Chapter 1: Introduction to International Business and Trade

Meaning of International Business

• International business consists of transaction that are devised and carried out across national borders to satisfy the objectives of
individuals, companies and organizations.

• The economic system of exchanging good and services, conducted between individuals and businesses in multiple countries.

• The specific entities, such as multinational corporations (MNCs) and international business companies (IBCs), which engage in
business between multiple countries.

Need for International Business

• Causes the flow of ideas, services and capital across the world.
• Offer consumer new choices.
• Permits the acquisition of a wider variety of products.
• Facilitate the mobility of labor, capital and technology.
• Provide the challenging employment opportunities.
• Reallocate resources makes preferential choices and shifts activities to global level.

Types of International Business

• Export –Import trade

• Foreign Direct investment
• Licensing
• Franchising
• Management contract

Franchising refers to the methods of practicing and using another person's business philosophy. The franchisor grants the
independent operator the right to distribute its products, techniques, and trademarks for a percentage of gross monthly sales and a
royalty fee. Various tangibles and intangibles such as national or international advertising, training, and other support services are
commonly made available by the franchisor. Agreements typically last from five to thirty years, with premature cancellations or
terminations of most contracts bearing serious consequences for franchisees.

Businesses for which franchising works best

 Businesses for which franchising is said to work best have the following characteristics:
 Businesses with a good track record of profitability.
 Businesses built around a unique or unusual concept.
 Businesses with broad geographic appeal.
 Businesses which are relatively easy to operate.
 Businesses which are relatively inexpensive to operate.
 Businesses which are easily duplicated.

Licensing

• A business arrangement in which one company gives another company permission to manufacture its product for a specified
payment.

• There are few faster or more profitable ways to grow your business than by licensing patents, trademarks, copyrights, designs, and
other intellectual property to others .

Management contracts

• Agreement between investors or owners of a project, and a management company hired for coordinating and overseeing a
contract. It spells out the conditions and duration of the agreement, and the method of computing management fees.

• An agreement by which a company will provide its organizational and management expertise in the form of services.

FDI and FII

 FDI stands for Foreign Direct Investment, a component of a country's national financial accounts. Foreign direct
investment is investment of foreign assets into domestic structures, equipment, and organizations. It does not include
foreign investment into the stock markets. Foreign direct investment is thought to be more useful to a country than
investments in the equity of its companies because equity investments are potentially "hot money" which can leave at the
first sign of trouble, whereas FDI is durable and generally useful whether things go well or badly.

 FII The term is used most commonly in India to refer to outside companies investing in the financial markets of India.
International institutional investors must register with the Securities and Exchange Board of India to participate in the
market. One of the major market regulations pertaining to FIIs involves placing limits on FII ownership in Indian
companies

Drivers of International business

1. Regional developments helping internationalization:

a. Emergence of NAFTA comprising united states, Canada and Mexico has created a huge north American
market. Movement of goods and services among these countries is easy as all trade barriers have been
removed. The result will be a giant “American market” that would parallel similar development in Asia and
Europe.
Chapter 1: Introduction to International Business and Trade

b. The most recent changes of GAAT are stimulating increased world trade. Under the new agreement, tariffs
would be reduced world wide by 38%and in some cases, eliminated completely.
c. Japan, of late has invested relatively more in Asia than in any part of the world. Japanese corporations want
to take advantage of the underdeveloped but growing Asian market.
d. Export potential is vast in central and eastern Europe, Russia which are converting themselves into market
economies.
e. There is also recent economic progress among less developed economies. For example India Globalization
and liberalization approach toward economy
f. The new economy, a characteristic feature of the present century, itself demands trading across the globe.

International Investment and Trade

• Developed countries are active players in international investment. Approx. 80% of the global investment emanate from rich
countries. For example FDI in the US stands at over $600 billion, while the US FDI is almost $ 800 billion.

• The developed and developing countries are the major recipient of FDI

Other reasons of Internationalization

• There is a lot of money in the overseas market. The MNCs from the triadthe US, Europe and Japan – have huge assets than a
quarter of these assets are found in foreign market. GE of the US is one of the top MNC with assets of over $ 300 billion in 1997 and
nearly a third of its assets were found in overseas countries. The Dutch /UK firm shell has huge assets and three fifth of these are
located overseas.

• It is being realized that the domestic markets are no longer adequate and rich. Japan flooded American with automobiles and
electronics because domestic market was not large enough to absorb whatever was produced.

• Companies often set up overseas plant to reduce high transportation cost. The higher the ratio of unit cost to the selling price per
unit, the more significant the transportation factor becomes.

