International business

Part 1. Introduction International business encompasses a full range of cross-border exchanges of goods, services, or resources between two or more nations. These exchanges can go beyond the exchange of money for physical goods to include international transfers of other resources, such as people, intellectual property (e.g., patents, copyrights, brand trademarks, and data), and contractual assets or liabilities (e.g., the right to use some foreign asset, provide some future service to foreign customers, or execute a complex financial instrument). The entities involved in international business range from large multinational firms with thousands of employees doing business in many countries around the world to a small one-person company acting as an importer or exporter. This definition of international business also encompasses for-profit border-crossing transactions as well as transactions motivated by nonfinancial gains (corporate social responsibility, and political favor) that affect a business’s future. When we try to understand, who cares about international business in the first place, we should identify all types of stakeholders. Individuals or organizations will have an interest in international business if it affects them in some way—positively or negatively. Beyond the company and governments, other stakeholder groups might include industry associations, trade groups, suppliers, and labor. As a rule, companies engage in international business because they have one of three major operating objectives: • expanding sales; • acquiring resources; • reducing risks. Foreign sources may give companies: • lower costs. • new or better products. • additional operating knowledge When company operates internationally, it will engage in modes of business, such as exporting and importing, which differ from those it uses domestically. At the same time, physical, social, and competitive conditions differ among countries and affect the optimum ways to conduct business. Thus, international companies have more diverse and complex operating environments than purely domestic ones. Part 2. The interrelation of globalization processes and trends in the development of international business Globalization - trend away from distinct national economic units and toward one huge global market. Globalization has several facets, including the globalization of markets and the globalization of production. The globalization of markets refers to the merging of historically distinct and separate national markets into one huge global marketplace. Falling barriers to cross-border trade and investment have made it easier to sell internationally. It has been argued for some time that the tastes and preferences of consumers in different nations are beginning to converge on some global norm, thereby helping create a global market. These differences frequently require companies to customize marketing strategies, product features, and operating practices to best match conditions in a particular country. The most global of markets are not typically markets for consumer products – where national differences in tastes and preferences can still be important enough to act as a brake on globalization – but markets for industrial goods and materials that serve universal needs the world over. In an increasing number of industries, it is no longer meaningful to talk about “the German market,” “the American market,” “the Brazilian market,” or “the Japanese market”; for many firms, there is only the global market. Globalization of production – trend by individual firms to disperse parts of their productive processes to different locations around the globe to take advantage of differences in cost and quality of factors of production. The globalization of production refers to the sourcing of goods and services from locations around the globe to take advantage of national differences in the cost and quality of factors of production (such as labor, energy, land, and capital). By doing this, companies hope to lower their overall cost structure or improve the quality or functionality of their product offering, thereby allowing them to compete more effectively. But as with the globalization of markets, companies must be careful not to push the globalization of production too far. Substantial impediments still make it difficult for firms to achieve the optimal dispersion of their productive activities to locations around the globe. These impediments include formal and informal barriers to trade between countries, barriers to foreign direct investment, transportation costs, issues associated with economic and political risk, and the sheer managerial challenge of coordinating a globally dispersed supply chain. Nevertheless, the globalization of markets and production will probably continue. Modern firms are important actors in this trend, their actions fostering increased globalization. Two macro factors underlie the trend toward greater globalization. The first is the decline in barriers to the free flow of goods, services, and capital that has occurred since the end of World War II. The second factor is technological change, particularly the dramatic developments in recent decades in communication, information processing, and transportation technologies. Implications for the Globalization of Production As transportation costs associated with the globalization of production have declined, dispersal of production to geographically separate locations has become more economical. Implications for the Globalization of Markets In addition to the globalization of production, technological innovations have facilitated the globalization of markets. Low-cost global communications networks, including those built on top of the Internet, are helping create electronic global marketplaces. As noted earlier, low-cost transportation has made it more economical to ship products around the world, thereby helping create global markets. This has reduced the cultural distance between countries and is bringing about some convergence of consumer tastes and preferences. At the same time, global communications networks and