South Korea and North Korea but
white and blue are preferred in the Czech Republic and Denmark.
Adapted from ‘Managing Images in Different Cultures: A Cross-National Study of Color

Meanings and Preferences’ by Hewett, Kelly, Madden, Thomas J., Roth, Martin S. (2000)

Conflicting attitudes
Cultural values are not the same due to which there can be many instances where individual
attitudes conflict and don’t sync with each other. This impacts business largely as cultural
values reflect in the way business is carried out. If the cultural basics are not understood,
there is a possibility that a deal ends even before the negotiations start.
Some of the important cultural elements are the customs, manners, art, education, humor,
and social set up of the society.
3.2 Comparative Study On Cultures Of Japan, China, Brazil, France, And

USA
Companies that intend to do business in other countries should be sensitive to that particular
country’s cultural and business environment. Every country differs in their style of
communication, treatment towards women in business and dress code. Table 4.1 depicts the
business culture followed by various nations in relation to communication pattern, women
in business, and business dress code.
Table 4.1: Comparison of cultures in different nations

Country Communication style Women in business Business dress
code
Japan It is difficult if Japanese Discrimination The Japanese

language is not known. The towards women in the mainstream
combination of vagueness workplace still exists. business follows
and lack of understanding Women are assigned to a conventional
of the language results in perform lower grade business dress
problems which make tasks. Women from code of dark
decision-making very western countries suit, shirt and tie.
difficult. Body language is working in Japan Business dress
very minimal and hence probably face must be
difficult to read for an difficulties working restrained and
untrained observer. The with Japanese male co- formal for
Japanese sit in a formal workers. women. In
upright posture and look business, women
still. Visibility of reaction or do not wear
emotion is rare. trousers.

China Translators are required Women are treated Men wear suits
for the Chinese language if equally in the and ties and
it is not known. workplace. women wear
The body language of Businesswomen from skirts and
people from China is very foreign countries are blouses.
limited. treated with great
respect and courtesy.
Although ancient
Chinese culture does
not treat women
equally.
Brazil Speaking Brazilian is an Businesswomen from Men are advised
advantage, even though foreign countries are to wear
English is spoken and treated with respect. conservative
understood by people in dark suits.
Brazil. Women are less
Body language and Eye conservative in
contact plays a vital role their dressing
when speaking to people. when compared
with women
from other
countries.
France The French have great love Women are in a high With position,
and respect for the use of position in France dress codes
their language. especially in business, differ within the
The logical presentation retail and service company,
and well-defined ideas with industries. industrial sector,
clear communication is and region in
preferred by the French. France.
It is important to People in higher
thoroughly check anything positions follow
sent to them in writing. a very formal
dress code.
In the southern
region the
business dress
code is informal.

4. The most important cultural components of a country which relate business

transactions are ________, _____________, and ______________.
5. The combination of Japanese vagueness and lack of understanding results in
problems which make decision-making very twisted. (True/False)
6. Coded speech and verbosity are considered a waste of time and in time pressured
corporate ________________ , it is a crime.
a) Brazil.
b) China.
c) USA.
d) France.

4. CULTURE IN AN INTERNATIONAL BUSINESS ORGANIZATION
In the previous section, we learnt how culture differs and its importance differs in every
country. In this section, we will discuss the culture of an international business organization.
4.1 Cross Cultural Management
In international management, people who work hail from different cultures, based on which
you have to develop and apply your knowledge about cultures as the use of a standard
process for everyone will fail. This is called cross cultural management.
In a global market you may have to deal with clients abroad or vendors or service providers
of different countries. So, knowledge about different cultures is important.
The factors to be considered in cross cultural management are:
• Cross cultural management skills.

• Handling cultural diversity.
• Factors controlling group creativity.
• Ignoring diversity.
Cross cultural management skills
Skill is the ability to show a series of behavior that is useful at the workplace or business. It
is functionally linked to achieving a performance goal.
Communication skills are the most important aspect to qualify as a manager for positions of
international operations. The managers must be adaptable to other cultures along with the
knowledge and ability to lead their members.
The managers cannot expect to force members of other cultures to fit into their cultural
customs. This is the main assumption of learning cross-cultural skills. Organizations that try
to enforce behavioral customs on workers from another culture often face conflict. The
manager has to possess the skills linked with the following:
• Providing inspiration and appraisal systems.

• Establishing and applying formal structures.

• Identifying the importance of informal structures.
• Formulating and applying plans for modification.
• Identifying and solving disagreements.
Handling cultural diversity
Cultural diversity creates opportunities and difficulties in a team-based work environment.

The Economy benefits when the work groups are managed successfully. The organization’s
capability to retain, motivate and inspire people from different cultures can bring advantages
to the organization in terms of cost, creativity, problem solving, and adapting to change.
Cultural diversity brings teamwork and co-operation in global organizations if managed
well.
Exhibit 3: Doing Business with UAE: Business Etiquettes & Protocol
United Arab Emirates in recent years has emerged as the largest destination for Indian
goods. India’s exports to UAE are 25.41 billion
dollar in 2009 and 27.41 billion dollars in 2010. India’s exports are growing
at a Compound Annual Growth Rate (CAGR) of 26% during 2006–2010. It constitutes around
12.4% share in India’s total exports. Being an Islamic country, UAE has a different culture for
doing business. In order to make business relationships and communication with UAE, one
has to have a local ‘sponsor’ or ‘wakeel’ to enter the country. This ‘wakeel’ plays an important
role as ‘sponsor’ and helps in arranging the appointments with appropriate individuals;
otherwise, it is tough to get in touch with sheikhs. These sheikhs do not require much
personal space during business negotiations and they can stand close to you while
discussing/negotiating business. Indians and westerners are used to maintaining space and
usually feel that their personal space has been invaded. Sheikhs of UAE respect people whom
they know and trust. Sheikhs, especially in the first few meetings, will spend a great deal of
time on the getting-to-know-you part of relationship building. Indians are advised to be
patient in business negotiations with Sheikhs as they at time may stare at your appearances,
dress etc. to make a judgement.

It is important to fix business meetings including appointments with concerned

persons/UAE counterparts several weeks or months in advance. However, while meeting
very important sheikhs/government officials, a date will not be confirmed until one has
reached UAE. Sheikhs prefer meetings in the morning. One should arrive on time; however,
a sheikh may keep you waiting for hours only to check how serious you are about business.
It is not uncommon if a sheikh/emirate may cancel a meeting at the last minute.
During the meeting, they will first enquire about your family and health in general. The
sheikhs may feel offended if you enquire about his wife or daughter. It is common for a
Sheikh to leave a meeting in between, go for ‘prayer’, and come back. This should not stop
you from continuing the discussion. The Sheikhs speak less and like to watch/observe.
Usually, they appoint deputies who negotiate for them.
During business negotiations, UAE counterparts make sure not to use any kind of pressure
techniques as they believe in process driven talks which may be very slow at times. One is
advised not to rush through the negotiations process. UAE society is highly bureaucratic; it
is not uncommon if you come across several layers of approvals for a normal business
decision. Sheikhs regard trust; thus, it may take several visits even for simple tasks before a
contract or order is given. UAE counterparts are slow but steady and tough negotiators. One
has to keep immense patience as business decisions are hierarchical and are made by the
highest-ranking person. Being tough negotiators, it is not uncommon if a Sheikh makes the
initial offer at a very low price but may subsequently agree to buy at a much higher price.
Gaining their trust and confidence is very important to business decisions. Sheikhs are very
conscious of their dignity and will not compromise on it. Avoid gifting the following to the
UAE counterparts: wine, idols or photos of God/goddess. UAE is governed by Sharia law, and
one should be careful enough to dress modestly. One should preferably wear robes and the
next option could be a suit. One can make a good impression by dressing well. Being a male-
dominated society, business women are strictly advised to keep their collarbones and knees
fully covered. Business women should avoid wearing revealing or tight-fitting clothes. Make
sure that business cards are shared with each delegate of the opposite side. The cards should
have one side in English with Arabic translation on the other side of the card. Source:

Adapted from International Management: Cross-Cultural Dimensions by Richard Mead

Blackwell Publishers; 3rd edition & Nancy
J. Adler, International Dimensions of Organization Behavior, 2nd ed. Boston PWS-Kent,1991
Factors controlling group creativity
On complicated problem-solving jobs, diverse groups do better than identical groups.

Diverse groups require time to solve issues of working together. Work experience helps to
overcome gender, racial, organizational and functional discriminations. But the impact
cannot be evaluated and there is always a risk in creating a diverse group. A successful group
is profitable with respect to quick results and the creation of concern for the future. Negative
stereotypes are emphasized if it fails.
Factors related to industry and company culture are also important. Diverse groups do well
when the members:
• Assist in making group decisions.

• Value the exchange of different points of view.
• Respect each other’s skills and share their own.
• Value the chance for cross-cultural learning.
• Tolerate uncertainty
A diverse group is known to be more creative, where the members are tolerant of differences.
The top management level provides moral and administrative support, and gives time for
the group to overcome the usual process difficulties. They also provide diversity training,
and the group members are rewarded for their commitment.
Ignoring diversity
It may be difficult to manage diversity. It is better to ignore, which is also an alternative. The
management must:
• Ignore cultural diversity within the employees.

• Downplay the importance of cultural diversity.

• This denial to identify diversity happens when management:
• Fails to have sufficient awareness and skills to identify diversity.
• Identifies diversity but does not have the skill to manage diversity.
• Recognizes that the negative consequences of identifying diversity will cause greater
issues than ignoring it.
• Thinks the likely benefits of identifying and managing diversity do not validate the
expected expenses.
• Identifies that the job provides no chances for drawing advantages from diversity.
Strategies to ignore diversity may be possible when culture groups are given various jobs,
and sharing required resources are independent in the workplace. Groups and group
members are equally incorporated and work together. In such circumstances, confusion and
conflict occurs when the diverse value systems of different staff groups are not identified.
4.2 Comparative study on corporate cultures of Japan, China, Brazil,

France, and USA
Multinational companies succeed depending on the corporate techniques and cultures.

Corporate culture means an organizational culture, related to managing the businesses with
respect to organizational structure, strategy, and control. It is related to all the factors and
aspects that a company describes and relates to its stakeholders.
Corporate culture also includes the way it organizes its workforce, allowing them to express
themselves, and convey values. The corporate culture will be positive when the formal
relationships are reasonably considered, members have a share in the company profits, and
demands for production are considered reasonable. The corporate culture is said to be
negative when the opposite conditions apply and the relationship with the management is
not productive.
Table 4.2 displays the different approaches to corporate culture.

Table 4.2: Comparison of Corporate Cultures

Basis of
approach to Business Teamwork
Country Management style
corporate structure
culture
Japan Relationships The Information moves A consensus is
are more organization upward from the low taken among the
important structure is to high level in the team as an
than business. based on a company. agreement
Hierarchy. Decisions taken are before a formal
There is co- actively involved in meeting to avoid
operation framing the conflicts.
among policy. Individual People are
employees Personality is not a modest and
who are aware major requirement promoting
of their for good leadership oneself is not
position and encouraged.
work in
harmony.
China Based on Uses Subordinates cannot Though the
Confucian operational revoke the higher approach is based
values. structures, level management on hierarchy a
chains of decisions. consensus is
command that taken. The group
are is more
hierarchical in important than
a Confucian individual
society. requirements.
Brazil Is Open to The hierarchy A manager’s Team members
doing and management style is are aware of
business and information a major requirement. their role and
encourages flow are Primary importance responsibilities
international organized. All is given to the within the team
investors to Key decisions relationships and act within
invest in are made at between the the line of
Brazil. upper levels. manager and command in a
subordinates who team.
strive to build and
retain relationships
based on trust and
respect to maintain
personal dignity.

France The right Hierarchy and Decisions are taken Teamwork is not
level of operations are at higher levels that encouraged and
Education within the flow to the lower employees are
and the system. Future levels for expected to have
government direction and implementation. personal
initiatives are vision are objectives and
important. decided by the targets during
CEO who then work
passes it down
to the lower
management.
USA Every aspect The company The managers are Teams are
of commercial is a separate free to work in their temporary in
life is studied entity and is own management nature;
and analyzed. treated style and are Therefore,
independently responsible for the Groups of
of its workers. decisions made individuals are
The focus is on within their regions roped in to
top-level assigned to them. complete a task.
management. Meetings are Everybody
In the US conducted in an open works on
people are forum where key common goals
keen to know decisions are taken. for that period.
their position Once the goals
as reporting are met the
manager and group is
responsibilitie dissolved or
s. dispersed.
7. The ability to demonstrate a series of behavior is called ….._______ .

8. Diverse groups do not require time to solve issues of working together.
(True/False)
9. In international management, where people are from different cultures, you
have to develop and apply your knowledge about cultures and not use a
standard process for everyone. This is called___________ .

Activity 2
Assume that you are the manager of Company manufacturing cellular phones. You
have to design a new model that suits the requirements of users in the country of
the secondary branch Country Q.
There is local sales-force which knows about local needs, market segments which
can buy the product, the amount that the users will pay and advertising channels
which can be used to interact with consumers. But the local sales-force does not
understand modern research methods and the main branch’ resources for
designing new products. The marketers of the headquarters have access to the
technology and can account on research and development carried out elsewhere,
but they are not local experts and have no contacts. The expert team of your
company lays out the specifications for a phone designed to fulfil the requirements
of the budding youth market in Country Q.
How will you handle this case to expand the business in Country Q?
Hint: Cultural diversity.

5. SUMMARY
Let us summarize the important points covered in this unit on culture and international
business:
• Culture is an important factor when dealing with international business. Culture

impacts all business-related functions from accounting to operations.
• Awareness and knowledge about the impact of cultural differences is important while
working in the global business environment.
• As per Professor Hofstede, the five dimensions used to differentiate culture are:
• Power distance index (PDI).
• Individualism.
• Masculinity.
• Uncertainty avoidance index (UAI).
• Long term orientation (LTO).
• The cultural elements that impact the business transactions are Language, religion and
conflicting attitudes.
• Every country in its business environment develops their own method of
communication, treatment towards women and dress code.
• In international business management, people hail from diverse cultures therefore,
businesses cannot use a standard process for everyone. This is called cross cultural
management.
• Companies can build international competencies by improving levels of cultural
awareness and help their workforce in becoming globally profound.

6. GLOSSARY
Consensus: is an opinion agreed by a group as a whole
Globalization: Integration of regional economies, cultures, and societies through a

worldwide network
Homogeneous: where all the elements and parts related to a particular subject are of the
same kind.
Individualistic: Attributes that are independent in terms of action or thought
Marginalize: To be made unimportant in a social standing
Stereotypes: Generalizations about a specific group of people that share common

characteristics
1. What is the need to understand cultural differences?

2. Explain Hofstede’s cultural dimensions.
3. Explain the three important cultural elements.
4. Differentiate the communication styles of Japan, China, Brazil, France, and USA.
5. What is cross cultural management? Explain the cross-cultural management factors.

8. ANSWERS
Self-Assessment Questions 1
1. Culture
2. False
3. (a) – 3, (b) – 4, (c) – 5, (d) – 1, (e) – 2
4. Language, religion, conflicting attitudes

5. True
6. c) USA
7. Skill
8. False
9. Cross cultural management.
Terminal Questions
1. Cultural differences affect the success or failure of multinational firms in many ways.
Refer to sub-section 2.1 of this unit for details.
2. The five cultural dimensions of Hofstede. Refer to sub-section 2.2 of this unit for details.
3. The most important cultural components of a country which relate business
transactions are language, religion, and conflicting attitudes. Refer to sub-section 3.1 of
this unit for details.
4. Refer to sub-section 3.2 of this unit for details.
5. Cross cultural management is defined as the development and application of
knowledge about cultures in the practice of international management, when people
involved have diverse cultural identities. Refer to sub-section 4.1 of this unit for details.

9. CASE-LET
India-Japan software outsourcing
An Indian based software company, PQR has been doing business with Japan. The company
faced many issues. The first and foremost issue faced by the company was the Japanese
language. Japanese language is considered to be one of the most difficult languages for people
of other countries. The Indian employees found it difficult to adjust to the Japanese culture.
It was difficult to sign the deal because the software requirements were explained in the
Japanese way. The other problem experienced by the employees was to work in the Japanese
style. The company took some steps to solve the problem. First step is that the company
attempted to train the software developers to speak Japanese at least at basic level. The
second step is that the company tried to make
the employees adjust to the Japanese culture. The company had to know the requirements
of the people and understand their needs to derive more data and design the products
accordingly. The requirement needs selection from top management, managers, and users.
By focussing on all the aspects, the software developed could ultimately adjust itself to the
Japanese method of working and accomplishing success.
1. What are the issues faced by Company PQR? (Hint: Language)

2. What are the steps taken by Company PQR to overcome the issues? (Hint: Train
employees)
Source: Cross-cultural management: Text and cases
References:
• Paul, Justin. (2008). International Business (6th ed). PHI Learning Private Limited.
• Mitchell, Charles. (2000). A Short Course in International Business Culture (3rd Ed)
World Trade Press.
• Mead, Richard. (2005). International Management: Cross-Cultural Dimensions. (4th ed)
Blackwell Publishing Ltd.

• Nakata, Cheryl. (2009), Beyond Hofstede, Culture Frameworks for Global Marketing
and Management. (2009th ed) Palgrave MacMillan.
E-References:
• http://www.worldbusinessculture.com/, retrieved on 3rd November, 2010


SEMESTER 4
DMBA402
MANAGEMENT
Unit 5 : Foreign Investments – Types and Motives 1

Unit 5
Foreign Investments – Types and Motives
Table of Contents

Topic Page No
No / Graph Activity
1 Introduction - -
3-4
2 Foreign Investment Explained - I 5
3 Advantages of Foreign Investment - 1 6-7
4 Types of Foreign Investments - - 8

5 Foreign Direct Investment - 2 II
9 - 17
5.1 Foreign Portfolio Investment - -
6 Motives for Foreign Investment - 3 III
6.1 Political motives - -
18 - 22
6.2 Economic motives - -
6.3 Competitive motives - -
7 Summary - - 22
8 Glossary - - 23
9 Terminal Questions - - 23 - 24
10 Answers - - 24 - 26

1. INTRODUCTION
Foreign investment is a powerful tool that accelerates economic development in developing
countries like India that do not have the capital resources to fund their business and financial
activities.
In the previous unit, you studied the importance of understanding cultural differences and
applying cross-cultural management in International Business. In this unit, we will discuss
the various types of foreign investments including foreign direct investment (FDI) and
portfolio investments.
Foreign investment means the investment of capital made by foreign countries or

companies. Foreign countries or companies prefer to invest their money in a different
country or a company situated in a different country to earn higher returns. The country
which is making the investment is a ‘foreign investor’.
Foreign investors are of two types –
FDI: Foreign Direct investment involve those investors who make long term investments
such as ‘Joint Ventures’ with local companies or through ‘acquiring or purchasing the local
company’ or starting the ‘Green Field Projects’ in order to tap the country’s innate potential
in the desired areas of economic activity. Foreign direct investors seek controlling stakes in
the company they invest in.
Foreign Portfolio Investment: investors who invest in the secondary markets of the
country with expectation of good returns; however, the tenure of such investments is short
term and cyclical in nature. Such investments can be in the form of ‘Depository Receipts’ or
‘Foreign Currency Loans’ or ‘Institutional Investments’. Portfolio investment in stocks or
companies can produce good returns and a good growth rate in the future.
The foreign investor can have stakes in various proportions and can also have a say in the
management of companies in which the investment is made. Stakes can be held as low as
10% or may also cross 49% of the ownership stocks by foreign investors in a foreign
company. For example, the Reserve Bank of India allows 100% foreign equity in Sectors such
as Specific Agriculture Activities, Tea Plantation, Specific Mining, Manufacturing, Civil

Aviation, NBFCs, and Current affairs TV Channel. Whereas in the insurance sector it was only
up to 26%, 51% in the banking sector; 51% in the organized retail sector and 74% in the
telecom sector.
After reading this unit, you should be able to:
❖ Explain the meaning of foreign investments

❖ List the advantages of foreign investments in developing economies.
❖ Explain the meaning and significance of various types of foreign investments.
❖ Analyze the motives behind the foreign investment decisions
❖ Describe the impact of foreign investments on developing nations.

2. FOREIGN INVESTMENT EXPLAINED
Foreign investments provide access to companies into new markets in foreign countries.
Foreign investments help companies find low-cost production facilities and low-cost
destinations. During this process, companies get familiar with advanced technologies,
effective marketing channels, and high-quality products. They also come across various
financing methods to channel their investments for future benefits.
Foreign investment benefits the host country or the foreign company as the investments
open routes to Business processes, organizational technologies and management skills.
Foreign investment, in its classic definition, “is defined as a company from one country making
a physical investment into building a factory in another country”. In an era of global economic
liberalization, privatization and globalization, the definition of foreign investment is a wide
term thereby including acquisition or purchase of a foreign firm, green field investments, or
a joint venture with a foreign firm.
Foreign investment can also be a strategic alliance with foreign firms that involves sharing
technology and technical knowhow, licensing intellectual property, or entering into
management contracts or turnkey projects.
Activity 1
Find out the sector specifc caps/ceilings put up by the government of India for
various sectors/industries in India for FDI?
Hint: open the website https://www.iaccindia.com and read Manual for Policy of
Foerign Investment in India

3. ADVANTAGES OF FOREIGN INVESTMENT

Globalization and the formation of the World Trade Organization (WTO) resulted in both
developed and developing nations competing with each other for foreign investments. There
can be no economic development when there is no foreign investment in a country. This is
quite evident in a developing nation like India where there is an abundance of two major
factors of production i.e., land and labor. Although India is abundant with land and labor it
lacks the capital investment to utilize its physical resources. The following are some of the
advantages due to which nations give emphasis to their economic development.
a. Easier access to the global economy: A developing country like India needs foreign
investment to bring in economic development which can only happen if it can get
greater access into global markets. Foreign Investors and their companies usually make
products to be sold in the global markets resulting in increasing the exports of the
country and creating employment in the country.
b. Technological advancement: Foreign investments lead to the transfer of advanced
technology from developed countries to developing countries. Therefore, developing
countries get access to world-level technology thereby leading to upgradation in
technical know-how and production processes. For example, India has got access to
nuclear technology by signing the deal with Nuclear Supplier Group; thus having an
access to advanced nuclear technology form countries like France, USA, Russia, Britain,
Germany and Japan. India has also been benefited with advanced technology in areas
of ports, ship building, power sector, energy sector and telecommunication in the
recent year.
c. Increased competition and improved productivity: Foreign Investment has led to
an increase in competition and productivity in the domestic economy of developing
nations such as India. Foreign Investors tie up with domestic players to function and
operate in domestic markets. When Foreign investors invest in developing economies,
they bring foreign technology, advanced work processes, and management capabilities.
This results in greater productivity that spreads across industries and sub-sectors.
Each company tries to stay competitive so as to retain market share and sales turnover.

d. Improvement in human development skills: Companies that invest in developing

nations that are rich in labor resources know exactly how to make optimum utilization
of human resources in terms of cost and productivity. Foreign investors invest in
companies and also influence the development of existing human resources skills and
abilities through training and skills upgradation so that they can meet their future
production needs and reap long-term benefits. Employees also get exposure to globally
valued skills.
e. Other advantages: The other advantages of foreign investment are access to a larger
market for foreign investors in the host country. Foreign investors get to tap huge
resources of cheap and skilled labor. They can make effective utilization of raw material
and other physical resources in the host country. Foreign investors get the added
advantage of expanding operations in terms of capacity to generate economies of scale
and cost optimization and diversification into various product categories.
1. Foreign investment is the investment by foreign company/ individual in Indian

company/industry/sector. (True/False)
2. Foreign Investment is of two types – direct and portfolio investment.
(True/False)
3. Identify the correct answer. Which of the following is not the result of foreign
investment .
a) Improvement in human development skills.
b) Increased competition improved productivity.
c) Grants/donation to Indian companies.
d) Easier integration into the global economy.

4. TYPES OF FOREIGN INVESTMENTS

Foreign investment can be commonly classified into two types: Foreign Direct Investment
and Foreign Portfolio Investment.
1. FDI or Foreign Direct Investment refers to capital investment made into new projects
or greenfield projects such as new factories, infrastructure projects pertaining to roads,
flyover construction etc. FDI can be in the form of:
a) Green field investment which are completely new projects.
b) Brown field investment is investing in a Sick unit that needs complete restructuring.
c) Acquisition in which a foreign investor acquires an existing and running Indian unit.
d) Joint venture in which a foreign investor joins hands with local firms to manufacture in
an agreed proportion
2. Foreign portfolio investment refers to an investment made by a foreign investor in the
country or region’s financial instrument, such as investment in the market or stock
investing. Portfolio investment includes depository receipts, FII’s and Foreign Currency
Convertible Bonds.
a. Depository receipts: buying depository receipts in the form of Global Depository
Receipts or American Depository Receipts or Indian Depository Receipts etc.
b. FII’s: Portfolio investment forms the major chunk by making investment in the
existing ‘stocks’ of the local companies in stock exchanges by Foreign Institutional
Investors, popularly known as FIIs.
c. Foreign Currency Convertible Bonds: Foreign portfolio investment can also be in
the form of Foreign Currency Convertible Bonds, popularly known as FCCBs.
Foreign direct and portfolio investment is diagrammed and discussed below:

5. FOREIGN DIRECT INVESTMENT
5.1 Foreign Direct Investment
FDI creates an inflow of foreign currency and financial investment into a country. This is an
integral part of the national financial accounts as it influences the exchange rate and foreign
exchange reserves.
In simple terms, Foreign direct investment or FDI means an investment made by foreign
investors into the host country. Investment can be made in infrastructure, real estate,
industries, businesses, sectors, and financial institutions of the host country. For instance,
roads, ports, rail, plants & machinery, equipment, insurance, banking companies, and into
organizations like investment in the Indian Premier League (IPL) by foreign counties. FDI
excludes foreign investment in the stock markets of the host country. FDI is considered to
carry greater benefits in terms of economic development, Profits, and GDP for any country
globally in comparison to the investment being made in the equity or stocks of host country
companies. The economic and political changes in the country do not impact FDI. Portfolio
investment is made with a short-term objective and can be withdrawn at any time from the
host country based on the investor's discretion. In certain cases, the foreign investor may not
see growth and profits. Similarly, the investor withdraws the investment when trouble is
anticipated in the host country that may impact profits.

The government of developing or emerging countries like India choose FDI over other forms
of an external financial investment as FDIs are non-debt creating, non-volatile and their
returns totally depend on the project performance financed by the investors. The positive
after effects of FDI in India, are Uniform development of international trade, transfer of
technical Knowledge, upgrading skills and advancements in technology.
There are two routes that are regulated for Non-residents to enter into FDI in India. The
automatic route and approval route.
Automatic route: is meant for those sectors that are subject to minimal government
regulation and approvals from Reserve Bank or Government of India are not required. All
those sectors that fall under the Automatic route are specified under the FDI policy.
Approval route: Here the government agencies have to provide approvals for foreign
investments to go ahead with the FDI. The government agencies that handle the approval of
foreign investment proposals under approval route are CCEA and DEA as per the FDI policy
Foreign Investment Promotion Board (FIPB) approves foreign investment proposals up to

Rs 5000 crores
Cabinet Committee on Economic Affairs (CCEA) or Cabinet Committee on Securities

approves foreign investment proposals above Rs 5000 crores
The Department of Economic Affairs (DEA) or Department of Industrial Policy & Promotion
also assists the above approving agencies. The approvals depend on the limit of Equity
holdings or FDI investment fixed as per the FDI policy for various sectors subject to
restrictions.
Different types of FDIs are elaborated as under:
a. Greenfield Investments: When Foreign investment is made into new businesses or

for the expansion of existing facilities, it is known as ‘green field investments. The
demand for green field investments is higher in developed or developing nations or the
host country as these are new investments that create new production capacities,
employment opportunities and scaling up to the latest technology levels and upgrading

research related facilities. On the other hand, the demand for Brown field investments
is considerably lesser as it involves purchasing an existing business or factory that has
low performance results in the past in terms of low sales and demand in the markets
due to old ineffective production methods, high cost and low profits, management and
worker complacence. Brown field investments are targeted at companies, factories or
firms that are initially adopted by other interested companies or as a government
initiative to revive such sick industrial units where initial investment on setting up a
plant capacity is not needed. Green field investments bring economic development but
also carry drawbacks such as domestic players losing their market share to foreign
investors; all the profits are repatriated by MNC’s to their home country resulting in
outflow of foreign currency from host nations.
b. Mergers and acquisitions: Mergers and acquisitions take many forms such as the
transfer of existing assets from local firms to foreign firms whereby the local firm sells
its assets to foreign firms. Due to globalization, there is a trend of ‘cross-border
mergers’ which creates new legal entities by combining the assets and operation of
firms from different countries. Cross-border acquisition on the other hand refers to a
situation when the control of assets and operations is transferred from a local to a
foreign company, whereby the local company becomes an affiliate of the foreign
company. Mergers and acquisitions do not provide major long-term benefits to the local
economy. In most cases, the owners of the local firm are paid in stocks by the acquiring
firm, which means that there is no FDI or fresh foreign currency being invested by the
host country.
c. Joint ventures: A joint venture is said to take place when two or more parties agree to
form and develop a new business for a certain period of time to make profits through
high sales and long-term expansion. The risks, responsibility, management and profits
of the contributing parties will be equal to the proportion of capital they have
contributed to form this new entity. The benefit of joint ventures is that if one
contributes capital then the other party can contribute technology and technical
knowledge so that the joint venture can benefit from the contribution made by either
of the parties. In certain cases, the companies get to use each other's brand name,
existing market share, distribution network, knowledge base, technical design research

and business contacts. In a Joint venture agreement that is ‘limited by guarantee’ the
role of either party is limited to the share of ownership stakes or business contribution
held by each party in such venture. Certain countries have economies that are
controlled by nature such as India, where the easiest way for foreign companies to
enter Indian markets are by way of joint venture. This works especially in the case of
smaller projects that are stepping their foot into new market segments, established
businesses. Sectors such as Power generation, cement, construction, real estate, ports,
steel and oil production and automobiles view frequent joint ventures as the capital
contribution and the gestation period is involved is very high and works well with two
parties joining hands with an objective to make profits. The issue concerning joint
ventures is co-operation among both the parties, and willingness to work in harmony
with commitment is difficult to achieve. Lack of coordination, communication and
misunderstanding can bring an end to the Joint venture. Both Parties must create a
dedicated mechanism for smooth functioning through coordinated planning, execution,
command and control of all functional areas of operations. Synchronized
communication strategy should be in place so that both parties act in tandem for the
future of the partnership, suitable returns and sustainability of the joint venture.
Therefore, Joint venture works when either of the parties contribute in such a manner
that they complement each other thus compensating for weaknesses of the other
parties.

Did you know?
Sectors where FDI is Banned are:
1. Retail Trading (except single brand product retailing);

2. Atomic Energy;
3. Lottery Business including Government / private lottery, online lotteries etc;
4. Gambling and Betting including casinos etc.;
5. Business of chit fund;
6. Nidhi Company;
7. Trading in Transferable Development Rights (TDRs);
8. Activities/sector not open to private sector investment;
9. Agriculture (excluding Floriculture, Horticulture, Development of seeds, Animal
Husbandry, Pisciculture and cultivation of vegetables, mushrooms etc. under
controlled conditions and services related to Agro and allied sectors) and Plantations
(Other than Tea Plantations);
10. Real estate business, or construction of farm houses;
Manufacturing of Cigars, cheroots, cigarillos and cigarettes of tobacco or of tobacco
substitutes.
Activity 2
Find out the data for FDI in various sectors; sources of investment and volume of
such investments.
Hint: Refer www.unctad.org/en/docs/wir2011overview_en.pdf and read World
Investment Report

5.2 Foreign Portfolio Investment
Portfolio investment simply means the investment made by a foreign company in the
secondary market or a stock market of the host country.
Foreign companies invest in a collection or a set of financial assets such as shares, securities,
debentures, bonds and cash called as a portfolio. Foreign companies do not invest their
entire capital in one kind of financial asset and in turn invest in different types of assets in
various proportions to diversify their risk. Portfolio investment in any country requires
sound knowledge of stock markets and security investment. This also means that foreign
investors need to carefully plan, forecast and judge the potential sectors, companies and
industries they would like to invest in so that they can maximize profits. Portfolios
investments can be managed by financial professionals, hedge funds, insurance companies,
banks and other financial institutions. Portfolio investment in any country is made on the
basis of the following principles:
a. Global Depository Receipt (GDR): Depository receipts are negotiable certificates and
are issued by a country’s bank against a certain number of shares held in its custody.
Such stocks are traded on the stock exchange of another country. Depository receipts
may be of different types: the most popular is Global Depository Receipts
(GDR)/European Depository Receipts/American Depository Receipts (ADR) and

International Depository Receipts. International Depository Receipts are also known

as GDRs in Europe and are traded in the exchanges of London, Luxemburg, and
Frankfurt. They are also known as Depository receipts which entitle the shareholders
to all associated dividends and capital gains
that come from such investments. Depository receipts can be bought and sold like any
other securities in stock exchanges. Such trading flexibility of depository receipts
allows investors in any country to buy shares of any other country without losing the
income.
A company that intends to invest in different countries can opt to issue a GDR to obtain
greater exposure in the global market. GDR issues allow the company to have increased
liquidity in key markets where it operates. This helps to enhance the company’s brand
image in the local market as company stocks are traded internationally. GDRs help the
company to have a broader shareholder base and provide an opportunity to invest in
their home countries. Depository receipts are also popular as they help companies to
raise funds globally, especially where there are strict regulatory norms in the country
for allowing foreign investments.
ADRs are certificates issued by US-based banks. In the US they are often known as
International Depository receipts. The certificate represents or contains shares in a
foreign company (this can include companies situated in India, China, etc.) for trade on
the US Stock exchange. A US bank or a US Financial institution places a certain number
of foreign companies' shares into its depositary and this allows US Investors to buy the
shares of foreign companies. By investing in ADR US investors cannot get ownership
rights, however, they can diversify their funds globally without having to open overseas
accounts or getting into the hassle of a foreign currency or any taxes. ADRs may pay
dividends issued at various ratios. ADRs were introduced for the first time by the
investment house of JP Morgan in 1927.

b. Foreign Institutional Investors: Foreign institutional investors (FII) are the

organizations that pool large sums of money and invest such funds usually in the
secondary markets of a country. Investments are made in securities, real estate and
other investments in a country. FII may also get registered as companies in target
security markets. SEBI sets the rules and regulations for companies that are under the
category of Qualified institutional investors.
RBI guidelines regarding eligibility criteria to be get registered as FII in India is tabled
as under:
Eligibility to get Registered as Foreign Institutional Investor
in India
Broad based fund on behalf of
Entities and funds
investors
a. Pension funds a. Asset management
b. Mutual funds companies
c. Insurance companies b. Institutional
d. Investment trusts portfolio managers
e. Banks c. Trustees
f. University funds d. Power of attorney holders
g. Endowments
h. Foundations
i. Charitable trusts and societies
Source: Reserve Bank of India
FIIs normally invest in banks, insurance companies, retirement or pension funds, real
estate funds; hedge funds, investment advisors and mutual funds. FIIs act on behalf of
foreign investors as they have expertise in planning, executing and controlling funds in
the target markets. Investors who cannot directly participate in emerging and growing
markets due to lack of knowledge, expertise and time opt for FIIs. FII’s influence the
management of Companies as they have voting rights and fulfill the short-term capital
needs of corporate/companies
FII’s contribute to foreign exchange reserves handsomely. SEBI now has allowed FIIs
to invest in mutual funds also.

c. Foreign Currency Convertible Bonds (FCCB): FCCBs are convertible bonds that are
issued by a country in a currency other than its own. FCCBs help a country to raise
capital in a foreign currency, that is required for funding its overseas investments. This
ensures short-term loans and leveraging its capital requirements FCCBs are called
‘freely convertible’ as such bonds act like debt as well as equity instruments. FCCBs are
just like bonds as they make regular coupons as well as principal payments to investors
and at the same time give them an opportunity to convert them into equity or stock of
the company. Indian companies have used FCCBs a lot especially in financing their
overseas acquisitions in recent years.
According to Ministry of Finance, Government of India; “Foreign Currency Convertible Bonds

means bonds issued in accordance with this scheme and subscribed by a non-resident in foreign
currency and convertible into ordinary shares of the issuing company in any manner, either in
whole, or in part, on the basis of any equity related warrants attached to debt instruments”.
4. Portfolio Investment is better for a country in the long run. (True/False)

5. India does not allow green field investment in India? (True/False)
6. Which of the following is not the route for portfolio investment in a country?
a) Foreign Institutional Investor.
b) Joint Venture.
c) Depository Receipts.
d) Foreign Currency Convertible Bonds.

6. MOTIVES FOR FOREIGN INVESTMENT

Motives for foreign investment means the reason behind the investment made in a host
country by a foreign investor from a foreign country. Historically, the British invested in
India with a financial or profit motive. As India has a historical legacy of colonization at the
time of independence in 1947 India was not in favor of allowing foreign investment into the
country. Such a perception was given up in 1991 and India was an underdeveloped nation
that had to depend on foreign investment as it was capital deficient. On the contrary
Communist countries such as China, Cuba and Vietnam have never encouraged foreign
investment for the development of the economy. They have stood up for being independent
and self-sufficient.
Impact of Foreign investment on developing nations:
India allowed foreign investment in most sectors and reserved investment only in a few
strategic sectors where foreign investment was not allowed. Foreign investment helped the
Indian Economy with systematic and synergized economic development of the country.
Another school of thought propounds that ‘free flow of capital is beneficial for the country as
it promotes an efficient allocation of country’s economy and resources. The Short-term
implication of foreign investment is the creation of more jobs and employment
opportunities. The long-run implication of foreign investment is increased competition,
production, and higher productivity levels. All these developments lead to the development
of a robust services sector, thus leading to greater economic activity and higher per capita
income. Motives for foreign investment for any country can be broadly classified and
understood in three broad categories, discussed as under:

6.1 Political Motives
The government of countries usually deter from allowing foreign investments and in some
cases welcome the foreign investment as they have their own reasons behind them. These
reasons are called political motives. Political motives that deter nations from allowing
foreign investment are the fear of destroying domestic business and domestic market share
for home-based products. Loss of jobs due to destruction of domestic markets, Fear of loss
of foreign exchange due to repatriation of profits. Poor Political relations and cold wars
between nations. All these reasons sum up as political motives that discourage nations from
allowing foreign investors from making investments in their country. On the contrary,
Countries encourage other foreign countries and investors to make foreign investments to
accelerate economic development in the host country, create jobs, ensure technology
transfer, improvement of real estate and infrastructure, increase in the inflow of foreign
exchange, and improve trading relations between countries. All these reasons sum u p as
political motives for countries to encourage foreign investment.
In recent times, Burma is the best example of a country that has not opened its market for
foreigners, fearing ‘sovereign issues’, and negative impact to indigenous industry. There may
be disadvantages in not allowing imports as goods from abroad may be cheaper and this will
help in controlling inflation, cost competitive and of better quality.

Foreign companies that are denied the right to export to such countries that ban foreign
investments usually penetrate such markets by agreeing to manufacture or at least assemble
goods within the target country. They may even agree to establish themselves as the local
production hub, thus catering to adjoining markets resulting in exports from such a country.
When foreign companies resort to local production it also helps them tackle imports such as
quotas, tariffs, and import duties. Local production in the host country also reduces the risk
of employment loss.
India has allowed investment in areas where foreign investor has come not only to cater to
the domestic market but also to export to nearby emerging and adjoining markets. This has
helped in increasing the country’s exports. For Example, in the automobile sector, pharma
companies, engineering companies, and telecom sector.
6.2. Economic Motives: These are the reasons for which foreign companies intend to
invest in other countries and as well as the reasons why certain countries' governments
allow foreign investment. Economic factors such as capital land, labor, and natural resources
act as decisive elements. Some companies invest to obtain substantial economies of scale and
scope in emerging and developing markets. Conglomerates invest abroad as they want to
reap benefits in research and development, marketing, distribution, financing, and
production by operating at volumes to meet the requirement of the worldwide market.
In addition to economies of scale, companies make foreign investments in many countries as

they wish to overcome the shortages of factors of production. Sometimes the local
population cannot provide sufficient numbers of technicians and engineers, or particular
raw materials that are either unavailable or overpriced in local markets. For example,
American companies have invested in India’s Information Technology sector as India is
abundant with educated youth. Similarly, pharmaceutical MNCs in Japan are looking at India
as it produces most cost competitive generic drugs and is also a good market for health care
products.

6.3. Competitive Motives
Another important motive for making or seeking foreign investment is the competitive
advantages that the company will enjoy in future target markets. Competitive motives for
foreign investment are resultant of economic and political motives. A company may make
foreign investments in overseas markets for which there are no immediate economic or
political gains. However, the company may benefit in the long run from such markets due to
a variety of reasons. The major motive for overseas investment is to secure future business
opportunities against the threat of existing or potential competition.
Companies usually invest in emerging markets as they may desire to increase their
international market share or production even though this effort may be apparently
unprofitable at that moment. Another example of competitively motivated direct foreign
investment decision are merger and acquisition by foreign company in the host country as it
desires to get access to foreign technology/brand image, established distribution channel
etc. Tata Sky deal can be quoted as an example of competition seeking investment. Tata’s
investment in Jaguar is another good example as Tata Automobile wished to increase its
presence in higher segments/established markets of Europe at the cost of existing gains.
7. Competitive motives for foreign investment are resultant of ______ and ________
motives.
8. _________ is the best example of a country that has not opened its market for
foreigners, fearing negative impact to the indigenous industry.
9. As India has a historical legacy of colonization, India at the time of
independence in 1947 were not in favor of allowing __________.

Activity 3
What shall be the impact of foreign investment on India’s retail sector?
Hint: Refer www.iimk.ac.in/wto/seminar/KakaliMajumdar.doc and read
docuemtn on ‘Impact of FDI on India’s retail trade’
7. SUMMARY
• Foreign investment is a powerful tool that accelerates economic development in

developing countries like India which are low on capital investment.
• The major motives for making a foreign investment are integration into global
economies, technological advancement, improved productivity, and human
development skills.
• Foreign investments are of two types: FDIs and Foreign portfolio investment.
• Foreign direct investment or FDI is an investment made by foreign investors in the host
country. The routes for FDI are green field investments, Joint ventures, mergers and
acquisitions.
• Portfolio investment simply means the investment made by a foreign company in the
secondary market or a stock market of the host country.
• The major forms of portfolio investment are ADR, GDR, FII’s and FCCB’s
• Foreign investment, in its classic definition, “is defined as a company from a country
making a physical investment by building a factory in another country”.
• Motives for making foreign investment are Political, Economic and Competitive
motives.

