INTERNATIONAL BUSINESS: QUESTION BANK

1. What is IB? How does it differ from Domestic Business?

International business is defined as “any commercial transaction-taking place across the boundary lines of a
sovereign entity”. It may take place either between countries or companies or both. These transactions
include investments, physical movements of goods and services, transfer of technology and manufacturing.

Private companies involve themselves in such transactions for revenue, profit and prosperity. If governments
are involved, they need to maintain their image, dependency and economic growth. Sometimes economic
ties are strengthened through such transactions.

Domestic Business versus International Business:

There are certain similarities between domestic and international business in terms of broad objectives
and goals of the company, namely:
1. Generating revenue- either by creating opportunities or by optimizing strengths
2. Corporate image building
3. Customer satisfaction and building loyalty as patronage buyers
4. Carrying out their operations respecting and adhering to local regulations
5. Generation of employment opportunities
6. Both are subject to a set code of conduct and ethics that includes corporate governance.
7. Mass production through cost reduction and achieving economies of scale
8. Building a strong network in order to make product and services available in any part of the nation
or world
9. Adapting new standards and change in style and function.

Some business groups like Adanis started only overseas operations without any linkage with domestic
operation right from the beginning. Tata group established a good name at home country and
gradually moved to other countries. Gammon India, IRCON (Indian Railway Construction), Larsen
& Toubro (L&T) and Sapoorji Pallonji are successful due to their meticulous way of understanding
both operations.
2. Discuss the prime motive behind companies & nations going in for IB?

All organizations, irrespective of their size, are keen to enter in to international business. Established
companies are expanding their business. Many countries encourage trade, and removal of strangulating
trade barriers.
It motivates companies to aggressively multiply their targets. The governments of various countries are
also determined to make their economy grow through international business that has therefore become
inevitable part of their economic policy. The objective behind international business can be looked at:
1. From an individual company’s angle.
2. From the government angle.

From an individual company’s angle:

1. Managing the product life cycle:
All companies have products, which pass through different stages of their life cycles. After the product
reaches the last stage of the life cycle called the declining stage in one country, it is important for the
company to identify other countries where the whole cycle process could be encashed. For example,
Enfield India reached maturity and declining stage in India for the 350 cc motorcycle. The company
entered Kenya, West Indies, Mauritius and other destinations where the heavy engine two-wheeler
became popular. The Suzuki 800 cc vehicle reached the last stage of its life cycle in Japan and entered
India in the early 1980’s, where it is still doing good business today. HP laptops are moving all the
developing countries the moment they reached maturity in the U.S. market.

2. Geographic expansion as a growth strategy:

Even if companies expand their business at home, they may still look overseas for new markets and better
prospects. For example, Arvind mills expanded their business by either setting up units or opening
warehouses abroad. Ranbaxy’s growth is mainly attributed to geographic expansion every year to new
territories. Arabindo Pharma, Cipla and Dr. Reddys follow the same.

3. The adventurous spirit of the younger generation

The younger generation of business families has considerable International exposure. They are willing to
take risks and challenges And also create opportunities for their business. Laxmi Mittal has
Emerged as the steel king of the world and Vijay Mallya of the UB Group took a major risk in setting up
operations in South Africa. Kumar Birla expands to Australia and Europe through acquisitions.

4. Corporate ambition:
Every corporate in the country has strategic plans to multiply its sales turnover. In case some of the
ventures fail, others will offset the losses because of multi-location operations. For example, Coco Cola is
still today not earning any profit in a number of countries. But this will not affect the company because
more than a hundred countries are contributing to offset losses. Kellogge cannot think of profits in India
for further five years. They are ambitious to be visible and then revenue.

5. Technology advantage:
Some companies have outstanding technology through which they enjoy core competency. There is a
need for such technology in all countries. Biocon, Infosys, Gharda chemicals are known for their core
competency in biotechnology, IT and pesticides respectively and a huge demand exists throughout the
world for their technology. Thermax, Ion Exchange, Bharat Heavy Electricals and Larsen & Toubro have
marched ahead in International business.

6. Building a corporate image

Prior to profits and revenue generation, many companies first build their corporate image abroad. Once
the image is built, generating revenues is a comparatively easy task. Samsung and LG built their
image in India for the first three years and generation of revenue and profits has been considerable, as
they have expanded to semi-urban and rural India as well. Today their market share and penetration
levels have gone far ahead of other players in India.

7. Incentives and business impact

Companies, which are involved in international business, enjoy fiscal, physical and infrastructural
incentives while they setup business in the host country. The Aditya Birla Group enjoyed such incentives
in Thailand and Indonesia. All such incentives contribute to the company to enjoy multiple advantages
like economies of scale, access to import inputs, competitive pricing and aggressive promotion.
8. Lobour advantage
Many companies have a highly productive lobour force. Their unique skills may not be available
throughout the world. Manufacturing units in India have consistently performed well, whether in a
diamond industry, handicraft, woodwork or leather. Companies nurture the skills of the artisans and win
world markets. Knitwear, handlooms, embroidery, metal ware, carpet weaving, cashew processing and
seafood call for cost-effective lobour force. India is endowed with such skills.

9. New business opportunities

Many companies have entered in to business abroad, seeing unlimited opportunities. National foreign
trade policy emphasizes focus markets. Enormous amount of growth potential is untapped in Latin
America, Sub-Saharan Africa, CIS countries and China.

10. Emergence of SEZ’S, EOU’S, AEZ

Current approvals of Special economic zones, Agrizones and Technology parks by Ministry of
Commerce & Industry give new dimensions to international business. The companies setting up units in
SEZ’s enjoy innumerable benefits and competitiveness.

From a Government Angle

1. Earning valuable foreign exchange
Foreign exchange earning is necessary to balance the payments for imports. India imports crude oil,
defense equipments, essential raw materials and medical equipments for which the payments have to be
made in foreign exchange. If the exports are high and imports are low it indicates a surplus balance of
payment. On the other hand if imports are high and exports are low it indicates an adverse balance of
payment, which all economies would want to avoid. A vast majority of the nations in the world are facing
adverse balance of payment.

2. Interdependency of nations
From time immemorial, nations have depended on each other. Even during the era of Indus valley
civilization, Egypt and the Indus Valley depended on each other for various items. Today, India depends
on the Gulf regions for crude oil and in turn the Gulf region depends on India for tea, rice etc. Developed
countries depend on developing countries for primary goods, whereas developing countries depend on
developed countries for value added finished products. No single country is endowed with all the
resources to survive on her own.

3. Trade theories and their impact

The theories of absolute advantage, comparative advantage and competitive advantage, which have been
propounded by classical economists, indicate that a few nations have certain advantages of resources. The
resources may be in the form of labour or infrastructure or technology or even a proactive policy of the
government. Such theories are remaining foundations till today, for international business practices with
few changes and trends.

4. Diplomatic relations
Diplomacy and trade always go hand in hand. Many sovereign nations send their diplomatic
representatives to other countries with a motive of promoting trade besides maintaining cordial relations.
Indian diplomats in Latin America have done a remarkable job of promoting India’s business in the
1990’s. Indian embassies and high commissions in all the countries around the world play a catalytic role
of promoting trade and investment.