global media are creating a worldwide culture. Part 3. Country differences and environment of international business There are more challenges in doing international business than in domestic one because countries differ in many ways. Countries have different political, economic, and legal systems. They vary significantly in their level of economic development and future economic growth trajectory. Cultural practices can vary dramatically, both as the education and skill level of the population. All these differences can and do have major implications for the practice of international business. They have a profound impact on the benefits, costs, and risks associated with doing business in different countries; the way in which operations in different countries should be managed; and the strategy international firms should pursue in different countries. The political system of a country shapes its economic and legal systems. By political system can be meant the system of government in a nation. Political systems can be assessed according to two dimensions. The first is the degree to which they emphasize collectivism as opposed to individualism. The second is the degree to which they are democratic or totalitarian. These dimensions are interrelated; systems that emphasize collectivism tend toward totalitarian, whereas those that place a high value on individualism tend to be democratic. However, a large gray area exists in the middle. It is possible to have democratic societies that emphasize a mix of collectivism and individualism. Similarly, it is possible to have totalitarian societies that are not collectivist. There are five types of legal systems in the world today: • common law; • civil law; • theocratic law; • customary law; • mixed. Countries have different levels of economic development, performance, and potential. Managers frame analysis by evaluating the particular type of economic system in a country. There are three possible types of economic systems: the market, mixed, and command economies Broad classes of countries include: • Developing countries (NICs= newly industrialized countries, the least developed countries and other developing countries) • Emerging economies • Developed countries For analytical purposes, UN classifies all countries of the world into one of three broad categories: • developed economies, • economies in transition, • developing economies. Several countries (in particular the economies in transition) have characteristics that could place them in more than one category; however, for purposes of analysis, the groupings have been made mutually exclusive. Within each broad category, some subgroups are defined based either on geographical location or on ad hoc criteria, such as the subgroup of “major developed economies”, which is based on the membership of the Group of Seven. Geographical regions for developing economies are as follows: Africa, East Asia, South Asia, Western Asia, and Latin America and the Caribbean. A developed economy is typically characteristic of a developed country with a relatively high level of economic growth and security. Common criteria for evaluating a country's level of development are: • income per capita or per capita gross domestic product (GNI/capita, GDP/capita), • the level of industrialization (% of primary sector, industry and services in GDP) • the general standard of living  • the amount of technological infrastructure. Noneconomic factors, such as the human development index, which quantifies a country's levels of education, literacy and health into a single figure, can also be used to evaluate an economy or the degree of development. United Nations, which has developed the Human Development Index (HDI) to measure the quality of human life in different nations. The HDI is based on three measures: life expectancy at birth (a function of health care), educational attainment (measured by a combination of the adult literacy rate and enrollment in primary, secondary, and tertiary education), and whether average incomes, based on PPP estimates, are sufficient to meet the basic needs of life in a country (adequate food, shelter, and health care). The HDI is scaled from 0 to 1. Countries scoring less than 0,5 are classified as having low human development (the quality of life is poor); those scoring from 0,5 to 0,8 are classified as having medium human development; and those that score above 0,8 are classified as having high human development. Part 4. Main theories explaining the movement of goods and production factors between countries Mercantilism holds that a country’s wealth is measured by its holdings of “treasure,” which usually means its gold. According to this theory, which formed the foundation of economic thought from about 1500 to 1800, countries should export more than they import and, if successful, receive gold from countries that run deficits. The term neomercantilism describes the approach of countries that try to run favorable balances of trade in an attempt to achieve some social or political objective. A country may aim for increased employment by setting economic policies that encourage its companies to produce in excess of the demand at home and send the surplus abroad. Or it may attempt to maintain political influence in an area by sending more merchandise there than it receives from it, such as a government granting aid or loans to a foreign government to use to purchase the granting country’s excess production. In 1776, Adam Smith questioned the mercantilists’ assumptions by stating that the real wealth of a country consists of the goods and services available to its citizens rather than its holdings of gold. This theory of absolute advantage holds that different countries produce some goods more efficiently than others, and questions why the citizens of any country should have to buy domestically produced goods when they can buy them more cheaply from abroad. Smith reasoned that unrestricted trade would lead a country to specialize in those products that gave it a competitive advantage. In 1817, David Ricardo examined the question, “What happens when one country can produce all