• The motivation to go global in high tech industries is slightly different. They spend lot on research and development for new
products. If domestic sales and export do not generate sufficient cash flow, the company naturally might look to overseas
manufacturing plants and sales branches to generate higher sales and better cash flow.

• Firms go global to access resources that are unavailable or more expensive at home ( Japan largest paper company Nippon
Seishi, needs to do more than import of wood pulp. It owns huge forests and processing facilities in Australia, Canada and US.

• Labor market also attract companies into international business. One way companies gain competitive advantage is by locating
production facilities in low cost countries.

• Firms go global to avoid protectionist barrier imposed by local government. Government erect various forms of barriers to entry in
their domestic markets by foreign firms

• Companies enter foreign markets because competitors have already done it.

• Govt. throughout the world offer a variety of incentives to attract MNCs

International Vs. Domestic Business

Basis International Business Domestic

Payment Mostly in foreign currency Domestic Currency
Laws and rules Subject to international laws and Subject to national rules and regulations
regulations
Custom & Tradition s Different custom and traditions Same custom & Traditions
Legal and economic system Have to face different legal economic It is almost the same.
and tax rate system
Approach Have to follow geocentric approach Have to follow ethnocentric approach

Globalization refers to the shift towards a more integrated and independent world economy. Globalization has several facets,
including the globalization of markets and the globalization of production.

a. 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 have made it easier to sell internationally.

It has been argued for some time that the taste and preferences of customers in different nations are beginning to
converge on some global norm, thereby helping to create a global market.

For example consumer products such as cocacola soft drink, Sony play station videogame, McDonald hamburger are
frequently held up as prototypical example of this trend. Sony, McDonald, coca-cola are more than just benefactors of this
trend: they are also facilitator of this trend. By offering the same basic product world wide they help to create a global
market.

b. Globalization of production refers to the sourcing of goods and services from locations around the globe to take the
advantage of national difference in the cost and quality of factor of production. 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.
• For example- IBM ThinkPad X31 laptop computer. The product was designed in the united states by IBM engineers
because IBM believed that was the best location in the world to do the design work. The case keyboard and hard drive
were made in Thailand, display screen and memory were in south Korea, the built in wireless card in Malaysia, and the
microprocessor was manufactured in US. In each these components were manufactured in the optimal location given an
assessment of production cost and transportation cost.
Chapter 1: Introduction to International Business and Trade

Emergence of Global Institutions

• As markets globalize and as increasing proportion of business activity transcends national border, institutions are needed to help
manage regulate and police the global market place and to promote the establishment of multinational treaties to govern the global
business system.

• The world trade organization is primarily responsible for policing the world trading system and making sure nation-states adhere to
the rules laid down in trade treaties signed by WTO members.

• WTO has promoted the lowering the barriers to cross border trade and investment. Without an institution such as WTO the
globalization of market and production is unlikely to have proceeded as far as it has.

IMF and World Bank

• The task of IMF is to maintain order in the international monetary system and that of the worldbank is to promote economic
development. It has focused n making low interest loan to cash strapped governments in poor nations that wish to undertake
significant infrastructure investment.

• IMF is often seen as the lender of last resort to nation states whose economies are in turmoil and currencies are losing value
against those of other nations.

• The IMF loan come with strings attached; in return for loans, the IMF requires nation-states to adopt specific economic policies
aimed at returning their troubled economies to stability and growth.

Drivers of Globalization

Two macro factors seem to underlie the trend toward greater globalization:

• Decline in barriers to the free flow of goods and services and capital.

• Technological change

Declining Trade and Investment Barriers

 After the formation of WTO, many talks were scheduled to cutting tariffs on industrial goods, services and agricultural
products, phasing out subsidies to agricultural producers; reducing barriers to cross border investment and limiting the
use of antidumping laws.
 Many countries have also been progressively removing restrictions to FDI . According the UN some 94% of the 1885
changes made worldwide between 1991 and 2003 in the laws governing FDI created a more favorable environment

c. Globalization of investment refers to investment of capital by global company in any part of the world. Global company
conducts the financial feasibility of the new projects in different companies of the world and invests the capital in that
country where it is relatively more profitable. Globalization of investment is also known as foreign direct investment.

Reasons for Globalization of investment :

• There has been a rapid increase in the volume of global trade.
• Many countries are providing more congenial environment for attracting direct investment.
• Global co in order to have the control over manufacturing and marketing activities invest in foreign countries.
• International co go for FDI in order to avoid the restrictions imposed by the host country on exports.
• After liberalization, the flow of foreign fund cross the border by various countries.