5. Core competency of nations

Many countries are endowed with resources, which are produced at an optimum level. Such countries can
compete well anywhere in the world. Rubber products from Malaysia, knitwear from India, rice from
Thailand and wool from Australia are a few illustrations. Competing with a focused competency in any
major resource or technology gives core competency status. India’s core competency in IT is known
throughout the world.

6. Investment for infrastructure

Over the years all countries have invested huge amounts of money on infrastructure by building airports,
seaports, economic zones and inland container terminals. If the trade activities do not increase, the
country cannot recover the amounts invested. Hence, the government fixes targets for every infrastructure
unit and time frame to achieve it. Economies like Mauritius, Hong Kong, Singapore, Malta and Cyprus
invest in trade related infrastructure in order to elevate themselves to be foreign trade oriented economies.
Infrastructure and international business are the two eyes of a growing economy.

7. National image
A new era has emerged from conquering countries by sword to winning it by trade. A businessman gives
priority to the image of the country he belongs to. We come across products with labels such as “made in
China” and “Japan” & “made in India”. Businessmen from India, China and Japan bring credentials to
their country. When L.N.Mittal operaters in Indonesia or Kazakhstan or Trinidad he is perceived by the
people as Indian. The stigma cannot be detached.

8. Foreign trade policy and targets

All developing countries announce their trade policies. A clear road map is drafted and given to
promotional bodies so that timely implementation is possible. Every trade policy in India, in the past had
its agenda and action plans right from import control order in 1947. All the trade policies had three fold
objectives in their agenda- production promotion and competitiveness.

9. National targets
By the year 2010, India aims to have a 2% share of the global market from the current level of 1%. By the
year 2009-10, our trade status should cross $ 500 billion.

10. WTO and international agencies

The apex body of world trade, the WTO, a free, transparent and regulatory body upholds provisions
related to the elimination of tariffs and non-tariff barriers. The International Bank for Reconstruction and
Development (IBRD), popularly called the World Bank extends financial assistance on a soft loan basis
in order to assist developing countries in their infrastructure and industrial development. The International
Monetary Fund (IMF) maintains currency stability in various countries through regulatory mechanisms.
Many more organizations like International Maritime Organization, International Standard Organization,
International Telecommunication Union, and International Civil Aviation Organization are major
 catalysts to promote trade between nations. Over the past few years their role in promotion of trade,
especially amongst developing economies is unprecedented.

3. What is Multinational Corporation? Classify MNC’s depending upon their structure & country of
origin.

“The multinational is a business unit which operates simultaneously in different parts of the world. In
some cases the manufacturing unit may be in one country, while the marketing and investment may be in
other countries. In other cases all the business operations are carried out in different countries, with the
strategic head quarters in any part of the world.”

For example, the Manhattan based company, Colgate Palmolive Inc., which manufactures and markets
dental care, health care, hair care and skin care products, in more than 120 countries. Procter and Gamble,
based in Cincinnati also has similar product lines and operates in more than 150 countries. Their logo,
symbol, products and brands are easily identified in the malls, outlets and media.

The strategic nerve centre is the company’s headquarters, where major decisions are taken and policies
are formulated. Multinationals have headquarters and a number of subsidiaries that are scattered
throughout the world.

A typical multinational operates as per the following model:

CLASSIFICATION OF MULTINATIONALS DEPENDING UPON THEIR ORIGIN

Depending upon the relationship between the headquarters and subsidiaries, multinationals can be
classified into three broad categories:

1. Pyramidal Model Multinationals

a) It has strong headquarters and weak subsidiaries.

b) All decisions are made at the headquarters and
imposed on the subsidiaries,
c) Major decisions related to new product
development, plant location and managerial
decisions are taken only at the headquarters. At
times, the head-quarters may be quite autocratic
towards its subsidiaries.
d) They may be quite old fashioned in their day-to-
day functioning.
e) They do not bring sentiments and emotions for
the local population into their dealings.
A pyramid indicates a broad bottom and narrow top. f) They exercise complete control in their deals.
According to the typical pyramid model, the g) They run their business through power.
multinational operates as follows:
 Sympathy, compassion and human approach are generally far off in their approach. Lower is the prime
motive in their style. Age old colonialism and imperialism got percolated to follow such style.
Due to rigidity in their style of functioning, such organizations may invite opposition from
citizens in developing countries at any time. Fortunately, such multinationals changed became
adaptable to local environment.
2. Umbrella Model Multinationals
Here the headquarters acts as a facilitator.
Such MNCs believe in
a) Mutual exchange of knowledge and
technology.
b) Constant motivation of subsidiaries.
c) Building an image for both headquarters
and the subsidiary.
d) Harmony between employees at
different levels, and between employees
and employers.
e) High respect for the sovereignty of the
county where they operate.
Such organizations are concerned about their image, goodwill and reputation. For them doing business is a
way of life. They invite representatives from the subsidiaries to the headquarters for strategic decisions.
They do not practice favoritism, nepotism, parochialism and racial superiority. Merit is the only
consideration for growth and career enhancement. An Indian is the CEO of Mc.kinsey, Afghani is the head
of HR in Yahoo, Indonesian is the research head in Biorad and Indian woman is heading Pepsi world-wide
operations.

3. Inter-conglomerate Multinationals
Conglomerate indicates grouping of business activities aiming at high profits and revenue
generations, whether it is related to existing core business or not. Inter –conglomerate
multinationals are aggressive in expansion and achieving a high turnover. Such multinationals
enter into any business where the profits are exponentially high. They generally do not consider
any other aspect, except high profits, as a performance indicator.
b) They do not restrict themselves to their
core competency.
c) A ‘hire and fire’ policy is very common.
d) They set high targets for themselves.
e) No social consideration in the country
of their operation.
f) Growth, expansion, takeovers and
aggression are constant endeavours.
The investments are high and are made
with expectations of high returns, which
a) High profit motivation. will be used for aggressive expansion,
diversification and takeovers?

Although multinationals can be classified on the above basis, today the classification is not rigid.
Hence, multinationals have become flexible over the past two decades. As the indigenous forces
become strong in any developing country, the pure pyramidal model will not work. Organizations,
which work under a pure umbrella model cannot generate sufficient revenue to sustain itself and it
is also difficult for such organizations to face stiff competition. Organisation, which functions
under the inter-conglomerate model, cannot focus only on profit, considerations for social causes
and sensitivity towards the host country have to be maintained or else the nationals in the host
country pose major challenges and pull down the operations.

CLASSIFICATION OF MULTINATIONALS DEPENDING UPON THEIR ORIGIN

1. Ethnocentric: Such multinationals concentrate more on their place of origin. Since they understand their
own socio-cultural background it is easy for them to succeed in their home country. Instead of taking
high risks in other countries they first succeed in their home country and then slowly more abroad with
few changes in the product and mode of functioning. Mitsukoshi Super Market practices ethnic touch of
Japan in its malls wherever it operates.

2. Regio-centric: Few multinationals focus their activities only in a particular region like South
East Asia or the Gulf region. There are certain practices that are uniform in nature in a specific
region, and hence they succeed. A region covers many nations; hence the organization operates
in all parts of the region to get the title ‘multinational’. “Continent”, the French super market
chain has an influence in the whole of Indian Ocean rim countries.