8. GLOSSARY
Green field investment: An investment in a completely new project.
Brown field investment: An investment by foreign investor in a sick industrial unit in India
needing complete restructuring for revival.
Acquisition: A foreign investor acquiring an existing and running Indian unit.
Conglomerate: a multi-industry company. This is a corporation of several different,

sometimes unrelated, businesses under one corporate group
Per Capita Income: Per capita income is a measure of the amount of money earned per
person in a nation or geographic region.
A Non-Banking Financial Company (NBFC) is a company registered under the Companies

Act, 1956 engaged in the business of loans and advances, acquisition of
shares/stocks/bonds/debentures/securities issued by Government or local authority or
other marketable securities.
1. Define foreign investment. What are various types of foreign investment?

2. What are the advantages of making an investment in a foreign country?
3. What is green field investment? Why is it considered the best option for a developing
country like India?
4. Differentiate between any two of the followings?
a. ADR and GDR.
b. Green field and brown field investment.
c. Foreign direct and portfolio investment.
d. Joint venture and merger.
5. Define portfolio investment. Discuss the various types of portfolio investment with
relevant examples.
6. What do you mean by direct foreign investments? What are the advantages of direct
investment over portfolio investments?

7. Discuss the increasing role of foreign institutional investor for a country like India.
8. What are some of the motives behind the foreign investment decision of the investor?
Explain with relevant examples.
10. ANSWERS
1. True
2. True
3. C
4. False
5. False
6. B
Self- Assessment Questions 3
7. economic & political

8. Burma
9. foreign investment
Terminal Questions
1. Foreign investment, in its classic definition, “is defined as a company Refer to sec 2 and
4
2. Globalization and the formation of the World Trade Refer to sec 3 of the chapter
3. Greenfield Investments: When Foreign investment is made into Refer to sec 4.1 sub
para-
4. a. Global Depository Receipt (GDR): Depository receipts are negotiable certificates
refer sec 4.2
b. Greenfield Investments: When Foreign investment is made into refer sec 4.1
c. FDI creates an inflow of foreign currency and financial investment refer sec 4.1 and
4.2

d.Joint ventures: A joint venture is said to take place when two or more refer sec 4.1 b
and c
5. Portfolio investment simply means the investment made by a foreign Refer to sec 4.2
6. FDI creates an inflow of foreign currency and financial Refer to sec 4.1
7. Foreign Institutional Investors: Foreign institutional investors (FII) are the
organizations refer sec 4.2 b
8. Motives for foreign investment means the reason behind the investment. Refer sec 6
References:
• International Financial Management; PG Apte; Fourth Edition; Tata Mc- Grawhill

• Multinational Business Finance; Global Edition; 12th Edition David Eiteman, Arthur
Stonehill, Michael Moffett; Sep 2009, Pearson publication
• Reports: India Brand Equity Fund 2011
• Foreign Direct Investment: Analysis of Aggregate Flows; Assaf Razin & Efraim Sadka;
Princeton University Press
• Foreign direct investment in India; Volume 4, Issue 93 of OECD Working papers ;
Author Kelly A. Johnson ; Publisher O.E.C.D, 1996
• Manual On Foreign Direct Investment In India- Policy and Procedures; MAY-2003
Secretariat for Industrial Assistance; Department of Industrial Policy and Promotion;
Ministry of Commerce and Industry; Government of India
• Foreign Investment in India : 1947-48 to 2007-08; By Niti Bhasin; New Century
Publications; 2008
E references:
https://www.merriam-webster.com/dictionary
https://en.wikipedia.org › wiki ›
https://www.rbi.org.in/scripts/bs_viewcontent.aspx?Id=2513 Importat\
https://www.indianeconomy.net/splclassroom/what-is-automatic-route-and-approval-
route-in-fdi/

https://www.indianeconomy.net/splclassroom/fdi-limit-in-various-sectors-of-the-
economy-consolidated-fdi-policy/
https://www.rbi.org.in/fiilist/index.html#:~:text=The%20ceiling%20for%20overall%20i
nvestment,the%20State%20Bank%20of%20India.


SEMESTER 4
DMBA402
MANAGEMENT
Unit 6 : Regional Integration 1

Unit 6
Regional Integration
Table of Contents

No Graph Activity
1 Introduction - -
4
2 Overview of Regional - 1
2.1 Need for integration - - 5-6
2.2 Impact of integration - -
3 Types of Integration 1 2I
3.1 Preferential trading agreement - -
3.2 Free trade area - -
3.3 Custom Union - - 7 - 12
3.4 Common Market - -

3.5 Economic Union - -
3.6 Political union - -
4 Regional Trading Arrangements - 3 II
4.1 The European Union (EU) - -
4.2 European Free Trade Association
- -
(EFTA)
4.3 North American Free Trade Agreement
- -
(NAFTA)
4.4 South Common Market (MERCOSUR) - - 13 - 20
4.5 ASEAN Free Trade Area (AFTA) - -
4.6 Asia-Pacific Economic Cooperation

- -
(APEC)
4.7 Gulf Cooperation Council (GCC) - -
4.8 South Asian Free Trade Area (SAFTA) - -

5 India and Trade Agreements

- 4
5.1 Asia-Pacific Trade Agreement (APTA)

- -
5.2 Bay of Bengal Initiative for Multi-

Sectoral Technical and Economic - -
Cooperation (BIMSTEC) 21 - 26
5.3 Framework Agreement on
Comprehensive Economic Cooperation
- -
between India and the Association of
South East Asian Nations
5.4 India-MERCOSUR Preferential Trade
- -
Agreement (PTA)
6 Summary - - 27
7 Glossary - - 27
9 Answers - - 28 - 29
10 Case-let
- - 29 - 30

1. INTRODUCTION
In the previous section, we studied foreign investments and the major forms such as Foreign
Direct Investment and Foreign Institutional Investment. This unit covers the topic of regional
integration. Here we will go through the need and importance of regional integration. We
will also cover the current trading blocks, structure, and functions along with the
participation of the Indian government in trading agreements with other nations. Regional
integration is the process of countries joining hands to co-operate and collaborate in terms
of politics, culture, business, and economic factors.
❖ Explain the need for regional integration.

❖ Analyse the impact of different types of integration among countries.
❖ Describe several regional trade arrangements.
❖ Evaluate different trade agreements of India.

2. OVERVIEW OF REGIONAL INTEGRATION
Regional integration involves two or more countries joining together to co-operate and
support each other to develop economic growth, stability, and flourish. Regional integration
happens only when both countries are willing to share or unify into a larger whole. The level
of integration between countries is based on what kind of resources and how such resources
are going to be shared. Regional integration needs some acceptance and understanding from
participating countries. Regional integration brings an improvement in the quality of life of
citizens in the participating nations.
Most nations have been involved in regional integration in recent years. With an objective to
improve ties and relationships with each other. The European Union (EU) market integration
marked the beginning of the regional integration trend. This trend has moved both
developed and developing countries to form customs unions and Free Trade Areas (FTA).
The World Trade Organization (WTO) terms these agreements of integration as Regional
Trade Agreements (RTA).
2.1 Need For Integration
Countries have their own reasons to move towards regional integration and there are
many approaches that have led to regional integration among various nations. The
reasons for regional integration are:
• Facilitate trade growth.

• Achieve conducive climates for investment.
• Surmount the regulatory and administrative barriers to transit zones.
• Ensure safe and reliable trade routes.
• Enhance infrastructure – physical and institutional.
• Encourage economic expansion.

Functions of regional integration:
• Strengthen regional trade integration.

• Create a conducive environment to enable private sector development.
• Develop infrastructure plans to support economic growth and regional integration.
• Develop strong public sector institutions and good governance.
• Reduce social disparities and develop an inclusive civil society.
• Contribute to the peace and security of the region.
• Build environmental plans at the regional level.
• Strengthen the region’s interaction with other regions of the world.
2.2 Impact Of Integration
Regional integration brings development and growth to the region. It leads to the creation
and expansion of trade that increases income, production activities, and the volume of
business transactions. As new entrants get entry into the market from other countries the
level of competition increases, and better trading practices are adopted. The transfer of
technology and knowledge sharing enhances the manner of conducting business. Regional
integration induces a reduction on tariffs and prohibitions.
1. Regional integration can be defined as the unification of countries to meet

common objectives. (True/False)
2. Promoting _____________is a need of regional integration.
3. Identify the correct answer. Regional integration
should not _________________.
a) Build environmental plans at the regional level
b) Strengthen trade integration in the region
c) Contribute to the peace and security of the region
d) Break ties with other countries

3. TYPES OF INTEGRATION
This section covers the Different types of regional integration:
3.1 Preferential Trading Agreement
A Preferential trading agreement is a trading agreement between nations. It is the least

preferred form of economic integration as it only brings down the tax on a few products for
those countries that sign the pact. The tariffs are not removed completely. The tariffs are less
in comparison to the tariff charged to countries that are not a part of the agreement. India is
in PTA with countries like Afghanistan, Chile, and South Common Market (MERCOSUR). The
introduction of PTA has increased the market size and improved the availability of new
products.
3.2 Free Trade Area
Free Trade Area (FTA) is a type of trade bloc and is considered the second stage of economic
integration. It includes all nations that agree to reduce preferences, tariffs, and quotas on
goods and services traded between them. Countries choose this kind of economic integration
if their economic structures are almost the same. If countries compete among themselves,
they are likely to choose a customs union.
The importers must collect product-related information from all suppliers within the supply
chain in order to determine eligibility for a Free Trade Agreement (FTA). After receiving the
supplier documentation, the importer must evaluate the eligibility of the product depending
on the rules pertaining to the products. The importer's product is qualified individually by
the FTA. The product should have a minimum percentage of local content for the product to
be qualified.
3.3 Custom Union
Customs Union is an agreement between two or more countries that have already entered
into a free trade agreement to further align their external tariff that will help remove trade
barriers. Custom union agreements among negotiating countries may include reducing or

eliminating duty on mutually traded goods. Under customs union agreements, countries
generally impose a common external -tariff (CTF) on imports from non-member countries.
The common external tariff helps the member countries to make benefits of trade expansion,
trade creation and trade diversification. In the absence of common external tariffs, there is a
possibility that countries with lower customs duties may become conduits for members
which have higher customs duties. Custom union is the third stage in level of economic
integration and is followed only after free trade agreement among participating countries.
Table 6.2: Levels of economic integration

Levels of Economic Integration
Stages/Level Preferential Free Common Free Common Common
of Economic Tariff & Movement External Movement Banking Foreign &
Integration Highly of Goods & Tariff of Labour & & Defense
reduced Services Capital Monetary Policy
non-tariff Policies
barrier
Preferential √ × × × × ×
Trade
Agreement
Free Trade √ √ × × × ×
Agreement
Custom Union √ √ √ × × ×
Common √ √ √ √ × ×
Market
Economic √ √ √ √ √ ×
Union
Political Union √ √ √ √ √ √
3.4 Common Market
A Common market is a group formed by countries within a geographical area to promote

duty-free trade and free movement of labor and capital among its members. The European
community is an example of a common market. Common markets levy a common external
tariff on imports from non-member countries.
A single market is a type of trade bloc, that includes a free trade area with common policies
on product regulation, movement of goods, capital, labor, and services, which are technically
the four factors of production. This agreement aims to make the movement of four factors of
production between the member countries easier. The technical, fiscal, and physical barriers
among the member countries are eliminated to a large extent as these barriers reduce the

freedom of movement of the four factors of production. The member countries must come
forward to eliminate these barriers, have political will and formulate common economic
policies.
A common market is the first step towards a single market. It may be initially limited to an
FTA with moderate free movement of capital and services, but it is not capable of removing
the other trade barriers.
Benefits and costs
A single market has many benefits. The freedom of movement of the factors of production
between the member countries results in the efficient allocation of these production factors
and increases productivity.
A single market presents a challenging environment for businesses as well as for customers,
making the existence of monopolies difficult. This affects inefficient companies and hence
results in a loss of market share and the companies may have to close down. However,
efficient companies can gain from increased competitiveness, economies of scale, and lower
costs. The Single Market also benefits the consumers as the competitive environment
provides them with a variety of inexpensive products and more efficient providers of
products.
A country changing over to a single market may experience some short-term negative
impacts on the national economy due to increased international competition. National
companies that earlier profited from market protection and subsidies may find it difficult to
cope with their efficient peers. If these companies fail to improve their methods, they may
have to close down leading to migration and unemployment.

Level of Main Features of Regional Examples

Integration Economic Grouping
Free Tradea. Free movement of goods & services1. India Sri Lanka Free Trade
Area among countries Agreement
b. No tariffs or non-tariff barriers 2. India Asean Free Trade
c. Countries are free to decide their Agreement
trade policies towards non- 3. North America Free Trade
members Agreement, etc.
Customs 1. Second stage of economic 1. Southern African Customs
Union integration Union (SACU)
2. Common external tariff for Non- 2. Andean Pact;
member countries 3. Southern Common Market
3. Ensures orderly & balanced (MERCOSUR)
economic development of member4. EU- Turkey
countries 5. Customs Union of Belarus,
4. Promotes regions as single Kazakhstan and Russia
trading areas for all tariff & non-tariff
purposes for non- member
countries with single customs
policy
Common 1. Third stage of economic 1. Caribbean Common

Market integration of countries Market (Caricom);
2. Free movement of labor and 2. Association of South East
capital among participating Asian Nations (ASEAN)
countries 3. Central American
3. No restrictions on migration Common Market (CACM)
of people with economic
grouping
Economic 1. Fourth stage of economic The only example is the
Union integration of countries European Union (EU)
2. Common currency with
aligned banking & monetary
policy
3. Single trade policy
4. Harmonization of tax rates
5. Common fiscal, banking &
interest rate policy with
common bank
1. Fifth stage of economic No living example however;
Political integration European Union will become
Union 2. The Treaty of Lisbon provides first political union if treaty of
for such a framework for Lisbon is ratified by member
European Countries countries
3. If implemented, the EU will
have a single defense and
foreign policy

3.5 Economic Union
Economic union is a type of trade bloc and is governed through a trade pact. It comprises of
a common market with a customs union. The countries that are part of an economic union
have common policies on the freedom of movement of four factors of production, common
product regulations and a common external trade policy.
The purpose of an economic union is to increase closer cultural and political ties while
increasing the economic efficiency between the member countries.
Economic unions are established by means of a formal intergovernmental legal agreement

among independent countries with the intention of fostering greater economic integration.
The members of an economic union share some elements associated with their national
economic jurisdictions.
These include the free movements of:
• Goods and services within the union along with common taxation methods for imports
from non-member countries.
• Capital within the economic union.
• Persons within the economic union. Some forms of cooperation usually exist while
framing fiscal and monetary policies.
3.6 Political Union
A political union is a type of integration, which consists of smaller countries/nations. Here,

the individual nations share a common government and the union is acknowledged
internationally as a single political entity. A political union can also be termed as a legislative
union or state union.

4. Countries under a political union do not have a common government.

(True/False)
5. Countries under a Common External Tariff on imports from non-members are
known as Common Market. (True/ False)
6. The purpose of an economic union is to promote closer _____________ and
______ties.
7. Identify the factor of production.
a) Capital.
b) Consumers.
c) Market.
d) Policy maker.
Activity 1
Analyse the reasons that lead to the formation of economic unions and common
markets.
Hint: Economic regionalism, taxation and regional integration.

4. REGIONAL TRADING ARRANGEMENTS

After learning the various types of integration, we will now discuss the regional trading
arrangements required for integration. The different regional trading agreements that are in
existence today among various countries spread across different continents are discussed in
this section.
4.1 The European Union (EU)
The European Union (EU) is an economic union and was established in 1993. This came into
effect because of the Treaty of Maastricht, signed on 7th February 1992 by the European
Communities. The EU comprises of 27 member states committed to regional integration.
The EU has developed a single market for all the member states and sixteen member states
have adopted a common currency called the Euro. The member states sign an agreement
called the Schengen Agreement, which ensures the free movement of people, goods, capital
and services, including the abolition of passport controls. The agreement includes legislation
in justice and home affairs, and maintains common policies on trade, agriculture, fisheries
and regional development.
The EU has also framed a common foreign and security policy for its member states. It has
developed diplomatic missions around the world and represents the member states at the
United Nations, WTO, G8 and G20 summits. The EU Ambassadors head the EU delegations.
Important organizations of the EU include the European Commission, the Council of the
European Union, the European Council, the Court of Justice of the European Union, and the
European Central Bank. The EU citizens elect the European Parliament every five years.
4.2 European Free Trade Association (EFTA)
The European Free Trade Association (EFTA) is a free trade organization established in 1960
between four European counties, Norway, Switzerland, Iceland and Liechtenstein. The EFTA
was formed at the Stockholm Convention between seven countries, presently only four
countries remain as members of EFTA. The EFTA was formed as an alternative to the EU,
allowing countries to join EFTA if they were not willing to join EU. It operates parallel to the

EU. The Stockholm Convention was replaced by the Vaduz Convention. This Convention
provides a guideline for free and liberal trade amongst its member states.
4.3 North American Free Trade Agreement (NAFTA)
The North American Free Trade Agreement (NAFTA) was signed in 1994 by three
governments, Canada, Mexico and the United States. This trade agreement is the largest in
the world in terms of combined purchasing power parity Gross Domestic Product (GDP) and
second largest by nominal GDP comparison.
The NAFTA is divided into two sections, the North American Agreement on Environmental
Cooperation (NAAEC) and the North American Agreement on Labour Cooperation (NAALC).
The North American Agreement on Environmental Cooperation (NAAEC) was established in

1994. It is an environmental agreement between the United States of America, Mexico and
Canada. The agreement comprises of a declaration of objectives and principles regarding
conservation and the protection of the environment. The Commission for Environmental
Cooperation (CEC) was set up as part of the agreement.
North American Agreement on Labour Cooperation (NAALC) was also established in 1994
to achieve the following goals:
• Improve working conditions and living standards.

• Promote a set of guiding labor principles.
• Encourage cooperation to promote innovation.
• Improve the levels of productivity and quality.
NAALC provides various benefits such as exchanges of information, technical assistance and
consultations for achieving the above goals.
4.4 Southern Common Market (MERCOSUR)
MERCOSUR is a trade agreement between Argentina, Brazil, Paraguay and Uruguay. It was
formed in 1991 to promote free trade and a smooth movement in currency, goods and people
between these nations. The pact helps reduce tariffs between the nations by 90 percent.

MERCOSUR was initiated in 1985 when the Presidents of Argentina and Brazil signed the
Argentina-Brazil Integration and Economics Cooperation Program. Since then, other
countries like Bolivia, Chile, Columbia, Ecuador and Peru have become members in this pact.
In the 2004 presidential summit, it was agreed that it should have 18 representatives from
each country by 2010. The only non-South American partners are Egypt and Israel.
4.5 ASEAN Free Trade Area (AFTA)
AFTA is a trade agreement formulated by the Southeast Asian Nations association that
supports local manufacturing in all the ASEAN countries.
The AFTA agreement was signed in Singapore on 28th January, 1992. Initially when the
AFTA agreement was signed, ASEAN comprised of six members: Thailand, Singapore,
Philippines, Malaysia, Indonesia and Brunel. Then Vietnam joined the AFTA agreement in
1995, followed by Myanmar and Laos in 1997 and Cambodia in 1999. Now, AFTA consists of
ten ASEAN countries. The four latecomers had to sign the AFTA agreement to join ASEAN;
however, they were given longer time duration to meet the tariff reduction obligations of
AFTA.
The AFTA’s primary goals seek to:
• Enhance the competitive edge of ASEAN as a production base in the world market by
eliminating ASEAN’s non-tariff and tariff barriers.
• Attract more overseas direct investment to ASEAN.
Common Effective Preferential Tariff (CEPT) scheme is the prime source for attaining the
goals mentioned above. The CEPT scheme established a schedule for its initiation in 1992
with their self-described goal to enhance the competitive advantage of the region as a
production base for world market.
The Association of Southeast Asian Nations (ASEAN) is an economic and geo-political

organization of ten countries situated at Southeast Asia. The ASEAN organization was
formulated by Thailand, Singapore, Philippines, Malaysia and Indonesia on 8th August, 1967.
From then on, the membership has extended to comprise Vietnam, Laos, Cambodia, Burma

(Myanmar) and Brunei. The ASEAN organization aims to accelerate cultural development,
social progress, economic growth among their members, protection of stability and peace of
the region, and offer opportunities for member countries for discussing differences
peacefully.
4.6 Asia-Pacific Economic Cooperation (APEC)
The Asia-Pacific Economic Cooperation (APEC) is the best platform for initiating trade
investment assistance, trade cooperation, and economic growth in the Asia- Pacific region.
APEC is the sole inter-governmental grouping in the world functioning on the basis of mutual
and equal respect, open communication, and non-binding commitments for the views of its
participants. Unlike WTO and other multilateral trade bodies, APEC does not have any treaty
obligation for the participants. The decisions within APEC are finalized by commitments and
consensus undertaken on a voluntary basis.
The 21 ‘Member Economies’ of APEC are Australia, Brunei, Canada, Chile, China, Hong Kong,
Indonesia, Japan, South Korea, Malaysia, Mexico, New Zealand, Papua New Guinea, Peru,
Philippines, Russia, Singapore, Taiwan, Thailand, USA and Vietnam.
APEC came into existence in 1989 to further enhance the prosperity and economic growth
of the region and to uphold the Asia-Pacific community. From its start, APEC has worked to
bring down the tariffs and other kinds of trade barriers around Asia-Pacific region. They have
also worked towards largely increasing exports and for creating efficient domestic
economies. The key to achieve APEC’s vision is what is referred to as ‘Bogor Goals’ of free
and open trade and investment in the Asia- Pacific by 2010 for industrialized economies and
2020 for developing economies. In fact, these goals were embraced by the leaders in their
meeting in Indonesia and Bogor in 1994.
Let us consider more about Bogor Goals in 1994 Leaders’ Declaration. The free and open
trade investment assists economies to grow, generates jobs and offers greater prospects for
international investment and trade. On the contrary to this, protectionism maintains higher
price tags and fosters inefficiencies in a few industries. Free and open business assists in

lowering the production costs and in reducing the prices of services and goods, which is a
direct advantage for everyone.
APEC also functions to create a safe and efficient environment for the movement of people,
services and goods across borders with the help of technical and financial collaboration and
policy alignment.
Objectives:
In order to meet Bogor Goals, the APEC functions in three prime areas:
• Technical and financial collaboration.

• Trade assistance.
• Investment and business liberalization.
4.7 Gulf Cooperation Council (GCC)
On 25th May, 1981, GCC’s leaders of United Arab Emirates like State of Kuwait, State of Qatar,
Sultanate of Oman, Kingdom of Saudi Arabia and State of Bahrain met in Abu Dhabi. Here,
the leaders formulated a framework to join the six states for effective inter-connection,
integration and coordination among member states in every field for achieving unity as per
article four of GCC Charter. Article four highlights the strength and depth of cooperation,
links and relations among their citizens. In fact, the underpinnings that are clearly provided
in the GCC charters’ preamble confirms the similar systems, common qualities and special
relations founded on the creed of Islamic faith, in sharing a common goal and to cooperate
among these states to serve the objectives of the Arab nation.
GCC on one hand is an institutionalization, evolution and continuation of the old prevailing
realities. On the other hand, it is a practical solution to challenges of economic development
and security in those areas. Also, GCC is a fulfilment of aspirations of their citizens towards
certain kind of Arab regional unity.

Objectives:
GCC charter helps to inter-connect, integrate and coordinate between the member states in
every field.
The GCC also known as Cooperation Council for the Arab States of the Gulf (CCASG) is an
economic and political union that involves six Arab states of Persian Gulf with various social
and economic objectives.
A few of the stated objectives are to:
• Formulate similar kinds of regulations in several fields like administration, legislation,

tourism, customs, trade, finance and economy.
• Foster technical and scientific progress in animal, water, agriculture, mining and
industry resources.
• Formulate scientific research centers.
• Establish joint ventures.
• Encourage cooperation of private sector.
• Strengthen relationships among people.
• Formulate a mutual currency by 2010.
However, on December 2006, Oman announced that they would not be able to comply with
the target date. Then in May 2009, UAE announced its withdrawal from the monetary union
project. This happened just after they had announced that their monetary union central bank
would be situated in Riyadh instead of the UAE. The proposed currency name is ‘Khaleej’.
Recently, the Council leaders had to face lots of issues for combating the economic downturn.
The GCC countries were the first to be hit by the downturn and the prime ones to react to the
crisis. Their programs had lots of disparities which deepened the crisis. The recovery plans
were present in the private sector which failed to set concise priorities for development and
failed to restore confidence in the investor and weak consumer.

4.8 South Asian Free Trade Area (SAFTA)
South Asian Free Trade Area (SAFTA) agreement was initiated at the 12th SAARC summit on
6th January, 2004 in Pakistan. This agreement envisaged the creation of a free trade zone
model in its seven member nations. The seven member nations consist of nearly 1.4 billion
people from various countries like:
• Nepal.
• Maldives.
• Bhutan.
• Bangladesh.
• Pakistan.
• India
• Sri Lanka
• Afghanistan.
SAFTA agreement was framed to levy zero customs duty for trading products by 2012. This
agreement was implemented after confirming its compliance by the governments of seven
member nations. The agreement facilitates healthy trading-based relationships across
borders to bring about several structural reforms in the economy of seven countries. But
there are a few obstacles that hinder trade across the South
Asian countries, thereby, the trade across the South Asian borders' accounts for just five
percentage of the overall trade. In fact, the reason could be attributed to the two most
prominent factors like:
• Political causes: During the late 1940s, most nations of South Asia were a part of the
British India. During this period, there was considerable trade between many South
Asian countries. But in 1947 when Pakistan and India became independent, Pakistan
started importing most of their important articles from India. Pakistan also exported
many of their commodities to India. Because of the conflicts happening in various
spheres, trade activities started declining sharply between Pakistan and India.

• Protectionism: Almost all the South Asian countries started stressing their import
activities rather than promoting their export activities. Such a tendency lowered
productivity in various sectors of the economy. However, Various economies have
started cooperating among themselves.
8. The European Free Trade Association (EFTA) was established in the year:
a) 1950.
b) 1960.
c) 1970.
d) 1980.
9. ____________ is a trade pact between Argentina, Brazil, Paraguay and Uruguay.
10. The EU comprises of ________member states.
11. SAFTA agreement was initiated at the 12th SAARC summit held in Bangladesh.
(True/False)
12. The Gulf Cooperation Council (GCC) is also known as Cooperation Council for
the Arab States of the Gulf (CCASG). (True/False)
Activity 2
Find out how the Bogar goals set by APEC are being pursued by APEC member
countries.
Hint:http://www.apec.org/apec/news media/media_releases/08_pe_sin
gaporeiap.html

5. INDIA AND TRADE AGREEMENTS

After learning about regional trading arrangements in the previous section, we shall now
discuss the trading agreements conducted by India.
India considers Regional Trading Arrangements (RTA) as the building blocks toward the
objective of trade liberalization. Therefore, India participates in a number of RTAs, which
include Free Trade Agreements (FTAs), Preferential Trade Agreements (PTAs), and so on.
These agreements take place bilaterally or in a regional group. We shall now discuss some
of the major agreements signed by India.
5.1 Asia-Pacific Trade Agreement (APTA)
The Asia-Pacific Trade Agreement (APTA), previously known as the Bangkok Agreement,
was signed on 31st of July 1975, as an initiative of the United Nations Economic and Social
Commission for Asia and the Pacific (ESCAP).
The United Nations Economic and Social Commission for Asia and the Pacific (ESCAP) is the
regional development arm of the United Nations for the Asia-Pacific region. It focuses on
issues that are most effectively addressed through regional cooperation and includes:
• Issues of all or a group of countries in the region face, for which it is necessary to learn
from each other.
• To Benefit from regional or multi-country involvement.
• To Cut across boundaries, or that would benefit from collaborative inter- country
approaches.
• Are sensitive or emerging and require further advocacy and negotiation.
The first agreement on trade negotiations among the developing member countries of ESCAP
was the APTA/ Bangkok agreement. It is basically a preferential tariff agreement that aims
at promoting intra-regional trade through exchange of mutually agreed concessions by the
members of the ESCAP region.
The first signatories to the agreement were Bangladesh, India, Lao People’s Democratic
Republic, the Republic of Korea and Sri Lanka. China's accession to the agreement was

accepted at the 16th Session of the Standing Committee of the Bangkok Agreement in April
2000.
The aim of this agreement is to encourage economic development gradually through trade
expansion among the developing member countries of ESCAP and to further international
economic cooperation through the adoption of mutually beneficial trade liberalization
measures.
The following general principles govern the agreement:
• The Agreement shall be based on overall cooperation and mutuality of advantages in

such a way, to benefit all participating states equally.
• The principles of transparency, national treatment and most-favored- nation treatment
shall apply to the trade relations among the participating states.
• The special needs of less developed countries and participating states shall be clearly
recognized and concrete preferential measures in their favor shall be agreed upon.
5.2 Bay of Bengal Initiative for Multi-Sectoral Technical and Economic

Cooperation (BIMSTEC)
Bangladesh India Myanmar Sri Lanka and Thailand Technical and Economic Cooperation
(BIMSTEC), a sub-regional economic cooperation grouping, was formed in Bangkok in June
1997. Myanmar joined the grouping later in December 1997. Bhutan and Nepal too joined in
February 2004. Five members of SAARC (India, Bangladesh, Bhutan, Nepal and Sri Lanka)
and two members of ASEAN (Thailand, Myanmar) are members of this agreement. Thus, it
is considered as a ‘bridging link' between the two major regional groupings that is, ASEAN
and SAARC. The chairmanship of BIMSTEC rotates among the member countries in
alphabetical order. The immediate priority of the grouping is to merge its activities to make
it attractive for economic cooperation.

Initially, cooperation was proposed into six sectors. But, during the 11th Senior Official
Meeting in New Delhi in August 2006, it was agreed that the areas of cooperation should be
expanded to 13 sectors and each sector will be led by members in a voluntary manner.
The member countries proposed cooperation in the following sectors:
• Trade and Investment (Bangladesh).

• Technology (Sri Lanka).
• Energy (Myanmar).
• Transport and Communication (India).
• Tourism (India).
• Fisheries (Thailand).
• Agriculture (Myanmar).
• Cultural Co-operation (Bhutan).
• Climatic Change
• Environment and Disaster Management (India).
• Public Health (Thailand).
• People-to-People Contact (Thailand).
• Poverty Alleviation (Nepal).
• Counter-Terrorism and Trans-national Crimes (India).
BIMSTEC member countries agreed to establish the BIMSTEC Free Trade Area Framework
Agreement in order to encourage trade and investment in the countries party to the
agreement, and attract outsiders to trade with and invest in BIMSTEC at a higher level. The
Framework Agreement on the BIMST-EC FTA was signed on 8th February, 2004 in Phuket,
Thailand.
5.3 Framework Agreement on Comprehensive Economic Co- operation

between India and the Association of South East Asian Nations
‘Look East Policy’ led India to engage with the Association of South East Asian Nations
(ASEAN) and it started in the year 1991. The ASEAN’s political economic and strategic
importance in the larger Asia-Pacific Region and its capability to become a major partner of

India in trade and investment made India to join association with ASEAN. While, ASEAN
looks to utilize and access India’s technical and professional wealth, India and ASEAN look
forward to strengthen the security in the region.
ASEAN was established on 8th August 1967 in Bangkok by the five original member
countries, namely, Indonesia, Malaysia, Philippines, Singapore, and Thailand. Now, it has a
membership of 10 countries namely Brunei Darussalam, Cambodia, Indonesia, Lao PDR,
Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam. India is one of the four
'Summit level Dialogue Partners' of ASEAN.
An agreement on Comprehensive Economic Cooperation between ASEAN and India was

signed on 8th October 2003 in Bali (Indonesia). The main elements of the agreement are FTA
in services, goods and investment as well as in the areas of economic cooperation.
The objectives of this agreement are to:
• Promote and strengthen trade, economic and investment co-operation between the
parties.
• Progressively liberalize and promote trade in goods and services as well as create a
transparent, liberal and facilitative investment regime.
• Explore new areas and develop appropriate measures for closer economic co-operation
between the parties.
• Facilitate the more effective economic integration of the new ASEAN Member States
and bridge the development gap among the parties.
The areas where economic cooperation is required are, when appropriate, parties:
• Agree to strengthen their cooperation in the following areas:

o Trade facilitation.
o Sectors of cooperation.
o Trade and investment promotion.
• Agree to implement capacity building plans and technical assistance, particularly for
the New ASEAN Member States, in order to adjust their economic structure and expand
their trade and investment with India.

• Establish other bodies, which may be necessary to coordinate and implement any
economic cooperation activities undertaken pursuant to this Agreement.
5.4 India-MERCOSUR Preferential Trade Agreement (PTA)
India and MERCOSUR signed a framework agreement on 17th June 2003. The main aim of
this agreement is to create an environment for negotiations in the first stage, by granting
mutual tariff preferences, and in the second stage, to negotiate FTA between the two parties
in conformity with the rules of the WTO. As a follow up to the framework agreement, a
Preferential Trade Agreement (PTA) was signed in New Delhi on January 25, 2004. The aim
of this PTA is to expand and strengthen the existing relations between MERCOSUR and India
and promote the expansion of trade by granting mutual fixed tariff preferences with the
ultimate objective of creating a free trade area between the parties.
Other agreements include:
• India and Singapore Comprehensive Economic Cooperation Agreement (CECA).

• India-Sri Lanka Free Trade Agreement (ISFTA).
• India-Chile Preferential Trade Agreement (PTA).
• India-Afghanistan Preferential Trade Agreement (PTA).
• India-Bhutan Trade Agreement.
• India-Nepal Trade Treaty.
• Framework Agreement for Establishing Free Trade between India and Thailand.
• Free Trade Agreement (FTA) between India and Gulf Cooperation Council (GCC).
• India- Japan Trade Agreement.
• Joint Study Group between India and Korea.
• Trade Agreement between India and Bangladesh.
• Comprehensive Economic Cooperation and Partnership Agreement (CECPA) between
India and Mauritius.
• Expansion of India-MERCOSUR PTA through the IBSA Declaration made by the Heads
of India, Brazil and South Africa in 2006. Here the countries agreed to expand the India-

MERCOSUR PTA by increasing the number of products covered and increasing the tariff
concessions agreed by each side.
• The first meeting of Joint Administrative Committee (JAC) on India-MERCOSUR PTA
was held in November, 2009 in Uruguay to discuss the various aspects of the
implementation and expansion of the Agreement. The 2nd meeting of JAC on India-
MERCOSUR PTA was held in June, 2010, in which both sides exchanged their respective
wish list of additional items for expansion of the PTA and further discussed the points
of action.
13. India and MERCOSUR signed a Framework Agreement on .

14. The association of India and ASEAN started in the year 1991. (True/False)

6. SUMMARY
Let us summarize the points covered in this unit:
• Regional integration is necessary to improve the relationship between countries and to

promote trade. The overall development of the region is the principal behind regional
integration.
• There are different types of regional integration such as free trade areas, customs
unions, common markets, economic unions, political unions, and Preferential trading
agreements.
• These are the basic ideas behind the different regional integration agreements existing
in the world.
• The different regional integration agreements are NAFTA, APEC, EU, EFTA, AFTA,
MERCOSUR, GCC and SAFTA.
• India also considers RTS’s to be the basis for trade liberalization. Therefore, India has
entered into various agreements with many countries spanning many continents.
7. GLOSSARY
GDP: Gross Domestic Product is the amount of goods and services produced in a country
every year.
Trade bloc: It is an agreement between countries to reduce tariffs and other trade barriers.
Preferential Trade Agreement: Trade agreement whereby negotiating countries offer each
other tariff & non-tariff preference on all tariff lines or on select tariff lines.
Custom Union: Regional economic engagement of countries with a single mutually agreed
common external tariff.
Transit zone: It is a free trade area and goods passing through a transit zone are normally
not subject to any customs formalities, duties, or import restrictions of the host country.

1. What is the need for regional integration?
2. Write short notes on the common market, economic union and free trade area.
3. Write short notes on NAFTA and APEC.
4. How has India reacted towards regional integration?
9. ANSWERS
1. True
2. Economic diversification
3. d) Break ties with other countries
4. False
5. True
6. Cultural and political
7. a) Capital
8. b) 1960
9. MERCOSUR
10. 27
11. False
12. True
13. 17th June 2003
14. True
Terminal Questions
1. Regional integration facilitates the growth of trade, ensures peace and security of the
region and binds different countries together. Refer section 2.
2. A common market is a group of countries within a particular geographical area,
whereas FTA is a trade bloc that has agreed to reduce tariffs. Refer to sub-section 3.2,
3.3, and 3.4 of this unit. Refer the same for details.

3. NAFTA is the largest in the world in terms of purchasing GDP. APEC is the best form for
trade cooperation in the Asia-Pacific region. Refer to sub-section 4.3 and 4.6
4. India considers RTAs as building blocks towards the objective of trade liberalization.
Therefore, India is participating in a number of RTAs. Refer to section 5
10. CASE-LET
Role of Integration in Maintaining Peace
The war in the Balkans proved to be the motivation behind the development of European
Foreign policy to establish stability and security in the region. The policy proposed to
integrate the Western Balkans through political and economic assistance especially provided
by a regional approach and by the Stabilization Association Process and the Stability Pact. In
the context of the policy towards the Balkans, Siberia was charged with the responsibility to
oversee the transition of democracy and participate in the integration process.
The role of Siberia is crucial as it has to take care of its own political and economic progress
in the process of integration. Therefore, the policy emphasize that the process of the
integration is not mainly related to security and economic interests, but also with a
normative ambition that is most importantly building and enforcing the rules needed to
guarantee democratic development and political stability. The EU’s more rationale interests
such as economic development and security are correlated and also embedded in the EU’s
normative concerns. The strategies employed by the EU towards Serbia particularly had the
ambition to create political stability and in turn, increase the security throughout the
Balkans, and thereby decrease the risk for further conflict around Europe’s borders. For
instance, the support towards the democratic entities and the promotion of European norms
and rules is of high priority.
Discussion questions
1. Analyse the role of Siberia in integrating the Balkans.
(Hint: Political and economic participation)
Source: http://www.essays.se/essay/f468debd57/

References:
• Bernadette Andréosso-O'Callaghan (2005), Regional integration:

Europe and Asia compared. Ashgate Publishing.
• Rouhollah K. Ramazani, Joseph A. Kechichian (1988), The Gulf Cooperation Council:
record and analysis. University Press of Virginia.
• Hill; International Business-competing in Global Market Place; fourth Edition; Tata
McGraw-Hill
• Sisir Gupta (1981), India and regional integration in Asia. Asia Publishing House.
E- References:
• http://business.gov.in/trade/trade_agreements.php, retrieved on 10th November,

2010
• http://en.wikipedia.org/wiki/Regional_integration, retrieved on 6th November 2010
• www.indianindustry.com, retrieved on 22 April 2012
• https://commerce.gov.in/international-trade/trade-agreements


SEMESTER 4
DMBA402
MANAGEMENT
Unit 7: Global Trade Institutions 1

Unit 7
Global Trade Institutions
Table of Contents

No Graph Activity
1 Introduction - -
3
2 Introduction to Global Trade Institutions - 1
2.1 Institutions - - 4-7
2.2 Objectives - -
3 World Trade Organisation (WTO) - 2I
3.1 Objectives and functions - -
3.2 Structure - -
8 - 17
3.3 Principles - -
3.4 Agreements - -
3.5 Issues - -
4 International Labour Organisation (ILO) - 3 II
4.1 History - - 18 - 21
4.2 International labour code - -
5 Summary - - 22
6 Glossary - - 22
8 Answers - - 23 - 24
9 Case-let
- - 24 - 25

1. INTRODUCTION
In the previous unit, you went through the regional integrations across the world and also
studied the important agreements which India has with other countries. International
business involves conducting business between several countries. There are both
opportunities as well as challenges involved in doing business overseas. The challenges
create barriers in the smooth functioning of the business operations in foreign markets. To
support the challenges faced by international business, certain support systems are
established. In this unit, you will learn about support systems for international business.
This unit covers the institutional support systems. Various international organizations are
working towards removing trade barriers, promoting international business, and providing
a regulatory framework. It also covers the International Labour Organization and the
international labor code.
❖ Describe the various international organizations working to facilitate international

trade.
❖ Evaluate the role of WTO.
❖ Discuss the major agreements in WTO.
❖ Interpret the scope of ILO.
❖ Explain the international labor code.