products at an absolute advantage?” His resulting theory of comparative advantage says that global efficiency gains may still result from trade if a country specializes in what it can produce most efficiently – regardless of other countries’ absolute advantage. Both absolute and comparative advantage theories are based on increasing output and trade through specialization. However, these theories make assumptions, some of which are not always valid. Free-trade theories of specialization neither propose nor imply that only one country should or will produce a given product or service. Nontradable goods – products and services (haircuts, retail grocery distribution, etc.) that are seldom practical to export because of high transportation costs – are produced in every country. However, among tradable goods, some countries depend on imports and exports more than others. The theory of country size holds that large countries usually depend less on trade than small ones. Countries with large land areas are apt to have varied climates and an assortment of natural resources, making them more self-sufficient than smaller ones. While land area helps explain the relative dependence on trade, countries’ economic size helps explain differences in the absolute amount of trade. The major part of the world’s top 10 exporters in are developed countries, developed countries account for well over half of the world’s exports. Simply put, they produce so much that they have more to sell, both domestically and internationally. In addition, because they produce so much, incomes are high and people buy more from both domestic and foreign sources. Eli Heckscher and Bertil Ohlin developed the factor-proportions theory, maintaining that differences in countries’ endowments of labor compared to land or capital endowments explain differences in the cost of production factors. For instance, if labor were abundant in comparison to land and capital, labor costs would be low relative to land and capital costs; if scarce, the costs would be high. These relative factor costs would lead countries to excel in the production and export of products that used their abundant and so cheaper production factors. The theories explaining why trade takes place have focused so far on the differences among countries in terms of natural conditions and factor endowment proportions. That most trade takes place among developed countries can be further explained by the country-similarity theory, which says that companies create new products in response to market conditions in their home market. They then turn to markets and consumer economic levels they see as most similar to what they are accustomed. In this case, trading partners are affected by: • cultural similarity; • political relations between countries; • distance between countries The international product life cycle (PLC) theory of trade states that the production location of certain manufactured products shifts as they go through their life cycle. The cycle consists of four stages: introduction, growth, maturity, and decline. During the life cycle of a product, focus on its production and market locations often shifts from industrial to developing markets. The process is accompanied by changes in the competitive factors affecting both production and sales, as well as in the technology used to produce the product. Types of products abound for which production locations usually do not shift. Such exceptions include the following: • Products with high transport costs that may have to be produced close to the market, thus never becoming significant exports. • Products that, because of very rapid innovation, have extremely short life cycles, making it impossible to reduce costs by moving production from one country to another. Some fashion items fit this category. • Luxury products for which cost is of little concern to the consumer. In fact, production in a developing country may cause consumers to perceive the product as less luxurious. • Products for which a company can use a differentiation strategy, perhaps through advertising, to maintain consumer demand without competing on the basis of price. • Products that require specialized technical personnel to be located near production so as to move the products into their next generation of models. So, according to the PLC theory of trade, the production location for many products moves from one country to another depending on the stage in the product’s life cycle. The diamond of national competitive advantage is a theory showing four features as important for competitive superiority: demand conditions; factor conditions; related and supporting industries; and firm strategy, structure, and rivalry. The existence of the four favorable conditions does not guarantee that an industry will develop in a given locale. Entrepreneurs may face favorable conditions for many different lines of business. In fact, comparative advantage theory holds that resource limitations may cause a country’s firms to avoid competing in some industries despite an absolute advantage. A second limitation concerns the growth of globalization. The industries on which this theory is premised grew when companies’ access to competitive capabilities was much more domestically focused. Part 5. Core strategies of International Companies Strategies among MNEs: • international, • multidomestic, • global, • transnational. Each strategy archetype embodies a unique concept of value creation that reflects its resolution of the asymmetric pressure for global integration versus local responsiveness. The international strategy leverages a company’s core competencies into foreign markets. Companies implement an international strategy when they leverage core competencies around the globe in an industry marked by low pressure for global integration and local responsiveness. This approach emphasizes replicating home-country-based competencies, such as production expertise, design skills, or brand power, in foreign markets. The primacy of replication requires that foreign units operate activities that are configured and coordinated by the home-country headquarters. Ultimate