3. Continental: There are multinationals that are very successful in particular continent for their
specific product ranges. The cost of storing and warehousing can be brought down if the
product is distributed in the whole continent. There are hundreds of multinationals doing
exceedingly well only in Europe, but are not able to face cross-cultural challenges in other
continents. Therefore, they remain as continental multinationals. TESCO serves the whole
European continent by understanding the need of every European community.

4. Polycentric: The majority of multinationals have to simultaneously enter different countries.

It is not possible to adopts a ‘wait and watch’ policy to enter different countries and commence
operations. Once a company invests in an innovation, it has to spread its activities everywhere,
otherwise it will lose the opportunity, and competitors will step in to get the business.
Therefore, companies like Proctor & Gamble, Unilever, Sony, Electrolux, Henkel and Colgate-
Palmolive are present in almost every part of the world.

5. Trans-national: Multinational like Hewlett Packard has set up subhead quarters close to the
subsidiaries for easy accessibility. The sub-headquarters are located in Singapore or Hong
Kong but the main office remains in California. The trans-national multinationals sole
problems arising from nearby countries through their sub-headquarter. It is serving the purpose
of administrative convenience.

6. Global organizations: These organizations have a physical presence in other parts of the
world and cater to customers in different countries through standardized products by
consolidating resources from any part of the world. Today, every company dreams of
becoming a global company. Companies shift their manufacturing bases to more profitable
locations, open up warehouses in special economic zones and train people to be multilingual,
multi-strategic and multi-functional in order to manage the business successfully.
 The difference between polycentric and global multinationals is that the latter is very closed to
customer and does not give extra weight-age to the headquarters. Global orgainsations take
into account customer tastes and preferences. They employ cost cutting techniques and are able
to provide customers with good quality, low-priced items. They have enormous respect for the
country in which they operate and integrate themselves into the society.

Should MNC’s be allowed to come to India?

MNC Issues

 Protectionism

– A call for tariffs and special treatment to protect domestic firms from foreign
competition.

 Corruption

– Illegal practices to further one’s business interests.

Transparency International gives these countries its poorest corruption scores:

• Indonesia • Nigeria

• Tajikistan • Bangladesh

• Haiti • Paraguay

• Myanmar

 Sweatshops

– Employ workers at very low wages, for long hours, and in poor working conditions.

 Child labor

– The full-time employment of children for work otherwise done by adults.

 Sustainable Development

– Development that meets the needs of the present without hurting future generations.

 Currency Risk

– The possible loss of profits because of fluctuating exchange rates.

  Expatriate

– An employee who lives and works in a foreign country.

 Global Manager

– A person who is culturally aware and informed on international affairs.

– Personal Attributes for Expatriate Success

o High degree of self-awareness

o Cultural sensitivity

o Desire to live and work abroad

o Family flexibility and support

o Technical job competence

o Are you willing to admit that the world isn’t just for traveling anymore,
and to embrace it as a career opportunity? Is it possible that you might stand out to a
potential employer as someone with the skills to excel as a global manager?

4. Discuss FDI and strategies to attract FDIs from investors’ point of view.

When a firm invests directly in facilities in a foreign country it is said to be FDI.

Investment is “the flow of funds one destination to another”, for any activity, including
industrial development, infrastructure and manufacturing. When the investment goes from the
home country to another country it is defined as ‘investment outflow’ and when the foreign
investment comes from other countries to home country it is termed as ‘investment inflow’.
Both inward and outward movements are encouraged in majority of the countries.

Practically, FDI represents foreign assets in domestic structures, equipment and organizations.
It does not include foreign investment in the stock markets. Foreign direct investment in useful
to a country if the focus is more on projects rather than investments in the equity of companies
because equity investments are potentially “hot money” which can leave at the first sign of
trouble. The current Foreign Direct Investment (FDI) is related to investment in developing
 countries and Less Developed Countries (LDCs) require huge investments in other activities,
such as infrastructure, healthcare, housing, power generation etc

FDI involves the active control of the investment not really determined by level of stock
ownership. Many multinational enterprises become involve in FDI with the ultimate objective
of reaping short term as well as long term benefits.

Factors influencing FDI are related to increasing business opportunities across national borders
and their involvement could be in the following functional areas.
• Production
• Marketing / services
• Research & development
• Raw materials or other resources

Investment Patterns:
• Follow Competitors – Oligopolistic industries and interdependence of a few major
competitors force a strategic approach of following competitors:
American Motor Company (AMC) invested in Shanghai Motor Company in China. All others
were on bee line including Japanese and South Korean companies besides other American
companies.
• International Product Life Cycle – Reduces cost by shifting production to developing
countries. Essel Propack moved to China for instance.
• Location – Specific advantages make FDI easier than exporting or licensing. Mahindra
tractors are manufactured in North America.
• Contract manufactures – brings down the cost of manufacturing and also contributes to
consolidate competitive sourcing and competing in world market. Honda motors manufactures
its vehicles in Europe.
• Assured return on investment – R & D centres and futuristic projects enable the investor to
achieve great success through high revenue. Roseh products invest huge money in Genentech
in California to get innovative products to their outlets around the world.

5. Discus: Modern foreign trade theories & implications in the trade.

6. What is Globalization? How do organizations focus on strategies to prosper?

Globalisation is the “strategy of optimizing” the resources available in various countries and
catering to customers throughout the world with internationally standardised products, at
competitive prices.
It advocates that the nation or a company or product involved should be global.

Globalisation can be defined in several different ways depending on the level we choose to focus
on. The philosophy is “the whole world is my market; wherever the opportunity arises I will tap
it irrespective of location, standard of economy, ethnic relations and all other parameters.”
“Cross border customers are my neighbours; I will be close to them at any time” – a slogan of a
global manager. “Globalisation is a mindset rather than physical pharmaceutical giant in India.

At the level of a specific country, globalisation refers to the ability of the country to expand its
trade and aggressively dominate in other parts of the world; by motivating its entrepreneurs by
investing, manufacturing and marketing.

7. What is risk analysis? How do companies overcome risk?

 8. Discuss the environmental factors influencing IB.

An international business entry or operation depends upon multiple environmental factors. They
may change the direction, strategy and every moment of international business operations.

An international marketer is required to understand, evaluate and work out various parameters
before venturing into any country. These Parameters are called environmental factors and they
determine the direction and purpose of the international business operation. Many decisions
depend upon environmental factors right from selection of the country, location of the plant,
liaison with the government, and entry of investment from local bodies, product launch, channel
management, promotion and opening of outlets. The first challenge for an organization is to
navigate from its home country to the host country. Thereafter it has to develop a proper system
so that the venture is successful in the host country; learn all about the regulatory bodies both in
the host country and home country; understand the customer’s changing tastes and attitude
towards foreign goods and finally obtain revenue and make the business effective with right
people.

Prior to entry or investing millions of dollars, the experts gather all the relevant information
about the country and interpret those facts to facilitate the company. By such risk analysis,
companies can safeguard themselves from future dangers. The major risks are:
1. Political
2. Economic
3. Exchange
4. Socio culture
5. Financial
6. Legal
7. Technological
8. Competitive
9. Infrastructural and
10. Labour.

An organization can overcome the effects of all the risks by taking into account the different
environmental factors. Since the home environment is known, one can understand and overcome
the pitfalls in the event that any action goes wrong.