2. INTRODUCTION TO GLOBAL TRADE INSTITUTIONS

International business involves conducting business and running business operations in
multiple countries. Multinational corporations (MNCs) and international business
companies (IBCs) are involved in business with different countries. Post-World War II, the
Western leaders did not want to follow economic isolationism that played a major part in
leading to the war. This led to the creation of international trade organizations in the later
stages, that helped to create new international political and economic institutions which
encouraged and preserved peaceful international relations.
A country’s trade policy choices are connected to various factors of the international system.
A number of institutions provide support for an open, multilateral trading system. Trade
liberalization is influenced by institutions like GATT (General Agreement on Tariffs and
Trade) and IMF (International Monetary Fund). The influence of these international
institutions depends on the economic, political conditions or changing domestic preferences
of trade.
2.1 Institutions
The support system institutions for international business include WTO (World Trade
Organization), World Bank, and International Monetary Fund (IMF). Regional trade
institutions have an ambiguous effect on the multilateral system whereas some institutions
such as NAFTA (North American Free Trade Agreement) and ASEAN (Association of
Southeast Asian Nations) have a positive effect on lowering trade barriers. These institutions
have different effects on the countries’ trade policies. The major support systems for
international business are:
• IMF or International Monetary Fund: The IMF is an international organization that

was established in 1944 after the Great Depression of the 1930s. There were 44
founding member nations that built a framework for international economic
cooperation. Currently, there are 190 countries as members, with staff drawn from 150
nations. The IMF is governed by and is accountable to these 190 countries spread
across the globe. The board of governors constitutes the top part of the organization

structure. The day-to-day work of the IMF is overseen by its 24-member executive
board that includes the entire membership and the support of the IMF staff. The
Managing Director is the head of the IMF Staff and Chair of the Executive Board. The
Managing Director is supported by four Deputy Managing Directors. The IMF's
resources mainly come from the money that countries pay as their capital subscription
(quotas) when they become members. Each member of the IMF is assigned a quota,
based broadly on its relative position in the world economy. Countries can then borrow
from this pool when they fall into financial difficulty. The main objective of the IMF is
to facilitate the expansion and balanced growth of international trade and provide
exchange stability. IMF ensures the stability of the international monetary and financial
system.
• The World Trade Organization (WTO) has over 160 members representing 98 per
cent of world trade. Over 20 countries are seeking to join the WTO. The World Trade
Organization (WTO) is the only global international organization dealing with the rules
of trade between nations. The WTO agreements are negotiated and signed by the
world’s trading nations. The WTO helps in the smooth flow of international trade and
provides countries with a constructive platform for dealing with disputes over trade
issues.
Objective of the WTO:
• To help its members use trade as a means to raise living standards, create jobs and
improve people’s lives
• The WTO operates the global system of trade rules
• Helps in developing countries build their trade capacity
• It also provides a forum for its members to negotiate trade agreements
• To resolve the trade problems, they face with each other.
• The World Bank is an international financial institution that provides loans and grants
to the governments of low-and middle-income countries for the purpose of pursuing
capital projects. The two main goals of the world bank are ending extreme poverty and
boosting shared prosperity. It was established along with the International Monetary

Fund at the 1944 Bretton Woods Conference. The World Bank is the collective name for
five institutions
• The international bank for reconstruction and development
• The international Development Association
• The international finance corporation
• The Multilateral Investment Guarantee Agency
• The International center for settlement of investment disputes.
The IBRD and IDA are owned by the world bank. The World Bank is run by a president and
25 executive directors, as well as 29 various vice presidents. IBRD and IDA have 189 and
174 member countries, respectively. The U.S., Japan, China, Germany and the U.K. have the
most voting power.
• The United Nations Conference on Trade and Development (UNCTAD) was

established in 1964 as an intergovernmental organization intended to promote the
interests of developing states in world trade. UNCTAD is the part of the United Nations
Secretariat dealing with trade, investment, and development issues.
UNCTAD was established by the United Nations General Assembly in 1964 and it
reports to the UN General Assembly and United Nations Economic and Social Council.
The conference ordinarily meets once in four years; the permanent secretariat is in
Geneva.
The main objective of UNCTAD is to formulate policies regarding trade, finance and
technology. It is a specialized agency that performs three main functions:
• Provides a forum for intergovernmental discussions.

• Undertakes research, data collection and policy analysis for debates of government
representatives and experts.
• Provides technical assistance to the specific requirements of developing countries.

2.2 Objectives
The international institutions provide information about other countries’ behavior, forums
for dispute resolution and a common framework for sustaining trade flows. A strong
international financial system is required to support growing international trade. It helps to
reduce the risk of payment imbalances and financial crisis. The international institutions
work together to provide a strong system for international trade which is open to all
countries. This kind of system is essential for supporting economic growth, reducing poverty
and raising the standard of living around the globe.
1. _____________ is the process of conducting business in multiple countries.

2. IMF stands for:
a) International Monetary Fund.
b) International Management Foundation.
c) Indian Monetary Fund.
d) Indian Management Foundation.
3. NAFTA has a positive effect on reducing the trade related barriers. (True/False)

3. WORLD TRADE ORGANISATION (WTO)

In this section, we will discuss the World Trade Organization (WTO). WTO was established
on 1st January 1995. In April 1994, the Final Act was signed at a meeting in Marrakesh,
Morocco. The Marrakesh Declaration of 15th April 1994 was formed to strengthen the world
economy which would lead to better investment, trade, income growth and employment
throughout the world. The WTO is the successor to the General Agreement on Tariffs and
Trade (GATT). India is one of the founders of WTO. WTO represents the latest attempts to
create an organizational focal point for liberal trade management and to consolidate a global
organizational structure to govern world affairs. WTO created a qualitative change in
international trade. It is the only international body that deals with the rules of trade
between nations. WTO has initiated structured discussions on trade and environment
sustainability in the year 2020.
3.1 Objectives And Functions
The key objective of WTO is to promote and ensure international trade in developing
countries. The other major functions include:
• Increasing trade capacities of economies by encouraging nations to adopt

discriminatory trade policies.
• Promoting employment, expanding production and trade and raising the standard of
living and income and utilizing the world’s resources.
• Ensuring that developing countries secure a better share of growth in world trade.
• Providing forum for trade negotiations.
• Taking steps and measures to act in cooperation with international Institutions.
• Resolving trade disputes.
The important functions of the WTO as stated in the WTO agreement are the following:
• Developing transitional economies – The major portion of WTO members involve

developing countries such as India, China, Mexico, and, Brazil. The members have an
important role in the organization. The WTO helps in solving the problems of
developing economies. The developing states are provided with trade and tariff data.

This depends on the country’s individual export interest and their participation in WTO
bodies. The new members benefit hugely from these services.
• Providing help for export promotion – The WTO provides specialized help for export
promotion to its members. The export promotion is done through the International
Trade Center established by the GATT in 1964. It is operated by the WTO and the United
Nations. The International Trade Center accepts requests from member countries,
which are usually developing countries. WTO provides assistance and support to plan
and execute programs for export promotion. The center provides information on the
export market updates and marketing techniques. The center also provides assistance
in accessing marketing services. The WTO proves its commitment to the upliftment of
the world economy through such measures.
• Cooperating in global economic policy-making – The main function of the WTO is to
cooperate in the making of global economic policies. In the Marrakesh Ministerial
Meeting in April 1994, a separate declaration was adopted to achieve this objective. The
declaration specifies the responsibility of WTO, to improve and maintain cooperation
with international organizations such as the World Bank and International Monetary
Fund (IMF) that are involved in monetary and financial matters. WTO analyses the
impact of liberalization on the growth and development of national economies which
is the important factor in the success of the economy.
• Monitoring implementation of the agreement – The WTO administers sixteen
different multilateral agreements that all the members of WTO are part of. The WTO
has two plurilateral agreements of which only a few members are part of the
plurilateral agreement. The member-governments sign and confirm all WTO
agreements on attainment.
• Providing forum for negotiations – The WTO provides a permanent forum for
negotiations among members. The negotiations can be on matters already stated in the
WTO agreements or matters not addressed in the WTO law.
• Administrating dispute settlement – The important function of WTO is the
administration of the WTO dispute settlement system. It helps in settling multilateral
trading disputes. A dispute arises when a member country adopts a trade policy and
other fellow members consider this as a violation of WTO agreements. The Dispute

Settlement Body (DSB) is responsible for the settlement of disputes. The dispute
settlement system is prohibited from adding or deleting the rights and obligations
provided in the WTO agreements. The WTO dispute settlement system helps to:
• Preserve the rights and responsibilities of the members.
• Clarify the current provisions of the agreements.
3.2 Structure
The structure of the WTO consists of the Ministerial Conference, which is the highest
authority. This body consists of representatives from all WTO members. The members meet
once every two years and decisions on all matters regarding the multilateral trade
agreements are taken. Subsidiary bodies and the General Council composed of WTO
members undertake the daily activities of the WTO. The members report to the Ministerial
Conference. On behalf of the Ministerial Conference, the General Council administers the
Dispute Settlement Body to handle the dispute settlement procedures. It also acts as the
Trade Policy Review Body that regularly reviews the trade policies of individual WTO
members.
The General Council delegates responsibility to other major bodies. They are:
• The Council for Trade in Goods – It manages the implementation and functioning of
all agreements covering trade in goods. Includes committees on Market Access
Agriculture Sanitary and Phytosanitary Measures Technical Barriers to Trade Subsidies
and Countervailing Measures Anti-Dumping Practices Customs Valuation Rules of
Origin Import Licensing Trade-Related Investment Measures Safeguards
Working party on State-Trading Enterprises
• Council for Trade-Related Aspects of Intellectual Property Rights

• Council for Trade in Services - These two councils are responsible for their respective
WTO agreements. They can also establish their own subsidiary bodies, if required.
The Council for Trade in Services includes the following:
Committees on Trade in Financial Services Specific Commitments

Working parties on Domestic Regulation GATS Rules
Plurilateral Trade in Civil Aircraft Committee Government Procurement Committee
• Committee on Trade and Development – It handles issues related to

developing countries. This includes committees on Trade and Environment Trade and
Development Sub-committee on Least- Developed Countries' Regional Trade
Agreements
The Committee on Balance of Payments – Consultations between WTO members and

countries that take trade-restrictive measures to handle balance-of-payments
difficulties.
Committee on Budget and Administration – Issues concerning Financing and the

budget of WTO are handled by them.
Working parties on Accession
Working groups on Trade, debt and finance Trade and technology transfer
• Trade Negotiations committee – Reports to general council and includes
Special Sessions of Services Council / TRIPS Council / Dispute Settlement

Body / Agriculture Committee and Cotton Sub-Committee / Trade and
Development Committee / Trade and Environment Committee
Negotiating groups on Market Access / Rules / Trade Facilitation

Source: WTO Sectariat; Geneva; Switzerland
3.3 Principles
The WTO principles of the trading system are:
• Trading without discrimination – One aspect of indiscrimination is that foreigners and

natives must be treated equally. This implies that imported goods that are in the market
must not face discrimination.
• There is also a Most Favored Nation (MFN) principle which requires the nations to treat
all WTO members equally. If one nation grants a special trade deal to another nation,
the deal must be extended to all WTO members.

• Trade barriers negotiated downwards – Trade barriers such as import tariffs, customs
duties, and red tape should be lowered. Trade growth must be encouraged. Measures
such as import bans or bans on quotas restrict quantities selectively.
• Predictable trading – Predictability in business helps us to know the real costs. Member
countries usually promise not to raise trade barriers. The WTO operates with tariff
bindings and agreements that restrict raising a specific tariff over a given time. This
provides the business with realistic data. Businesses can also anticipate a stable future
if the trade rules are made clear and accessible.
• Competitive trading – The WTO works towards trade liberalization and understands
that trade relationships between nations can be very complex. The WTO agreements
support healthy competition in services and intellectual property and discourage
subsidies and dumping of products at prices below the cost of their manufacturer.
• Encourage the development and economic reforms – The majority of the WTO
members are developing economies that are changing to market economies. The
developed nations must give market access to goods from underdeveloped countries
and provide technical assistance. Developed countries are allowing duty-free and
quota-free imports for all the products from underdeveloped countries.
3.4 Agreements
The WTO agreements are a set of rules that are followed by the member governments while
formulating policies and practices in the area of international trade. The agreements mainly
cover goods, services and intellectual property. The agreements comprise of the rights and
obligations of the government that are enforceable in multilateral framework. The
agreement supports individual countries’ commitments to lower customs tariffs and other
trade barriers, and to open services markets. The agreements also recommend governments
to make their trade policies transparent. According to the agreement, the government must
notify the WTO about the measures adopted to make their trade policies transparent. The
major agreements are:

• General Agreement on Trade in Services (GATS) – GATS is a framework agreement

defining the rules under which trade in services must occur. GATS aims at extending
the rules covering trade in goods to trade in services. A detailed rule has been included
to take into account the differences between goods and services and the way in which
trade in services is conducted. Trade services cover a wide range of activities in the area
of telecommunication, information, banking, insurance and education. WTO has
recognized over 150 service sub-sectors.
The main objective of GATS is to establish a framework for liberalizing trade in services.
It encourages countries to modify their domestic regulations. This modification results
in the elimination of restrictions applied to service products entering the country and
are applicable to international service suppliers who are carrying out business in
various modes. According to the GATS, MFN status and transparency are applicable to
all services. Other commitments such as national treatment and market access are only
applicable to services that are opened according to the specified negotiated
commitments. GATS covers services known as ‘consumption abroad’ where services
such as e-commerce are used by the consumers in a host country and citizens of a
country travel overseas to consume products such as tourism or education.
• Trade-Related Aspects of Intellectual Property Rights (TRIPS) – The Agreement on
Trade-Related Aspects of Intellectual Property Rights (TRIPS) is one of the WTO
agreements that is compiled by all WTO members. According to TRIPS, developed and
developing members of WTO must adopt the same minimum levels of intellectual
property protection. The TRIPS Agreement includes rules on domestic enforcement
procedures. The TRIPS Agreement focuses on issues such as innovation and the
dissemination of technology, development of biotechnology, health care and the
operation of multilateral environment agreements.
The TRIPS agreement states that members can take action to protect public health and
nutrition. It encourages the protection of new plant varieties. The members are
encouraged to develop national systems that promote local breeding, and the rights of
farmers and protect human fundamental human rights which include the right to food
and health. It promotes the use and protection of knowledge that is relevant to the
conservation and use of biological diversity. This includes knowledge of technology and

genetic material. The 1995 WTO TRIPS Agreements covers copyright and related rights,
geographic indications, trademarks, and patents of integrated circuits, protection of
information and control of anticompetitive practices in contractual licenses.
• General Agreement on Tariffs and Trade (GATT) – GATT is a multilateral agreement
among countries providing a framework for conducting international trade. GATT is
regarded as an international institution governing international trade relations. It
consists of disciplines on governments and matters related to import and export of
goods. It was established to promote international trade by reducing tariff and non-
tariff restrictions on imports imposed by member nations. Tariff barrier refers to
imposing import duty and non-tariff barriers means restricting imports through import
licensing and by banning the imports. GATT provides a framework for negotiations on
the level of tariff. It promotes multilateral trade among member nations. It provides
protection against unfair trade and obstructions to trade.
Sanitary-phyto-sanitary barriers in trade: A caselet of Indian red chillies
Sudan Red is a synthetic colorant which is used in red chilly powder to make the powder look red.
There are three grades of Sudan Red colorant used in red chilly powder in India. Other grades
have been found in Chinese duck eggs in the recent times. Sudan Red is a carcinogenic material.
Indian red chilly powders containing Sudan Red has been banned in European Union countries.
In October 2003, the European Union has specified the requirements of Sudan‐free certificates
for all spices imported into Europe. Accordingly; inspection agencies in India namely Spice Board
& Export Inspection Agency has been communicated and notified for the same by European
Union. Now, the inspection of red chilli has been made compulsory by Spice Board and each
consignment exported must comply to the EU guidleines. The Spice Board inpects all
consignments on sample basis of red chillies. For exporters, it has become an additional
transactioncal cost to exports as it is estimated that Sudan tests cost
as much as Rs. 2,000 per sample and several samples are drawn from a container load. Total cost
of such Sudan test is estimated to be around 3% of CIF value.
Source: www.indianspices.com

3.5 Issues
The issues related to WTO are:
• The Trend toward unilateral action by some developed countries disregards the
provisions laid down in the Uruguay Round. Developing countries and least-developed
countries have to overcome issues like constraints of resources, skills shortage, and
expertise in these areas. Unilateral action can disgrace the entire multilateral trading
system. This slows down the motivation for reform in all developing countries.
• Another issue is the Favour of regionalism. Third world countries can face
discrimination as regional economic groupings have resulted in more trade between
countries in the region.
• The Agreement on Agriculture has a number of inequities in its implementation of the
Agreement. Most developing countries cannot provide export subsidies. However,
developed countries can resort to such subsidies. Thus, countries that have been
previously distorting the market can continue to maintain subsidy regimes. Other
countries are banned from utilizing these measures.
• The WTO’s current position on trade, environment and sustainable development faces
criticism. Liberalization of trade leads to larger growth, higher incomes and increased
consumption. However, it affects production which in turn has an adverse effect on the
environment. Though the WTO trading system creates growth, it also causes pollution.
The WTO trade and growth policies are responsible for environmental degradation.
• The other issues are green room negotiations. Green room negotiations are the
informal negotiation meetings at the WTO in which 35 countries are chosen by the
Director General.
Activity 1
Refer to any website and create a report on the principles laid down by GATT to the member
countries on anti-dumping measures.
Refer to the following link for guidance –
http://commerce.nic.in/wto-feb.pdf

4. The WTO is the successor to the _________ .

5. The majority of the WTO members belong to developed countries. (True/False)
6. The main objective of _____________ agreement is to establish the framework for
liberalizing trade in services.
a) GATT.
b) NAFTA.
c) TRIPS.
d) GATS.
7. The WTO agreements are a set of rules that are followed by the governments
while formulating policies and practices in the area of international trade.
(True/False)
8. The highest authority of WTO is the _____________ .

4. INTERNATIONAL LABOUR ORGANISATION (ILO)
International Labour Organization (ILO) is a specialized agency of the United Nations that
deals with labor issues. It is a tripartite UN Agency, since 1919 and includes 187 member
states. It brings the governments, employers and workers of these member states together.
The headquarters is situated in Geneva, Switzerland. The secretariat includes the people
employed by the organization throughout the world. The secretariat is known as the
International Labour Office. The ILO manages work through three main bodies. They are:
• International Labour Conference – The members of the ILO meet at the International
Labour Conference every year in June, in Geneva. Two government delegates along with
an employer delegate and a worker delegate represent their respective member state.
The technical advisors also accompany the delegates. The Cabinet Ministers are usually
responsible for labor affairs, head the delegations and present the viewpoint of their
government. The Conference creates and implements standards for international labor.
Social and labor issues are discussed in the Conference. It also assigns the budget of the
organization and elects the Governing Body.
• Governing Body – The executive council of the ILO is known as the Governing Body. It
meets thrice a year in Geneva and takes decisions on the ILO policies. It forms
programmes and budgets which are submitted to the Conference for adoption. The
Governing Body has 28 government members, 14 employer members and 14 worker
members. Ten government seats are permanently held by states of chief industrial
importance. Taking into consideration the geographical distribution, representatives of
other member countries are elected at the Conference once in every three years. The
representatives are elected by the employers and workers.
• International Labour Office – The permanent secretariat of the International Labour
Organization is the International Labour Office. It is the central point for all activities
that are administered by the governing body. The Office is a center for administration,
research and documentation. It employs more than 1,700 officials from 110
nationalities. The Office also organizes certain programmes to extend technical help to
all member nations. Under this programme of technical cooperation, around 600
experts undertake missions in all regions of the world.

4.1 History
Following the Treaty of Versailles, the ILO was established as an agency of the League of
Nations. The ILO was created in 1919, after the First World War. The ideas of the
International Association for Labour Legislation were incorporated in the Constitution of the
International Labour Organization. The initial motivation of the ILO was humanitarian
because the workers were exploited without any improvement in their health and family.
The preamble of the constitution of the ILO states the conditions of labor and the injustice
and privation to large number of people. The economic factor was the second motivation as
it has a certain effect on the cost of production. The failure of a nation to adopt humane
conditions of labor affects the economic situation of the country adversely.
The ILO constitution was written in April 1919 by the Labour Commission that was set up
by the Peace Conference. The first annual International Labour Conference had two
representatives from the government. It included one representative from the employers’
organizations and another representative from the workers’ organizations of each member
state. The first six International Labour Conventions that dealt with working hours in
industry, minimum age, unemployment, maternity protection and night work for women
and night work for young persons in was implemented in the first annual International
Labour Conference. Albert Thomas was chosen as the first Director of the International
Labour Office by the Governing Body. From the beginning, he drove organization with a
strong motivation. 16 International Labour Conventions and 18 Recommendations were
adopted in 2 years. In 1920, the ILO headquarters was set up in Geneva.
4.2 International Labour Code
The International Labour Code is composed of Conventions and Recommendations adopted

by the International Labour Conference. In 1997, the Code contained 181 conventions and
188 recommendations that covered important subjects in labor and social fields. The main
function of the ILO is to set international labor standards by adopting conventions and
recommendations covering the major labor-related issues which are referred to as the
International Labour Code. The Conference adopts conventions and recommendations
which is prepared by the International Labour Office and the governing body. The

representatives of the member nations bring the conventions and recommendations to the
notice of the authorities.
• Conventions – These treaties are not bound to a country unless they are approved by
that country. ILO conventions that have secured a two- third majority should be
presented by the member country in the Conference. The ILO conventions are
approved as written and without reservations. Flexibility clauses are included in the
conventions to accommodate different climatic conditions or states of development of
particular countries.
• Recommendations – When state practices vary largely, non-binding guidelines known
as recommendations are issued. Recommendations are issued when the subject is:
• Very technical and cannot be handled by a convention.
• Already covered by a convention but needs to be addressed in more detail.
• Member states are required to bring recommendations to the attention of their
governments.
4.3 Functions of ILO:
• ILO aims at promoting social justice, internationally recognized labor and human
rights.
• ILO connects the governments, employers and workers representatives of 187 member
States in order to set labor standards, and develop policies to promote decent work for
all women and men.
• Formulate international policies and programmes to provide basic human rights,
improve working and living conditions, and increase employment opportunities
• Creating international labor standards based on a unique system to supervise their
application.
• Training, education and research activities to put the objectives into action.

Activity 2
On February 2010, India signed the Decent Work Country Programme (DWCP)
document. Refer to any business magazine or website and discuss the main objectives of
DWCP.
Refer to the following link for guidance –
http://www.ilo.org/public/english/bureau/program/dwcp/
9. The _______________ establishes and implements international labour standards.

10. The Governing Body meets once a year in Geneva and takes decisions on the
ILO policies. (True/False)
11. The ILO was created in:
a) 1920.
b) 1919.
c) 1929.
d) 1991.
12. The body of ILO Conventions and Recommendations is commonly known as
the International Labour Conference. (True/False)
13. The executive council of the ILO is known as the _________ .

5. SUMMARY
Let us now summarize the salient points you learnt about support systems for international
business:
• International business is the process of conducting business in multiple countries.

Multinational corporations (MNCs) and international business companies (IBCs)
conduct business between different countries.
• The major support systems for international business are WTO (World Trade
Organization), World Bank, and International Monetary Fund (IMF).
• WTO (World Trade Organisation) was established on 1st January 1995. In April 1994,
the Final Act was signed at a meeting in Marrakesh, Morocco.
• The major agreements of WTO are GATS, TRIPS, and GATT.
• The International Labour Organization (ILO) is a specialized agency of the United
Nations which deals with labor issues.
• The ILO manages work through three main bodies, namely the International Labour
Conference, Governing Body and International Labour Office.
• The International Labour Code is composed of conventions and recommendations
adopted by the International Labour Conference.
6. GLOSSARY
League of Nations: An intergovernmental organization founded as a result if the Treaty of

Versailles in 1919-1920.
Red tape: A sequence of forms and procedures required to gain bureaucratic approval for
something. It is an obstructive and time-consuming official routine.
Tariff bindings: A ceiling level above which a member cannot apply a tariff. It is the
maximum tariff that can be applied by a member.
Treaty of Versailles: One of the peace treaties at the end of World War I.

1. Describe the international organizations working to facilitate international trade.
2. Evaluate the role of WTO.
3. Discuss the major agreements in WTO.
4. Interpret the scope of ILO.
5. Explain the international labour code.
8. ANSWERS
Self-Assessment Questions
1. International business.
2. a) International Monetary Fund.
3. False.
4. GATT.
5. False.
6. d) GATS.
7. True.
8. Ministerial Conference.
9. International Labour Conference.
10. False.
11. b) 1919.
12. False.
13. Governing body.
Terminal questions
1. The major support systems for international business are WTO (World Trade
Organization), World Bank, and International Monetary Fund (IMF). Refer to section 2
of this unit for details.
2. WTO represents the latest attempts to create an organizational focal point for liberal
trade management and to consolidate a global organizational structure to govern world
affairs. Refer to section 3 of this unit for details.

3. The WTO agreements are a set of rules that are followed by the member governments
while formulating policies and practices in the area of international trade. Refer to
section 3.4 of this unit for details.
4. The International Labour Organization (ILO) is a specialized agency of the United
Nations which deals with labor issues. Refer to section 4 of this unit for details.
5. The International Labour Code is composed of conventions and recommendations
adopted by the International Labour Conference. Refer to section 4.2 of this unit for
details.
9. CASELET
WTO and the Challenges Faced by Indian Pharmaceutical Companies

India is favourable location for big pharmaceutical companies because of its cheap and
educated labor force. The major concern of the WTO is to take care of the poor, especially
in the area of health care. The TRIPS Agreement of the WTO in pharmaceuticals brought the
health care issue to the forefront. According to the agreement, developing countries had to
revise their patent laws to conform to WTO requirements by 2006. The success or failure of
the TRIPS Agreement depends on countries like India. India’s pharmaceutical industry is
highly efficient and India needs to implement the IPR (Intellectual Property Rights) laws to
simultaneously maintain its position in the pharmaceutical sector. The challenge for India
is to maintain its international obligations and to satisfy domestic interest that includes
consequent access to cheap medicine.
Indian pharmaceutical companies are using adaptive strategies to cope up with the WTO
product patent law. In order to adapt and benefit from the opportunities created by the new
patent system, firms are adapting a combination of cooperative and competitive strategies.
Indian pharma companies face international competition. Companies that get huge profits
from exports spend huge amount on R&D (Research & Development). Large companies such
as Ranbaxy and Cipla were preparing for the new patent regime since 1995. A company can
lose market share on a patent expired product. However, the cost of developing the product
can be recovered even after the expiration date of the patent if the marketing strategies are
well planned. Visionary strategies such as drug discovery, focus on production of high
quantum and moderately priced generics, outsourcing to MNC's upgrading manufacturing

facilities, etc., are also being adopted by Indian pharma companies. India can be the top
global pharma Industry with the help of these facilities and pharma support services such as
clinical research operations, diagnostic services and data management services.
Discussion question
1. Discuss the adaptive strategies of Indian pharmaceutical companies to cope up with the
WTO product patent law.
(Hint: Cooperative and competitive strategies)
Source: http://www.eurojournals.com/ejefas_13_04.pdf retrieved on 10th November 2010
Reference:
• Walter Carlsnaes, Thomas Rissee and Beth A Simmons. (2006): Handbook of

International Relations. Sage Publications Ltd.
E-References:
• www.indianspices.com, retrieved on 20 April 2012

• www.wto.org, retrieved on 21 April 2012
• http://www.indianembassy.org, retrieved on 2 Feb 2009
• https://www.wto.org/english/thewto_e/whatis_e/tif_e/utw_chap7_e.pdf
• https://www.ilo.org/global/about-the-ilo/how-the-ilo-works/lang--en/index.htm
• https://www.ilo.org/global/about-the-ilo/mission-and-objectives/lang--
en/index.htm
• https://www.imf.org/en/About
• https://unctad.org/about


SEMESTER 4
DMBA402
MANAGEMENT
Unit 8: International Financial Management 1

Unit 8
International Financial Management
Table of Contents

No Graph Activity
1 Introduction - -
3
2 Overview of International Financial
- 1I
Management
2.1 Evolution - - 4 -8
2.2 Domestic versus International
- -
Financial Management
3 Components of International Financial
1 2
Management
3.1 Foreign exchange market - -
3.2 Foreign currency derivatives - - 9 - 16
3.3 International monetary systems - -

3.4 International financial markets - -
4 Scope of International Financial
- 3 II
Management
4.1 Management of working capital
- -
17 - 21
4.2 Financing decisions - -
4.3 Taxation
5 Summary - - 22
6 Glossary - - 23
8 Answers - - 24
9 Case-let
- - 25 - 26

1. INTRODUCTION
Financial management plays an important role in international business, as no business can
survive without investment, profits and funding. In Overseas business operations, the
financial requirements may involve funding new business ventures, and funding business
expansion to move from a domestic business model to a global or international operation-
based model. Businesses intend to go global due to economies to scale, higher profit margins,
better returns, increased productivity, and access to advanced technology. Such firms
require an efficient financial management mechanism that helps with managing investments
to an optimum level. This can be achieved by ensuring the proper planning and execution of
a financial plan for the successful conduct of international business.
The main aim of international financial management is to maximize returns and the net
worth of the firm. This will eventually increase the stock value and benefit the shareholders.
International trade gave way to the growth of international business. The success of a firm
largely depends on the management of finances and business accounts appropriately. The
rise in significance and complexity of financial administration in a global scenario poses
several challenges for financial managers. Financial innovations such as currency
derivatives, international stock listing, and multicurrency bonds have necessitated the
accurate management of the flow of international funds through the study of international
financial management.
In this unit, you will study international financial management and the components of
international financial management. We will also study the scope covering other aspects of
financial decisions, taxation and management of working capital.
❖ Explain the overview of International Financial Management

❖ Differentiate between domestic and international financial management.
❖ Describe the various components involved in international financial management.
❖ Discuss the scope of international financial management.

2. OVERVIEW OF INTERNATIONAL FINANCIAL MANAGEMENT
In this section, we will discuss the evolution of international financial management and also
distinguish between domestic and international financial management.
The term International Financial Management refers to managing financial resources in an

international business environment, in a manner in which the organization maximizes
returns and profits. This is achieved through accounting, managing fixed assets, and
identifying income and expenses. Financial management involves recording and
maintenance of all monetary transactions in a standard manner in order to show the
financial position and performance of the organization. Financial Management can be
categorized into domestic and international financial management.
Domestic financial management refers to managing financial services within the country.
International financial management refers to managing and sharing finances between
countries.
2.1 Evolution
International Financial Management (IFM) came into existence when there was an increase
in international business transactions and business dealings between countries all over the
world. Countries became more open to doing business with other countries and encouraged
foreign investment. This was termed liberalization. Since the end of the Second World War,
the integration in terms of foreign activities has grown substantially. Firms of all types are
now opting to operate their business and deploy their resources abroad due to globalization.
However, differences between countries have led to the rise in the prevalence of market
imperfections.
As a result, the fundamental financial decisions have now advanced to cross-border

complexities. The choices to be made with respect to investment, raising capital, acquisition
activity, restructuring as well as various aspects of financial policy require financial
considerations. Whenever decisions are taken, the managers must analyze differences in tax
rules, country risk factors, exchange rates and variation in legal rules.

IFM has four distinct modules as follows:
• Currencies and asset prices – The basic mechanism of exchange rates, assets prices in
global markets and currencies that influence stock prices are explained in his module.
• Multinational financial decision making – The decisions of multinational firms
pertaining to capital structure, tax optimization and risk management are clarified.
• In addition, this module covers the following aspects:
o The way in which the firms take advantage of subsidiaries around the world.
o The association of firms with local firms.
o The exposure of firms to trade rates.
o The tax considerations feature in internal financial decision- making.
• Cross-border valuation and financing – The financial decisions and valuation
techniques to be modified in a cross-border setting are covered in this module.
In addition, this module covers the following aspects:
• Consideration of the price of capital around the world.

• The assessment of investments in order to raise the markets.
• The profit made by the firms through their financing and investment decisions is a
result of market imperfection.
• Institutions and finance – The inconsistent formal and informal institutional
arrangements will result in a major impact on financial decision making. It focuses on
the differences in legal rules, particularly variation in the legal protection of creditors
and shareholders affecting investment and reforming decisions. In addition, the
emphasis on the significance of informal institutional arrangements and relationship
building, emerging markets using cases on merger and acquisition is also covered.
2.2 Domestic Versus International Financial Management
The management of finance in domestic and international business is considerably different.

The four major aspects which distinguish international financial management from domestic
financial management are the introduction of foreign exchange, political risks, market
imperfection and enhanced opportunity set. They are explained as follows:

• Foreign exchange risks – Domestic financial management deals with domestic

currency and does not involve foreign exchange risks. IFM consists of foreign exchange
risks due to fluctuation in currency value. Such currency variations can convert a
profitable deal to a loss-making one. Therefore, foreign exchange risks have to be
managed in IFM.
• Legal and Tax Impact: In Domestic Financial management the legal rules and tax
structure are familiar to the finance manager whereas in IFM the legal and tax impacts
of different countries have to be understood and dealt with.
• Economic and Political environment: In Domestic Financial management the
business is familiar with the risks and changes that the domestic environment goes
through. In IFM the finance manager has to scan the economic and political
environment of different countries. The assessment of the risk, profitability, and impact
of the economic and political changes needs to be made before making any financial or
business-related decisions.
• Reporting standards: IFM has to meet the requirements of international reporting
standards. The treatment of assets and accounting rules change based on the country
with which the business deals in. In domestic financial management, the reporting
standards of the domestic country are followed.
• Capital: For an MNC in IFM there are many options, methods and markets to raise
capital whereas in Domestic financial management the options for raising capital are
limited to the domestic boundaries.
• Market imperfection – Domestic financial management involves dealing with
consistency in the domestic markets. Whereas in International financial management,
the integration of countries into the world economy has resulted in differences in
transportation costs and different tax rates. Inadequate markets can force a finance
manager to struggle for the best opportunities across the country’s border.
The goal of international financial management:
Wealth maximization of shareholders: Wealth maximization is a long-term goal in

International financial management. Increase in the share prices, long-term growth of share
value, dividend payouts result in maximizing shareholders’ wealth.

Profit maximization: International financial management aims at maximizing profits by

supporting the business in taking the right financing decisions, dividend decisions,
investment decisions, and working capital management decisions that ensure optimum
utilization of funds that increase the profit turnover.
Foreign Exchange Risk management: Foreign exchange rates are extremely volatile and
result in gains or losses. Such unpredictable exchange rates are not favorable to the growth
of the business. International financial management ensures that such risks are minimized
through foreign exchange risk management and methods such as hedging.
Tax planning: is one of the important goals of International financial management. IFM
helps in dealing with various taxation policies, tax slabs, procedures, provisions and
exemptions of the country in which the business operates.
Supporting MNC’s: Without knowledge in International Financial Management, it can be

hard for MNCs let alone any international business entity, to continue in the market because
international financial markets have totally diverse shapes and analytics in contrast to the
domestic financial markets. Sound knowledge of International Financial Management can
assist an organization to accomplish similar competence and effectiveness in all markets.
Multi-National Corporations (MNC) have come into existence due to liberalization and
international agreements.
Institutional Support: The international trade is being promoted and shaped by

international institutions called the Bretton Woods Institutions: International Monetary
Fund (IMF), World Bank and World Trade Organization (WTO) through its legal initiatives
such as the General Agreement of Trade and Tariffs (GATT), General Agreement on Trade in
Services (GATS) and so on. All these institutions are an integral part of IFM.

Activity I
Play the role of a financial manager of XYZ company and describe the way you
would manage the finance and accounting of your company.
Hint: The four major aspects.
Self-Assessment Questions -1
1. International Financial Management came into existence when there was

___________ (liberalization / Second world war) .
2. The management of finance in domestic and international business is
considerably different. (True/False)
3. The ________ may include any changes that will impact on the economic
environment of the country.
a) Foreign exchange
b) Political risks
c) Market imperfection
d) Enhance opportunity set

3. COMPONENTS OF INTERNATIONAL FINANCIAL MANAGEMENT
The components like foreign exchange markets, foreign currency derivatives, international
monetary markets and international financial markets which are essential to international
financial management, are discussed in this section.
3.1 Foreign Exchange Market
The foreign exchange or the forex markets facilitates the participants to obtain, trade,
exchange, and speculate on foreign currency. The foreign exchange market consists of banks,
central banks, commercial companies, hedge funds, investment management firms, and
retail foreign exchange brokers and investors. It is considered to be the leading financial
market in the world. It is vital to realize that foreign exchange is not a single exchange, but is
created by a global network of computers that connects participants from all over the world.
The foreign exchange market is quite big and includes various functions including funding of
cross-border investment, loans, trade in goods, trade in services and currency speculation.
The participant in a foreign exchange market will normally ask for a price.
The trading in the foreign exchange market may take place in the following forms:
• Outright cash or ready – foreign exchange currency deals that take place on the date
of the deal.
• Next day – foreign exchange currency deals that take place on the next working day.
• Swap – Simultaneous sale and purchase of identical amounts of currency for different
maturities.
• ‘Spot’ and ‘Forward’ contracts – A spot contract is a binding obligation to buy or sell
a definite amount of foreign currency at the existing or spot market rate. A forward
contract is a binding obligation to buy or sell a definite amount of foreign currency at
the pre-agreed rate of exchange, on or before a certain date.
Depreciating Rupee Bleed Indian company in Overseas Debt Servicing
Depreciation of Indian rupee in the recent months has made Indian banks jittery about
companies that have substantial overseas payments coming due. Companies, which have not

hedged themselves against such volatility and resultant increased payments are sweating in
accessing the loans from Indian banks as they don’t want to default in the overseas market.
Tight monetary policy coupled with reduced liquidity in system has made their job worse as
Indian banks are overstretching themselves to help such companies restructure their debt.
Indian companies owe overseas loans and borrowing worth $5 billion or 280000 crore
rupees. The problem is that a majority of them are foreign currency convertible bonds and if
they are converted into equity, Indian companies shall be in long-term loss as they have to
issue more shares due to a depreciated value of the rupee. Most companies are interested in
redeeming their FCCBs by accessing finances from domestic markets. In such a scenario,
Indian banks are quite wary as more and more companies are seeking to enter corporate
debt restructuring (CDR) programmes, which involves renegotiating repayments and
interest rates.
3.2 Foreign Currency Derivatives
A foreign currency derivative is a financial contract that derives its value from an underlying
asset. It can also be termed as an agreement where the value can be determined from the
rate of exchange of two currencies on the spot. The currency derivative trades in markets
that correspond to the spot (cash) market. Hence, the spot market exposures can be enclosed
with the currency derivatives. The main advantage from derivative hedging is the basket of
currency available.
Figure 8.1 describes the examples of currency derivatives. The derivatives can be hedged
with other derivatives. In the foreign exchange market,
Currency derivatives like currency futures, currency options, and currency swaps are usually
traded.
Currency futures: The standard agreement made in order to buy or sell foreign currencies
in the future is termed currency futures. These are usually traded through organized
exchanges. Currency futures are exchange traded future contracts that specify the quantity,
date and price of the currencies to be exchanged in future. The traders in currency futures

do not physically deliver the currencies but only make or lose money based on the change in
price of the futures contract.
Currency option: These are contracts that give the buyer the right but not the obligation to
buy or sell a currency in future at a pre-determined price. The authority to buy or sell foreign
currencies in the future at a specified rate is provided by the currency option. These will help
businessmen to enhance their foreign exchange dealings.
Currency Swaps: The agreement undertaken to exchange cash flow streams in one currency
for cash flow streams in another currency in the future is provided by currency swaps. These
will help to increase the funds of foreign currency from the cheapest sources.
Figure 8.1: Example for Foreign Currency Derivatives
Some of the risks associated with currency derivatives are:
• Credit risk takes place, arising from the parties involved in a contract.
• Market risk occurs due to adverse moves in the overall market.
• Liquidity risks occur due to the requirement of available counterparties to take the
other side of the trade.

• Settlement risks similar to the credit risks occur when the parties involved in the
contract fail to provide the currency at the agreed time.
• Operational risks are one of the biggest risks that occur in trading derivatives due to
human error.
• Legal risks pertain to the counterparties of currency swaps that go into receivership
while the swap is taking place.
3.3 International Monetary Systems
The international monetary system includes a set of international rules and conventions that
are accepted and agreed upon internationally. It also consists of a set of rules that govern the
international scenario, supporting institutions which will facilitate worldwide trade,
investment across cross-borders and the re-allocation of capital between the states.
International monetary systems provide a mode of payment acceptable between buyers and
sellers of different nationalities, with addition to deferred payment. The global balance can
be corrected by providing sufficient liquidity for the variations occurring in trade. Thereby
it can be operated successfully.
The gold and gold bullion standards
The first modern international system was the gold standard, which operated between the
late 19th and early 20th centuries. It enabled nations using gold coins of the standard
specification to enjoy free circulation. Under the system, gold happened to be the only
standard. The stabilizing influence of gold is what gives the system its advantages. Any nation
which had more exports than imports would be paid in gold for its balance payment. This in
turn has resulted in the lowered value of the domestic currency. The higher prices lead to
decreased demand for exports. The sudden increase in the supply of gold may be due to the
discovery of rich deposits, which in turn will result in an increase in price abruptly.
In the 1920s the gold bullion standard replaced the gold standard leading to the cessation of
gold coins being minted. Their currencies instead were gold bullion which was bought and
sold at a fixed price. This system ended by the next decade.

The gold-exchange system
Trading was conducted internationally with respect to the gold-exchange standard following
World War II. In this system, the value of the currency is fixed by the nations with respect to
some foreign currency but not with respect to gold. Most of the nations fixed their currency
to the US dollar funds in the United States. With a view to maintaining a stable exchange rate
at the global level, the International Monetary Fund (IMF) was created at the ‘Bretton Woods
International Conference’ held in 1944. Until the 1970s the US gold reserves continued to be
drained. When the US discarded the gold convertibility in 1971, the world was devoid of a
single international monetary system.
Floating exchange rates and recent developments
A floating exchange rate is an exchange rate system where the currency price of a country is
determined by the foreign exchange market based on the demand and supply level of other
currencies. Unlike a fixed exchange rate which is a nominal exchange rate fixed by the
government or monetary authority with respect to a particular foreign currency or a basket
of currencies.
After the abundance of the gold convertibility by the US, the IMF in 1976 decided to be in
agreement on the float exchange rates. The gold standard was suspended and the values of
different currencies were determined in the market. The ‘Japanese Yen’ and the ‘German
Deutschmark’ strengthened and turned out to be increasingly important in international
financial market; at the same time the US dollar diminished in importance. In 1999 the Euro
replaced the currencies and became the most commonly used currency in the international
market, second only to the dollar. The better exchange rates enticed many large companies
to choose the Euro over the Dollar when in bond trading. Very recently some of the members
of Organization of Petroleum Exporting Countries (OPEC) such as Saudi Arabia, Iraq have
opted to trade petroleum in Euro than in Dollar.