Modes of Globalization of Investment

• Acquisition of foreign companies

• Joint ventures
• Long term loans
• Issuing equity shares, debentures and bonds.
• Global depositary receipts etc.

d. Globalization of Technology

• Technological change is amazing and phenomenal after 1950. In fact it is like a revolution in case of telecommunication,
information technology and transportation technology.

Methods of Globalization technology:

• Companies with latest technology acquire distinctive competencies and gain the advantage of producing high quality
products at low cost
• Co may have technological collaboration with the foreign co through which technology spreads from one to another
country.
• The foreign co allow the companies of various other countries to adopt their technology on royalty payment basis.
• Companies also globalize the technology through the modes of joint ventures and mergers.

Advantages of Globalization
• Free flow of capital
• Free flow of technology
• Increase in industrialization
• Spread up of production facilities throughout the globe
• Balanced development of world economies.
• Increase in production and consumption
• Lower prices with high quality
• Cultural exchange and demand for a variety of products.
Chapter 1: Introduction to International Business and Trade

• Increase in employment and income

• Higher standard of living
• Balanced human development
• Increase in welfare and prosperity.

Disadvantages of Globalization
• It kills domestic business
• Exploits human resources
• Violation of labor and environmental laws
• Leads to unemployment
• Decline in domestic demand
• Decline in income
• Widening the Gap between rich and poor
• Transfer of natural resources
• Leads to commercial and political colonialism
• National sovereignty at stake

STAGES IN GLOBALISATION
• Domestic company links with dealer & distributor.
• Company does the activities on its own. Company begins to carryout its own manufacturing , marketing & sales in the foreign
markets.
• Company starts full fledged operations including business systems and R&D. At this stage the managers are expected to perform
the tasks which they were doing in domestic markets to replicate them in foreign markets.

Approaches to international Business

The various approaches to international business are:
a. Ethnocentric Approach:
- a company operating its business activities in domestic market may enter into the foreign market without any
change in its marketing strategies.
- The excessive production more than the demand for product may compel the co to sell the product in the foreign
market.
- The domestic co continues export to the foreign country and views the foreign market as an extension to the
domestic market just like a new region.
- The top mgt of the company makes the decision relating to export and the marketing personnel of the company
monitor the export operations with the help of export department. Such approach of international business is called
ethnocentric approach.
b. Polycentric Approach
- Refers to the different approaches of marketing in different countries. When a company has entered into the foreign
market and feels that its ethnocentric approach is not effective to influence the consumers of the other countries,
then it is essential to make required changes in the marketing mix. Instead of depending on centralized policies, the
company establishes a subsidiary unit in the foreign country and decentralize all the operations and delegates
decision making authority to its executives. The parent co appoints the required staff in the foreign subsidiary. The co
appoint key personnel from the host country and other staff from the host country. The staff members in consultation
with the MD takes necessary marketing decisions according to the market requirement of the host country.
c. Regiocentric Approach
- A co managing its business at international level has successfully established in a foreign country while it is using
polycentric approach and feels that regional environment of the neighbouring countries is much similar to that of the
host country, the co may start exporting product to the neighbour countries. This approach is known as the
regiocentric approach.
- As for example a Japan based co has successfully established in India. This practice will certainly be considered as
the regiocentric approach though the co market more or less the same product, designed under the polycentric
approach, in other countries of the region, the marketing strategies may be different for the neighbouring countries.
d. Geocentric Approach
- A company using the geocentric approach considers the whole world as a single country. The employees are
selected in different countries. The headquarter coordinates the activities of each subsidiary which function like an
independent and autonomous co in carrying out managerial practices like strategy formulation, product design HR
policy formulation etc.

FDI
• The investment made by a Company in new manufacturing and or marketing facilities in a foreign country is referred to as FDI.
Investment made by Enron in power plant in India is an example of FDI.
• The total investment made by company in foreign country up to given time is called “ The stock of foreign direct investment”
• US government statistics defines FDI as “ ownership or control of 10% or more of an enterprise’s voting securities or the
equivalent interest in an unincorporated US business”
• Generally it is stipulated that ownership of a minimum of 10- 25% of the voting share in a foreign co allows the investment to be
considered direct.