1. ECONOMIC ENVIRONMENT:
The economic environment can be classified into three categories:
a) Economy in the home country
b) Economy in the host country
c) Economy at a global level.
a) Home country Economy
In order to encourage the business community to venture overseas, it is necessary for a country
to have liberal economic and trade policies.
b) Host Country Economy.
When a firm from one country enters any other country, the following major criteria are taken
into account:
1. Size of the market
2. Gross Domestic Product (GDP)
3. Industrialization
4. Banking
5. Purchasing Power
6. Foreign Exchange
7. Income Levels
8. Economic diversity
c) Economy at a Global level
 Organizations such as the World Trade Organization, World Bank, International Monetary
Fund, Asian development bank and the organization of petroleum Exporting countries (OPEC)
can affect international business. The preferential treatment given to the members of NAFTA,
ASEAN, the European Union and COMESA can have a negative impact on the trade between
outside cartels and non-members.

2. SOCIAL ENVIRONMENT
The social environment encompassing religious aspects, language, customs, traditions and
beliefs, influences buying consumption habits. Many companies face failure in foreign
countries, due to their inability to understand the socio cultural environment. For example
whenever any company establishes business in some African countries, the local population
expects that many jobs will open up for them. Very few countries perceive tat they may be
exploited.
1. National Taste
2. Language
3. Values and beliefs
4. Demography
5. Literacy rate
6. Female Workforce
7. Double Income Families
8. Impulse buying
3. POLITICAL ENVIRONMENT.
The political environment in international business operates in different dimensions:
1. The home country political environment;
2. The host country political environment, and
3. The global political environment.

4. CULTURAL ENVIRONMENT
The cultural environment for international business refers to the set of factors which shape the
material and psychological development of a nation and represents the primary influence on
individual lifestyle, attitude, pre-deposition and behavior as consumers in the market. The most
important task of international business is to identify relevant similarities and differences among
countries, and means and methods to match the organization’s culture with that of the country of
its operation. For example, when Toshiba gained 100 percent ownership of Rank-Toshiba in the
Plymouth all the managers in charge learnt the British Style of working.
The performance of a company in the international arena partly depends on how well the
strategic elements fit into the culture of the host country. Culture may be described as the totality
of the complex and learned behavior of members of a given society. Elements of culture include
beliefs, art, morale, code of conduct and customs.

5. TECHNOLOGY ENVIRONMENT
Technology and its applications are key factors in determining the international competitiveness
of a firm in conducting international business. Multimedia using Pentium 4 is common in
advanced countries whereas it will take at least another five years to introduce such products in
Africa. Leadership in technology is achieved and maintained through a consistent program of
intensive research and development, which can be very expensive. Only those companies that
are able to maintain their technological activities will remain competitive.

6. LEGAL ENVIRONMENT :
This relates to the laws and regulations governing the conduct of business activities in the
country. Before entering any country, firms avail of the services of local legal firms to
understand business interpretations pertaining to labor legislations, taxes, environment,
pollution, investment, distribution, contracts, logistics etc. The international legal environment
has three
aspects:
a) Home country laws
b) Host country laws
 c) International laws.

7. COMPETITIVE ENVIRONMENT:
Competition is a threat imposed by an environment, which may effect or hamper or challenge
the operation of an international business firm. Competition either could be from the firm’s
home country or host country or third country. Some times product related competition may
crop up through substitutes or low cost production process or technology or cost reduction
through economies of scale. The current international business operation has to encounter
competition as various levels such as entry, operation, production, administration, human
resource, technical resource, and financial resource. Distribution and logistics

9. What is WTO? How does it function to maintain its agenda? Discuss the achievements & limitations.

The roots of the World Trade Organisation (WTO) lie in the General Agreement on Tariffs and
Trade (GATT) which was established in 1948 by 23 original founders, India being one of them.
The 8th round of talks under GATT (1986-1994), KNOWN AS THE Uruguay Round, led to the
birth of the WTO on 1st January 1995. In the Uruguay Round, new agreements such as the
General Agreement on Trade in Services (GATS) and the Agreement on Trade Related Aspects
of Intellectual Property Rights (TRIPS) and Trade Related Investment Management System
(TRIMS) were negotiated. All the three major agreements along with their associate agreements
now rest under the umbrella organization, namely the WTO.

The WTO, which has its headquarters in Geneva, Switzerland, has a membership of 150
countries. More than 98% of the global trade is transacted among the members.

As the only regulatory body of world trade, the WTO’s objective is to ensure a freer, more
transparent and more predictable trading regime in the world. The WTO is based on a sound
legal system and its agreements are ratified by the parliaments of member countries. No one
country controls the WTO; wherein the top decision makers are the designated ministers of
member countries.
The WTO agreements cover:
• Goods, e.g., all industrial products, FMCGs etc.
• Services, e.g., banking, insurance, consultancy etc.
• Intellectual property, e.g., patents, copyrights, designs and trademarks etc.

The agenda of the WTO, the implementation of its agreements, and the much-praised dispute
settlement system all serve to advance interests of developed countries, sidelining those of the
developing countries.

Contributions of the WTO:

It is a tribute to human civilization that sovereign nations have agreed to subordinate their
freedom (to act) and have agreed to work within the framework of rules to promote global trade.
The Uruguay Round of negotiations resulted in formation of a rule based system, which is
expected to lead to smooth and orderly international trade.

• The WTO and its agreements have an impact on every economic activity, be it agriculture,
trading, service or manufacturing.
• World markets are opening up due to lowering of tariffs and dismantling of other restrictions in
developed and developing countries to benefit from their comparative advantages.
• Domestic markets will be increasingly threatened because of lowering of tariffs leading to freer
entry of foreign goods and because of foreign companies’ establishing local manufacturing
bases.
• Whereas the developing countries will have greater opportunities in sectors in which they have
cost bases comparative advantages e.g., textiles, agriculture etc., the developed countries benefit
due to the opening of the service sector and tightening of Intellectual Property Regime.
• Export markets will become more difficult because of competition among developing countries
with similar comparative advantages.
• Products from developing countries will face higher quality standards in developed markets
particularly in the areas where they have comparative cost advantage.
• Every company, whether serving the domestic or international market, will have to undertake
an internal exercise to identify factors affecting its international competitiveness in terms of cost
as well as quality. It will need to study whether it can remain competitive once the product can
be imported freely or tariffs are further lowered or both.
• The WTO regime will be of greater benefit to those countries that show ability and skill in the
ongoing dialogue. The governments that are in constant touch with their industries and affected
groups will be able to clearly determine how and what should be negotiated at multilateral
negotiations to the best of their advantage.
• International trade is becoming increasingly trade, deregulation and privatization of internal
economy have now been strengthened and legalized under the WTO. Countries have no option
but to follow this direction. Countries that have understood this have moved swiftly in
finetuning their domestic and international trade policies, to create a winning environment for
industry and business. Those who are still debating the issue or do not understand it clearly will
be left behind.

10. Discuss the importance of International Organizations and their role to promote IB.

An international organisation must be established by a treaty (constituent instrument) providing

it with legal recognition. International organizations so established are subjects of international
law, capable of entering into agreements among themselves or with states.

International Organizations exist to increase international relations, promote education, health

care, economic development, environmental protection, human rights, and conflict resolution
throughout a region.