3.4 International Financial Markets
Independent markets that are not under the authority of any one country and the financial
markets of each country are linked by international foreign markets. What governs the heart
of the international financial market is the market where international trade and investment
dominates foreign currency. As a result, the purchase of currency precedes the purchase of
services and goods.
The purpose of international securities markets, international capital markets, international

money markets and foreign currency markets is stated below:
• The foreign currency markets – It is also called the Forex or foreign exchange market.
This is a global, decentralized or over-the-counter market for currency trading. The
foreign exchange rates for every currency are determined in this market. Here
currencies are bought, sold, and exchanged at current or pre-determined prices. It is an
international market that has no central or physical place for trading. The ’market’ is
actually the telecommunication network that links financial institutions around the
globe and opens for business at any time. Large International Banks are the main
participants in this market and financial centers act as a link between buyers and
sellers.
• International money markets – A market for accounts, deposits or deposits that
include maturities of one year or less may be conventionally said to be an international
money market. An example of this is the Euro currency markets which make up a huge
financial market that does not fall under the governance and supervision of world
governmental and financial authorities. The Euro currency market is a money market
for depositing and borrowing money located outside the country where that money is
officially permitted as tender. Further, Euro currencies are bank deposits and loans
existing outside any particular country.
• International capital markets – The capital markets of individual countries are linked
by international capital. It also comprises a separate market of their own, the capital
market that flows into the Euro markets. The firms enjoy the freedom to raise capital,

debit, fixed or floating interest rates and maturities varying from one month to thirty
years in an international capital market.
• International security markets – is a part of the international financial market where
securities can be bought and sold based on demand and supply. The international
security market includes private placements, derivatives, stocks, bonds and equities
market. The prices are determined and participants that are both professional and non-
professional can meet. Professional participants may include brokers, investment
managers, market makers and speculators. It is meant to attract new capital, make
short- or long-term investments and determine prices to balance demand and supply.
The enormous growth in the trading of foreign currency can be attributed to the following:
• Deregulation of international capital flows – Most of the deregulation that has

characterized the past ten to fifteen years has made the movement of currencies and
capital around the globe very easy.
• Gain in technology and transaction cost efficiency – In addition to the performance of
exchange and trading, advancements in technology have resulted in the quick
dissemination of information. This has greatly impacted the capacity of individuals in
these markets to accomplish instantaneous arbitrage by buying and selling assets,
securities, stocks to take advantage of the difference in price and make profits.
• Market fluctuations – Over recent years the financial markets have become increasingly
volatile. Various factors such as supply demand for securities, currencies, government,
volume of international transactions, speculation and expectation cause market
fluctuations causing an increase or decrease in the interest rates and value of stocks.

4. A _________needs a more complex calculation.

5. The greater part of the world’s deal in foreign currencies is still taking place in the
cities where international financial activity is centered. (True/False)
6. The__________ provides links among the capital markets of individual countries.
a) Foreign currency markets
b) International security markets
c) International capital markets
d) International money markets

4. SCOPE OF INTERNATIONAL FINANCIAL MANAGEMENT
The list of all functions, activities and the decision regarding the management of
international business defines the scope of IFM.
4.1 Management Of Working Capital
The management of current assets and current liabilities is associated with working capital.
The main goal of working capital management is to guarantee that the firms maintain their
operations normally and have adequate cash flow to satisfy short-term debt and forthcoming
operational expenses.
Let us discuss some of the working capital policies which serve as guidelines to business.
They are as follows:
• Liquidity policy – This is also known as the aggressive working capital financing
policy. This is a risky policy as the maximum investment is in current assets. Both
fluctuating and permanent current assets are financed through short-term debt. The
level of liquidity is very high and the payment to creditors is delayed. The manager can
increase the amount of liquidity in order to reduce the risk to the business. If the firm
has a high level of cash and bank balances within the business to conduct its production
operations, then the business can utilize the liquid cash to run the operations and focus
on paying its dues at maturity. It is the responsibility of the finance manager to know
that the excess cash will not produce the required earnings but will Instead, decrease
the return on investment. Therefore, the liquidity policy should be optimized.
• Profitability policy – This policy is also known as the conservative policy. Here the
finance manager tries to avoid the risk involved in financing current assets. Here,
although the risk is really low, it fails to make optimum utilization of funds and
therefore cuts down the expected returns for shareholders. In this policy, the finance
manager will maintain a low amount of cash in the business and aim to invest the
maximum amount of cash and bank balance. It will guarantee that the profit of business
will rise due to the increase of investment in the correct way. But the risk of business
will also increase because liquidity of business will reduce and can ruin the business.

Need for working capital management
After understanding the nature of production, we can make an estimation of the working
capital. For example, If the company produces under a large scale and continues producing
goods, it will need a high amount of working capital.
The high amount of working capital will decrease the return on investment, whereas the low
amount of working capital will increase the risk of business as the company cannot meet its
ongoing production expenses. The shortage of working capital can slow down production
and the income inflow and profits through sales of goods. Therefore, it is necessary to get an
optimum level of working capital where both the profit and risk will be balanced. If the
manager supervises the cash and inventory, then the working capital will repeatedly be
optimized.
4.2 Financing Decisions
The method of arranging finance refers to the raising of capital. Financing decisions of a
company are the decisions taken regarding the proportion of equity and debt in their capital
structure. Here are the factors to be considered in the financing decision:
• Cost: The cost of raising funds and the flotation cost, which are the expenses incurred
in issuing the debt, have to be the lowest in terms of cost to benefit the company in the
long run.
• Cash flows: A company with a higher and continuous cash inflow can opt for Debt as
the company will have a better debt repayment capacity and a company with limited or
lower cash inflow can opt for equity.
• Flexibility – While making financing decisions future additional capital requirements
have to be considered. If the company requires additional funding in the future, it
should not completely use debt for its current funding needs. Initially, the company can
opt for equity in a larger proportion and a small percentage of debt. In the future, it can
use debt to raise additional funds for expansion.

• Risk – There are chances to increase risk by financing with the use of debt. There exists
a limit on the amount of debt to be used to finance our business. A high amount of debt
can result in economic failure.
• Returns – Financing can generate earnings and thus influence the return on equity.
Financing decisions depend on whether the goal is to ensure returns to equity
shareholders or not. Then the financing decision will require certain adjustments.
Income also depends on other factors such as receiving the benefit of tax deductions
for interest on debt.
• Control – Financing decisions are associated with either ownership (equity) or
creditors (debt). If the company intends to maintain control over the organization, then
debt is a better option as the issue of equity dilutes the ownership.
• Time – To take advantage of the marketplace, the financing decision needs to be timed.
The type of securities to be sold and the length of maturity to be used for debt financing
should be decided.
Refinancing risk
One of the main aims of financing decisions is to go with the maturity of liabilities with the
life expectancy of assets. This will allow the liabilities to be self-liquidating. There are
chances of facing refinancing risk if the maturity of liabilities is less than the life expectancy
of assets. Here, the capital has to be raised to pay off liabilities. In either case, there will be
an abundance of assets around to pay off debts if the maturity of liabilities is longer than the
life expectancy of assets.
Inflation
As a result of using debt financing in periods of high inflation, one will pay back the debt with
currencies that are worthless. While expectations of inflation increase, the rate of borrowing
will be raised since creditors must be compensated for a loss in value. Since inflation is a
main motivating force behind interest rates, the financing decision should be aware of
inflationary development.

4.3 Taxation
Taxation plays a vital role for the worldwide operation of firms. The tax decision or taxation
which is relevant in domestic firms has become central to various financing decisions
involving fund raising decisions, international investment decisions, international working
capital decisions and decisions related to dividend and other payments.
The various reasons why international corporations find managing taxation an extremely
difficult issue is stated below:
• Multiple tax jurisdictions or authorities with diverse tax rates and irregular
administration of the tax system in areas firms are expected to work in.
• A more complex interaction of varying descriptions of the tax base determines the
ultimate tax load in the framework of international firms.
• The difference in tax treatment in different nations will lead to distortions in worldwide
trade and investment. The companies which are situated in the low-tax country can
have a periphery over other firms in the worldwide market. There are possibilities to
divert the investment to those countries that have low-cost rates.
• International firms overlap with different tax jurisdictions and this enables them to
utilize the arbitrage opportunities which helps them retain an edge over the domestic
firms.
The bases of the international tax system are:
• Tax neutrality – To keep the economic efficiency from being affected the international
tax system should remain neutral. The nationality of the investor or the locality of the
investment not to be influenced, a neutral tax is important. Such an environment will
allow capital to move from a nation with a lesser return to a nation with a higher return,
resulting in well allocated resources that will ensure a high gross world output.
• Tax equity – The principle of tax equity states that all equally positioned tax players
contribute to the cost of operating the government according to the equal rules. The
concept of equity can be perceived in two ways. It is asserted by the first view that the
input of each tax player must be consistent with the amount of public services as

received. The second maintains that the contribution of each tax player must be in
terms of their ability to pay. The ability to pay means the one with greater ability is
likely to pay a larger amount of tax.
• Avoidance of double taxation – The avoidance of double income asserts that one
must not be taxed twice for the same income. However, double taxation occurs if the
recipient of post-tax income in a foreign country is taxed again. As an alternative, the
requirements of foreign tax credits may be formed in the domestic tax system.
There also exist some tax laws which prevent tax through artificial transactions such as
transfer pricing. In addition, the corporate structures will help to reduce the overall tax
burden to the enterprise.
7. The device of finance is the________ management.

8. The financing decisions made today will have an impact on the future.
(True/False)
9. The principle of _________ states that all equally positioned tax payers should
contribute in the cost of operating the government according to the equal rules.
a) Tax equity.
b) Tax neutrality.
c) Avoidance of double taxation.
d) Taxation.
Activity II
Using resources on internet analyse how the financial management takes place in
different countries.
Hint: www.bjreview.com

5. SUMMARY
Let us summarize the points covered in this unit about international financial management:
• International Financial Management came into existence when countries all over the
world started opening their doors to each other. This phenomenon is also called
liberalization.
• The four major aspects which distinguish international financial management from
domestic financial management are the introduction of foreign exchange, political risks,
market imperfection and enhanced opportunity set.
• Components of International Financial Management are foreign exchange markets,
foreign currency derivatives, the international monetary system and international
financial markets.
• The scope of international financial management includes management of working
capital, financing decisions and taxation.
• The policies of working capital management are liquidity and profitability policy. The
financing decisions consider factors like flexibility, risk, income, control and time. The
bases of the international tax system include tax neutrality, tax equity and avoidance of
double taxation.

6. GLOSSARY
Arbitrage: The purchase of securities on one market for immediate resale on another
market in order to profit from a price difference.
Denominated: To express in terms of the monetary unit.
Equity: Funds provided to the business by the sale of stock.
Hedging: It is a method of reducing the risk of loss caused by price variations.
Inflation: The term refers to a persistent increase in the level of consumer prices or a
persistent decline in the purchasing power of money, caused by an increase in available
currency and credit beyond the proportion of available goods and services.
Liquidity: The term refers to the volume of transactions. With sufficient buyers and sellers,
a market enjoys continuous offers, bidding, and consummated transactions, thus achieving
market liquidity.
1. Explain domestic versus international financial management.

2. Discuss foreign currency derivatives.
3. Explain the need for international financial market.
4. State the management of working capital.
5. Explain the importance of taxation.

8. ANSWERS
1. Liberalization
2. True
3. Political risks
4. Forward market
5. True
6. International capital markets
7. Working capital
8. True
9. Tax equity
Terminal Questions
1. Foreign exchange, political risks, market imperfection and enhanced opportunity set
are the four major aspects that distinguish international management from domestic
financial management. These are explained in subsection 2.2. Refer to the same for
details.
2. A currency derivative is a financial contract in order to swap two currencies at a
predetermined rate. These are explained in subsection 3.2. Refer to the same for details.
3. Deregulation of international capital flows, gain in technology and transactions are the
causes normally given for the enormous growth in the trading of foreign currency.
These are explained in the subsection
3.4. Refer the same for details.
4. The working capital policy which serves as guidelines to business are liquidity policy,
profitability policy and the need of working capital management. These are explained
in subsection 4.1. Refer the same for details.
5. Management of taxation is an extremely difficult issue for international corporations.
The basis of the international tax system includes tax neutrality, tax equity and
avoidance of double integration. These are explained in subsection 4.3. Refer the same
for details.

9. CASE-LET
XYZ Fruit Beverage Company

M/s. XYZ Company was in the business of making fruit beverages. The said M/s. XYZ
intended to expand its market and started exporting fruit beverages to Japan.
Subsequently, it so happened that the Japanese Government, imposed higher tax on the
fruit beverages imported from other countries into Japan. The Japanese Government with
intention to protect its own domestic market imposed a lesser tax to domestic producers
compared to the foreign producers.
1. What do you think would be the strategy of XYZ Company in protecting their business
interests?
(Hint: The XYZ Company can work out a possible option of a joint venture with the
domestic producer which would help them pay similar tax to that of domestic
producers.)
2. How relevant is the concept of political risk to the managerial decisions of a
Company and whether sufficient recourse is available in the international forum to
mitigate such risks?
(Hint: The Japanese Government introduced new tax rules for foreign alcohol.
However the countries do not have the liberty to impose unfair rules rather every
country has to treat everybody equally. As a risk mitigation strategy, the XYZ Company
through its country can approach the WTO Dispute Settling Union (DSU) against such
discriminatory rules.
Source: http://www.nuigalway.ie/law/GSLR/1998/case6.html
References:
• Sharan, Vyuptakesh. (1998). International Financial Management, (5th Ed), PHI

learning Private Limited.
• Kevin. (2009). Fundamentals of International Financial Management. Pearson
Publications.
• Gary Shoup.(1998).The International Guide to Foreign Currency Management.

E-References:
• http://www. brainmass.com, retrieved on 5th November 2010

• http://finance.mapsofworld.com/foreign-exchange-market/ retrieved on 1st
November 2010


SEMESTER 4
DMBA402
MANAGEMENT
Unit 9: International Accounting Practices 1

Unit 9
International Accounting Practices
Table of Contents

No Graph Activity
1 Introduction - -
3
2 International Accounting Standards 1 1I
2.1 Domestic vs. international accounting - -
4-8
2.2 National differences in accounting - -
2.3 Legal systems - -
3 Accounting for International Business 2 2
3.1 Classification of accounting systems - - 9 - 14
3.2 Harmonizing of accounting systems - -

4 International Regulatory Bodies - 3 II 15 - 18
5 International Financial Reporting Standards - 4 19 - 23

6 Summary - - 24
7 Glossary - - 25
9 Answers - - 25 - 26
10 Case-let
- - 27 - 28

1. INTRODUCTION
In the previous unit, you studied international financial management and the forex market.
In this unit, you will learn about international accounting standards, regulatory bodies, and
international financial reporting standards. While presenting financial statements, publicly-
traded companies should follow some rules for international accounting practices so that the
reader can easily compare different companies.
This unit covers various factors involved in accounting practices followed by MNCs. It
explains various regulators and accounting standards followed by different countries and
regions. It also includes international regulatory bodies and international financial reporting
standards.
❖ Explain international accounting standards.

❖ Differentiate domestic and international accounting practices.
❖ Explain Accounting for international business
❖ Describe the international regulatory bodies.
❖ Discuss the international financial reporting standards.

2. INTERNATIONAL ACCOUNTING STANDARDS
Accounting is vital for the growth of a business. International Accounting Standards set
guidelines to record and maintain business transactions and events in financial statements.
International accounting refers to international comparative analysis, accounting
measurements, and reporting issues pertaining to multinational corporations.
Accounting Standards are the key mandatory and regulatory mechanism for financial
reporting and conducting financial audits. It is used almost in all countries throughout the
world. They are concerned with the structure, financial analysis, rules for preparation and
arrangement of financial statements. They are designed to supply practical information to
diverse users of financial statements such as shareholders, creditors, lenders, organizations,
investors, suppliers, competitors, researchers, regulatory bodies. These statements are
designed and approved to develop and benchmark the quality of financial reporting.
A financial reporting system of an international standard acts as a tool to attract foreign and
potential investors at home, which can be achieved by harmonizing the accounting
standards.
2.1 Domestic Vs. International Accounting
Different countries, whether domestic or international, have different accounting standards

that represent the quality, presentation, and importance of accounting information.
Accounting standards determine financial reporting quality and provide verified
information about an organization's financial performance to investors and creditors.
Though there are differences in accounting methods, domestic businesses are not affected.
The accounting system of a domestic organization must meet the specific regulatory
standards of its home country. But, an MNC and its subsidiaries must meet the accounting
and auditing standards of all the countries in which it operates. Therefore, there arises a
need to compare accounting standards, conventions, and practices of the businesses in the
group. In order to successfully manage and organize their operations, local managers require
accounting information, which should be prepared according to the local accounting
concepts and denominations in the local currency. In the case of financial controllers, to

measure the foreign subsidiary’s performance and worth, the subsidiary’s accounts must be
translated into the organization’s home currency. This translation is made using accounting
concepts and measures provided by the organization. Investors worldwide look for the
highest possible returns on their capital. For this purpose, in order to interpret the track
record, they use a currency and an accounting system of their own. The organization has to
pay taxes to the countries where it does business, based on the accounting statements
prepared in these countries. Besides this, when a parent corporation tries to combine the
accounting records of its subsidiaries to produce consolidated financial statements, extra
complexities occur because of the changes in the value of the host and home currencies.
There are many differences between International Accounting Standards (IAS) and Domestic
Accounting Standards (DAS). On the basis of difference between the two, two indices, namely
'divergence' and 'absence', are created. Absence is the difference between DAS and IAS; the
rules on certain accounting issues are missed out in DAS and covered in IAS. Divergence
represents the differences between DAS and IAS; the rules on the same accounting issue
differ in DAS and IAS.
Measurement of differences between IAS and DAS
You can measure the differences between IAS and DAS in the following way:
• Literature on international accounting differences – Referring to earlier reports on

international accounting could give more information about the subject. Most of the
earlier reports understand international accounting differences and various options
adopted by nations for similar accounting problems, which correspond to divergence
concept are found here.
• Framework of analysis – Links between variations in accounting standards and
financial reporting quality of various countries could be clearly seen from the reports
published earlier. We should consider the institutional determinants of accounting
differences such as legal origin, governance structure, economic development, and
equity market.

2.2 National Differences In Accounting
One of the major problems encountered by an international business is lack of consistency

in accounting standards in various countries. Organizations show different financial results
due to the differences in accounting standards.
Differences in accounting standards exist because of diverse political, legal, economic, and
cultural systems of the countries. Accounting standards and practices are also prejudiced by
the sources of capital used to fund business. Figure 9.1 shows the influencing factors on a
country’s accounting practices.
Figure 9.1: Influences on a Country’s Accounting System
Source: International Business by Ashwathappa, TMH
The increasing trend in globalization of business makes understanding various accounting

systems important.
2.3 Legal Systems
Legal systems are divided into civil law and common law in countries worldwide. In
countries like US, Australia, UK and New Zealand accounting procedures originate from
decisions of independent standards setting boards, such as US Financial Accounting
Standards Board (FASB). Each board works with professional accounting groups. In
countries that follow common law, accountants follow Generally Accepted Accounting
Principles (GAAP), which provides a 'true and fair view' of the organization's performance,
based on the standards approved by these professional boards. Countries following civil law
are likely to codify their national accounting measures and standards. In these countries,

accounting practices are determined by the law. To assist the legal role, all business
accounting records must be officially registered with the government.
The manner in which accounting practices are imposed depends on the legal system. Most
developed countries depend on both private and public enforcement of business
performance, though the public or private combination varies from country to country. The
difference in the legal systems are a major obstacle to the growth of accounting standards.
In some countries, the accounting policies are restricted to detailed legislation, which is
passed by governments. This restriction forms a major problem for international accounting
bodies that are created to increase harmonization of national accounting frameworks.
Government-controlled regimes are inclined to be less flexible, and perceive private sector
influences as less acceptable.
Culture: Culture influences accounting standards in terms of differences in measurement

and disclosure practices among countries. Countries such as Germany, Switzerland, and
Japan have less disclosure than UK and US. German Companies tend to be conservative in
recording profits as it keeps them from paying taxes and declaring dividends whereas US
and UK-based companies show optimistic earnings to attract investors.
Political System: This has an impact on accounting and auditing practices. In centrally
planned economies or communist economies such as Eastern Europe, all accounting is based
on the fact of whether the production plan and targets are met or not. On the contrary,
Western Europe has its general accounting developed in a more constructive manner.
Economic System: Developed countries tend to have large and complex organizations with
accounting issues that are more difficult in comparison to small organizations that serve
local markets where accounting regulations and international influence is minimum.
Sources of Capital: Here Investors, creditors, shareholders, bankers are considered as the
source of capital. Australian Accounting standards cater to investors to make investment
decisions as most companies raise capital by selling shares and debentures. In Germany, the
banks play a major role in raising capital for companies therefore the accounting standards
cater to Creditors and Banks.

1. Accounting Standards are the key mandatory and regulatory mechanism for
financial reporting and conducting financial audits. (True/False)
2. _____________ and __________ are the two indices created based on the
differences between IAS and DAS.
3. GAAP stands for Generally accepted accounting principle. (True/False)
Activity I
The link below provides an article on ‘International Accounting Standards’. Find out how
standards help to bring financial stability in the market and discuss how it affect companies.
Hint: Refer link: www.iasplus.com/dttpubs/dtiias.pdf

3. ACCOUNTING FOR INTERNATIONAL BUSINESS
In the previous section you learnt about international accounting standards and differences
between accounting standards in different countries. In this section you will cover
accounting for international business.
The two major accounting problems that arise in international business are:
Transaction in foreign currencies: A major concern in accounting for MNCs is dealing with
different foreign currencies and that involves recording transactions, accounting assets,
liabilities, revenues, and expenses in foreign currencies. Firms often face problems when
they make or receive payments in foreign currencies, recording such transactions and
dealing with exchange rate fluctuation. Firms witness exchange rate fluctuations between
the time firms enter into transactions and until they receive the payment.
Foreign currency translation: When an MNC reports the results of its foreign subsidiaries'
operations to its home country shareholders and tax authorities. The firm must convert its
subsidiaries' financial reports to its home currency. The process of transforming a
subsidiary’s reported operations denominated in a foreign currency into the parent’s home
currency is called translation. For most MNC’s translation process is intertwined with the
creation of consolidated financial statements to report on the combined operations of a
parent company and its subsidiaries in a single set of accounting statements in a single
currency.
3.1 Identification Of Accounting Systems
It is important to classify accounting systems because these are developed to provide

information to the decision makers. The classification of accounting systems in financial and
cost systems leads to a difference of opinion between the decision makers. Creditors,
investors, tax authorities, and government agencies are decision makers existing outside the
organization. Whereas, managers are within the organization and they also take part in the
accounting decisions.

Financial accounting
The information provided in financial accounting is not meant for organization managers but
for decision-makers. Managers are normally outside the organization. The information for
public organizations is available on the websites of the organizations. Managers in the
organization are sincerely concerned about reports that produce financial accounting, but
the information would not be sufficient for making operational decisions for the
organization. Individuals who depend on information from financial accounts usually
compare their organization with others. For example, comparing Apple Computer and
Microsoft for investment. Information obtained after financial accounting can be compared
between organizations. This means that when an investor looks at the revenues of Apple
Computers and then looks at the revenues of Microsoft signify the same thing. Because of
this, financial accounting systems are characterized by a series of regulations that explain
how to check transactions.
Cost accounting
Cost accounting information is planned for managers. The need for comparison between
different organizations does not arise in the case of managers as they take decisions only for
their organization. But the significant principle is that the information must be appropriately
decided. Though information on cost accounting is usually used in financial accounting, it
should be determined whether this is beneficial for managers to take decisions. The
accountants add value by giving the cost accounting information to managers so that they
can take appropriate decisions. The cost accounting system results from the decisions made
by managers about an organization. Some aspects of cost accounting in regard to its clients,
with GAAP and ethics are given below:
• Cost accounting and GAAP – The key principle of financial accounting is to supply
information about the organization and the performance of the management to
investors or creditors. The financial information for this purpose is overseen by
Generally Accepted Accounting Principles (GAAP). GAAP maintains consistency in the
accountancy data used for reporting information between organizations. The cost

accounting information used to evaluate the expenditure of goods sold, inventory

assessment, accounting used for external reports should be in accordance with GAAP.
• Clients of cost accounting – The administration must consider the customer as
important out of all the participants in a business. Without customers, the organization
loses its capability and reason to exist. The cost information itself is a product with its
individual customers. The major problem with the accounting system occurs when
managers utilize accounting information that was designed for external reporting, in
decision-making.
• Cost accounting and ethics – The format of costing systems is finally about the
payment of costs to various activities, products, projects and corporate units, and
people. The method in which this is done affects prices, reimbursement and payment.
Based on the events, the cost accounting systems plan the potential to misuse and fraud
the shareholders, employees or customers. As user or preparer of the cost information,
you should be aware of what it means, and how it could be utilized. Most importantly
you should be aware of when the system has the potential to be misused.
3.2 Harmonizing Of Accounting Systems
Though there are many differences in accounting standards and practices, a number of forces
are leading to harmonization. Some of these forces are:
• A ‘Movement to present information’ well-matched with the

‘Requirements of investors.
• The global mixing of capital markets indicates that investors have easier and quicker
access to investment opportunities around the world, and thus require financial
information that is more equivalent to other accounting standards.
• The need of MNCs to increase the capital outside their home-country capital markets,
while generating few diverse financial statements.
• Regional, political and economic harmonization, such as the initiatives by the European
Union (EU) influence accounting, trade and investment issues.

• Pressure from MNCs for consistent standards, which allows for reduced costs in
reporting in each country, and in reporting that is used by investors in the
organizations’ home-country.
Differences in accounting systems are confusing and expensive for international business.
Incomparability in these systems makes it complex for organizations to examine their
foreign operations and for investors to understand the relative performance of organizations
that are based in different countries. To help in solving such problems, many accounting
professionals and national regulatory bodies are trying to harmonize diverse accounting
practices. It is also important to understand the arguments in favor of harmonization.
Arguments supporting harmonization
Harmonization of accounting and external financial reporting assists in the optimal global
delivery of private-sector finance. Harmonization means bringing down the gap between
accounting practices so that comparability between financial reports from various countries
can be improved. Investors must be able to realize a more proficient portfolio of
organizations on a national, as well as international scale. This will benefit the investor.
When
Global capital markets operate properly, and the financial information disclosed to the
marketplace must be global. Figure 9.2 highlights points that are for and against
harmonization.
MNC’s: Harmonization will lead to consolidation of accounting in foreign subsidiaries

thereby simplifying accounting and auditing standards.
Investors: This also leads to simplifying reporting and disclosure requirements in stock
exchanges.
Developing countries: Harmonization helps governments of countries to exercise greater

control over MNCs as the differences in accounting will be minimized.
Tax Authorities: Harmonization ensures net income is computed on similar accounting

principles and tax regulations are uniform.

International Accounting Firms: Harmonization ensures that the training in accounting

standards is less expensive as there is uniformity in norms across boundaries.
Others: It also introduces consistent internal and external management reporting.
Figure 9.2: Arguments for and Against Harmonization
Arguments against Harmonization:
The standard of accounting disclosure needs and auditing vary in different countries, and
makes cross-border investigation very difficult. It is difficult for investors to understand the
information presented, which is very different from what exists in their home-country.
Nationalization: There is general unwillingness to accept the principles and practices

adopted by other countries or accept changes to bring in uniformity.
User groups: In the UK and US main users of accounts are investors and in Germany, the
main users are the tax authorities. In France, the government is the main user of accounts.
Therefore, it is difficult to meet the needs of all these groups.
Legal Systems: For a codified Law system harmonization of financial reporting will require
changes in legislation which most governments are unwilling to go for.

Different Starting points: Different countries differ in terms of their legal systems and
accounting regulations therefore harmonization means different countries may have to start
at different levels, making this process a complicated one.
Conflicts between organizations: Various public and private sector organizations involved
in the harmonization process have different goals and therefore have different expectations
making the process of Harmonization difficult to meet the varying needs in terms of financial
disclosure and accounting practices.
Professional accounting body: In developing countries, the absence of a proper accounting

body makes the implementation of harmonization difficult.
4. Information_______ is planned for decision-makers and those who are not involved
in the daily management of the organization.
5. Cost accounting information is planned for__________ .
6. Customer is the most important participant in a business who should be given
importance by the administration. (True/False)

4. INTERNATIONAL REGULATORY BODIES
In the previous section, we covered accounting for international business. In this section you
will learn about various international regulatory bodies.
Certain regulatory bodies are active in bringing out harmonization of accounting standards.
The Efforts of some of the bodies are explained here.
European Union
The European Union is pro-active in the harmonization process. The European Commission
sets directives, which are orders to the member countries, to bring their laws in line with EU
needs, within some transition period. The earlier accounting directives are:
• The nature and design of financial statements.

• The measurement support on which the financial statements are to be organized.
• The significance of consolidated financial statements.
• The need that auditors to ensure that the financial statements reflect a true perspective
of the organization’s operations.
Though the EU has enhanced the comparability of financial statements, the directives do not
cover several essential issues. Additionally, some directives provide options, but member
countries understand the directives differently. Thus, EU organizations listing outside their
home-countries must supply the following two sets of financial statements, they are:
• Home-country statements.
• Reconciliation statements.
United Nations
The United Nations has been interested in international accounting since the early 1970s
and has been operating under a 'Group of Eminent Persons'. This further led to the
establishment of an Inter-governmental Working Group of Experts on International
Standards of Accounting and Reporting (ISAR) by the UN Economic and Social Council.

The ISAR attempts to support the developing countries, by creating recommendations on the
accessibility and comparability of information disclosed by international businesses.
The discussions of the ISAR are reported in annual publications. Publications cover
accounting developments worldwide, and reports on issues significant to global accounting.
The ISAR is presently concerned about developing discussions on the international

environment reporting, and the role and responsibilities of accountants and auditors.
Organization for Economic Cooperation and Development (OECD)
The OECD was established by world's 24 developed countries, of which some are Australia,
Austria, Belgium, and Canada. This was set up to promote world trade and international
economic growth. This looks at matters from the perspective of economically developed
countries. The council of OECD has established a committee on International Investment and
Multinational Enterprises (MNEs). This committee in turn has established a Working Group
on Accounting Standards.
The ‘Working Group’ has recently published a 'Clarification of the OECD Guidelines', and
published reports as an element of an 'Accounting Standards Harmonization' series. Most
recently, the OECD has established a 'Centre for European Economies in Transition', which
along with ‘Working Group’ has prepared workshops, seminars, and meetings, to recognize
the purpose and constituents of accounting systems in these countries.
International Accounting Standards Committee (IASC)
The International Accounting Standards Committee was created in the year 1973. It has
issued a series of standards to harmonize management of accounting issues globally. The
chief objective of IASC is the encouragement of comparability of financial statements
between countries, by establishing standards for inventory assessment, depreciation,
delayed income taxes, and so on.
An important accomplishment of the IASC has been the creation of the International
Accounting Standards (IAS). The publication and global recognition of these standards is
necessary for the harmonization efforts of the IASC.

The International Federation of Accountants (IFA)
The International Federation of Accountants was founded in the year 1977. It completely
supports the work of the IASC, and recognizes the IASC as having responsibility and
authority to issue rules on international accounting standards. IFA has parallel responsibility
for IASC’s objective of developing international guidelines for auditing, ethics, education and
management accounting.
Some other Organizations:
• The Confederation of Asian and Pacific Accountants (CAPA)

• The Intra American Accounting Association (IAA)
• The European Accounting Association
• The Industry Groups
Some of the other international regulatory bodies are:
• Governmental Accounting Standards Board.

• Independence Standards Board.
• International Accounting Standards Board.
• International Organization for Securities Commission.
• National Association of State Boards of Accountancy.
• Public Company Accounting Oversight Board.
• UK Accounting Standards Board.
7. The European Commission sets directives which orders member countries to bring
their laws in line with EU needs within some transition period. (True/False)
8. _________________________considers the matters from the perspective of economically
developed countries.
9. The International Federation of Accountants was founded in the year

Activity II
.
The link below provides an article on various International Regulatory Bodies. Find
out the responsibilities of OECD and WHO.
Hint: Refer link: http://www.iraup.com/results.php?page_name=int_org

5. INTERNATIONAL FINANCIAL REPORTING STANDARDS

After learning about different international regulatory bodies, we shall now discuss
reporting standards used in international finance.
International Financial Reporting Standards (IFRS) are a set of accounting standards

developed by the International Accounting Standards Board (IASB); an independent body
based in London. IASB has succeeded the International Accounting Standards Committee
(IASC)
Structure of IFRS
International Financial Reporting Standards comprise of the following:
• International Financial Reporting Standards (IFRS) (Standards issued after 2001).

• International Accounting Standards (IAS) (Standards issued before 2001).
• Interpretations developed from the International Financial Reporting Interpretations
Committee (IFRIC) (Issued after 2001).
• Standing Interpretations Committee (SIC) (Issued before 2001).
• Framework for the Preparation and Presentation of Financial Statements (1989).
Framework
The framework used for the preparation and presentation of financial statements states the
basic rules for IFRS.
Objective of financial statements
A financial statement should reproduce a true and fair view of the business dealings of the
organization because these statements are used by different constituents of society.
Underlying assumptions
IFRS approved two basic accounting models, which are:
• Financial capital preservation in nominal monetary units.

• Financial capital preservation in units of invariable purchasing power.
The four underlying assumptions in IFRS are given below:
• Accrual basis – The result of dealings and other measures are recognized when they
happen.
• Going concern – a company has the resources to continue making enough money to
stay afloat for the foreseeable future.
• Stable measuring unit assumption - The assumption that financial capital is
measured in nominal monetary units. This is the historical cost accounting in which
assets and liabilities are recorded at their values when first acquired and not generally
restated for changes in values. That is, accountants believe that it would not be
sufficient for them to take decisions when variations in the purchasing power of
functional currency changes is up. Taking decisions, here, imply for financial capital
safeguarding in the units of regular purchasing power during low inflation and
deflation as authorized in IFRS, in the Framework.
• Units of constant purchasing power - Financial capital preservation in units of
regular purchasing power during low inflation and deflation, that is, the denial of the
constant measuring unit statement. Measurement in units of constant purchasing
power (inflation - adjustment) helps to sort out the loss due to historical cost
accounting.
Qualitative characteristics of financial statements
There are some qualitative characteristics of financial statements. These are as given below:
• Comparability.
• Reliability.
• True and fair view or fair presentation.
• Relevance.
• Understandability.

Elements of financial statements
The financial position of an enterprise is mainly provided in the ‘Statement of Financial

Position’. The fundamentals of financial statements are given below:
• Asset – An asset is a resource guarded by the enterprise as an effect of past procedures,

from which potential economic benefits are likely to flow.
• Liability – Liability is a present requirement of the enterprise that is rising from past
procedures, the closure of which is likely to result in an outflow from the Enterprizes
possessions (assets).
• Equity – Equity is the outstanding concentration on the assets of the enterprise after
subtracting all the liabilities under the historical cost accounting model. Equity is well-
known as owner's equity. Under the units of invariable purchasing power model, equity
is the regular real value of shareholders´ equity.
The financial performance of an enterprise is mainly provided in an income statement or

profit and loss statement. The elements of an income statement or the elements that
determine financial performance are as follows:
• Revenues – It is the increase in economic profit during an accounting period, in the

type of inflows or enhancements of assets, or diminishing of liabilities that results in
the increase of equity. But it does not comprise the contributions made by the equity
participants, like owners, partners and shareholders.
• Expenses – It is the reduction in economic benefits in an accounting period, in the form
of outflows, or reduction of assets or committing to liabilities that results in decreasing
equity.
Measurement of the elements of financial statements
Measurement is the method of determining the monetary amounts. But it does not comprise
the contributions made by the equity participants, that is, owners, partners and
shareholders. The components of the financial statements are documented and approved in
the balance sheet and income statement. A number of diverse measurement bases are

engaged in various degrees, and in changing combinations in financial statements. These

measurements include the following:
• Historical cost – Assets are entered as the amount of cash or cash equivalents paid or
the fair cost of the consideration given to obtain them at the time of purchase. Liabilities
are recorded as the amount of earnings received in exchange for the commitment, or in
some situations (for example, income taxes), as the amounts of cash or cash equivalents
likely to be paid to convince the liability in the normal course of business.
• Current cost – Assets are approved at the amount of cash or cash equivalents that
needs to be paid, if a similar or an equivalent asset was acquired at present. Liabilities
are approved at the undiscounted amount of cash or cash equivalents that would be
necessary to settle the requirement at present.
• Realizable (settlement) value – Assets are approved at the amount of cash or cash
equivalents that could, at present, be obtained by exchanging the asset in methodical
removal. Assets are accepted at the current discounted value of the future net cash
inflows that the item is likely to produce in the typical course of business. Liabilities are
carried at the current discounted value of the future net cash outflows that are likely to
be essential to resolve the liabilities in the typical course of business.
The measurement basis that is generally adopted by entities in preparing their financial
statements is historical cost. This is generally combined with other measurement bases.

10. Accrual basis is one of the underlying assumptions of _____________ .

11. Equity is the outstanding concentration on the assets of the enterprise after
subtracting all the liabilities under the historical cost accounting model. (True/
False)
12. Which among the following is not an element of financial statements?
a) Asset.
b) Liability.
c) Equity.
d) Accountability.

6. SUMMARY
Let us now summarize the salient points you learnt in this unit on international accounting
practices:
• Accounting standards are the type of compulsory and regulatory mechanisms for
training on financial reports and conducting successful audits for the same. It is used in
almost all countries.
• International businesses meet a number of accounting problems that do not stop
domestic businesses. There are many differences between both Domestic Accounting
Standards (DAS) and International Accounting Standards (IAS). Considering the list of
differences, two indices are created-'absence' and 'divergence'.
• The Law system is divided into civil law and common law in countries worldwide.
• The harmonization of accounting and exterior financial reporting helps in the best
international delivery of private-sector finance. Harmonization of accounting and
auditing practices helps to diminish the size of the barrier.
• Certain regulatory bodies are dynamic in bringing harmonization of accounting
standards. Some of them are the European Union, United Nations, and so on.
• International Financial Reporting Standards (IFRS) are principle-based values;
interpretations and the arrangement followed by the International Accounting
Standards Board (IASB).

7. GLOSSARY
Benchmark: It is used to evaluate performance in the organization.
Depreciation: It refers to the decrease in price or value.
Harmonization: It refers to the process of making a pleasing or consistent whole.
1. Explain briefly how the differences between IAS and DAS can be measured.
2. Explain briefly about accounting for international business.
3. Explain the factors that lead to harmonization of the accounting system.
4. Explain briefly the work of United Nation as one of the international regulatory bodies.
5. How do you measure the elements of financial statements of IFRS?
9. ANSWERS
1. True
2. Absence, divergence
3. True
4. Financial accounting
5. Managers
6. True
7. True
8. OECD
9. 1977
10. IFRS
11. True
12. Accountability

Terminal Questions
1. You can measure the differences between IAS and DAS in the following way:
• Literature on international accounting differences.
• Framework of analysis.
These are explained in sub section 2.1 of this unit. Refer the same for details.
2. The two major accounting problems that arise in international business are:
1) Transaction in foreign currencies: A major concern in accounting for MNCs is
dealing with different foreign currencies and that involves recording.... This is
explained in section 9.3 of this unit. Refer the same for details.
3. Though there are many differences in accounting standards and practices, a number of
forces are leading to harmonization. Some of these forces are: These are explained in
sub-section 3.2 of this unit. Refer the same for details.
4. The United Nations has been interested in international accounting since the early
1970s under a 'Group of Eminent Persons'. This further led to the establishment of the
Intergovernmental Working Group of Experts on International Standards of
Accounting and Reporting (ISAR) by the UN Economic and Social Council. These are
explained in section 9.4 of this unit. Refer the same for details.
5. Measurement is the method of determining the monetary amounts at which the
elements of the financial statements are to be documented and approved in the balance
sheet and income statement. A number of diverse measurement bases are engaged in
various degrees and in changing combinations in financial statements. They include
historical cost, current cost, and realisable (settlement) value. These are explained in
the section 9.5 of this unit. Refer the same for details.

9. CASELETc
Application of International Accounting Standards to Central Banks As the financial
markets are becoming internationalised, the international accounting standards are applied
to central banks. The primary objective of these entities is to maintain the value of the
country's currency.
The idea of applying IAS is to guarantee high level transparency and comparability among
financial reports and find an efficient operation of the Community's capital market and the
domestic market.
A sample of accounting and financial information were published on the websites of 19

central banks to know as to how the IAS’s are being applied to the accounting policies and
practices used by central banks in the region. The findings of the analysis are described as
follows:
1. Accounting standards governing the preparation of financial statements - It was found

that there was a beginning of an alignment with International Accounting Standards.
2. Publication of financial statements - IAS states that a total set of financial statements
should include an income statement, a balance sheet, changes in equity statement, and
a summary of accounting policies and a cash flow statement. It was found out that the
biggest problem for central banks was to prepare statements of changes in equity and
cash flow statements.
3. Proper disclosure of information - According to IAS, a business is appreciative to
disclose the accounting policies used and other explanatory notes. The study show that
the central banks reveal accounting policies and practices in their notes.
4. Use of ultimate exchange rates and fair value - AS states that in each balance sheet, the
dates of the items in foreign currency must be reported at closing rate. The findings
about central bank focuses on the use of closing rates for assets and liabilities decreased
in foreign currency and on the use of reasonable values for portfolios in both foreign
and domestic currency.
5. Reporting changes in the exchange rate - According to IAS, exchange differences that
happen when monetary items are developed, must be reported as fixed cost or income

for the phase in which they appeared. Through the study, it was found out that the
central banks apply diverse policies and procedures to proof their exchange
differences.
All these helped in internationalisation of central banks and helped in maintaining the
international accounting standards on the domestic currency.
Discussion Question
1. Discuss the application of international accounting standards to central bank. (Hint:
Accounting Standards Governing the Preparation of Financial Statements)
Source: www.cemla.org/pdf/acp/acp_9_Jairo_Contreras.pdf retrieved on 30 october
2010
References:
• Aswathappa. K. (2008). International Business. Tata McGraw Hill Education: New Delhi.
• Paul Rodgers (2007), International Accounting Standards, From UK Standards to IAS –
An Accelerated Route for Understanding the Key Principles, Elsevier Ltd.
• International Accounting Standards Committee (2000), International Accounting
Standards Explained, Chichester: Wiley.
E -References:
• media.wiley.com/product_data/excerpt/22/EHEP0005/EHEP000522.pdf, retrieved
on 31 october 2010
• http://www.indianmba.com/faculty_column/fc137/fc137.html, retrived on 30
october 2010
• http://www.loscostos.info/english/accsyst.html, retrieved on October 31st, 2010


SEMESTER 4
DMBA402
MANAGEMENT
Unit 10: International Marketing 1

Unit 10
International Marketing
Table of Contents

No Graph Activity
1 Introduction - -
3
2 Scanning international markets 1 I 4-5
3 Mode of entering into potential markets - II 1 III 6-9
4 Global marketing strategies - 2 IV
4.1 Segmentation - -
4.2 Market positioning - -
4.3 International product policy - -
4.4 International pricing decisions - - 10 - 17
4.5 Transfer pricing - -

4.6 International advertising - -
4.7 International promotion and
- -
distribution
5 Branding for international markets - 3
5.1 Valuation of brands - - 18 - 19
5.2 Challenges of international branding - -
6 Summary - - 20
7 Glossary - - 20
9 Answers - - 21 -22
10 Case-let
- - 22 - 24

1. INTRODUCTION
In the previous unit, we learnt about finance management at an international level. We learnt
the differences between domestic and international financing. The unit also included the
components of international financial management and the scope of these components.
International marketing refers to the marketing of goods and products by companies

overseas or across national borderlines. The techniques used while dealing overseas are an
extension of the techniques used in the home country by the company.
In this unit, you will cover all the aspects of international marketing like strategies, policies,
valuation of brands and the different ways of circumventing the difficulties and challenges.
❖ Explain the importance of scanning international markets.