Forms of FDI
• Purchase of existing assets in a foreign country.
• New investment in property
• Participation in joint venture with a local partner.
• Transfer of many assets like human resource, system, technology
• Exports of goods for equity

Factors influencing FDI

Supply factors: production cost

• Logistics
• Resource availability
Chapter 1: Introduction to International Business and Trade

• Access to technology

Demand factor: customer access

• Marketing advantages
• Exploitation of competitive advantages
• Customer mobility

Political factor : avoidance of trade barriers

• Economic development incentives

Reasons for FDI

• To increase sales and profits( Toyota, Suzuki in US
• To enter fast growing markets (IBM in Japanese laptop market 40%)
• To reduce costs (US firms in India)
• To consolidate trade blocs (to access wider market)
• To protect domestic market
• To protect foreign market (British petroleum in USA)
• To acquire technological and managerial know how. ( US co Kodak invested in Japan to acquire technology)

Benefits of FDI

• Benefits to Home Country: inflow of foreign currencies in the form of dividend interest. Nissan’s profit repatriated to Japan are from
FDI in the UK. It helped Japan for positive BOP.
• FDI increases export of machinery, equipments, technology from the home country to the host country. This enhances the
industrial activity of home country.
• The increased industrial activity in the home country enhances employment opportunities.
• The firm and other home country firms can learn skills from its exposure to the host country and transfer those skills to the industry
in the home country

Costs to Home Country

• Home country’s industry and employment position are at stake when the firms enter foreign market due to low cost labor. The US
textiles moved to central America. This resulted in retrenchment in the USA.
• Current account position of the home country suffers as FDI is a substitute for direct exports.

Benefits to host country

• Resource transfer effects
• Employment effect
• Balance of payment effect

Costs to Host country: intensifying competition

• Negative effect on balance of payment:
• Company may repatriate their dividend to home country.
• Imports the goods from its subsidiary
• National sovereignty and autonomy

Theories of International Trade

a. Mercantilism is the oldest international trade theory that formed the foundation of economic thought during about 1500 to
1800.
o According to this theory the holding of a country’s treasure primarily in the form of gold constituted its wealth. The
theory specifies that countries should export more than they import and receive the value of trade surplus in the form
of gold from those countries which experience trade deficit.
o GOVT. imposed restriction on imports and encouraged exports in order to prevent trade deficit and experience trade
surplus.
o Colonial powers like the British used to trade with their colonies like India, Srilanka etc. by importing the raw material
from and exporting the finished goods to colonies.
o The colonies had to export less valued goods and import more valued goods. Thus colonies were prevented from
manufacturing.
o This practice allowed the colonial power to enjoy trade surplus and forced the colonies to experience deficit.
o The mercantilism theory suggests for maintaining favorable balance of trade in the form of import of gold for export
of goods and services. But the decay of gold standard reduced the validity of theory. Consequently this theory was
modified in neo mercantilism.
o Neo mercantilism proposes that countries attempt to produce more than the demand in the domestic market in order
to achieve a social objective like full employment in the domestic country or a potential objective like assisting a
friendly country.
o The theory was criticized on the ground that the wealth of nation is based on its available goods and services rather
than gold.
o Adam smith developed the theory of absolute cost advantage which says that different countries can get the
advantage of international trade by producing certain goods more efficiently than others .

b. Absolute Cost Advantage Theory

o Adam smith, the Scottish economist viewed free trade enables to country to produce a variety of goods and services.
Smith proposes the theory of absolute cost advantage theory of international trade based on the principle of division of
labor.
o According to theory the principle of absolute cost advantage will help the countries to specialize in the production of
those goods in which they have cost advantage over others.
o According to theory every country should specialize in producing those products at the cost less than that of other
countries.
Chapter 1: Introduction to International Business and Trade

o Trade between two countries takes place when one country produces one product at less cost than that of another
country and having a cost advantage and vice versa.

Skilled advantage and specialization advantage

• Countries have absolute cost advantage due to:
• Economies of scale
• Suitability of the skill of the labor of the country in producing certain products.
• Specialization of labor in producing certain products leads to higher productivity and less labor cost per unit of output.
• Natural Advantage natural advantage is due to climatic conditions and natural resources.
• Acquired Advantage acquired advantage is due to technology and skill development.