GLOBAL ORGANISATIONS REGIONAL ORGANISATIONS

1. United Nations 1. European Union
2. World Trade Organization 2. Asia Co-operation Dialogue
3. International Hydrographic Organization 3. Common wealth of Independent States
4. International Seabed Authority 4. African Union
5. Organisation for the Prohibition of 5. APEC
Chemical Weapons 6. Organization of American State

International Organizations as facilitators of International Business:

International Organizations like the World Bank were set up to maintain orderly international
financial conditions and to provide capital and advice for economic development, particularly of
developing countries. International Business Organizations are required to understand the
system and lending criteria of such institution, so that it would be easy to avail their funds to
develop business.

World Bank Group

• International Development Association
• International Finance Corporation
• Multilateral Investment Guarantee Agency
Other International Organizations
• International Monetary Fund
• Bank of International Settlements
• Asian Development Bank
• African Development Bank

Asian Clearing Union

• Established in 1974
• Members- Central Banks of India, Iran, Bangladesh, Nepal, Pakistan, Sri Lanka and Myanmar
(Burma).
• To provide facility to settle payments for current international transactions.
• Promote use of participant’s currencies in current transactions.
• Promote monetary cooperation.
• Exempted categories:
_ Travel between India and other countries.
_ Foreign trade financed by World Bank, ADB etc.
_ Payments between India and Nepal, Pakistan and Iran individually.
• With effect from 1.1.1996, 1 A.C.U. $ = 1 U.S. $.
• ACU accounts are settled at the end of every two months.
• The balance outstanding in ACU Vostro account with the Authorized Dealers is subject to
CRR and SLR.

Offshore Banking Unit (OBU)

An Offshore Banking Unit (OBU) of a bank is a deemed foreign branch of the parent bank
situated within India, and shall undertake international banking business involving foreign
currency denominated assets and liabilities. The Reserve Bank of India (RBI) has given
permission to certain select banks in India, fulfilling certain criteria, to set up OBUs in “Special
Economic Zones” (SEZ), for facilitating exports from India. Offshore Banking Units can accept
Multi Currency Deposits from NRIs and Eligible Resident Indians as per FEMA.
Companies/Units within the “SEZs” in India as well as companies outside “SEZs” as per
existing FEMA guidelines can go for Multi Currency Borrowing from OBU.

E-Money India
This is a completely online mode of sending money from US to India. Any person/organization
who wishes to make a payment (in foreign currency) to an individual/organization in India (in
Indian rupees) can use e-Money India. The customer needs to follow three simple steps to send
money to India:
• Register on the e-money India site by providing elementary details.
• Provide his bank details.
• Provide the receiver’s details in India.
Presently, a customer can make an inward remittance in US Dollars only for family
maintenance, purchase of property, investments, or transfers to NRE accounts. Remittances from
foreign tourists visiting India and trade related remittances can also be sent. The remittance will
be delivered to his/her beneficiary’s doorstep as a locally payable demand draft or deposited
directly into the receiver’s account in India in Indian Rupees only.

Some of the International Organizations are:

1. World Bank
The World Bank (the Bank), a part of the World Bank Group (WBG), was formally established
on the 27 December 1945. The World Bank Group (WBG) is a family of five international
organizations responsible for providing finance and advice to countries for the purposes of
economic development and eliminating poverty.
The Bank’s mission is to aid developing countries and their inhabitants achieve the MDGs
(Millennium Development Goals), through the alleviation of poverty, by developing an
environment for investment, jobs and sustainable growth, thus promoting economical growth
and through investment in and empowerment of the poor to enable them to participate in
development. The World Bank sees the four key factors necessary for economic growth and the
creation of a business environment as:
i. Capacity Building – Strengthening governments and educating government officials
ii. Infrastructure creation – implementation of legal and judicial systems for the
encouragement of business, the protection of individual and property rights and the honouring of
contracts
iii. Development of Financial Systems – the establishment of strong systems capable of
supporting endeavours from micro credit to the financing of larger corporate ventures
iv. Combating corruption – Eradicating corruption to ensure optimal effect of actions
2. International Monetary Fund
The IMF is an international organization of 185 member countries. It was established to promote
international monetary cooperation, exchange stability, and orderly exchange arrangements; to
foster economic growth and high levels of employment; and to provide temporary financial
assistance to countries to help ease balance of payments adjustment.

3. Asian Development Bank

The work of the Asian Development Bank (ADB) is aimed at improving the welfare of the
people in Asia and the Pacific, particularly the 1.9 billion who live on less than $2 a day. ADB's
vision is a region free of poverty. Its mission is to help its developing member countries reduce
poverty and improve the quality of life of their citizens.
ADB's main instruments for providing help to its developing member countries are
 policy dialogue
 loans
 technical assistance
 grants
 guarantees
 Equity investments.

4. International Maritime Organisation

IMO's main task has been to develop and maintain a comprehensive regulatory framework for
shipping and its remit today includes safety, environmental concerns, legal matters, technical co-
operation, maritime security and the efficiency of shipping.

5. International Labour Organisation

The International Labour Organization (ILO) is devoted to advancing opportunities for women
and men to obtain decent and productive work in conditions of freedom, equity, security and
human dignity. Its main aims are to promote rights at work, encourage decent employment
opportunities, enhance social protection and strengthen dialogue in handling work-related issues.
In promoting social justice and internationally recognized human and labour rights, the
organization continues to pursue its founding mission that labour peace is essential to prosperity.
Today, the ILO helps advance the creation of decent jobs and the kinds of economic and
working conditions that give working people and business people a stake in lasting peace,
prosperity and progress.

6. International Telecommunication Union

The ITU is a specialized agency of the United Nations and is the world's oldest international
organization. In general, the ITU seeks "to promote, at the international level, the adoption of a
broader approach to telecommunications issues in the global information economy and society."
ITU decisions are made on a one nation, one vote basis; therefore, each member-nation has
equal authority in the ITU decision making process. In part due to this voting policy, developing
countries view the ITU as an important organization to provide assistance and aid infrastructure
development in these nations

11. How will you do business with NAFTA?

 1989 US & Canada – 1994 & Mexico
 Remove tariffs on 99% of goods in 10 years
 Removal of barriers to cross-border flow of services
 Protection of intellectual property rights
 Removal of most restrictions on FDI
 Application of national environmental standards (scientific basis)
 Establishment of 2 commissions
– Monitor environmental standards & health/safety, minimum wage or child labor laws
 – Impose fines & remove trade privileges for violations

 Market Access - eliminate all tariffs on products traded between the three countries within
10 years – Dec 2005.

 Non-tariff Barriers - Mexico will eliminate all non-tariff barriers like quotas, Import
licenses.local content requirements, etc.

 Rules of Origin - Tariff-Shift rule and Value-Content (62.5%) Rule.

 Customs Administration - uniform customs procedures and regulations.

 Investment – No requirements like exports, local content, transfer of technology, limits on

imports.

 Services - allowed to open wholly owned subsidiaries and operate without any restrictions.

 Intellectual Property - protection of intellectual property.

 Government Procurement - fair and open competition, and transparent and predictable
procurement procedures.

 Standards - prohibits the use of standards and technical regulations as obstacles to trade.