❖ Discuss the Modes of entering into international markets.
❖ Discuss global marketing strategies.
❖ Explain branding for international markets.

2. SCANNING INTERNATIONAL MARKETS
The firm’s sustainable competitive advantages shall be based on the assessment and
appraisal that how effectively the various competitive advances will blend with the
important features of that market. Scanning the global markets is important in order to look
for the competitive strength of the firm as it will provide the firm with a sustainable
environment for growth, expansion and diversification.
An organization aspiring to get started in international marketing should address, appraise

and analyze the issues in advance carefully. Success in international marketing largely
depends on the fact that the firm shall exploit its opportunities to its full capacity, use its
strengths smartly and address and improve its weakness patiently which may come on its
way. While scanning the international markets, the firms shall properly study all the aspects
of economic data that can be effectively used for making decisions on whether to enter
markets or not. Such data analysis can also help the firm to understand the various aspects
of risks and can guide in the degree of its engagement in that market. The specific
information which can be of use is as follows:
Table 10.3: Specific information to be scanned for getting started in international

marketing
1. Market information
Marketing decision Attitudes and behavior of consumers, disposable income,
statistics and potential per capita income, size of family, purchase frequency.
of market
Physical features of Available infrastructure, communication facilities,
target market money markets, banks, etc.
Kind of channels of Their type, availability, effectiveness and cost factors
distribution influencing distribution channel.
Availability, Various information sources, quality, availability and
effectiveness and cost cost factors in media, such as newspaper, television,
of media for accessing telecommunication, internet cost, etc.
buyers
Resources needed for Money, manpower, materials, their availability, cost,
doing business quality, development.
2. Overall business environments
Economic factors Rate of economic growth, economy structure, i.e. share of
agriculture, manufacturing and services, competitiveness
and conduct, capital adequacy, economic blocs and
regional integration. Role of cartel, trade practices,
inflation rates.

Social factors Customs, culture, attitudes, preferences for products and

services.
Political/legal Legislation governing business and trade, such as rules,
factors regulations acts and overall laws friendliness with
business, investment climate, government and
opposition ideology on trade and investment, political
stability.
Technological State funding for research and innovation, trends

factors development in country research.
Competition Type, structure, operations, strategy plans, acquisitions,

factors mergers.
Trading partner Trade openness, trade propensity, regional intensity and

and their role in orientation, trade intensity product and market
target market diversification.
Management Country diplomatic reach and activeness foreign
capability embassies, role of NGOs and other developmental thrust.
3. Financial factors
Market access Quotas, tariffs and non-tariff barriers, various duties, SPS
issues and technical barriers to trade.
Monetary and fiscal Fiscal and current account deficit, trade balance, balance
policy of payments, foreign exchange reserves, interest rates,
ease in accessing funds.
Expectations of Investors, economists, business people.
players
Commodity Legislation governing foreign exchange, rigidity issues,
exchanges exchange rate system, i.e., free float, managed float, dirty
float, fixed float and frequency of regulatory interference.
Taxes Legislation governing the trade and business incentives,

dividends tax rules, earnings, repatriation of profits.
Spot forward Level of developed, stage of maturity.

market
Intervention by outside IMF or world bank and their effect on county economic
bodies policy.
Source: Adapted from, S. Carter, Global Agricultural Marketing Management
Activity I
How can one find out the data for the potential markets for export and import?
Hint: www.trademap.org

2. MODE OF ENTERING INTO POTENTIAL MARKETS
Having scanned the best potential international markets which meet the corporate
competitiveness criteria of the firm, it has to evaluate the most profitable way of market
entry so as to sell its products and services to potential customers in these markets. There
are several methods used in the globalized era for international market entry, such as
exporting, licensing, joint venture and wholly owned subsidiary.
1. Exporting
Exporting is most commonly used by small- and first-time businesses as exporting

involves limited start-up costs and risks and profit under this method can be realized
as early as a firm gets started. The most advantageous aspect of market entry through
exporting is that it involves minimal preliminary expenditures except some which incur
on market research and product promotion. Getting through exports into the
international market can be in two basic ways, namely:
a. Direct export.
b. Indirect export.
Direct exporting requires the firm/company to find a potential foreign buyer and then the
firm is supposed to make all necessary arrangements for transporting the products into the
destined market.
The firms which cannot locate direct buyers for the product can export indirectly by using
an export intermediary. Several types of export intermediaries whom the firm can use are as
follows.
a. commissioned agents.
b. export management companies (EMCS).
c. export trading companies (ETCS).
d. foreign trading companies.
e. export merchants/export agents/buying houses.
f. piggyback exporting.

2. Licensing
Licensing is also an easy, risk free and costless method to enter into international
markets. Licensing operates in a way that permits another company in the target country
to use its property as a licensee and in exchange, pays a fee or royalty on sales so
incurred. The property of licensor is intangible, such as trademarks, patents, copy rights,
technical know-how and production techniques. The licensee has to pay the fee in
exchange for the right to use the intangible property as granted by the licensor. Licensing
is the very preferred way of market entry into the international market in a globalized
era as it requires little investment on the part of the licensor. Licensing, if effectively used
as an entry mode, has the potential to provide good return to the licensor, but usually it
has been seen that licensee who produces and markets the product takes away returns
from manufacturing and marketing activities due to vague regulatory law in developing
countries.
3. Joint ventures
Joint ventures are market entry options whereby firm and another company or firm in
target market may join together to form a new incorporated company for business
operations in that market. In joint ventures, both the parties are supposed to provide
capital and resources in the agreed proportion and accordingly they will represent and
share profits and losses. Such mode of entry is popular in countries where there are
restrictions on foreign ownership. For example, Venezuela, China, Vietnam.
Joint venture is also a preferred way of market entry as it is good tradeoff between
potential risks and returns and usually joint ventures are manifested with the following
common objectives for market entry in globalized era. They are:
a. Market entry into potential market.

b. Risk/reward sharing between parties.
c. Technology sharing between parties.
d. Joint product development between parties.
e. Conforming to government regulations.
f. Possible advantages from political connections.

4. Wholly Owned Subsidiary (WOS)
A wholly owned subsidiary, as the name suggests, is the direct ownership of production
facilities in the potential international market. It requires a long-term commitment on
the part of the firm as it involves transfer of resources, such as capital, technology and
personnel to the potential market. A wholly owned subsidiary can also be made through
the acquisition of an existing firm or the establishment in the target market. WOS has
several advantages as it provides a high degree of administrative control in the business
operations of the firm and the firm has better chances to understand and analyze the
consumers and competitive environment in the target market.
On the other hand, such an entry strategy requires a high level of physical and capital
resources to run the business in the target market.
Activity II
What can be the best possible way for entering into China and India for getting
started in business? Which method of entry will be suitable?
Hint: Read the case ‘drivers of success for market entry into china and india’ at
weblink www.bus.miami.edu

1. For a firm to be successful internationally, it is not necessary to be successful

locally. (true/false)
2. The culture of a country influences the marketing strategy of the firm. (true/false)
3. __________________ involves a firm shipping goods directly to a foreign market.
4. Direct investment involves _________________ in the overseas market.
5. A joint venture is an understanding between
a. Two or more firms.
b. Two or more countries.
c. The firm and its subsidiary.
d. two or more parties.
Activity III
Find out few countries where direct foreign investment is not entertained.
Hint: China, Saudi Arabia.

4. GLOBAL MARKETING STRATEGIES
After getting an overview of international marketing, we shall now discuss the strategies
followed in global marketing.
Taking into account the various conditions on which markets vary and depend, appropriate
marketing strategies should be devised and adopted. Some countries prevent foreign firms
from entering into their market space through protective legislation. Protectionism in the
long run results in inefficiency of local firms as it is inept towards competition from foreign
firms and other technological advancements. It also increases the living costs and protects
inefficient domestic firms.
To counter this scenario, firms must learn how to enter foreign markets and increase their
global competitiveness. Firms that plan to do business in foreign land find the marketplace
different from the domestic one. Market sizes, customer preferences and marketing
practices all vary, therefore the firms planning to venture abroad must analyze all segments
of the market in which they expect to compete.
The decision of a firm to compete internationally is strategic; it will have an effect on the
firm, including its management and operations locally. The decision of a firm to compete in
foreign markets has many reasons. Some firms go abroad as the result of potential
opportunities to exploit the market and grow globally. And for some it is a policy driven
decision to globalize and to take advantage by pressurizing competitors.
But, the decision to compete abroad is always a strategic down to business decision rather
than simply a reaction. Strategic reasons for global expansion are:
• Diversifying markets that provide opportunistic global market development.

• Following customers abroad (customer satisfaction).
• Exploiting different economic growth rates.
• Pursuing a global logic or imperative to harvest new markets and profits.
• Pursuing geographic diversification.
• Globalizing for defensive reasons.
• Exploiting product life cycle differences (technology).

• Pursuing potential abroad.
Likewise, there can be other reasons like competition at home, tax structures, comparative
advantage, economic trends, demographic conditions and the stage in the product life cycle.
In order to succeed, a firm should carefully look at their geographic expansion and global
marketing strategy. To a certain extent, a firm makes a decision about its extent of
globalization by taking a stance that may span from entirely domestic to a global reach where
the company devotes its entire marketing strategy to global competition. In the process of
developing an international marketing strategy, the firm may decide to do business in its
home-country (domestic operations) only or host-country (foreign country) only.
4.1 Segmentation
Firms that serve global markets can be segregated into several clusters based on their
similarities. Each such cluster is termed as a segment. Segmentation helps the firms to serve
the markets in an improved way. Markets can be segmented into nine categories, but the
most common method of segmentation is on the basis of individual characteristics, which
include the behavioral, psychographic and demographic segmentations. The basis of
behavioral segmentation is the general behavioral aspects of the customers. Demographic
segmentation considers factors like age, culture, income, education and gender.
Psychographic segmentation takes into account–beliefs, values, attitudes, personalities,
opinions, lifestyles and so on.
Once you are done with the segmentation of the market, you can choose one or more
segments to carry out trade. This process of selecting or choosing the potential market
segment is known as targeting. The three basic criteria for targeting are – potential
competition, the current size and growth rate of the market and compatibility and feasibility.
After the target market has been ascertained, firms should select a global marketing strategy.
Marketing in less developed countries offers several advantages to organizations. They can
take advantage of the huge unexploited markets and avail tax benefits. By focusing on less-
developed countries, firms can increase their market share and become market leaders.
Less-developed countries usually offer special benefits for the firms who are willing to

establish their operations in their countries. Thus, for firms marketing at a global level, less-
developed countries provide them with an advantage.
4.2 Market Positioning
The next step in the marketing process is the firms should position their product in the global
market. Product positioning is the process of creating a favorable image of the product
against the competitor's products.
Some of the common positioning strategies are relating the product or brand based on its
benefits, attributes, price, quality, use or application and competitors.
One challenge that firms face is to make a tradeoff between adjusting their products to the
specific demands of a country and gaining advantage of standardization, such as the
maintenance of a consistent global brand image and cost savings.
4.3 International product policy
Some theorists of the industry feel that there is a difference between conventional products
and services, stressing on service characteristics, such as heterogeneity (variation in
standards among providers and different locations of the same firm), inseparability from
consumption, intangibility and perishability. Typically, products are composed of some
service component like documentation, warranty and distribution. These service
components are an integral part of the product and its positioning.
We often think of a product in terms of fulfilling the need of our own culture. However, the
functions served by that product may be very different in other cultures, for example cars
play a large transportation role in the U.S., but they are impractical to drive in Japan and thus,
their cars are used for individual indulgence or act as a status symbol. Thus, it is important
to consider the findings of marketing research and determine customer’s desires, motives
and expectations in buying a product.
Firms have a choice in marketing their products across markets. Many a times firms opt for
a strategy which involves customization through which the firm introduces a unique product
in each country. On the other hand, standardization proposes the marketing of one global

product with the belief that the same product can be sold in different countries without
significant changes. For example, intel microprocessors are the same irrespective of the
country in which they are sold.
Finally, in most cases, firms will go for some kind of adaptation. When moving a product
between markets, minor modifications are made to the product. For example, in the U.S., fuel
is relatively cheap, therefore cars have larger engines than the cars in Asia and Europe.
4.4 International Pricing Decisions
Pricing is the process of ascertaining the value for the product or service that will be offered
for sale.
In international markets, various factors like different currencies, greater distances and
barriers to trade make the pricing decisions more difficult. It is vital to analyze the target
market before establishing the price. It is also to be in line with the firm’s objective. There
could be pricing objectives like return on investments, profit, market share, quality of
product or sometimes existence itself. The strategies for international pricing can be
classified into the following three types:
• Market penetration: It is the technique of selling a new product at a lower price than
the current market price.
• Market holding: It is a strategy to maintain buy orders in order to maintain stability
in a downward trend.
• Market skimming: It is a pricing strategy where the price of the goods is set high
initially to skim the revenue from the market layer by layer.
The factors that influence pricing decisions are inflation, devaluation and revaluation, nature
of product or industry and competitive behavior, market demand and transfer pricing.
There could be various approaches of company towards pricing when working in

international markets – ethnocentric, polycentric and geocentric.
A company following an ethnocentric approach will maintain the same price throughout the
world. In the polycentric approach, the regional managers of the company are allowed to

decide on product prices depending upon the situations in which they are operating. While
in the geocentric approach, the company takes a middle position and decides on a price
somewhere between global price and subsidiary requirement. Price can be defined by the
following equation:
Resource given up
Price =
Goods received
The pricing decision enables us to change the price in many ways, some of them are:
• ‘Sticker’ price changes – The simplest way of changing the price is by changing the
price tag. By doing this, you are going to get the same thing, but for a different amount.
• Change quantity – When sticker prices are increased, the response of consumers is
unfavorable and usually changes in quantity are noticed less.
• Change quality – Another way to effectively increase profit is through reducing the
quality of the product.
• Change terms – For a firm it is possible to save money by altering the terms of
operations or transactions with consumers. For example, earlier most software
manufacturers provided free support for their programs but now services are being
charged.
4.5 Transfer Pricing
Transfer pricing is the process of setting a price for inter unit sale of goods or services of a
firm.
Transfer pricing is an important issue for a firm having global operations. It is determined in
three ways – Market based pricing, transfer at cost and cost-plus pricing. For transfer pricing,
an arm’s length pricing rule is used.
Transfer pricing can also be defined as the rates or prices that are utilized when selling goods
or services between a parent company and a subsidiary or company divisions and
departments that may be across many countries. The price that is set for the exchange in the
process of transfer pricing may be a rate that is reduced due to internal depreciation or the
original purchase price of the goods in question. When properly used, transfer pricing helps

to efficiently manage the ratio of profit and loss within the company. Transfer pricing assists
in saving the organization's tax by shifting accounting profits from high tax to low tax
jurisdictions. It also enables us to fix transfer prices on a non-market basis and thus enables
us to save tax. This method facilitates moving the tax revenues of one country to another. A
similar trend can be observed in domestic markets where different states try to attract
investment by reducing the sales tax rates and this leads in an outflow from one state to
another. Therefore, the government is trying to implement a taxing system in order to curb
tax evasion.
4.6 International Advertising
International advertising is usually associated with using the same brand name all over the
world. However, a firm can use different brand names for historic reasons. The acquisition
of local firms by global players has resulted in a number of local brands. A firm may find it
unfavorable to change those names as these local brands have their own distinctive market.
Therefore, the company may want to come up with a certain advertising approach or theme
that has been developed as a result of extensive global customer research. Global advertising
themes are advisable for marketing across the world with customers having similar tastes.
The purpose of international advertising is to reach and communicate with target audiences
in more than one country. The target audience differs from country to country in terms of
the response towards humor or emotional appeals, perception or interpretation of symbols
and stimuli and level of literacy. Sometimes, globalized firms use the same advertising
agencies and centralize the advertising decisions and budgets. In other cases, local
subsidiaries handle their budget, resulting in greater use of local advertising agencies.
International advertising can be thought of as a communication process that transpires in

multiple cultures that vary in terms of communication styles, values and consumption
patterns. International advertising is a business activity and not just a communication
process. It involves advertisers and advertising agencies that create advertisements and buy
media in different countries. This industry is growing worldwide. International advertising
is also considered as a major force that mirrors both social values and propagates certain
values worldwide.

4.7 International Promotion And Distribution
Distribution of goods from manufacturer to the end user is an important aspect of business.
Companies have their own ways of distribution. Some companies directly perform the
distribution service by contacting others, whereas a few companies take help from other
companies who perform the distribution services. The distribution services include:
• The purchase of goods.

• The assembly of an attractive assortment of goods.
• Holding stocks.
• Promoting the sale of goods to the customer.
• The physical movement of goods.
In international marketing, companies usually take advantage of other countries for the
distribution of their products. The selection of distribution channel is helpful to gain a
competitive advantage. The distribution channel is also dependent on the way to manage
and control the channel. Selecting the distribution channel is very important for agents and
distributors.
In order to reach its target markets, a company utilizes a combination of sales promotion,
personal selling, advertising and public relations, which is collectively called promotion.
Advertising is a non-personal form of communication about an organization or its products

that is propagated to a target audience through a broadcast medium. A firm can focus on a
small, clearly defined market segment by employing this type of promotion. This
promotional method is also cost efficient. A large number of prospective customers can be
reached at a minimal cost per person.
The activity of catching the attention of prospects is known as sales promotion. It involves
activities and materials that are meant to attract customers. One motive of promotion is to
gain a competitive edge, another is to concentrate on this method as it provides quick return.
The consumers also look forward to sales promotions before purchasing a product.

People interested in a particular industry can be brought together by organizing overseas

product exhibitions. These events have the potential to attract important visitors, such as
distributors, agents, journalists, potential customers, politicians and competitors. These
events also provide us with an ideal opportunity to get attention.
6. Firms that serve global markets cannot be segregated into several clusters based
on their similarities. (True/False)
7. Advertising is a paid form of_______________ communication about an
organization or its products.
8. The promotional mix is a blend of advertising, personal selling, sales promotion
and .
9. Globalized advertising is associated with the use of the same ________
name across the world.
10. Transfer pricing is considered to be a relatively simple method of moving goods
and services among the overall corporate family. (true/false)
11. ___________ is the process of ascertaining the value for the product or service.
Activity IV
Find out the stages in the process of international promotions and

distributions of a multinational company.
Hint: http:// www. Ehow. Com /list _ 6781615_ examples - advertising- trade-
show- exhibitions.html

5. BRANDING FOR INTERNATIONAL MARKETS

Global marketing strategies provide techniques and methods to sell a product. Once the
product is sold, the image of the product has to be maintained. We will discuss this branding
here in this section.
With the spread of markets and the increase in competition on a global scale, firms are
expanding their operations overseas either through investments or acquiring firms in other
countries. Firms are also entering into strategic alliances with firms in other countries or
exporting directly or indirectly to target countries. At the same time markets are getting
more integrated due to the spread of media, the expansion of international retailers and the
mobility of people, goods and firms across national borders. To respond to this global
market, international firms need to have coordinated and integrated international branding
strategy in place.
International branding is different from marketing in domestic markets in a number of ways.

The macro-marketing environment, such as legal, cultural, technological and economic
aspects in which a firm operates in the overseas market is different.
The intended audience must be considered while developing an intra-organizational

marketing communication strategy. A successful promotional strategy is one which is
communicated clearly and distributed thoroughly to their intended audience. In addition, it
is important to ensure that consistent branding and non-contradictory messages are
eliminated.
5.1 Valuation Of Brands
Brand value can be defined as the branding efforts that build customer confidence and
loyalty by adding unique advantages to the firm’s product or service. The concept of brand
value surpasses the concepts of tangible product and basic brand. This facet of brand value
distinguishes a brand from a product. The three levels of brand value are:
• Core functionality.
• Emotional values.

• Added value services.
The core functionality deals with the core physical product and its features., Emotional value
is characterized by the intangible aspects of a brand that fits the psychological profile of the
target customer. Added values concentrate on bringing in extra futures and are critical to the
brand, which would enhance the usage of the brand for the customers.
5.2 Challenges Of International Branding
A challenge to international branding is to maintain a balance between being global and

being local. Brand ideas, values and concepts have to remain the same, but the methods of
communicating them and making them familiar to customers have to vary. Brand values and
ideas can principally be the same, but the propagating methods cannot.
The task of building a strong brand is hard and complicated. The firm has to honor the
promises made by the marketing theme. Two conflicting challenges an international brand
has to face are to remain easily recognized at any global location and simultaneously should
be able to blend with the local culture, traditions and customers' way of perception.
In the international branding process, the challenges increase many folds. Therefore, the
process of building a strong brand is a complicated and challenging task.
12. Brand value builds customer confidence and loyalty. (true/false)

13. International branding is all about differentiating between being global and being
local. (true/false)
14. The task of building a brand is:
A) Complicated.
B) Easy.
C) Critical.
D) Moderate.

6. SUMMARY
Let us summarize the points covered in this unit about international marketing:
• Selling a product involves considering the needs of the customers. In order to build the
customer base, the firms have to take up an advertising activity.
• Firms, both global and local, have to advertise their products in order to inform the
customers about the benefits and features of the product. International marketing or
advertising differs from domestic or local marketing as the communication process is
across cultures, geographic conditions and tastes and preferences of the people.
• A firm has to develop global marketing strategies in order to deal with protectionism.
The goal of a firm to move to a foreign country is to exploit the market there.
• The different approaches for global marketing are segmentation, market positioning,
branding, promotions, competitive pricing and so on.
• Segmentation is the process of dividing the market into clusters and then positioning
the product with respect to the segment and target audience.
• The pricing decision has to be competitive as there could be local firms competing.
7. GLOSSARY
Arm’s length pricing rule: This is defined as the price a buyer is willing to pay for an
identical item under identical terms and conditions.
Foreign investment: It is the long-term participation of a firm in a foreign country to do

business.
Non-current asset: It is an asset that will not convert to cash within the next year.
Piggyback exporting: Practice of a foreign seller representing complementary, non-

competing lines. Here an exporter is using another exporter as an intermediary

1. Discuss the process of scanning the global markets for international marketing
opportunities.
2. Elaborate the various methods of entering into international markets.
3. Write a short note on two of the following:
a. Joint ventures.
b. Licensing.
c. Wholly owned subsidiary.
d. Direct exporting.
4. Write a note on global marketing strategies.
5. What is transfer pricing?
6. What are the factors considered while branding a product or service in an international
market?
9. ANSWERS
1. False
2. True
3. Exporting
4. Manufacturing
5. a) two or more firms
6. False
7. Non-personal
8. Public relations
9. Brand
10. True
11. Pricing
12. True
13. False
14. A) Complicated

Terminal Questions
1. The firm’s sustainable competitive advantages shall be based on the assessment and
appraisal that how effectively the various competitive advances will blend with the
important features of that market. Refer to section 2 for details.
2. There are several methods used in the global era for international market entry. Please
refer to section 3 for details.
3. The modes of entry are explained in detail in section 3. Please refer to the same.
4. Different global marketing strategies regarding market segmentation, market
positioning, advertising is explained in section 4 Refer the same for details.
5. Transfer pricing is usually used by companies to reduce the tax levied on them. This is
explained in sub-section 4.5. Refer the same for details.
6. To respond to the global market, international firms need to have a coordinated and
integrated international branding strategy in place. These are explained in section 5.
Refer the same for details.
10. CASELET
Flatbread goes around the world

ABC Ltd. is located near El Mante, Mexico and produces corn flour and other flour products
which it processes into tortillas and related snacks for markets worldwide. Its brand names
include X, Y and Z. Its customers include supermarkets, mass merchandisers, smaller
independent stores, restaurant chains, food service distributors and schools. The company
was established in 1949. In the early 1970s, ABC Ltd. introduced its product on the central
american markets, specifically in Costa Rica. In 1976, it expanded to the United States and
in 1987 it began expanding its operations across the globe, opening plants in Honduras, El
Salvador, Guatemala and Venezuela. It now has plants in Europe and most recently China.
The Asian market presents a very exciting development for ABC Ltd. The company
established their presence on continental China in the first instance and then gradually
expanded their penetration of markets across Asia to the middle east. It has already
established distributorships in Japan, Korea, Singapore, Hong Kong, Thailand, the
Philippines, Taiwan and India.

How has a Mexican company with a niche food product like corn flour succeed so well in
international markets?
The answer is that the firm has focused on emerging markets which follow the same path of
development. In these emerging markets, the customer demand is predictable as it follows a
pattern and this is evident in every major economic segment. What ABC Ltd. is following in
their international expansion is the tried and tested method of leveraging the similarities
across from market to market and growing their company accordingly. The root of the
success of ABC Ltd. has been their ability to observe the life cycle of emerging markets
around the world and expertly time their entry into these markets.
However, the other key factor has been their ability to adapt their products to local market
tastes. Their key competitive advantage in international markets is based not on their
product, but the ability to roll any kind of flour from rice to corn to wheat into viable
flatbread. In India, many people eat a flatbread made form wheat called naan, but do not eat
corn tortillas. So, ABC Ltd. plans to sell corn tortillas in India. The Chinese do not eat many
corn tortillas, but they buy wraps made by ABC Ltd. for Peking duck. Also follows a policy of
deploying a senior ‘beachhead’ team to enter the new market in which they are building a
presence. In China, the beachhead team had enhanced their skills through many years of
experience in Latin America and was already primed to develop the necessary market
insights to feed into their marketing campaign. some of the observed trends in China are
decrease in home cooking among dual-career couples, increase in the number of fast food
chains, increase in cold storage refrigeration in supermarkets and rapid improvements in
the logistics and distribution channels were all utilised in thinking through the ABC Ltd.
market-building strategy in China.
Discussion question
1. Evaluate the reasons behind the success of abc ltd. (Hint: focusing on emerging markets)
Source: http://estore.bized.co.uk/freecontent/300081f9.pdf

References:
• Colin Gilligan, Martin Hird (1986). International marketing: Strategy and

Management.(1st Ed) Croom Helm Pub
• Kumar N (2002). International marketing, (1st Ed ) Anmol publication.
• Roger Bennett, Jim Blythe (2002). International marketing: Strategy planning, market
entry. (3rd Ed) Kogan Page
• Sean De Burca, Richard Fletcher And Linden Brown (2004), international marketing:
an SME perspective, (!st Ed) London: Ft - Prentice Hall.
• Michael R. Czinkota, Ilkka A. Ronkainen.(2001), International marketing, Fort
Worth;(8th Ed) London: Harcourt college publishers.
• Vern Terpstra, Ravi Sarathy (2000), international marketing, Dryden press.
• Michael R. Czinkota, best practices in international marketing, the Harcourt college
publishers series in marketing.
E-References:
• Http://www.consumerpsychologist.com/international_marketing.html, retrieved on
2nd November, 2010
• Http://www.slideshare.net/chanvich/international-pricing-decisions-for- upload,
retrieved on 31st October 2010


SEMESTER 4
DMBA402
MANAGEMENT
Unit 11: International Strategic Management 1

Unit 11
International Strategic Management
Table of Contents

No Graph Activity
1 Introduction - -
3
2 Strategic Management - 1, I
2.1 Nature of international strategic
- -
management 4-9
2.2 Advantages and disadvantages of
- -
formulating strategy
3 Strategic Planning - 2, II
3.1 Types of planning - -
10 - 14
3.2 GAP analysis - -
3.3 Top-down vs. bottom-up planning - -
4 Strategic Management Process 1 3, III
4.1 Strategy formulation - - 15 - 19
4.2 Strategic implementation - -
5 Summary - 20 - 21
6 Glossary - - 21
8 Answers - - 22 - 23
9 Case-let
- - 24 - 26

1. INTRODUCTION
In the previous unit, you learned about international marketing and scanning the market.
You also learned about various modes of entry into the international market. The global
marketing strategies were also highlighted for your understanding. In this unit, we will
discuss more about international strategic management. International strategic
management refers to strategy planning in international business to compete and ensure
that there is a long-term strategy for survival. Strategic management focuses on developing
a strong structure for an organization's business that will gradually be changed by combining
the efforts of each individual that the organization employs.
❖ Explain the nature of international strategic management.

❖ List the advantages and disadvantages of strategy in international business.
❖ Discuss strategic planning and its types.
❖ Describe strategic management process.

2. STRATEGIC MANAGEMENT
The nature of strategic management plays a vital role in the international business world. It
is important to understand the term ‘strategic management’ before discussing its nature.
The term strategic management refers to the complete range of strategic- decision making
activity in an organization. Strategic management identifies and comprehends the
environmental factors to control the plans accordingly. It has evolved as a concept over time
and will continue to evolve.
Strategic Management is an ongoing management planning process that aims at building

strategies to help an organization expand abroad and compete internationally.
2.1 Nature Of International Strategic Management
Strategic management focuses on the process of formulating, implementing, and evaluating

strategies to achieve the objectives of an organization. The concept of strategic management
process in an MNC is similar to that of any other organization. However, before considering
various strategic options, the strategic management process has to analyze and understand
the environmental needs from a regional and country perspective. Both time and effort go
into identifying and evaluating external trends and events in MNCs. Communication between
home offices and overseas operations has become complicated because of cultural and
national differences, geographic distances and variations in business practices. The strategy
implementation becomes difficult as different cultures involve varied values and work
ethics.
Strategic management holds significance in international business. An MNC has to keep track
of their various operations in an ever-changing international environment.
Strategic objectives
Strategic objectives assist in the implementation process of the organization's objectives or

goals. While implementing an international strategy, an organization has to identify the
opportunities present in these countries, explore the various resources available, their
strengths and capabilities and plan to work on their core competencies. The objectives

should be measurable. The strategic objectives must help the organization to achieve their
mission and vision.
Most strategic objectives focus on generating greater profits and returns for the business
owners; others focus on customers or society at large. The strategic objectives (SMART) are
as follows:
• Specific: A clear message as to what needs to be achieved must be provided.

• Measurable: There must be at least one indicator to measure progress against fulfilling
the objective.
• Appropriate: The objectives must be consistent with the given vision and mission of
the organization.
• Realistic: The objectives must be achievable given the organization’s abilities and
opportunities in the environment. This means that the objectives must be challenging
and attainable.
• Timely: To accomplish the objective there must be a time frame.
Two more aspects have been added to the objectives and it has now become SMARTER. They
are ‘Ethical’ and ‘Recorded’.
When strategic objectives are thoroughly implemented, it will result in strategic

competitiveness that improves the performance and innovation of these organizations. The
advantages of preparing strategic objectives are:
• First, they guide employees of an organization towards achieving common goals. This
aids the organization to concentrate and conserve valuable resources and work
together in a timely manner.
• Second, challenging objectives encourage and inspire employees to demonstrate higher
levels of commitment and effort. Research has supported the concept that individuals
work harder when they are motivated towards a specific goal, rather than being asked
to simply do their best.

• Third, different parts of an organization always have the potential to follow their own
goals rather than the overall company goals. Though the intentions are good, they may
work at cross purposes to the
• organization as a whole. Thus, meaningful objectives help resolve divergence in such
instances.
• Finally, appropriate objectives offer a standard for rewards and incentives. They not
only result in higher levels of motivation for employees but they also ensure a greater
sense of equality or fairness when rewards are allocated.
There are other objectives that are more specific. These are commonly referred to as short-
term objectives that are essential components of action plans. They play a critical role in
implementing an organization's chosen strategy.
Strategic alliances
In today’s trade, the increasing number of strategic alliances stands as one among the fastest-
growing developments. According to Booz-Allen and Hamilton, strategic alliances are far-
reaching through nearly every industry and are becoming an important driver of higher
growth. Alliances vary in scope from an informal business association based on a simple
contract to a joint project agreement. To manage the alliance for legal and tax purposes
either a corporation or partnership is set up.
Strategic alliances involve organizations working together towards a common goal for small
businesses, without losing their individuality. Forming strategic alliances helps one reap
considerable profits as well as obtain rewards of team effort. Statistical studies claim
organizations that take part in alliances account for 18 percent of their profits that come
from their alliances.
But it is not just profit that encourages the increase in alliances. The other factors are: a
growing intensity of competition, a rising need to operate on a global scale, a fast-varying
marketplace, and an industry union in many markets. Particularly in a time when upcoming
international marketing is becoming the standard, these alliances and partnerships can
influence the growth. Instead of taking the risk and expense that international expansion

requires, any organization can enter the international market by identifying a suitable
alliance with a business operating in the marketplace that the organization wants to enter.
A strategic alliance is basically a partnership in which the organizations unite by entrusting

efforts on a certain project. The efforts exerted on the project include getting a better price
for supplies, purchasing bulk products and building them with each of the organizations that
are a part of its production. The goal of alliances is to reduce risk while increasing power and
profit. Alliances should not be confused with acquisitions, mergers and outsourcing.
However, there are some similarities in the situation in which a business may consider one
of these solutions. Mergers and acquisitions are everlasting and determine the survival of
the organization. Outsourcing is just a way of attaining a functional service for the company.
An alliance is basically a business-to-business partnership. Another term that is commonly

used in combination with alliances is establishing a business network. Alliances are formed
for joint production, design collaboration, joint marketing, joint sales or distribution,
technology licensing, and research and development. The relationship between a vendor and
a customer is vertical, while the relationship between vendors situated locally or globally is
horizontal. Alliances are established formally in a joint project or partnership.
Strategic alliances are used in businesses to:
• Attain advantages of scope and speed.

• Boost market access.
• Improve competitiveness in domestic or global markets.
• Improve product development.
• Increase new business opportunities through new products and services.
• Enlarge market development.
• Enhance exports.
• Diversify.
• Make new businesses.
• Minimize costs.

Strategic alliances are becoming a common tool for increasing the reach of the organization
without exerting organization to expensive internal expansions beyond the core business.
2.2 Advantages and Disadvantages Of Formulating Strategy
The advantages of a well-structured strategy in international business are:
• It provides proper guidance in business.

• It alerts the manager about new opportunities and threats.
• It aligns members to work towards common goals that are set.
• It facilitates management to become more proactive than reactive.
• It helps the decision-making course of assigning resources.
The problems in strategic management are:
• As it is tough to predict the future, it becomes difficult to anticipate the

• forthcoming environment for developing plans or strategies.
• It is expensive to hire an external consultant to develop strategies. It is prudent to
address the immediate crisis before allocating resources (like opportunity cost, people,
money, time) to strategic management process.
• Sometimes few opportunities might be available in firms after completing a strategic
management process. The firm may want to consider them which becomes difficult
then.
1. The nature of _________ plays a vital role in the international business world.
2. The strategic objectives should be measurable, appropriate, realistic, specific, and
timely. (True/False)
3. _____________ is a way of attaining a functional service for the company.

Activity I
Assume that you own a company that manufacturestoys for the international market. Your
specialty lies in integrating the cultural and religious aspects into toys. Mention in terms of
strategic objectives, how you would frameyour objectives, and what steps you would take
to be better accepted internationally.
Hint: Identify cultural differences, plan strategy to combat the same and for alliances.

3. STRATEGIC PLANNING
We had discussed strategic management in the previous section. In this section we will learn
about the key components of strategic management, that is strategic planning and its types.
Strategic planning involves the structured efforts of an organization to effectively recognize

its purposes for existing, the direction that the organization will pursue, and how that
direction will allow the entity to achieve its short-term and long-term goals. Strategic
planning is an important element in all kinds of organizations and is applied by governments,
non-profit agencies, individuals and businesses.
A simple approach to strategic planning is discussed below:
1. The first step is to accurately assess where the entity is today, with respect to its ability
and resources.
2. The second step is to recognize where the organization would like to reach at some
specific point of time in the future, by efficiently setting goals and objectives that it
needs to accomplish.
3. The third and final step involves choosing how to successfully progress from the
conditions of today and methodically work toward those goals in a structured and
logical manner.
During the strategic planning process, experts employ many ways, and sometimes break
down each process into a series of steps. The complexity of the exact approach used
frequently comprises of the nature of the organization, the kind of goals laid down and the
resources needed to attain those goals.
3.1 Types Of Planning
Strategic planning process involves allocation of resources to firms to fulfil their long-term
goals. Any business plan can be classified into three types. They are:
• Strategic planning: This planning process is the best among the three business
planning processes. It is a long-term process that the business owners utilize to unveil
their business’ vision and mission. It also determines a gateway for business owners

for achieving their goals. Strategic planning fulfills the mission and the overall goals of
the firm. Whereas, the other two are rather more short-term and are used sometimes
without any relation to the long-term business goals. However, these three kinds of
planning work well when used within a strategic plan.
• Intermediate planning: This planning process is for six months to two years. They
outline the manner in which the strategic plan is pursued. Intermediate plans are often
used for campaigns with the purpose and goal of supporting the trades’ long-term goals.
• Short-term planning: This planning process involves planning for a few weeks or at
least for a year. It involves detailing the functioning of a strategic plan on a daily basis.
Resources are allocated for business management and development that takes place
daily within the strategic plan.
3.2 GAP Analysis
A GAP analysis is a simple tool that helps the planning team to identify methods to close the
performance gaps. The current affairs and the required future state must be considered by
the planning team. It must be made clear whether or not the gap can feasibly be closed by
the planning team. The performance gap is closed by modifying resources from activities to
be terminated to activities to be started. If there is uncertainty that the initial gap cannot be
closed, then the feasibility of the required future state must be reconsidered.
Businesses implement gap analysis to accomplish company-wide goals, or those for a specific
department or area. For example, a firm that wishes to reduce overhead costs creates a
financial gap analysis. Or an organization that wants to enlarge its product distribution might
come up with a marketing analysis. Gap analysis helps businesses measure their possible
profitability of a goal. This helps the management and staff to understand the plans laid out
in the analysis as well as stay eager about it.
3.3 Top-down vs. bottom-up planning
Top-down planning
Top-down planning is a common strategy that is used for project planning. It helps maintain
the decision-making process at the senior level. Goals and allowances are established at the

highest level. Senior-level managers have to be very specific when laying out expectations
because the people following the plan are not involved in the planning process. It is very
important to keep the morale of the employees high and motivate them to perform the job.
Since employees are not included in any of the decision-making processes, they are
motivated only through fear or incentives.
Management must choose techniques to align projects and goals with top- down planning.
Management alone is held responsible for the plans set and the end result. The benefit of
talented employees with prior experience on definite aspects of the project are not utilized
based on the assumption that the management can plan and perform a project better without
the input from these employees. Some think that the top-down planning process is the right
way to make a plan, and that plan development is not important. It permits the management
to segregate a project into steps, and then break the work into smaller executable parts of
the project. Simultaneously, the work that is broken down is analyzed until all the steps can
be studied, due-dates are precisely assigned, and then parts of the project are given to
employees. However, the focus is on long-term goals and the short-term and uncertain goals
can get lost. This approach is most applicable for small projects.
Bottom-up planning
Bottom-up planning is commonly referred to as tactics. With bottom-up planning, an

organization gives its project deeper focus because each organization has a huge number of
employees involved, and each employee is an expert in their own area. Team members work
side-by-side and contribute during each stage of the process. Plans are developed at the
lowest levels, and then passed on to each of the subsequent higher levels. Finally, it then
reaches the senior management for approval.
Lower-level employees take personal interest in a plan that they are involved in planning.
Employees are more encouraged, which in turn improves their morale. Project managers are
responsible for the successful completion of the project. Let us now consider the key points
of top-down and bottom-up planning.

Top-down planning
Top-down planning helps:
• Determine all the goals at the initial stage of the process.

• Identify the lack of ground level staff participation.
• Estimate the inflexibility.
• Find out how management imposes the processes.
• Determine the lack of motivation.
• Find out whether the staff feel that their input is valued or not.
Bottom-up planning
Bottom-up planning helps:
• As there is no long-term vision here.

• Encourage teamwork.
• Estimate flexibility.
• Determine whether team motivation is of a high level.
• Identify whether the project is team driven.
• Find out whether the staff feels valued or not.
Finally, a combination of these two project management methods is most effective. Using the
positive aspects of each, the organization can align each step so that the requirements of the
project are met. An organization can determine the top requirements of the project and allow
accountability to get down with the lower levels. With this combination, the vision of senior
management with the skills of lower-level employees is merged. This helps in completion of
the project more efficiently using the best employees of the organization.

4. A _______________ is a simple tool that helps the planning team identify methods to
close the performance gaps that have been identified.
5. Top-down planning encourages teamwork. (True/False)
6. ___________- are responsible for the successful completion of the project.
Activity II
Assume that you are the manager of an international chemical dyeing firm that is undergoing
a technological change in one of its main units. How will you implement your strategic
planning so that employees accept and adopt change?
Hint: Use Bottom-up planning.