Assumption of the theory

• Trade is between two countries only
• Only two commodities are traded
• Free trade exists between the countries
• The only element cost of production is labor

Criticism of the theory

• No absolute advantage
• Country size
• Variety of resources
• Transport cost
• Scale economies
• Absolute advantage for many products

c. Comparative Cost Theory

• The comparative cost theory was first systematically formulated by the English economist David Ricardo in the principle
of political economy and taxation in 1817. it was later refined by J.S.Mill, Marshall, Taussig and others.
• In a Nutshell the doctrine of comparative cost maintains that if trade if left free, each country in the long run tends to
specialize in the production and export of those commodities in whose production it enjoys a comparative advantage in
terms of real cost and to obtain by import those commodities which could be produced at home at a comparative
disadvantage in terms of real cost and that such specialization is to the mutual advantage of the countries participating in
it.
Assumptions
• Labor is only element of cost of production.
• Goods are exchanged against one another according to the relative amount of labor embodied in them.
• Labor is perfectly mobile within the country not outside.
• Labor is homogeneous
• Production is subject to the law of constant return.
• Free trade and no trade barriers.
• No transportation cost
• There is full employment
• There is perfect competition
• There are only two commodities and two countries.

Explanation
• The law of comparative advantage indicates that a commodity should specialize in the production of those goods in
which it is more efficient and leave the production of the other commodity to the other country. The two countries will
then have more of both goods by engaging in trade.
• Ricardo in his two country two commodity model has taken the hypothetical example of production costs of cloth
and wine in England and Portugal to illustrate the comparative cost theory.

Implications of the theory

• Efficient allocation of global resources
• Maximization of global production at the least possible cost
• Product prices become more or less equal among world market
• Demand for resources and products among world nations will be maximized
• It is better for the countries to specialize in those products which they relatively do best and export them
• It is better for the countries to buy other goods from other countries who are relatively better at producing them

Comparative cost theory is really an improvement over absolute cost advantage. This theory is not only an extension
to the principle of division of labor and specialization but applies the opportunity cost concept. It is also argued that
lower labor cost need not be a source of comparative advantage.
• However Ricardo fails to consider the money value of cost of production.
• F.W.Taussig bridged this gap in comparative cost advantage theory.

Criticism of theory
• Two countries
• Transportation cost
• Two products
• Full employment
• Economic efficiency
• Division of gains
• Mobility services

d. Product life cycle theory

• Raymond Vermon of the Harvard Business school developed the Product Life cycle theory. International product life
cycle theory traces the roles of innovation market expansion comparative advantage and strategic response of global
rivals in international manufacturing trade and investment decision.
Chapter 1: Introduction to International Business and Trade

• International product life cycle consists of four stages:

• New product innovation
• Growth
• Maturing stage
• decline

Basis Introduction Growth Maturity Decline

Product location In innovating (usually In innovating and Multiple countries Mainly in LDCs
industrial country other industrial
countries
Market Location In country with some Industrial country Growth in LDCs Mainly in LDCs
exports
Shift in export Some decrease in Some LDCs exports
markets as foreign industrial countries
production replaces
export in some
countries
Competitive factor Near monopoly Fast growing Overall stabilized Overall declining
situation demand demand
No of competitors
Sale based on No of competitors decreases Price is key weapon
uniqueness rather increases
than price Price is very No of producers
Price cutting by important continues to decline
Evolving product competitors Product
characteristics become more
standardized
Production Short production run Capital input Long production runs Unskilled labor on
technology increases using high capital mechanized long
Evolving methods to inputs production runs
coincide with product Methods more
evolution standardized Highly standardized

High labor and labor Less skilled labor

skill relative to capital needed
input

Explanation

• Introduction stage: firms innovate new products based on needs and problems in domestic country.

• Growth: attracting competitors

- Increased competitor
- Further innovation
- Shift manufacturing to foreign countries

• Maturity : standard product

- Large scale production and economies
- Low unit cost of production
- Shift manufacturing to developing countries

• Decline: location of manufacturing facilities in developing countries

- Original innovating country becomes net importer.

Limitations of Theory :
• Production facilities do not move to foreign countries to achieve cost reduction due to short product life cycle consequent upon
very rapid innovation.
• Cost reduction has a little concern to the consumer in case of luxury products.
• Export may not be in significant volume where cost of transportation is very low.
• Non cost strategies like advertising may nullify the opportunity to move to foreign countries for cost minimization.
• Requirement of specialized knowledge and expertise reduce the chances of locating production facilities in foreign countries.
• The rapid development may not shift the production to various foreign countries.

e. Global Strategic Rivalry Theory

• International trade takes place between/among companies based on relative competitive advantage but not countries
competitive advantage.
• Companies acquire and develop competitive advantage through a number of means:
• Owing intellectual property rights
• Investing in research and development
• Achieving large scale economies
• Exploiting the experience curve.

f. Porter’s National Competitive Advantage Theory

• Companies get competitive advantage or superiority from:
• Demand conditions
• Factor endowment
• Related and support industries
• Firm strategy, structure and rivalry