For NAFTA

• Opportunity to create an enlarged & efficient production base for region

• Mexico would benefit from inwards FDI

• US & Canada benefit

– increased Mexican incomes – importing

– consumers benefit – lower prices

– Competitiveness of firms that move production to Mexico

Against NAFTA

• Mass exodus of jobs from US & Canada to Mexico

• Mexico’s lower wage & less strict environmental laws

Impact

• Expose Mexico to more competitive US & Canadian firms – ST - Economic

restructuring & unemployment in Mexico

• Trade grew by 109%

• Increase in productivity growth

• Increase in political stability in Mexico

12. Discuss the business strategy to do business in European Union.

European Economic Community (European Union)

• Targeted towards creating Economic, monetary, fiscal and political union.

• Single European Act (A true common market for goods, people and money by 1992)

• Maastricht Treaty 1994 (Economic and monetary union with a commitment to political union).

• EU has 450 million consumers and at 10 trillion Euros, will account for a fourth of world’s GNP.

• EC institutions - The European Commission, Council of Ministers, European Parliament,

European Court of Justice.

European Union

• European Union = product of 2 political factors

– Devastation of 2 World Wars & desire for peace
– Desire to hold their own on the world’s political and economic stage
• Treaty of Rome = Creation of Common Market
– Elimination of internal trade barriers
– Creation of common external tariff
– Abolish obstacles to free movement of factors of production
– Harmonization of member states’ laws
– Common policies in agriculture & transportation

Political Structure of European Union

• European Council
– Heads of State & President of European Commission
– Resolves major policy issues & sets direction – 2x year
• European Commission – Brussels, Belgium
– Proposing, implementing & monitoring compliance - EU laws
– Commissioners appointed by each country – 5 year renewable terms
– Competition Commissioner regulator of competition and M&A
• Council of the European Union
– Ultimate controlling authority – approves proposed laws
– 1 representative from each state – varies with topic
– Use majority voting rules rather than unanimous agreement
• European Parliament – Strasbourg, France
– Directly elected by population – 732 members
– Debates legislation – Consultative body
• Court of Justice
– Supreme appeals court for EU law
– 1 judge from each state – required to act as independent officials

Strategic implications of E.U.

 One Large market - standardization.
 Global Strategies - production, distribution, financing etc.
 Transaction costs eliminated.
 Economies of scale in - Production, transportation, promotions, pricing etc.
 Highly competitive environment - efficiencies needed to compete.
 Mergers and other shakeouts in industry.
  Centralization and consolidation.

13. How will you do business in Asia?

14. Compare & Contrast the business potential in India & China.
15. Discuss the challenges involved in Global Human Resource Management.

16. Discuss all the barriers related to International Trade.

A trade barrier is defined as “any hurdle, impediment or road block that hampers the smooth
flow of goods, services and payments from one destination to another”. They arise from the
rules and regulations governing trade either from home country or host country or intermediary.
Trade barriers are man-made obstacles to the free movement of goods between different
countries, and impose artificial restrictions on trading activities between countries. Despite the
fact that all international organisations such as GATT, WTO and UNCTAD advocate reduction
or elimination of barriers, they still continue in different forms.

Objectives of trade barriers:

1. To protect domestic industries from foreign goods.
2. To promote new industries and research and development activities by providing a home
market for domestic industries.
3. To maintain favourable balance of payment, by restricting imports from foreign countries.
4. To conserve foreign exchange reserves of the country by restricting imports from foreign
countries.
5. To protect the national economy from dumping by other countries with surplus production.
6. To mobilize additional revenue by imposing heavy duties on imports. This also restricts
conspicuous consumption within the country.
7. To counteract trade barriers imposed by other countries.
8. To encourage domestic production in the domestic market and thereby make the country
strong and self-sufficient.

Since trade barriers are harmful for the growth of free trade, efforts were made to reduce such
trade barriers, and international organisations initiated collective efforts of all countries involved
in trade.
Types of trade barriers:
Broadly, Trade barriers are classified as tariff barriers and non-tariff barriers. A country may use
both tariff and non-tariff barriers order to restrict the entry of foreign goods.

Tariff Barriers

A tariff is a special tax on imported goods (and sometimes, imported products), raising their price.

To try to overcome this price handicap, the foreign exporter may try several different approaches.

 It may use marginal cost pricing.

 It may try to get a more favorable tariff classification with a lower duty.
 It may ship unassembled products.
 If none of these is sufficient, the firm may produce in the local market to get
behind the tariff wall

Non-tariff Barriers
 • Specific Limitations on Trade:
o Quotas - specific quantitative restrictions - much more rigid than tariffs and give
the foreign exporter fewer options. It can accept the limited sales available under the quota,
or it can choose to produce inside the country.
o Import Licensing requirements
o Proportion restrictions of foreign to domestic goods (local content requirements)
o Minimum import price limits
o Embargoes
• Customs and Administrative Entry Procedures:
o Valuation systems
o Antidumping practices
o Tariff classifications
o Documentation requirements
o Fees
• Standards:
o Standard disparities
o Intergovernmental acceptances of testing methods and standards
o Packaging, labeling, marking and safety standards
• Government Participation in Trade:
o Government procurement policies
o Export subsidies
o Countervailing duties
o Domestic assistance programs
• Charges on imports:
o Prior import deposit subsidies
o Administrative fees
o Special supplementary duties
o Import credit discriminations
o Variable levies
o Border taxes
• Others:
o Voluntary export restraints
o Orderly marketing agreements

Monetary Barriers

• This is the most extensive tool of trade regulation because it involves restrictions on
both trade and foreign exchange.
• It is practiced especially by former communist and developing countries.
• The international firm may have difficulty getting exchange to import products and
supplies or components.
• It usually has greater difficulty getting exchange to remit profits. It is tempted to use
transfer pricing to avoid these negative effects.

17. Discuss the role played by the Government of India to promote International Trade.

Why does the government get involved in International business?

There are many reasons and many ways of looking at this.

1. Economic reasons

2. Non-Economic reasons.
 Why are Economic considerations so important? Because the government needs money to pay
for the programs and services that satisfy the population - and who will re-elect the government
when the next election occurs.

Economic Rationales for Governmental Intervention

 unemployment
 protection of infant industry
 using intervention to increase industrialization
 economic relationships with other countries

Non-Economic Rationales for Governmental Intervention

 maintaining essential industries

 "unfriendly" countries
 maintaining spheres of influence
 preserving culture and national identity

Things the government does to intervene

The phrase "Instruments of Trade Control" is popular with IB textbook writers, it is a lot more
simple to say "basic ways gov't controls trade"

 Trade Restrictions / Trade Barriers

o Tariffs
o Non tariff Barriers

– Dumping
– Anti-dumping Tariffs

  example; the EU anti-dumping tariff on Chinese

energy-saving light bulbs
 Countervailing Duties
 (sometimes countervailing duties and anti-dumping tariffs can be the
same thing)
 Subsidies
 aid (loans and grants)
 Quotas - limits by quantity
 VERs - Voluntary Export Restraints
 customs valuation
 "buy national" policies
 standards
 trade sanctions

18. Discuss major criteria to set up a business in another country.

• Examining international geographic strategies is important because companies seldom have

enough resources to take advantage of all opportunities.
• Committing human, technical, and financial resources to one locale may mean forgoing
projects in other areas.
• Because companies’ motives and competencies may differ substantially, what may be a very
attractive country for one company may , at the same time , be unattractive for another.
 A - Choosing Sites for Marketing and Production

• Companies must determine where to market and where to produce.