4. STRATEGIC MANAGEMENT PROCESS
In the previous section we learnt about strategic planning and its types. In this section, we
will discuss the strategic management process.
Strategic management process is the way businesses build strategies that help firms respond
quickly to new challenges. This process helps organizations to find new and more efficient
ways to do business.
The organization should have a good strategic plan that clearly describes objectives and
evaluates both the internal and external situation to establish the strategy, implement,
evaluate, and make necessary changes to stay as per the vision and mission of the
organization. A pictorial representation of the strategic planning process is shown in figure
11.1.
Figure 11.1: Strategic Management Process
The five levels of the strategic management process are:
1. Mission and objectives: The mission defines the organization's existence. The purpose
of the organization is stated by a mission statement. The mission statement projects
the organization's image to customers and conveys a purpose to its employees. The
goals of the organization are called objectives. These objectives are challenging by
nature but achievable. Objectives should be measurable so that the company can keep
track of its progress and make modifications, if necessary.
2. Situation analysis: After specifying the objectives, the organization must devise a
strategic plan to attain them. New opportunities and methods are adopted to attain the
objectives when there are changes in the external environment. Thereby, an
environmental scan is conducted to find the opportunities. To select opportunities, the
organization has to know its own abilities and limitations. Situation analysis includes
analysis of both external and internal environment. The external environment consists
of political, social, technological and other factors. It also analyses the functionality of

the organization. The internal environment consists of situations like organizational

structure, market share, operational efficiency and others. Situation analysis provides
huge amounts of information. To efficiently manage this information, the internal
factors should be categorized into strengths and weaknesses of the organization and
external factors should be categorized into opportunities and threats.
3. Strategy formulation: After getting a clear picture of the organizational goals, the
strategic alternatives are developed. Depending on the organization's situations,
different organizations adopt different alternatives. Michael Porter’s identified generic
strategies could be applied to all organizations with includes cost leadership,
differentiation, cost focus and differentiation focus. All these can be considered while
defining strategic alternatives.
4. Implementation: The strategy is expressed in high-level conceptual terms. The
conceptual terms should be translated into detailed policies for effective
implementation and also for the understanding of the functional level of the
organization. The functional policies should also state practical issues clearly. The
strategy must be translated into specific policies for functional areas like marketing,
production, research and development, human resources, information system and
others. The implementation stage also involves finding the required resources and
categorizing organizational changes.
5. Evaluation and control: After implementation, the outcome of the strategy must be
measured and evaluated along with the changes that have been made. To do this,
monitoring control-systems are developed and implemented. The steps involved in
evaluation and control are to:
1. Describe the parameters to be measured.
2. Describe the target values for those parameters.
3. Carry out measurements.
4. Compare the measured results to the pre-defined standard.
5. Make necessary changes.

4.1 Strategy Formulation
Strategy formulation is the second phase in the strategic management process. It is the
process of deciding the best course of action for accomplishing organizational objectives and
achieving organizational purposes. In fact, objectives and strategies are modified many times
to make the organization more successful. This includes creating sustainable competitive
advantages though most of them are swept out gradually by the competitors’ efforts.
There are three aspects of strategy formulation. Each aspect has a different focus that
includes requirements to be met within the formulation stage of strategic management. The
three aspects of recommendations must be internally steady and match together in a jointly
supportive manner that outlines an integrated hierarchy of strategy. The three aspects are:
• Corporate level strategy.

• Business level strategy or competitive strategy.
• Functional strategy.
Corporate level strategy: This aspect of strategy is concerned with the broad decisions
about the overall organization's scope and direction. Basically, the changes which should be
made in the growth objective and strategy for achieving the objective are considered, the
lines of business at present and how these lines of business go together. The three
components of corporate level strategy are:
• Directional or growth strategy: This designs the organization's growth objective. The
objectives range from cutback through stability to altering levels of growth and how
the organization accomplishes them.
• Portfolio strategy: This strategic activity plans the organization's portfolio in line with
those businesses, which needs reconsidering and, if so, how much concentration or
diversification the organization should have.
• Parenting strategy: This defines the way the organization assigns resources and
manages abilities and activities across the portfolio, where to emphasize, and how
much the organization should integrate into its various lines of business.

Business level strategy or competitive strategy: This is also called business level strategy.
It involves deciding how the organization would compete within each line of business or
strategic business unit.
Functional strategy: Functional strategies are more localized with shorter- horizon
activities. They deal with how each functional area and unit performs its functional activities
to be effective and increase resource productivity.
4.2 Strategic Implementation
Strategy implementation is one of the stages of strategic management. It refers to decisions

that are made to lay out a new strategy or reinforce present strategies. The basic activities
of strategic implementation are to establish annual objectives, devise policies and allocate
resources. In addition, strategy implementation also includes decision making with respect
to strategy and organizational structure, developing budgets and motivational systems. The
features of strategic implementation are to:
• Establish annual objectives.

• Devise policies.
• Motivate employees.
• Allocate resources.
• Develop strategy-supportive culture.
• Create organizational structure.
• Redirect the marketing efforts.
• Prepare budgets.
• Develop information system.

Activity III
A firm is in the business of detergent production which caters to the rural and suburban
areas of Uttar Pradesh. Due to the entry of international players it is facing increasing
competition from branded products.After review meetings, the management decides to
concentrate on controlling costs. It is decided to recast/reengineer the full production and
marketing processes so as to reduce waste. The firm is also planning to to re- negotiate
with its suppliers s to minimise cost of inputs. There are certain limittions to cost cutting
as the firm cannot compromise on quality and social issues. Suppliers of inputs are also
reluctant to yield to pressures of renegotiating the cost of raw materials. After some time,
sales of the firm has started declining very fast. What other steps can the management of
the firm plan in order to cope with the growing competition?
Hint: Read the success story of Ghari Detergent at http://www.business-
standard.com/india/news/watch-out-for-ghari-express/413280/
7. The ________________ process is the way businesses build strategies that

help firms respond quickly to new challenges.
8. The kind of strategy concerned with broad decisions about the total
organization's scope and direction is ________ .
a) Business level strategy
b) Corporate level strategy
c) Functional strategy
d) Competitive strategy
9. One of the phases of strategic management process which includes decision
making with respect to strategy and organizational structure; develop
budgets and motivational systems is ___________ .

5. SUMMARY
Let us summarize the points covered in this unit about international strategic management:
• International strategic management refers to planning the strategy in international

business to compete and also ensure that they have a long-term strategy for survival.
• Strategic management focuses on the process of formulating, implementing and
evaluating strategies to achieve the objectives of an organization.
• Strategic objectives assist in the implementation process of the organization's
objectives or goals. Most strategic objectives focus on producing greater profits and
returns for the business owners; others focus on customers or society at large.
• Strategic alliances are the means to work together with others towards a common goal
for small businesses without losing their individuality.
• Alliances are a way to obtain the rewards of team effort and one can reap considerable
profits from forming strategic alliances.
• Strategy in international business has various advantages and disadvantages.
• Strategic planning involves the structured efforts of an organization to effectively
recognize its purposes for existing, the direction that the organization will pursue and
how that direction will allow the entity to achieve its short-term and long-term goals.
• The strategic planning process involves allocation of resources to firms to fulfill their
long-term goals. The three types of planning are strategic planning, intermediate
planning and short-term planning.
• A GAP analysis is a simple tool that helps the planning team to identify methods to close
performance gaps. Gap analysis helps businesses measure their possible profitability
of a goal.
• Top-down planning is a common strategy that is used for project planning. It helps
maintain the decision-making process at the senior level. Goals and allowances are
established at the highest level.
• In bottom-up planning, an organization gives its project deeper focus because the
organization has a huge number of employees involved and each employee is an expert
in their own area. Team members work side-by-side and they contribute during each
stage of the process.

• The concept of strategic management is still evolving and will continue to undergo
changes. Thus, understanding and following the process of strategic management in
international business is helpful for practicing managers in achieving the organizations'
objectives.
6. GLOSSARY
Regulatory bodies: These are professional bodies established on the basis of legal mandate
to protect the public.
Uncertainty: It is the situation where the consequences of events are unpredictable.
MNC: Acronym for multinational company.
Strategy: Plan of action designed to achieve a specific objective.
Alliances: An agreement between two or more entities to achieve a common goal.
Partnership: An arrangement where individuals agree to cooperate towards a common goal.
Mergers: Combination of two or more companies, usually by offering the stockholders of

one company securities in the acquiring company for the surrender of their stock.
Acquisitions: Corporate action in which a company buys most or all the target company's
ownership stakes to assume control of the target firm.

1. Explain strategic objectives and alliances.

2. What is strategic planning?
3. Explain top-down and bottom-up planning.
4. What is Strategic management process?
5. Explain strategy formulation and implementation.
8. ANSWERS
1. Strategic management.
2. True.
3. Outsourcing.
4. GAP analysis.
5. False.
6. Project managers.
7. Strategic management.
8. b) corporate level strategy.
9. Strategy implementation.
Terminal Questions
1. In order to measure the fulfilment of the objectives, strategic objectives need to be

implemented. Strategic alliances are far-reaching through nearly every industry. These
are explained in sub-section 2 of this unit. Refer the same for details.
2. Strategic planning involves the structured efforts of an organization to effectively
recognize its purposes for existing, the direction that the organization will pursue and
how that direction will allow the entity to achieve its short-term and long-term goals.
These are explained in sub- section 3 of this unit. Refer the same for details.
3. Top-down planning is commonly referred to as strategy. Bottom-up planning is
commonly referred to as tactics. These are explained in sub- section 3.3 of this unit.

4. The strategic management process is the way businesses build strategies that help the
company respond quickly to new challenges. The five levels of management process are
explained in sub-section 4 of this unit. Refer the same for details.
5. Strategy formulation is the second phase in the strategic management process. Strategy
implementation is one of the stages of strategic management. These are explained in
sub-section 4.1 and 4.2 of this unit. Refer the same for details.

9. CASE-LET
Magazine Distribution – GAP Analysis
Company PQR is the top bio-medical magazine in Pune. The vision of Company PQR was to
be the top distributor throughout India and also expand their operation abroad. Company
PQR initially completed an analysis showing how it got to be the top regional, then top
national magazine distributor. This includes an overview of every aspect of the business that
contributes to the Company PQR's success, including marketing, accounting, information
technology, management and other departments.
Company PQR outlined the advantages of achieving its goal of becoming the top distributor
in the country as well as internationally. Goals were designed that were specific and
measurable. There was a time frame set for regional supremacy. In this case, Company PQR
planned to become the top nationwide magazine distributor within two years. They achieved
their primary goal of nationwide popularity by bringing innovative schemes that attracted
consumers to buy the same. They brought out an exclusive section for researchers who were
in the field. Company PQR then researched as to how they would achieve international
distributor and what it requires to do to arrive at this goal. The outcome of Company PQR's
analysis was a complete plan that analyzed the competitor analysis using Porter’s model as
to what they required to do so that they can see their goal of international distribution. The
aim was to achieve international reach as they coordinated with scientists abroad. They
shared information on various aspects of the bio-medical field. There were many seminars
organized and eminent scientists were recognized.
At the next step, they gathered information and conducted GAP analysis to see where they
lacked. The analysis includes a review of competitors, knowing the needs of the foreign
customers, and also interviews with staff members to find out their strengths. After
gathering all the information, a gap analysis report was tabulated.
The report provided a summary of the present situation, the goals the company wishes to
achieve and the steps they had to implement to achieve these goals. The steps were analyzed
into strategic planning. This plan includes detailed action steps of the business for each area,
an agenda to complete each step and a plan that outlines how much the plan will cost.

The next and final step was for the management to approve and support the action plan and
confirm the budget. The plan was put into action. Each step was tracked to assure that the
plan stays as per the agenda and within the allotted budget. The success of the Indian bio-
medical magazine in foreign shores was the talk of the town that year.
1. What did the initial analysis include? (Hint: Review of current system)
2. What does the gap analysis report include (Hint: Refer the steps, summary, plan)
Sources: http://www.wisegeek.com/what-is-gap-analysis.htm – retrieved on 15th

November 2010
References:
• K.Aswathappa (2008). International Business (8th Ed) Tata McGraw Hill

Publishing Company Limited.
• Geoff Goldman, Cecile Nieuwenhuizen (2006). Strategy: Sustaining Competitive
Advantage in a Globalized Context. Juta and Co.
• Mike W Peng (2009), Global Strategic Management, (2nd Ed) Cengage, London.
• Phillippe Lesserre (2007), Global Strategic Management, (2nd Ed) Palgrave Macmillan.
• Gerardo R Ungson & Yim Yu Wang, (2008), Global Strategic Management, Library of
Congress Cataloging in Publication Data.
• Abbass F Alkhafaji, (2003), Strategic Management,
Formulation Implementation in dynamic environment, Haworth Press.
E-Reference:
• http://www.smallbusinessnotes.com/operating/leadership/strategi calliances.html,
retrieved on 10th November, 2010
• http://www.referenceforbusiness.com/management/Sc-Str/Strategy-
Formulation.html, retrieved on 5th November, 2010
• http://ezinearticles.com/?Types-of-Strategic-Planning- Models&id=4892128,

• http://www.brighthub.com/office/project-management/articles/8542.aspx,
• http://www.strategicmarketsegmentation.com/strategic-planning- process-types-
and-elements-of-plans/ retrieved on 10th November, 2010


SEMESTER 4
DMBA402
MANAGEMENT
Unit 12: Ethics in International Business 1

Unit 12
Ethics in International Business
Table of Contents

No Graph Activity
1 Introduction - -
3
2 Business Ethics Factors - 1
4-6
2.1 Importance of business ethics - -
3 International Business and Ethics 1 2
3.1 Managing ethics - - 7 - 11

3.2 Free market ethics - -
4 National Differences in Ethics 2, 3 3,I
4.1 Negotiating across cultures - - 12 - 18
4.2 Ethical issues - -
5 Corporate Governance 4,5 4 , II
5.1 Code of conduct for MNCs - -
19 - 23
5.2 Corporate ethical programmes - -
5.3 Social responsibility and ethics - -
6 Summary - - 24
7 Glossary - - 24
9 Answers - - 25 - 26
10 Case-let
- - 27 - 28

1. INTRODUCTION
In the previous unit you learned about strategic management and the role of strategy in a
firm’s success. You also learned about the strategic management process.
In this unit, we will discuss ethics, which is an important part of managing an organization.
Ethics can be defined as the evaluation of moral values, principles, and standards of human
conduct and its application in daily life to determine acceptable human behavior.
Business ethics pertains to the application of ethics to business, and it is a matter of concern
in the corporate world. It is almost similar to the generally accepted norms and principles.
Behavior that is considered unethical and immoral in society, for example dishonesty,
applies to business as well.
This unit covers various topics on workplace ethics, its importance and application in a
global business environment. It also gives a perspective of business ethics practiced in
different countries. It includes the code of ethics, policies and procedures, and the general
code of conduct followed by multinational companies.
❖ Explain business ethics factors.

❖ Evaluate the importance of ethics in an international context across cultures.
❖ Explain the role of ethics in international business
❖ Describe the national differences in ethics.
❖ Analyse the corporate governance of an international business.

2. BUSINESS ETHICS FACTORS

During the mid 1960s and 1970s, social awareness movements raised expectations of
businesses to use their financial and social influence to address social issues such as poverty,
literacy, women rights, public health, and environmental protection. It was argued that these
businesses used community resources and profits generated by public participation to
address social issues. Hence, there arose a need for managers to take up the responsibility
to understand and address social issues guided by high ethical standards.
In this unit, let us learn the different factors that influence the ethics of a business and its
managers. Managers are influenced by three factors affecting ethical values. These factors
have unique value systems that have varying degrees of control over managers.
Religion – Religion is one of the oldest factors affecting ethics. Despite the differences in
religious teachings, all religions agree on the fundamental principles and ethics. All major
religions preach the need for high ethical standards, an orderly social system, and stress on
social responsibility as contributing factors to the general well-being.
Culture – Culture refers to a set of values and standards that define acceptable behavior
passed on to generations. These values and standards are important because the code of
conduct of people reflects on the culture they belong to. Civilization is the collective
experience that people have passed on through three distinct phases: the hunting and
gathering phase, agriculture phase, and the industrial phase. These phases reflect the
changing economic and social arrangements in human history.
Law – Law refers to the rules of conduct, approved by the legal system of a country or state
that guides human behavior. Laws change and evolve with emerging and changing issues.
Every organization is expected to abide by the law, but in the pursuit of profit, laws are
frequently violated. The most common breach of law in business is tax evasion, producing
inferior quality goods, and disregard for environmental protection laws.

2.1 Importance of business ethics
Ethics is significant in all areas of business and plays an important role in ensuring a
successful business. The role of business ethics is evident from the conception of an idea to
the sale of a product. In an organization, every division such as sales and marketing,
customer service, finance, and accounting and taxation has to follow certain ethics.
Public image – In order to gain public confidence and respect, organizations must ascertain
that they are honest in their transactions. The services or products of a business affect the
lives of thousands of people. It is important for the top management to set high ethical
standards for their employees who develop these services or products.
A company that is ethically and socially responsible has a better public image. People tend
to trust the products and services of such organizations. This in turn will help gain investors’
trust—a company that practices high ethical standards creates a positive impression among
its stakeholders.
Management’s credibility with employees – Common goals and values are developed
when employees feel that the management is ethical and genuine. Management’s credibility
with employees and the public are inter- related. Employees feel proud to be a part of an
organization that is respected by the public. Generous compensations and effective business
strategies do not always guarantee employee loyalty, organizational ethics are equally
significant. Thus, companies benefit from being ethical because they attract and retain good
and loyal employees.
Better decision-making – Ethical Decisions made by a management are in the best interest
of the organization, its employees, and the public. Ethical decisions take into account various
social, economic and ethical factors.
Profit maximization – Companies that emphasize ethical conduct are successful in the long
run, even though they lose money in the short run. Hence, a business that is inspired by ethics
is a profitable business. Costs of audit and investigation are lower in an ethical company.

Protection of society – In the absence of proper enforcement, organizations are responsible

to practice ethics and ensure mechanisms to prevent unlawful events. Thus, by propagating
ethical values, a business organization can save the resources of the government and protect
the society from exploitation.
1. The three factors governing ethical values are __________ , _________, and _________.
2. _____________ is the collective experience that people have passed on through the
hunting and gathering phase, agriculture phase, and the industrial phase.
3. A company can maximize its profits by being ethical. (True/False)

3. INTERNATIONAL BUSINESS AND ETHICS

In the previous section, you learned about ethics and its importance in business. Now let us
discuss the effects of ethics in international business.
Most countries have similar ethical values, but are practiced differently. This section deals
with the way individuals in different countries approach ethical issues, and their ethically
acceptable behavior. With the rise in global firms, issues related to ethical values and
traditions have become more common. These ethical issues create complications for Multi-
National Companies (MNCs) while dealing with other countries for business. Hence, many
companies have formulated well-designed codes of conduct to help their employees.
Two of the most prominent issues that managers in MNCs operating in foreign countries face
are bribery and corruption and worker compensation.
Bribery and corruption – Bribery can be defined as the act of offering, accepting, or
soliciting something of value for the purpose of influencing the action of officials in the
discharge of their duties. Corruption is the abuse of public office for personal gain. The issue
arises when there are differences in perception in different countries. For example, in the
Middle East, it is perfectly acceptable to give money to an official, whereas in Britain it is
considered an attempt to bribe the official, and hence, considered unlawful.
Worker compensation – Businesses invest in production facilities abroad because of the

availability of low-cost labor, which enables them to offer goods and services at a lower price
than their competitors. The issue arises when workers are exploited and are underpaid
compared to the workers in the parent country who are paid more for the same job. The
disparity arises due to the differences in the regulatory standards in the two countries.
3.1 Managing Ethics
Earlier, ethics was considered to be the exclusive perquisite of individuals. However, this
view has changed now. Many companies encourage ethical behavior in the organization with
the help of appropriate management techniques. Different techniques of managing ethics
like practicing ethics at the top-level management, special training on ethics, forming

committees to oversee ethical issues, and defining and implementing code of ethics are
illustrated in figure 12.1.
Figure 12.1: Techniques of Managing Ethics
Let us discuss each technique in detail.
Top management – It is important that the senior management is committed to ensuring

that the company is meeting ethical standards. The management must not engage in business
practices that will be harmful to the employees, or the society. The top management must
focus on ethical practices while informing employees of their intention.
Code of ethics – Forming a ‘corporate ethical statement’ and communicating it within the
company is one of the best practices for ethics. This will help in enhancing the company’s
public image. Almost all Fortune 500 companies have such codes.
Ethics committee – Ethics committees are formed to help the company deal with and advise
on issues related to professional ethics. The Chief Executive Officer (CEO) can head the
committee that includes the Board of Directors. Such a committee answers employees’
queries, helps the company to establish policies in uncertain areas, advises the Board on
ethical issues, and oversees the enforcement of the code of ethics.
Ethics hotline – Many companies have ethical hotlines to help the employees report any
ethical issues faced at work. The ethics committee then investigates these issues. Such calls
are treated confidentially, where the caller’s identity is protected. This will encourage
employees to bring such issues to the management’s notice.

The act of reporting illegal, immoral, or illegitimate practices by former or current employees
involving its employees is known as whistle-blowing. Whistle-blowing is favorable to a
company because employees can alert the management to possibly irregular and unusual
behavior rather than reporting it to the media, which adversely affects the company. A case
of whistle-blowing in Xerox corporation (a pioneer in copier machines), led its Chief
Financial Officer to be fined $ 5.5 million and be banned from practicing accountancy after
reports of falsified financial statements emerged.
Ethics training – Most firms take ethics seriously and provide training for their managers
and employees. Such training demonstrates the use of official policies in everyday decision-
making, which will help the employees become familiar with the policies. Ethics training is
most effective when conducted by managers and when focused on the work environment.
Ethics and law – Both law and ethics, though different, focus on defining the perfect human
behavior. Law is the government’s attempt to formalize rightful behavior. But the written
laws are hardly enforced. It depends on individuals or business ethics to reduce unlawful
incidents. Ethical concepts are more complex than written rules since it deals with human
dilemmas that go beyond the formal language of law.
Legal rules seek to promote ethical behavior in companies. The following are some of the
Acts which seek to ensure fair business practices in India:
• Foreign Exchange Management Act (FEMA) of 1999 – FEMA regulates the cross-border
movement of foreign and local currencies.
• Companies Act of 1956 – Companies Act provides the complete legal framework for the
formation, running, and winding up of a company.
• Consumer Protection Act of 1986 (CPA) – CPA provides and regulates the framework
for the protection of consumer rights.
• Essential Commodities Act of 1955 – This act defines the goods and services that are
essential for the people at all times and provides a legal framework for the
uninterrupted supply of the same.

3.2 Free Market Ethics
In this section, we will discuss the ethical aspects of competition used to explain free market
ethics. Competition is an important element that differentiates free market from command
market. It is a mechanism for free market production and distribution of goods and services
that are in demand. Competition in business is seen as an essential cultural trait of a free
market society. Most activities of the free market can be viewed as a competitive contest in
which businesses engage to provide products and services for profit.
In addition to the economic nature of the free market system, there are ethic-related issues
as well. The three widely accepted factors of ethics in the free market are market ethics, the
protestant ethics, and the liberty ethics. These three ethics set the stage for the industrial
revolution and the accompanying growth in business. During this period, industrial
capitalists were allowed to freely operate businesses, build large organizations, exploit
workers, and engage in fiercely competitive practices for profit and economic expansion.
Market ethics – Market ethics is the basic system of ethics followed by a business in a free
market scenario. It covers the entire spectrum of business including sales, pricing, and
competitor issues.
The protestant ethics – The protestant ethics consider ideology as an important factor
along with the moral aspects in a capitalist scenario. As an ideology, this ethic served to
legitimize the capitalistic system by providing a moral justification for the pursuit of profit
and distribution of income.
Liberty ethics – Liberty ethics encourage a person to play a participatory role in the
government, encourages private property, and introduces more freedom and individualism
in all spheres of life.

4. _____________ is an example of whistle-blowing in corporations.

5. In international business, ___________ and __________ are the prominent ethical issues
6. _____________ is an important element that differentiates free market and command
market.

4. NATIONAL DIFFERENCES IN ETHICS

In the previous section, we examined how ethics is significant internationally. In this section,
let us consider the differences in understanding ethics across countries. The differences in
national cultures have an impact on the social and ethical practices of multinational firms.
Cultural norms and values that usually influence business practices are attitudes towards
women, minorities, bribery, and law. Religion and law are the key social factors that
influence the type of ethical issues.
In MNCs, managers play a key role in managing ethics. While working in a foreign country, a
manager may not have a comprehensive knowledge of that country’s culture and social
factors that affect business. Therefore, the international manager needs to acquire adequate
knowledge of a country’s cultural, legal, and social scenarios to ascertain the important
ethical issues and to manage these issues. The approaches to understand national
Differences in ethics are ethical relativism, ethical universalism, and ethical convergence. Let
us discuss each of them in detail.
Ethical relativism and ethical universalism
Ethical relativism means that each country’s outlook on ethics must be considered valid and
ethical. This implies that if bribery is not unethical in a foreign country, then it is acceptable
for an MNC to encourage bribery even if it is illegal in its home country. Ethical relativism
means when a company deals with a host country for business, the international managers
must follow the ethical norms of the host country. Another example is the attitude towards
women employees in certain Arab countries. This attitude differs to a large extent compared
to western countries. In Saudi Arabia, women employees are segregated from their male
counterparts at the workplace. All companies, MNCs or local, must comply with these rules.
The principle of ethical universalism states that there are basic moral principles that are
valid across all cultural and political boundaries. For example, all countries forbid unethical
accounting practices and tax evasion.
Both these principles have drawbacks when in international business. Ethical relativism is a
convenient way to indulge in unethical practices with cultural differences as an excuse. The

universal approach can be perceived as cultural imperialism as business managers may

regard business practices in some countries as inferior or immoral.
Ethical convergence
Ethical convergence is defined as the practice of a uniform system of ethical codes in different
countries that are culturally and socially different.
There is a growing pressure on international business to follow a uniform set of guidelines

in managing ethical behavior and social responsibility across the countries in which they
operate. Some of the advantages of ethical convergence are:
• The growth of international trading blocks, such as North American Free Trade
Agreement (NAFTA) and the European Union promotes common ethical practices
across national cultures and borders to reduce institutional differences. Predictable
interaction and behavior among trading partners from different countries makes
trade more efficient.
• People from different cultural backgrounds increase their interactions and exposure
to varying ethical traditions. They adopt, adjust to, and imitate new behavior and
attitudes which leads to acceptance of best practices.
• International businesses have employees from different cultural backgrounds.
Companies rely on their corporate culture to provide consistent norms and values
that govern ethical issues to set common standards for employees from different
cultural backgrounds.
4.1 Negotiating Across Cultures
Negotiations in international businesses face cultural barriers. When people from two
different countries try to discuss commercial issues, they have to understand and
acknowledge any ethical issues that may come up. These standards of conduct and moral
judgement are the basis of an outcome. They can create misunderstandings if the messages
and views are misinterpreted. The basic concepts of fairness, dependability, politeness, and
punctuality have to be followed at all times. Given below are the two models of negotiating
as presented by Solomon and Bertrand:

• Linear model.
• Encompassing model.
Linear model – Linear model, illustrated by Figure 12.2, relates to the Chinese culture. The
first stage is the discussion of the goals and principles. In China, this stage is emphasized so
that foreigners understand their commitments. The second stage deals with bargaining
positions, which are the offers that are proposed. The third stage clarifies details and the last
stage involves implementing the process.
Figure 12.2: Linear Model of Negotiation
Encompassing model – The encompassing model, illustrated by Figure 12.3, is more

descriptive and includes stages that are identical to the linear model, but focusses on the
extent to which each stage is presented. The Chinese base their negotiations on improving
their national goals which include national development, growth, and improvement of the
overall quality of life in China. The western companies that operate in China are expected to
sacrifice their goals whenever necessary, so that the Chinese goals are achieved.
Firms base their negotiations on corporate objectives such as product quality, profit, and
maximizing shareholder value. Sacrificing such goals is against corporate responsibility,
hence is the main reason for negotiations.

Figure 12.3: Encompassing Model of Negotiation
4.2 Ethical Issues
International business managers face ethical issues that vary based on the market and
geography. Some of these issues have been widely publicized in the past. Most of these issues
are related to the safety and compensation practices of manufacturing plants in emerging
countries. Ethical considerations also tend to be connected to political situations. For
example, the decision to move a company’s headquarters elsewhere to reduce taxes becomes
a political issue due to the potential loss of tax revenue for that country.
Some other ethical issues are more subtle. Many firms forbid offering gifts in their home
countries. But in Japan, offering gifts and entertaining guests play a key role in building trust
and understanding with potential customers, suppliers, and government officials.
While there will always be issues about moral and ethical appropriateness, the boundary
between ethical and unethical business practices is reasonably clear in most societies. If the
boundary is not clear, the law is vague on a certain point, or firms act in an unacceptable
manner, then governments may have to take relevant actions against the erring parties.
Businesses must refrain from engaging in illegal activities, but the legislature in some
countries is not very clear and causes ambiguity. International business managers find it
difficult because legally and culturally acceptable activities in the home country may be
illegal and culturally unacceptable in the foreign country. The international manager has to
make prudent decisions on such occasions.

MNCs deal with issues related to ethics in foreign countries. Some of the issues are the
following:
• Conduct business in a country where the government violates human rights.

• Market a product in a country that lacks adequate consumer protection and product
liability laws.
• Sell products with harmful side effects, where there is a high level of illiteracy that
prevents the customers from following the directions for safe usage of a product.
• Be responsible for the end-user behavior that may not be legal.
• Bribe officials in a country where corruption is widespread.
• Follow local laws in areas such as employee safety and environmental protection that
are not as strict as in the home country.
• Change attitude towards female employees in a country where women do not enjoy the
same rights as men.
• Use tax avoidance strategies.
• Accomplish business goals with a firm engaged in practices that are illegal in the home
country.
Multinational firms should have a moral and ethical responsibility to ensure safe, fair,
environmentally sustainable, and legal work environment in emerging markets irrespective
of the local laws.
These are the issues that international businesses face when they conduct business in other
parts of the world, where the laws are different from their home countries.
Ethical decision making
In the previous section, you learned about the various ethical issues to be considered in an
international scenario, let us discuss the process of ethical decision making.
The competitive nature of business and the emphasis on profit causes managers to violate
business ethics. For example, employing workers in a foreign country, where wages are low
and working conditions are substandard. Ideally, a manager must consider all the choices
available to him and make a decision that does not violate the ethics of business.

There are many differences in opinion concerning business ethics. The following are four
approaches that help managers make the right decision.
• Utilitarian – Maximum benefit to the greatest number of people is the basis of this
approach. For example, in the case of low-wage foreign workers, the cost saving helps
the company perform better, but results in layoffs in the home country. If the manager
is not willing to employ low-wage workers, the company becomes uncompetitive which
in turn results in both foreign and domestic workers being laid off. On the other hand,
lower wages tend to bring down the level of wages for everyone, which decreases their
purchasing power and affects the sale of all the company’s goods in an economy.
• Moral rights – Morality is the basis of this approach without considering the
consequences. Paying someone extremely low wages is morally wrong. Those who
accept this approach believe that a business must not exist if the workers are not paid
adequately.
• Universalism – There are two steps in this approach. Firstly, one needs to decide if the
action being considered has to apply to everyone in all situations. Secondly, the same
action must be applied to the manager.
• Cost-benefit – The profitability of every action is analyzed. For example, the negative
publicity of paying extremely low wages weighed against being more competitive.
In conclusion, it is evident that a manager has several approaches to choose from. The
manager must take time to analyze all the possibilities, in order to make the right decision.
7. Ethical business practice in one country might differ from another country in
practice. (True/False)
8. _________ and _________ are the two models of negotiating.
9. _________ is defined as the practice of a uniform system of ethical codes in
different countries that are culturally and socially different.
10. Utilitarian, moral rights, universalism, and cost-benefit are approaches to
___________.

Activity I
Compare and describe the cultural differences between the US and India that give rise to
problems concerning business ethics.
Hint: Refer this link for guidance:
http://now2gether.org/submissions/Shen/DifferencebetweenAmerica& India.pdf

5. CORPORATE GOVERNANCE
Corporate governance refers to the mechanism to monitor managers of a company to ensure

that they fulfil the legal requirements of their role. Governance rests solely with the Board of
Directors, but the composition of the Board differs across countries. Hence, various bodies
from different countries have suggested methods of constituting a board. Some of these
corporate bodies include the Cadbury Committee and the Veinot Report in France.
Governance norms differ across countries, accounting standards, employment laws, and
legal framework. Table 12.1 illustrates the differences in some of the important corporate
governance issues in some of the developed countries.
Table 12.1: Corporate governance practices in developed countries

Practices Britain Germany Italy Japan USA
Independent
Yes No Yes Yes Yes
auditors
Rotation of Every 5–7 Every 9 Every 7 Every 5 years
No
auditors years years years
Executive pay on
shareholders’ Advisory No Yes Yes No
approval
Nomination of
independent
directors by No No Yes Yes No
shareholders
Majority of
independent Recomm- Recomm-
directors on the No No Yes
ended ended
Board
Separate Chairman
Recomm-
and CEO Yes Voluntary Voluntary Voluntary
ended

5.1 Code of Conduct For MNCS
The code of conduct for MNCs refers to a set of rules that guides corporate behavior. These
rules prescribe the duties and limitations of all employees, including the manager. The top
management must communicate the code of conduct to all members of the organization
along with their commitment to enforcing the code.
Some of the ethical requirements for international companies are as follows:
• Respect basic human rights.

• Minimize any negative impact on local economic policies.
• Maintain high standards of local political involvement.
• Transfer technology.
• Protect the environment.
• Protect the consumer.
• Employ labor practices that are not exploitative.
When a manager of an international firm faces an ethical problem, certain models help in
solving these ethical issues. Figure 12.4 depicts the process flow for ethical decision making
in an MNC.
The first task is to consider the ethical and legal consequences of the issue and whether the
action or its consequences are in accordance with the law, both in the home and host country.

Figure 12.4: Steps in Ethical Decision Making
The second task is to perform an ethical analysis, followed by a cultural and a personal ethical
analysis. An international manager begins with these analyses at different stages, but at some
point, a personal moral judgement is made. If the answer is negative to any of the first three
questions, the decision making is deferred.
5.2 Corporate Ethical Programs
Multinational firms face a wide array of ethical challenges as a result of increased

competition due to globalization. A formal corporate ethical program is important to any
organization. The following are some of the elements used by a corporate ethical program:
• Formal ethical codes that articulate expectations about ethics.

• Ethics committees that are empowered with developing policy and evaluating actions
of the company and its employees.
• Ethics communication systems where the employees report any misconduct.
• Ethics officers are charged with coordinating policies, educating employees on ethics
and investigating allegations.
• Training programs aimed at helping employees recognize and respond to ethical issues.

Given the broad range of potential ethical issues a multinational firm may encounter, the
code of conduct must meet the expectations of various parties involved. The code of conduct
must fulfil the following requirements:
• Be economically viable.
• Address major issues that are important to the company’s stakeholders.
• Engage important stakeholders in formulation and implementation.
• Specify performance standards that can be measured.
5.3 Social Responsibility And Ethics
International businesses face many challenges while undertaking social actions as part of
their corporate strategy. Corporate social strategy helps overcome such challenges. Starting
a corporate social strategy includes the following:
• Be socially responsible.
• Be responsive to stakeholders in each country.
• Be able to treat employees, customers, suppliers. and the local community in a fair and
just way.
• Abide by the host government's regulations and policies.
• Ensure that the employees and personnel of the company follow corporate policies.
• Recognize emerging issues in the host countries and communities.
• Conduct business in accordance with the values, customs, and moral principles of
society.
Organizations that adhere to these strategies are better equipped to react to global
challenges and corporate responsibilities. They are better prepared to prevent crises,
anticipate changes, and avoid situations that compromise the values and principles of the
organization.

11. Social responsibility is an integral part of business ethics. (True/False)

12. Respecting human rights is not a basic ethical requirement for an MNC.
(True/False)
13. Corporate _________ rests solely with the Board of Directors.
Activity II
Devise a model for corporate governance for an Indian company that does business outside
India, keeping in mind the current challenges that businesses face.
Hint: Refer section 12.5.

6. SUMMARY
Now let us summarize the salient features in this unit on ethics in international business:
• Ethics is significant in all areas of business and plays an important role in ensuring a
successful business. People tend to favor the products and services of a company that
is ethically and socially responsible. The different factors that influence the ethics of a
business and its management are religion, culture, and law.
• With the rise in global firms, issues related to ethical values and traditions have become
more common. Bribery, corruption, and worker compensation related issues are the
most common ethical issues that MNCs face.
• Negotiations across countries include the linear model where the principles are first
agreed upon, then the various positions are negotiated and details of the agreement are
finalized, followed by the process of implementation. The other model for negotiations
is the encompassing model, which is more descriptive and includes the same stages as
the linear model, but focuses on the extent to which each stage is presented.
• Four approaches that help managers make ethical decisions include utilitarian, moral
rights, universalism, and cost benefit approaches. The code of conduct for MNCs refers
to a set of rules that guides corporate behavior. These rules prescribe the duties and
limitations of a manager.
• Organizations that follow corporate social strategies like treating customers in the
home and foreign country alike, recognizing potential issues, and abiding by the host
government regulations are better equipped to react to global challenges and corporate
responsibilities.

7. GLOSSARY
Bribery: The financial inducement offered to persuade someone to act improperly in favour
of the person offering the bribe.
Whistle-blowing: The act of reporting a wrongdoing by a current or former employee of a

company.
1. Discuss the business ethic factors.

2. Explain the importance of business ethics.
3. Describe different techniques for managing ethics.
4. Analyse different models of negotiating.
5. Explain various steps involved in the ethical decision-making process of an MNC.
9. ANSWERS
1. Law, religion, and culture

2. Civilization
3. True
4. Xerox
5. Bribery and corruption and worker compensation
6. Competition
7. True
8. Linear and encompassing model
9. Ethical convergence
10. Ethical decision making
11. True
12. False
13. Governance

Terminal Questions
1. Ethics is the system of moral values and principles of human conduct and its application
in life. Religion, culture and law are the main factors governing business ethics. These
are explained in sub-section 2.1 of this unit. Refer the same for details.
2. Business ethics is important to an organization because it leads to a better public image,
increased credibility of management, helps in better decision making, and profit
maximization. These are explained in sub-section 2.1 of this unit. Refer the same for
details.
3. The techniques that can be used for managing ethics at the workplace include the
formation of an ethics committee, implementation of a code of ethics, setting up an
ethics hotline and training on ethics and so on. These are explained in sub-section 3.1
of this unit. Refer the same for details.
4. There are two types of negotiations widely used in business – linear and encompassing
model. These are explained in sub-section 4.1 of this unit. Refer the same for details.
5. Legal aspects are considered in the first step of decision making followed by a
company’s ethical code, cultural analysis and personal moral judgement. These are
explained in sub-section 5.1 of this unit. Refer the same for details.

10. CASELET
Satyam Computer Services Ltd.
In December 2008, Satyam announced acquisition of two companies— Maytas Properties

and Maytas Infrastructure owned by the family members of Satyam's founder and Chairman
Ramalinga Raju. Within a day of the announcement, the deal was withdrawn because of the
adverse reaction from institutional investors and stock markets. Issues were raised on
corporate governance practices of Satyam, with investors seeking answers from the Board
about the acquisition because the transaction was evidently made within the promoter’s
family.
After the deal was aborted, four of the prominent independent directors resigned from the
board of the company. In early January 2009, Ramalinga Raju confessed that the revenue and
profit figures of Satyam had been inflated for the past several years. The revelation further
deepened the concerns about poor corporate governance practices in the company.
After this debacle, questions were raised about the corporate governance structure in
Satyam, its code of conduct, roles and responsibilities of different committees under the
Board, whistle-blower policy and so on. Several industry bodies questioned the role played
by the independent directors of Satyam in approving the Maytas deal.
The events that unfolded after Mr. Raju’s confessions to his illegal activities placed the future
of thousands of employees and the well-being of their dependents at risk, jeopardised
projects worth millions of dollars, and portrayed Indian companies inherently corrupted.
Regulators and several Indian corporate companies acted quickly to persuade clients and
the business community to prove that Satyam’s case was an isolated event. People with vast
experience and knowledge of Indian business processes were brought in to assist in
preventing a total collapse of Satyam Computers, which was later bought by Tech Mahindra.
1. Analyse the instances where the ethics system failed in preventing the fraud. (Hint:
Auditing)

2. Formulate a sample code of conduct for Satyam Computers. (Hint: Refer discussions in
Section 4 of this unit)
References
• Bhalla V. K. and Shiva Ramu S. (2008). International Business –

• Environment and Management, (7th Ed) Anmol Publications.
• Bhatia SK. (2004). Business Ethics and Corporate Governance, Deep and Deep
Publications Ltd.
• Chauhan PL, KakkadRatish, Patel Rupal H. (2006). International Business, (1st Ed)
ShanthiPrakashan.
• Cherunilam Francis. (2010). International Business Environment, (1st Ed) Himalaya
Publishing House.
• K. Aswathappa. (2010). International Business, (2nd Ed) Tata McGraw-Hill
Publications Co Ltd.
• McDonald Frank and Burton Fred. (2002) International Business, International
• Weiss Joseph. (2009). Business Ethics Concepts and Cases, (1st Ed) Cengage Delmar
learning India Pvt. Ltd.
E - references
• www.managementhelp.org/ethics/ethics.htm, retrieved on 3rd October 2010


SEMESTER 4
DMBA402
MANAGEMENT
Unit 13: International Human Resource Management 1

Unit 13
International Human Resource Management
Table of Contents

No Graph Activity
1 Introduction - -
3
2 International Organisational Structures 1, 2, 3, 4, 5, 6 1
2.1 Factors influencing organisation
- - 4 - 10
structure
2.2 Types of structures - -
3 Introduction to International Human
7, 8 2 ,I
Resource Management
3.1 Managing international human
- -
resource activity 11 - 18
3.2 Domestic versus international human
- -
resource management
3.3 Expatriate staff - -
4 Scope of International Human Resource - 3, II
Management
4.1 National differences in HRM practices - -
4.2 Strategies for international human
- - 19 - 26
resources management
4.3 International employee relations - -
4.4 Staffing policies in international
- -
business
5 Summary - - 27
6 Glossary - - 28
8 Answers - - 29 - 30
9 Case-let
- - 30 - 32

1. INTRODUCTION
In the previous unit, we studied the importance of ethics in international business. We also
learned the various methods adopted for formulating ethics and how the difference in
culture affects ethical practices around the world. In this unit you will learn about the
structure of MNCs and various dimensions and strategies for international human resource
management.
As businesses transform into multinational companies and as the world evolves into a global
marketplace, international firms need to be supported by adequate human resources.
Human Resource Management (HRM) practices are necessary in order to procure, allocate,
and utilize human resources particularly managerial manpower in an efficient manner.
While many aspects of traditional HRM policies and procedures are applicable when a
company operates abroad, the integration of the various regulatory aspects and diverse
cultural dimensions makes it necessary for a company to dwell into international HRM to
operate efficiently at an international level.
❖ Interpret the types of international organizational structures.

❖ Describe the international HRM process.
❖ Examine the various aspects of expatriate employment.
❖ Discuss the scope of HRM.
❖ Explain the staffing policies of a multinational corporation.

2. INTERNATIONAL
The ORGANIZATIONAL
organizational structure of an international STRUCTURES
business plays a very important role in
realizing the goals of the company. The structure of an international business is more
complex than in a purely domestic firm. The more assets and employees a firm has in its
foreign offices, the more languages, cultures, and time zones it has to cope with, results in a
more complex structure.
The structure has to be well-designed and should be based on the business strategy. It is
important that various structural components are considered properly. The following are
the objectives of a well-designed organizational structure:
• Facilitate the decision-making Process.