control resides with executives there, given their reasoning that they best understand the application, protection, and extension of the company’s core competencies. The testing ground of new ideas, goes such thinking, is the home market, not foreign countries; hence, subsidiaries have limited autonomy to adapt products or processes. An international strategy creates value by transferring core competencies to units in foreign markets where rivals lack a competitive alternative. The international strategy works well when industry conditions do not demand high degrees of global integration or local responsiveness and the firm business practices, either in minimizing costs or leveraging its brand, set market standards. The multidomestic strategy adjusts value activities to local circumstances. Some MNE faces high pressure for local responsiveness and a low need to reduce costs via global integration. In these industries, unique local cultural, legal-political, and economic conditions spur the MNE to adapt value activities. The multidomestic strategy superbly speaks to the unique features of consumer preferences, market tendencies, and institutional expectations found in national markets. Localizing value activities also helps the MNE reduce political risk given its company’s local standing, lower exchange-rate risks given less need to repatriate funds, and translate local performance into national prominence. The strategy also gives the MNE a distinctive advantage against local competitors who lack the benefits provided by the parent’s global operations. This strategy requires replicating value activities from subsidiary to subsidiary. Essentially, the MNE operates “mini-me” units around the world. Customizing a product or process to a particular market situation increases costs along the value chain. Different product designs require different materials, smaller markets make for shorter production runs, different channel structures call for dissimilar distribution formats, and divergent technology platforms complicate information exchange. The global strategy drives worldwide performance by making and selling common products that vary little from country to country. The global strategy pushes companies to create products for a world market, manufacturing them on a global scale in a few highly efficient plants, and marketing them through a few focused distribution channels. It requires that MNEs aggressively exploit location economies to maximize the scale effects of making a standardized product for a global market segment; using resources for anything other than improving efficiency erodes competitiveness. The transnational strategy reconciles global integration and local responsiveness in ways that leverage the MNE’s core competency throughout worldwide operations. The transnational strategy requires a sophisticated value chain that simultaneously implements integration, responsiveness, and learning. Part 6. Modes of entry to international markets The first group of entry modes concerns the sphere of exchange and is dedicated to international trade, mainly by addressing export and import activities. Import of raw materials from abroad, is usually preliminary to export of products abroad. This phase is associated with low risk. The firm only realizes foreign orders as they are received. In most cases this is the only form of engagement (especially SMEs) in international activities. This phase is a natural consequence of growth and occurs when the firm after reaching all its capabilities in the domestic market and achieving an appropriate volume of production, as well as surplus production, aims to expand its market and start exporting. Exporting and importing are the most popular modes of international business, especially among smaller companies. In indirect export modes the manufacturer uses independent export intermediaries located in its own country, so the manufacturer doesn’t have a direct contact with international customers or partners and the transaction is treated as a domestic one. There are the several types of indirect export intermediaries: the export commission house (ECH), the export/import broker, the export management company (EMC), the export trading company (ETC). While implementing direct exporting, exporters take on the duties of intermediaries and make direct contact with customers in the foreign market. Direct exporting can be performed in several ways: an own representative office operating, a foreign agent, a foreign distributor, its own distribution network abroad. Also cooperative export is possible. Cooperative exporting is recommended entry mode especially for small and medium-sized firms, due to their resource constraints (mainly financial and human). The second group of entry modes relates to cooperative relations implemented through contacts with foreign partners, mostly manufacturers. These modes include international licensing, international franchising, international subcontracting, buy also various assembly operations. The third group of entry modes are so-called investment modes. Dividends and interest paid on foreign investments are also considered service exports and imports because they represent the use of assets (capital). The investments themselves, however, are treated in national statistics as separate forms of service exports and imports. Note that foreign investment means ownership of foreign property in exchange for a financial return, such as interest and dividends, and it may take two forms: direct and portfolio. Foreign investment can be created in two ways, as: • brownfield investment that is the mergers and acquisitions (M&A) of local firms, • greenfield investment that is by investing from the beginning. As for the organization term, the investment modes are usually divided into two basic types: • a foreign branch, • a subsidiary. Highly committed international companies usually draw on multiple operating types. Companies work together – in joint ventures, licensing agreements, management contracts, minority ownership, and long-term contractual arrangements – all of which are known as collaborative arrangements.