• Companies also must ascertain where to locate such specialized units as R&D
departments and regional headquarters.
• Market-location and production-location
B - Overall Geographic Strategy

• In essence a company needs to decide where to operate and what portion of operations to
place within each country
II - Scanning for Alternatives

• Scanning is useful because otherwise a company might consider too few or too many
possibilities.
A - Risk of Overlooking Opportunities

• As a company tries to optimize its sales or minimize its costs, it can easily overlook or
disregard some promising options.
• Further, certain locales sometimes are lumped together and rejected before being sufficiently
examined for expansion possibilities.
B - Risk of Examining too Many Opportunities

• A detailed analysis of every alternative might result in maximized sales, but the cost of so
many studies would erode profits
C - The Environmental Climate

• In any company, decision-makers’ perception of the environmental climate , those

external conditions in host countries that could significantly affect the success or failure of a
foreign business enterprise will determine whether a detailed feasibility study will be
undertaken and the terms under which a project will be initiated.
III - Influential Variables: Oppotunities

• Investment decisions are made on the basis of expected opportunities versus

risks. Opportunities, in turn, are determined by revenues less costs.
Examining key variables helps companies:

a) Determine the order of entry

b) Set the rates of resource allocation among Countries

A - Market Size

• Sales potential is probably the most important variable in ascertaining which locations
will be considered and whether an investment will be made
• Indicators of Market Size: GNP, per capita income, growth rates, size of the middle
class, and level of industrialization.
Ex: The triad market of the United States, Japan, and Western Europe accounts for about
half the world’s total consumption, and an even higher proportion of purchases of
computers, consumer electronics, and machine tools.

B - Ease and Compatibility of Operations

• Geographic, Language and Market Similarities

• Companies are highly attracted to countries that are located nearby, share the
same language, and have similar market conditions.
• Fit with Company Capabilities and Policies
• There is the best chance for a proposal to be accepted when a location offers
size, technology and other factor familiar to a company personnel
• Allows ownership
• Impose no restrictions on remittance of profits
C - Costs and Resource Availability

• Costs, especially labor costs are an important factor in the production-location

decision
• Other costs: raw materials, capital, taxes
• Availability of specific skills
• Availability of infrastructure to allow for the efficient movement of supplies
and finished products.
• Availability of banks, universities, insurance groups, public accountants,
customs brokers, etc.
• Product Image also dictate location of investment
• Red Tape
IV - Influential Variables: Risk

A - Risk and Uncertainty

• Should return on investment be calculated on the basis of the entire earnings

of a foreign subsidiary or just on the earnings that can be remitted to the parent?
• Does it make sense to accept a low return in one country if doing so will help
the company’s competitive position elsewhere?
B - Competitive Risk

• A company’s innovative advantage may be short-lived. Even when the

company has a substantial competitive lead time.
• Companies also may develop strategies to find countries in which there is least
likely to be significant competition.
C - Monetary Risk

• If a company’s expansion occurs through direct investment abroad, access to

the invested capital and the exchange rate on its earnings are key considerations.
• Liquidity Preference
D - Political Risk

• A major concern of international companies is that the political climate will

change in such a way that their operating position will deteriorate.
Ex: during the period of apartheid in South Africa, many foreign investors were affected by
boycotts.

Approaches to Predicting Political Risk:

a) Analysis of Past Patterns

b) Opinion Analysis
c) Instability Assessment
V - Business Research
 • Business research is undertaken to reduce uncertainties in the decision
process, to expand or narrow the alternatives under consideration, and to assess the merits of
existing programs.
• How much research: Companies should compare the cost of information with
its value.
• Problems with Data: lack, currency, inaccuracy, data discrepancies
External Sources of Information:

• Country Reports:
– The Economist Intelligence Unit
– Specialized Studies
– Service Companies
– Governmental Agencies
– International Agencies
– Trade Associations
– Information Service Companies
Comparability problems: differences in collection methods, definitions, distortion in
currency conversions.

VI - Tools For Comparing Countries

• Environmental Scanning: systematic assessment of external conditions that

might affect a companies operations.
A - Grids

• A grid may be used to compare countries on whatever factors are deemed

important.
• Both the variables and the weights will vary by product and company.
• Grids rank countries by important variables
B - Opportunity-Risk Matrix

• A company can decide on indicators and weight them, evaluate each country
on the weighted indicators.
• It is up to the company to determine which factors are good indicators of risk
and opportunity, the factors then must weighted to reflected their importance.
• One key ingredient of this matrix: projection of the future country location.
• The matrix is important as a reflection of the placement of a country relative to
other countries.
C - Country Attractiveness – Company Strength Matrix

This matrix highlights the fit of a company’s product to the country.

• Country Factors: market size, growth prospects, price controls, red tape, requirements
for local content and exports, inflation, trade balance, political stability
• Company Strength: market share, market share position, product fit to the country’s
needs, absolute profit per unit, percentage profit on cost, quality of products, fit of the
company’s promotion program to the country in comparison with that of its competitors.
• Problems: a) a company may choose to stay in a market to prevent competitors from
using their dominance there to fund expansion elsesewhere, b) often difficult to separate
the attractiveness of country from a company’s position, and c) some of the recommended
take a defeatist attitude to a company’s competitive position
VII - Diversification Versus Concentration Strategies

Strategies for ultimately reaching a high level of commitment in many countries are:
 Diversification: fast expansion in many markets

Concentration: go to one or a few and build up fast before going to others.

Growth Rate in Each Market: Fast growth favors concentration because companies must use
resources to maintain market share.

Sales Stability in Each Market: The more stable that sales and profits are within a single
market, the less advantage there is from a diversification strategy.

Competitive Lead Time: the first to enter a market often gains advantage in terms of brand
recognition and because it can line up the best suppliers, distributors, and local partners.

Spillover Effects: marketing program in one country results in awareness of the product in
other countries. In this case a diversification strategy has positive impacts.

Need for Product, Communications, and Distribution Adaptation: favors concentration

VIII - Divestment Strategies

Companies must decide how to get out of operations if:

a) They no longer fit the overall strategy

b) There are better alternative opportunities.

19. How will you evaluate the competitive forces in IB?

The Competitive Advantage of Nations

A. Overview

 Porter is a famous Harvard business professor. He conducted a comprehensive study

of 10 nations to learn what leads to success. Recently his company was commissioned to
study Canada in a report called "Canada at the Crossroads".
 Porter believes standard classical theories on comparative advantage are inadequate
(or even wrong).
 According to Porter, a nation attains a competitive advantage if its firms are
competitive. Firms become competitive through innovation. Innovation can include
technical improvements to the product or to the production process.