• Establish reporting hierarchy and accountability.
• Facilitate easy flow of information in the organization.
• Provide a positive work environment that encourages efficiency.
• Integrate and coordinate activities.
A multinational firm shares large amounts of information between the headquarters and its
various offices and subsidiaries across the world.
Hence, integrating and coordinating organizational activities is imperative in the

organizational structure.
There are various factors that influence the design of organizational structures. Let us
discuss some of these factors in detail.
2.1 Factors Influencing Organization Structure
The major factors that influence organizational structure can be classified very broadly in
two as follows:
• Environment.
• Technology.

Environment
Environmental factors include both internal and external factors affecting the organizational
structure. Let us briefly discuss these factors.
Internal environment – Internal environment includes factors controlled by the

management or based on the functions of management. The manner in which the
management functions contribute to the design of the organization structure. Some of the
management approaches affecting organizational structure are as follows:
• Ethnocentric management – Decision making is controlled by the head office and

most of the managers are from the parent company.
• Polycentric management – Decisions are largely decentralized and managers in the
subsidiaries are mostly from the host country
• Geocentric management – Decision making is decentralized and managers from
across the globe make decisions affecting operations internationally. In this approach,
managers in one country can make decisions affecting the operations in another
country.
The size of an organization influences its structure. Bigger companies with multiple divisions
add to the level of complexity of the organizational structure. The increase in the
organization size prompts an increasing number of employees to keep up with the
organization's growing business. It also brings in the need for additional rules and
regulations to maintain optimum levels of efficiency and productivity. The need for
decentralization increases when the company grows in size.
External environment – The external environment refers to a wide array of factors beyond
the company's control. These factors can be classified as follows:
• Environmental risks – The instability caused by the differences in culture,

government policies, strength of the economy, and availability of qualified employees,
industry cycle, and stability of the financial system constitute environmental risks.

• Strategy for expansion – These include the strategies that a company adopts to enter
new markets or expand its business. The structure of a business, in turn, depends on
the strategy adopted by the company.
Technology
Technology plays an important role in the designing of an organization structure. The

application of technology at different levels like employee, division and organization
determines the design of the structure. An organization may use the technology at different
stages like procurement of inputs and raw material, production stage, and delivery stage.
The sophistication of technology determines the design of a modern business organization.
The integration of Information Technology (IT) facilitates communication among

employees. A conscious effort must be made to maintain relationships with each group. IT
representatives must provide updates to the employees about their various products and
applications. In return, the employees must provide feedback on these products and
application to the IT department. These relationships within departments are often
overlooked and are lost due to immediate organizational design challenges. Hence,
relationships with all future participants must be maintained through well planned
communication.
Technology and the knowledge-based economy are not constrained by the physical objects
and materials of an organization. Information is flexible and can be structured and organized
in a number of ways. For example, videoconferencing and telecommuting allow members of
project teams from different departments to work together, regardless of their geographic
location or department. Thus, technology enables departments within organizations with
easier communication.
2.2 Types Of Structures
Organizations adopt the most suitable structure based on the various factors that we
discussed in the previous section. Let us now discuss some of the most commonly used
structures for international business.

Export structure – A domestic company has to make provisions for an exclusive export
division. If the export division undertakes all the export activities instead of using an agent,
then it needs to maintain a minimal staff for the following functions:
• Maintain export documentation like shipping, insurance, finance, and customs.

• Conduct international marketing research to understand procedures and regulations.
• Distribute products in the foreign markets.
• Indulge in sales and marketing, advertising, promotions, mail order catalogues and so
on.
International division structure – An international division is established in a company

when there are substantial branches or subsidiaries operating in foreign countries. This
division controls all the foreign operations of the organization. Since all the foreign
operations are under one authority, control and communication are easy. Figure 13.1 depicts
an organization with an international division.
Figure 13.1: International division structure
Functional structure – In this structure, each functional department is responsible for

activities around the world. For example, the finance department is responsible for the
organization's finance activities around the world. This is the case with all the other
functional departments, such as marketing, manufacturing, and human resources
management. This design is used by international firms that have a narrow product line with
a limited number of products. Figure 13.2 depicts an organization with a functional
structure.

Figure 13.2: Functional structure
From the figure you can see that each division directly deals with countries A and B.
Regional structure – In this structure, international operations are organized by dividing

the entire globe into different geographic regions. Strategic decisions are made at the
headquarters and the regional manager is responsible for all operational issues within the
region. Figure 13.3 depicts the regional structure in an organization.
Figure 13.3: Regional structure
From the figure above, you can see that regional managers for Europe and Asia Pacific
regions report directly to the company headquarters while taking charge of their respective
countries.
Foreign subsidiary structure – In this structure, each of the company’s foreign subsidiaries
reports directly to the headquarters. This structure eliminates the necessity of a regional
manager. Though strategic decisions are taken at the headquarters, each subsidiary acts

autonomously for their local operations. Figure 13.4 depicts the foreign subsidiary structure
in an organization.
Figure 13.4: Foreign subsidiary structure
From the figure you can see subsidiaries based in USA, UK, France, and Japan report directly
to the headquarters in India.
Product division structure – International companies that have a diversified product range
across diversified markets can opt for a product–based organizational structure. Global
responsibility for a product or a group of products is in separate operational divisions within
the company. This organizational structure, as depicted in figure 13.5, is followed most
commonly by multinational consumer goods companies.
Figure 13.5: Product division structure
From the figure above, you can see that the product managers report directly to the
headquarters while they are responsible for all the operations in their respective countries.
International matrix structure – This structure is the most complex organizational

structure. This form of structure is suitable where several functional divisions from across
the globe performing related duties are grouped together into an international product
division. These product divisions can then plan, design, develop, and produce the products
or services required. The product divisions are dissolved or the teams are assigned to some

other division after the project is executed. Figure 13.6 gives you an idea of the international
matrix structure.
Figure 13.6: International matrix structure
In the matrix structure, you can see that different product managers work with different
departments across the globe, breaking all the divisional barriers.
1. A well designed ___________ facilitates efficient communication in an organization.

2. Technology and the environment are factors that influence
organizational structure. (True/false)
3. _____________ is the most complex form of organizational structure.
a) Product division structure
b) Functional structure
c) International matrix structure
d) Foreign subsidiary structure

3. INTRODUCTION TO INTERNATIONAL HUMAN RESOURCE

MANAGEMENT
In the previous section you learned about international business organizational structures.
In this section, you will learn about the ways in which HRM deals with workforce
management and its relationship with the organization. The purpose of HRM is to make the
maximum utilization of the firm’s human resources so that both employer and employee
benefit from their association. The following are some of the functions of HRM:
• Plan, recruit and terminate employees.

• Educate and train employees for career development.
• Provide compensation and terms of employment for employees.
• Facilitate communication between employers and employees.
• Settle disputes and negotiate on wages and working conditions.
International Human Resource Management (IHRM) is the process of recruiting and

managing the services of an organization's personnel across the globe, to achieve its goals.
3.1 Managing International Human Resource Activity
Employees are an asset to the organization. HRM activities need to be designed to utilize the
employee’s potential to the maximum. This can be achieved through their involvement with
the organization and by increasing the employees’ commitment to the business objectives of
the organization. The employees are trained to accept change, be innovative, and become
quality conscious and flexible. HRM’s task is to integrate personnel into the organization's
corporate ideologies and to constantly help the workforce to be more productive and
efficient, thereby making the business more productive. Figure 13.7 illustrates some of the
important activities involved in HRM.

Figure 13.7: HR Activities
As depicted in figure 13.7, human resource planning, recruitment and selection, training and
development, performance management, remuneration, repatriation and employee
relations play an active role in the organization's efficiency. Let us now discuss some of the
important activities.
Human Resource Planning (HRP) – HRP is a very important aspect in the process of HRM.
It is the process of assessing staffing requirements for the future and taking care of the
adequate and timely supply of human resources for the same. In an international scenario,
HRP plays a greater role in achieving the global objectives of the organization, as the sourcing
of HR is spread across countries. Some of the challenges in international HRP are as follows:
• Identify the key top management executives.

• Design organizational structure and responsibilities of international managers.
• Provide adequate training for managers and equip them with multicultural experience.
• Maintain the career focus of the international managers by providing adequate
developmental opportunities.
• Integrate multiple business units across the globe to a common strategic objective.
Recruitment and selection – Hiring employees is a challenge for any international

business. The international HR managers have to make sure that they hire the most suited
candidates. This means that possessing the right skill is not the only criterion. They must also
look at the adaptability of the potential employees to the corporate culture and beliefs of the

organization. The HR manager also needs to make sure the organization hires new
employees with flexibility to adapt to foreign cultures.
3.2 Domestic Versus International Human Resource Management
Fundamentally, domestic HRM and IHRM have the same processes and objectives. IHRM
differs from domestic HRM in terms of its scope and its challenges because of the
internationalization of business and its managers. Let us discuss some of the factors that
differentiate IHRM from domestic HRM.
• The scope of the HR activities is larger because the organization deals with multiple
countries and employees from several cultures.
• The international workforce requires greater involvement of management at a
personal level.
• The approach is complex because of the potential cultural mix in the workforce.
• Risk management is an integral part of the IHRM policies.
• Expatriates are subject to tax at home and in the host country. Hence, tax policies have
to be devised in a way that they do not penalize the employee for moving to another
country.
• Relocation of staff involves providing immigration and travel services, providing
housing, medical care, and schooling for employees’ children, pre-departure training,
international allowances and so on.
• The laws in the host country vary from those in the parent country. The human
resource department must be equipped to deal with all potential issues and ensure that
the newly relocated employees and their families are able to function properly in the
foreign country.
• Differences in government policies of foreign countries requires the human resource
team to ensure that all the expat employees adhere to the norms set by the government.

3.3 Expatriate Staff
Expatriates play a major role in international businesses. Multinational companies put a lot
of effort into selecting employees. By employing staff from the parent country in the
company’s various international locations, senior management ensures that the foreign
subsidiary runs according to the requirements of the head office. The senior management
also ensures that experienced employees with the right attitude and capabilities are involved
with foreign operations and are fully aware of company policies. Expatriates also tend to
have greater product knowledge and managerial expertise than the locals.
The following are some of the disadvantages of employing expatriates:
• Problems with the local language, customs, culture, and business practices.
• Time to settle in the new environment, which has a negative impact on the employee’s
productivity.
• Prejudices towards certain ethnic groups may arise during foreign posting.
• Imposed management style that the host country employees are not comfortable with
and may find inappropriate.
• Obstruction of opportunities for local staff.
Expatriate selection
Selection of expatriate employees is a highly specialized function in HRM. The following

factors are important when recruiting an expat employee:
• Technical competency.
• Interpersonal skills.
• Ability to cope with the foreign environment.
• Ability of the expatriate’s family to adjust to the foreign environment.
Figure 13.8 presents the different criteria for recruiting expatriate employees. The HR team
must consider the candidate’s personal expectations, as well as the candidate’s family
comfort, in moving to a foreign country.

Figure 13.8: Expat selection criteria
After the HR team selects the right candidate, they provide proper support and information
to the employee and family for a smooth transition. This step is critical to the success of
employing the expatriate and in turn the success of the international business unit. Before
posting the newly recruited employee to the international location, the company must do the
following:
• Provide the employee and family with cultural and language orientation with the
intention of familiarizing the new country to them.
• Make provision for pre-assignment visits so that the employee, spouse and family can
find appropriate accommodation, schools, recreational options and so on.
• Assign mentors who are familiar with the experience of relocation, preferably from the
home country.
• Counsel the family about the challenges of moving to a new country so that they can
prepare themselves.

Adjusting to expatriate life
Managing the overseas employee has always been a tough job for the HR manager. Host
country culture can be dramatically different from the way things are ‘back home’. Most of
the time, new expatriates, including their spouses and children feel overwhelmed and
disoriented by the shock of a novel cultural environment. Possible ways of adjusting to new
life as expatriates can be psychological adjustment to the new environment which is largely
an internally oriented process of feeling of well-being or satisfaction of being abroad. The
second method is the sociocultural adjustment process which is externally oriented and
involves how well one can adjust himself or can act with new team of unfamiliar people or
community. One can find new friends and here are several general suggestions on how to
make new friends:
• Expats with children have an opportunity to start or strike up a conversation with other
parents at school, sporting activities, and social events.
• Cities especially in Europe and North America has networking groups for professional
women. Even in developing countries, respective embassies/cultural centers have
information about networking meetings or cultural events where expatriates can
familiarize themselves.
• One can take a course in dance, music, painting, pottery and even the local language.
This helps in getting people to know about expatriates’ choice and interests and
interact.
• One can become a volunteer or even become a member of a local NGO. It is one of the
most rewarding ways to meet new people as you contribute to the society.
• Expats can also mingle with their neighbours and make new friends especially if the
area has predominantly expatriate population. For example, Geneva or New York
• One can join an athletic club or join a sport club which not only keeps him busy but
makes him physical and emotionally strong.
• Spouse of the expatriates can even join a job which is considered least cost and most
effective way of immersion in the host culture.
Adapted from: How to Adjust to Expat Life, Maria Fole at www.suite101.com

Expatriate failure
Globally, there has been a failure rate of more than 25 percent amongst expat employees.
Despite the training and efforts undertaken by the HRM, the expat’s underperformance and
failure has been a matter of concern for the multinational companies. Most cases of
expatriate failure have been due to the following reasons:
• Spouse’s inability to adjust.

• Marital stress.
• Employee’s inability to adjust.
• Home sickness.
• Hostility towards host nationals.
• Loss of confidence.
• Family tension and conflict.
• Personal or emotional maturity.
• Inability to cope with larger international responsibilities.
• Difficulties with a new environment.
• Personal or emotional problems.
• Lack of technical competence.

4. Planning, recruiting, and termination are some of the functions of the ___________
management.
5. The expat’s underperformance and failure is not a matter of concern for the
multinational companies. (True/False)
6. HRM activities need to be designed to utilise the employee’s potential to the

maximum. (True/False)
7. Which one of the following is not an important activity involved in HRM?
a. Human resource planning.

b. Recruitment and selection.
c. Remuneration.
d. Project planning.
Activity I
Play the role of an international HR manager and devise a plan in 500 words to
help with the transition of an expatriate employee and his family to an Indian city.
Hint: Domestic versus international human resource management

4. SCOPE OF INTERNATIONAL HUMAN RESOURCE MANAGEMENT
In the previous section we studied the role and other aspects of selecting expatriate
employees. In this section, we will discuss the scope of IHRM. The three main dimensions of
international human resources management are as follows:
• Human resource activities.

• Countries of operation.
• Origin of employees.
Human resource activities – HR activities in an IHRM context involve procurement,

allocation, and utilization of workforce. These functions in turn cover all the six activities of
human resources management, that is, human resource planning, hiring, training and
development, remuneration, performance management, and employee relations.
Countries of operation – The countries of operation in an IHRM perspective involves the

host country in which the overseas operation is located, the home country that houses the
headquarters of the company, and other countries that supply labor and finance.
Origin of employees – The origin of the workforce of an international business can be

classified into three types – parent country nationals, host country nationals, and third
country nationals.
4.1 National Differences In HRM Practices
In this section, let us discuss the factors that determine human resources management
practices in each country. The different factors are economic, social, cultural, legal, labor
market, business stakeholders, role of the state, the workforce and so on. Differences that
arise at a national level are as follows:
• Degree of employee participation in decision-making by the management.

• Legal regulations of employee relations and rights of employees.
• The importance of market forces when deciding remuneration and employment
conditions.
• Cultural background of the key people involved in human resources management.

Across various countries, the same jobs can vary with respect to motivation, commitment,
pay scale, skill set, and education. Other factors that determine national differences are
length of employment that has an effect on the attitude of personnel towards the
organization, age and gender, expectation regarding working hours, etc. The attitude of
managers from different countries also varies in many aspects. Some of these aspects include
the following:
• Management style.
• Values and ethics.
• Approach to decision making.
• Approach to problem solving.
• Expectations with respect to remuneration.
• Importance given to management models and techniques.
• Attitude to risk.
4.2 Strategies For International Human Resources Management
The success of a multinational company depends on the techniques and strategy adopted to
select, train, develop, manage, and motivate its workforce. An organization achieves its
objectives only with competent employees. The main reasons for organizations to formulate
a human resources strategy are as follows:
• Capable of competing on an international level with rivals when they have the most
efficient employees.
• Employee expenses are a large part of the total spending of a multinational firm.
• Capacity to innovate, add new business lines, and enter new markets depends more on
its employees than on capital investment.
• Emphasis on the computerization of administrative and manufacturing functions has a
large impact on the structure of employment within a business. There is lower demand
or unskilled labor.
• Need for specialist skills, which are attained over time and experience, to increase
organizational complexity.

• Employees have to be treated based on the specific labor laws that the host countries
follow.
A proper human resources strategy is needed if the management emphasizes human

relations. It thus encourages a professional approach to human resources management.
Problems with the strategies discussed earlier include the following:
• The lack of genuine commitment to execute the strategy since strategies are sometimes
formulated as a formal procedure based on the norms of the headquarters.
• The differences in opinion over a worthwhile human resources strategy may arise
between the human resources department at the head office and the subsidiaries.
• The necessity for all the organization's employees to be aware of the human resource
strategy through proper communication between management and the workforce.
Without proper employee involvement, it is difficult to implement the HR strategies.
• Improper HR strategies lead to various organizational issues that are not obvious in the
short term.
Influences on international human resources management
External factors that influence human resources strategies are as follows:
• Legal factors related to the workforce on issues such as the right to strike, employee
protection, participation in management decisions, setting of minimum wage levels,
etc.
• Political environment, which refers to the attitude of the host country government,
guidelines on employment, and industrial relations.
• Economic factors include inflation, unemployment, competition, and growth prospects.
• Social trends such as participation of women in the workforce, attitude towards
working hours, demands for improvement of working life quality, changes in living
standards, opportunities for education and so on.
• Technological factors that affect working methods need to impart new skills on the
workforce, flexibility of labor, and the impact of new technologies on the management.
The internal factors that affect the international human resources strategies are as follows:

• The level of decentralization of the company.

• Morale of the employees.
• Ability of unskilled workers to complete jobs.
• Background, educational level, and technical skills of the local workforce.
• Trade union activity within the subsidiaries.
• Attitude of the important stakeholders towards employee relations.
• Perspectives of top managers.
4.3 International Employee Relations
Employee relations deal with all the formal and informal relationships between employees
and the management. There is a greater emphasis on cooperation than on conflict in the
management of employee relations. It is important for the management to recognize the
importance of harmony within the workforce across various countries. The management
should credit increased competitiveness to employee relations policies for better employee
cooperation.
Some of the major aspects the management must consider while devising an employee
relations strategy are as follows:
• Decide whether to recognize trade unions.

• Implement procedures that affect employee relations and the way managers approach
employee relations. For example, selection, recruitment, appraisal, training, and
promotion.
• Check if external agencies used by the management help in resolving conflicts.
• Divide the profit between the business owners and workers.
• Communicate effectively with employees.
• Know the extent to which employee representatives are involved in making decisions
at a management level.
Generally, MNCs customize the employee relations policies for each subsidiary or country
depending on that country’s labor laws and practices. Because of the differences in the
approach by different countries, companies cannot use a standardized model across their

international operations. The state of employee relations in the subsidiaries is important in

controlling labor costs and helping the organization grow. This is a cause of concern to the
parent company. Headquarters advise on the following aspects:
• The firm’s philosophy on workers’ relation with the management and the role of trade
unions.
• Various solutions to employee relations.
• Cost factors that arise due to the company’s overall strategy.
• Comparison of success of employee relation policies in other countries.
• Pay scales and employment conditions in various countries.
• Measures to improve productivity in other countries.
Management aims to apply consistent policies to its subsidiaries throughout the world,
though such policies need not be identical. It is also vital for managers in subsidiaries to be
completely aware of the relationship between management and employees to create
harmony. Harmony results in greater competitiveness and efficiency.
4.4 Staffing Policies In International Business
The international human resources manager needs to formulate staffing policies before
starting the process of hiring employees. The four main policies regarding staffing are
explained as follows:
Ethnocentric approach
The key managers are from the parent country. The strategy is important during the early
stages of the business because a part of the business that was successful in the home country
needs to be transferred to the host country. Some of the reasons for this approach are as
follows:
• The lack of qualified employees from the host country.

• The need for a united corporate culture.

• The maintenance of good communication, coordination, and control with

headquarters.
The following are the disadvantages of the ethnocentric approach:
• Host country employees being deprived of promotion.
• The time taken by the home country managers to adapt to the host countries.
• The sensitivity of the expatriates to the needs and expectations of their host country
subordinates.
Polycentric approach
This approach requires host country nationals to manage subsidiaries. The benefits of such
a policy are that there are fewer possibilities of language issues, expensive training periods,
and cultural adjustment issues. The disadvantage of this approach is that the local managers
may find it hard to bridge the gap between the subsidiary and the parent company. There
may also be language issues, loyalties to the host country that conflict with the needs of the
multinational organization, and cultural differences between the home country managers.
Regio-centric approach
Managers from various countries in the region are employed within the geographic region
of a business. Although they operate with a certain amount of independence, they are not
moved to their home country. This is a flexible approach and locals are hired when regional
expertise is needed whereas employees from the parent country are brought in if product
knowledge is required. The disadvantage of this approach is that managers in the region may
not understand those at the head office and an adequate number of managers with
international experience cannot be hired. This approach serves as a step towards a
geocentric approach.
Geocentric approach
The best suited employees for vital positions are hired throughout the company without
taking into account the nationality of the employees. The success of this approach is based
on the following five assumptions:

• Availability of highly skilled employees at the subsidiaries.

• International experience required to succeed in top positions.
• Ambitious and promising managers who can be readily transferred from one country
to another.
• Adaptability of managers to different countries after international exposure over a
period of time.
This approach helps a company create a pool of efficient international managers,

comfortably working in a number of cultures.

8. The workforce of a multinational is of three types – parent country nationals,

host country nationals, and .
9. Ethnocentric and polycentric approaches are examples
of_____________ policies.
10. Remuneration is one of the key staffing policies in an international business.
(True/False)
11. The nationality of the employees is not taken into account while hiring for the
company in a geocentric approach. (True/False)
12. Which of the following is not an approach under staffing policy?
a) Geocentric approach.
b) Biometric approach.
c) Polycentric approach.
d) Ethnocentric approach.
Activity II
Using resources on the internet, analyse the HR practices that an Indian MNC employs to
recruit and retain its expat employees.
Hint: http://www.streetdirectory.com/travel_guide/183845/human_resources/ne
ed_for_effecting_recruitment_and_hr_practices.html

5. SUMMARY
Let us summarize the points covered in this unit on international human resource
management:
• The structure of an organization plays a vital role in HRM. Internal and external
environment contribute to the structure of an organization. Business strategy plays an
important role in the structure of an organization.
• The different types of international organizational structures are export structure,
international division structure, functional structure, regional structure, international
subsidiary structure, product structure, and international matrix structure.
• IHRM is a vital component in the functioning of a multinational enterprise. IHRM helps
deal with the factors that make the workforce more efficient and the organization more
competitive.
• Though there are many strategies and policies regarding the deployment of personnel
across various countries, the one that best aligns the needs of the parent country and
employees in foreign subsidiaries is the one that yields the best results.
• International staffing policies depend on the approach adopted by an organization. The
four approaches are ethnocentric, polycentric, Regio- centric, and geocentric approach.

6. GLOSSARY
Home country: The country where a company’s headquarters is located.
Host country: A country other than the home country where a company operates.
Remuneration: The total package, which includes salary, bonuses, allowances, stock
options and so on, that the employee receives from the employer.
1. Analyse different structures in an international organization.

2. Explain the function of human resource planning.
3. List the key factors affecting the recruitment of expats.
4. State the key national differences in HRM practices.
5. Discuss the different approaches to staffing in an international business.

8. ANSWERS
1. Organizational structure.
2. True.
3. c) international matrix structure.
4. Human resources.
5. False. The expat’s underperformance and failure has been a matter of concern for the
multinational companies.
6. True.
7. d) Project planning.
8. Third country.
9. Staffing.
10. False. Remuneration is not one of the key staffing policies in an international business.
11. True.
12. b) Biometric approach.
Terminal Questions
1. Export, international division, functional, regional, international subsidiary, product

and international matrix are some of the organizational structures in the international
business. These are explained in sub-section 2.2 of this unit. Refer the same for details.
2. Human resource planning is the process of assessing the staffing requirement for the
future and taking care of the adequate and timely supply of human resources in an
organization. These are explained in sub-section 3.1 of this unit. Refer the same for
details.
3. Technical competency, willingness to work in a foreign country, adequate growth
opportunity, spouse and family’s willingness to adapt in a new country are some of the
factors affecting the recruitment of expats. These are explained in sub-section 3.3 of
this unit. Refer the same for details.
4. Employee participation in decision making, legal framework of employee relations,
individualism, collectivism, cultural background, and so on is the common national

differences in HRM practices. These are explained in sub-section 4.1 of this unit. Refer
the same for details.
5. Ethnocentric, polycentric, region-centric and geocentric are the approaches taken by
HRM in an international business. These are explained in sub-section 4.4 of this unit.
9. CASE LET
IHRM at Unilever
Unilever PLC. is the world’s largest Fast Moving Consumer Goods (FMCG) Company with a
turnover of €39.8 billion and is the leader in Home and Personal Care Products, Foods and
Beverages. It employs 1,63,000 people in more than 100 countries worldwide. Unilever’s
products are sold in over 170 countries around the world.
Their manufacturing facilities are spread across many countries and they also export
products to countries where they do not have manufacturing operations. Currently, they
have 264 manufacturing sites worldwide, all of which strive for improved performance on
safety, efficiency, quality and environmental impacts working to global Unilever standards
and management systems.
Hindustan Unilever Limited (HUL), a subsidiary of Unilever PLC. is India's largest FMCG
company with around two thirds of the market share in its sector. HUL has several
manufacturing plants spread across the country. The mission that inspires more than 15,000
employees, including over 1,400 managers of HUL group, is to help people feel good, look
good and get more out of life with brands and services that are good for them and good for
others. It is a mission HUL shares with its parent company, Unilever.
The fundamental principle determining the organization structure is to infuse speed and
flexibility in decision-making and implementation with empowered managers across the
company’s nationwide operations.
HUL is known for its capability to appeal to and hire the right employees. Several Unilever
India managers have taken senior level responsibilities in Unilever's worldwide system. In

2008, over 80 HUL managers held top positions in different Unilever companies or corporate
functions.
The management realized that to be competitive, they had to re-structure their hiring
policies, and hence developed an international cadre of managers. The management posted
its employees to various parts of the world after providing them intensive training on culture
and country- specific details. These managers are expected to work in any country with the
same amount of efficiency as they would in any other.
Discussion questions
1. Suggest the most appropriate organisational structure for HUL. (Hint: HUL has multiple
global products and manufacturing plants across the globe)
2. What makes HUL’s managers most sought after in Unilever? (Hint: Refer HRP in section
2.1)
Source:http://www.unilever. com/ boutus/ introductiontounilever/

unileverataglance/?WT.LHNAV=Unilever_at_a_glance – Retrieved on 8th October 2010
http://www.hul.co.in/aboutus/introductiontohul/HULataglance/default.aspx– Retrieved
on 8th October 2010
References:
• Bhalla, V. K. & Shiva Ramu, S. (2008). International Business - Environment and

Management. (7th Ed) Anmol Publications.
• Brewster, Chris, Sparrow, Paul & Vernon, Guy. (2008). International Human Resource
Management. (4th Ed) Universities Press (India) Limited.
• Cherunilam, Francis. (2010). International Business Environment. (1st Ed) Himalaya
Publishing House.
• Harzing, Anne Will & Rusysseveldt, Joris Van. (2007). International Human Resource
Management. Sage Publications India Pvt. Ltd.
• K., Aswathappa & Sadhna, Dash. (2009). International Human Resource Management –
Text and Cases. (9th Ed) Tata McGraw-Hill Publications Co. Ltd.

• McDonald, Frank & Burton, Fred. (2002) International Business. International

E-References:
• http://managementhelp.org/hr_mgmnt/hr_mgmnt.htm, retrieved on 6th October

2010


SEMESTER 4
DMBA402
MANAGEMENT
Unit 14: Finance and International Trade 1

Unit 14
Finance and International Trade
Table of Contents

No Graph Activity
1 Introduction - -
4
2 Understanding Payment Mechanism in
1, 2, 3 1
foreign trade
2.1 Payment terms in foreign trade - - 5 - 10
2.2 Letter of credit - -

3 Documentation in International Trade 4, 2, I
3.1 Commercial invocie - -
3.2 Packing list - - 11 -16
3.3 Bill of lading - -

3.4 Insurance certificate - -
4 Financing Techniques - 3
4.1 Banker’s acceptance - -
17 - 18
4.2 Factoring - -
4.3 Forfaiting - -
5 Export Promotion Schemes 5 4 19 - 21
6 Export and Import Finance - 5, II
6.1 Short term credit - -
22 - 24
6.2 Long term credit - -
6.3 EXIM bank - -
7 Summary - - 25
8 Glossary - - 26

10 Answers - - 27 - 28
11 Case-let
- - 28 - 29

1. INTRODUCTION
In the previous unit, you studied the various aspects of human resource management in an
international organization, the organizational structure and managing expatriates. This unit
is based on international trade.
Walk into any mall, you will come across Washington apples, cheap Chinese toys and plastics,
South Korean and Japanese television sets, Brazilian coffee or South African wine. Today,
Indian spices are popular all over the world. All these are the results of increasing
international trade. International trade is a system which deals with the exchange of goods
and services between nations. International Trade shapes our lives and boosts the economy
of the participating countries. There are various financing techniques that play a major role
in international trade and finance.
This unit covers the benefits, payment systems and arrangements related to international
trade. We will discuss documentation required to make any foreign trade transaction. We
will also learn about various export promotion schemes supported by the government and
methods to avail finance as exporters and importers within India.
❖ Describe the payment mechanism that facilitates foreign trade.

❖ Analyse the documentation required to facilitate international trade.
❖ Explain various Government schemes to promote exports in India.
❖ Explain the various finance options available for international trade.

2. UNDERSTANDING PAYMENT MECHANISM IN FOREIGN TRADE
In today’s competitive international environment, it is essential for the exporters to offer

attractive sales terms and payments to importers in order to increase trade volumes. One of
the major concerns for an exporter is to choose the appropriate payment method in order to
minimize risks related to payments of trade transactions. Exporters can choose any mode of
payment depending on the risk perception, size of deal, importer credit worthiness and
economic situation in importer’s country.
Table 14.1: Factors to be considered for choosing payment terms

Consider Documentary Consider Open
Factor Required Letter of
Collection Against Payment Account
Credit
Type of Undetermined Acceptable Excellent

customer
Relationship New Established Established
Economic Unstable Stable Very stable
stability
Type of order Custom Regular production In stock
Transaction Large Moderate Small
Size
Cash flow Always Never Never
Source: John Michael Pierobon; How to Succeed in International Business
In the case of domestic business, the main factor driving a salesman’s decision criteria for
realization of payments is based on the buyer's ability, willingness and honesty to make
payment. Usually, sales in the domestic market are based on an open account and in certain
cases it can be based on cash in advance. Such methods also depend on the buyer’s and
seller’s power to negotiate and the nature of competition such as:
• Monopoly conditions favor the seller.

• Perfect competition favors the buyers.
However, in the case of international trade, exporters have to take more precautions as some
methods of payment are unique and usually used in the case of international trade only. Key
consideration while deciding upon a payment term in foreign trade is elaborated as under.

A. Some of the major risks involved in realization of payments in international trade can
be either related to the importer, importer’s bank or importer’s country. This includes
issues such as insolvency and payment default by importer, insolvency of importer
bank, exchange control restrictions, and convertibility issues with importer’s country.
B. Some of the risks involved in international trade, especially in the Liberalization,
Privatization and Globalization era may or may not be under the control of the exporter.
Certain risks can be controlled by the exporter For instance, credit risk which arises
from a change in
The credit worthiness of importers can be covered by Export Credit Guarantee

Corporation of India. Exchange Rate Fluctuation risk can be covered by hedging the
currency invoiced in forward contract market but certain risks cannot be controlled
such as Force Majeure which arises due to a change in policy of a country, which in turn
affects the trade capability, and by a natural disaster that cannot be anticipated in
complex international environments. Other risks which mainly arise due to a difference
in culture, law, or language are also beyond the control of the exporter.
Exhibit 14.1: Choice of payments method: Decision Matrix
1. Buyer-Seller relationship.
2. Competition.
3. Buyer’s credit standing.
4. Uniqueness of the product (Is it custom made?)
5. Cash flow considerations.
6. Country conditions (political, economic).
7. Transaction costs.
8. Risk tolerance/aversion.
9. Other.
Source: Craig F. Schaffer, Inside Trade Finance
C. International Trade Operations brings different types of risks, thereby confusing the
exporter with uncertainty over realization of payments and timing of payments
between the exporter and importer2.
D. For exporters, any international sale is at risk until and unless the payment is not
realized from the importer. For an importer any payment is at risk unless and until the
cargo is received from the exporter.

E. Exporters will always be interested in receiving the payments as soon as he/she sends
the goods to the importer through shipment. The importer will be willing to delay the
payments as he/she will be interested in selling these goods in markets and then
making the payments to the exporter.
F. However, the selection criteria for mode of payment are based on mutual negotiation
of exporter and importer and in Liberalization, Privatization, Globalization Model era
there are other parties such as bank, credit insurer involved which helps an exporter in
financing and assuring about the payment.
G. Though safe modes of payment such as letters of credit are popular, this mode of
payment is not usually used by small exporters and importers due to heavy transaction
costs. For example, letters of credit are used as the mode of payment only in 14% trade
transactions due to heavy transactions costs3.
H. Exporters can alternatively divide the payment category into secure mode and
unsecure mode. The secure mode of payment for exporters is cash in advance and letter
of credit. Unsecure modes of payment are Open Account, Documents against Acceptance
and Documents against Payments.
2.1 Payment Terms In Foreign Trade
As international trade deals with the exchange of goods, there are various ways to handle
the payment terms (finance).
Both seller and trader should be careful about the method of payment as they are at different
locations and transactions happen without face-to-face interaction. There are four methods
of payment for international transactions. This includes the Cash-in-advance method, Letter
of Credit, Documentary collections and the Open Account. These are shown in figure 14.1.

Figure 14.1: Payment Risk Diagram
As shown in figure 14.1, there is uncertainty involved when the payment of transactions
takes place between the importer and exporter. Apparently the most secure methods that
work for the exporter are not considered safe for the importer. For exporters, documentary
collection and open accounts are less secure and letter of credit and cash in advance are more
secure methods. In the same way, with respect to the importer, the letter of credit and cash
in advance are less secure and the documentary collection and open account are more
secure. These terms are explained as follows.
Cash-in-advance
Cash-in-advance helps in removing the risks of credit for the exporter. By this method, the
exporter receives the payment before the transfer of goods. The options that are available
with the cash-in-advance method include wire transfers and credit cards. This is the least
attractive method for many of the buyers as it creates cash flow problems. The buyers are
concerned about the quality/quantity and delivery of the goods that are not sent if the
payment is made in advance.
Letters of credit
The letter of credit is the most secure instrument available for international traders. This is
the commitment made by the bank that the payment will be made to the exporter if the terms
and conditions are met. The terms and conditions of the payment are explained in the
required documents.

Documentary collections
Documentary collection is a transaction in which the exporter's bank (remitter bank) sends
the documents to the importer's bank (collecting bank). The document contains information
about the payment. The funds are collected from the importer and paid to the exporter
through the banks involved in the collection, in exchange for the documents.
Open account
The open account transaction involves the shipping and delivery of goods in advance. The
payment is due usually from 30 to 90 days. This is advantageous for the importer in terms of
cash flow and cost terms, but at the same time it is very risky for the exporters. Buyers from
abroad insist on open accounts as the extension of credit from the seller to the buyer are
more common in many countries. Exporters who avoid extending credit may face a loss in
sales because of competitors in the market.
2.2 Letter Of Credit
International Trade is affected by distance, laws, political instability and lack of familiarity
by the transacting parties. Letter of credit assumes significance since it can be used to
mitigate risk. It is a document that is issued by the bank that guarantees payment to a
beneficiary. It is written by the financial institution in favor of the importer of goods to the
seller. In the letter, the bank promises that it will honor the drafts drawn on it if the seller
confirms the specific conditions that are set forth in the letter of credit. The process of letter
of credit works as shown under:

Exhibit 14.2: Process of Execution for Payment under L/C Mode
1. The letter of credit is a letter that is beneficial for both buyer and seller.
(True/False)
2. The __________ transaction involves the shipping and delivery of goods in advance.
a) Open account.
b) Draft.
c) Cash-in-advance.
d) Letter of credit.

3. DOCUMENTATION IN INTERNATIONAL TRADE

Now, we will learn about documentation involved in international trade. A number of
international trade documents are required at various stages of international trade
transactions; the process of trade begins with a proforma Invoice and ends with negotiations
of documents with the banks for payments of export deals. Documents are very important in
international trade deals and fulfil the commercial as well as regulatory requirements of
international trade transactions. Such documents may be aimed for various purposes such
as bill of lading carries the title of goods. It is a contract of affreightment, proof of ownership
and tells the origin and destination of goods. Hence sound knowledge of the International
Trade Documentation is essential for a successful international marketer. Export and import
documents are broadly classified into two; namely commercial and regulatory documents.
Various commercial and regulatory documents that are used in India are as provided in the
table:
COMMERCIAL DOCUMENTS
Auxiliary Commercial Documents Principal Commercial
Documents
1. Shipping Instruction 1. Commercial Invoice
2. Pro-forma Invoice 2. Packing List
3. Shipping Order 3. Certificate of Inspection/Quality
4. intimation of Inspection Control
5. Mate’s Receipt 4. Certificate of Insurance
6. Insurance Declaration 5. Bill of Lading/Combined
7. Application for Certificate of Transport Document
Origin 6. Certificate of Origin
8. Letter to the Bank for 7. Bill of Exchange
Collection/Negotiation of 8. Shipment Advice
Documents

REGULATORY DOCUMENTS
Main and important regulatory Allied regulatory
documents documents
1. Shipping Bill / Bill of Export 1. Export Application/Dock
2. Application for Remission of Excise Challan/Port Trust Copy
(ARE I & II) of Shipping Bill
3. Exchange Control Declaration 2. Receipt for Payment of
(SDF/GR/PP/SOFTEX/VOP) Forms Port Charges
4. Bank Realisation Certificate 3. Vehicle Chit
5. Proof of Landing 4. Freight Payment
Certificate
5. Insurance Premium
Payment Certificate
Table 14.2: Commercial and regulatory documents
3.1 Commercial Invoice
A commercial invoice is the document that is given from seller to buyer. It is called the import
invoice or export invoice. It is mainly used by the custom authorities of the importer country.
Commercial invoices help to evaluate goods for the purpose of taxation.
The following are some criteria that are considered while issuing a commercial invoice. The
commercial invoice must be:
• Issued by the seller in the credit, who is the beneficiary. It must include the price
amount that should not exceed the price stated in the credit.
• Addressed to the applicant of the credit, which refers to the buyer. It must include the
details of the goods, included in the credit.
• Signed by the beneficiary if it is required.
• Issued in the specified number of originals and copies and must include the price and
unit prices, if it is required.
• Clear about the shipping terms.

3.2 Packing List
Customs officials use packing lists to check what is being exported or imported while
importers use it to know without opening the carton/packing that goods are of specified
nature as requested by importer in exporter order. Cargo manifest or packing list provides
all the information with respect to all the items in the box, crate, pallet, and container
including their dimensions, type, and container weight so as to help the customs to know
what is inside the carton or packet.
3.3 Bill Of Lading
The legal document that is issued by the shipping agency for the merchandise that is shipped
from one destination to the other is called the bill of lading. The bill of lading is signed by the
representatives of the carrying vessel. It contains the details of the type, quantity and
destination of the goods.
Several times, the bill of lading is issued as a set of two, three or more. The number present
on each bill of lading is to ensure security. The shipping company or the agent has to sign the
bill of lading. It should also show the number of originals (signed).
The bill of lading indicates whether the cost of carriage is paid or not. This will be of the
following two types:
• Freight prepaid - This is paid for the shipper.

• Freight collects – The buyer has to pay this amount at the port of discharge.
To be acceptable by the buyer, the bill of lading should:
• Carry the correct date of shipment on board.

• Have the notation of the shipping company if the goods are damaged.
The main people that are involved in the bill of lading are mentioned below:
• Shipper/Consignor – He/she is the person who sends the merchandise.

• Consignee - He/she is the person who receives the merchandise.

• Notify party - He/she is person who is informed by the shipping company on the arrival
of goods.
• Carrier - This can be a person or company who is in contract with the shipper for
transport of the merchandise.
Bill of lading has to be in line with the specifications of the letter of credit. Even a small
spelling mistake may lead to rejection of documents.
• The consignee, exact shipper, and the notifying party need to be known.
• Means of transportation and ports of loading and release need to be mentioned.
• The description/quality of the goods needs to be consistent with the other as shown in
the documents.
• The measurements/quantity need to match with the measurements/ quantity that are
on the other documents.
• The shipping marks and numbers need to match the numbers that are shown on the
other documents.
• The bill of lading has to state whether the goods are paid for or if it needs to be paid for
during the release of goods.
• The bill of lading has to state the last date for the shipment, that is before the date
specified in the credit.
• The bill of lading has to state the actual name of the carrier.
3.4 Insurance Certificate
Insurance certificate is also called an insurance policy, an insurance certificate certifies that
the goods that are transported are insured through an open policy. It is mandatory that the
date of effectiveness of the insurance is either same or earlier than the date of issuance of
transport documents. If the document is submitted under the letter of credit, the insured
amount should be in the currency as mentioned in the credit. This is usually the amount of
the bill with an additional 10 percent.
For the insurance policy to be complete, the following information is needed:
• The name of the party in favor of whom the document has been issued.

• The place from where the insurance has to commence should be in detail. The insurance
includes the buyer’s warehouse and the port of destination.
• The details of the flight and the name of the vessel.
• The marks and numbers need to match the numbers that are present on the other
documents.
• The value of insurance needs to be specified in the credit.
• The information related to the names and addresses of the claims should be included
in this document.
• Consistency should be maintained in case of the description of the goods with that of
the invoice credit.
• Wherever it is necessary, the document is countersigned.
• The date of issue of the insurance certificate should not be later than the date of
issuance of transport documents unless the cover that is shown be effective before the
date of transport documents.