B. The Diamond - Four Determinants of National Competitive Advantage

 Four attributes of a nation comprise Porter's "Diamond" of national advantage. They

are:

a. factor conditions (i.e. the nation's position in factors of production, such as

skilled labour and infrastructure),
b. demand conditions (i.e. sophisticated customers in home market),
c. related and supporting industries, and
d. firm strategy, structure and rivalry (i.e. conditions for organization of
companies, and the nature of domestic rivalry).

a. Factor Conditions
 Factor conditions refers to inputs used as factors of production - such as labour, land,
natural resources, capital and infrastructure. This sounds similar to standard economic
theory, but Porter argues that the "key" factors of production (or specialized factors) are
created, not inherited. Specialized factors of production are skilled labour, capital and
infrastructure.
 "Non-key" factors or general use factors, such as unskilled labour and raw materials,
can be obtained by any company and, hence, do not generate sustained competitive
advantage. However, specialized factors involve heavy, sustained investment. They are
more difficult to duplicate. This leads to a competitive advantage, because if other firms
cannot easily duplicate these factors, they are valuable.
 Porter argues that a lack of resources often actually helps countries to become
competitive (call it selected factor disadvantage). Abundance generates waste and scarcity
generates an innovative mindset. Such countries are forced to innovate to overcome their
problem of scarce resources. How true is this?

i. Switzerland was the first country to experience labour shortages. They

abandoned labour-intensive watches and concentrated on innovative/high-end watches.
ii. Japan has high priced land and so its factory space is at a premium. This lead
to just-in-time inventory techniques (Japanese firms can’t have a lot of stock taking up
space, so to cope with the potential of not have goods around when they need it, they
innovated traditional inventory techniques).
iii. Sweden has a short building season and high construction costs. These two
things combined created a need for pre-fabricated houses.

b. Demand Conditions

 Porter argues that a sophisticated domestic market is an important element to

producing competitiveness. Firms that face a sophisticated domestic market are likely to sell
superior products because the market demands high quality and a close proximity to such
consumers enables the firm to better understand the needs and desires of the customers (this
same argument can be used to explain the first stage of the IPLC theory when a product is
just initially being developed and after it has been perfected, it doesn’t have to be so close to
the discriminating consumers).
 If the nation’s discriminating values spread to other countries, then the local firms will
be competitive in the global market.
 One example is the French wine industry. The French are sophisticated wine
consumers. These consumers force and help French wineries to produce high quality wines.
Can you think of other examples? Or counter-examples?

c. Related and Supporting Industries

 Porter also argues that a set of strong related and supporting industries is important to
the competitiveness of firms. This includes suppliers and related industries. This usually
occurs at a regional level as opposed to a national level. Examples include Silicon valley in
the U.S., Detroit (for the auto industry) and Italy (leather-shoes-other leather goods
industry).
 The phenomenon of competitors (and upstream and/or downstream industries)
locating in the same area is known as clustering or agglomeration. What are the advantages
and disadvantages of locating within a cluster? Some advantages to locating close to your
rivals may be

i. potential technology knowledge spillovers,

ii. an association of a region on the part of consumers with a product and high
quality and therefore some market power, or
iii. an association of a region on the part of applicable labour force.
  Some disadvantages to locating close to your rivals are

i. potential poaching of your employees by rival companies and

ii. obvious increase in competition possibly decreasing mark-ups.

  d. Firm Strategy, Structure and Rivalry

1. Strategy

(a) Capital Markets

o Domestic capital markets affect the strategy of firms. Some countries’ capital
markets have a long-run outlook, while others have a short-run outlook. Industries
vary in how long the long-run is. Countries with a short-run outlook (like the U.S.)
will tend to be more competitive in industries where investment is short-term (like
the computer industry). Countries with a long run outlook (like Switzerland) will
tend to be more competitive in industries where investment is long term (like the
pharmaceutical industry).
o What about Canada?

(b) Individuals’ Career Choices

o Individuals base their career decisions on opportunities and prestige. A

country will be competitive in an industry whose key personnel hold positions that
are considered prestigious.
o Does this appear to hold in the U.S. and Canada? What are the most
prestigious occupations? What about Asia? What about developing countries?

2. Structure

 Porter argues that the best management styles vary among industries. Some countries
may be oriented toward a particular style of management. Those countries will tend to be
more competitive in industries for which that style of management is suited.
 For example, Germany tends to have hierarchical management structures composed
of managers with strong technical backgrounds and Italy has smaller, family-run firms.

3. Rivalry

 Porter argues that intense competition spurs innovation. Competition is particularly

fierce in Japan, where many companies compete vigorously in most industries.
 International competition is not as intense and motivating. With international
competition, there are enough differences between companies and their environments to
provide handy excuses to managers who were outperformed by their competitors.

C. The Diamond as a System

 The points on the diamond constitute a system and are self-reinforcing.

 Domestic rivalry for final goods stimulates the emergence of an industry that provides
specialized intermediate goods. Keen domestic competition leads to more
sophisticated consumers who come to expect upgrading and innovation. The diamond
promotes clustering.
 Porter provides a somewhat detailed example to illustrate the system. The example is
the ceramic tile industry in Italy.
 Porter emphasizes the role of chance in the model. Random events can either benefit
or harm a firm’s competitive position. These can be anything like major technological
 breakthroughs or inventions, acts of war and destruction, or dramatic shifts in
exchange rates.
 One might wonder how agglomeration becomes self-reinforcing…

1. When there is a large industry presence in an area, it will increase the supply of
specific factors (ie: workers with industry-specific training) since they will tend to get
higher returns and less risk of losing employment.
2. At the same time, upstream firms (ie: those who supply intermediate inputs) will
invest in the area. They will also wish to save on transport costs, tariffs, inter-firm
communication costs, inventories, etc.
3. At the same time, downstream firms (ie: those use our industry’s product as an input)
will also invest in the area. This causes additional savings of the type listed before.
4. Finally, attracted by the good set of specific factors, upstream and downstream firms,
producers in related industries (ie: those who use similar inputs or whose goods are
purchased by the same set of customers) will also invest. This will trigger subsequent
rounds of investment.

D. Implications for Governments

 The government plays an important role in Porter’s diamond model. Like everybody
else, Porter argues that there are some things that governments do that they shouldn't,
and other things that they do not do but should. He says, "Government’s proper role is
as a catalyst and challenger; it is to encourage - or even push - companies to raise
their aspirations and move to higher levels of competitive performance …"
 Governments can influence all four of Porter’s determinants through a variety of
actions such as

a. Subsidies to firms, either directly (money) or indirectly (through

infrastructure).
b. Tax codes applicable to corporation, business or property ownership.
c. Educational policies that affect the skill level of workers.
d. They should focus on specialized factor creation. (How can they do this?)
e. They should enforce tough standards. (This prescription may seem
counterintuitive. What is his rationale? Maybe to establish high technical and
product standards including environmental regulations.)

 The problem, of course, is through these actions, it becomes clear which industries
they are choosing to help innovate. What methods do they use to choose? What
happens if they pick the wrong industries?

E. Criticisms

Although Porter theory is renowned, it has a number of critics.

1. Porter developed this paper based on case studies and these tend to only apply to
developed economies.
2. Porter argues that only outward-FDI is valuable in creating competitive advantage,
and inbound-FDI does not increase domestic competition significantly because the
domestic firms lack the capability to defend their own markets and face a process of
market-share erosion and decline. However, there seems to be little empirical
evidence to support that claim.
3. The Porter model does not adequately address the role of MNCs. There seems to be
ample evidence that the diamond is influenced by factors outside the home country.

 Are Porter’s arguments persuasive? What arguments do you agree with and what
arguments do you find unconvincing?
20. Discuss intellectual property rights for commercialization.