3. The legal document given by the shipping company for the merchandise to be
shipped from one place to another is called as _____________ .
4. The ________________ document is required when you are exporting the goods to
other countries.
5. Which of the following documents certifies that the goods that are transported
are insured under an open policy?
a) Consular invoice
b) Insurance certificate
c) Commercial invoice
d) Bill of lading
Activity I
Consider that you are a product manager in XYZ creations and your company is
exporting leathers and laces to the ST Company in Thailand and importing shoes
from the same company. Your management has asked you to maintain the
documents related to the international trade of both the exports and imports. Name
the documents that you would maintain for the same.
Hint: Insurance certificate.

4. FINANCING TECHNIQUES
In the previous section, we learnt about documentations that play an important role during
transactions in the international market. Now let us learn about the financing techniques
that enable us to know various ways of transactions other than direct bank financing.
Planning plays an important role in the lifespan of investment so that financing is available
at every stage.
There are some well-known financing techniques that are explained in the upcoming
sections.
4.1 Banker’s Acceptance
In financial terms, the banker’s acceptance is the credit instrument that is developed by a
non-financial firm and guaranteed by a bank for payment. Usually, the acceptances are
traded at discounts from face value in the secondary market, depending on the credit quality
of the guaranteeing bank. The banker's acceptance has played an important role in financing
foreign trade for many years. A banker's acceptance, is a promised future payment, or time
draft, which is accepted and guaranteed by a bank and drawn on a deposit at the bank. After
accepting the draft, the bank gives an unconditional promise to pay the holder of the draft a
specified amount on a specified day. So, the bank substitutes its own credit for that of a
borrower and in the process, creates an instrument that is freely traded.
4.2 Factoring
The term factoring means the financial transaction in which the factoring organization buys
the exporter’s foreign accounts receivable at a discount. In this, the factor assumes all the
credit and political risks that are present with the importer. From the perspective of the
exporter, factoring is advantageous as it serves to help the firm realize cash immediately.
The following are the three ways in which factoring differs from bank loan:
 factoring mainly focuses on the value of the receivables but not on the worth of the
organization's credit.

 Factoring is the purchase of a financial asset, which refers to the receivable, but it is not
a loan.
 Bank involves just two parties for a loan, factoring involves three parties – the seller,
debtor and factor.
4.3 Forfaiting
In international trade, the term forfaiting refers to the purchase of an exporter’s receivables,
i.e., the amount importers owe the exporter. Forfaiting is the financing technique that is used
for financing the sale of capital goods. In Forfaiting, the buyer is known as the Forfaiter who
takes on all the risks involved with the receivables – the importer now is obliged to pay the
Forfaiter. It involves the sale of notes signed by the importer in favor of the exporter. In this
technique, exporter gets the payment for the goods. Forfaiter does not have recourse on the
promissory notes and the structure of the payment is extended for a period of three to seven
years.
6. The _______________ is the credit instrument that is developed by

the non-financial firm.
7. The term factoring is the financial transaction in which the business sells its
accounts receivable at a discount. (True/False)
8. In which of the following techniques the buyer is known as the forfaiter?
a) Banker’s acceptance.
b) Factoring.
c) Forfaiting.
d) Commercial invoice.

5. EXPORT PROMOTION SCHEMES
In the previous section, we learnt about financing techniques. Now let us understand the
promotion schemes.
The government, in order to promote the exports from the country, offers some export
assistance and export promotion schemes so that exporters can benefit from them. They can
improve their key weaknesses and stand up to compete in the international market by
offering quality Indian products and services. Such export-promotion measures can be
divided into direct and indirect assistance from the government agencies to enable Indian
exporters to standardize the products and services as appropriate for the international
quality and aesthetic appeal. Such measures may be targeted at any of the combination of
the following:
i. Market Access Initiatives (for studies, brochures etc.).

ii. Marketing Development Assistance for participation in trade fairs etc.
iii. Providing services to the international market.
iv. Marketing in difficult markets like certain African, Latin American and
Commonwealth of Independent States (CIS) markets.
v. Marketing difficult products like those from rural areas.
vi. Special agricultural products and rural industrial products.
vii. High-technology products
India being a developing economy, export promotion schemes are needed to give a boost to
our economy. The needs of the export promotion scheme are explained below.
As the economy of the country is progressing with the increase in population, there is a need
for a greater number of imports. We need to have surplus exports to pay for our imports.
• It is not wise to depend on external assistance for financing essential imports, instead
exportable surplus needs to be created.
• In any country, there are some capital goods, machinery and raw materials that cannot
be produced for some time and they have to be imported from other countries. In order

to pay for such imports, the country needs to generate sufficient funds through its
exports.
• The earnings from the exports need to be increased to generate purchasing power in
order to import the essential goods.
• We need to explore the foreign markets in order to expand the capacities of the existing
units and find a market for new units.
• To tap our export potential completely, we need to focus on our strengths like price
stability, low wages and the industrial bases to increase its exports.
• The deficits of payments in Indian economy can be resolved using funds received
through foreign assistance. We need to create repayment capacity with the help of
exports.
Table 14.3 shows the three main categories that are associated with the export promotion
and assistance measures.
Table 14.3: Export promotion and assistance schemes in India

Export incentives Duty neutralization Capacity building and
and benefits and remission infrastructural support
a. Market focus scheme a. Advance a. Export promotion
Product focus scheme authorization capital goods scheme
b. Status holder scheme scheme b. EOU/STPI/BTP EHTP
c. VKGUY scheme b. Duty free import scheme
d. Services from India authorization c. Textiles and apparel
scheme scheme park scheme
e. Services export scheme c. Duty drawback d. Agri export zones
scheme scheme
f. Special focus d. Imprest license for e. SEZ and FTWZ
initiatives in deemed export scheme
agriculture and village f. ASIDE scheme
industry, handlooms,
g. Market access
handicrafts, gems and
initiative scheme
jewelry, leather and
footwear, marine h. Market development
sector, electronics and assistance scheme
IT hardware i. Board of trade
manufacturing j. Town of export
industries, sports excellence scheme
goods and toys, green k. Brand promotion and
products and quality and test
technologies, houses scheme
incentives for exports
from the North
Eastern Region

9. The ________________ helps in identification of the product and market.

10. The imports of second-hand goods that have the minimum residual life of six years
are allowed free of licensee. (True/False)
11. Which of the following schemes aims at importing goods free of cost?
a) Export Promotion Capital Goods Scheme
b) Software Technology Parks
c) Electronic Hardware Technology Parks
d) Duty exemption scheme

6. EXPORT AND IMPORT FINANCE
In the previous section, we studied the export promotion schemes. In this section, we will
learn about export and import finance. The export credit in India is studied with response to
its two stages. The two stages are the pre-shipment credit and the post-shipment credit. The
pre- shipment credit is mainly used for production, processing and packaging. Post-shipment
credit is mainly required to finance the foreign buyers. Depending on the period of loans,
there are three types of credits–short term, medium term and long-term credit.
6.1 Short Term Credit
The short-term credit is provided in the form of pre-shipment and post- shipment finance.
This can be provided by the commercial banks that are authorized dealers in foreign
exchange. Short term credits are covered by RBI and provide credits at a lower rate of
interest. In relation to this type of credit, there are two schemes that are explained as follows:
• Pre-shipment Credit in Foreign Currency (PCFC) for which the exporters can take the
credit both in rupees as well as the foreign currency. We get the credit in Indian rupees
at base rate+1% of interest and the foreign exchange at London interbank offered rate
(LIBOR)+1% rate of interest. Concessional pre-shipment credit as per RBI rules can be
for 6 months.
• The second scheme is the post-shipment credit that is available in Indian rupees. This
post-shipment credit rate of interest is available in Indian currency which does not
exceed 13% for a maximum of 180 days. Higher rates of interest are charged when post-
shipment finance is availed for more than 6 months.
6.2 Long Term Credit
Long-term credit is provided by the EXIM bank and the commercial banks that are refinanced
by the IDBI.
The important aspect of export credit is the risk of transacting with overseas buyers. The
risks with foreign buyers occur due to insolvency of the buyers when there are fluctuations
in exchange rates and some government actions that cause delays in the payment to

exporters. These types of risks can be averted by the insured Export Credit and Guarantee
Corporation (ECGC). This corporation offers two types of services that are given below:
• Export credit insurance, which consists of the policies that are issued to the exporters
to protect themselves against the losses that occur from granting credit terms to the
foreign buyers.
• The direct guarantees are the guarantees to the banks that give protection in respect of
exporters.
6.3 EXIM Bank
The EXIM bank is the export import bank that has been set up by the Government of India
on Jan 1, 1982.
EXIM Bank has the power to borrow from the RBI as well as from abroad. The Bank plays an
important role in export financing as it provides financial assistance for promoting the
Indian exports. Financial assistance is provided through direct financial assistance, abroad
investment finance, pre-shipment credit, buyer’s lines, export bills discounting and so on.
EXIM Bank also extends the help through the non-funded facility for the exporters in the
form of guarantees. This aims at export of manufactured goods, export of technology, export
of software. EXIM bank provides pre shipment and post shipment credit in Indian rupees
and foreign currency. Finance is extended for short term i.e., up to 6 months and also for
medium/long term i.e., beyond 6 months for eligible products and projects. Medium/long
term export credit is extended by way of supplier's credits (i.e., through the Indian exporter)
with recourse to the exporter or buyer's credits
i.e., directly to the overseas buyer with no recourse to the Indian exporter. Certain RBI
guidelines apply for such medium/long term export credit.
The financial assistance schemes provided by the EXIM bank are the most comprehensive
among the export credit agencies across the globe.

12. The _____________ Credit is mainly used for production, processing and packaging.
13. Name the credit that is provided by the EXIM bank and the commercial banks that
are again financed by the IDBI?
14. EXIM bank is a privately owned body. (True/False)
Activity II
Consider that you are a business head in the company and you have to deal with the finance
related to the imports and exports of the company. Due to the transit period in the company,
there is shortage of funds and your management has planned to go for credit terms. Name
the credits that you would suggest for the same.
Hint: Short term credit.

7. SUMMARY
Let us summarize the points covered in this unit about finance and international trade:
• International trade refers to the exchange of products, services and money at the
national level. International trade increases gross domestic product by increasing
economic opportunities.
• There are some risks with both the exporter and importer of the goods. The letter of
credit is a letter that was given to the seller. The letter of credit helps in solving the risks
that the importer and exporter may face in terms of payment or delivery of goods.
• Documentation plays an important role while making transactions at international
markets. The bill of lading is a document that is given by the shipping agency for the
goods that are shipped from one destination to another.
• A commercial invoice is the document that is given to the seller from the buyer. The
insurance certificate is the insurance policy which allows the transport of goods under
the open policy.
• The consular invoice plays an important role while transporting the goods to another
country.
• Different financing techniques play an important role in the lifespan of the investment.
• The factoring technique helps to realize the cash immediately. The forfaiting technique
is used for financing the sale of capital goods.
• The export promotion schemes are the incentive programs developed to attract more
firms towards exporting. There is a need for the export promotion schemes in the
developing country like India.
• There are many exports promotion schemes and Export Promotion Capital Goods
(EPCG) is one of the export promotions schemes that aim at import of capital goods at
a reduced rate.
• The three broad categories of credits include the short term, medium term and long-
term credit.

8. GLOSSARY
Beneficiary: In insurance, the beneficiary is the person or organization that receives money
from the insurance company when the insured event occurs.
Commodity: The physical substances such as food, grains and metals are interchangeable
with other products of the same type.
Export promotion: Program that promotes the domestic producer for exporting and
importing goods.
Foreign Direct Investment (FDI): This is the amount of money that is invested by foreign
companies and other assets that help the economies to grow more efficiently and become
competitive participants.
Gross Domestic Product (GDP): The final market value of all the goods and services are
produced in the country in one financial year.
Monopoly: Situation in which a single firm owns almost all the market of a given type of
product or service.
1. Explain in brief about letter of credit.

2. Write a short note on insurance certificate.
3. Discuss factoring.
4. Elaborate on the need for an export promotion scheme in the country.
5. Describe the functions of the EXIM bank.

10. ANSWERS
1. True
2. a. Open account
3. Bill of lading
4. Consular invoice
5. b. Insurance certificate
6. banker’s acceptance
7. True
8. c. Forfaiting
9. export promotion scheme
10. False
11. d. Duty exemption scheme
12. Pre-shipment
13. Long term
14. False
Terminal Questions
1. The letter of credit is a letter that is given to the seller. In the letter, the bank promises
that it will honor the drafts drawn on it if the seller confirms the specific conditions
that are set forth in the letter of credit. For more information, refer to subsection 2.2
of this unit.
2. Insurance certificate is known as an insurance policy which certifies that the goods
that are transported are insured under an open policy and are not actionable with the
risks that are covered. We have discussed this in subsection 3.3 of this unit. You can
refer to the same for more details.
3. Term factoring is the financial transaction in which the business sells its accounts
receivable at a discount. For more information on factoring, refer to subsection 4.2 of
this unit.

4. As the country's economy is progressing, there is a need for a greater number of

imports. We need to have much of the exports to pay for our imports. You can refer
to section 5 of this unit for more details.
5. EXIM bank plays an important role in export financing. This bank provides the
financial assistance for promoting the Indian exports. For more information, refer to
subsection 6.3 of this unit.
11. CASE LET
In order to promote paperless, transparent and cost-effective export-import operations;

government of India with the help of UNCTAD has implemented the ‘ICEGATE’ platform
which is a one-stop-window for filing of export import documents so that the goods can be
cleared for export and import. ICEGATE is an e-commerce initiative for filing of all export
import documents so that the cargo can be cleared on a real time basis and informed
decisions vis-a-vis composition and direction of foreign trade can be taken. Thus, ICEGATE
is an infrastructure project that fulfils the customs department's electronic
communication/electronic data interchange and data communication requirements.
ICEGATE system facilitates the smooth functioning of Central Board of Excise and Customs
through various facilities such as electronic filing of Bill of Entry (import goods declaration)
and Shipping Bills (export goods declaration) and related electronic messages between
customs and the trading partners using communication facilities, i.e., e-mail. ICEGATE also
ensures 24X7 helpdesk facilities on status of trade documents to trading partners, i.e.,
exporters and importers. For safe and secure transactions, it is mandatory that one should
use only digital signatures on Bill of Entry and other documents/messages to be handled on
the gateway.
At present, ICEGATE system at Indian customs is working through a MPLS based Wide Area
Network. It links all the buildings of the 582 departments of Indian customs all over the
country. In addition to e-filing of export import documents, ICEGATE also provides a host of
other services like e-payment, online registration for intellectual property rights/SPS
barriers/TBT barriers etc. One can check the status of trade by using Document Tracking
status platform at ICEGATE. Now, it is possible to make online verification of export

promotion schemes like DCS/DEPB/DEEC/EPCG licenses, Importer-Exporter code status.

ICEGATE is also linked up with other systems like ACES (excise and service tax), PAN (income
tax) for availing input credit if any. Custom House Agents can also use it on behalf of
exporter/importer and can access important information relating to export or import from
other websites and databases. Due to all these reasons, Indian exporters and importers are
fast moving towards paperless trade by filing shipping bill/bill of entry at ICEGATE.
Q. No. 1: What are the major benefits of customs clearance platform called as ICEGATE?
Q. No. 2: How does ICEGATE system ensure cost effective operations of customs?
Q. No. 3: What are the advantages of ICEGATE linkages with other systems like ACES (excise
and services tax), PAN (income tax) Quality assurance agency and DGFT?
References:
• B.L. Mathur (2001), Towards economic development, Discovery

publishing house.
• Aswathappa (2008), International business, Tata McGraw-Hill.
E-Reference:
• http://www.businesslink.gov.uk/bdotg/action/detail?itemId=1077787643&
type=RESOURCES, retrieved on 3rd November, 2010.
• http://www.infodriveindia.com/Exim/Guides/Export-
inance/Ch_4_Trade_Documents.aspx, retrieved on 4th November, 2010
• http://www.investopedia.com/articles/03/112503.asp, retrieved on 5th November,
2010
• http://ecedweb.unomaha.edu/ve/library/bfte.pdf, retrieved on 11th November, 2010.
• http://www.economywatch.com/international-trade/heckscher-ohlin- model.html,
retrieved on 15 Nov 2010
• http://www.bangkoklogistics.com/international-business/Three-Barriers- To-
International-Trade.html, retrieved on 18th November 2010
• http://www.pierobon.org/export/outline.htm, retrieved on 20 April 2012


SEMESTER 4
DMBA402
MANAGEMENT
Unit 15: Global Sourcing and Indian Industries Structure 1

Unit 15
Global Sourcing and Indian Industries
Structure
Table of Contents

No Graph Activity
1 Introduction - -
4
2 What is Global Sourcing? 1 I 5-7
3 Reasons for Global Sourcing 2, 3 1
3.1 Lower salary and wages - -

3.2 Regulatory costs in business - -
3.3 Tax breaks and benefits - -
8 - 11
3.4 Improved performance - -
3.5 Faster turnaround time - -
3.6 Uncertainty over political/business
- -
climate
3.7 Proximity to key markets - -
4 Advantages of Global Sourcing 4 II
4.1 Benefits of Core Competency - -
4.2 Effective and efficient business
- -
operations
4.3 Reduced overhead expenses - - 12 -13
4.4 Better control on operations - -
4.5 Manpower staffing flexibility - -
4.6 Sustainable business operations and
- -
reduced risks
5 Disadvantages of Global Sourcing 5 - 14 -18

5.1 Loss of managerial control - -

5.2 Hidden costs in business operations:
when company outsources business - -
process
5.3 Threat to security and confidentiality - -
5.4 Quality assurance in business process - -
5.5 financial dependence on another
- -
company
5.6 Ill-will and bad publicity - -
6 Global Sourcing Challenges to Indian
- 2
Industries
6.1 Recruiting competent and skilled
- -
workforce
6.2 Training and development for
- -
manpower 19 - 21
6.3 Controlling attrition and managing
- -
retention
6.4 Ensuring satisfactory customer
- -
satisfaction/service levels
6.5 Infrastructural and logistical challenges - -
7 Summary - - 22
8 Glossary - - 23
10 Answers - - 24
11 Case-let
- - 25 - 26

1. INTRODUCTION
In this unit, you will study about global sourcing and its impact on Indian industries. Global
sourcing is a procurement strategy that is aimed at exploiting global efficiencies in
production.
This unit discusses the evolution of globalization in India and its impact on Indian business.
It also discusses the prevailing competitive environment in India with respect to
international business, challenges and threats faced by Indian business. Some proven
strategy models have also been discussed for better understanding of international business
operations in India.
❖ Explain the concept of global sourcing.

❖ Analyze the reasons for global sourcing
❖ List the advantages & disadvantages of global sourcing
❖ Describe the global sourcing challenges to Indian industry.

2. WHAT IS GLOBAL SOURCING?
Globalization of the world economy under the WTO has opened abundant opportunities for
cost cutting, attaining competitive advantage and saving time for industries worldwide.
Indian industries have experienced such developments as India is a member of the WTO
since its inception in 1995. ‘Global sourcing’ is described as ‘the practice of sourcing cost
effective and best goods and services across geopolitical boundaries in order to cater to global
markets. Global sourcing strategy is aimed at exploiting ‘global efficiencies’ in all areas of
manufacturing, trading and services to enable offering clients and customer the best possible
product or services. Usually, firms opt for global sourcing due to low-cost skilled labor, low-
cost raw material, proximity to key markets, time zone differences and other economic
factors such as tax exemption and low trade tariffs.
Indian industries have successfully utilized global sourcing strategies in their global trade
operations and sourcing has been the driving force behind the development and expansion
of Indian foreign trade in the recent past. Global sourcing strategy has made Indian industry
more globalized as buyers from all over the world are bidding for Indian goods, particularly
services, to enable executing their contracts on time, reduce prices and generate efficiency
in the system through increased competition. Indian industries, in order to reap the benefits
of sourcing opportunities, has opened global offices and subsidiaries to tap opportunities on
all fronts, i.e., manufacturing, trading, skilled services and call centers.
As we know, manufacturing costs vary across countries due to factors such as currency
conversion and cost of living. Due to different factor endowments in various countries, the
costs of labor and materials may differ, for example, labor cost is far lower in developing
countries like India than in North America and Europe. For companies that have labor
intensive work, this difference in cost results in significant savings in terms of salaries,
wages, post-retirement benefits, fringe benefits and other benefits. India is emerging as a
global hub in gems and jewelry, oil refining, engineering equipment, textiles, sports goods,
auto components, etc.
In a globalized set up, trade and commerce of skilled services such as IT enabled services,
software development and testing, purchasing, engineering and integrated chip designing,

knowledge process outsourcing (KPO), offshoring and home shoring is growing much faster
than trade in merchandise. India, with its demographic dividends has been benefitted from
all such developments as the level of skill and knowledge held by Indian professional allows
them to provide high quality services to their clients in developed countries. For example,
India has been successful in software development, BPO services, KPO services and in the
recent past in areas like Engineering Process Outsourcing, Analysis Process Outsourcing,
content development and website designing. The main reasons for skills sourcing to India is
represented pictorially as under:
Figure 15.1 Reasons Why India is preferred in Skill Sourcing
Global sourcing has both benefits and risks for the Indian industry. Global sourcing has
helped Indian companies in the generation of additional revenue and profits, precious
foreign exchange, scalable business operations and employment. There are spillover effects
of outsourcing to India and its economy has grown additionally by emerging as lower cost
suppliers of merchandise and services. Brand India is widely recognized in the ‘Silicon Valley’
and the Indian government’s bargaining power has increased due to the dependence of many
countries for Indian services. Living standards of the people has improved, higher wages,
improved working conditions and learning transferable skills has helped thousands of
Indians.

Risks from global sourcing such as cultural and language related issues, withdrawal of tax
benefits, accent problems, high labor attrition, diversification of business operations across
different countries, increased business travel and local management issues are present. In
addition to this, there also comes the risks related to logistics and transportation.
Activity I
What are the reasons that India is a global power house in IT and ITes enabled services
outsourcing?
Hint: http://www.outsource2india.com/india/why-outsourcing-india-good- for-
business.asp

3. REASONS FOR GLOBAL SOURCING

Global sourcing is one of the most controversial subjects as the benefits of outsourcing is not
properly understood by both companies and politicians. In the current phase of global
economic recession, politicians condemn outsourcing as it sends both money and work out
of the country thus affecting employment and people’s income level. Even then, the global
sourcing industry is on a growth run as there are sound business reasons in global sourcing.
These reasons are explained as under:
3.1 Lower Salary And Wages
The foremost reasons for global sourcing have been the ‘financial incentive’ of outsourced
operations to low-cost labor destinations such as India, Philippines, Poland and Romania.
Due to the different stages of economic development, labor cost of workers in any developed
countries is far higher than their counterparts. The following table illustrate labor cost
differentials among countries.
Figure 15.2: Source: Bureau of Labour Statistics; US Department of Labour
3.2 Regulatory Costs In Business
An underappreciated incentive in global sourcing to developing countries including India

has seen significant difference in the regulatory cost of business. Attorneys in India charge a
fraction of the cost compared to those in the US, hence, law firms in the US get their law
related work done in India. Moreover, cost of employment in US is far higher as companies

have to offer legally complying pay packages which includes social security, medical care,
post-retirement benefits, entertainment allowances, employee group insurance,
unemployment insurance, etc. Such components may not exist in countries like India. Layoff
expenditure in US is far higher than in India, thus, companies outsource their business
operations to countries like India, China, Vietnam, Thailand, South Africa, Nigeria and Brazil.
3.3 Tax Breaks And Benefits
Developing countries like India offer tax breaks for new entrants thus offering cost savings
for these companies. For example, Hyundai was offered a tax break, back then the tax break,
was given in terms of VAT for 5 years by the Tamil Nādu government for setting up a plant.
Nokia shifted its plant from Germany to Romania as it had low labor cost coupled with tax
breaks offered by government.
3.4 Improved Performance
Developed countries usually outsource their business operations to developing countries

like India which is at the bottom of their core operations, monotonous and require huge
labor. Such work can be done by dedicated outsourced labor force in developing country at
a fraction of the cost of developed countries. It is found that such bottom of the pyramid,
monotonous and repetitive work has far better performance in developing countries due to
specialization and dedicated expertise for the work.
3.5 Faster Turnaround Time
Companies as well as government are outsourcing their non-core operations to low-cost

countries as it helps not only to focus on core activities but to also get the required job done
much faster with reduced time and accuracy. In business, ‘time is money’ as the saying goes,
thus, firms outsource some of their business operations for faster and quicker turnaround
time.

Figure 15.3 Reasons for global sourcing
3.6 Uncertainty over political/business climate
Another advantage of global sourcing is that companies want to evade their political and
business risks by locating their business operations at various parts of the world. If political
or economic problems occur in any region, the company will be able to continue its
operations without disruption by fulfilling their needs from other global sourcing location.
For example, auto companies worldwide have invested in India as well as in Thailand for
supply of auto components as both are low-cost countries having specialization in the auto
component industry. If there is a problem in India supplies can be taken from Thailand or
vice versa.
3.7 Proximity To Key Markets
In an era of globalization, firms have outsourced their business operations close to their key
markets. For example, it is cheaper to manufacture goods in Thailand or China and then ship
them to Japan than to ship them from US or Europe. Multinational organizations have

resorted to global sourcing to countries like India to fulfil their markets demand not only for
South Asia but also for East Asia, Middle-East and Eastern Africa.
Self-Assessment Questions – 1
1. Firms outsource as it enables them for faster turnaround time in their business
operations. (True/ False)
2. Manufacturing costs vary from country to country. (True/ False)
3. Low wages and salary are the prime motivators for US companies to outsource
to India. (True/ False)
4. Which of the following is not a reason for India’s outsourcing attractiveness?
a) Cost Restructuring.
b) Better Capacity Management.
c) Focus on Core Business.
d) Polite People.

4. ADVANTAGES OF GLOBAL SOURCING
As business operations diversified in the global production chain due to globalization,

companies have to evaluate their choices, decisions and strategy for outsourcing different
components at a cost-effective level from all around the world. Outsourcing offers several
advantages as different countries are endowed with different natural, physical and
demographic resources. Multinationals spread their production to low cost, developing
countries. Business operations are shifted to many countries depending on the comparative
and competitive advantage. Global sourcing has actually helped multinational enterprises to
grow and save money. There are other advantages of global sourcing that go beyond financial
benefits. Detailed below are some advantages that prompt companies to source globally for
cost, reliability and efficiency reasons.
4.1 Benefits Of Core Competency
A large company offering products and services in many segments and industries need to
constantly focus on delivering innovative products. Larger business organization sometimes
develop stagnancy due to their back-office operations which may affect its core function or
activities. Therefore, such companies usually outsource their non-core activities to other
companies.
For example, for a pharma company it is important that its manpower focuses on research
and innovation of new drugs, but if it expands its organization to resolve problems such as
order processing, managing inventory, warehousing, documentation, booking new orders
and handling customer problems it will make the organization redundant since most of its
top management energy will go into non-core issues. Outsourcing these non-core activities
can make firms lean, fast, cost effective and competitive in the market.

Figure 15.4
4.2 Effective And Efficient Business Operations
Back-office operations for any firm in today’s’ competitive environment is not only
complicated in nature but also expensive in terms of both financial resources and time.
Organizations can focus on core strength when such non allied activities are outsourced at
consistent and reasonable cost. Outsourcing such operations can help firms tide over such
problems areas.
4.3 Reduced Overhead Expenses
Firms have to outsource some of their functions to cost effective destinations as overhead
costs of performing a particular back-office function may be extremely high in its own
country due to different factor endowments. For example, medical transcription which is
considered as a non-core activity is outsourced to India by US firms. India is considered as
the most cost effective and cost competitive market leader in medical transcription
outsourcing because of its large resource of young, college educated and productive
workforce. Indians are also good in the use of the English language. Globally, firms are
looking at India’s best-in- class medical transcription training methodologies for outsourcing
their work in medical transcription outsourcing.

4.4 Better Control On Operations
Any business operations for which costs are running out of control is better outsourced.
Sometimes, there are certain departments that may have evolved over time into
uncontrolled and poorly managed areas. This becomes a prime motivator for outsourcing.
Outsourcing such departments to another country/region helps the firm learn/imbibe better
management skills, innovation and practices.
4.5 Manpower Staffing Flexibility
Outsourcing seasonal/cyclical business operations also help firms save costs. There are
seasonal or cyclical demands of goods and services requiring additional manpower
resources from firms. Firms can outsource such operations to another region/country where
labor expenses may be just a fraction of what it is in the domestic market. For example,
taxation related work processes of many US states have been successfully outsourced to
Indian firms.
4.6 Sustainable Business Operations And Reduced Risks
Due to uncertain business scenarios and the changing demographic profile of countries,
there have been trends and periods of high employee turnover which add uncertainty and
inconsistency to a firm’s business operations. More so, it has been observed that sometimes
a region of the world may go into turmoil, civil disorder, God or manmade catastrophes, etc.
If a firm’s business operations are outsourced to different parts of the world, it can survive
from such risks and can ensure sustainable business operations. For example, due to the
Jasmine revolution many multinationals survived even after the shutdown of their
businesses in the Gulf/Arab region. Firms who had outsourced their activities to multiple
regions were able to fulfil their client/customer needs from another part of the world.

Activity II
What makes India so attractive for global outsourcing companies to outsource auto
components from India?
Hint: Read the case “Indian Auto Component Industry: New Destination for Outsourcing” at
http://www.frost.com/prod/servlet/market-insight- top.pag?docid=8011194

5. DISADVANTAGES OF GLOBAL OUTSOURCING
Global sourcing also has certain disadvantages such as loss of managerial control, hidden
costs, threat to security and confidentially, quality problems, financial dependence on
another company and bad publicity campaign to sourced city/countries/region. For
example, retrenched employees of a US firm usually talk about being “Bangalored”; meaning
laid off from the job. One has to make a trade-off of between advantages and disadvantages
before arriving at ‘outsource’ or ‘not to outsource’ decision.
5.1 Loss Of Managerial Control
One of the main disadvantages of global outsourcing is that the company loses managerial
control on the certain functions to the outsourced company. As the outsourcing company
only holds a contract and the entire functional responsibilities are handed over to another
company; it becomes dependent on the outsourced company for its operations. The main
motive of the outsourced company is profits. Thus, the same performance standards; mission
and drives cannot be expected from an outsourced company.
5.2 Hidden Costs In Business Operations: When Company Outsources

Business Process
The outsourced company has to sign a contract with the outsourcing company which covers
the details of the services that will be provided by the outsourced company. Usually, the
contract that best suits the requirements is framed by the outsourcing company with the
help of their legal team. Additional charges will have to be paid for anything which is not
covered in the contract. Additionally, each time the company signs the contract, it will have
to incur legal charges and fees to a lawyer to review the contracts that company gets into.
5.3 Threat To Security And Confidentiality
In an era of globalization; information is well considered as the fourth factor of production,

in addition to land, labor and capital. Information keeps a business running. If business
operations such as payroll processing, medical records, credit cards records, accounting and
financial information are provided to the outsourcing company, the security and

confidentiality of the company may be at risk. While outsourcing any business process, it is
important that the outsourcing company should ensure protection of data from falling into
miscreant hands and the contract should have a penalty clause if such an incident occurs.
5.4 Quality Assurance In Business Process
Outsourcing companies usually neglect the quality assurance and control in business
operations as they are motivated to increase their profits by reducing operating expenses.
Sourcing contracts usually fix the price for any service rendered. If any additional services
are needed in line with this service, the outsourced company will neglect it or demand extra
charges for that. Additionally, a company will lose the ability to respond to emerging quality
control changes in business operations
Figure 15.5
5.5 Financial Dependence On Another Company
When an operation or work is outsourced to another company; such companies become

dependent on the financial well-being of the outsourcing company. If the outsourcing
company becomes insolvent or defaults on financial as well as in business operations,
the very existence; brand image and reputation of the outsourcing company comes under
risk.

5.6 Ill-Will And Bad Publicity
When business operations are outsourced from one country to another, various factors are
taken into consideration. The Chinese are looked upon negatively in Europe for offering low
cost, inferior products. Similarly in the US, retrenched employees talk of being ‘Bangalored,
as the company in the US would have outsourced its business operations to a Bangalore
based company in India. Job losses lead to ill feelings. As China and India are the
powerhouses in outsourcing (China in goods and India in services), both the countries have
certain amount of bad publicity in developed countries especially among the people who
have been laid off.

6. GLOBAL SOURCING CHALLENGES TO INDIAN INDUSTRIES
Once it becomes clear for any company that it is strategically in its interest to outsource,
strategic planning and review of the advantages and disadvantages of each scenario under
which it will outsource its business operations to other country/region should be done.
There can be many potential opportunities and challenges which can be converted into
opportunities while outsourcing business operations to another country. The challenges
while outsourcing to India are detailed as under the following:
6.1 Recruiting Competent And Skilled Workforce
India has the largest cost effective, professional talent pool of English-speaking people in the
world. The main reason for outsourcing of US/UK/ Australia/Canada companies to India has
been the English-speaking strengths of Indian people. While outsourcing their business
operations to India, companies look into it that the service provider has considerable
outreach activities to reach a potential talent pool. A more systematic selection process is
required than that of the home country especially in case of voice-based process. It is
estimated that a BPO company in India has to screen at least 20 candidates to be able to
recruit one employee (the ratio is 20:1). The major challenge for Indian BPO/KPO companies
is that this number is increasing. Recruitment market for providing services to clients in
India are getting extremely competitive and companies in India are compelled to open offices
in second tier cities to expand their business operations by recruiting cost effective talent
pool.
6.2 Training And Development For Manpower
For creating a successful platform in services sector sourcing in global markets, India has to
have trained workforce that is competent to respond to onetime floor challenges. This is
especially true in case of IT/ITes sector where India has many opportunities in terms of
ramp-up of people and processes. In addition to improving the soft skills, accent adaptation
and cross-cultural sensitivity, workforce also needs to be trained in maintaining a balance in
social and professional life. Health of employees is important. Yoga, physical exercise can be

made part of routine life of such workforce in order to reap the desired benefits of India’s
potential in global markets.
6.3 Controlling Attrition And Managing Retention
In India’s IT and ITes companies; attrition levels are in the range of 15%- 60% per year. The
average attrition level for a voice-based call center in India is around 40%. There is huge
challenge in workforce management in India. Most young employees leave the BPOs industry
due to the monotonous work, and the physical toil of night-shift jobs. Companies in India
need to realize this aspect and set realistic expectations for the employees. There should be
support services by HR department for recreation and entertainment of the employees.
6.4 Ensuring Satisfactory Customer Satisfaction/Service Levels
Companies from developed countries that outsource their established processes to Indian
services provider expect that the quality and performance standards should be of highest
level. Customers must be satisfied from such offshoring of business operations with at least
the same level of or even higher level of performance standards.
6.5 Infrastructural And Logistical Challenges
India has infrastructural bottlenecks in all areas, i.e., roads, rail, air and maritime transport.
Even virtual infrastructure like internet access, telecommunication, etc., which are vital for
growth of services outsourcing is poor in India. Power and connectivity are the most
important components for sustainable growth of services sector outsourcing from India.
Data/voice connectivity, lower bandwidth, transportation, food, services, etc., are some of
the other challenges confronting the growth of outsourcing from India.
If these challenges are overcome, India can reap the desired benefits from growth and
expansion of sourcing of services and can even emerge as market leader in the world.

Self-Assessment Questions – 2
5. IT/ITes outsourcing has brought some ill will/bad publicity towards Indians.
(True/False)
6. Outsourcing helps the firm with increased managerial control over all functions.
(True/False)
7. Global sourcing does not pose any security/confidentiality threat to the country.
(True/False)
8. Which one of the following is not a concern for India for increasing its strength
as outsourcing destination?
a) Lack of skilled workforce.
b) Tax breaks.
c) Logistical challenge.
d) Managing retention.

7. SUMMARY
Let us now summaries the salient points you have learnt in this unit on global sourcing and
its impact in India:
• Globalization of world economy under WTO has opened abundant opportunities of cost
cutting, competitive advantage and time saving for industries worldwide.
• Manufacturing costs vary from country to country due to factors such as currency
conversion and the cost of living in different countries.
• Principal reasons for global sourcing have been the ‘financial incentive’ to outsource
operations to low-cost labor destinations such as India, Philippines, Poland and
Romania.
• Outsourcing offers several advantages as different countries are endowed with
different natural, physical and demographic resources.
• Firms have to outsource certain functions to cost effective destinations because of high
overhead costs of executing a back-office function in its own country due to different
factor endowments.
• India has the largest cost effective, available, professional talent pool of English-
speaking people in the world.
• Virtual infrastructure like internet access, telecommunication. etc., which are vital for
growth of services outsourcing is poor in India.
• Outsourcing companies usually neglect the quality assurance and control in business
operations as they are motivated to increase their profits by reducing operating
expenses.

8. GLOSSARY
Sourcing: It refers to a number of procurement practices, aimed at finding, evaluating and

engaging suppliers of goods and services for better work delivery and cost-effective services.
Bangalored: Losing a job to an Indian outsourcing firm based in Bangalore city is called
“Bangalored” in US.
BPO: Business Process Outsourcing
KPO: Knowledge Process Outsourcing
Jasmine Revolution: This is the December-January mass uprising incident that overthrew
the president Zine El Abidine Ben Ali. An intensive campaign of civil resistance along with a
series of street demonstrations took place in Tunisia.
Sub-contracting: The practice of assigning work under a contract to another party.
1. What is global sourcing? What makes India so attractive for global sourcing?
2. Elaborate the reasons due to which firm outsource to India.
3. What are the advantages of global sourcing?
4. What are disadvantages of global sourcing?
5. What has been the impact of global sourcing on Indian business?

10. ANSWERS
1. True.
2. True.
3. True.
4. Polite people.
5. True.
6. False.
7. False.
8. Tax breaks.
Terminal Questions
1. Global sourcing is described as ‘the practice of sourcing cost effective and best goods
and services’ across geopolitical boundaries in order to cater to global markets”. Refer
to section 2
2. Global sourcing industry is on growth run as there are sound business reasons in global
sourcing. Refer to section 3
3. Global sourcing has helped the multinational enterprises to grow and save money.
There are other advantages of global sourcing that go beyond financial benefits. Refer
to section 4
4. Global sourcing also has certain disadvantages such loss of managerial control, hidden
costs, threat to security and confidentially, quality problems, financial dependence on
another company and bad publicity. Refer to section 5
5. Indian business is facing competition and has to improve in efficiency and quality due
to market forces. This will ultimately help India in utilizing opportunities and facing
challenges. Refer to section 6.

11. CASE-LET
Challenges faced by McDonalds in India
McDonalds is an MNC and is one of the largest fast food chains in the world. McDonalds began
its operations in India in 1996. Initially, the McDonalds food outlets reported accumulated
losses. To overcome this failure, McDonalds developed a business strategy in India which
adapted
to the local culture in India, its localisation and pricing strategy. McDonalds famous dish is
the beef-based hamburger. In India, most of the people do not eat beef and pork and some
prefer vegetarian. McDonald’s customised its menu with more than 50 percent vegetarian
products. It introduced an Indian version of burgers which are made from mutton and
chicken. McDonalds also introduced its price strategy in India. It announced reduction in
prices by 25 percent for its lunch and dinner menus. Today, McDonalds is a successful food
chain and has more than 170 restaurants in India.
Discussion question
1. What challenges did McDonalds face in India?
Source: http://www.scribd.com/doc/6464143/McDonalds-4Ps-Of- marketing
References:
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• Boutilier, Robert. (1993). Targeting Families: Marketing To and Through the New
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DMBA402: International Business Management Manipal University Jaipur (MUJ)

MASTER OF BUSINESS ADMINISTRATION

Unit 1 : International Business Management 1

SL Fig No / Table SAQ /

3.1 Domestic vs. international business - -

Unit 1 : International Business Management 2

1.1 Learning Objectives:

After studying this unit, you should be able to:

❖ Explain the concept of international business.

Unit 1 : International Business Management 3

2. INTRODUCTION TO INTERNATIONAL BUSINESS

• Product presence in different markets of the world

Unit 1 : International Business Management 4

Figure 1.3: Ancient Silk Road and Spice Route

Unit 1 : International Business Management 5

• Establishment of International Monetary Fund (IMF) and International Bank for

Unit 1 : International Business Management 6

A. List out the differences between domestic and international trade?

Unit 1 : International Business Management 7

3. ELEMENTS OF INTERNATIONAL BUSINESS

3.1 Domestic Vs. International Business

Unit 1 : International Business Management 8

3.2 Advantages Of International Business

Unit 1 : International Business Management 9

3.3 Drivers Of International Business

Unit 1 : International Business Management 10

Technological innovation: Technology is the most powerful driver in triggering

Unit 1 : International Business Management 11

3.4 Entry Modes Of International Business

Trade-related Entry Modes:

Transfer-related Entry Modes:

FDI-related Entry Modes:

Unit 1 : International Business Management 12

Trade-related Entry Modes:

Unit 1 : International Business Management 13

Unit 1 : International Business Management 14

FDI-related Entry Modes:

Foreign Direct Investment – The investment made by a company in a foreign country to

Unit 1 : International Business Management 15

Unit 1 : International Business Management 16

Unit 1 : International Business Management 17

According to business terminologies, globalization is defined as ‘the worldwide trend of

According to IMF: “the growing economic interdependence of countries worldwide through

Globalization encompasses the following:

• Expanding the business globally

Unit 1 : International Business Management 18

4.1 Global Vs International Company :

A global company operates across In International business a

Unit 1 : International Business Management 19

4.3 Demerits Of Globalization

The Demerits of globalization are as follows:

Refer this link for guidance –

5. ‘The worldwide trend of businesses expanding beyond their domestic

Unit 1 : International Business Management 20

• International business is mainly concerned with issues related to companies and

ITES: is Information Technology enabled services. Information Technology enables the

Subsidiary: A company whose controlling interest is held by a bigger (parent) company.

Unit 1 : International Business Management 21

1. Explain the evolution of international business.

Self- Assessment Questions 1

Self-Assessment Question 2 Answers

Unit 1 : International Business Management 22

Bata Shoe Company, founded in 1894 in the former Czechoslovakia (presently